**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

| **ý**                                              |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**  |
|---------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|
|                                                    |   |                                                                                                |
| **Commission File Number 001-31333**                    |
|                                                    |   |                                                                                                |
| **For the quarterly period ended March 31,  2003**      |
|                                                    |   |                                                                                                |
| **or**                                                  |
|                                                    |   |                                                                                                |
| **o**                                                   |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                                    |   |                                                                                                |
| **Eon Labs, Inc.**                                 |
| (Exact name of registrant as specified in  its charter) |

 
| **Delaware**                                               |   | **13-3653818**                       |
|------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of incorporation)             |   | (I.R.S. Employer Identification No.) |
|                                                       |   |                                 |
| **227-15 North Conduit Avenue   Laurelton, New York**      |   | **11413**                            |
| (Address of principal executive offices)                   |   | (Zip Code)                           |
|                                                       |   |                                 |
| **(718) 276-8600**                                         |
| (Registrant’s telephone number, including  area code) |

 

Indicate bycheck mark whether the Registrant (1) has filed all reports required bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days: Yes   ý         No  o

 

As of May 2, 2003, there were 44,199,048 shares of the Registrant’sCommon Stock, $0.01 par value per share, outstanding.

 

 

----

 

**Table of Contents**
|       |   |                                                                                                                       |   |
|------------|--------|----------------------------------------------------------------------------------------------------------------------------|--------|
| PART I.    |   | FINANCIAL INFORMATION                                                                                                      |   |
|       |   |                                                                                                                       |   |
| ITEM 1.    |   | Financial Statements                                                                                                       |   |
|       |   |                                                                                                                       |   |
|       |   | Condensed Consolidated Balance Sheets as of  March 31, 2003 (unaudited) and December 31, 2002                              | 1      |
|       |   |                                                                                                                       |   |
|       |   | Condensed Consolidated Statements of Income  (unaudited) for the Three Months Ended March 31, 2003 and March 31, 2002      | 2      |
|       |   |                                                                                                                       |   |
|       |   | Condensed Consolidated Statements of Cash  Flows (unaudited) for the Three Months Ended March 31, 2003 and March 31,  2002 | 3      |
|       |   |                                                                                                                       |   |
|       |   | Notes to Condensed Consolidated Financial  Statements (unaudited)                                                          | 4      |
|       |   |                                                                                                                       |   |
| ITEM 2.    |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                | 13     |
|       |   |                                                                                                                       |   |
| ITEM 3.    |   | Quantitative  and Qualitative Disclosure about Market Risk                                                                 | 17     |
|       |   |                                                                                                                       |   |
| ITEM 4.    |   | Controls and Procedures                                                                                                    |   |
|       |   |                                                                                                                       | 17     |
| PART  II.  |   | OTHER  INFORMATION                                                                                                         |   |
|       |   |                                                                                                                       |   |
| ITEM 2.    |   | Changes in Securities and Use of Proceeds                                                                                  | 19     |
|       |   |                                                                                                                       |   |
| ITEM 6.    |   | Exhibits and Reports on Form 8-K                                                                                           | 20     |
|       |   |                                                                                                                       |   |
| SIGNATURES | 21     |

 
|               |                                                                                                                    |   |
|--------------------|-------------------------------------------------------------------------------------------------------------------------|--------|
| EXHIBIT  99.1 | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 |
|               |                                                                                                                    |   |
| EXHIBIT  99.2 | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

i

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**Eon Labs, Inc. andSubsidiaries**

**Condensed Consolidated Balance Sheets**

(dollarsin thousands, except per share amounts) 

 
|                                                                                                                                                                                   |   | **March 31,  2003** |    | **December  31,  2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|-------------------------|--------|
|                                                                                                                                                                                   |   | **(Unaudited)**     |    |                    |   |
| **Assets**                                                                                                                                                                             |   |                |    |                    |   |
|                                                                                                                                                                                   |   |                |    |                    |   |
| **Current assets**                                                                                                                                                                     |   |                |    |                    |   |
| Cash and cash equivalents                                                                                                                                                              |   | $                   | 72,479  |                    | $      | 62,323 |   |
| Investments                                                                                                                                                                            |   | 29,417              |    | 24,961                  |   |
| Accounts receivable, net                                                                                                                                                               |   | 22,739              |    | 23,822                  |   |
| Inventories                                                                                                                                                                            |   | 51,081              |    | 41,946                  |   |
| Deferred tax assets, net                                                                                                                                                               |   | 43,204              |    | 43,648                  |   |
| Prepaid expenses and other current assets                                                                                                                                              |   | 8,102               |    | 10,402                  |   |
| Due from related party                                                                                                                                                                 |   | 81                  |    | 280                     |   |
|                                                                                                                                                                                   |   |                |    |                    |   |
| **Total current assets**                                                                                                                                                               |   | 227,103             |    | 207,382                 |   |
|                                                                                                                                                                                   |   |                |    |                    |   |
| Property, plant and equipment, net                                                                                                                                                     |   | 43,724              |    | 42,788                  |   |
| Goodwill and other intangible assets, net                                                                                                                                              |   | 75,760              |    | 76,701                  |   |
| Other assets                                                                                                                                                                           |   | 3,184               |    | 3,000                   |   |
|                                                                                                                                                                                   |   |                |    |                    |   |
| **Total assets**                                                                                                                                                                       |   | $                   | 349,771 |                    | $      | 329,871 |   |
|                                                                                                                                                                                   |   |                |    |                    |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                          |   |                |    |                    |   |
|                                                                                                                                                                                   |   |                |    |                    |   |
| **Current liabilities**                                                                                                                                                                |   |                |    |                    |   |
| Accounts payable                                                                                                                                                                       |   | $                   | 13,693  |                    | $      | 10,974 |   |
| Accrued liabilities                                                                                                                                                                    |   | 54,772              |    | 48,785                  |   |
| Current portion of note payable                                                                                                                                                        |   | —              |    | 4,530                   |   |
|                                                                                                                                                                                   |   |                |    |                    |   |
| **Total current liabilities**                                                                                                                                                          |   | 68,465              |    | 64,289                  |   |
|                                                                                                                                                                                   |   |                |    |                    |   |
| **Long-term liabilities**                                                                                                                                                              |   |                |    |                    |   |
| Deferred tax liabilities, net                                                                                                                                                          |   | 6,998               |    | 6,998                   |   |
| Deferred revenue                                                                                                                                                                       |   | 372                 |    | 430                     |   |
|                                                                                                                                                                                   |   |                |    |                    |   |
| **Total****liabilities**                                                                                                                                                               |   | 75,835              |    | 71,717                  |   |
|                                                                                                                                                                                   |   |                |    |                    |   |
| Contingencies (Notes 8 and 9)                                                                                                                                                          |   |                |    |                    |   |
|                                                                                                                                                                                   |   |                |    |                    |   |
| **Stockholders’ equity**                                                                                                                                                          |   |                |    |                    |   |
|                                                                                                                                                                                   |   |                |    |                    |   |
| Common stock, par value $.01 per share;  70,000,000 shares authorized; shares issued and outstanding 44,177,612 and  44,077,282 at March 31, 2003, and December 31, 2002, respectively |   | 442                 |    | 441                     |   |
| Preferred stock, par value $.01 per share;  5,000,000 shares authorized and no shares issued or outstanding at March 31,  2003 and December 31, 2002                                   |   | —              |    | —                  |   |
| Additional paid-in capital                                                                                                                                                             |   | 193,238             |    | 192,662                 |   |
| Retained earnings                                                                                                                                                                      |   | 80,746              |    | 65,639                  |   |
| Accumulated other comprehensive income                                                                                                                                                 |   | 30                  |    | 44                      |   |
|                                                                                                                                                                                   |   | 274,456             |    | 258,786                 |   |
| Less: Unearned deferred stock-based  compensation                                                                                                                                      |   | (520                | )       | (632                    | )      |
| **Total stockholders’  equity**                                                                                                                                                   |   | 273,936             |    | 258,154                 |   |
| **Total liabilities  and stockholders’ equity**                                                                                                                                   |   | $                   | 349,771 |                    | $      | 329,871 |   |

* *

*The accompanying notes are an integral part of thesecondensed consolidated financial statements.*

 

1

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**Eon Labs, Inc. andSubsidiaries**

**Condensed Consolidated Statements of Income**

(dollarsin thousands, except per share amounts) (unaudited)

 
|                                                |   | **For the three months ended   March 31,** |   |
|-----------------------------------------------------|--------|--------------------------------------------|--------|
|                                                |   | **2003**                                   |   | **2002** |   |
| Net sales                                           |   | $                                          | 70,857 |   | $ | 48,198 |   |
| Cost of sales                                       |   | 32,445                                     |   | 24,985 |   |
|                                                |   |                                       |   |   |   |
| **Gross profit**                                    |   | 38,412                                     |   | 23,213 |   |
|                                                |   |                                       |   |   |   |
| Operating expenses                                  |   |                                       |   |   |   |
| Selling, general and administrative  expenses:      |   |                                       |   |   |   |
| Amortization of other intangible assets             |   | 940                                        |   | 940 |   |
| Other selling, general and administrative  expenses |   | 8,737                                      |   | 6,153 |   |
| Research and development expenses                   |   | 3,642                                      |   | 3,281 |   |
|                                                |   |                                       |   |   |   |
| **Total operating  expenses**                       |   | 13,319                                     |   | 10,374 |   |
|                                                |   |                                       |   |   |   |
| **Operating income**                                |   | 25,093                                     |   | 12,839 |   |
|                                                |   |                                       |   |   |   |
| Other income (expense), net                         |   |                                       |   |   |   |
| Interest income                                     |   | 331                                        |   | 40 |   |
| Interest expense                                    |   | (284                                       | )      | (2,113 | ) |
| Other income, net                                   |   | 37                                         |   | — |   |
|                                                |   |                                       |   |   |   |
| **Total other income  (expense), net**              |   | 84                                         |   | (2,073 | ) |
|                                                |   |                                       |   |   |   |
| Income before income taxes                          |   | 25,177                                     |   | 10,766 |   |
|                                                |   |                                       |   |   |   |
| Provision for income taxes                          |   | (10,070                                    | )      | (4,420 | ) |
|                                                |   |                                       |   |   |   |
| **Net income**                                      |   | $                                          | 15,107 |   | $ | 6,346 |   |
|                                                |   |                                       |   |   |   |
| Net income per common share                         |   |                                       |   |   |   |
| Basic                                               |   | $                                          | 0.34   |   | $ | — |   |
| Diluted                                             |   | $                                          | 0.33   |   | $ | 0.19 |   |
|                                                |   |                                       |   |   |   |
| Weighted average common shares outstanding          |   |                                       |   |   |   |
| Basic                                               |   | 44,113,516                                 |   | — |   |
| Diluted                                             |   | 45,214,718                                 |   | 33,481,332 |   |

* *

*The accompanying notes are an integral part of thesecondensed consolidated financial statements.*

 

2

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**Eon Labs, Inc. andSubsidiaries**

**Condensed Consolidated Statements of CashFlows**

(dollarsin thousands) (unaudited)

 
|                                                                               |   | **For  the three months ended   March 31,** |   |
|------------------------------------------------------------------------------------|--------|---------------------------------------------|--------|
|                                                                               |   | **2003**                                    |   | **2002** |   |
| **Cash flows from operating  activities**                                          |   |                                        |   |   |   |
| Net income                                                                         |   | $                                           | 15,107 |   | $ | 6,346 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |   |                                        |   |   |   |
| Provision for accounts receivable allowances                                       |   | 14,199                                      |   | 18,401 |   |
| Depreciation and amortization                                                      |   | 2,146                                       |   | 1,902 |   |
| Deferred compensation                                                              |   | 112                                         |   | 290 |   |
| Amortization of deferred revenue                                                   |   | (58                                         | )      | (57 | ) |
| Amortization of discount on note payable                                           |   | 269                                         |   | 519 |   |
| Interest paid in-kind                                                              |   | —                                      |   | 1,468 |   |
| Tax benefit from exercises of stock options                                        |   | 887                                         |   | — |   |
| Changes in assets and liabilities:                                                 |   |                                        |   |   |   |
| Accounts receivable                                                                |   | (13,116                                     | )      | (26,746 | ) |
| Inventories                                                                        |   | (9,135                                      | )      | (1,097 | ) |
| Prepaid expenses and other current assets                                          |   | 2,283                                       |   | (2,272 | ) |
| Other assets                                                                       |   | (184                                        | )      | (335 | ) |
| Accounts payable                                                                   |   | 2,719                                       |   | (798 | ) |
| Accrued liabilities                                                                |   | 5,859                                       |   | 1,768 |   |
| **Net cash  provided by (used in) operating activities**                      |   | 21,088                                      |   | (611 | ) |
|                                                                               |   |                                        |   |   |   |
| **Cash flows from investing  activities**                                          |   |                                        |   |   |   |
| Capital expenditures                                                               |   | (2,141                                      | )      | (1,798 | ) |
| Purchases of short-term investments                                                |   | (4,480                                      | )      | — |   |
| **Net cash used in investing  activities**                                         |   | (6,621                                      | )      | (1,798 | ) |
|                                                                               |   |                                        |   |   |   |
| **Cash flows from financing  activities**                                          |   |                                        |   |   |   |
| Payment on seller note                                                             |   | (4,799                                      | )      | (15,201 | ) |
| Proceeds from revolving line of credit                                             |   | —                                      |   | 10,000 |   |
| Advances from related parties, net                                                 |   | 337                                         |   | 668 |   |
| Decrease in restricted cash                                                        |   | 17                                          |   | 67 |   |
| Proceeds from exercises of stock options                                           |   | 134                                         |   | — |   |
| **Net cash used in financing  activities**                                         |   | (4,311                                      | )      | (4,466 | ) |
|                                                                               |   |                                        |   |   |   |
| **Net increase (decrease) in cash  and cash equivalents**                          |   | 10,156                                      |   | (6,875 | ) |
|                                                                               |   |                                        |   |   |   |
| Cash and cash equivalents at beginning of period                                   |   | 62,323                                      |   | 17,624 |   |
|                                                                               |   |                                        |   |   |   |
| Cash and cash equivalents at end of period                                         |   | $                                           | 72,479 |   | $ | 10,749 |   |

* *

*The accompanying notes are an integral part of thesecondensed consolidated financial statements.*

 

3

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**Eon Labs, Inc. andSubsidiaries**

**Notes to Condensed Consolidated FinancialStatements**

(dollarsin thousands, except per share amounts)

 

**1. Basis of Presentation**

 

The condensed consolidated financial statements included herein havebeen prepared by Eon Labs, Inc. (the “Company”) without audit pursuant to therules and regulations of the United States Securities and ExchangeCommission.  Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with generally acceptedaccounting principles have been condensed or omitted pursuant to such rules andregulations.  In the opinion of management, the accompanying unauditedcondensed consolidated financial statements reflect all adjustments (consistingonly of normal recurring accruals) necessary for a fair presentation of thefinancial position as of March 31, 2003 and results of operations and cashflows for the periods presented.  The consolidated balances as of December 31,2002 were derived from audited financial statements but do not include alldisclosures required by generally accepted accounting principles.  Theaccompanying condensed consolidated financial statements have been prepared inaccordance with accounting standards for interim financial statements andshould be read in conjunction with the Company’s audited consolidated financialstatements and the notes thereto for the year ended December 31,2002.  The results of operations for the interim periods are notnecessarily indicative of the results of operations to be expected for theyear.

 

***Change of CompanyOwnership and Reorganization***

 

Prior to the reorganization described below, HexalPharmaceuticals, Inc. (“HPI”), a wholly-owned United States subsidiary ofSanto Holding (Deutschland) GmbH, which is under common control with Hexal AG,owned 50% of the outstanding capital stock of the Company.  HPI also owned 100% of EonHoldings, Inc. (“EHI”), whose principal asset was the remaining 50%ownership of the Company.

 

Effective May 22, 2002, in conjunction with the initial public offeringof the Company’s common stock, the Company was combined with HPI and EHI into asingle entity through a series of reorganization mergers.  EHI was merged with and into HPI and HPI wassubsequently merged with and into the Company. This reorganization was accounted for as a merger of entities undercommon control and the accounts of the companies were combined in a mannersimilar to a pooling of interests effective January 1, 2000.  The condensed consolidated financialstatements for the three months ended March 31, 2002 reflect results on acombined basis.

* *

***Revenue Recognition***

 

Sales are recognized when the products are received by the customer,which represents the point when the risks and rewards of ownership aretransferred to the customer.  Discounts,rebates and contract pricing adjustments are recorded as a reduction of salesbased on agreed upon terms with the Company’s customers at the time ofsale.  The Company calculates a reservefor discounts and rebates based upon actual sales under such arrangements.  Reserves for contract pricing adjustmentsrepresent the difference between the prices wholesalers are billed by theCompany and the prices billed to their customers to whom the Company has givencontract prices.  In determining areserve for contract price adjustments, the Company takes into account anestimate of the percentage of product sales subect to such pricing adjustmentsbased on historical trends.  Historicaltrends are adjusted for new product introductions and changes in wholesaler orcontract prices.

 

Accounts receivable is presented net of allowances for discounts,rebates, contract pricing adjustments and doubtful accounts, which were $89,709and $75,510 at March 31, 2003 and December 31, 2002, respectively.

 

4

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Shelf stock adjustments are provided following a reduction in theprices of any of the Company’s products due to the competitiveenvironment.  Such adjustments arecredited to the Company’s customers based on their on-hand inventoryquantities.  Reserves are generallyestablished when the Company reduces its prices.

 

Estimates for returns, which are recorded at the time of sale, relateprimarily to returns of expiring products. The Company utilizes historical trends to estimate the amount ofproducts to be returned due to product expiration.

 

***Shipping andHandling Costs***

 

The Company classifies shipping and handling costs as part of selling,general and administrative expenses.  Shipping and handling costs were$1,090 and $593 in the three months ended March 31, 2003 and 2002,respectively.

 

***Investments***

 

The Company invests in publicly traded debt securities which arecategorized as securities available-for-sale and are carried at fair value,with unrealized gains and losses excluded from income and recorded directly toaccumulated other comprehensive income.  The market value of suchsecurities exceeded book value by $49 and $73 at March 31, 2003 and December31, 2002, respectively.  Accordingly, net income is decreased by $14,resulting in comprehensive income of $15,093 for the three months ended March31, 2003.

### ** **

### **2.  Initial Public Offering and Shareholders’Equity**

 

On June 11, 2002, the Company completed its initial public offering ofcommon stock, which resulted in net proceeds of $139,236 and the issuance of10,200,813 shares of common stock.  Upon the consummation of the Company’sinitial public offering, all of the previously outstanding shares of theCompany’s preferred stock were converted into 30,000,000 shares of common stockand warrants were exercised resulting in the issuance of 1,680,528 shares ofcommon stock.  Immediately following the closing of the Company’s initialpublic offering, debt of $25,178 due to Hexal AG was converted into 1,678,561shares of common stock and debt of $66,942 due to Hexal AG was paid from theproceeds of the offering.

 

***Stock Splits***

 

In May 2002, the Company effected a 30-for-1 stock split of theCompany’s preferred stock and the Company’s non-voting common stock with nochange in par value.  Additional paid-incapital, preferred stock, common stock, per share and shares outstanding datain the unaudited Condensed Consolidated Financial Statements and Notes to the unauditedCondensed Consolidated Financial Statements have been retroactively restated toreflect this stock split.

 

In May 2002, the outstanding 30,000,000 preferred shares were convertedto common stock. In addition, the Company changed the number of shares ofauthorized preferred stock to 5,000,000, increased the number of shares ofauthorized voting common stock to 70,000,000 and converted shares of non-votingcommon stock to shares of a single class of common stock.

 

5

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***Deferred Stock-BasedCompensation***

 

The Company amortized deferred stock compensation in the amount of $112and $290 for the three months ended March 31, 2003 and March 31, 2002,respectively.

### ** **

### **3.  Net Income Per Common Share**

 

Basic net income per share is computed by dividing net income by theweighted average number of common shares outstanding for the period.  Diluted earnings per share reflects thepotential dilution of stock options, warrants, and the conversion of preferredstock.  Details of the calculations areas follows:

 
|                                           |   | **For the three months ended March 31,** |   |
|------------------------------------------------|--------|------------------------------------------|--------|
|                                           |   | **2003**                                 |   | **2002** |   |
|                                           |   |                                     |   |   |   |
| **Net income per share****—****basic:**   |   |                                     |   |   |   |
| Net income                                     |   | $                                        | 15,107 |   | $ | 6,346 |   |
| Weighted average shares—basic             |   | 44,113,516                               |   | — |   |
| Net income per share**-**basic                 |   | $                                        | 0.34   |   | $ | — |   |
|                                           |   |                                     |   |   |   |
| **Net income per share****—****diluted:** |   |                                     |   |   |   |
| Net income                                     |   | $                                        | 15,107 |   | $ | 6,346 |   |
|                                           |   |                                     |   |   |   |
| Weighted average shares outstanding—basic |   | 44,113,516                               |   | — |   |
| Effect of preferred stock prior to conversion  |   | —                                   |   | 30,000,000 |   |
| Effect of warrants prior to conversion         |   | —                                   |   | 1,680,528 |   |
| Dilutive effect of stock options               |   | 1,101,202                                |   | 1,800,804 |   |
|                                           |   |                                     |   |   |   |
| Weighted average shares**—**diluted       |   | 45,214,718                               |   | 33,481,332 |   |
| Net income per share**—**diluted          |   | $                                        | 0.33   |   | $ | 0.19 |   |

### ** **

### **4.  Adoption of New Accounting Pronouncements**

 

In December 2002, the Financial Accounting Standards Board(“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 148 “Accounting for Stock-Based Compensation—Transition andDisclosure” that amends SFAS No. 123 “Accounting for Stock-BasedCompensation.”  SFAS No. 148provides alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation. SFASNo. 148 amends the disclosure requirements of Accounting Principal Board(“APB”) Opinion No. 28, “Interim Financial Reporting” and StatementNo. 123 to require prominent disclosures in both annual and interimfinancial statements about the method of accounting for stock-based employeecompensation and the effect of the method used on reporting results.  SFAS No. 148 is effective for fiscalyears 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 requireddisclosure have been provided below.

 

The Company applies APB Opinion No. 25, “Accounting for StockIssued to Employees,” and related interpretations in accounting for itsstock-based compensation.  In addition,the Company provides pro forma disclosure of stock-based compensation, asmeasured under the fair value requirements of SFAS No. 123, “Accountingfor Stock-Based Compensation” and as determined through the use of theBlack-Scholes option pricing model.  Thesepro forma disclosures are provided as required under SFAS No. 148,“Accounting for Stock-Based Compensation—Transition and Disclosure.”

 

6

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The fair value of the options was determined using the Black-Scholesoption pricing model with the following assumptions:

 
|                        |   | **March  31, 2003** |   | **March  31, 2002** |       |
|-----------------------------|--------|---------------------|--------|---------------------|------------|
|                        |   |                |   |                |       |
| **Dividend yield**          |   | **0%**              |   | **0%**              |       |
| **Volatility**              |   | **45%**             |   | **45%**             |       |
| **Risk-free interest rate** |   | **3.0% to 4.0%**    |   | **3.0% to 4.0%**    |       |
| **Expected life**           |   | **1 to 5 years**    |   | **1 to 5 years**    | ** ** |

 

A reconciliation of the Company’s net earnings to pro forma netearnings and the related pro forma earnings per share amounts, for the threemonths ended March 31, 2003 and March 31, 2002 is provided below. Forpurposes of pro forma disclosure, stock-based compensation expense isrecognized in accordance with the provisions of SFAS No. 123.

 
|                                                                                                |   | **For  the three months ended March 31,** |   |
|-----------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                |   | **2003**                                  |   | **2002** |   |
|                                                                                                |   |                                      |   |   |   |
| Net income, as reported                                                                             |   | $                                         | 15,107 |   | $ | 6,346 |   |
| Adjustment to net income for pro forma stock-based  compensation expense, net of related tax effect |   | (126                                      | )      | (4 | ) |
|                                                                                                |   |                                      |   |   |   |
| Pro forma net income                                                                                |   | $                                         | 14,981 |   | $ | 6,342 |   |
|                                                                                                |   |                                      |   |   |   |
| As reported and pro forma net earnings per share:                                                   |   |                                      |   |   |   |
| Basic                                                                                               |   | $                                         | 0.34   |   | $ | — |   |
| Diluted                                                                                             |   | $                                         | 0.33   |   | $ | 0.19 |   |

### ** **

### **5.  Inventories**

 

Inventories consist of the following:

 
|            |   | **March  31,  2003** |   | **December  31,  2002** |   |
|-----------------|--------|----------------------|--------|-------------------------|--------|
|            |   |                 |   |                    |   |
| Raw material    |   | $                    | 24,733 |                    | $      | 19,937 |   |
| Work-in-process |   | 10,554               |   | 9,655                   |   |
| Finished goods  |   | 15,794               |   | 12,354                  |   |
|            |   |                 |   |                    |   |
|            |   | $                    | 51,081 |                    | $      | 41,946 |   |

### ** **

### **6.  Line of Credit**

 

On February 8, 2002, the Company entered into a three-year$25 million credit agreement, which is collateralized by accountsreceivable and inventory.  Interest onany borrowing under the line will accrue at the rate of interest equal toeither the adjusted LIBOR rate plus 1.5%, the prime rate or the fixed rate (asset by the bank).  The rate will depend upon the terms of the selectedborrowings.  The agreement has covenants which require the maintenance ofcertain financial ratios including leverage, consolidated debt and asset coverage,as defined.  At March 31, 2003, there were no borrowings outstanding underthe line of credit.

### ** **

7

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** **

### **7.  Transactions Between the Company and RelatedParties**

 

The following is a summary of related party transactions:

 
|                                                              |   | **For the three months ended March 31,** |   |
|-------------------------------------------------------------------|--------|------------------------------------------|--------|
|                                                              |   | **2003**                                 |   | **2002** |   |
|                                                              |   |                                     |   |   |   |
| Net sales to (returns from) subsidiaries of Hexal  AG             |   | $                                        | — |   | $ | (100 | ) |
| Purchases of products and supplies from  subsidiaries of Hexal AG |   | (235                                     | )      | — |   |
| Cyclosporine agreements with Hexal AG(a)                          |   | (1,343                                   | )      | (1,059 | ) |
| Interest on intercompany loans from Hexal AG                      |   | —                                   |   | (1,468 | ) |
|                                                                   |        |                                          |        |  |  |  |  |

 

----

(a)Under agreements with Hexal AG, the Company pays Hexal AG based on sales ofspecific products, which were developed using Hexal AG’s patented technology.

 

In 2002, HPI was a party to certain research and development contractswith third parties for which Hexal AG loaned $0.7 million to HPI for thepayment of its obligations.  During2002, the research and development contracts which were unrelated to the Company’sbusiness were transferred to an entity that is unrelated to the Company.

 

Included in accrued liabilities are amounts due to Hexal AG andsubsidiaries of $2.6 million at March 31, 2003.

### ** **

### **8.  Litigation**

 

***Product LiabilityLitigation***

 

*Fen-phen Litigation*

 

Since May 1997, the Company and certain of its customers have beennamed as defendants in numerous product liability lawsuits, some of which areclass actions, filed in various state and federal courts in connection with itsmanufacture of phentermine hydrochloride. These lawsuits typically name as a defendant Wyeth (formerly AmericanHome Products Corporation), the manufacturer of two anti-obesity drugs,fenfluramine and dexfenfluramine, and also name manufacturers and distributorsof phentermine. Fenfluramine and phentermine were prescribed in combination inan off-label use commonly called “fen-phen,” while dexfenfluramine wasgenerally prescribed alone, but occasionally in combination withphentermine.  In September 1997,the manufacturer of fenfluramine and dexfenfluramine agreed with the Food andDrug Administration (“FDA”) to voluntarily withdraw both products from themarket.  The FDA has not requested thatphentermine be withdrawn from the market.

 

The plaintiffs in these cases (the “fen-phen cases”) typically allegethat the short- and long-term use of fenfluramine in combination withphentermine causes, among other things, primary pulmonary hypertension,valvular heart disease and/or neurological dysfunction.  Some lawsuits allege emotional distresscaused by the purported increased risk of injury in the future.  Plaintiffs typically seek relief in the formof monetary damages (including economic losses, medical care and monitoringexpenses, loss of earnings and earnings capacity, other compensatory damagesand punitive damages), generally in unspecified amounts, on behalf of theindividual or the class.  Some actionsseeking class certification ask for certain types of equitable relief,including, but not limited to, declaratory judgments and the establishment of aresearch program or medical surveillance fund. Certain companies that distributed or sold the Company’s phentermine andare named as defendants in certain of these lawsuits seek a defense andindemnity from the Company.

 

8

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During 2000, the United States District Court for the Eastern Districtof Pennsylvania, the federal court before which all federal cases wereconsolidated for discovery, found that proposed anti-phentermine “causation”testimony by two expert witnesses was not supported by scientific evidence andthus would be barred.  These two expertswere the only “national” anti-phentermine “causation” experts identified in theconsolidated federal litigation, and were to have been “generic” experts inhundreds of cases.  The Court’s decisionto substantially curb their testimony has resulted in many cases beingdismissed.  To date, there has been noscientific testimony accepted by any court that establishes a connectionbetween the use of phentermine either alone or in combination with fenfluramineand/or dexfenfluramine and the allegations made by plaintiffs in theselawsuits.

 

In late 1999, Wyeth, the major defendant in the fen-phen litigation andthe former manufacturer of both fenfluramine and dexfenfluramine, announced aproposed settlement of all fen-phen claims against it nationwide (exceptingonly claims for certain serious medical conditions).  The United States District Court for the Eastern District ofPennsylvania, which supervises discovery of all federal fen-phen cases in aconsolidated multidistrict litigation (the “Fen-Phen MDL”), certified anationwide settlement class and approved the proposed settlement, which becamefinal in January 2002.  Thissettlement has reduced the number of cases in which the Company and itsdistributors have been named as defendants.

 

As of March 31, 2003, the Company had been named and served inapproximately 6,400 fen-phen product liability cases.  More than 96% of these cases have been dismissed, and fewer than190 remained open. Since the beginning of the fen-phen litigation, only onecase has gone to trial with the Company and its distributors asdefendants.  In that case, the Companyand all the phentermine defendants, including other phentermine manufacturersand distributors, were dismissed on motion before the presentation of anyevidence.

 

While the number of lawsuits being filed has decreased substantially,the Company expects additional, similar lawsuits to be filed.  The Company and its outside counsel believethat the Company has substantial defenses to these claims, though the ultimateoutcome cannot be determined.  As ofMarch 31, 2003, there had been no finding of liability for fen-phen injuryagainst the Company and no payment by the Company to settle any combination-relatedfen-phen lawsuit.

 

*Phentermine Litigation*

 

The Company has been named as a defendant in several cases in which theplaintiff alleges injury from the use of phentermine alone, and in one instancethe Company was named as a third-party defendant in a medical malpractice casein which negligent prescription of phentermine was alleged.  A number of these claims have been dismissedin the Company’s favor, and as of March 31, 2003 only two such claimsremained pending.

 

Both cases are currently pending in a consolidated federal fen-phenmultidistrict litigation pending in the United States District Court for theEastern District of Pennsylvania.

 

Additionally, the Company has been named as a defendant in one statecourt case alleging injury from the use of Company phentermine in combinationwith phenylpropanolamine (“PPA”) made by another company.  The Company has filed an unopposed motion todismiss this claim and that motion is pending.

 

Because discovery has not been completed in these pending cases, predictingthe ultimate outcome of these actions is not possible, and no provision for anyliability has been reflected in the Company’s financial statements.  The Company believes it has substantialdefenses to these claims.

 

9

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Gross sales of phentermine by the Company for the three months endedMarch 31, 2003 and March 31, 2002 were $5,666 and $7,464, respectively.

* *

*Defense/Indemnity Issues Related to Fen-phenand Phentermine Litigation*

 

In or about April 2000, the Company exhausted its productliability insurance covering all combination-related phentermine lawsuits andany non-combination phentermine lawsuits resulting from claims regarding theingestion of phentermine prior to June 1998.  Since that time, the Company has funded its own defense in thefen-phen, phentermine-only and phentermine-PPA product liability lawsuits.  Additionally, the Company has reachedagreements under which the Company will fund or partially fund the defense ofcertain of its distributors, and to indemnify them provided certain conditionsare met.  Further, the Company hasreached favorable defense/indemnity agreements with several retailers, and isnegotiating the resolution of several additional claims with otherretailers.  Fen-phen and phenterminelitigation defense costs, and the costs of related defense agreements, arebeing expensed as incurred.

 

*Other Product Liability Litigation*

 

The Company has been named as a defendant in several other productliability lawsuits in which plaintiffs allege that Company-manufacturedpharmaceuticals containing phenylpropanolamine caused injury.  PPA was removed from the market in 2000 atthe FDA’s request after a study appeared to show a potentially increased riskof hemorrhagic stroke in certain patient cohorts.  The Company previously manufactured two low-volume prescriptionproducts that contained PPA that were discontinued in 1999 and 2000,respectively.

 

To date, the Company has been named in six lawsuits alleging injury orwrongful death from the use of Company-manufactured pharmaceuticals containingPPA.  As of March 31, 2003, all but twoPPA cases against the Company had been dismissed or discontinued.  Discovery in these two lawsuits has yet tobegin.  The first lawsuit is pending instate court in New York.  The secondlawsuit was filed in the United States District Court for the District ofMaryland and served upon the Company in January 2003.  It is likely to be transferred to the theconsolidated federal phenylpropanolamine multidistrict litigation (“PPA MDL”)pending in the United States District Court for the Western District ofWashington.  Because these two lawsuitswere only recently filed, and discovery in them has yet to begin, predictingthe ultimate outcome of these actions is not possible, no provision for anyliability has been reflected in the Company’s financial statements.

 

***Patent InfringementLitigation***

 

On August 30, 2000, Novartis Pharmaceuticals Corporation filed acomplaint in the United States District Court for the District of Delawarealleging among other things that the Company’s generic cyclosporine productinfringes a patent owned by Novartis. An adverse outcome in patent litigation with Novartis involvingcyclosporine capsules could result in the Company being unable to market thisproduct which would materially harm its profits and cash flows and could resultin the Company paying damages, cost, expenses, and fees that could have amaterial adverse impact on its financial performance.  The Company’s potential liability and expenses in this matter arenot covered by insurance.  InDecember 2002, the United States District Court for the District ofDelaware granted the Company’s motion for summary judgment of non-infringementof the patent. Novartis has appealed the judgment.  The ultimate outcome of this lawsuit cannot be determined at thistime.

 

10

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In January 2001, Apotex, Inc. filed an action in the UnitedStates District Court for the Eastern District of New York alleging that bymanufacturing, selling and offering to sell cyclosporine capsules the Companyis infringing a patent of which Apotex alleges it is the exclusivelicensee.  Apotex seeks injunctiverelief as well as an unspecified amount of damages and has also asserted aclaim that the alleged infringement was willful, that the case is thereforeexceptional and that Apotex should therefore be awarded the attorney fees ithas incurred in the action.  TheCompany’s potential liability and expenses in this matter are not covered byinsurance.  An adverse outcome in thislitigation could result in the Company being unable to market cyclosporine,which could materially harm profits and cash flows, and could result in payingdamages, costs, expenses and fees that could have a material impact on theCompany’s financial performance.

 

The Company has denied that it has infringed any valid patent claimsasserted by Apotex, has alleged affirmatively, among other things, that thepatent is invalid and that it is not infringed by the Company’s manufacture,sale or offer to sell its cyclosporine capsules.

 

In addition, the Company has been named in several other patentinfringement actions alleging that the Company has infringed patents by filingan application with the FDA for approval to market products before theplaintiffs’ patents expire.  In general,plaintiffs seek judgments precluding the FDA from approving the Company’sapplication to market the product before their patent expires and have assertedclaims that the alleged infringement was willful, that the action is thereforeexceptional and that plaintiffs should therefore be awarded the attorney feesthey have incurred in the action.

 

The Company and its outside counsel believe that the Company hassubstantial defenses and counterclaims to these above patent infringementactions, though the ultimate outcome cannot be determined.

 

Because predicting the ultimate outcome of these actions is notpossible, no provision for any liability has been reflected in the Company’sfinancial statements.

 

***Other Litigation***

 

The Company is in other litigation incidental to its businessactivities.  The ultimate disposition ofsuch lawsuits will not materially affect the Company’s financial statements.

### ** **

### **9. **Contingencies

*** ***

***Rebates***

 

The Omnibus Budget Reconciliation Act of 1990, effective January 1,1991, requires drug companies to enter into a rebate agreement with the HealthCare Financing Administration of the Federal government.  The rebate agreement states that drugcompanies must pay rebates to states for drugs (prescription, non-prescriptionor biological products) sold to Medicaid recipients.  At March 31, 2003 and December 31, 2002, $4,260 and $4,055,respectively, are included in accrued liabilities as the estimated liabilityfor Medicaid rebates.

 

***State MedicaidClaims***

 

EHI purchased Major Pharmaceuticals, Inc. (“Major”), a distributor ofdrug products, in 1991 and sold Major in 1995. At the time of the sale, EHI established an escrow account to cover anyMedicaid drug rebate liabilities incurred by Major prior to the sale.

 

11

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As of March 31, 2003, the recorded liability for such claims is $927,which management believes is adequate to resolve such matters.  The Company has approximately $791 as ofMarch 31, 2003 in an escrow account to resolve such claims.

 

***FDA Regulations***

 

In January 2003, the Company received Inspectional Observations - FormFDA 483 (the “FDA 483”) at its Laurelton facility following the mislabeling ofone lot of product that was distributed. The mislabeled lot was recalled. The Company provided a written response to the FDA 483 discussing theimplementation of corrective actions and revisions to procedures that theCompany believes addresses the concerns and issues raised by the FDA 483.  In February 2003, the FDA issued a WarningLetter and requested that the Company clarify and supplement its responses tothe FDA 483.  The Company has providedits supplemental responses to the FDA. Based on follow-up discussions with the FDA, the Company has beenadvised that a Current Good Manufacturing Practices or “GMP” inspection will beconducted by the FDA at the Laurelton facility beginning in May 2003.

 

12

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**ITEM 2****.  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The following discussion and analysis of the Company’s financialcondition and results of operations should be read in conjunction with theconsolidated financial statements, the related notes to consolidated financialstatements and “Management’s Discussion and Analysis of Financial Condition andResults of Operations” included in the Company’s annual report on Form 10-K/Aand the unaudited interim condensed consolidated financial statements includedin Item 1 of this Quarterly Report on Form 10-Q.

 

**THREE MONTHS ENDED MARCH 31, 2003 COMPAREDWITH THREE MONTHS ENDED MARCH 31, 2002**

 

**Net sales.**  Net sales increased 47.0% to $70.9 millionfor the three months ended March 31, 2003 from $48.2 million in the comparableperiod in 2002.  The majority of the netsales increase was attributable to products introduced subsequent to March 31,2002.  These products includeLisinopril, USP, Lisinopril/HCTZ, Tizanidine HCl, Tramadol HCL and Nizatidine,USP.  In addition, the Company alsointroduced a Dextroamphetamine and Amphetamine Mix Salt Product.  An increase in unit volume of severalexisting products also contributed to higher sales for the three months endedMarch 31, 2003.

 

**Gross profit.**  Gross profit as a percentage of net salesincreased to 54.2% for the three months ended March 31, 2003 compared to 48.2%in the comparable period in 2002.  Theincrease was primarily due to increased utilization of manufacturing capacity,including a significant increase in production at the Company’s North Carolinafacility.  Additionally, in 2002 therewas a $1.6 million write down of a raw material that will not be utilized inproduction.  The Company’s gross profitmargins are dependent on several factors, including product sales mix, cost,volumes and competitive activity.

 

**Amortization of other intangible assets. **Amortization ofother intangible assets was $0.9 million for the three months ended March 31,2003 and for the comparable period in 2002.

 

**Other selling, general andadministrative. **Otherselling, general and administrative expenses increased $2.6 million to $8.7million for the three months ended March 31, 2003 compared to $6.2 million inthe comparable period in 2002.  As apercentage of net sales, other selling, general and administrative expensesdecreased to 12.3% for the three months ended March 31, 2003 from 12.8% in thecomparable period in 2002.  The increasein other selling, general and administrative expenses was principally due tohigher insurance, legal and distribution expenses.  Insurance expense increased by $1.1 million, primarily the resultof higher product liability and director and officers insurance premiums.  Legal expenses increased $0.7 million, ofwhich $0.4 million is associated with patent litigation activities, with muchof the remaining balance being for additional compliance and reportingrequirements of a publicly-traded company. Higher sales volume increased distribution expense by $0.5 million.

** **

**Research and development. **Research anddevelopment expenses increased $0.4 million to $3.6 million for the threemonths ended March 31, 2003 compared to $3.3 million for the comparable periodin 2002.  The increase was attributableto an increase in generic drug development of $0.9 million offset by a decreaseof $0.5 million related to certain basic research contracts unrelated to theCompany’s business that were transferred in March 2002 to an unrelatedentity.  The increase in generic drugdevelopment costs was primarily attributed to increases in costs related topersonnel, bio-studies, materials and supplies.

** **

**Operating income. **Operating income increased $12.3 millionto $25.1 million for the three months ended March 31, 2003 from $12.8 millionfor the comparable period in 2002.  Theincrease in operating

 

13

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income was the result of increased sales and gross profit, offset byincreases in other selling, general and administrative expenses and researchand development costs.

 

**Interest income (expense). **Net interest incomefor the three months ended March 31, 2003 was $0.05 million compared to netinterest expense of $2.1 million in the comparable period in 2002.  A decrease in outstanding debt, including theelimination of $92.1 million of intercompany debt, reduced interest expense by$1.8 million.  Interest income increasedby $0.3 million, the result of higher investment balances.

 

**Taxes on income. **Taxes on income increased $5.7 millionto $10.1 million during the three months ended March 31, 2003 from $4.4 millionin the comparable period in 2002.  Theincrease was the result of higher pre-tax income for 2003.  The effective tax rate decreased to 40.0%from 41.1% due principally to lower state and local taxes in 2003.

 

**Net income. **Net income increased $8.8 million to $15.1million for the three months ended March 31, 2003 from $6.3 million in thecomparable period in 2002 for the reasons described above.

 

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**LIQUIDITY AND CAPITAL RESOURCES**

 

Cash and cash equivalents were $72.5 million at March 31, 2003 comparedto $62.3 million at December 31, 2002. Additionally, at March 31, 2003 the Company had investments inmarketable debt securities of $29.4 million and no outstanding debt.

 

The Company also has a three-year $25 million credit facility whichexpires on February 8, 2005.  Under thisfacility, the Company can borrow at LIBOR plus 1.5%, the bank’s prime rate or afixed rate.  The credit facility, whichis for working capital purposes, had no outstanding borrowings against it atMarch 31, 2003.

 

Stockholders’ equity increased to $273.9 million at March 31,2003 from $258.2 million at December 31, 2002.  Stockholders’ equity increased by$0.6 million (including tax benefits) from the exercise of employee stockoptions, net earnings of $15.1 million for the three months ended March31, 2003 and $0.1 million for the amortization of deferred stock-basedcompensation costs.

 

During the three months ended March 31, 2003, the Company generated netcash of $10.2 million.  Operationsgenerated $21.1 million of cash, comprised of net earnings of$15.1 million and non-cash items totaling $17.6 million offset by anincrease in working capital of $11.6 million.  The increase in working capital resulted from increases inaccounts receivable, inventory and other assets of $13.1 million, $9.1 millionand $0.2 million, respectively.  Adecrease in prepaid expenses and other current assets of $2.3 million andincreases in accounts payable and accrued liabilities of $8.6 million partiallyoffset the other working capital increases. The increases in accounts receivable, inventory, accounts payable andaccrued liabilities are associated with higher sales and production levels.  Prepaid expenses were lower due toamortization of prepaid insurance during the period.

 

Investing activities consumed $6.6 million of cash during thisperiod.  Approximately $4.5 millionwas used to purchase short-term investment grade debt instruments with thebalance of $2.1 million used for capital expenditures.  The capital expenditures relate primarily toequipment required to support increased production volume in the Company’sNorth Carolina facility.

 

Financing activities consumed $4.3 million of cash during thethree months ended March 31, 2003, with $4.8 million used to pay the remainingbalance of the EHI acquisition note. Additional sources of cash during this period included $0.3 millionrelated to an increase in advances from an affiliate and $0.1 million ofproceeds from the exercise of stock options.

 

The Company is involved in various litigation matters in which thepotential liabilities and/or related expenses are not covered byinsurance.  In addition, an adverseoutcome in patent litigation with Novartis and Apotex involving cyclosporinecapsules could result in the Company being unable to market this product whichwould materially harm its profits and cash flows and could result in theCompany paying damages, cost, expenses, and fees that could have a materialadverse impact on its financial performance. In December 2002, the United States District for the District ofDelaware granted the Company’s motion in the Novartis case for summary judgmentof non-infringement of the patent.  Novartishas appealed the judgment.

 

The Company does not currently have or anticipate any short-termfunding requirements outside of the ordinary course of its business, and theCompany does not have or anticipate any liquidity concerns.  The Company’s principal future cashrequirements are associated with increased working capital to support futuregrowth, capital expenditures and legal defense costs.  The Company anticipates that its operating cash flows, together withits available borrowings under its credit facility and current cash balanceswill be sufficient to meet all of its working capital and capital expenditurerequirements 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 areimportant to the portrayal of its financial condition and results of operationsand require management’s subjective judgments. As a result, these judgments are subject to an inherent degree ofuncertainty.  The Company bases itsjudgments on its experience and various other assumptions that the Companybelieves to be reasonable under the circumstances.  On an ongoing basis, the Company evaluates its estimates,including those related to revenues, returns, inventories, income taxes andlitigation.  The Company’s actualresults could differ from these estimates under different assumptions orconditions.  The Company believes thefollowing 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 aretransferred to the customer.  Sales areshown net of discounts, rebates, contract pricing adjustments and returns,which are estimated based on the Company’s experience.  Discounts, rebates and contract pricingadjustments are recorded as a reduction of sales based on agreed upon termswith the Company’s customers at the time of sale.  The Company calculates a reserve for discounts and rebates basedupon actual sales under such arrangements. Reserves for contract pricing adjustments represent the differencebetween the prices wholesalers are billed by the Company and the prices billedto their customers to whom the Company has given contract prices.  In determining a reserve for contractpricing adjustments, the Company takes into account an estimate of thepercentage of product sales subject to such pricing adjustments based onhistorical trends.  Historical trendsare adjusted for new product introductions and changes in wholesaler orcontract prices.

 

Shelf stock adjustments are provided following a reduction in theprices of any of the Company’s products due to the competitiveenvironment.  Such adjustments arecredited to the Company’s customers based on their on-hand inventoryquantities.  Reserves are generallyestablished when the Company reduces its prices.

 

Estimates for returns, which are recorded at the time of sale, relateprimarily to returns of expiring products. The Company utilizes historical trends to estimate the amount ofproducts to be returned due to product expiration.

 

In determining whether liabilities should be recorded for pendinglitigation claims, the Company must assess the allegations made and the likelihoodthat it will successfully defend itself. When the Company believes it is probable that it will not prevail in aparticular matter, it will then make an estimate of the amount of liabilitybased in part on advice of outside legal counsel.

** **

**IMPACT OF RECENTLY ISSUED ACCOUNTINGSTANDARDS**

 

In December 2002, the FASB issued SFAS No. 148 “Accountingfor Stock-Based Compensation—Transition and Disclosure” that amends FASBStatement No. 123 “Accounting for Stock-Based Compensation.” SFASNo. 148 provides alternative methods of transition for a voluntary changeto the fair value based method of accounting for stock-based employeecompensation.  SFAS No. 148 amendsthe disclosure requirements of APB Opinion No. 28, “Interim FinancialReporting” and Statement No. 123 to require prominent disclosures in bothannual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used onreporting results.  SFAS No. 148 iseffective for fiscal years ending after December 15, 2002.  The adoption of SFAS No. 148, exceptfor the disclosure requirements, had no impact on the consolidated financialstatements.  The additional requireddisclosure is included as part of note 4 in the notes to the consolidatedfinancial statements on Form 10-Q.

 

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**ITEM 3****.  QUANTITATIVEAND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**

 

The following discusses the Company’s exposure to market risk relatedto changes in interest rates, equity prices and foreign currency exchangerates.  The Company does not believethat its exposure to market risk is material.

 

As of March 31, 2003, the Company had cash and cash equivalents of$72.5 million.  Cash equivalentsare interest-bearing investment grade securities, primarily short-term, highlyliquid investments with maturities at the date of purchase of less than90 days.  These investments aresubject to interest rate risk and will decrease in value if market interestrates increase.  A hypothetical increaseor decrease in the market interest rates by 10 percent from the rates ineffect on the date of this Form 10-Q would cause the fair value of theseshort-term investments to decline by an insignificant amount.  The Company has the ability to hold theseinvestments until maturity, and therefore it does not expect the value of theseinvestments to be affected to any significant degree by the effect of a suddenchange in market interest rates.  Declinesin interest rates over time will, however, reduce the Company’s interestincome.

 

The Company currently owns $29.4 million in publicly traded debtsecurities which are subject to market fluctuations.

 

The Company currently does not have any international operations or anysignificant assets or liabilities denominated in foreign currencies, andcurrently does not enter into forward exchange contracts or other financialinstruments with respect to foreign currency. Accordingly, the Company currently does not have any significant foreigncurrency exchange rate risk.

** **

**ITEM4.  CONTROLS****AND PROCEDURES**

 

As of March 31, 2003, an evaluation was performed under the supervisionand with the participation of the Company’s management, including the ChiefExecutive Officer and the Chief Financial Officer, of the effectiveness of thedesign and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s management, including the ChiefExecutive Officer and the Chief Financial Officer, concluded that the Company’sdisclosure controls and procedures were effective as of March 31, 2003. There have been no significant changes in the Company’s internal controls or inother factors that could significantly affect the internal controls subsequentto March 31, 2003.

** **

**SPECIAL NOTEREGARDING FORWARD-LOOKING STATEMENTS**

 

This quarterly report on Form 10-Q report contains forward-lookingstatements relating to future events and future performance of the Companywithin the meaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934, including, without limitation,statements regarding the Company’s expectations, beliefs, intentions or futurestrategies that are signified by the words “expects,” “anticipates,” “intends,”“believes” or similar language.  Actual results could differ materiallyfrom those anticipated in such forward-looking statements.  Some specificfactors that may have a significant effect on the Company’s operating resultsand common stock market price include:

 

•                  new productintroductions;

•                  changes in thedegree of competition for the Company’s products;

•                  regulatoryissues, including, but not limited to, receipt of ANDA approvals from the FDA,compliance with FDA or other agency regulations or the lack or failure of eitherof the foregoing;

•                  the inability toacquire sufficient supplies of raw materials;

 

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•                  litigationand/or threats of litigation;

•                  changes in theCompany’s growth rates or the Company’s competitors’ growth rates;

•                  legislative andFDA actions with respect to the government regulation of pharmaceuticalproducts;

•                  public concernas to the safety of the Company’s  products;

•                  changes inhealth care policy in the United States;

•                  conditions inthe financial markets in general or changes in general economic conditions;

•                  the Company’sinability to raise additional capital;

•                  conditions ofother generic pharmaceutical companies or the generic pharmaceutical industrygenerally; and

•                  changes in stockmarket analyst recommendations regarding the Company’s common stock, othercomparable companies or the generic pharmaceutical industry generally.

 

All forward-looking statements included in this document are based oninformation available to the Company on the date hereof, and the Companyassumes no obligation to update any forward-looking statements.  The Company cautions investors that itsbusiness and financial performance are subject to substantial risks anduncertainties.

#  

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# **PART II****.        OTHER INFORMATION**

 

**ITEM 2.          CHANGESIN SECURITIES AND USE OF PROCEEDS**

 

In June 2002, the Company closed an initial public offering of itscommon stock.  The Registration Statement on Form S-1 (File No. 333-83638)was declared effective by the Securities and Exchange Commission on May 23,2002 and the Company commenced the offering on that date.  After deductingunderwriting discounts and commissions and the offering expenses, the netproceeds from the offering to the Company were approximately $139.2 million.

 

The Company has used proceeds from the offering as follows: (i) $66.9million has been used to repay debt due to Hexal AG; (ii) $10.0 million hasbeen used to repay debt incurred in connection with the acquisition of EHI; and(iii) $2.0 million has been used for general working capital purposes. The remaining $60.3 million of the proceeds to the Company from the offeringare invested in cash investments and short-term investment grade debtsecurities.  The Company anticipates using the balance of the proceedsfrom the offering for general corporate purposes, including to fund workingcapital, increased research and development to expand the Company’s productofferings and the potential acquisition of product lines or companies. The Company has no present understandings, commitments or agreements withrespect to any acquisitions.  The Company has not determined the amountsit plans to spend on any of the areas listed above or the timing of theseexpenditures.

 

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**ITEM 6.          EXHIBITSAND REPORTS ON FORM 8-K**

 
| (a)    |   | Exhibits                                                                                                                |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                    |
| 99.1   |   | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 |
|   |   |                                                                                                                    |
| 99.2   |   | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|         | **Eon Labs, Inc** |
|--------------|-------------------|
|         |              |   |
|         |              |   |
| May 14, 2003 | By                | /s/  Bernhard Hampl, Ph.D. |   |
|         |              | Bernhard  Hampl, Ph.D. |
|         |              | President,  Chief Executive Officer  and Director |
|         |              |   |
|         |              |   |
| May 14, 2003 | By           | /s/  William F. Holt |   |
|         |              | William  F. Holt |
|         |              | Chief  Financial Officer |

 

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**Certification**

 

I, Bernhard Hampl, Ph.D., certify that:

 
| 1.     | I have reviewed this quarterly report on Form 10-Q of Eon Labs, Inc.;                                                                                                                                                                                                                                                                                                                               |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
| 2.     | Based on my knowledge, this quarterly report does not contain any  untrue statement of a material fact or omit to state a material fact  necessary to make the statements made, in light of the circumstances under  which such statements were made, not misleading with respect to the period  covered by this quarterly report;                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
| 3.     | Based on my knowledge, the financial statements, and other financial  information included in this quarterly report, fairly present in all material  respects the financial condition, results of operations and cash flows of the  registrant as of, and for, the periods presented in this quarterly report;                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
| 4.     | The registrant’s other certifying officers and I are responsible for  establishing and maintaining disclosure controls and procedures (as defined  in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
|   | a)                                                                                                                                                                                                                                                                                                                                                                                                  | designed such disclosure controls and procedures to ensure that  material information relating to the registrant, including its consolidated  subsidiaries, is made known to us by others within those entities,  particularly during the period in which this quarterly report is being  prepared; |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
|   | b)                                                                                                                                                                                                                                                                                                                                                                                                  | evaluated the effectiveness of the registrant’s disclosure controls  and procedures as of a date within 90 days prior to the filing date of this  quarterly report (the “Evaluation Date”); and |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
|   | c)                                                                                                                                                                                                                                                                                                                                                                                                  | presented in this quarterly report our conclusions about the  effectiveness of the disclosure controls and procedures based on our  evaluation as of the Evaluation Date; |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
| 5.     | The registrant’s other certifying officers and I have disclosed,  based on our most recent evaluation, to the registrant’s auditors and the  audit committee of registrant’s board of directors (or persons performing the  equivalent function):                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
|   | a)                                                                                                                                                                                                                                                                                                                                                                                                  | all significant deficiencies in the design or operation of internal  controls which could adversely affect the registrant’s ability to record,  process, summarize and report financial data and have identified for the  registrant’s auditors any material weaknesses in internal controls; and |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
|   | b)                                                                                                                                                                                                                                                                                                                                                                                                  | any fraud, whether or not material, that involves management or other  employees who have a significant role in the registrant’s internal controls;  and |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
| 6.     | The registrant’s other certifying officers and I have indicated in  this quarterly report whether or not there were significant changes in  internal controls or in other factors that could significantly affect  internal controls subsequent to the date of our most recent evaluation,  including any corrective actions with regard to significant deficiencies and  material weaknesses. |

 
|   | Date: May 14, 2003        |   |
|--------|---------------------------|--------|
|   |                      |   |
|   | /s/ Bernhard Hampl, Ph.D. |   |   |
|   | Bernhard Hampl, Ph.D.     |   |
|   | Chief Executive Officer   |   |
|        |                           |        |  |

 

 

22

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**Certification**

 

I, William F. Holt, certify that:

 
| 1.     | I have reviewed this quarterly report on Form 10-Q of Eon Labs, Inc.;                                                                                                                                                                                                                                                              |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                               |   |
| 2.     | Based on my knowledge, this quarterly report does not contain any  untrue statement of a material fact or omit to state a material fact  necessary to make the statements made, in light of the circumstances under  which such statements were made, not misleading with respect to the period  covered by this quarterly report; |
|   |                                                                                                                                                                                                                                                                                                                               |   |
| 3.     | Based on my knowledge, the financial statements, and other financial  information included in this quarterly report, fairly present in all material  respects the financial condition, results of operations and cash flows of the  registrant as of, and for, the periods presented in this quarterly report;                     |
|   |                                                                                                                                                                                                                                                                                                                               |   |
| 4.     | The registrant’s other certifying officers and I are responsible for  establishing and maintaining disclosure controls and procedures (as defined  in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                               |   |
|   | a)                                                                                                                                                                                                                                                                                                                                 | designed such disclosure controls and procedures to ensure that  material information relating to the registrant, including its consolidated  subsidiaries, is made known to us by others within those entities,  particularly during the period in which this quarterly report is being  prepared; |
|   |                                                                                                                                                                                                                                                                                                                               |   |
|   | b)                                                                                                                                                                                                                                                                                                                                 | evaluated the effectiveness of the registrant’s disclosure controls  and procedures as of a date within 90 days prior to the filing date of this  quarterly report (the “Evaluation Date”); and |
|   |                                                                                                                                                                                                                                                                                                                               |   |
|   | c)                                                                                                                                                                                                                                                                                                                                 | presented in this quarterly report our conclusions about the  effectiveness of the disclosure controls and procedures based on our  evaluation as of the Evaluation Date; |
|   |                                                                                                                                                                                                                                                                                                                               |   |
| 5.     | The registrant’s other certifying officers and I have disclosed,  based on our most recent evaluation, to the registrant’s auditors and the  audit committee of registrant’s board of directors (or persons performing the  equivalent function):                                                                   |
|   |                                                                                                                                                                                                                                                                                                                               |   |
|   | a)                                                                                                                                                                                                                                                                                                                                 | all significant deficiencies in the design or operation of internal  controls which could adversely affect the registrant’s ability to record,  process, summarize and report financial data and have identified for the  registrant’s auditors any material weaknesses in internal controls; and |
|   |                                                                                                                                                                                                                                                                                                                               |   |
|   | b)                                                                                                                                                                                                                                                                                                                                 | any fraud, whether or not material, that involves management or other  employees who have a significant role in the registrant’s internal controls;  and |

 
| 6. | The registrant’s other certifying officers and I have indicated in  this quarterly report whether or not there were significant changes in  internal controls or in other factors that could significantly affect  internal controls subsequent to the date of our most recent evaluation,  including any corrective actions with regard to significant deficiencies and  material weaknesses. |
|----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 
|   | Date: May 14, 2003      |   |
|--------|-------------------------|--------|
|   |                    |   |
|   | /s/ William F. Holt     |   |   |
|   | William F. Holt         |   |
|   | Chief Financial Officer |   |
|        |                         |        |  |

 

23

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