**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES  EXCHANGE ACT OF 1934**   |
|------------|-----------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                                |
| **or**     |
| ** ** |
| **o**      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF  THE SECURITIES  EXCHANGE ACT OF 1934** |

 

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**CommissionFile Number 001-31333**

 

**For thequarterly period ended March 31, 2005**

 

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**Eon Labs, Inc.**

(Exact Name of Registrant as Specified in itsCharter)

 
| **Delaware**                                               | ** ** | **13-3653818**                           |
|------------------------------------------------------------|------------|------------------------------------------|
| (State or Other  Jurisdiction of Incorporation)            |       | (I.R.S. Employer  Identification Number) |
|                                                       |       |                                     |
| **1999  Marcus Avenue  Lake Success, New York**            | ** ** | **11042**                                |
| (Address of Principal  Executive Offices)                  |       | (Zip Code)                               |
|                                                       |       |                                     |
| **(516) 478-9700**                                         |
| (Registrant’s Telephone  Number, Including Area Code) |

 

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Indicateby check 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

 

Indicateby check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2of the Securities Exchange Act of 1934). Yes ý No o

 

Asof May 5, 2005, there were 88,884,164 shares of the Registrant’s CommonStock, $0.01 par value per share, outstanding.

 

 

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**Eon Labs, Inc. and SubsidiariesTable of Contents**

 
| PART I.       | FINANCIAL INFORMATION                                                                                                             |                                                                                                                                        |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------|
|               |                                                                                                                              |                                                                                                                                        |
|               | ITEM 1.                                                                                                                           | Financial Statements                                                                                                                        |   |
|               |                                                                                                                              |                                                                                                                                        |   |
|               |                                                                                                                              | Condensed  Consolidated Balance Sheets as of March 31, 2005 (unaudited) and December 31,  2004                                    |   |
|               |                                                                                                                              |                                                                                                                                        |   |
|               |                                                                                                                              | Condensed  Consolidated Statements of Income (unaudited) for the Three Months Ended March 31,  2005 and March 31, 2004            |   |
|               |                                                                                                                              |                                                                                                                                        |   |
|               |                                                                                                                              | Condensed  Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31,  2005  and March 31,  2004 |   |
|               |                                                                                                                              |                                                                                                                                        |   |
|               |                                                                                                                              | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                                           |   |
|               |                                                                                                                              |                                                                                                                                        |   |
|               | ITEM  2.                                                                                                                          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                 |   |
|               |                                                                                                                              |                                                                                                                                        |   |
|               | ITEM  3.                                                                                                                          | Quantitative  and Qualitative Disclosure about Market Risk                                                                                  |   |
|               |                                                                                                                              |                                                                                                                                        |   |
|               | ITEM 4.                                                                                                                           | Controls and Procedures                                                                                                                     |   |
|               |                                                                                                                              |                                                                                                                                        |
| PART II.      | OTHER INFORMATION                                                                                                                 |                                                                                                                                        |
|               |                                                                                                                              |                                                                                                                                        |
|               | ITEM 1.                                                                                                                           | Legal Proceedings                                                                                                                           |   |
|               |                                                                                                                              |                                                                                                                                        |   |
|               | ITEM  2.                                                                                                                          | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                |   |
|               |                                                                                                                              |                                                                                                                                        |   |
|               | ITEM 5.                                                                                                                           | Other Information                                                                                                                           |   |
|               |                                                                                                                              |                                                                                                                                        |   |
|               | ITEM 6.                                                                                                                           | Exhibits                                                                                                                                    |   |
|               |                                                                                                                              |                                                                                                                                        |
| SIGNATURES         |                                                                                                                              |                                                                                                                                        |
|               |                                                                                                                              |                                                                                                                                        |
| EXHIBIT  31.1 | Certifications pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002                                                    |                                                                                                                                        |
|               |                                                                                                                              |                                                                                                                                        |
| EXHIBIT  31.2 | Certifications pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002                                                    |                                                                                                                                        |
|               |                                                                                                                              |                                                                                                                                        |
| EXHIBIT  32.1 | Certification Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |                                                                                                                                        |
|               |                                                                                                                              |                                                                                                                                        |
| EXHIBIT  32.2 | 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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**Eon Labs, Inc.and SubsidiariesCondensed ConsolidatedBalance Sheets**(dollars in thousands, except per share amounts)

 
| ** **                                                                                                                                                                                                                      | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                      | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                                                      | ** ** | ** **               | ** ** | ** **                  | ** ** |
|                                                                                                                                                                                                                            |       |                     |       |                        |       |
| **Current  assets**                                                                                                                                                                                                             |       |                     |       |                        |       |
| Cash and  cash equivalents                                                                                                                                                                                                      |       | $                        | 63,290     |                        | $          | 59,500 |   |
| Investments                                                                                                                                                                                                                     |       | 165,696                  |       | 136,252                     |       |
| Accounts  receivable, net                                                                                                                                                                                                       |       | 51,032                   |       | 68,010                      |       |
| Inventories                                                                                                                                                                                                                     |       | 85,866                   |       | 72,465                      |       |
| Deferred tax  assets, net                                                                                                                                                                                                       |       | 62,945                   |       | 62,955                      |       |
| Prepaid  expenses and other current assets                                                                                                                                                                                      |       | 7,966                    |       | 20,788                      |       |
|                                                                                                                                                                                                                            |       |                     |       |                        |       |
| **Total  current assets**                                                                                                                                                                                                       |       | 436,795                  |       | 419,970                     |       |
|                                                                                                                                                                                                                            |       |                     |       |                        |       |
| Property,  plant and equipment, net                                                                                                                                                                                             |       | 53,248                   |       | 52,481                      |       |
| Goodwill                                                                                                                                                                                                                        |       | 42,734                   |       | 42,734                      |       |
| Other  intangible assets, net                                                                                                                                                                                                   |       | 21,307                   |       | 22,247                      |       |
| Other assets                                                                                                                                                                                                                    |       | 9,155                    |       | 7,742                       |       |
|                                                                                                                                                                                                                            |       |                     |       |                        |       |
| **Total  assets**                                                                                                                                                                                                               |       | $                        | 563,239    |                        | $          | 545,174 |   |
|                                                                                                                                                                                                                            |       |                     |       |                        |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                  |       |                     |       |                        |       |
|                                                                                                                                                                                                                            |       |                     |       |                        |       |
| **Current  liabilities**                                                                                                                                                                                                        |       |                     |       |                        |       |
| Accounts  payable                                                                                                                                                                                                               |       | $                        | 11,972     |                        | $          | 11,987 |   |
| Accrued  liabilities                                                                                                                                                                                                            |       | 72,097                   |       | 81,265                      |       |
|                                                                                                                                                                                                                            |       |                     |       |                        |       |
| **Total  current liabilities**                                                                                                                                                                                                  |       | 84,069                   |       | 93,252                      |       |
|                                                                                                                                                                                                                            |       |                     |       |                        |       |
| **Long-term  liabilities**                                                                                                                                                                                                      | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Deferred tax  liabilities, net                                                                                                                                                                                                  |       | 7,355                    |       | 7,355                       |       |
| Deferred  revenue                                                                                                                                                                                                               |       | 125                      |       | 151                         |       |
| Other                                                                                                                                                                                                                           |       | 1,202                    |       | 892                         |       |
|                                                                                                                                                                                                                            |       |                     |       |                        |       |
| **Total  liabilities**                                                                                                                                                                                                          |       | 92,751                   |       | 101,650                     |       |
|                                                                                                                                                                                                                            |       |                     |       |                        |       |
| Contingencies  (Notes 9 and 10)                                                                                                                                                                                                 |       |                     |       |                        |       |
|                                                                                                                                                                                                                            |       |                     |       |                        |       |
| **Stockholders’  equity**                                                                                                                                                                                                  |       |                     |       |                        |       |
| Common  stock, par value $.01 per share; 100,000,000 shares authorized; 89,012,924  and 88,982,924 shares issued; 88,884,164 and 88,830,564 shares outstanding at  March 31, 2005 and December 31, 2004, respectively |       | 890                      |       | 890                         |       |
| Preferred  stock, par value $.01 per share; 5,000,000 shares authorized; none issued                                                                                                                                            |       | —                   |       | —                      |       |
| Additional  paid-in capital                                                                                                                                                                                                     |       | 193,010                  |       | 192,767                     |       |
| Retained  earnings                                                                                                                                                                                                              |       | 281,204                  |       | 255,125                     |       |
| Accumulated  other comprehensive loss                                                                                                                                                                                           |       | (150                     | )          | (8                          | )          |
|                                                                                                                                                                                                                            |       | 474,954                  |       | 448,774                     |       |
| Less:                                                                                                                                                                                                                           |       |                     |       |                        |       |
| Treasury  stock, at cost, 128,760 and 152,360 shares at March 31, 2005 and December 31,  2004, respectively                                                                                                           |       | (4,466                   | )          | (5,250                      | )          |
| **Total  stockholders’ equity**                                                                                                                                                                                            |       | 470,488                  |       | 443,524                     |       |
| **Total  liabilities and stockholders’ equity**                                                                                                                                                                            |       | $                        | 563,239    |                        | $          | 545,174 |   |

 

The accompanying notes are an integral partof these condensed consolidated financial statements.

 

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**Eon Labs, Inc. and SubsidiariesCondensed ConsolidatedStatements of Income**(dollars in thousands, except per share amounts) (unaudited)

 
| ** **                                  | ** ** | **For the three months ended  March 31,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
|                                        |       |                                           |       |   |   |
| Net sales                                   |       | $                                              | 101,048    |   | $ | 104,229 |   |
| Cost of  sales                              |       | 41,652                                         |       | 42,921 |   |
|                                        |       |                                           |       |   |   |
| **Gross  profit**                           |       | 59,396                                         |       | 61,308 |   |
|                                        |       |                                           |       |   |   |
| Operating  expenses                         |       |                                           |       |   |   |
| Selling,  general and administrative        |       | 10,953                                         |       | 12,983 |   |
| Research and  development                   |       | 4,954                                          |       | 5,570 |   |
| Merger  related costs                       |       | 2,976                                          |       | — |   |
|                                        |       |                                           |       |   |   |
| **Total  operating expenses**               |       | 18,883                                         |       | 18,553 |   |
|                                        |       |                                           |       |   |   |
| **Operating  income**                       |       | 40,513                                         |       | 42,755 |   |
|                                        |       |                                           |       |   |   |
| Other  income, net                          |       |                                           |       |   |   |
| Interest  income                            |       | 954                                            |       | 448 |   |
| Other  (expense) income, net                |       | (4                                             | )          | 10,022 |   |
|                                        |       |                                           |       |   |   |
| **Total  other income, net**                |       | 950                                            |       | 10,470 |   |
|                                        |       |                                           |       |   |   |
| Income  before provision for income taxes   |       | 41,463                                         |       | 53,225 |   |
|                                        |       |                                           |       |   |   |
| Provision  for income taxes                 |       | (15,384                                        | )          | (20,908 | ) |
|                                        |       |                                           |       |   |   |
| **Net  income**                             |       | $                                              | 26,079     |   | $ | 32,317 |   |
|                                        |       |                                           |       |   |   |
| Net income  per common share                |       |                                           |       |   |   |
| Basic                                       |       | $                                              | 0.29       |   | $ | 0.36 |   |
| Diluted                                     |       | $                                              | 0.29       |   | $ | 0.36 |   |
|                                        |       |                                           |       |   |   |
| Weighted  average common shares outstanding |       |                                           |       |   |   |
| Basic                                       |       | 88,841,105                                     |       | 88,710,774 |   |
| Diluted                                     |       | 90,608,434                                     |       | 90,778,406 |   |

 

The accompanying notes are an integral partof these condensed consolidated financial statements.

 

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**Eon Labs, Inc. and SubsidiariesCondensed ConsolidatedStatements of Cash Flows**(dollars in thousands) (unaudited)

 
| ** **                                                                         | ** ** | **For the three months ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
| **Cash  flows from operating activities**                                          |       |                                           |       |   |   |
| Net income                                                                         |       | $                                              | 26,079     |   | $ | 32,317 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                           |       |   |   |
| Provision  for customer allowances                                                 |       | —                                         |       | 4,844 |   |
| Depreciation  and amortization                                                     |       | 2,820                                          |       | 2,550 |   |
| Deferred  income taxes                                                             |       | 10                                             |       | 735 |   |
| Amortization  of deferred compensation                                             |       | —                                         |       | 46 |   |
| Amortization  of deferred revenue                                                  |       | —                                         |       | (58 | ) |
| Loss on  foreign currency translation                                              |       | —                                         |       | (12 | ) |
| Tax benefit  from exercises of stock options                                       |       | 354                                            |       | 3,368 |   |
| Changes in  assets and liabilities:                                                |       |                                           |       |   |   |
| Accounts  receivable                                                               |       | 16,978                                         |       | (18,136 | ) |
| Inventories                                                                        |       | (13,401                                        | )          | (5,522 | ) |
| Prepaid  expenses and other current assets                                         |       | 12,807                                         |       | 2,218 |   |
| Other assets                                                                       |       | —                                         |       | (564 | ) |
| Accounts  payable                                                                  |       | (14                                            | )          | (1,981 | ) |
| Accrued  liabilities                                                               |       | (9,286                                         | )          | 6,629 |   |
| Deferred  revenue and other long term liabilities                                  |       | 94                                             |       | — |   |
| **Net cash  provided by operating activities**                                     |       | 36,441                                         |       | 26,434 |   |
|                                                                               |       |                                           |       |   |   |
| **Cash  flows from investing activities**                                          |       |                                           |       |   |   |
| Capital  expenditures                                                              |       | (4,062                                         | )          | (1,860 | ) |
| Net  purchases of short-term investments                                           |       | (29,617                                        | )          | 11,478 |   |
| **Net cash  (used in) provided by investing activities**                           |       | (33,679                                        | )          | 9,618 |   |
|                                                                               |       |                                           |       |   |   |
| **Cash  flows from financing activities**                                          |       |                                           |       |   |   |
| (Increase)  Decrease in restricted cash                                            |       | (3                                             | )          | 65 |   |
| Proceeds  from exercises of stock options                                          |       | 673                                            |       | 635 |   |
| Purchase of  treasury shares                                                       |       | —                                         |       | (5,547 | ) |
| Other                                                                              |       | 191                                            |       | — |   |
| **Net cash  provided by (used in) financing activities**                           |       | 861                                            |       | (4,847 | ) |
| Effect of  exchange rate changes on cash and cash equivalents                      |       | 167                                            |       | — |   |
|                                                                               |       |                                           |       |   |   |
| **Net  increase in cash and cash equivalents**                                     |       | 3,790                                          |       | 31,205 |   |
|                                                                               |       |                                           |       |   |   |
| Cash and  cash equivalents at beginning of period                                  |       | 59,500                                         |       | 43,852 |   |
|                                                                               |       |                                           |       |   |   |
| Cash and  cash equivalents at end of period                                        |       | $                                              | 63,290     |   | $ | 75,057 |   |

 

The accompanying notes are an integral partof these condensed consolidated financial statements.

 

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**Eon Labs, Inc.and SubsidiariesNotes to CondensedConsolidated Financial Statements**(dollars in thousands, except per share amounts)(unaudited)

 

# **1.**                   Natureof Operations

 

Eon Labs, Inc. and Subsidiaries (the “Company”) is a genericpharmaceutical company engaged in the development, licensing, manufacturing,selling and distribution of a broad range of prescription pharmaceuticalproducts primarily in the United States. The Company’s products are soldprimarily to drug wholesalers, national drug chains and mail order accounts, aswell as large HMOs. The Company operates in one business reporting segment.

 

On February 20, 2005, the Company entered into an Agreement andPlan of Merger (the “Merger Agreement”) with Novartis Corporation, a New Yorkcorporation (“Novartis”), Zodnas Acquisition Corp., a Delaware corporation anda wholly owned subsidiary of Novartis (“Merger Sub”), and, solely with respectto its guarantee of Novartis’s and Merger Sub’s obligations thereunder,Novartis AG, a Swiss corporation (“Parent”).  See Note 11 for additional informationregarding the Merger Agreement.

 

# **2.**                   Basisof Presentation

 

The condensed consolidated financial statements included herein havebeen prepared by Eon Labs, Inc. and its subsidiaries without auditpursuant to the rules and regulations of the United States Securities andExchange Commission.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting 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 the Company’sfinancial position as of March 31, 2005 and results of its operations andcash flows for the periods presented.  The consolidated balances as of December 31,2004 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, 2004. The results of operations for the interim periods are not necessarilyindicative of the results of operations to be expected for the year.

 

## **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 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 areserve for discounts and rebates based upon actual sales under sucharrangements. Reserves for contract pricing adjustments represent the differencebetween the prices wholesalers are billed by the Company and the contractprices billed by wholesalers to their customers. In determining a

 

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reserve for contract pricing adjustments, the Company takes intoaccount an estimate of the percentage of product sales subject to such pricingadjustments based on historical trends. Historical trends are adjusted for newproduct introductions and changes in wholesaler or contract prices.

 

Accounts receivable is presented net of allowances for discounts,rebates, contract pricing adjustments and doubtful accounts, which were $123,181and $138,022 at March 31, 2005 and December 31, 2004, respectively.

 

Shelf stock adjustments are provided following a reduction in theprices of the Company’s products due to the competitive environment. Suchadjustments are credited to the Company’s customers based on their on-handinventory quantities. Reserves are generally established when the Companyreduces its prices.

 

Estimates for returns, which are recorded at the time of sale, relateprimarily to returns of expiring products. The Company utilizes historicaltrends to estimate the amount of products to be returned due to productexpiration.

 

Accrued liabilities include $55,833 and $67,435 for returns,promotional incentives and Medicaid rebates at March 31, 2005 and December 31,2004, respectively.

 

## **Shipping andHandling Costs**

 

The Company classifies shipping and handling costs as part of selling,general and administrative expenses.  Shipping and handling costs were$1,359 and $1,315 for the three months ended March 31, 2005 and 2004,respectively.

 

## **Investments**

 

The Company invests in publicly traded debt securities which arecategorized as securities available-for-sale and are carried at fairvalue.  Unrealized gains and losses related to such securities, net oftaxes, are excluded from operating results and reported as accumulated othercomprehensive income/loss in the Stockholders’ Equity section of thebalance sheet.  The Company periodically evaluates declines in the valueof its investments to determine if such declines are other-than-temporary andthus the investment is impaired.  A variety of factors are considered whendetermining whether declines are other-than-temporary, including, among others,the financial condition of the investee, the length of time and magnitude ofthe decline, and the Company’s ability and intent to hold the investment.

 

The book value of such securities exceeded market value by $466 at March 31,2005 and $292 at December 31, 2004. The book value of such securities exceeded market value by $59 at March 31,2004.

 

## **ComprehensiveIncome**

 

Statement of Financial Accounting Standard (“SFAS”) No. 130, “ReportingComprehensive Income,” requires reporting and displaying comprehensive incomeand its components, which for the Company includes net income, unrealized gainsand losses, net of tax, on available-for-

 

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sale securities and foreign currency translation gains andlosses.  Total comprehensive income was $25,937 and $29,962 for the three monthsended March 31, 2005 and 2004, respectively.  In accordance with SFAS No. 130, theaccumulated unrealized gains (losses) on available-for-sale securities and gains(losses) on foreign currency translation are shown as a separate component ofstockholders’ equity.

 

## **Other Income**

##  

Other income for the three months ended March 31, 2004 includesthe receipt of a $10,000 settlement from GlaxoWellcome Inc. (“Glaxo”), inexchange for agreeing to the dismissal of the Company’s complaint against Glaxofor malicious prosecution of an earlier suit against the Company, which claimedthe Company’s Nabumetone product infringed Glaxo’s patent.  See Note 9.

 

**Merger-Related Costs**

 

For the first quarter ended March 31, 2005, merger-related costs,primarily legal and investment banking fees, of $3.0 million were expensed asincurred in connection with the pending acquisition of the Company by NovartisAG.  See Note 11.

 

## **Reclassifications**

 

Amortization of other intangibles of $940 for the three months ended March 31,2004 previously included in selling, general and administrative expenses hasbeen reclassified to cost of sales.

 

# **3.**                   Stockholders’Equity

 

## **Stock Split**

 

On June 1, 2004, Eon distributed approximately 44.5 millionadditional shares of common stock in order to effect a 2-for-1 stock splitdeclared in May 2004.  The stock split was effected in the form of a100% stock dividend for stockholders of record at the close of business on May 17,2004.  All share and per share data have been retroactively restated toreflect the impact of the stock split.

 

## **AdditionalPaid-In Capital**

 

Additional paid-in capital increased by $243 to $193,010 at March 31,2005 from $192,767 at December 31, 2004.  The increase is the resultof $673 of proceeds from the exercise of employee stock options and $354 of taxbenefits associated with these transactions offset by the reissuance of $784 oftreasury shares.

 

## **Stock Options**

 

During the three months ended March 31, 2005, options to purchase 585,000shares of common stock at an average exercise price of $28.75 per share weregranted.  The stock options granted are exercisable for up to 10 yearsfollowing the date of the grant.  Except for 60,000 options,

 

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which vested immediately upon grant, the options vest and becomeexercisable at the rate of 20% per year.

 

During the three months ended March 31, 2005, 53,600 options witha weighted-average exercise price of $12.59 were exercised and 150,000 optionswere cancelled.

 

## **DeferredStock-Based Compensation**

 

The Company recorded amortization for deferred stock compensation of $46for the three months ended March 31, 2004.

 

## **Stock-BasedCompensation**

 

The Company has adopted SFAS No. 123 “Accounting for Stock-BasedCompensation.”  SFAS No. 123 allows companies which have stock-basedcompensation arrangements with employees to adopt a new fair-value basis ofaccounting for stock options and other equity instruments, or to continue toapply the existing accounting required by Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock Issued to Employees.”  TheCompany continues to account for stock-based compensation arrangements underAPB Opinion No. 25 and related interpretations in accounting for itsstock-based compensation.  The Company recognizes no compensation expensewith respect to stock options if the exercise price equals or exceeds the fairvalue of the underlying security on the date of grant and other terms arefixed.  The Company has also adopted the disclosure provisions ofSFAS No. 148 “Accounting for Stock-Based Compensation - Transitionand Disclosure.”  This pronouncement requires prominent disclosures inboth annual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used onreporting results as determined through the use of the Black-Scholesoption-pricing model.  The additional required disclosures are foundbelow.

 

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

 
| ** **               | ** ** | **March 31, 2005** | ** ** | **March 31, 2004** | ** ** |
|--------------------------|------------|-------------------------|------------|-------------------------|------------|
|                     |       |                    |       |                    |       |
| Dividend  yield          |       | 0                       | %          | 0                       | %          |
| Volatility               |       | 45                      | %          | 45                      | %          |
| Risk-free  interest rate |       | 3.54                    | %          | 3.41                    | %          |
| Expected  life           |       | 5 years                 |       | 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, 2005 and 2004 is provided below.  For purposesof pro forma disclosure, stock-based compensation expense is recognized inaccordance with the provisions of SFAS No. 123.

 

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| ** **                                                                                                  | ** ** | **For the three months  ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
|                                                                                                        |       |                                           |       |   |   |
| Net income,  as reported                                                                                    |       | $                                              | 26,079     |   | $ | 32,317 |   |
| Add:  Compensation expenses included in net income, net of related tax effect                               |       | —                                         |       | 28 |   |
| Less:  Adjustment to net income for pro forma stock-based compensation expenses, net  of related tax effect |       | (1,115                                         | )          | (922 | ) |
|                                                                                                        |       |                                           |       |   |   |
| Pro forma  net income                                                                                       |       | $                                              | 24,964     |   | $ | 31,423 |   |
|                                                                                                        |       |                                           |       |   |   |
| As reported  net earnings per share:                                                                        |       |                                           |       |   |   |
| Basic                                                                                                       |       | $                                              | 0.29       |   | $ | 0.36 |   |
| Diluted                                                                                                     |       | $                                              | 0.29       |   | $ | 0.36 |   |
|                                                                                                        |       |                                           |       |   |   |
| Pro forma  net earnings per share:                                                                          |       |                                           |       |   |   |
| Basic                                                                                                       |       | $                                              | 0.28       |   | $ | 0.35 |   |
| Diluted                                                                                                     |       | $                                              | 0.28       |   | $ | 0.35 |   |

 

## **StockRepurchase Program**

 

In February 2004, the Company adopted a plan to repurchase up to187,500 shares of the Company’s Common Stock through March 31, 2004. In April 2004, the Company adopted a plan to repurchase up to 187,500shares of the Company’s Common Stock through June 30, 2004. As of March 31,2005, the Company had 128,760 treasury shares and does not expect to make anyadditional future purchases.  The repurchased shares have been accountedfor as treasury shares and will be used to offset potential dilution from theexercise of outstanding stock options.

 

During the three months ended March 31, 2004, in accordance withthese plans, the Company repurchased 187,500 of the Company’s Common Stock atan average price of $29.58 per share totaling $5,547.  These transactionsare accounted for under the cost method.

 

# **4.**                   NetIncome 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 the potential dilution of stockoptions.  Details of the calculations are as follows:

 

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| ** **                                 | ** ** | **For the three months  ended March 31,** | ** ** |
|--------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
|                                       |       |                                           |       |   |   |
| **Net  income per share-basic:**           |       |                                           |       |   |   |
|                                       |       |                                           |       |   |   |
| Net income                                 |       | $                                              | 26,079     |   | $ | 32,317 |   |
|                                       |       |                                           |       |   |   |
| Weighted  average shares outstanding-basic |       | 88,841,105                                     |       | 88,710,774 |   |
| Net income  per share-basic                |       | $                                              | 0.29       |   | $ | 0.36 |   |
|                                       |       |                                           |       |   |   |
| **Net  income per share-diluted:**         |       |                                           |       |   |   |
|                                       |       |                                           |       |   |   |
| Net income                                 |       | $                                              | 26,079     |   | $ | 32,317 |   |
|                                       |       |                                           |       |   |   |
| Weighted  average shares outstanding-basic |       | 88,841,105                                     |       | 88,710,774 |   |
| Dilutive  effect of stock options          |       | 1,767,329                                      |       | 2,067,632 |   |
|                                       |       |                                           |       |   |   |
| Weighted  average shares-diluted           |       | 90,608,434                                     |       | 90,778,406 |   |
| Net income  per share-diluted              |       | $                                              | 0.29       |   | $ | 0.36 |   |

 

Excluded from this earnings per share calculation are options topurchase 1,185,000 and 600,000 shares for the three months ended March 31,2005 and 2004, respectively, as their impact would be anti-dilutive.

 

# **5.**                   Adoptionof New Accounting Pronouncements

 

In December 2004, the FASB issued FASB Statement No. 123(R) (revisedDecember 2004), “Share-Based Payments” (“FAS 123(R)”), which requirescompanies to expense the value of employee and director stock options andsimilar awards. FAS 123(R) is effective for fiscal years beginningsubsequent to June 15, 2005. The Company is reviewing the variousimplementation methods under this pronouncement.

 

In December 2004, the FASB issued SFAS No. 153, “Exchange ofNonmonetary Assets an amendment of APB Opinion No. 29.” This Statementprecludes companies from using the “similar productive assets” criteria toaccount for nonmonetary exchanges at book value with no gain or loss beingrecognized. Effective for fiscal periods beginning after June 15, 2005,all companies will be required to use fair value for most nonmonetaryexchanges, recognizing gain or loss, if the transaction meets acommercial-substance criteria. The Company does not expect this Standard tohave a significant impact on its consolidated financial statements.

 

In December 2004, the FASB issued FSP FAS 109-1, “Application ofFASB Statement No. 109, ‘Accounting for Income Taxes,’ to the TaxDeduction on Qualified Production Activities Provided by the American JobsCreation Act of 2004” to provide accounting guidance on the

 

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appropriate treatment of tax benefits generated by the enactment of theAct. The FSP requires that the manufacturer’s deduction be treated as a specialdeduction in accordance with SFAS 109 and not as a tax rate reduction.  Provisions in the American Jobs Creation Actof 2004 reduced the Company’s effective tax rate for the quarter ended March 31,2005 by less than 1%.

 

In November 2004, the FASB issued Statement No. 151, “InventoryCosts, an amendment of ARB 43, Chapter 4” (“SFAS 151”), to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted materials (spoilage). ARB 43 allowed some of these “abnormalcosts” to be carried as inventory whereas the new Standard requires that thesecosts be recognized in income as incurred. This Statement is effective forfiscal years beginning after June 15, 2005. The Company is currentlyevaluating what effect, if any, this Standard will have on its consolidatedfinancial statements.

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidationof Variable Interest Entities” (as revised by Fin No. 46R). Thisinterpretation, as revised, provides guidance with respect to the consolidationof certain entities, referred to as variable interest entities (“VIEs”), inwhich an investor is subject to a majority of the risk of loss from the VIEs’activities, or is entitled to receive a majority of the VIEs’ residual returns.This interpretation also provides guidance with respect to the disclosure ofVIEs in which an investor maintains an interest, but is not required toconsolidate. The provisions of the interpretation were effective immediatelyfor all VIEs created after January 31, 2003, or in which the Companyobtains an interest after that date. For VIEs created before February 1,2003, the provisions were effective July 1, 2003. In November 2003,the Company invested $1,150 for 50% ownership in an entity formed to provideresearch and development services for the Company as well as third parties. Ithas been determined that such investee is deemed a VIE, which has beenconsolidated in the Company’s financial statements. The net assets and resultof operations of this entity have not been material to the Company. Creditors,or beneficial interest holders, of the consolidated VIE have no recourse to thegeneral credit of the Company.

 

# **6.**                   Inventories

 

Inventories consist of the following:

 
| ** **      | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------|------------|--------------------------|------------|-----------------------------|------------|
| Raw material    |       | $                        | 42,925     |                        | $          | 39,279 |   |
| Work-in-process |       | 12,093                   |       | 8,988                       |       |
| Finished  goods |       | 30,848                   |       | 24,198                      |       |
|            |       |                     |       |                        |       |
|            |       | $                        | 85,866     |                        | $          | 72,465 |   |

 

# **7.**                   Lineof Credit

 

On February 8, 2002, the Company entered into a three-year$25 million credit agreement, which was amended and restated on July 30,2004, extending the term of the agreement to December 31, 2007 andeliminating a security interest in the Company’s accounts receivable and

 

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inventories.  Interest on any borrowing under the line will accrueat the rate of interest equal to either the adjusted LIBOR rate plus 1.5%, theprime rate or the fixed rate (as set by the bank).  The rate will dependupon the terms of the selected borrowings.  There is an annual commitmentfee of 0.2% on any unused portion of the line. The agreement has covenantswhich require the maintenance of certain financial ratios, including leverage,consolidated debt and minimum consolidated net worth, as further describedtherein.  At March 31, 2005 and December 31, 2004, there were noborrowings under the credit agreement.

 

# **8.**                   TransactionsBetween the Company and Related Parties

 

The following is a summary of the Company’s related-party transactions:

 
| ** **                                                                                              | ** ** | **For the three months ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
| Net sales to  subsidiaries of Hexal AG                                                                  |       | $                                              | 438        |   | $ | 564 |   |
| Purchases of  products and supplies from subsidiaries of Hexal AG                                       |       | 487                                            |       | 607 |   |
| Hexal AG  reimbursement to the Company for expenditures that were made on Hexal AG’s  behalf       |       | —                                         |       | 574 |   |
| Company’s  reimbursement to Hexal AG for expenditures that were made on the Company’s  behalf |       | 20                                             |       | 90 |   |
| Cyclosporine  agreements with Hexal AG(1)                                                               |       | 563                                            |       | 1,220 |   |
| Fees  incurred under product development agreements with Hexal AG                                       |       | —                                         |       | 300 |   |
|                                                                                                         |            |                                                |            |  |  |  |  |

 

----

(1)               Underagreements with Hexal AG, the Company pays Hexal AG based on sales of specificproducts, which were developed using Hexal AG’s patented technology.

 

At March 31, 2005 and December 31, 2004, the Company had apayable to Hexal AG of approximately $1,017 and $1,713, respectively, includedin accrued liabilities.

 

At March 31, 2005 and December 31, 2004, the Company hadreceivables from subsidiaries of Hexal AG of approximately $515 and $104,respectively, included in prepaid expenses and other current assets.

 

# **9.**                   LegalProceedings

 

### *Fen-phenLitigation*

###  

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

 

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typically name as a defendant Wyeth (formerly American Home ProductsCorporation), the manufacturer of two anti-obesity drugs, Fenfluramine andDexfenfluramine, and also name manufacturers, distributors and retailers ofPhentermine. Fenfluramine and Phentermine were prescribed in combination in anoff-label use commonly called “fen-phen,” while Dexfenfluramine was generallyprescribed alone, but occasionally in combination with Phentermine. In September 1997,the manufacturer of Fenfluramine and Dexfenfluramine agreed with the FDA tovoluntarily withdraw both products from the market. The FDA has not requestedthat Phentermine 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 allegeemotional distress caused by the purported increased risk of injury in thefuture.  Plaintiffs typically seek reliefin the form of monetary damages (including economic losses, medical care andmonitoring expenses, loss of earnings and earnings capacity, other compensatorydamages and punitive damages), generally in unspecified amounts, on behalf ofan individual or a class. Some actions seeking class certification ask forcertain types of equitable relief, including, but not limited to, declaratoryjudgments and the establishment of a research program or medical surveillancefund. 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.

 

During 2000, the U.S. District Court for the Eastern District ofPennsylvania, 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 experts were the only “national”anti-Phentermine “causation” experts identified in the consolidated federallitigation, and were to have been “generic” experts in hundreds of cases. TheCourt’s decision to curb their testimony substantially has resulted in manycases being dismissed. To date, there has been no scientific testimony acceptedby any court that establishes a connection between the use of Phentermine,either alone or in combination with Fenfluramine and/or Dexfenfluramine, andthe allegations of injury made by plaintiffs in these lawsuits.

 

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 U.S. District Courtfor the Eastern District of Pennsylvania, which supervises discovery of all federalfen-phen cases in a consolidated multidistrict litigation, certified anationwide settlement class and approved the proposed settlement, which becamefinal in January 2002. This settlement, which has been amended severaltimes, has reduced the number of new cases in which the Company and itsdistributors have been named as defendants.

 

As of May 5, 2005, the Company had been named and served in over7,100 fen-phen product liability cases. More than 97% of these cases have beendismissed, and the Company remains a defendant in approximately 178 pendingfen-phen cases. Since the beginning of the fen-phen litigation, only one casehas gone to trial with the Company and its distributors as defendants. In thatinstance, the case against the Company and all the Phentermine defendants,including other

 

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Phentermine manufacturers and distributors, was dismissed on motionbefore the presentation of any evidence.

 

While the number of lawsuits being filed has decreased substantially,the Company expects additional, similar lawsuits to be filed. The Company andits outside counsel believe that the Company has substantial defenses to theseclaims, though the ultimate outcome cannot be determined. As of March 31,2005, there had been no finding of liability for fen-phen injury against theCompany and no payment by the Company to settle any combination-relatedfen-phen lawsuit.

 

### *PhentermineLitigation*

 

The Company has been named as a defendant in several cases in which theplaintiffs allege 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 theseclaims have been dismissed in the Company’s favor, and as of March 31,2005, only one such claim remained pending.

 

Because discovery has not been completed in this pending case,predicting the ultimate outcome of this action is not possible, and noprovision for any related liability has been reflected in the Company’sfinancial statements. The Company believes it has substantial defenses to thisclaim.

 

### *Defense/IndemnityIssues Related to Fen-phen and 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 Companyhas funded its own defense in such lawsuits. However, pursuant to an October 1999settlement with an insurance carrier, the Company has made insurance coverageclaims for fen-phen claims filed on or after June 22, 2003, which allegefen-phen use prior to June 1998. These claims were settled during thethird quarter of 2004 for a one-time payment of approximately $1.4 million thatwas used to defray fen-phen defense costs. Additionally, the Company agreed tofund or partially fund the defense of certain of its distributors and toindemnify them, provided certain conditions are met. Furthermore, the Companyhas reached favorable defense/indemnity agreements with several retailers ofthe Company’s Phentermine products.

 

The Company currently maintains $75.0 million per claim and in theaggregate of claims-made product liability/completed operations insurance forits products, all of which is available for Phentermine-related claims(retroactive to June 1998), excluding fen-phen and Phentermine combinationclaims. Under the Company’s current product liability/completed operationsinsurance plan, the Company has a self-insured retention of $10.0 million perclaim not to exceed $10.0 million in the aggregate.

 

### *Other ProductLiability Litigation*

 

The Company has been named as a defendant in several other productliability lawsuits in which plaintiffs allege that Company-manufacturedpharmaceuticals containing phenylpropanolamine

 

15

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(“PPA”) caused injury.  PPA wasremoved from the market in 2000 at the FDA’s request after a study appeared toshow a potentially increased risk of hemorrhagic stroke in certain patientcohorts.  The Company previouslymanufactured two low-volume prescription products that contained PPA that werediscontinued in 1999 and 2000.

 

To date, the Company has been named in five lawsuits alleging injury orwrongful death from the use of Company-manufactured pharmaceuticals containingPPA.  As of March 31, 2005, all buttwo PPA cases against the Company had been dismissed or discontinued.  Lawsuits filed in 2002 in the New YorkSupreme Court and in 2003 in the U.S. District Court for the District ofMaryland, which was later transferred to the U.S. District Court for theWestern District of Washington, remain pending.  Discovery in these lawsuits is ongoing, andpredicting the ultimate outcome of these actions is not possible.  The Company believes its product liabilityinsurance is adequate to cover existing PPA claims.

 

In May 2004, the Company was also named defendant in a productliability lawsuit in the U.S. District Court for the Northern District of Ohioin which the plaintiff alleges injury from the use of Company-manufacturedLisinopril/HCTZ.  As the Company productliability insurance policy is a claims made policy, the insurance coverageavailable to the Company is the amount that was in effect on the date the claimwas made. The policies in effect at the time the claim was made provided for$50.0 million of coverage with a self-insured retention of $100,000. Discoveryin this case continues, and the Company believes it would be premature toexpress a judgment as to its outcome.

 

The Company has been named as a defendant in several lawsuits in whichplaintiffs allege that Company-manufactured Amiodarone caused injury or death.  As of March 31, 2005, the Companyremained a defendant in two Amiodarone-related lawsuits. In the first lawsuit,pending in the U.S. District Court for the Middle District of Florida, theplaintiffs allege generic Amiodarone manufactured by the Company and severalother pharmaceutical companies caused a wrongful death.  In the second lawsuit, pending in the SuperiorCourt of New Jersey, plaintiffs purporting to represent a class comprised ofusers of Amiodarone nationwide from 1985 to the present allege injury and seekclass certification, damages, refunds, medical monitoring, exemplary damagesand other relief, including injunctive relief, against several of themanufacturers of Amiodarone.  Discoveryin these cases has not yet begun, and the Company believes it would bepremature to express a judgment as to their outcomes.

 

In March 2005, the Company was named in an action filed in theSupreme Court of New York, in which the plaintiff alleges various injuries,including toxic epidermal necrolysis, from the use of generic Oxaprozin.  In the action, plaintiff Annie Jones allegesthat generic Oxaprozin was defectively designed and unreasonably dangerous, andthat the Company failed adequately to warn of the risks of the drug.  The complaint, which also alleges breach ofexpress and implied warranties and loss of consortium by plaintiff’s husband,seeks damages and punitive damages.  Thecomplaint also names Pfizer Inc. (“Pfizer”), which manufactures the applicablebrand name product, as a defendant. Because this litigation has just begun, it is not possible to speculateon its merits or its eventual outcome, though the Company believes it has validdefenses to this claim.

 

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## **PatentInfringement Litigation**

 

On August 30, 2000, Novartis Pharmaceuticals Corporation (“NovartisPharmaceuticals”) filed a complaint in the U.S. District Court for the Districtof Delaware alleging, among other things, that the Company’s genericCyclosporine product infringes a patent owned by Novartis Pharmaceuticals. TheCompany obtained a non-infringement opinion with regard to its product prior tomarketing it, and believes that there is no merit to the allegations in thecomplaint. Novartis Pharmaceuticals is seeking injunctive relief to prevent theCompany’s alleged acts of infringement, as well as an unspecified amount ofdamages, costs and expenses, reasonable attorneys’ fees and treble damages forwillful infringement. The Company’s potential liability and expenses in thismatter are not covered by insurance. In December 2002, the U.S. DistrictCourt for the District of Delaware granted the Company’s motion for summaryjudgment of non-infringement of the patent. In April 2004, the U.S. Courtof Appeals for the Federal Circuit affirmed the judgment of the DelawareDistrict Court that the Company’s generic Cyclosporine product does notinfringe Novartis Pharmaceuticals’ patent. Novartis Pharmaceuticals’ requestfor a rehearing by the U.S. Appeals Court is still pending. An adverse outcomein this litigation could result in the Company being unable to marketCyclosporine, which could materially harm profits and cash flows and couldresult in paying damages, costs, expenses and fees that could have a materialadverse impact on the Company’s financial performance.

 

On January 26, 2001, Apotex Inc. (“Apotex”), a Canadian genericpharmaceutical company, filed a complaint in the U.S. District Court for theEastern District of New York alleging, among other things, that the Company hasbeen and is infringing its patent related to Cyclosporine. Apotex is seekinginjunctive relief to prevent alleged acts of infringement, as well as damages,including a reasonable royalty, costs, expenses, reasonable attorneys’ fees andtreble damages for willful infringement. A trial is scheduled for May 2005.The Company’s potential liability and expenses in this matter are not coveredby insurance. The Company believes that it has meritorious defenses to Apotex’claims and is vigorously defending itself. 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 adverse impact onthe Company’s financial performance.

 

In November 2000, Glaxo filed suit against the Company in the U.S.District Court for the Southern District of New York alleging infringement oftwo patents based on the Company’s filing of an ANDA to market genericBupropion Hydrochloride 100mg and 150mg ER (extended release) tablets. In April 2004,a Stipulation and Order was entered in the U.S. District Court for the SouthernDistrict of New York, terminating all pending claims and counterclaims in a patentinfringement litigation that Glaxo brought against the Company in November 2000,concerning the Company’s Bupropion HCl, ER 100 mg and 150 mg tablets. Under theterms of the Stipulation and a separate Settlement Agreement, Glaxo agreed todrop any further effort to pursue its claim that the Company’s Bupropion HCl,ER 100 mg and 150 mg tablets infringe Glaxo’s patents. In April 2004, theCompany received $3.0 million as part of the Settlement Agreement. The $3.0million received has been be recorded as other income by the Company in thequarter ended June 30, 2004.

 

In July 2004, the U.S. District Court for the Eastern District ofNew York ruled on a pending patent infringement case that involved Itraconazolecapsules. The suit, filed in April 2001 by

 

17

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Janssen Pharmaceutica, N.V. (“Janssen”), claimed that the Company’sfiling of an ANDA for Itraconazole capsules infringed its patent. The DistrictCourt ruling found that the Company’s ANDA product did not infringe the patent,but the Court did not invalidate the patent. On August 10, 2004, Janssenfiled a Notice Of Appeal to the Federal Circuit Court of Appeals. Janssen’sappeal of the District Court’s ruling is pending. In February 2005, theCompany began selling Itraconazole capsules. A reversal of the District Court’sruling by the Court of Appeals could result in the Company being enjoined frommarketing the product which could materially harm profits and cash flows, andresult in paying damages, costs, and fees that could have a material adverseimpact on the Company’s financial performance. The Company and its outsidecounsel believe that the Company has substantial defenses and counterclaims tothe foregoing patent infringement actions, though the ultimate outcome cannotbe determined.

 

In March 2001, Pfizer filed suit against the Company in theEastern District of New York (now consolidated in the U.S. District Court forthe District of New Jersey) alleging that the Company infringed a patent heldby Pfizer by filing an ANDA to market the generic drug Gabapentin in capsuleform.  In April 2005, the Companybegan selling Gabapentin capsules.  Anadverse ruling could result in the Company being enjoined from furthermarketing the product which could materially impair profits and cash flows, andresult in paying damages, costs, and fees which could have a materially adverseimpact on the Company’s financial performance.

 

On October 29, 2004, the Company began shipping the generic drugCitalopram Hydrobromide. Earlier in October 2004, the Company received anotice from Forest Laboratories, Inc. and H. Lundbeck A/S that requestedcertain information from the Company. The notice also included a list ofpatents that they hold which they allege covers Citalopram Hydrobromide.  To date, the Company has not been sued forpatent infringement in connection with its sale of Citalopram Hydrobromide.

 

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 precludingthe FDA from approving the Company’s application to market a product beforetheir respective patents expire and have asserted claims that the allegedinfringements were willful, the actions are therefore exceptional and theplaintiffs should therefore be awarded the attorney’s fees they have incurredin the actions.

 

The Company and its legal counsel are unable to determine the ultimateoutcome of these actions or the probability that a material loss could beincurred. As such, no provision for any related liability has been reflected inthe Company’s financial statements.

 

## **Nabumetone  Settlement**

 

In August 2001, the Company was successful in defending itself inthe U.S. District Court for the District of Massachusetts against a patentinfringement claim involving Nabumetone. At the conclusion of the trial, theCompany filed a motion to recover the legal fees it incurred in defending theaction. The motion was stayed pending the appeal of the District Court’sruling. The Court of Appeals affirmed the District Court decision in August 2002.In May 2003, the Company and the original plaintiff reached an agreementregarding the Company’s motion to

 

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recover legal fees. Under the agreement, the Company was reimbursed$3,500 for legal fees it had incurred in defending itself. The recovery oflegal fees was reflected in other selling, general and administrative expensesduring the quarter ended June 30, 2003. In February 2004, the Companystipulated to an order dismissing its complaint against Glaxo for maliciousprosecution of Glaxo’s earlier suit against the Company, which claimed theCompany’s Nabumetone product infringed Glaxo’s patent. In exchange for theCompany agreeing to the dismissal of its complaint, the Company received$10,000, which was included in other income in the quarter ended March 31,2004.

 

## **OtherLitigation**

 

In January 2005, the Company filed a declaratory judgment actionagainst Pfizer regarding generic Azithromycin. The Company filed an ANDA tomarket 250mg, 500mg, and 600mg tablets. The complaint seeks declaration ofnon-infringement of Pfizer’s patent Nos. 6,268,489 and 5,605,889. Thelitigation is pending in the U.S. District Court for the Southern District ofNew York. On or about February 23, 2005, Pfizer filed a motion to dismissthe complaint.

 

Subsequent to the public announcement of the execution of the MergerAgreement on February 21, 2005, eight purported class actions were filed —one in the Supreme Court of the State of New York and seven in the Court ofChancery of the State of Delaware — naming as defendants the Company, NovartisAG, Thomas Strüngmann, Ph.D., Bernhard Hampl, Ph.D., Mark R. Patterson, FrankF. Beelitz and Douglas M. Karp.  (Inthree of those actions, Novartis was also named as a defendant, in two of thoseactions Merger Sub was also named as a defendant, and in one of those actionsSanto Holding (Deutschland) GmbH (“Santo”) was also named as a defendant.)

 

The actions, purportedly on behalf of all public stockholders of theCompany other than the defendants, in substance allege that the terms of the Offerand Merger (each as defined in Note 11) are unfair to the Company’s publicstockholders because the value of Company’s publicly held common stock isgreater than the $31 per share price being offered to the Company’s publicstockholders in the Offer and the Merger. All of the complaints assert claims for breach of fiduciary duty and, intheir prayers for relief, seek, interalia, to enjoin the Offerand the Merger.

 

The seven Delaware  actions arecaptioned as follows:  Ellen Wiehl v.Eon Labs, Inc., et al., C.A. No. 1116-N (Del. Ch. Feb. 22,2005); Paulena Partners LLC v. Eon Labs, Inc., et al., C.A. No. 1117-N(Del. Ch. Feb. 22, 2005); Robert Kemp, IRRA v. Eon Labs, Inc., etal., C.A. No. 1119-N (Del. Ch. Feb. 22, 2005); Peter J.Calcagno v. Eon Labs, Inc., et al., C.A. No. 1125-N (Del. Ch. Feb. 23,2005); Erste Sparinvest Kapitalanlagegesellschaft MBH v. Eon Labs, Inc.,et al., C.A. No. 1134-N (Del Ch. Mar. 1, 2005); Huntsinger v.Eon Labs, Inc., et al., C.A. No. 1136-N (Del. Ch. Mar. 1,2005); and Jason Hung v. Eon Labs, Inc. et al., C.A. No.  1139-N(Del. Ch. Mar. 3, 2005).  The NewYork action is captioned as follows:  ChristopherPizzo v. Novartis AG et al., No. 600680/05 (Sup. Ct. Feb. 23,2005).

 

On April 8, 2005, the plaintiff in the Huntsinger casevoluntarily dismissed his claim without prejudice.  That same day, the plaintiffs in theremaining Delaware actions requested that the Court consolidate the pendingcases, and appoint Milberg Weiss Bershad & Schulman as leadcounsel.  The Court granted plaintiffs’consolidation motion on April 12, 2005. There has been no further activity in the case.

 

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The Company and the individual defendants have until June 3, 2005,to answer, move, or otherwise respond to the complaint in the New York action.

 

The Company and its directors believe that all of the actions arewithout merit and intend to vigorously defend them.

 

# **10.**            Contingencies

 

## **MedicaidRebates**

 

The Omnibus Budget Reconciliation Act of 1990, effective January 1,1991, as amended, requires drug companies to enter into a rebate agreement withthe Centers for Medicare and Medicaid Services (formerly called the Health CareFinancing Administration) of the federal government. The rebate agreementstates that drug companies must pay rebates to states for drugs (prescription,non-prescription or biological products) sold to Medicaid recipients. At March 31,2005 and December 31, 2004, the estimated liability for Medicaid rebatesof $5,781 and $7,135, respectively, are included in accrued liabilities.

 

In December 2003, the Attorneys General in at least six states,including the state of Florida, sent letters to numerous pharmaceuticalmanufacturers instructing them to maintain all records relating to their reportingof pricing information under the Medicaid Drug Rebate Statute. The lettersstate that the document retention demand is in furtherance of an ongoinginvestigation of the manufacturers’ compliance with Medicaid drug rebateprogram requirements. The Company received letters from some, but not all, ofthe states believed to be involved, including the state of Florida. The Companybelieves these letters may have been motivated, at least in part, by a federalregulation published in August 2003 that, effective January 1, 2004,would have limited the document retention provisions under the federal MedicaidDrug Rebate Statute to three years unless the records are the subject of anaudit or a government investigation of which the manufacturer is aware. Thatregulation was amended, effective January 6, 2004, to substitute a 10-yearrecord retention requirement. The State of Florida issued subpoenas to sixmanufacturers requesting documents relating to their pricing and discountingpractices in July 2004. The Company has not received any subpoenas,informal document requests, or any other communications from federal or stateenforcement authorities that suggest an investigation of its Medicaid drugrebate reporting practices or its pricing practices is under way. The Companybelieves it operates in compliance with the requirements of the Medicaid DrugRebate Statute.

 

## **State MedicaidClaims**

 

Eon Holdings, Inc. (“EHI”) purchased Major Pharmaceuticals, Inc.(“Major”), a distributor of drug products in 1992 and sold Major in 1995. Atthe time of the sale, EHI established an escrow account to cover any Medicaiddrug rebate liabilities incurred by Major prior to the sale.

 

As of March 31, 2005, the recorded liability for such claims is$817, which management believes is adequate to resolve such matters. TheCompany has approximately $689 as of March 31, 2005, in an escrow accountto fund any such claims.

 

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**11. Proposed Merger**

 

On February 20, 2005, the Companyentered into the Merger Agreement with Novartis, Merger Sub, and, solely withrespect to its guarantee of Novartis’s and Merger Sub’s obligations thereunder,Parent.  Pursuant to the MergerAgreement, Merger Sub will commence a tender offer (the “Offer”) to purchaseall of the issued and outstanding shares of the Company’s common stock, parvalue $0.01 per share (the “Common Stock”) (other than those shares owned bySanto), at a purchase price of $31.00 per share (the “Offer Price”).

 

In connection with the execution of theMerger Agreement, Novartis, Santo and Parent entered into an Agreement forPurchase and Sale of Stock (the “Santo Agreement”), pursuant to which Novartisagreed to purchase, and Santo agreed to sell, all of the shares of the Companyheld by Santo (the “Santo Shares,” such transaction, the “Santo Purchase”),representing approximately 67.5% of the outstanding shares of Common Stock, for€1.3 billion in cash on the terms and subject to the conditions set forththerein.

 

The Offer is not conditioned upon any minimumnumber of shares being tendered, but is contingent upon the contemporaneous (orimmediately subsequent) closing of the Santo Purchase pursuant to the SantoAgreement.  In addition to certaincustomary conditions, the closing of the Santo Purchase is conditioned on theacquisition by Novartis (Deutschland) GmbH of all of the outstanding shares andpartnership interests of Hexal AG (“Hexal”), including shares held directly andindirectly by Dr. Thomas Strüngmann, the Chairman of the Board ofDirectors of the Company and an indirect significant stockholder of Santo, and Dr. AndreasStrüngmann, an indirect significant stockholder of Santo.  Additionally, the Santo Purchase is subjectto customary regulatory approvals, including clearance under theHart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.  Following the completion of the Offer and thepurchase of the Santo Shares, if a majority of the outstanding shares of CommonStock other than the Santo Shares are purchased in the Offer, any remainingshares of Common Stock will be acquired by Merger Sub and, in accordance withDelaware General Corporation Law (the “DGCL”), Merger Sub will be merged withand into the Company (the “Merger”).

 

The Merger Agreement provides that uponconsummation of the Offer, the Confidentiality Agreement, dated February 11,2005, between the Company and Novartis (which currently restricts the abilityof Novartis and its affiliates to acquire shares of Common Stock other than theSanto Shares (the “Public Shares”) without approval of a majority of thespecial committee of independent board members, which was appointed to reviewthe Offer and the Merger, and of the Company’s Board of Directors) will beamended to provide that Novartis and its affiliates will be permitted to makeacquisitions of Public Shares that are voluntary to the holders of PublicShares (such as by means of legally permissible open market purchases or tenderoffers), but, prior to February 11, 2006, Novartis and Merger Sub will notbe permitted to cause a merger transaction (or other business combination) tobe effected which would cancel Public Shares unless (i) a majority of theoutstanding Public Shares vote in favor of such a transaction or (ii) Novartisand its subsidiaries, at that time, own at least 90% of the outstanding CommonStock; provided, that the consideration to be received by the holders of PublicShares in any such transaction described in (ii) above must be at leastequal to $31.00 per Public Share. Following the completion of the Offer and until the earlier of theconsummation of the Merger and February 11, 2006, Novartis and Merger Subare required to use their reasonable best efforts to keep the Common Stockquoted for trading on the NASDAQ National Market unless the Company is no

 

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longer required to be registered under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), or no longersatisfies NASDAQ’s listing standards (other than standards entirely within theCompany’s control).

 

At the effective time of the Merger, eachissued and outstanding share of Common Stock (other than shares owned byNovartis, any of its subsidiaries (including Merger Sub) or any of itsaffiliates, any shares held in the treasury of the Company and shares held bystockholders who properly demand appraisal and comply with the provisions of Section 262of the DGCL, relating to dissenters’ rights of appraisal) will be convertedinto the right to receive an amount equal to the Offer Price.  Following the consummation of the Merger, theCompany will continue as the surviving corporation and will be a wholly ownedsubsidiary of Novartis.

 

## **ITEM 2.  MANAGEMENT’S DISCUSSION ANDANALYSIS 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-Kand the unaudited interim condensed consolidated financial statements and notesthereto included in Part I, Item 1 of this Quarterly Report onForm 10-Q.

 

## **Overview**

 

The Company is a generic pharmaceutical company engaged in developing,licensing, manufacturing, selling and distributing a broad range ofprescription pharmaceutical products primarily in the United States. TheCompany focuses primarily on drugs in a broad range of solid oral dosage forms,utilizing both immediate and sustained release delivery, in tablet, multiplelayer tablet, film-coated tablet and capsule forms. The Company does not dependon any single drug or therapeutic category for a majority of its sales.

 

## **ProposedMerger**

 

On February 20, 2005, the Company entered into the MergerAgreement with Novartis, Merger Sub, and, solely with respect to its guaranteeof Novartis’s and Merger Sub’s obligations thereunder, Parent.  See Note 11 in the Condensed ConsolidatedFinancial Statements for additional information regarding the Merger Agreement.

 

## **THREE MONTHSENDED MARCH 31, 2005 COMPARED WITH THREE MONTHS ENDED MARCH 31, 2004**

 

**Net sales**.  Netsales were $101.0 million for the three months ended March 31, 2005compared to $104.2 million for the comparable period in 2004, a decrease of3.1%.  The majority of the sales decrease is attributable to a decrease inthe sales of Bupropion HCl, ER 100 mg and 150 mg tablets, the result of adecrease in price and unit volume.  Thedecrease in price is due to competition in the market.  The decrease in unit volume occurredprincipally because the prior year included the initial stocking impact thatoccurs when a new product is launched. Price reductions and a decrease in unit volume of other selectedproducts also contributed to the

 

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decrease in sales.  These decreases were partially offset by thelaunch of Itraconazole during the quarter ended March 31, 2005, and by thesales of certain products that were introduced subsequent to March 31,2004 including Fosinopril Sodium, Citalopram and Cilostazol.

 

**Gross profit**. Gross profit as a percentage of net sales was 58.8% for the three months ended March 31,2005 and 2004, respectively.  The Company’sgross profit margins are dependent on several factors, including product salesmix, customer, volume and competitive activity. The gross margin percentage forthe quarters ended March 31, 2005 and 2004 benefited from the introductionof new products (primarily Itraconazole, which was launched during the firstquarter of 2005, and Bupropion, which was launched during the comparablequarter in 2005).

 

**Selling, general and administrative**. Selling, general and administrative expenses decreased by $2.0 million to $11.0million for the three months ended March 31, 2005 from $13.0 million forthe comparable period in 2004.  Thedecrease in expenses for the three months ended March 31, 2005 isprimarily attributable to lower legal expenses of $1.6 million, a $0.5 milliondecrease in product liability insurance premiums, a $0.7 million decrease inpersonnel related costs and a $0.3 million decrease in commissions to an independentsales representative.  The decrease inlegal expenses is attributable to a decrease in patent-related expenses, whichwere higher in 2004 due to litigation involving the launch of Bupropion, andlower expenses related to phentermine litigation.  The decrease in product liability insurance isdue to modifications in the terms of the insurance policies.  The decrease in personnel-related costs andcommissions to an independent sales representative is attributed primarily to adecrease in the provision for management bonuses and a decrease in thecommission rate, respectively.

 

The above-mentioned decreases were partiallyoffset by increases of approximately $1.0 million in other items, including anincrease in rent expense, other insurance, advertising, and professional fees.

 

**Research and development**. Research and development expenses decreased by $0.6 million to $5.0 million forthe three months ended March 31, 2005 from $5.6 million for the comparableperiod in 2004.  The $0.6 milliondecrease is due to the timing of certain expenditures relating to bio-studies.

 

**Merger-Related Costs. **For the first quarter ended March 31, 2005, merger-related costs,primarily legal and investment banking fees, of $3.0 million were expensed asincurred in connection with the pending acquisition of the Company by NovartisAG.

 

**Operating income**. Operating income decreased $2.2 million to $40.5 million for the three monthsended March 31, 2005 from $42.8 million for the comparable period in 2004. The decrease in operating income was the result of decreased sales and grossprofit and a net increase in operating expenses, which resulted because merger-relatedcosts more than offset the decreases in selling, general and administrative andresearch and development expenses.

 

**Interest income**. Interest income for the three months ended March 31, 2005 was $1.0 millioncompared to interest income of $0.5 million for the comparable period in 2004, whichis the result of higher interest rates and investment balances.

 

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**Other income, net**. Other income for the three months ended from March 31, 2005 decreased by$10.0 million compared to the comparable period in 2004.  The three months ended March 31, 2004 includeda $10.0 million settlement received from Glaxo in exchange for the Companyagreeing to the dismissal of its complaint against Glaxo for the maliciousprosecution of its earlier suit against the Company, which claimed the Company’sNabumetone product infringed Glaxo’s patent.

 

**Taxes on income**. Taxes on income decreased $5.5 million to $15.4 million during the three monthsended March 31, 2005 from $20.9 million for the comparable period in 2004. The decrease is the result of lower pre-tax income and a lower effective taxrate for 2005.  The effective tax rate decreased to 37.1% from 39.3% dueprincipally to changes to the tax law relating to the American Jobs CreationAct and an increase in tax-exempt interest on investments.

 

**Net income**. Net income decreased $6.2 million to $26.1 million for the three months ended March 31,2005 from $32.3 million for the comparable period in 2004 for the reasonsdescribed above.

 

## **LIQUIDITY ANDCAPITAL RESOURCES**

 

Cash and cash equivalents were $63.3 million at March 31, 2005,compared to $59.5 million at December 31, 2004.  Additionally, theCompany had investments in marketable debt securities of $165.7 million at March 31,2005, compared to $136.3 million at December 31, 2004.

 

The Company has a three-year $25 million credit facility whichexpires on December 31, 2007. Under this facility, the Company can borrowat the adjusted LIBOR rate plus 1.5%, the bank’s prime rate or a fixed rate (asset by the bank).  The credit facility, which is for working capitalpurposes, had no outstanding borrowings against it at March 31, 2005 and December 31,2004, respectively.

 

Stockholders’ equity increased to $470.5 million at March 31, 2005from $443.5 million at December 31, 2004.  The increase instockholders’ equity was comprised primarily of net earnings of $26.1 millionfor the three months ended March 31, 2005, and $1.0 million (including taxbenefits) from the exercise of stock options.

 

During the three months ended March 31, 2005, cash increased by $3.8million.  Operations generated $36.4 million of cash comprised of net earningsof $26.1 million, non-cash items totaling $3.2 million and a net reduction ofworking capital of $7.2 million. Working capital is defined as current assets(excluding cash and cash equivalents, investments and restricted cash) lesscurrent liabilities.  The working capital reduction is attributedprimarily to decreases in accounts receivable and prepaid and other currentassets of $17.0 million and $12.8 million, respectively.  These decreases were offset by increases ininventory of $13.4 million and decreases in accounts payable and accruedliabilities of $9.3 million.

 

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The decrease in accounts receivable is due to the timing of customerpayments and lower sales in the period. The decrease in prepaid expenses and other current assets occurredprimarily because the quarterly estimated federal income tax payments’ due datefor the first quarter was extended an extra month to April 15, 2005.  A lower prepaid insurance balance alsocontributed to the decrease in working capital. Inventory was increased to support anticipated future sales.  The decrease in accrued liabilities isattributed primarily to the change in amount of credit balances reclassed fromaccounts receivable.

 

Investing activities consumed $33.7 million of cash for the three monthsended March 31, 2005.  Approximately $29.6 million represented netpurchases of short-term investment grade debt securities and $4.1 million usedfor capital expenditures during the three months ended March 31, 2005. The capital expenditures relate primarily to equipment required to supportincreased production volume in the Company’s North Carolina facility, and furnitureand equipment for the Company’s Lake Success Headquarters.

 

Financing activities provided $0.9 million of cash during the threemonths ended March 31, 2005, of which $0.7 million represents cashproceeds received from employees who exercised stock options.

 

In March 2005, the Company was named in an action filed in theSupreme Court of New York, in which the plaintiff alleges various injuries,including toxic epidermal necrolysis, from the use of generic Oxaprozin.  In the action, plaintiff Annie Jones allegesthat generic Oxaprozin was defectively designed and unreasonably dangerous, andthat the Company failed adequately to warn of the risks of the drug.  The complaint, which also alleges breach ofexpress and implied warranties and loss of consortium by plaintiff’s husband,seeks damages and punitive damages.  Thecomplaint also names Pfizer, which manufactures the applicable brand nameproduct, as a defendant.  Because thislitigation has just begun, it is not possible to speculate on its merits or itseventual outcome, though the Company believes it has valid defenses to thisclaim.

 

In March 2001, Pfizer filed suit against the Company in theEastern District of New York (now consolidated in U.S. District Court for theDistrict of New Jersey) alleging that the Company infringed a patent held byPfizer by filing an ANDA to market the generic drug Gabapentin in capsule form.  In April 2005, the Company began sellingGabapentin capsules.  An adverse rulingcould result in the Company being enjoined from further marketing the productwhich could materially impair profits and cash flows, and result in payingdamages, costs, and fees which could have a materially adverse impact on theCompany’s financial performance.

 

The Company is involved in various other product liability and patentlitigation not covered by insurance.  Adverse rulings in litigationrelated to product liability and patent infringement could result in theCompany paying damages and expenses that could have a material adverse effecton the Company’s financial performance.  See Note 9 from “Notes toConsolidated Financial Statements” herein for further details.

 

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’sprincipal future cash requirements are associated with increased

 

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working capital to support future growth, capital expenditures andlegal defense costs.  The Companyanticipates that its operating cash flows and current cash balances, togetherwith its available borrowings under its credit facility, will be sufficient tomeet all of its cash requirements for both the short-term and foreseeablefuture.

 

## **CriticalAccounting 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, thesejudgments are subject to an inherent degree of uncertainty.  The Companybases its judgments on its experience and various other assumptions that theCompany believes to be reasonable under the circumstances.  On an ongoingbasis, the Company evaluates its estimates, including those related torevenues, returns, inventories, income taxes and litigation.  The Company’sactual results could differ from these estimates under different assumptions orconditions.  The Company believes the following accounting policies to becritical:

 

### *RevenueRecognition*

 

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.  When the Company recognizes revenue fromproduct sales, the Company records estimates for contract pricing adjustments,rebates, discounts, expected product returns and other sales allowances. These allowances are recorded as a reduction of product sales.  Contractpricing adjustments, rebates and discounts are recorded as a reduction of salesbased on agreed-upon terms with the Company’s customers at the time of sale.

 

### *Reserves forContract Pricing Adjustments, Rebates and Discounts*

 

Reserves for contract pricing adjustments and rebates represent thedifference between prices wholesalers are billed by the Company for productssold and the contract prices billed by wholesalers to their customers (theCompany’s indirect customers) for the products.  These contract pricingand rebate reserve estimates are based on agreements between the Company andits indirect customers or between the Company and the wholesalers and arerecorded as a reduction in sales at the time of sale.  In determining areserve for contract pricing adjustments and rebates, the Company estimates theamount of such pricing adjustments by product based on historical trends andchanges in wholesaler or contract prices.  As part of the Company’s reviewof this estimation process, the Company obtains inventory reports from keywholesalers to determine the level of inventory in that distribution channel tocompare with inventory levels used in our estimation process.  The Companycalculates a reserve for discounts based upon actual sales under such discountarrangements.  No revisions were made to the methodology used indetermining these provisions during the three months ended March 31, 2005.

 

As of March 31, 2005 and December 31, 2004, accountsreceivable are presented net of allowances for contract pricing adjustments,rebates and discounts of $123,181 and $138,022, respectively.  The decrease in aggregate allowances is dueto a decrease in sales and an acceleration in the issuance of credits, offsetagainst existing accounts receivable allowances

 

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which occurred as a result of the lowering of selling prices forcertain products to wholesalers. No revisions were made to the methodology usedin determining these provisions during the three months ended March 31,2005.

 

### *Reserve for ProductReturns*

 

The Company’s policy is to accept customer returns of products, whichconsist primarily of products whose expiration date has been exceeded, uponappropriate approval by authorized personnel of the Company.  The majorityof the Company’s products have a two to three year expiration date. Estimates for returns, which are recorded as a reduction of sales at the timeof sale, relate primarily to products expected to be returned uponexpiration.  The Company utilizes historical trends to estimate the amountof products expected to be returned.  As of March 31, 2005 and December 31,2004, the Company had a reserve for product returns of $23,066 and $25,586,respectively. The Company’s estimate for future returns was decreased asthe historical trends used in the calculation have become more favorable. Therewere no revisions made to the methodology used in determining these provisionsduring the three months ended March 31, 2005.

 

### *PricingAdjustments, Promotions and Allowances and Medicaid Rebates*

 

Shelf stock adjustments are provided following a reduction in the priceof any of the Company’s products due to changes in the competitiveenvironment.  Such adjustments are credited to the Company’s customersbased on their on-hand inventory quantities at the time of the reduction inprice.  Reserves are generally established when the Company reduces ourprices.  As of March 31, 2005, there were no liabilities recorded forshelf stock adjustments.  As ofDecember 31, 2004, there was a liability for a shelf stock adjustment of$0.8 million.

 

The Company typically provides sales incentives to its customers at thetime of a new product launch to obtain distribution and market share. Since most of these promotional arrangements do not require a minimum purchaselevel, they are recorded as a reduction of sales upon shipment of the customer’sinitial order.  The Company also participates in trade show and otherpromotions where additional discounts may be given as an incentive for thecustomer to purchase products.  Such discounts and incentives are recordedas a reduction of sales at the time of sale of the related product.  Sincethe Company allows customers to return short-dated or expired products withappropriate approval, it is in the Company’s interest to ensure that itscustomers do not maintain excess inventory levels of our products.  TheCompany evaluates unusually large orders to ensure that customers’ inventoriesare not in excess of their ordinary course of business inventory levels.

 

As of March 31, 2005 and December 31, 2004, the reserve forpromotions and allowances was $19,816 and $18,028, respectively.  Theincrease in the reserve for promotions and allowances is primarily attributedto promotions for new products launched during 2005.

 

All generic pharmaceutical manufacturers whose products are covered bythe Medicaid program are required to rebate to each state a percentage of theiraverage manufacturer’s price for the products dispensed.  Many states alsohave implemented supplemental rebate programs that obligate manufacturers topay rebates in excess of those required under federal law.  The Companyestimates these rebates based on historical trends of sales for such productsin each

 

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state.  The reserve for Medicaid rebates at March 31, 2005and December 31, 2004 was $6,598 and $7,952, respectively.

 

### *Reserve for PendingLitigation Claims*

 

In determining whether liabilities should be recorded for pendinglitigation claims, the Company must assess the allegations made and thelikelihood that it will successfully defend itself.  When the Companybelieves it is probable that it will not prevail in a particular matter, itwill then make an estimate of the amount of liability based in part on adviceof outside legal counsel.  There were no liabilities recorded for pendingclaims as of March 31, 2005 and December 31, 2004.

 

## **Impact of RecentlyIssued Accounting Standards**

 

In December 2004, the FASB issued FAS 123(R), which requirescompanies to expense the value of employee and director stock options andsimilar awards. FAS 123(R) is effective for fiscal years beginningsubsequent to June 15, 2005. The Company is reviewing the variousimplementation methods under this pronouncement.

 

In December 2004, the FASB issued SFAS No. 153, “Exchange ofNonmonetary Assets an amendment of APB Opinion No. 29.” This Statementprecludes companies from using the “similar productive assets” criteria toaccount for nonmonetary exchanges at book value with no gain or loss beingrecognized. Effective for fiscal periods beginning after June 15, 2005,all companies will be required to use fair value for most nonmonetaryexchanges, recognizing gain or loss, if the transaction meets acommercial-substance criteria. The Company does not expect this Standard tohave a significant impact on its consolidated financial statements.

 

In December 2004, the FASB issued FSP FAS 109-1, “Application ofFASB Statement No. 109, ‘Accounting for Income Taxes,’ to the TaxDeduction on Qualified Production Activities Provided by the American JobsCreation Act of 2004” to provide accounting guidance on the appropriatetreatment of tax benefits generated by the enactment of the Act. The FSPrequires that the manufacturer’s deduction be treated as a special deduction inaccordance with SFAS 109 and not as a tax rate reduction.  Provisions in the American Jobs Creation Actof 2004 reduced the Company’s effective tax rate for the quarter ended March 31,2005 by less than 1%.

 

In November 2004, the FASB issued Statement No. 151, “InventoryCosts, an amendment of ARB 43, Chapter 4” (“SFAS 151”), to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted materials (spoilage). ARB 43 allowed some of these “abnormalcosts” to be carried as inventory whereas the new Standard requires that thesecosts be recognized in income as incurred. This Statement is effective forfiscal years beginning after June 15, 2005. The Company is currentlyevaluating what effect, if any, this Standard will have on its consolidatedfinancial statements.

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidationof Variable Interest Entities” (as revised by Fin No. 46R). Thisinterpretation, as revised, provides guidance with respect to the consolidationof certain entities, referred to as variable interest entities (“VIEs”), inwhich an investor is subject to a majority of the risk of loss from the VIEs’activities, or is entitled to receive a majority of the VIEs’ residual returns.This interpretation also provides

 

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guidance with respect to the disclosure of VIEs in which an investormaintains an interest, but is not required to consolidate. The provisions ofthe interpretation were effective immediately for all VIEs created after January 31,2003, or in which the Company obtains an interest after that date. For VIEscreated before February 1, 2003, the provisions were effective July 1,2003. In November 2003, the Company invested $1,150 for 50% ownership inan entity formed to provide research and development services for the Companyas well as third parties. It has been determined that such investee is deemed aVIE, which has been consolidated in the Company’s financial statements. The netassets and result of operations of this entity have not been material to theCompany. Creditors, or beneficial interest holders, of the consolidated VIEhave no recourse to the general credit of the Company.

 

## **Off-BalanceSheet Arrangements**

 

None.

 

## **ITEM 3 - QUANTITATIVE AND QUALITATIVEDISCLOSURE 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 believe that its exposure to market risk ismaterial.

 

As of March 31, 2005, the Company had cash and cash equivalents of$63.3 million.  Cash equivalents are interest-bearing investment gradesecurities, primarily short-term, highly liquid investments with maturities atthe date of purchase of less than 90 days.  In addition, the Companycurrently owns $165.7 million in publicly traded debt securities with anaverage maturity of approximately 116 days, which are subject to marketfluctuations.

 

These investments are subject to interest rate risk and will decreasein value if market interest rates increase.  A hypothetical increase inthe market interest rates by 10% from the rates in effect on the date of this Form 10-Qwould cause the fair value of these short-term investments to decline by animmaterial amount.  The Company has the ability to hold these investmentsuntil maturity, and therefore it does not expect the value of these investmentsto be affected to any significant degree by the effect of a sudden change inmarket interest rates.  Declines in interest rates over time will,however, reduce the Company’s interest income.

 

The Company currently does not have any significant foreign currencyexchange rate risk.

 

## **ITEM 4 - CONTROLS AND PROCEDURES**

 

As of the end of the period covered by this report, the Company’smanagement performed an evaluation, under the supervision and with the participationof its Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures (as defined in Rules 13a-15(e) and 15d-15(e) ofthe Exchange Act). Based on that evaluation, the Company’s management,including its Chief Executive Officer and Chief Financial Officer, concludedthat the Company’s disclosure controls and procedures were effective as of theend of the period covered by this report.

 

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There have been no changes in the Company’s internal control overfinancial reporting that have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reportingduring the three months ended March 31, 2005.

 

## **SPECIAL NOTEREGARDING FORWARD-LOOKING STATEMENTS**

 

This quarterly report on Form 10-Q 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 Exchange Act, including, without limitation, statements regarding theCompany’s expectations, beliefs, intentions or future strategies that aresignified by the words “expects,” “anticipates,” “intends,” “believes” orsimilar language.  Actual results could differ materially from thoseanticipated in such forward-looking statements.  Some specific factorsthat may have a significant effect on the Company’s operating results and themarket price of its common stock include:

 

•             newproduct introductions;

•             changesin the degree 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 ofeither of the foregoing;

•             theinability to acquire sufficient supplies of raw materials;

•             litigationand/or threats of litigation;

•             changesin the Company’s growth rates or the growth rate of the Company’s competitors;

•             legislativeand FDA actions with respect to the government regulation of pharmaceuticalproducts;

•             publicconcern as to the safety of the Company’s  products;

•             changesin health care policy in the United States;

•             conditionsin the financial markets in general or changes in general economic conditions;

•             theCompany’s inability to raise additional capital;

•             conditionsof other generic pharmaceutical companies or the generic pharmaceuticalindustry generally; and

•             changesin stock market analyst recommendations regarding the Company’s common stock,other comparable 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.  TheCompany cautions investors that its business and financial performance aresubject to substantial risks and uncertainties.

 

## **PART II –OTHER INFORMATION**

 

## **ITEM 1 – LEGAL PROCEEDINGS**

 

In March 2005, the Company was named in an action filed in theSupreme Court of New York, in which the plaintiff alleges various injuries,including toxic epidermal necrolysis, from the use of generic Oxaprozin.  In the action, plaintiff Annie Jones allegesthat generic Oxaprozin was

 

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defectively designed and unreasonably dangerous, and that the Companyfailed adequately to warn of the risks of the drug.  The complaint, which also alleges breach ofexpress and implied warranties and loss of consortium by plaintiff’s husband,seeks damages and punitive damages.  Thecomplaint also names Pfizer, which manufactures the applicable brand nameproduct, as a defendant.  Because thislitigation has just begun, it is not possible to speculate on its merits or itseventual outcome, though the Company believes it has valid defenses to thisclaim.

 

In March 2001, Pfizer filed suit against the Company in theEastern District of New York (now consolidated in U.S. District Court for theDistrict of New Jersey) alleging that the Company infringed a patent held byPfizer by filing an ANDA to market the generic drug Gabapentin in capsuleform.  In April 2005, the Companybegan selling Gabapentin capsules.  Anadverse ruling could result in the Company being enjoined from furthermarketing the product which could materially impair profits and cash flows, andresult in paying damages, costs, and fees which could have a materially adverseimpact on the Company’s financial performance.

 

In January 2005, the Company filed a declaratory judgment actionagainst Pfizer regarding generic Azithromycin. The Company filed an ANDA tomarket 250mg, 500mg, and 600mg tablets. The complaint seeks declaration ofnon-infringement of Pfizer’s patent Nos. 6,268,489 and 5,605,889. Thelitigation is pending in the U.S. District Court for the Southern District ofNew York. On or about February 23, 2005, Pfizer filed a motion to dismissthe complaint.

 

**Merger-RelatedLitigation**

 

Subsequent to the public announcement of the execution of the MergerAgreement on February 21, 2005, eight purported class actions were filed —one in the Supreme Court of the State of New York and seven in the Court ofChancery of the State of Delaware — naming as defendants the Company, NovartisAG, Thomas Strüngmann, Ph.D., Bernhard Hampl, Ph.D., Mark R. Patterson, FrankF. Beelitz and Douglas M. Karp.  (Inthree of those actions, Novartis was also named as a defendant, in two of thoseactions Merger Sub was also named as a defendant, and in one of those actionsSanto was also named as a defendant.)

 

The actions, purportedly on behalf of all public stockholders of theCompany other than the defendants, in substance allege that the terms of theOffer and Merger are unfair to the Company’s public stockholders because thevalue of Company’s publicly held common stock is greater than the $31 per shareprice being offered to the Company’s public stockholders in the Offer and theMerger.  All of the complaints assertclaims for breach of fiduciary duty and, in their prayers for relief, seek, interalia, to enjoin the Offer and the Merger.

 

The seven Delaware  actions arecaptioned as follows:  Ellen Wiehl v.Eon Labs, Inc., et al., C.A. No. 1116-N (Del. Ch. Feb. 22,2005); Paulena Partners LLC v. Eon Labs, Inc., et al., C.A. No. 1117-N(Del. Ch. Feb. 22, 2005); Robert Kemp, IRRA v. Eon Labs, Inc., etal., C.A. No. 1119-N (Del. Ch. Feb. 22, 2005); Peter J.Calcagno v. Eon Labs, Inc., et al., C.A. No. 1125-N (Del. Ch. Feb. 23,2005); Erste Sparinvest Kapitalanlagegesellschaft MBH v. Eon Labs, Inc.,et al., C.A. No. 1134-N (Del Ch. Mar. 1, 2005); Huntsinger v.Eon Labs, Inc., et al., C.A. No. 1136-N (Del. Ch. Mar. 1,2005); and Jason Hung v. Eon Labs, Inc. et al., C.A. No.  1139-N (Del.Ch. Mar. 3, 2005).  The New Yorkaction is captioned as follows:  ChristopherPizzo v. Novartis AG et al., No. 600680/05 (Sup. Ct. Feb. 23,2005).

 

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On April 8, 2005, the plaintiff in the Huntsinger casevoluntarily dismissed his claim without prejudice.  That same day, the plaintiffs in theremaining Delaware actions requested that the Court consolidate the pendingcases, and appoint Milberg Weiss Bershad & Schulman as leadcounsel.  The Court granted plaintiffs’consolidation motion on April 12, 2005. There has been no further activity in the case.

 

The Company and the individual defendants have until June 3, 2005,to answer, move, or otherwise respond to the complaint in the New York action.

 

The Company and its directors believe that all of the actions arewithout merit and intend to vigorously defend them.

 

## **ITEM 2 – UNREGISTERED SALES OF EQUITYSECURITIES 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 millionhas been used to repay debt incurred in connection with the acquisition of EHI;and (iii) $2.0 million has been used for general working capitalpurposes.  The remaining $60.3 million of the proceeds to the Company fromthe offering are invested in cash investments and investment grade debtsecurities.  The Company anticipates using the balance of the proceedsfrom the offering for general corporate purposes, including funding workingcapital, increased research and development expenditures to expand the Company’sproduct offerings and the potential acquisition of product lines orcompanies.  The Company has no present understandings, commitments oragreements with respect to any acquisitions.  The Company has notdetermined the amounts it plans to spend on any of the areas listed above orthe timing of these expenditures.

 

## **ITEM 5 - OTHER INFORMATION**

 

## **AuditCommittee Pre-Approval of Non-Audit Services**

 

During the quarter ended March 31, 2005, the Company’s AuditCommittee pre-approved three categories of audit-related services in a total aggregateamount of $100,000.  The individualcategories have sub-limits ranging from $25,000 to $50,000.  During the quarter ended March 31, 2005,the Audit Committee also pre-approved eight categories of tax-related servicesin a total aggregate amount of $220,000. The individual categories have sub-limits ranging from $10,000 to$50,000.

 

## **ITEM 6 – EXHIBITS**

 

(a)                                 Exhibits

 

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The exhibits required to be filed by Item 601 of Regulation S-K areincorporated herein by reference to the exhibit index of the Company’s AnnualReport on Form 10-K for the fiscal year ended December 31, 2004.

 
| 31.1   | Certifications pursuant to Section 302  of the Sarbanes-Oxley Act of 2002                                                    |
|--------|-----------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                              |
| 31.2   | Certifications pursuant to Section 302  of the Sarbanes-Oxley Act of 2002                                                    |
|   |                                                                                                                              |
| 32.1   | Certification Pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|   |                                                                                                                              |
| 32.2   | 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 to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
|         | Eon Labs, Inc. |
|--------------|---------------------|
|         |                |
| May 10, 2005 | By:                 | /s/ Bernhard Hampl, Ph.D. |   |
|         |                | Bernhard Hampl, Ph.D. |
|         |                | President, Chief Executive Officer |
|         |                | and Director |
|         |                |   |
| May 10, 2005 | By:                 | /s/ William F. Holt |   |
|         |                | William F. Holt |
|         |                | Chief Financial Officer |

 

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