**UNITED STATESSECURITIES 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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**Commission File Number 001-31333**

 

**For the quarterly period ended March 31,2004**

 

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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) |
|                                                       |   |                                    |
| **227-15 North Conduit Avenue  Laurelton, New York**       |   | **11413**                               |
| (Address of Principal Executive Offices)                   |   | (Zip Code)                              |
|                                                       |   |                                    |
| **(718) 276-8600**                                         |
| (Registrant’s Telephone Number, Including Area  Code) |

 

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Indicate by check mark whether the Registrant (1) has filed allreports required by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports) and (2) has been subject tosuch filing requirements for the past 90 days. Yes ýNo o

 

Indicateby check mark whether the Registrant is an accelerated filer (as defined inRule 12b-2 of the Securities Exchange Act of 1934). Yes ýNo o

 

As of May 3, 2004, there were 44,397,712 shares of the Registrant’sCommon Stock, $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, 2004 (unaudited) and December 31,  2003                             |   |
|          |                                                                                                                                |                                                                                                                                 |   |
|          |                                                                                                                                | Condensed  Consolidated Statements of Income (unaudited) for the Three Months Ended  March 31, 2004 and March 31, 2003     |   |
|          |                                                                                                                                |                                                                                                                                 |   |
|          |                                                                                                                                | Condensed  Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended  March 31, 2004 and March 31, 2003 |   |
|          |                                                                                                                                |                                                                                                                                 |   |
|          |                                                                                                                                | 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.                                                                                                                             | Changes  in Securities, Use of Proceeds and Issuer Purchases of Equity Securities                                                    |   |
|          |                                                                                                                                |                                                                                                                                 |   |
|          | ITEM 5.                                                                                                                             | Other Information                                                                                                                    |   |
|          |                                                                                                                                |                                                                                                                                 |   |
|          | ITEM 6.                                                                                                                             | Exhibits  and Reports on Form 8-K                                                                                                    |   |
|          |                                                                                                                                |                                                                                                                                 |   |
| 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 |                                                                                                                                 |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1.****  FINANCIALSTATEMENTS**

 

**Eon Labs, Inc. and SubsidiariesCondensed Consolidated Balance Sheets**(dollars in thousands, except per share amounts)

 
|                                                                                                                                                                                                                           |   | **March 31,  2004** |    | **December 31,  2003** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                                                                                                                                                                                                                           |   | **(Unaudited)**          |    |                        |   |
| **Assets**                                                                                                                                                                                                                     |   |                     |    |                        |   |
|                                                                                                                                                                                                                           |   |                     |    |                        |   |
| **Current assets**                                                                                                                                                                                                             |   |                     |    |                        |   |
| Cash and cash equivalents                                                                                                                                                                                                      |   | $                        | 75,057  |                        | $      | 43,852 |   |
| Investments                                                                                                                                                                                                                    |   | 103,737                  |    | 115,281                     |   |
| Accounts receivable, net                                                                                                                                                                                                       |   | 48,970                   |    | 35,678                      |   |
| Inventories                                                                                                                                                                                                                    |   | 61,963                   |    | 56,441                      |   |
| Deferred tax assets, net                                                                                                                                                                                                       |   | 55,704                   |    | 56,439                      |   |
| Prepaid expenses and other current assets                                                                                                                                                                                      |   | 5,813                    |    | 8,096                       |   |
|                                                                                                                                                                                                                           |   |                     |    |                        |   |
| **Total current  assets**                                                                                                                                                                                                      |   | 351,244                  |    | 315,787                     |   |
|                                                                                                                                                                                                                           |   |                     |    |                        |   |
| Property, plant and equipment, net                                                                                                                                                                                             |   | 50,659                   |    | 50,409                      |   |
| Goodwill and other intangible assets, net                                                                                                                                                                                      |   | 72,001                   |    | 72,941                      |   |
| Other assets                                                                                                                                                                                                                   |   | 2,972                    |    | 2,408                       |   |
|                                                                                                                                                                                                                           |   |                     |    |                        |   |
| **Total assets**                                                                                                                                                                                                               |   | $                        | 476,876 |                        | $      | 441,545 |   |
|                                                                                                                                                                                                                           |   |                     |    |                        |   |
| **Liabilities and  Stockholders’ Equity**                                                                                                                                                                                 |   |                     |    |                        |   |
|                                                                                                                                                                                                                           |   |                     |    |                        |   |
| **Current liabilities**                                                                                                                                                                                                        |   |                     |    |                        |   |
| Accounts payable                                                                                                                                                                                                               |   | $                        | 11,631  |                        | $      | 13,612 |   |
| Accrued liabilities                                                                                                                                                                                                            |   | 95,829                   |    | 89,226                      |   |
|                                                                                                                                                                                                                           |   |                     |    |                        |   |
| **Total current  liabilities**                                                                                                                                                                                                 |   | 107,460                  |    | 102,838                     |   |
|                                                                                                                                                                                                                           |   |                     |    |                        |   |
| **Long-term  liabilities**                                                                                                                                                                                                     |   |                     |    |                        |   |
| Deferred tax liabilities, net                                                                                                                                                                                                  |   | 9,136                    |    | 9,136                       |   |
| Deferred revenue                                                                                                                                                                                                               |   | 142                      |    | 200                         |   |
| Other                                                                                                                                                                                                                          |   | 591                      |    | 591                         |   |
|                                                                                                                                                                                                                           |   |                     |    |                        |   |
| **Total liabilities**                                                                                                                                                                                                          |   | 117,329                  |    | 112,765                     |   |
|                                                                                                                                                                                                                           |   |                     |    |                        |   |
| Contingencies (Notes 8 and 9)                                                                                                                                                                                                  |   |                     |    |                        |   |
|                                                                                                                                                                                                                           |   |                     |    |                        |   |
| **Stockholders’  equity**                                                                                                                                                                                                 |   |                     |    |                        |   |
| Common stock, par value $.01 per share;  70,000,000 shares authorized; 44,491,162 and 44,361,912 shares issued;  44,397,412 and 44,299,812 shares outstanding at March 31, 2004 and  December 31, 2003, respectively |   | 446                      |    | 444                         |   |
| Preferred stock, par value $.01 per share;  5,000,000 shares authorized; none issued                                                                                                                                           |   | —                   |    | —                      |   |
| Additional paid-in capital                                                                                                                                                                                                     |   | 196,742                  |    | 194,951                     |   |
| Retained earnings                                                                                                                                                                                                              |   | 168,091                  |    | 135,774                     |   |
| Accumulated other comprehensive (loss)  income                                                                                                                                                                                 |   | (47                      | )       | 5                           |   |
|                                                                                                                                                                                                                           |   | 365,232                  |    | 331,174                     |   |
| Less: Unearned deferred stock-based  compensation                                                                                                                                                                              |   | (138                     | )       | (184                        | )      |
| Treasury stock at cost: 93,750 and 62,100  shares at March 31, 2004 and December 31, 2003, respectively                                                                                                              |   | (5,547                   | )       | (2,210                      | )      |
| **Total stockholders’  equity**                                                                                                                                                                                           |   | 359,547                  |    | 328,780                     |   |
| **Total liabilities  and stockholders’ equity**                                                                                                                                                                           |   | $                        | 476,876 |                        | $      | 441,545 |   |

 

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

 

3

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

 
|                                       |   | **For the  three months ended  March 31,** |    |
|--------------------------------------------|--------|-------------------------------------------------|---------|
|                                       |   | **2004**                                        |    | **2003** |   |
| Net sales                                  |   | $                                               | 104,229 |   | $ | 70,857 |   |
| Cost of sales                              |   | 41,981                                          |    | 32,445 |   |
|                                       |   |                                            |    |   |   |
| **Gross profit**                           |   | 62,248                                          |    | 38,412 |   |
|                                       |   |                                            |    |   |   |
| Operating expenses                         |   |                                            |    |   |   |
| Selling, general and administrative:       |   |                                            |    |   |   |
| Amortization of other intangible assets    |   | 940                                             |    | 940 |   |
| Other selling, general and administrative  |   | 12,983                                          |    | 8,737 |   |
| Research and development                   |   | 5,570                                           |    | 3,642 |   |
|                                       |   |                                            |    |   |   |
| **Total operating  expenses**              |   | 19,493                                          |    | 13,319 |   |
|                                       |   |                                            |    |   |   |
| **Operating income**                       |   | 42,755                                          |    | 25,093 |   |
|                                       |   |                                            |    |   |   |
| Other income (expense), net                |   |                                            |    |   |   |
| Interest income                            |   | 448                                             |    | 331 |   |
| Interest expense                           |   | —                                          |    | (284 | ) |
| Other income, net                          |   | 10,022                                          |    | 37 |   |
|                                       |   |                                            |    |   |   |
| **Total other income,  net**               |   | 10,470                                          |    | 84 |   |
|                                       |   |                                            |    |   |   |
| Income before income taxes                 |   | 53,225                                          |    | 25,177 |   |
|                                       |   |                                            |    |   |   |
| Provision for income taxes                 |   | (20,908                                         | )       | (10,070 | ) |
|                                       |   |                                            |    |   |   |
| **Net income**                             |   | $                                               | 32,317  |   | $ | 15,107 |   |
|                                       |   |                                            |    |   |   |
| Net income per common share                |   |                                            |    |   |   |
| Basic                                      |   | $                                               | 0.73    |   | $ | 0.34 |   |
| Diluted                                    |   | $                                               | 0.71    |   | $ | 0.33 |   |
|                                       |   |                                            |    |   |   |
| Weighted average common shares outstanding |   |                                            |    |   |   |
| Basic                                      |   | 44,355,387                                      |    | 44,113,516 |   |
| Diluted                                    |   | 45,389,203                                      |    | 45,214,718 |   |

 

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

 

4

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**Eon Labs, Inc. and SubsidiariesCondensed Consolidated Statements of CashFlows**(dollars in thousands) (unaudited)

 
|                                                                               |   | **For the  three months ended  March 31,** |   |
|------------------------------------------------------------------------------------|--------|-------------------------------------------------|--------|
|                                                                               |   | **2004**                                        |   | **2003** |   |
| **Cash flows from  operating activities**                                          |   |                                            |   |   |   |
| Net income                                                                         |   | $                                               | 32,317 |   | $ | 15,107 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |                                            |   |   |   |
| Provision for accounts receivable  allowances                                      |   | 4,844                                           |   | 14,199 |   |
| Depreciation and amortization                                                      |   | 2,550                                           |   | 2,146 |   |
| Deferred income taxes                                                              |   | 735                                             |   | — |   |
| Deferred compensation                                                              |   | 46                                              |   | 112 |   |
| Amortization of deferred revenue                                                   |   | (58                                             | )      | (58 | ) |
| Amortization of discount on note payable                                           |   | —                                          |   | 269 |   |
| Loss on foreign currency translation                                               |   | (12                                             | )      | — |   |
| Tax benefit from exercises of stock options                                        |   | 3,368                                           |   | 887 |   |
| Changes in assets and liabilities:                                                 |   |                                            |   |   |   |
| Accounts receivable                                                                |   | (18,136                                         | )      | (13,116 | ) |
| Inventories                                                                        |   | (5,522                                          | )      | (9,135 | ) |
| Prepaid expenses and other current assets                                          |   | 2,218                                           |   | 2,283 |   |
| Other assets                                                                       |   | (564                                            | )      | (184 | ) |
| Accounts payable                                                                   |   | (1,981                                          | )      | 2,719 |   |
| Accrued liabilities                                                                |   | 6,629                                           |   | 5,859 |   |
| **Net cash provided  by operating activities**                                     |   | 26,434                                          |   | 21,088 |   |
|                                                                               |   |                                            |   |   |   |
| **Cash flows from  investing activities**                                          |   |                                            |   |   |   |
| Capital expenditures                                                               |   | (1,860                                          | )      | (2,141 | ) |
| Net sales (purchases) of short-term  investments                                   |   | 11,478                                          |   | (4,480 | ) |
| **Net cash provided  by (used in) investing activities**                           |   | 9,618                                           |   | (6,621 | ) |
|                                                                               |   |                                            |   |   |   |
| **Cash flows from  financing activities**                                          |   |                                            |   |   |   |
| Payment on seller note                                                             |   | —                                          |   | (4,799 | ) |
| Advances from related parties, net                                                 |   | —                                          |   | 337 |   |
| Decrease in restricted cash                                                        |   | 65                                              |   | 17 |   |
| Proceeds from exercises of stock options                                           |   | 635                                             |   | 134 |   |
| Purchase of treasury shares                                                        |   | (5,547                                          | )      | — |   |
| **Net cash used in  financing activities**                                         |   | (4,847                                          | )      | (4,311 | ) |
|                                                                               |   |                                            |   |   |   |
| **Net increase in  cash and cash equivalents**                                     |   | 31,205                                          |   | 10,156 |   |
|                                                                               |   |                                            |   |   |   |
| Cash and cash equivalents at beginning of  period                                  |   | 43,852                                          |   | 62,323 |   |
|                                                                               |   |                                            |   |   |   |
| Cash and cash equivalents at end of period                                         |   | $                                               | 75,057 |   | $ | 72,479 |   |

 

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

 

5

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

 

# **1.**              Basis ofPresentation

# ** **

Thecondensed consolidated financial statements included herein have been preparedby Eon Labs, Inc. and its subsidiaries (the “Company”) without audit pursuantto the rules and regulations of the United States Securities and ExchangeCommission.  Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with generally accepted accounting principles have been condensed oromitted pursuant to such rules and regulations.  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 theCompany’s financial position as of March 31, 2004 and results ofoperations and cash flows for the periods presented.  The consolidated balances as of December 31, 2003 werederived from audited financial statements but do not include all disclosuresrequired by generally accepted accounting principles.  The accompanying condensed consolidated financial statements havebeen prepared in accordance with accounting standards for interim financialstatements and should be read in conjunction with the Company’s auditedconsolidated financial statements and the notes thereto for the year ended December 31,2003.  The results of operations for theinterim periods are not necessarily indicative of the results of operations tobe expected for the year.

 

**Revenue Recognition**

 

Salesare recognized when the products are received by the customer, which representsthe point when the risks and rewards of ownership are transferred to thecustomer. Discounts, rebates and contract pricing adjustments are recorded as areduction of sales based on agreed upon terms with the Company’s customers atthe time of sale. The Company calculates a reserve for discounts and rebatesbased upon actual sales under such arrangements. Reserves for contract pricingadjustments represent the difference between the prices wholesalers are billedby the Company and the contract prices billed by wholesalers to theircustomers. In determining a reserve for contract pricing adjustments, theCompany takes into account an estimate of the percentage of product salessubject to such pricing adjustments based on historical trends. Historical trendsare adjusted for new product introductions and changes in wholesaler orcontract prices.

 

Accounts receivable is presented net of allowances fordiscounts, rebates, contract pricing adjustments and doubtful accounts, whichwere $99,500 and $94,656 at March 31, 2004 and December 31, 2003,respectively.

 

Shelf stock adjustments are provided following areduction in the prices of any of the Company’s products due to the competitiveenvironment. Such adjustments are credited to the Company’s customers based ontheir on-hand inventory quantities. Reserves are generally established when theCompany reduces its prices.

 

6

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Estimates for returns, which are recorded at the time ofsale, relate primarily to returns of expiring products. The Company utilizeshistorical trends to estimate the amount of products to be returned due toproduct expiration.

 

Accrued liabilities include$72,547 and $73,086 for returns, promotional incentives and Medicaid rebates atMarch 31, 2004 and December 31, 2003, respectively.

 

## ***Shippingand Handling Costs***

## *** ***

TheCompany classifies shipping and handling costs as part of selling, general andadministrative expenses.  Shipping andhandling costs were $1,315 and $1,090 for the three months ended March 31,2004 and 2003, respectively.

 

## ***Investments***

## *** ***

TheCompany invests in publicly traded debt securities which are categorized assecurities available-for-sale and are carried at fair value.  Unrealized gains and losses related to suchsecurities, net of taxes, are reported in other comprehensive income.  The book value of such securities exceededmarket value by $59 at March 31, 2004 while the market value of suchsecurities exceeded book value by $7 at December 31, 2003.  At March 31, 2003, the market value ofsuch securities exceeded book value by $49. Accordingly, net income for the three months ended March 31, 2004and 2003 decreased by $40 and $14 resulting in comprehensive income of $32,277and $15,093, respectively.

 

**Other Income**

 

Includedin other income is a $10,000 settlement received from GlaxoSmithKline(“Glaxo”) in exchange for agreeing to the dismissal of the Company’s complaintagainst Glaxo for malicious prosecution of an earlier suit against the Company,which claimed the Company’s Nabumetone product infringed Glaxo’s patent.  See Note 8.

 

# **2.**              Stockholder’sEquity

# ** **

**Additional Paid-In Capital**

 

Additionalpaid-in capital increased by $1,791 to $196,742 at March 31, 2004 from$194,951 at December 31, 2003.  Theincrease represents proceeds of $633 from the exercise of employee stockoptions and $3,368 of tax benefits associated with these exercise transactionsoffset by the reissuance of $2,210 of treasury shares.

 

**Stock Options**

 

Duringthe three months ended March 31, 2004, options to purchase 300,000 sharesof common stock at an average exercise price of $58.65 per share weregranted.  The stock options granted are exercisable for up to ten yearsfollowing the date of the grant.  Except for 30,000 options, which wereimmediately vested, the options vest and become exercisable at the rate of 20%per year.

 

Duringthe three months ended March 31, 2004, 191,350 options with aweighted-average exercise price of $3.32 were exercised and 5,600 options wereterminated.

 

7

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## ***DeferredStock-Based Compensation***

## *** ***

TheCompany amortized deferred stock compensation in the amount of $46 and $112 forthe three months ended March 31, 2004 and 2003, respectively.

 

**Stock-Based Compensation**

 

TheCompany has adopted Statement of Financial Accounting Standards (“SFAS”)No. 123 “Accounting for Stock-Based Compensation” (“SFAS No. 123”).SFAS No. 123 allows companies which have stock-based compensationarrangements with employees to adopt a new fair-value basis of accounting forstock options and other equity instruments, or to continue to apply theexisting accounting required by Accounting Principles Board (“APB”) OpinionNo. 25, “Accounting for Stock Issued to Employees.” The Company intends tocontinue to account for stock-based compensation arrangements under APB OpinionNo. 25 and related interpretations in accounting for its stock-basedcompensation. The Company recognizes no compensation expense with respect toawards if the exercise price equals or exceeds the fair value of the underlyingsecurity on the date of grant and other terms are fixed. The Company has alsoadopted the disclosure provisions of SFAS No. 148 “Accounting forStock-Based Compensation -Transition and Disclosure.”This pronouncement requiresprominent disclosures in both annual and interim financial statements about themethod of accounting for stock-based employee compensation and the effect ofthe method used on reporting results. The additional required disclosures arefound below.

 

In addition, the Company provides pro formadisclosure of stock-based compensation, as measured under the fair valuerequirements of SFAS No. 123, “Accounting for Stock-Based Compensation”and as determined through the use of the Black-Scholes option pricing model. These pro forma disclosures are provided as required under SFAS No. 148,“Accounting for Stock-Based Compensation—Transition and Disclosure.”

 

The fair value of the options was determinedusing the Black-Scholes option pricing model with the following assumptions:

 
|                     |   | **March 31, 2004** |   | **March 31, 2003** |   |
|--------------------------|--------|-------------------------|--------|-------------------------|--------|
| Dividend  yield          |   | 0%                      |   | 0%                      |   |
| Volatility               |   | 45%                     |   | 45%                     |   |
| Risk-free  interest rate |   | 3.0% to 4.0%            |   | 3.0% to 4.0%            |   |
| Expected  life           |   | 1 to 5 years            |   | 1 to 5 years            |   |

 

A reconciliation of theCompany’s net earnings to pro forma net earnings and the related pro formaearnings per share amounts for the three months ended March 31, 2004 and2003, respectively, is provided below. For purposes of pro forma disclosure, stock-based compensation expenseis recognized in accordance with the provisions of SFAS No. 123.

 

8

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|                                                                                                 |   | **For the three months ended  March 31,** |   |
|------------------------------------------------------------------------------------------------------|--------|------------------------------------------------|--------|
|                                                                                                 |   | **2004**                                       |   | **2003** | ** ** |
|                                                                                                 |   |                                           |   |   |   |
| Net  income, as reported                                                                             |   | $                                              | 32,317 |   | $ | 15,107 |   |
| Adjustment  to net income for pro forma stock-based compensation expense, net of related  tax effect |   | (922                                           | )      | (126 | ) |
|                                                                                                 |   |                                           |   |   |   |
| Pro  forma net income                                                                                |   | $                                              | 31,395 |   | $ | 14,981 |   |
|                                                                                                 |   |                                           |   |   |   |
| As  reported net earnings per share:                                                                 |   |                                           |   |   |   |
| Basic                                                                                                |   | $                                              | 0.73   |   | $ | 0.34 |   |
| Diluted                                                                                              |   | $                                              | 0.71   |   | $ | 0.33 |   |
|                                                                                                 |   |                                           |   |   |   |
| Pro  forma net earnings per share:                                                                   |   |                                           |   |   |   |
| Basic                                                                                                |   | $                                              | 0.71   |   | $ | 0.34 |   |
| Diluted                                                                                              |   | $                                              | 0.69   |   | $ | 0.33 |   |

 

**Stock Repurchase Program**

 

In April 2003, the Company’s Board of Directorsapproved the repurchase of up to 300,000 shares of the Company’s commonstock.  In July 2003, the Companyadopted a plan to repurchase up to 125,000 shares through December 31,2003.  In February 2004, theCompany adopted a plan to repurchase up to 93,750 shares through March 31,2004.  In April 2004, the Companyadopted a plan to repurchase up to 93,750 shares through June 30,2004.  Depending on market conditions,the Company also expects to conduct purchases in the open market and inprivately negotiated transactions from time to time during its normal tradingwindow and may enter into future plans to repurchase shares.  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,under the Company’s plan, the Company repurchased 93,750 shares of itsoutstanding common stock at an average price of $59.16 per share totaling$5,547.  These transactions areaccounted for under the cost method.

 

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

# ** **

Basic net income per share is computed bydividing net income by the weighted average number of common shares outstandingfor the period.  Diluted earnings pershare reflects the potential dilution of stock options.  Details of the calculations are as follows:

 

9

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|                                      |   | **For the  three months ended  March 31,** |   |
|-------------------------------------------|--------|-------------------------------------------------|--------|
|                                      |   | **2004**                                        |   | **2003** |   |
|                                      |   |                                            |   |   |   |
| **Net income per  share-basic:**          |   |                                            |   |   |   |
|                                      |   |                                            |   |   |   |
| Net income                                |   | $                                               | 32,317 |   | $ | 15,107 |   |
|                                      |   |                                            |   |   |   |
| Weighted average shares outstanding-basic |   | 44,355,387                                      |   | 44,113,516 |   |
| Net income per share-basic                |   | $                                               | 0.73   |   | $ | 0.34 |   |
|                                      |   |                                            |   |   |   |
| **Net income per  share-diluted:**        |   |                                            |   |   |   |
|                                      |   |                                            |   |   |   |
| Net income                                |   | $                                               | 32,317 |   | $ | 15,107 |   |
|                                      |   |                                            |   |   |   |
| Weighted average shares outstanding-basic |   | 44,355,387                                      |   | 44,113,516 |   |
| Dilutive effect of stock options          |   | 1,033,816                                       |   | 1,101,202 |   |
|                                      |   |                                            |   |   |   |
| Weighted average shares-diluted           |   | 45,389,203                                      |   | 45,214,718 |   |
| Net income per share-diluted              |   | $                                               | 0.71   |   | $ | 0.33 |   |

 

# **4.**              Adoption of NewAccounting Pronouncements

# ** **

In January 2003, the FASB issued InterpretationNo. 46, “Consolidation of Variable Interest Entities.” This interpretationprovides guidance with respect to the consolidation of certain entities,referred to as variable interest entities (“VIE”), in which an investor issubject to a majority of the risk of loss from the VIE’s activities, or isentitled to receive a majority of the VIE’s residual returns. Thisinterpretation also provides guidance with respect to the disclosure of VIEs inwhich an investor maintains an interest,but is not required to consolidate. The provisions ofthe interpretation are effective immediately for all VIEs created afterJanuary 31, 2003, or in which the Company obtains an interest after thatdate. For VIEs created before February 1, 2003, the provisions areeffective July 1, 2003. In November 2003, the Company invested $1,150for 50% ownership in an entity formed to provide research and developmentservices for the Company as well as third parties. It has been determined thatsuch investee is deemed a VIE, which has been consolidated in the Company’sfinancial statements. The net assets and results of operations of this entitywere not significant to the Company in 2004.

 

# **5.**              Inventories

# ** **

Inventoriesconsist of the following:

 
|            |   | **March 31,  2004** |   | **December 31,  2003** |   |
|-----------------|--------|--------------------------|--------|-----------------------------|--------|
|            |   |                     |   |                        |   |
| Raw material    |   | $                        | 24,399 |                        | $      | 24,745 |   |
| Work-in-process |   | 10,128                   |   | 7,529                       |   |
| Finished goods  |   | 27,436                   |   | 24,167                      |   |
|            |   |                     |   |                        |   |
|            |   | $                        | 61,963 |                        | $      | 56,441 |   |

 

10

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# **6.**              Line of Credit

# ** **

On February 8, 2002, the Company enteredinto a three-year $25 million credit agreement, which is collateralized byaccounts receivable and inventory. Interest on any borrowing under the line will accrue at the rate ofinterest equal to either the adjusted LIBOR rate plus 1.5%, the prime rate orthe fixed rate (as set by the bank). The rate will depend upon the terms of the selected borrowings.  The agreement has covenants which requirethe maintenance of certain financial ratios including leverage, consolidateddebt and asset coverage, as defined.  AtMarch 31, 2004 and December 31, 2003, there were no outstandingborrowings under the line of credit.

 

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

# ** **

Thefollowing is a summary of related party transactions:

 
|                                                               |   | **For the  three months ended  March 31,** |   |
|--------------------------------------------------------------------|--------|-------------------------------------------------|--------|
|                                                               |   | **2004**                                        |   | **2003** |   |
|                                                               |   |                                            |   |   |   |
| Net sales to subsidiaries of Hexal AG                              |   | $                                               | 564    |   | — |   |
| Purchases of products and supplies from  subsidiaries of Hexal AG  |   | 607                                             |   | 235 |   |
| Reimbursement of other expenses from Hexal  AG                     |   | 484                                             |   | — |   |
| Cyclosporine agreements with Hexal AG(1)                           |   | 1,220                                           |   | 1,343 |   |
| Fees incurred for rights of product  development files of 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.

 

AtMarch 31, 2004 and December 31, 2003, the Company had a payable toHexal AG of approximately $1,209 and $1,102, respectively, included in accruedliabilities.

 

AtMarch 31, 2004 and December 31, 2003, the Company had receivablesfrom subsidiaries of Hexal AG of approximately $549 and $120, respectively,included in prepaid expenses and other current assets.

 

# **8.**              Litigation

# ** **

**Product Liability Litigation**

 

### *Fen-phen Litigation*

### * *

SinceMay 1997, the Company and certain of its customers have been named asdefendants in numerous product liability lawsuits, some of which are classactions, filed in various state and federal courts in connection with itsmanufacture of Phentermine Hydrochloride. These lawsuits typically name as a defendant Wyeth (formerly AmericanHome Products Corporation), the manufacturer of two anti-obesity drugs,Fenfluramine and Dexfenfluramine, and also name manufacturers, distributors andretailers of Phentermine. Fenfluramine and Phentermine were prescribed incombination in an off-label use commonly called “fen-phen,” while Dexfenfluraminewas generally prescribed alone, but occasionally in combination with

 

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Phentermine.  In September 1997, the manufacturer ofFenfluramine and Dexfenfluramine agreed with the Food and Drug Administration(“FDA”) to voluntarily withdraw both products from the market.  The FDA has not requested that Phenterminebe withdrawn from the market.

 

Theplaintiffs in these cases (the “fen-phen cases”) typically allege that theshort- and long-term use of Fenfluramine in combination with Phenterminecauses, among other things, primary pulmonary hypertension, valvular heartdisease and/or neurological dysfunction. Some lawsuits allege emotional distress caused by the purportedincreased risk of injury in the future.  Plaintiffs typically seek relief in the form of monetary damages(including economic losses, medical care and monitoring expenses, loss ofearnings and earnings capacity, other compensatory damages and punitive damages),generally in unspecified amounts, on behalf of the individual or the class.Some actions seeking class certification ask for certain types of equitablerelief, including, but not limited to, declaratory judgments and theestablishment of a research program or medical surveillance fund. Certaincompanies that distributed or sold the Company’s Phentermine and are named asdefendants in certain of these lawsuits seek a defense and indemnity from theCompany.

 

During2000, the United States District Court for the Eastern District of Pennsylvania,the federal court, before which all federal cases were consolidated fordiscovery, found that proposed anti-Phentermine “causation” testimony by twoexpert witnesses was not supported by scientific evidence and thus would bebarred.  These two experts were the only“national” anti-Phentermine “causation” experts identified in the consolidatedfederal litigation, and were to have been “generic” experts in hundreds ofcases.  The Court’s decision tosubstantially curb their testimony has resulted in many cases beingdismissed.  To date, there has been noscientific testimony accepted by any court that establishes a connectionbetween the use of Phentermine either alone or in combination with Fenfluramineand/or Dexfenfluramine and the allegations of injury made by plaintiffs inthese lawsuits.

 

Inlate 1999, Wyeth, the major defendant in the fen-phen litigation and the formermanufacturer of both Fenfluramine and Dexfenfluramine, announced a proposedsettlement of all fen-phen claims against it nationwide (excepting only claimsfor certain serious medical conditions). The United States District Court for the Eastern District ofPennsylvania, which supervises discovery of all federal fen-phen cases in aconsolidated multidistrict litigation (the “Fen-Phen MDL”), certified anationwide settlement class and approved the proposed settlement, which becamefinal in January 2002.  Thissettlement has reduced the number of cases in which the Company and itsdistributors have been named as defendants.

 

Asof March 31, 2004, the Company had been named and served in approximately7,057 fen-phen product liability cases. Approximately 89% of these cases have been dismissed. Since thebeginning of the fen-phen litigation, only one case has gone to trial with theCompany and its distributors as defendants. The case against the Company andall the Phentermine defendants, including other Phentermine manufacturers anddistributors, was dismissed on motion before the presentation of any evidence.

 

Whilethe number of lawsuits being filed has decreased substantially, the Companyexpects additional, similar lawsuits to be filed.  The Company and its outside counsel believe that the Company hassubstantial defenses to these claims, though the ultimate outcome cannot be

 

12

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determined.As of March 31, 2004, there had been no finding of liability for fen-pheninjury against the Company and no payment by the Company to settle anycombination-related fen-phen lawsuit.

 

### *Phentermine Litigation*

 

TheCompany has been named as a defendant in several cases in which the plaintiffalleges injury from the use of Phentermine alone, and in one instance theCompany was named as a third-party defendant in a medical malpractice case inwhich negligent prescription of Phentermine was alleged.  A number of these claims have been dismissedin the Company’s favor, and as of March 31, 2004 only one such claimremained pending.

 

Becausediscovery has not been completed in this pending case, predicting the ultimateoutcome of this action is not possible, and no provision for any relatedliability has been reflected in the Company’s financial statements.  The Company believes it has substantialdefenses to this claim.

 

Netsales of Phentermine by the Company for the three months ended March 31,2004 and 2003 were approximately $1,500 and $2,400,  respectively.

 

### *Defense/Indemnity Issues Related to Fen-phen and Phentermine Litigation*

### * *

Inor about April 2000, the Company exhausted its product liability insurancecovering all combination-related Phentermine lawsuits and any non-combinationPhentermine lawsuits resulting from claims regarding the ingestion ofPhentermine prior to June 1998. Since that time, the Company has funded its own defense in suchlawsuits.  However, pursuant to anOctober 1999 settlement with an insurance carrier, the Company has madeinsurance coverage claims for fen-phen claims filed on or after June 22,2003 which allege fen-phen use prior to June 1998.  The Company has reached an agreement inprinciple with its insurer regarding these insurance claims that, if completed,will defray the future cost of the Company’s fen-phen defense by approximately$1,400.  Additionally, the Company hasreached agreements under which the Company has agreed to fund or partially fundthe defense of certain of its distributors and indemnify them, provided certainconditions are met.  Furthermore, theCompany has reached favorable defense/indemnity agreements with several retailersof the Company’s Phentermine products. Fen-phen and Phentermine litigation defense costs, and the costs ofrelated defense agreements, are being expensed as incurred.

 

### *Other Product Liability Litigation*

### * *

TheCompany has been named as a defendant in several other product liabilitylawsuits in which plaintiffs allege that Company-manufactured pharmaceuticalscontaining phenylpropanolamine (PPA) caused injury.  PPA was removed from the market in 2000 at the FDA’s requestafter a study appeared to show a potentially increased risk of hemorrhagicstroke in certain patient cohorts.  TheCompany previously manufactured two low-volume prescription products thatcontained PPA that were discontinued in 1999 and 2000.

 

Todate, the Company has been named in five lawsuits alleging injury or wrongful deathfrom the use of Company-manufactured pharmaceuticals containing PPA.  As of March 31, 2004, all but two PPAcases against the Company had been dismissed or discontinued.  Discovery in these

 

13

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lawsuitsis incomplete, and predicting the ultimate outcome of these actions is notpossible.  The Company believes itsproduct liability insurance is adequate to cover existing PPA claims and,consequently, no provision for any related liability has been reflected in theCompany’s financial statements.

 

**Patent Infringement Litigation**

 

In August 2000, Novartis Pharmaceuticals Corporation (“Novartis”)filed a complaint in the United States District Court for the District ofDelaware alleging, among other things, that the Company’s generic Cyclosporineproduct infringes a patent owned by Novartis. In December 2002, the United States District Court for the Districtof Delaware granted the Company’s motion for summary judgment ofnon-infringement of the patent.  InApril 2004, the United States Court of Appeals for the Federal Circuitaffirmed the judgment of the Delaware district court that the Company’s genericCyclosporine product does not infringe Novartis’ patent.  Novartis’ request for a rehearing by theUnited States Appeals Court is pending. TheCompany’s potential liability and expenses in this matter are not covered byinsurance.  An adverse outcome in thislitigation could result in the Company being unable to market Cyclosporine,which could materially harm profits and cash flows, and could result in payingdamages, costs, expenses and fees that could have a material adverse impact onthe Company’s financial performance.

 

InJanuary 2001, Apotex, Inc. (“Apotex”) filed an action in the UnitedStates District Court for the Eastern District of New York alleging that bymanufacturing, selling and offering to sell Cyclosporine capsules the Companyis infringing a patent of which Apotex alleges it is the exclusivelicensee.  Apotex seeks injunctiverelief as well as an unspecified amount of damages and has also asserted aclaim that the alleged infringement was willful, that the case is thereforeexceptional and that Apotex should therefore be awarded the attorney fees ithas incurred and treble damages in the action. The Company’s potential liability and expenses in this matter are notcovered by insurance.  An adverseoutcome in 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.

 

TheCompany has denied that it has infringed any valid patent claims asserted byApotex, has alleged affirmatively, among other things, that the patent isinvalid and that it is not infringed by the Company’s manufacture, sale oroffer to sell its Cyclosporine capsules.

 

InNovember 2000, Glaxo filed suit against the Company in the United StatesDistrict Court for the Southern District of New York alleging infringement oftwo patents based on the Company’s filing of an Abbreviated New DrugApplication (“ANDA”) to market generic Bupropion Hydrochloride 100 mg and 150mg ER (extended release) tablets.  InApril 2004, a Stipulation and Order was entered in the United StatesDistrict Court for the Southern District of New York, terminating all pendingclaims and counterclaims in the patent infringement litigation that Glaxobrought against the Company in November 2000, concerning the Company’sBupropion HCl, ER 100 mg and 150 mg tablets (generic equivalents of Glaxo’sWellbutrin SRÒ 100 mg and 150 mgtablets).  Under the terms of theStipulation and a separate Settlement Agreement, Glaxo agreed to drop anyfurther effort to pursue its claim that the Company’s Bupropion HCl, ER 100 mgand

 

14

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150 mg tablets infringe Glaxo’s patents.  The Company received $3,000 as part of the Settlement Agreementwhich will be recorded as income in the quarter ending June 30, 2004.

 

Inaddition, the Company has been named in several other patent infringementactions alleging that the Company has infringed patents by filing anapplication with the FDA for approval to market products before the plaintiffs’patents expire.  In general, plaintiffsseek judgments precluding the FDA from approving the Company’s application tomarket a product before their respective patents expire and have assertedclaims that the alleged infringements were willful, that the actions aretherefore exceptional and that plaintiffs should therefore be awarded theattorney fees they have incurred in the actions.

 

TheCompany and its outside counsel believe that the Company has substantialdefenses and counterclaims to the foregoing patent infringement actions, thoughthe ultimate outcome cannot be determined.

 

Becausepredicting the ultimate outcome of these actions is not possible, no provisionfor any related liability has been reflected in the Company’s financial statements.

 

**Nabumetone Settlements**

 

In August 2001, the Company was successful in defending itself inthe United States District Court for the District of Massachusetts against apatent infringement claim involving Nabumetone.  At the conclusion of the trial, the Company filed a motion torecover the legal fees it incurred in defending the action.  The motion was stayed pending the appeal ofthe District Court’s ruling.  The Courtof Appeals affirmed the District Court decision in August 2002. InMay 2003, the Company and the original plaintiff reached agreementregarding the Company’s motion to recover legal fees. Under the agreement, theCompany was reimbursed $3,500 for legal fees it had incurred in defendingitself.  The $3,500 recovery of legalfees was reflected in other selling, general and administrative expenses duringthe quarter ended June 30, 2003. In February 2004, the Company stipulated to an order dismissing itscomplaint against Glaxo for malicious prosecution of Glaxo’s earlier suitagainst the Company, which claimed the Company’s Nabumetone product infringedGlaxo’s patent.  In exchange foragreeing to the dismissal of its complaint, the Company received $10,000, whichwas included in other income in the quarter ended March 31, 2004.

 

**Other Litigation**

 

TheCompany is in other litigation incidental to its business activities.  The ultimate disposition of such lawsuitswill not materially affect the Company’s financial statements.

 

# **9.**              Contingencies

 

**Medicaid Rebates**

 

TheOmnibus Budget Reconciliation Act of 1990, effective January 1, 1991, asamended, requires drug companies to enter into a rebate agreement with thecenters for Medicare and Medicaid Services (formerly called the Health CareFinancing Administration) of the Federal government.  The rebate agreement states that drug companies must pay rebatesto states for

 

15

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drugs(prescription, non-prescription or biological products) sold to Medicaidrecipients.  At March 31, 2004 andDecember 31, 2003, $5,003 and $4,009, respectively, are included inaccrued liabilities as the estimated liability for Medicaid rebates.

 

TheAttorneys General in at least six states sent letters to numerouspharmaceutical manufacturers during December 2003 instructing them tomaintain all records relating to their reporting of pricing information underthe Medicaid Drug Rebate Statute. The letters state that the document retentiondemand is in furtherance of an ongoing investigation of the manufacturers’compliance with Medicaid drug rebate program requirements.  The Company received letters from some, butnot all, of the states believed to be involved. The Company believes theseletters may have been motivated, at least in part, by a federal regulationpublished in August 2003 that, effective January 1, 2004, would havelimited the document retention provisions under the federal Medicaid DrugRebate Statute to three years unless the records are the subject of an audit ora government investigation of which the manufacturer is aware. That regulationwas amended, effective January 6, 2004, to substitute a ten-year recordretention requirement.  The Company hasnot received any subpoenas, informal document requests, or any other communicationsfrom federal or state enforcement authorities that suggest an investigation ofits Medicaid drug rebate reporting practices is under way. The Company believesit operates in compliance with the requirements of the Medicaid Drug RebateStatute.

 

## ***StateMedicaid Claims***

 

EonLabs Holdings, Inc. purchased Major Pharmaceuticals, Inc. (“Major”), adistributor of drug products, in 1991 and sold Major in 1995.  At the time of the sale, EHI established anescrow account to cover any Medicaid drug rebate liabilities incurred by Majorprior to the sale.

 

Asof March 31, 2004, the recorded liability for such claims is $817, whichmanagement believes is adequate to resolve such matters.  The Company has approximately $684 as ofMarch 31, 2004, in an escrow account to fund any such claims.

 

**Environmental Contingencies**

 

TheCompany received an inquiry from the United States Environmental ProtectionAgency (“EPA”) in 2002 concerning the Company’s relationship as a possiblesuccessor to a party that may be among a substantial number of parties liablefor cleanup of the Mattiace Petrochemical Superfund site, a contaminated sitecurrently being addressed by the EPA at a cost estimated by the EPA to beapproximately $36.0 million.  Basedon information available at this time, the Company does not expect this matterto require significant capital expenditures or to have a material adverseeffect on its earnings or financial position.

 

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

 

Thefollowing discussion and analysis of the Company’s financial condition andresults of operations should be read in conjunction with the consolidatedfinancial statements, the related notes to consolidated financial statementsand “Management’s Discussion and Analysis of Financial Condition and Results ofOperations” included in the Company’s annual report on

 

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Form10-K and the unaudited interim condensed consolidated financial statements andnotes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

 

**Three Months Ended March 31, 2004Compared With Three Months Ended March 31, 2003**

 

**Net sales.**  Net sales increased 47.1% to$104.2 million for the three months ended March 31, 2004 from $70.9million in the comparable period in 2003. The majority of the sales growth for the first quarter was due to theintroduction of Bupropion HCl, ER 100 mg and 150 mg tablets, which wereintroduced during the first quarter of 2004. Other products introduced subsequent to March 31, 2003 thatcontributed to the increase in net sales include Mirtazapine, Midodrine HCl,Nefazadone HCl, Metolazone USP, Benazepril HCl and Benazepril HCTZ.

 

**Gross profit.**  Gross profit as a percentageof net sales increased to 59.7% for the three months ended March 31, 2004compared to 54.2% in the comparable period in 2003.  The increase was primarily due to the benefit of a favorableproduct mix principally from the introduction of Bupropion HCl, ER 100 mg and150 mg tablets.  The Company’s grossprofit margins are dependent on several factors, including product sales mix,cost, volumes and competitive activity.

 

**Amortization of otherintangibles. **Amortization ofother intangibles was $0.9 million for the three months ended March 31,2004 and for the comparable period in 2003.

 

**Otherselling, general and administrative. **Other selling,general and administrative expenses increased $4.2 million to $13.0 million forthe three months ended March 31, 2004 from $8.7 million for the comparableperiod in 2003.  As a percentage of netsales, other selling, general and administrative expenses for the three monthsended March 31, 2004 were consistent with the comparable period in2003.  The dollar increase is primarilyattributable to increases of $1.1 million for insurance expense due to higherinsurance premiums, $1.3 million for higher legal costs primarily associatedwith patent challenges, $1.1 million in compensation costs and $0.7 million inother expenses.

 

**Research and development. **Researchand development expenses increased $1.9 million to $5.6 million for the threemonths ended March 31, 2004 from $3.6 million in the comparable period in2003.  The increase is primarilyattributable to increases in the cost for bio-studies, the purchase ofmaterials and expenses relating to the completion of defined milestones underthird-party product development agreements. These increases reflect anacceleration of the Company’s product development program.

 

**Operating income.**  Operating income increased $17.7million to $42.8 million for the three months ended March 31, 2004 from$25.1 million for the comparable period in 2003.  The increase inoperating income is the result of increased sales and gross profit, offset byincreases in other selling, general and administrative expenses and researchand development costs.

 

**Interest income (expense). **Netinterest income for the three months ended March 31, 2004 increased $0.4from the comparable period in the prior year due to the elimination ofoutstanding debt, which decreased interest expense by $0.3 million.

 

17

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**Other income, net.**  Other income for the threemonths ended March 31, 2004 included a $10.0 million settlement receivedfrom Glaxo in exchange for agreeing to the dismissal of the Company’s complaintagainst Glaxo for the malicious prosecution of its earlier suit against theCompany, which claimed the Company’s Nabumetone product infringed Glaxo’spatent. Other income for the three months ended March 31, 2003 was lessthan $0.1 million.

 

**Taxes on income. **Taxeson income increased $10.8 million to $20.9 million during the three monthsended March 31, 2004 from $10.1 million for the comparable period in2003.  The increase is the result of higher pre-tax income for 2004. The effective tax rate decreased to 39.3% from 40.0% due principally to lowerstate and local taxes in 2004.

 

**Net income.**  Net income increased $17.2million to $32.3 million for the three months ended March 31, 2004 from$15.1 million for the comparable period in 2003 for the reasons describedabove.

 

**Liquidity and Capital Resources**

 

Cashand cash equivalents were $75.1 million at March 31, 2004, as compared to$43.9 million at December 31, 2003. Additionally, the Company had investments in marketable debt securitiesof $103.7 million at March 31, 2004, as compared to $115.3 million atDecember 31, 2003.

 

TheCompany has a three-year $25 million credit facility which expires onFebruary 8, 2005. Under this facility, the Company can borrow at LIBORplus 1.5%, the bank’s prime rate or a fixed rate. The credit facility, which isfor working capital purposes, had no outstanding borrowings against it atMarch 31, 2004 and December 31, 2003.

 

Stockholders’equity increased to $359.5 million at March 31, 2004 from $328.8 millionat December 31, 2003.  The increasein stockholders’ equity was primarily comprised of $1.8 million (including taxbenefits) from the exercise of stock options, net earnings of $32.3 million forthe three months ended March 31, 2004, offset by net purchases of $3.3million of treasury shares.

 

Forthe three months ended March 31, 2004, cash increased by $31.2million.  Operations generated $26.4million of cash, comprised of net earnings of $32.3 million, non-cash itemstotaling $11.5 million, offset by an increase in working capital of $17.4million.  The increase in workingcapital resulted primarily from increases in accounts receivable, inventory andother assets of $18.1 million, $5.5 million and $0.6 million, respectively, anda decrease in accounts payable of $2.0 million.  A decrease in prepaid expenses and other current assets of $2.2million and an increase in accrued liabilities of $6.6 million partially offsetthe other working capital increases. The increases in accounts receivable and inventory are attributed toincreased sales.  The increase in otherassets is attributed to the timing of deposits on building improvements andmachinery primarily to support increased production volume in the Company’sNorth Carolina facility.  The increasein accrued liabilities is due to an increase in accrued taxes.  The decreases in prepaid expenses and othercurrent assets and accounts payable are due to lower amortization of prepaidinsurance and timing of payments, respectively.

 

Investingactivities provided $9.6 million of cash for the three months endedMarch 31, 2004.  Approximately$11.5 million of such amount represented net sales of short-term investment

 

18

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gradedebt during the three months ended March 31, 2004, offset by $1.9 millionused for capital expenditures.  Thecapital expenditures relate primarily to machinery and equipment required tosupport increased production volume in the Company’s North Carolina facility.

 

Financingactivities consumed $4.8 million of cash during the three months endedMarch 31, 2004.  The purchase oftreasury shares consumed $5.5 million. Financing activities generated $0.7 million, of which $0.6 millionrepresents cash proceeds received from employees who exercised stock options,with the remaining proceeds related to other financing activities.

 

The Company is involved in various product liability andpatent litigation not covered by insurance. Adverse rulings in litigationrelated to product liability could result in the Company paying damages andexpenses that could have a material adverse effect on the Company’s financialperformance.

 

An adverse outcome in patent litigation with Novartisand Apotex involving Cyclosporin capsules could result in the Company not beingable to market this product, which could materially harm its profits and cashflows.  Furthermore, an adverse outcomein this litigation could result in the Company paying damages, costs, expenses andfees that could have a material adverse impact on its financial performance. InDecember 2002, the United States District Court for the District ofDelaware granted the Company’s motion for summary judgment of non-infringementof the patent.  In April 2004, theUnited States Court of Appeals for the Federal Circuit affirmed the judgment ofthe Delaware district court that the Company’s generic Cyclosporine productdoes not infringe Novartis’ patent. Novartis’ request for a rehearing by the United States Court of Appealsis pending.

 

The Company does not currently have or anticipate anyshort-term funding requirements outside of the ordinary course of its business,and the Company does not have or anticipate any liquidity concerns. TheCompany’s principal future cash requirements are associated with increasedworking capital to support future growth, capital expenditures and legaldefense costs. The Company anticipates that its operating cash flows andcurrent cash balances together with its available borrowings under its creditfacility will be sufficient to meet all of its cash requirements for both theshort-term and foreseeable future.

 

**Critical Accounting Policies**

 

The Company’s critical accounting policies are thosepolicies that are important to the portrayal of its financial condition andresults of operations and require management’s subjective judgments. As aresult, these judgments are subject to an inherent degree of uncertainty. TheCompany bases its judgments on its experience and various other assumptionsthat the Company believes to be reasonable under the circumstances. On anongoing basis, 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:

 

Sales are recognized when the products are received bythe customer, which represents the point when the risks and rewards ofownership are transferred to the customer. Discounts, rebates and

 

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contract pricing adjustments are recorded as a reductionof sales based on agreed-upon terms with the Company’s customers at the time ofsale. The Company calculates a reserve for discounts and rebates based uponactual sales under such arrangements. Reserves for contract pricing adjustmentsrepresent the difference between the prices wholesalers are billed by theCompany and the contract prices billed by wholesalers to their customers. Indetermining a 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.

 

Shelf stock adjustments are providedfollowing a reduction in the prices of any of the Company’s products due to thecompetitive environment. Such adjustments are credited to the Company’scustomers based on their on-hand inventory quantities. Reserves are generallyestablished when the Company reduces its prices.

 

Estimates for returns, which are recorded atthe time of sale, relate primarily to returns of expiring products. The Companyutilizes historical trends to estimate the amount of products to be returneddue to product expiration.

 

In determining whether liabilities should be recordedfor pending litigation claims, the Company must assess the allegations made andthe likelihood 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.

 

**Impact of Recently Issued AccountingStandards**

 

InJanuary 2003, the FASB issued Interpretation No. 46, “Consolidationof Variable Interest Entities.” This interpretation provides guidance withrespect to the consolidation of certain entities, referred to as variableinterest entities (“VIE”), in which an investor is subject to a majority of therisk of loss from the VIE’s activities, or is entitled to receive a majority ofthe VIE’s residual returns. This interpretation also provides guidance withrespect to the disclosure of VIEs in which an investor maintains an interest,but is not required toconsolidate. The provisions of the interpretation are effective immediately forall VIEs created after January 31, 2003, or in which the Company obtainsan interest after that date. For VIEs created before February 1, 2003, theprovisions are effective July 1, 2003. In November 2003, the Companyinvested $1.2 million 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 were not significant to the Company in 2004.

 

**Off-Balance Sheet Arrangements**

 

None.

 

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**ITEM 3.**  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

Thefollowing discusses the Company’s exposure to market risk related to changes ininterest rates, equity prices and foreign currency exchange rates.  The Company does not believe that itsexposure to market risk is material.

 

Asof March 31, 2004, the Company had cash and cash equivalents of $75.1million.  Cash equivalents areinterest-bearing investment grade securities, primarily short-term, highlyliquid investments with maturities at the date of purchase of less than 90days.  In addition, as of March 31,2004, the Company owned $103.7 million in publicly traded debt securities withan average maturity of approximately 231 days, which are subject to marketfluctuations.

 

Theseinvestments are subject to interest rate risk and will decrease in value ifmarket interest rates increase.  Ahypothetical increase in the market interest rates by 10 percent from the ratesin effect on the date of this Form 10-Q would cause the fair value of theseshort-term investments to decline by an insignificant amount.  The Company has the ability to hold theseinvestments until maturity and therefore does not expect the value of theseinvestments to be affected to any significant degree by the effect of a suddenchange in market interest rates. Declines in interest rates over time will, however, reduce the Company’sinterest income.

 

TheCompany does not have any significant foreign currency exchange rate risk.

 

**ITEM 4.****  CONTROLS AND PROCEDURES**

 

As of the end of the period covered by this report, theCompany’s management performed an evaluation, under the supervision and withthe participation of its Chief Executive Officer and Chief Financial Officer,of the effectiveness of the design and operation of the Company’s disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) ofthe Securities Exchange Act of 1934, as amended). Based on that evaluation, theCompany’s management, including its Chief Executive Officer and Chief FinancialOfficer, concluded that the Company’s disclosure controls and procedures wereeffective as of the end of the period covered by this report.

 

There have been no changes in the Company’s internalcontrol over financial reporting that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**SPECIAL NOTE REGARDING FORWARD-LOOKINGSTATEMENTS**

 

ThisQuarterly Report on Form 10-Q contains forward-looking statements relating tofuture events and future performance of the Company within the meaning ofSection 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934, including, without limitation, statementsregarding the Company’s expectations, beliefs, intentions or future strategiesthat are signified by the words “expects,” “anticipates,” “intends,” “believes”or similar language.  Actual resultscould differ materially from those anticipated in such forward-

 

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lookingstatements.  Some specific factors thatmay have a significant effect on the Company’s operating results and commonstock market price include:

 

•                  new product introductions;

•                  changes in the degree ofcompetition for the Company’s products;

•                  regulatory issues,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;

•                  the inability to acquiresufficient supplies of raw materials;

•                  litigation and/or threats oflitigation;

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

•                  legislative and FDA actionswith respect to the government regulation of pharmaceutical products;

•                  public concern as to thesafety of the Company’s products;

•                  changes in health carepolicy in the United States;

•                  conditions in the financialmarkets in general or changes in general economic conditions;

•                  the Company’s inability toraise additional capital;

•                  conditions of other genericpharmaceutical companies or the generic pharmaceutical industry generally; and

•                  changes in stock marketanalyst recommendations regarding the Company’s common stock, other comparablecompanies or the generic pharmaceutical industry generally.

 

Allforward-looking statements included in this document are based on informationavailable to the Company on the date hereof, and the Company assumes noobligation to update any forward-looking statements. The Company cautionsinvestors that its business and financial performance are subject tosubstantial risks and uncertainties.

 

**PART II. OTHER INFORMATION**

 

**ITEM 1.****  LEGALPROCEEDINGS**

 

InApril 2004, AstraZeneca A.B. (“AstraZeneca”) filed suit against theCompany in the United States District Court of Delaware, alleging that theCompany infringed patents held by AstraZeneca by filing an ANDA to market thegeneric drug Metoprolol Succinate in tablet form.

 

In May 2000, AstraZeneca filed suit against the Company in the UnitedStates District Court for the Southern District of New York, alleginginfringement of six patents based on the Company’s filing of an ANDA to marketgeneric Omeprazole 10 mg and 20 mg capsules. The Company denied AstraZeneca’s allegations and filed appropriatecounterclaims.  Subsequently,AstraZeneca withdrew its claims regarding four of these patents, after threewere held invalid and the other was found, in a related litigation againstother generic drug companies, to be non-infringed by generic omeprazoleproducts.  The discovery process forthis litigation is nearing completion, but a trial date has not yet been set.

 

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Subsequently, the Company amended its ANDA to add Omeprazole 40 mgcapsules.  In April 2004,AstraZeneca filed another suit in the United States District Court for theSouthern District of New York against the Company, alleging the Company’samendment to its ANDA to market Omeprazole 40 mg capsules infringes the twopatents still in dispute in the suit filed in May 2000.  The Company anticipates that this suit willbe consolidated with the suit filed in May 2000.

 

In April 2004, aStipulation and Order was entered in the United States District Court for theSouthern District of New York, terminating all pending claims and counterclaimsin a patent infringement litigation that Glaxo brought against the Company inNovember 2000, concerning the Company’s Bupropion HCl, ER 100 mg and 150mg tablets (generic equivalents of Glaxo’s Wellbutrin SRÒ 100 mg and 150mg tablets). Under the terms of the Stipulation and a separate SettlementAgreement, Glaxo agreed to drop any further effort to pursue its claim that theCompany’s Bupropion HCl, ER 100 mg and 150 mg tablets infringe Glaxo’spatents.  In April 2004, theCompany received $3.0 million as part of the Settlement Agreement.  The $3.0 million received will be recorded asincome by the Company in the quarter ending June 30, 2004.

 

InAugust 2000, Novartis filed a complaint in the United States DistrictCourt for the District of Delaware alleging, among other things, that theCompany’s generic Cyclosporine product infringes a patent owned byNovartis.  In December 2002, theUnited States District Court for the District of Delaware granted the Company’smotion for summary judgment of non-infringement of the patent.  In April 2004, the United States Courtof Appeals for the Federal Circuit affirmed the judgment of the Delawaredistrict court that the Company’s generic Cyclosporine product does notinfringe Novartis’ patent.  Novartis’request for a rehearing by the United States Appeals Court is pending.

 

In February 2004, the Company stipulated to an order dismissingits complaint against Glaxo for malicious prosecution of Glaxo’s earlier suitagainst the Company, which claimed that the Company’s Nabumetone productinfringed Glaxo’s patent.  The Companyreceived $10 million in exchange for agreeing to a dismissal of its complaint.

 

**ITEM 2.****  CHANGES INSECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES**

 

InJune 2002, the Company closed an initial public offering of its commonstock.  The Registration Statement onForm S-1 (File No. 333-83638) was declared effective by the Securities andExchange Commission on May 23, 2002 and the Company commenced the offering onthat date.  After deducting underwritingdiscounts and commissions and the offering expenses, the net proceeds from theoffering to the Company were approximately $139.2 million.

 

TheCompany has used proceeds from the offering as follows: (i) $66.9 million hasbeen used to repay debt due to Hexal AG; (ii) $10.0 million has been used torepay debt incurred in connection with the acquisition of EHI; and (iii) $2.0million has been used for general working capital purposes.  The remaining $60.3 million of the proceedsto the Company from the offering are invested in cash investments andshort-term investment grade debt securities. The Company anticipates using the balance of the proceeds from theoffering for general corporate purposes, including funding working capital,increased research and development expenditures to expand

 

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theCompany’s product offerings and the potential acquisition of product lines orcompanies.  The Company has no presentunderstandings, commitments or agreements with respect to anyacquisitions.  The Company has notdetermined the amounts it plans to spend on any of the areas listed above orthe timing of these expenditures.

 

Thefollowing table sets forth the repurchases of shares of the Company’s commonstock made during the three months ended March 31, 2004:  (1)

 
| **Period**                                      |   | **(a) Total  Number  of Shares  Purchased** |   | **(b)  Average  Price Paid per  Share** |   | **(c) Total  Number  of Shares  Purchased as Part  of Publicly  Announced Plan  or Programs** |   | **(d)  Maximum  Number (or  Approximate  Dollar Value) of  Shares that May  Yet Be  Purchased Under  the Plans or  Programs** |   |
|-------------------------------------------------|--------|---------------------------------------------|--------|-----------------------------------------|--------|-----------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------|--------|
| January 1, 2004 - January 31,  2004   |   | —                                      |   | $                                       | — |                                                                                          | — |                                                                                                                          | — |   |
| February 1, 2004 - February 29,  2004 |   | 17,600                                      |   | 58.84                                   |   | —                                                                                        |   | 76,150                                                                                                                        |   |
| March 1, 2004 - March 31, 2004        |   | 76,150                                      |   | 59.24                                   |   | —                                                                                        |   | —                                                                                                                        |   |
| Total                                           |   | 93,750                                      |   | $                                       | 59.16  |                                                                                          | — |                                                                                                                          | — |   |
|                                                 |        |                                             |        |                                         |        |                                                                                               |        |                                                                                                                               |        |  |  |

 

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(1)In April 2003, the Company’s Board of Directors approved the repurchase ofup to 300,000 shares of the Company’s common stock.  In February 2004, the Company adopted a plan to repurchaseup to 93,750 shares through March 31, 2004.  In April 2004, the Company adopted a plan to repurchase upto 93,750 shares through June 30, 2004. Depending on market conditions, the Company also expects to conductpurchases in the open market and in privately negotiated transactions from timeto time during its normal trading window and may enter into future plans torepurchase shares.

 

**ITEM 5.**** OTHER INFORMATION**

 

**Audit Committee pre-approval ofnon-audit services**

 

Duringthe quarter ended March 31, 2004, the Company’s Audit Committeepre-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.

 

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Duringthe quarter ended March 31, 2004, the Audit Committee also pre-approvedsix categories of tax-related services in a total aggregate amount of$140,000.  The individual categorieshave sub-limits ranging from $10,000 to $40,000.

 

**ITEM 6.****  EXHIBITS ANDREPORTS ON FORM 8-K**

 

(a)                                  Exhibits

 

31.1                           Certifications pursuant toSection 302 of the Sarbanes-Oxley Act of 2002

 

31.2                           Certifications pursuant toSection 302 of the Sarbanes-Oxley Act of 2002

 

32.1                           Certification Pursuant to 18U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002

 

32.2                           Certification Pursuant to 18U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002

 

(b)                                 Reports on Form 8-K

 

On January 15, 2004, the Company filed a Current Report on Form8-K reporting the Press Release regarding the Company raising its previouslyissued guidance for the three months and full year ended December 31,2003.

 

On February 19, 2004, the Company filed a Current Report on Form8-K reporting the Press Release regarding earnings for the three months andfull year ended December 31, 2003.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|         | Eon  Labs, Inc. |
|--------------|-----------------|
|         |            |
| May  7, 2004 | By:             | /s/  Bernhard Hampl, Ph.D. |   |
|         |            | Bernhard  Hampl, Ph.D.  President, Chief Executive Officer  and Director |
|         |            |
|         |            |
| May  7, 2004 | By:             | /s/  William F. Holt |   |
|         |            | William  F. Holt  Chief Financial Officer |

 

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