**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

 

**FORM 10-Q**

** **

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

 

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**CommissionFile Number 001-31333**

 

**Forthe quarterly period ended June 30, 2003**

 

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**Eon Labs,Inc.**

(Exact Name ofRegistrant as Specified in its Charter)

 

| **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 all reports required by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the Registrant was required to file such reports) and(2) has been subject to such filing requirements for the past90 days: Yes ýNo o

 

As of August 4, 2003, there were 44,337,003shares of the Registrant’s Common Stock, $0.01 par value per share,outstanding.

 

 

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**Eon Labs, Inc. andSubsidiariesTable of Contents**

 
|               |   |                                                                                                                         |   | **Pages** |
|--------------------|--------|------------------------------------------------------------------------------------------------------------------------------|--------|-----------|
| PART I.            |   | FINANCIAL  INFORMATION                                                                                                       |   | 3         |
|               |   |                                                                                                                         |   |      |
| ITEM 1.            |   | Financial  Statements                                                                                                        |   | 3         |
|               |   |                                                                                                                         |   |      |
|               |   | Condensed Consolidated Balance Sheets as of  June 30, 2003 (unaudited) and December 31, 2002                                 |   | 3         |
|               |   |                                                                                                                         |   |      |
|               |   | Condensed Consolidated Statements of Income  (unaudited) for the Three and Six Months Ended June 30, 2003 and June 30,  2002 |   | 4         |
|               |   |                                                                                                                         |   |      |
|               |   | Condensed Consolidated Statements of Cash  Flows (unaudited) for the Six Months Ended June 30, 2003 and June 30, 2002        |   | 5         |
|               |   |                                                                                                                         |   |      |
|               |   | Notes to Condensed Consolidated Financial Statements  (unaudited)                                                            |   | 6         |
|               |   |                                                                                                                         |   |      |
| ITEM 2.            |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                  |   | 17        |
|               |   |                                                                                                                         |   |      |
| ITEM 3.            |   | Quantitative  and Qualitative Disclosure about Market Risk                                                                   |   | 22        |
|               |   |                                                                                                                         |   |      |
| ITEM 4             |   | Controls  and Procedures                                                                                                     |   | 23        |
|               |   |                                                                                                                         |   |      |
| PART II.           |   | OTHER INFORMATION                                                                                                            |   | 24        |
|               |   |                                                                                                                         |   |      |
| ITEM 2.            |   | Changes  in Securities and Use of Proceeds                                                                                   |   | 24        |
|               |   |                                                                                                                         |   |      |
| ITEM 6.            |   | Exhibits  and Reports on Form 8-K                                                                                            |   | 24        |
|               |   |                                                                                                                         |   |      |
| SIGNATURES         |   |                                                                                                                         |   | 26        |
|               |   |                                                                                                                         |   |      |
| 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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**Eon Labs, Inc. and Subsidiaries**

**CondensedConsolidated Balance Sheets**

(dollars inthousands, except per share amounts)

 
|                                                                                                                                                                                 |   | **June 30,  2003** |    | **December 31,  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------|------------------------|--------|
|                                                                                                                                                                                 |   | **(Unaudited)**    |    |                   |   |
| **Assets**                                                                                                                                                                           |   |               |    |                   |   |
|                                                                                                                                                                                 |   |               |    |                   |   |
| **Current assets**                                                                                                                                                                   |   |               |    |                   |   |
| Cash and cash equivalents                                                                                                                                                            |   | $                  | 38,593  |                   | $      | 62,323 |   |
| Investments                                                                                                                                                                          |   | 74,278             |    | 24,961                 |   |
| Accounts receivable, net                                                                                                                                                             |   | 22,891             |    | 23,822                 |   |
| Inventories                                                                                                                                                                          |   | 50,429             |    | 41,946                 |   |
| Deferred tax assets, net                                                                                                                                                             |   | 42,627             |    | 43,648                 |   |
| Prepaid expenses and other current assets                                                                                                                                            |   | 12,525             |    | 10,402                 |   |
| Due from related party                                                                                                                                                               |   | 243                |    | 280                    |   |
|                                                                                                                                                                                 |   |               |    |                   |   |
| **Total current assets**                                                                                                                                                             |   | 241,586            |    | 207,382                |   |
|                                                                                                                                                                                 |   |               |    |                   |   |
| Property, plant and equipment, net                                                                                                                                                   |   | 46,105             |    | 42,788                 |   |
| Goodwill and other intangible assets, net                                                                                                                                            |   | 74,820             |    | 76,701                 |   |
| Other assets                                                                                                                                                                         |   | 2,249              |    | 3,000                  |   |
|                                                                                                                                                                                 |   |               |    |                   |   |
| **Total assets**                                                                                                                                                                     |   | $                  | 364,760 |                   | $      | 329,871 |   |
|                                                                                                                                                                                 |   |               |    |                   |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                        |   |               |    |                   |   |
|                                                                                                                                                                                 |   |               |    |                   |   |
| **Current liabilities**                                                                                                                                                              |   |               |    |                   |   |
| Accounts payable                                                                                                                                                                     |   | $                  | 10,464  |                   | $      | 10,974 |   |
| Accrued liabilities                                                                                                                                                                  |   | 53,781             |    | 48,785                 |   |
| Current portion of note payable                                                                                                                                                      |   | —             |    | 4,530                  |   |
|                                                                                                                                                                                 |   |               |    |                   |   |
| **Total current liabilities**                                                                                                                                                        |   | 64,245             |    | 64,289                 |   |
|                                                                                                                                                                                 |   |               |    |                   |   |
| **Long-term liabilities**                                                                                                                                                            |   |               |    |                   |   |
| Deferred tax liabilities, net                                                                                                                                                        |   | 6,998              |    | 6,998                  |   |
| Deferred revenue                                                                                                                                                                     |   | 315                |    | 430                    |   |
|                                                                                                                                                                                 |   |               |    |                   |   |
| **Total liabilities**                                                                                                                                                                |   | 71,558             |    | 71,717                 |   |
|                                                                                                                                                                                 |   |               |    |                   |   |
| Contingencies  (Notes 8 and 9)                                                                                                                                                       |   |               |    |                   |   |
|                                                                                                                                                                                 |   |               |    |                   |   |
| **Stockholders’ equity**                                                                                                                                                        |   |               |    |                   |   |
| Common stock, par value $.01 per share;  70,000,000 shares authorized; 44,307,862 and 44,077,282 shares issued and  outstanding at June 30, 2003 and December 31, 2002, respectively |   | 443                |    | 441                    |   |
| Preferred stock, par value $.01 per share;  5,000,000 shares authorized and no shares issued or outstanding at June 30,  2003 and December 31, 2002                                  |   | —             |    | —                 |   |
| Additional paid-in capital                                                                                                                                                           |   | 194,351            |    | 192,662                |   |
| Retained earnings                                                                                                                                                                    |   | 98,778             |    | 65,639                 |   |
| Accumulated other comprehensive income                                                                                                                                               |   | 38                 |    | 44                     |   |
|                                                                                                                                                                                 |   | 293,610            |    | 258,786                |   |
| Less:   Unearned deferred stock-based compensation                                                                                                                              |   | (408               | )       | (632                   | )      |
| **Total stockholders’  equity**                                                                                                                                                 |   | 293,202            |    | 258,154                |   |
| **Total liabilities  and stockholders’ equity**                                                                                                                                 |   | $                  | 364,760 |                   | $      | 329,871 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

3

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**EonLabs, Inc. and Subsidiaries**

**Condensed Consolidated Statements of Income**

(dollars inthousands, except per share amounts) (unaudited)

 
|                                                |   | **For the three months ended  June 30,** |   | **For the six months ended  June 30,** |   |
|-----------------------------------------------------|--------|------------------------------------------|--------|----------------------------------------|--------|
|                                                |   | **2003**                                 |   | **2002**                               |   | **2003** |   | **2002** |   |
| Net sales                                           |   | $                                        | 78,681 |                                   | $      | 52,000 |   | $ | 149,538 |   | $ | 100,198 |   |
| Cost of  sales                                      |   | 37,081                                   |   | 23,697                                 |   | 69,526 |   | 48,682 |   |
|                                                |   |                                     |   |                                   |   |   |   |   |   |
| **Gross profit**                                    |   | 41,600                                   |   | 28,303                                 |   | 80,012 |   | 51,516 |   |
|                                                |   |                                     |   |                                   |   |   |   |   |   |
| Operating  expenses                                 |   |                                     |   |                                   |   |   |   |   |   |
| Selling, general and administrative  expenses:      |   |                                     |   |                                   |   |   |   |   |   |
| Amortization of other intangible assets             |   | 940                                      |   | 940                                    |   | 1,880 |   | 1,880 |   |
| Other selling, general and administrative  expenses |   | 5,316                                    |   | 7,075                                  |   | 14,053 |   | 13,228 |   |
| Research and development expenses                   |   | 5,680                                    |   | 2,985                                  |   | 9,322 |   | 6,266 |   |
|                                                |   |                                     |   |                                   |   |   |   |   |   |
| **Total operating  expenses**                       |   | 11,936                                   |   | 11,000                                 |   | 25,255 |   | 21,374 |   |
|                                                |   |                                     |   |                                   |   |   |   |   |   |
| **Operating income**                                |   | 29,664                                   |   | 17,303                                 |   | 54,757 |   | 30,142 |   |
|                                                |   |                                     |   |                                   |   |   |   |   |   |
| Other income  (expense), net                        |   |                                     |   |                                   |   |   |   |   |   |
| Interest income                                     |   | 333                                      |   | 126                                    |   | 664 |   | 166 |   |
| Interest expense                                    |   | (16                                      | )      | (1,331                                 | )      | (300 | ) | (3,444 | ) |
| Other income, net                                   |   | 74                                       |   | 11                                     |   | 111 |   | 11 |   |
|                                                |   |                                     |   |                                   |   |   |   |   |   |
| **Total other income  (expense), net**              |   | 391                                      |   | (1,194                                 | )      | 475 |   | (3,267 | ) |
|                                                |   |                                     |   |                                   |   |   |   |   |   |
| Income  before income taxes                         |   | 30,055                                   |   | 16,109                                 |   | 55,232 |   | 26,875 |   |
|                                                |   |                                     |   |                                   |   |   |   |   |   |
| Provision  for income taxes                         |   | (12,023                                  | )      | (6,605                                 | )      | (22,093 | ) | (11,025 | ) |
|                                                |   |                                     |   |                                   |   |   |   |   |   |
| **Net income**                                      |   | $                                        | 18,032 |                                   | $      | 9,504 |   | $ | 33,139 |   | $ | 15,850 |   |
|                                                |   |                                     |   |                                   |   |   |   |   |   |
| Net income  per common share                        |   |                                     |   |                                   |   |   |   |   |   |
| Basic                                               |   | $                                        | 0.41   |                                   | $      | 0.51 |   | $ | 0.75 |   | $ | 1.70 |   |
| Diluted                                             |   | $                                        | 0.40   |                                   | $      | 0.25 |   | $ | 0.73 |   | $ | 0.44 |   |
|                                                |   |                                     |   |                                   |   |   |   |   |   |
| Weighted  average common shares outstanding         |   |                                     |   |                                   |   |   |   |   |   |
| Basic                                               |   | 44,245,597                               |   | 18,497,264                             |   | 44,179,921 |   | 9,299,729 |   |
| Diluted                                             |   | 45,255,145                               |   | 38,405,203                             |   | 45,235,043 |   | 35,956,869 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

4

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**Eon Labs, Inc. andSubsidiaries**

**Condensed Consolidated Statements of CashFlows**

(dollars in thousands) (unaudited)

 
|                                                                               |   | **For the six months ended  June 30,** |   |
|------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                               |   | **2003**                               |   | **2002** |   |
| **Cash flows from operating activities**                                           |   |                                   |   |   |   |
| Net income                                                                         |   | $                                      | 33,139 |   | $ | 15,850 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |   |                                   |   |   |   |
| Provision  for accounts receivable allowances                                      |   | 41,847                                 |   | 18,985 |   |
| Depreciation  and amortization                                                     |   | 4,327                                  |   | 3,790 |   |
| Deferred  compensation                                                             |   | 224                                    |   | 578 |   |
| Amortization  of deferred revenue                                                  |   | (115                                   | )      | (115 | ) |
| Amortization  of discount on note payable                                          |   | 269                                    |   | 788 |   |
| Interest  paid in-kind                                                             |   | —                                 |   | 2,463 |   |
| Tax  benefit from exercises of stock options                                       |   | 2,454                                  |   | — |   |
| Changes in  assets and liabilities:                                                |   |                                   |   |   |   |
| Accounts  receivable                                                               |   | (40,916                                | )      | (30,822 | ) |
| Inventories                                                                        |   | (8,483                                 | )      | (6,610 | ) |
| Prepaid  expenses and other current assets                                         |   | (2,184                                 | )      | (2,721 | ) |
| Other  assets                                                                      |   | 751                                    |   | (1,746 | ) |
| Accounts  payable                                                                  |   | (510                                   | )      | (315 | ) |
| Accrued  liabilities                                                               |   | 4,991                                  |   | 4,358 |   |
| **Net cash provided  by operating activities**                                     |   | 35,794                                 |   | 4,483 |   |
|                                                                               |   |                                   |   |   |   |
| **Cash flows from investing activities**                                           |   |                                   |   |   |   |
| Capital  expenditures                                                              |   | (5,763                                 | )      | (3,299 | ) |
| Purchases  of short-term investments                                               |   | (49,330                                | )      | (12,395 | ) |
| **Net cash used in  investing activities**                                         |   | (55,093                                | )      | (15,694 | ) |
|                                                                               |   |                                   |   |   |   |
| **Cash flows from financing activities**                                           |   |                                   |   |   |   |
| Decrease  in loans and advances to Hexal AG                                        |   | —                                 |   | (66,942 | ) |
| Payment on  seller note                                                            |   | (4,799                                 | )      | (15,201 | ) |
| Proceeds  from initial public offering of common stock                             |   | —                                 |   | 142,303 |   |
| Costs of  initial public offering of common stock                                  |   | —                                 |   | (3,066 | ) |
| Advances  from related parties, net                                                |   | 49                                     |   | 836 |   |
| Decrease  in restricted cash                                                       |   | 61                                     |   | 71 |   |
| Proceeds  from exercises of stock options                                          |   | 258                                    |   | — |   |
| **Net cash (used in)  provided by financing activities**                           |   | (4,431                                 | )      | 58,001 |   |
|                                                                               |   |                                   |   |   |   |
| **Net (decrease)  increase in cash and cash equivalents**                          |   | (23,730                                | )      | 46,790 |   |
|                                                                               |   |                                   |   |   |   |
| Cash and cash equivalents at beginning of period                                   |   | 62,323                                 |   | 17,624 |   |
|                                                                               |   |                                   |   |   |   |
| Cash and cash equivalents at end of period                                         |   | $                                      | 38,593 |   | $ | 64,414 |   |
|                                                                               |   |                                   |   |   |   |
| Non-cash investing activities:                                                     |   |                                   |   |   |   |
| Unrealized  loss on investments                                                    |   | $                                      | 12     |   | $ | — |   |
|                                                                               |   |                                   |   |   |   |
| Non-cash financing activities:                                                     |   |                                   |   |   |   |
| Conversion  of preferred stock                                                     |   | $                                      | — |   | $ | 300 |   |
| Exercise  of warrants                                                              |   | $                                      | — |   | $ | 17 |   |
| Issuance  of common stock to repay loans and advances to Hexal AG                  |   | $                                      | — |   | $ | 25,178 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

5

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**Eon Labs, Inc. andSubsidiaries**

**Notes to Condensed Consolidated FinancialStatements**

(dollars in thousands, except per shareamounts)

# ** **

# **1.     Basis of Presentation**

 

The condensedconsolidated financial statements included herein have been prepared by EonLabs, Inc. (the “Company”) without audit pursuant to the rules and regulationsof the United States Securities and Exchange Commission.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted pursuant to suchrules and regulations.  In the opinionof management, the accompanying unaudited condensed consolidated financialstatements reflect all adjustments (consisting only of normal recurringaccruals) necessary for a fair presentation of the Company's financial positionas of June 30, 2003 and results of operations and cash flows for the periodspresented.  The consolidated balances asof December 31, 2002 were derived from audited financial statements but donot include all disclosures required by generally accepted accountingprinciples.  The accompanying condensedconsolidated financial statements have been prepared in accordance withaccounting standards for interim financial statements and should be read inconjunction with the Company’s audited consolidated financial statements andthe notes thereto for the year ended December 31, 2002.  The results of operations for the interimperiods are not necessarily indicative of the results of operations to beexpected for the year.

## *** ***

## ***Change ofCompany Ownership and Reorganization***

 

Prior to thereorganization described below, Hexal Pharmaceuticals, Inc. (“HPI”), awholly-owned United States subsidiary of Santo Holding (Deutschland) GmbH,which is under common control with Hexal AG, owned 50% of the outstandingcapital stock of the Company.  HPI alsoowned 100% of Eon Holdings, Inc. (“EHI”), whose principal asset was theremaining 50% ownership of the Company.

 

Effective May22, 2002, in conjunction with the initial public offering of the Company’s commonstock, the Company was combined with HPI and EHI into a single entity through aseries of reorganization mergers. EHI was merged with and into HPI and HPI wassubsequently merged with and into the Company. This reorganization wasaccounted for as a merger of entities under common control and the accounts ofthe companies were combined in a manner similar to a pooling of interestseffective January 1, 2000. The condensed consolidated financial statementsfor the three and six months ended June 30, 2002 reflect results on acombined basis.

## *** ***

## ***RevenueRecognition***

 

Sales arerecognized when the products are received by the customer, which represents thepoint when the risks and rewards of ownership are transferred to thecustomer.  Discounts, rebates and contractpricing adjustments are recorded as a reduction of sales based on agreed uponterms with the Company’s customers at the time of sale.  The Company calculates a reserve fordiscounts and rebates based upon actual sales under such arrangements.  Reserves for contract pricing adjustmentsrepresent the difference between the prices wholesalers are billed by theCompany and the prices billed to their customers to whom the Company has givencontract 

 

6

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prices.  In determining a reserve for contract priceadjustments, the Company takes into account an estimate of the percentage ofproduct sales subject to such pricing adjustments based on historical trends.  Historical trends are adjusted for newproduct introductions and changes in wholesaler or contract prices.

 

Accountsreceivable is presented net of allowances for discounts, rebates, contractpricing adjustments and doubtful accounts, which were $117,357 and $75,510 atJune 30, 2003 and December 31, 2002, respectively.

 

Shelf stockadjustments are provided following a reduction in the prices of any of theCompany’s products due to the competitive environment.  Such adjustments are credited to theCompany’s customers based on their on-hand inventory quantities.  Reserves are generally established when theCompany reduces its prices.

## *** ***

## ***Shipping andHandling Costs***

 

The Companyclassifies shipping and handling costs as part of selling, general andadministrative expenses.  Shipping andhandling costs were $1,125 and $630 for the three months ended June 30,2003 and 2002, respectively, and $2,215 and $1,223 for the six months endedJune 30, 2003 and 2002, respectively.

## *** ***

## ***Investments***

 

The Companyinvests in publicly traded debt securities which are categorized as securitiesavailable-for-sale and are carried at fair value, with unrealized gains andlosses excluded from income and recorded directly to accumulated othercomprehensive income.  The market valueof such securities exceeded book value by $61 and $73 at June 30, 2003 andDecember 31, 2002, respectively. Accordingly, net income is decreased by $6, resulting in comprehensiveincome of $33,133 for the six months ended June 30, 2003.  At June 30, 2002, no adjustment of netincome to determine comprehensive income is needed, as there were noinvestments in marketable securities.

# ** **

# **2.     Initial Public Offering andShareholders’ Equity**

 

On June 11,2002, the Company completed its initial public offering of common stock, whichresulted in net proceeds of $139,236 and the issuance of 10,200,813 shares ofcommon stock.  Upon the consummation ofthe Company’s initial public offering, all of the previously outstanding sharesof the Company’s preferred stock were converted into 30,000,000 shares ofcommon stock and warrants were exercised resulting in the issuance of 1,680,528shares of common stock.  Immediatelyfollowing the closing of the Company’s initial public offering, debt of $25,178due to Hexal AG was converted into 1,678,561 shares of common stock and debt of$66,942 due to Hexal AG was paid with the proceeds of the offering.

## *** ***

## ***Stock Splits***

 

In May 2002,the Company effected a 30-for-1 stock split of the Company’s preferred stockand the Company’s non-voting common stock with no change in par value.Additional paid-in capital, preferred stock, common stock, per share and sharesoutstanding data in the unaudited Condensed Consolidated Financial Statementsand Notes to the unaudited Condensed Consolidated Financial Statements havebeen retroactively restated to reflect this stock split.

 

7

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In May 2002,the outstanding 30,000,000 preferred shares were converted to common stock. Inaddition, the Company changed the number of shares of authorized preferredstock to 5,000,000, increased the number of shares of authorized voting commonstock to 70,000,000 and converted shares of non-voting common stock to sharesof a single class of common stock.

* *

***Additional Paid-In Capital***

 

Additionalpaid-in capital increased by $1,689 to $194,351 at June 30, 2003 from $192,662at December 31, 2002.  The increaserepresents proceeds of $258 from the exercise of employee stock options and$1,433 of tax benefits associated with these exercise transactions.

## *** ***

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

 

The Companyamortized deferred stock compensation in the amount of $112 and $288 for thethree months ended June 30, 2003 and 2002, respectively, and $224 and $578 forthe six months ended June 30, 2003 and 2002, respectively.

* *

***StockRepurchase Program***

 

In April 2003,the Company’s Board of Directors approved the repurchase of up to 300,000shares of the Company’s common stock over the next twelve months. The Companyhas adopted a plan to repurchase 125,000 shares under Rule 10b5-1 under theSecurities Exchange Act of 1934, as amended. 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 under Rule 10b5-1.The share purchases are expected to commence in the third quarter. Therepurchased shares will become treasury shares and will be used to offsetpotential dilution in the event outstanding stock options are exercised.

# ** **

# **3.     NetIncome Per Common Share**

 

Basic net income per share is computed by dividing netincome by the weighted average number of common shares outstanding for theperiod.  Diluted earnings per sharereflects the potential dilution of stock options, warrants, and the conversionof preferred stock.  Details of thecalculations are as follows:

 
|                                           |   | **For the three months ended  June 30,** |       | **For the six months ended  June 30,** |       |
|------------------------------------------------|--------|------------------------------------------|------------|----------------------------------------|------------|
|                                           |   | **2003**                                 |       | **2002**                               |       | **2003** |   | **2002** |   |
|                                           |   |                                     |       |                                   |       |   |   |   |   |
| **Net income per share-basic:**                |   |                                     |       |                                   |       |   |   |   |   |
|                                           |   |                                     |       |                                   |       |   |   |   |   |
| Net income                                     |   | $                                        | 18,032     |                                   | $          | 9,504 |   | $ | 33,139 |   | $ | 15,850 |   |
|                                           |   |                                     | ** ** |                                   | ** ** |   | ** ** |   | ** ** |
| Weighted  average shares outstanding-basic     |   | 44,245,597                               |       | 18,497,264                             |       | 44,179,921 |   | 9,299,729 |   |
| Net income  per share-basic                    |   | $                                        | 0.41       |                                   | $          | 0.51 |   | $ | 0.75 |   | $ | 1.70 |   |
|                                           |   |                                     |       |                                   |       |   |   |   |   |
| **Net income per share-diluted:**              |   |                                     |       |                                   |       |   |   |   |   |
|                                           |   |                                     |       |                                   |       |   |   |   |   |
| Net income                                     |   | $                                        | 18,032     |                                   | $          | 9,504 |   | $ | 33,139 |   | $ | 15,850 |   |
|                                           |   |                                     |       |                                   |       |   |   |   |   |
| Weighted  average shares outstanding-basic     |   | 44,245,597                               |       | 18,497,264                             |       | 44,179,921 |   | 9,299,729 |   |
| Effect of  preferred stock prior to conversion |   | —                                   |       | 17,142,857                             |       | — |   | 23,535,912 |   |
| Effect of  warrants prior to conversion        |   | —                                   |       | 960,302                                |       | — |   | 1,318,425 |   |
| Dilutive  effect of stock options              |   | 1,009,548                                |       | 1,804,780                              |       | 1,055,122 |   | 1,802,830 |   |
|                                           |   |                                     |       |                                   |       |   |   |   |   |
| Weighted  average shares-diluted               |   | 45,255,145                               |       | 38,405,203                             |       | 45,235,043 |   | 35,956,896 |   |
| Net income  per share-diluted                  |   | $                                        | 0.40       |                                   | $          | 0.25 |   | $ | 0.73 |   | $ | 0.44 |   |

 

8

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# **4.     Adoption ofNew Accounting Pronouncements**

 

In December 2002, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards (“SFAS”) No. 148 “Accounting for Stock-BasedCompensation—Transition and Disclosure” that amends SFAS No. 123“Accounting for Stock-Based Compensation.”  SFAS No. 148 provides alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation. SFAS No. 148 amends thedisclosure requirements of Accounting Principal Board (“APB”) OpinionNo. 28, “Interim Financial Reporting” and Statement No. 123 torequire prominent disclosures in both annual and interim financial statementsabout the method of accounting for stock-based employee compensation and theeffect of the method used on reporting results.  SFAS No. 148 iseffective for fiscal years ending after December 15, 2002.  Theadoption of SFAS No. 148, except for the disclosure requirements, had noimpact on the Company’s consolidated financial statements. The additionalrequired disclosure have been provided below.

 

The Company applies APB Opinion No. 25,“Accounting for Stock Issued to Employees,” and related interpretations inaccounting for its stock-based compensation.  In addition, the Companyprovides pro forma disclosure of stock-based compensation, as measured underthe fair value requirements of SFAS No. 123, “Accounting for Stock-BasedCompensation” and as determined through the use of the Black-Scholes optionpricing model.  These pro forma disclosures are provided as required underSFAS No. 148, “Accounting for Stock-Based Compensation—Transition andDisclosure.”

 

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

 

|                    |   | **June 30, 2003** |   | **June 30, 2002** |   |
|-------------------------|--------|-------------------|--------|-------------------|--------|
| Dividend yield          |   | 0%                |   | 0%                |   |
| Volatility              |   | 45%               |   | 45%               |   |
| Risk-free interest rate |   | 3.0% to 4.0%      |   | 3.0% to 4.0%      |   |
| Expected life           |   | 1 to 5 years      |   | 1 to 5 years      |   |

 

9

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A reconciliation of the Company’s netearnings to pro forma net earnings and the related pro forma earnings per shareamounts for the three and six months ended June 30, 2003 and 2002,respectively, is provided below. For purposes of pro forma disclosure,stock-based compensation expense is recognized in accordance with theprovisions of SFAS No. 123.

 
|                                                                                                 |   | **For the three months  ended June 30,** |   | **For the six months  ended June 30,** |   |
|------------------------------------------------------------------------------------------------------|--------|------------------------------------------|--------|----------------------------------------|--------|
|                                                                                                 |   | **2003**                                 |   | **2002**                               |   | **2003** |   | **2002** |   |
|                                                                                                 |   |                                     |   |                                   |   |   |   |   |   |
| Net income, as reported                                                                              |   | $                                        | 18,032 |                                   | $      | 9,504 |   | $ | 33,139 |   | $ | 15,850 |   |
| Adjustment  to net income for pro forma stock-based compensation expense, net of related  tax effect |   | (126                                     | )      | (4                                     | )      | (253 | ) | (8 | ) |
|                                                                                                 |   |                                     |   |                                   |   |   |   |   |   |
| Pro forma net income                                                                                 |   | $                                        | 17,906 |                                   | $      | 9,500 |   | $ | 32,886 |   | $ | 15,842 |   |
|                                                                                                 |   |                                     |   |                                   |   |   |   |   |   |
| As reported net earnings per share:                                                                  |   |                                     |   |                                   |   |   |   |   |   |
| Basic                                                                                                |   | $                                        | 0.41   |                                   | $      | 0.51 |   | $ | 0.75 |   | $ | 1.70 |   |
| Diluted                                                                                              |   | $                                        | 0.40   |                                   | $      | 0.25 |   | $ | 0.73 |   | $ | 0.44 |   |
|                                                                                                 |   |                                     |   |                                   |   |   |   |   |   |
| Pro forma net earnings per share:                                                                    |   |                                     |   |                                   |   |   |   |   |   |
| Basic                                                                                                |   | $                                        | 0.40   |                                   | $      | 0.51 |   | $ | 0.74 |   | $ | 1.70 |   |
| Diluted                                                                                              |   | $                                        | 0.40   |                                   | $      | 0.25 |   | $ | 0.73 |   | $ | 0.44 |   |

 

In May 2003, the FASB issued SFAS No. 150,“Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity.”  SFAS No. 150requires that certain financial instruments, which under previous guidance wereaccounted for as equity, must now be accounted for as liabilities.  The financial instruments affected includemandatory redeemable stock, certain financial instruments that require or mayrequire the issuer to buy back some of its shares in exchange for cash or otherassets and certain obligations that can be settled with shares of stock.  SFAS No. 150 is effective for all financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning after June 15,2003.  The initial adoption of SFAS No.150 on July 1, 2003 is not expected to have any impact on the Company’sconsolidated financial statements.

 

The FASB issued Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others – an Interpretation of FASBStatements No. 5, 57, and 107 and Rescission of FASB Interpretation No.34.”  This interpretation expands on theexisting accounting guidance and disclosure requirements for most guarantees,including indemnifications.  It requiresthat at the time a company issues a guarantee, the company must recognize aninitial liability for the fair value of the obligations it assumes under thatguarantee if that amount is reasonably estimable, and must disclose thatinformation in its interim and annual financial statements.  The provisions for initial recognition andmeasurement of the liability are to be applied on a prospective basis toguarantees issued or modified on or after January 1, 2003.  The Company’s initial adoption of thisstatement on January 1, 2003, did not have an impact on its results ofoperations, financial position, or cash flows. Guarantees issued or modified after January 1, 2003, will be recognizedat their fair value in the Company’s financial statements.  The Company has not issued any guarantees asof June 30, 2003.

 

10

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# **5.**                                      Inventories

 

Inventoriesconsist of the following:

 
|            |   | **June 30,  2003** |   | **December 31,  2002** |   |
|-----------------|--------|--------------------|--------|------------------------|--------|
| Raw material    |   | $                  | 22,107 |                   | $      | 19,937 |   |
| Work-in-process |   | 12,397             |   | 9,655                  |   |
| Finished goods  |   | 15,925             |   | 12,354                 |   |
|            |   |               |   |                   |   |
|            |   | $                  | 50,429 |                   | $      | 41,946 |   |

 

# **6.**                                      Line of Credit

 

On February 8, 2002, the Company entered into athree-year $25 million credit agreement, which is collateralized byaccounts receivable and inventory. Interest on any borrowing under the linewill accrue at the rate of interest equal to either the adjusted LIBOR rateplus 1.5%, the prime rate or the fixed rate (as set by the bank).  The rate will depend upon the terms of theselected borrowings.  The agreement hascovenants which require the maintenance of certain financial ratios includingleverage, consolidated debt and asset coverage, as defined.  At June 30, 2003, there were no borrowingsoutstanding under the line of credit.

# ** **

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

 

The followingis a summary of related party transactions:

 
|                                                              |   | **For the three months ended  June 30,** |   | **For the six months ended  June 30,** |   |
|-------------------------------------------------------------------|--------|------------------------------------------|--------|----------------------------------------|--------|
|                                                              |   | **2003**                                 |   | **2002**                               |   | **2003** |   | **2002** |   |
| Net sales to (returns from) subsidiaries of  Hexal AG             |   | $                                        | 162    |                                   | $      | — |   | $ | 162 |   | $ | (100 | ) |
| Purchases of products and supplies from  subsidiaries of Hexal AG |   | (83                                      | )      | —                                 |   | (318 | ) | — |   |
| Reimbursement of other expenses                                   |   | (27                                      | )      | (29                                    | )      | (27 | ) | (29 | ) |
| Cyclosporine agreements with Hexal AG(a)                          |   | (1,788                                   | )      | (746                                   | )      | (3,131 | ) | (1,805 | ) |
| Interest on intercompany loans from Hexal  AG                     |   | —                                   |   | —                                 |   | — |   | (1,468 | ) |
|                                                                   |        |                                          |        |                                        |        |  |  |  |  |  |  |  |  |

 

----

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

11

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In 2002, HPIwas a party to certain research and development contracts with third partiesfor which Hexal AG loaned $0.7 million to HPI for the payment of itsobligations.  During 2002, the researchand development contracts which were unrelated to the Company’s business weretransferred to an entity that is unrelated to the Company.

 

Included inaccrued liabilities are amounts due to Hexal AG and subsidiaries of $3,329 atJune 30, 2003.

# ** **

# **8.**                                      Litigation

## *** ***

## ***ProductLiability 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 and sale of phentermine hydrochloride.  These lawsuits typically name as a defendant Wyeth (formerlyAmerican Home Products Corporation), the manufacturer of two anti-obesitydrugs, fenfluramine and dexfenfluramine, and also name manufacturers anddistributors of phentermine. Fenfluramine and phentermine were prescribed incombination in an off-label use commonly called “fen-phen,” whiledexfenfluramine was generally prescribed alone, but occasionally in combinationwith phentermine.  In September 1997,Wyeth, the manufacturer of fenfluramine and dexfenfluramine, agreed with theFood and Drug Administration (“FDA”) to voluntarily withdraw both products fromthe market.  The FDA has not requested that phentermine be withdrawn fromthe market.

 

The plaintiffsin these cases (the “fen-phen cases”) typically allege that the short- andlong-term use of fenfluramine in combination with phentermine causes, amongother things, primary pulmonary hypertension, valvular heart disease and/orneurological dysfunction.  Some lawsuits allege emotional distress causedby the purported increased risk of injury in the future, and others allegefraud or conspiracy in the marketing of fenfluramine, dexfenfluramine andphentermine.  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 punitivedamages), generally in unspecified amounts, on behalf of the individual or theclass.  Some actions seeking class certification ask for certain types ofequitable relief, 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.

 

In 2000, theUnited States District Court for the Eastern District of Pennsylvania, whichsupervises discovery of all federal fen-phen cases in a consolidatedmultidistrict litigation (the “Fen-Phen MDL”), found that proposedanti-phentermine “causation” testimony by two expert witnesses was notsupported by scientific evidence and thus would be barred.  These twoexperts were the only “national” anti-phentermine “causation” expertsidentified in the consolidated federal litigation, and were to have been“generic” experts in hundreds of cases.  The Court’s decision tosubstantially curb their testimony has resulted in many cases being dismissed. To date, there has been no scientific testimony accepted by any court thatestablishes a connection between the use of phentermine, either alone or incombination with fenfluramine and/or dexfenfluramine, and the injuryallegations made by plaintiffs.

 

12

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In late 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 Courtfor the Eastern District of Pennsylvania certified a nationwide settlementclass in the Fen-Phen MDL and approved the proposed settlement, which becamefinal in January 2002.  This settlement has reduced the number ofcases in which the Company and its distributors have been named as defendants.

 

As of June 30,2003, the Company had been named and served in approximately 6,550 fen-phenproduct liability cases.  More than 95% of these cases have beendismissed, and fewer than 270 remained open. Since the beginning of thefen-phen litigation, only one case has gone to trial with the Company and itsdistributors as defendants.  In that case, the Company and all thephentermine defendants, including other phentermine manufacturers anddistributors, were dismissed on motion before the presentation of any evidence.

 

While thenumber of lawsuits being filed has decreased substantially since its peakseveral years ago, the Company expects additional, similar lawsuits to befiled.  Beginning in May 2003, in response to an upcoming opt-out deadlinein the Wyeth settlement, the Company and its distributors have been served withan increasing number of new fen-phen claims, and the Company has learned that alarge number of new fen-phen claims have been filed in several states.  While the Company has been served in anumber of new cases, it is not clear how many of the newly-filed cases name theCompany or its distributors, or how many new cases will be served on theCompany or its distributors in the future.

 

The Companyand its outside counsel believe that the Company has substantial defenses tothe fen-phen claims, though their ultimate outcome cannot be determined. As of June 30, 2003, there had been no finding of liability for fen-phen injuryagainst the Company and no payment by the Company to settle anycombination-related fen-phen lawsuit.

### * *

### *PhentermineLitigation*

The Companyhas been named as a defendant in several cases in which the plaintiff allegesinjury from the use of phentermine alone, and in one instance the Company wasnamed as a defendant in a state case alleging injury from the use ofCompany-produced phentermine in combination with phenylpropanolamine (“PPA”)made by another company.  Thephentermine/PPA claim was dismissed in the Company’s favor in 2003, and as ofJune 30, 2003 only two phentermine-only claims remained pending.  Because discovery has not been completed inthese remaining cases, predicting their ultimate outcome is not possible, andno provision for any liability has been reflected in the Company’s financialstatements.

 

Gross sales ofphentermine by the Company for the six months ended June 30, 2003 and June 30,2002 were $10.6 million and $19.7 million, respectively.

 

13

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### *Other ProductLiability Litigation*

The Companyhas been named as a defendant in several other product liability lawsuits inwhich plaintiffs allege that Company-manufactured pharmaceuticals containingphenylpropanolamine (PPA) caused injury. PPA was removed from the market in 2000 at the FDA’s request after astudy appeared to show a potentially increased risk of hemorrhagic stroke incertain patient cohorts.  Additionally,the Company was recently named in a product liability lawsuit in whichplaintiff alleges injury from amiodarone HCl, a generic antiarrhythmicagent.  Because discovery in the PPAcases is ongoing and discovery in the amiodarone case has yet to begin,predicting the ultimate outcome of these actions is not possible and noprovision for any liability has been reflected in the Company’s financialstatements.

### * *

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

In or aboutApril 2000, the Company exhausted its product liability insurance coveringcombination-related phentermine lawsuits and non-combination phenterminelawsuits resulting from claims regarding the ingestion of phentermine prior toJune 22,1998 on claims made before June 22, 2003.  Since April 2000, the Company has funded its own defense in thefen-phen, phentermine-only and phentermine-PPA product liability lawsuits, withthe exception of one phentermine-only case where ingestion occurred after June1998.  Additionally, the Company has reached agreements under which theCompany will fund or partially fund the defense of certain of its distributors,and to indemnify them provided certain conditions are met.  Further, theCompany has reached defense/indemnity agreements with several retailers, and isnegotiating the resolution of several additional claims with otherretailers.  Since April 2000, fen-phen and phentermine litigation defensecosts, and the costs of related defense agreements, have been expensed asincurred.

 

Under asettlement reached in October 1999 with an insurance carrier, $2,250 ofinsurance coverage would become available for certain product liability claimsmade on or after June 22, 2003 for occurrences prior to June 1998.  The Company has made insurance coverageclaims for fen-phen claims filed on or after June 22, 2003 which allegefen-phen use prior to June 1998, and these coverage claims are pending.  Fen-phen litigation costs and the costs ofrelated defense agreements are being expensed as incurred, except for costsrelated to claims made on or after June 22, 2003 that may be covered byinsurance.

## *** ***

## ***PatentInfringement Litigation***

 

On August 30,2000, Novartis Pharmaceuticals Corporation filed a complaint in the UnitedStates District Court for the District of Delaware alleging among other thingsthat the Company’s generic cyclosporine product infringes a patent owned byNovartis.  An adverse outcome in patentlitigation with Novartis involving cyclosporine capsules could result in theCompany being unable to market this product which would materially harm itsprofits and cash flows and could result in the Company paying damages, costs,expenses, and fees that could have a material adverse impact on its financialperformance.  The Company’s potentialliability and expenses in this matter are not covered by insurance.  In December 2002, the United States DistrictCourt for the District of Delaware granted the Company’s motion for summaryjudgment of non-infringement of the patent. Novartis has appealed the judgment. The ultimate outcome of this lawsuit cannot be determined.

 

14

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In January2001, Apotex, Inc. filed an action in the United States District Court for theEastern District of New York alleging that by manufacturing, selling andoffering to sell cyclosporine capsules the Company is infringing a patent ofwhich Apotex alleged it is the exclusive licensee.  Apotex seeks injunctive relief as well as an unspecified amountof damages and has also asserted a claim that the alleged infringement waswillful, that the case is therefore exceptional and that Apotex shouldtherefore be awarded the attorney fees it has incurred in the action.  The Company’s potential liability andexpenses in this matter are not covered by insurance.  An adverse outcome in this litigation could result in the Companybeing unable to market cyclosporine, which could materially harm profits andcash flows, and could result in paying damages, costs, expenses and fees thatcould have a material adverse impact on the Company’s financial performance.

 

The Companyhas denied that it has infringed any valid patent claims asserted by Apotex,has alleged affirmatively, among other things, that the patent is invalid andthat it is not infringed by the Company’s manufacture, sale or offer to sellits cyclosporine capsules.

 

In addition,the Company has been named in several other patent infringement actionsalleging that the Company has infringed patents by filing an application withthe FDA for approval to market products before the plaintiffs’ patentsexpire.  In general, plaintiffs seekjudgments precluding the FDA from approving the Company’s application to marketthe product before their patent expires and have asserted claims that thealleged infringement was willful, that the action is therefore exceptional andthat plaintiffs should therefore be awarded the attorney fees they haveincurred in the action.

 

The Companyand its outside counsel believe that the Company has substantial defenses andcounterclaims to these above patent infringement actions, though the ultimateoutcome cannot be determined.

 

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

## *** ***

## ***Legal FeeRecovery***

 

In August2001, the Company was successful in defending itself in the United StatesDistrict Court for the District of Massachusetts against a patent infringementclaim involving Nabumetone.  At theconclusion of the trial, the Company filed a motion to recover the legal feesit incurred in defending the action. The motion was stayed pending the appeal of the District Court’sruling.  The Court of Appeals affirmedthe District Court decision in August 2002. In May 2003, the Company and the original plaintiff reached agreementregarding the Company’s motion to recover legal fees.  Under the agreement the Company was reimbursed $3.5 million forlegal fees it had incurred in defending itself.  The $3.5 million recovery of legal fees has been reflected inother selling, general and administrative expenses for the quarter ended June30, 2003.

## *** ***

## ***OtherLitigation***

 

The Company is in other litigation incidental to itsbusiness activities.  The ultimatedisposition of such lawsuits will not materially affect the Company’s financialstatements.

 

15

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# **9.     Contingencies**

## *** ***

## ***Rebates***

 

The OmnibusBudget Reconciliation Act of 1990, effective January 1, 1991, requires drugcompanies to enter into a rebate agreement with the Health Care FinancingAdministration of the Federal government. The rebate agreement states that drug companies must pay rebates tostates for drugs (prescription, non-prescription or biological products) soldto Medicaid recipients.  At June 30,2003 and December 31, 2002, $4,669 and $4,055, respectively, are included inaccrued liabilities as the estimated liability for Medicaid rebates.

## *** ***

## ***State MedicaidClaims***

 

EHI purchasedMajor Pharmaceuticals, Inc. (“Major”), a distributor of drug products, in 1991and sold Major in 1995.  At the time ofthe sale, EHI established an escrow account to cover any Medicaid drug rebateliabilities incurred by Major prior to the sale.  As of June 30, 2003, the recorded liability for such claims is$883, which management believes is adequate to resolve such matters.  The Company has approximately $747 as ofJune 30, 2003 in an escrow account to resolve such claims.

## *** ***

## ***FDARegulations***

 

In January2003, the Company received Inspectional Observations - Form FDA 483 (the “FDA483”) at its Laurelton facility following the mislabeling of one lot of productthat was distributed.  The mislabeled lot was recalled.  The Companyprovided a written response to the FDA 483 discussing the implementation ofcorrective actions and revisions to procedures that the Company believesaddresses the concerns and issues raised by the FDA 483.  In February2003, the FDA issued a Warning Letter and requested that the Company clarifyand supplement its responses to the FDA 483.  The Company has provided itssupplemental responses to the FDA.  Based on follow-up discussions withthe FDA, the Company has been advised that a Current Good ManufacturingPractices or “GMP” inspection would be conducted by the FDA at the Laureltonfacility beginning in May 2003.  DuringMay 2003, the FDA successfully completed its GMP inspection at the Laureltonfacility.  The inspection also resolvedall open items related to the previously issued Warning Letter.

 

16

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**ITEM2****.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The followingdiscussion and analysis of the Company’s financial condition and results ofoperations should be read in conjunction with the consolidated financialstatements, the related notes to consolidated financial statements and“Management’s Discussion and Analysis of Financial Condition and Results ofOperations” included in the Company’s annual report on Form 10-K/A and theunaudited interim condensed consolidated financial statements included in Item1 of this Quarterly Report on Form 10-Q.

 

**SIX MONTHS ENDED JUNE30, 2003 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2002**

 

**Netsales.**  Net sales increased 49.2% to $149.5million for the six months ended June 30, 2003 from $100.2 million in thecomparable period in 2002.  The majorityof the increase was attributable to products introduced in late June 2002 orthereafter.  These products includeLisinopril, USP, Lisinopril/HCTZ, Tizanidine HCl, Tramadol HCL, Nizatidine, USPand a Dextroamphetamine and Amphetamine Mixed Salt Product.  An increase in unit volume of severalexisting products also contributed to higher sales for the six months endedJune 30, 2003.

 

**Gross profit.**  Grossprofit as a percentage of net sales increased to 53.5% for the six months endedJune 30, 2003 compared to 51.4% in the comparable period in 2002.  The increase was primarily due to increasedutilization of manufacturing capacity, including a significant increase inproduction at the Company’s North Carolina facility.  Additionally, in 2002 there was a $1.6 million write down of araw material that will not be utilized in production.  The Company’s gross profit margins are dependent on severalfactors, including product sales mix, cost, volumes and competitive activity.

 

**Amortization of other intangible assets. **Amortization ofother intangible assets was $1.9 million for the six months ended June 30, 2003and for the comparable period in 2002.

 

**Other selling, general and administrativeexpenses. **Otherselling, general and administrative expenses increased $0.8 million to $14.1million for the six months ended June 30, 2003 from $13.2 million for thecomparable period in 2002.  Expenses forthe six months ended June 30, 2003 were reduced by a $3.5 million recovery oflegal fees related to Nabumetone litigation. Excluding the recovery of legal fees, other selling, general andadministrative expenses were $17.6 million for the six months ended June 30,2003, representing an increase of $4.3 million compared to the prior year.  However, other selling, general andadministrative expenses, excluding the recovery of legal fees in 2003,decreased as percentage of net sales to 11.7% compared to 13.2% for the 2002period.  The increase in other selling,general and administrative expenses was principally due to higher insurancepremiums, an increase in distribution costs due to increased sales volume andincreased costs related to personnel.

 

**Research and development expenses. **Research and development expenses increased$3.1 million to $9.3 million for the six months ended June 30, 2003 compared to$6.3 million for the comparable period in 2002.  The increase wasattributable to an increase in generic product development costs of $3.6million, offset by a decrease of $0.5 million related to certain basic

 

17

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research contracts unrelated to the Company’sbusiness that were transferred in March 2002 to an unrelated entity.  Theincrease in generic product development costs was primarily attributable toincreases in costs related to bio-studies and materials.

 

**Operating income**. Operating income increased $24.6 million to $54.8 million for the sixmonths ended June 30, 2003 from $30.1 million for the comparable period in2002.  The increase in operating income was the result of increased salesand gross profit, offset by increases in other selling, general andadministrative expenses and research and development costs.

 

**Interest income (expense). **Net interest income for the six months endedJune 30, 2003 was $0.4 million compared to net interest expense of $3.3 millionin the comparable period in 2002.  A decrease in outstanding debt,including the elimination of $92.1 million of intercompany debt, decreasedinterest expense by $3.1 million.  Interest income increased by $0.5million, the result of higher investment balances.

 

**Taxes on income. **Taxeson income increased $11.1 million to $22.1 million during the six months endedJune 30, 2003 from $11.0 million for the comparable period in 2002.  Theincrease was the result of higher pre-tax income for 2003.  The effectivetax rate decreased to 40.0% from 41.0% due principally to lower state and localtaxes in 2003.

 

**Net income.**  Netincome increased $17.3 million to $33.1 million for the six months ended June30, 2003 from $15.9 million in the comparable period in 2002 for the reasonsdescribed above.

 

**THREE MONTHS ENDEDJUNE 30, 2003 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2002**

 

**Net sales. **Net sales increased 51.3% to $78.7 million forthe three months ended June 30, 2003 from $52.0 million for the comparableperiod in 2002.  The majority of the increase was attributable to productsintroduced in late June 2002 or thereafter. These products include Lisinopril, USP, Lisinopril/HCTZ, Tizanidine HCl,Tramadol HCL and Nizatidine, USP, and a Dextroamphetamine and Amphetamine MixedSalt Product.  An increase in unit volume of several existing productsalso contributed to higher sales for the quarter ended June 30, 2003.

 

**Gross profit. **Gross profit as a percentage of netsales decreased to 52.9% for the three months ended June 30, 2003 compared to54.4% in the comparable period in 2002.  The decrease was primarily due toa change in product mix, partially offset by the increased utilization ofmanufacturing capacity, particularly at the Company’s North Carolinafacility. The Company’s gross profit margins are dependent on severalfactors, including product sales mix, cost, volumes and competitive activity.

 

**Amortization of other intangible assets. **Amortization ofother intangible assets was $0.9 million for the three months ended June 30,2003 and for the comparable period in 2002.

 

**Otherselling, general and administrative expenses. **Other selling, general and administrativeexpenses decreased $1.8 million to $5.3 million for the three months ended June30, 2003 from $7.1 million for the comparable period in 2002.  Expenses for the three months ended June 30,2003 were reduced by a $3.5 million recovery of legal fees related toNabumetone litigation.  Excluding therecovery of legal fees, other selling, general and administrative expenses were$8.8 million for the three months ended June 30, 2003, representing an increaseof $1.7 million compared to the prior year. However, other selling, general and administrative expenses, excludingthe recovery of legal fees in 2003, decreased as percentage of net sales to11.2% from 13.6% for the 2002 period. The increase in other selling, general and administrative expenses wasprincipally due to higher insurance premiums, and an increase in distributioncosts.  Insurance expense increased by$1.0 million, primarily the result of higher product liability and directorsand officers insurance premiums. Higher sales volume increased distributionexpenses by $0.4 million.

 

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**Research and development expenses. **Research anddevelopment expenses increased $2.7 million to $5.7 million for the threemonths ended June 30, 2003 compared to $3.0 million for the comparable periodin 2002.  The increase was attributable to an increase in generic productdevelopment costs of $2.7 million.  The increase in generic productdevelopment costs was primarily attributable to increases in costs related tobio-studies and materials.

 

**Operating income. **Operating income increased $12.4 millionto $29.7 million for the three months ended June 30, 2003 from $17.3 millionfor the comparable period in 2002.  The increase in operating income wasthe result of increased sales and gross profit and the recovery of legal fees,offset by increases in research and development costs.

 

**Interest income (expense). **Net interest incomefor the three months ended June 30, 2003 was $0.3 million compared to netinterest expense of $1.2 million in the comparable period in 2002.  Adecrease in outstanding debt, including the elimination of $92.1 million ofintercompany debt, reduced interest expense by $1.3 million.  Interestincome increased by $0.2 million, the result of higher investment balances.

 

**Taxes on income.**  Taxes on income increased $5.4 million to$12.0 million during the three months ended June 30, 2003 from $6.6 million inthe comparable period in 2002.  The increase was the result of higherpre-tax income for 2003.  The effective tax rate decreased to 40.0% from41.0% due principally to lower state and local taxes in 2003.

 

**Net income**.  Net income increased $8.5 million to $18.0million for the three months ended June 30, 2003 from $9.5 million in thecomparable period in 2002 for the reasons described above.

 

**LIQUIDITY AND CAPITALRESOURCES**

 

Cash andinvestments increased $25.6 million to $112.9 million at June 30, 2003 from$87.2 million at December 31, 2002. Cash and cash equivalents were $38.6 million at June 30, 2003 comparedto $62.3 million at December 31, 2002. The $23.7 million decrease in cash and cash equivalents was more thanoffset by a $49.3 million increase in investments.

 

The Companyalso has a three-year $25 million credit facility which expires on February 8,2005.  Under this facility, the Companycan borrow at LIBOR plus 1.5%, the bank’s prime rate or a fixed rate.  The credit facility, which is for workingcapital purposes, had no outstanding borrowings against it at June 30, 2003.

 

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Stockholders’equity increased to $293.2 million at June 30, 2003 from $258.2 million atDecember 31, 2002.  Stockholders’ equityincreased by $1.7 million (including tax benefits) from the exercise ofemployee stock options, net earnings of $33.1 million for the six months endedJune 30, 2003 and $0.2 million for the amortization of deferred stock-basedcompensation costs.

 

During the sixmonths ended June 30, 2003, the Companyconsumed net cash of $23.7 million. Operations generated $35.8 million of cash, comprised of net earnings of$33.1 million and non-cash items totaling $49.0 million, offset by an increasein working capital of $46.4 million. The increase in working capital resulted from a decrease in accountspayable of $0.5 million and increases in accounts receivable, inventory andprepaid expenses and other current assets of $40.9 million, $8.5 million and$2.2 million, respectively.  A decreasein other assets of $0.8 million and an increase in accrued liabilities of $5.0million partially offset the other working capital increases.  The increases in accounts receivable,inventory, and accrued liabilities are associated with higher sales andproduction levels.  Prepaid expenses werehigher due to prepaid taxes.

 

Investingactivities consumed $55.1 million of cash during the six months ended June 30,2003.  Approximately $49.3 million wasused to purchase short-term investment grade debt instruments with the balanceof $5.8 million used for capital expenditures. The capital expenditures relate primarily to equipment required tosupport increased production volume in the Company’s North Carolina facility.

 

Financingactivities consumed $4.4 million of cash during the six months ended June 30,2003, with $4.8 million used to pay the remaining balance of the EHIacquisition note.  Additional sources ofcash during this period included $0.05 million related to an increase inadvances from an affiliate and $0.3 million of proceeds from the exercise ofstock options.

 

The Company isinvolved in various litigation matters in which the potential liabilitiesand/or related expenses are not covered by insurance.  In addition, an adverse outcome in patent litigation withNovartis and Apotex involving cyclosporine capsules could result in the Companybeing unable to market this product which would materially harm its profits andcash flows and could result in the Company paying damages, cost, expenses, andfees that could have a material adverse impact on its financialperformance.  In December 2002, theUnited States District for the District of Delaware granted the Company’smotion in the Novartis case for summary judgment of non-infringement of thepatent.  Novartis appealed the judgmentand the appeal is currently 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 oranticipate any liquidity concerns.  The Company’s principal future cashrequirements are associated with increased working capital to support futuregrowth, capital expenditures and legal defense costs.  The Company anticipatesthat its operating cash flows, together with its available borrowings under itscredit facility and current cash balances, will be sufficient to meet all ofits working capital and capital expenditures requirements for both theshort-term and foreseeable future.

 

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**CRITICAL ACCOUNTINGPOLICIES**

 

The Company’scritical accounting policies are those policies that are important to theportrayal of its financial condition and results of operations and requiremanagement’s subjective judgments.  As aresult, these judgments are subject to an inherent degree of uncertainty.  The Company bases its judgments on itsexperience and various other assumptions that the Company believes to bereasonable under the circumstances.  Onan ongoing basis, the Company evaluates its estimates, including those relatedto revenues, returns, inventories, income taxes and litigation.  The Company’s actual results could differfrom these estimates under different assumptions or conditions.  The Company believes the followingaccounting policies to be critical:

 

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

 

Shelf stockadjustments are provided following a reduction in the prices of any of theCompany’s products due to the competitive environment.  Such adjustments are credited to the Company’scustomers based on their on-hand inventory quantities.  Reserves are generally established when theCompany reduces its prices.

 

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

 

In determiningwhether liabilities should be recorded for pending litigation claims, theCompany must assess the allegations made and the likelihood that it willsuccessfully defend itself.  When theCompany believes it is probable that it will not prevail in a particularmatter, it will then make an estimate of the amount of liability based in parton advice of outside legal counsel.

 

**IMPACT OF RECENTLYISSUED ACCOUNTING STANDARDS**

 

In December2002, the FASB issued SFAS No. 148 “Accounting for Stock-BasedCompensation-Transition and Disclosure” that amends FASB Statement No. 123“Accounting for Stock-Based Compensation.” SFAS No. 148 provides alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation.  SFAS No. 148 amends thedisclosure requirements of APB Opinion No. 28, “Interim Financial Reporting”and Statement No. 123 to require prominent disclosures in both annual andinterim financial statements about the method of accounting for stock-basedemployee compensation and the effect of the method used on reportingresults.  SFAS No. 148 is effective forfiscal years ending after December 15, 2002. The adoption of SFAS No. 148, except for the disclosure requirements,had no impact on the consolidated financial statements.  The additional required disclosure isincluded as part of note 4 in the Notes to the Condensed Consolidated FinancialStatements on Form 10-Q.

 

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In May 2003, the FASB issued SFAS No. 150,“Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity.”  SFAS No. 150requires that certain financial instruments, which under previous guidance wereaccounted for as equity, must now be accounted for as liabilities.  The financial instruments affected includemandatory redeemable stock, certain financial instruments that require or mayrequire the issuer to buy back some of its shares in exchange for cash or otherassets and certain obligations that can be settled with shares of stock.  SFAS No. 150 is effective for all financial instrumentsentered into or modified after May 31, 2003, and otherwise is effective at thebeginning of the first interim period beginning after June 15, 2003.  The initial adoption of SFAS No. 150 on July1, 2003 is not expected to have any impact on the Company’s consolidatedfinancial statements.

 

The FASB issued Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others – an Interpretation of FASBStatements No. 5, 57, and 107 and Rescission of FASB Interpretation No.34.”  This interpretation expands on theexisting accounting guidance and disclosure requirements for most guarantees,including indemnifications.  It requiresthat at the time a company issues a guarantee, the company must recognize aninitial liability for the fair value of the obligations it assumes under thatguarantee if that amount is reasonably estimable, and must disclose thatinformation in its interim and annual financial statements.  The provisions for initial recognition andmeasurement of the liability are to be applied on a prospective basis toguarantees issued or modified on or after January 1, 2003.  The Company’s initial adoption of thisstatement on January 1, 2003, did not have an impact on its results ofoperations, financial position, or cash flows. Guarantees issued or modified after January 1, 2003, will be recognizedat their fair value in the Company’s financial statements.  The Company has not issued any guarantees asof June 30, 2003.

** **

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

 

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

 

As of June 30,2003, the Company had cash and cash equivalents of $38.6 million.  Cash equivalents are interest-bearinginvestment grade securities, primarily short-term, highly liquid investmentswith maturities at the date of purchase of less than 90 days.  These investments are subject to interestrate risk and will decrease in value if market interest rates increase.  A hypothetical increase in the marketinterest rates by 10 percent from the rates in effect on the date of this Form10-Q would cause the fair value of these short-term investments to decline byan insignificant amount.  The Companyhas the ability to hold these investments until maturity,

 

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and thereforeit does not expect the value of these investments to be affected to anysignificant degree by the effect of a sudden change in market interestrates.  Declines in interest rates overtime will, however, reduce the Company’s interest income.

 

The Companycurrently owns $74.3 million in publicly traded debt securities which aresubject to market fluctuations.  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.  However, the Company has the ability to holdthese investments until maturity, and therefore, it does not expect to realizeany loss upon a sudden change in market interest rates.

 

The Companydoes not have any international operations or any significant assets orliabilities denominated in foreign currencies, and currently does not enterinto forward exchange contracts or other financial instruments with respect toforeign currency transactions. Accordingly, the Company currently does not have any significant foreigncurrency exchange rate risk.

 

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

 

As of June 30,2003, an evaluation was performed under the supervision and with theparticipation of the Company’s management, including the Chief ExecutiveOfficer and the Chief Financial Officer, of the effectiveness of the design andoperation of the Company’s disclosure controls and procedures.  Based on that evaluation, the Company’smanagement, including the Chief Executive Officer and the Chief FinancialOfficer, concluded that the Company’s disclosure controls and procedures wereeffective as of June 30, 2003.  There havebeen no significant changes in the Company’s internal controls or in otherfactors that could significantly affect the internal controls subsequent toJune 30, 2003.

 

**SPECIAL NOTEREGARDING FORWARD-LOOKING STATEMENTS**

 

This quarterlyreport on Form 10-Q report 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 the SecuritiesExchange Act of 1934, including, without limitation, statements regarding theCompany’s expectations, beliefs, intentions or future strategies that aresignified by the words “expects,” “anticipates,” “intends,” “believes” orsimilar language.  Actual results could differmaterially from those anticipated in such forward-looking statements.  Some specific factors that may have asignificant effect on the Company’s operating results and common stock marketprice include:

 

•      new product introductions;

•      changes in the degree of competition forthe Company’s products;

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

•      the inability to acquire sufficientsupplies of raw materials;

•      litigation and/or threats of litigation;

•      changes in the Company’s growth rates orthe Company’s competitors’ growth rates;

 

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•      legislative and FDA actions with respectto the government regulation of pharmaceutical products;

•      public concern as to the safety of theCompany’s  products;

•      changes in health care policy in theUnited States;

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

•      the Company’s inability to raiseadditional capital;

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

•                  changes in stockmarket analyst recommendations regarding the Company’s common stock, othercomparable companies 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.

 

**PARTII****– OTHERINFORMATION**

 

**ITEM2****– CHANGES INSECURITIES AND USE OF PROCEEDS**

 

In June 2002,the Company closed an initial public offering of its common stock.  The Registration Statement on Form S-1 (FileNo. 333-83638) was declared effective by the Securities and Exchange Commissionon May 23, 2002 and the Company commenced the offering on that date.  After deducting underwriting discounts andcommissions and the offering expenses, the net proceeds from the offering tothe Company were approximately $139.2 million.

 

The Companyhas used proceeds from the offering as follows: (i) $66.9 million has been usedto repay debt due to Hexal AG; (ii) $10.0 million has been used to repay debtincurred in connection with the acquisition of EHI; and (iii) $2.0 million hasbeen used for general working capital purposes.  The remaining $60.3 million of the proceeds to the Company fromthe offering are invested in cash investments and short-term investment gradedebt securities.  The Companyanticipates using the balance of the proceeds from the offering for generalcorporate purposes, including funding working capital, increased research anddevelopment expenditures to expand the Company’s product offerings and thepotential acquisition of product lines or companies.  The Company has no present understandings, commitments oragreements with respect to any acquisitions. The Company has not determined the amounts it plans to spend on any ofthe areas listed above or the timing of these expenditures.

 

**ITEM6****– EXHIBITS ANDREPORTS ON FORM 8-K**

 

(a)           Exhibits

 

31.1         Certificationspursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

31.2         Certificationspursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

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

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

 

(b)           Reports on Form 8-K

 

On April 24, 2003, the Company filed aCurrent Report on Form 8-K reporting the Press Release regarding earnings forthe quarter ended March 31, 2003.

 

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**SIGNATURES**

 

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

 
|             | Eon Labs,  Inc. |
|------------------|-----------------|
|             |            |   |
| August 12,  2003 | By:             | /s/ Bernhard  Hampl, Ph.D. |   |
|             |            | Bernhard  Hampl, Ph.D. |
|             |            | President,  Chief Executive Officer  and Director |
|             |            |   |
|             |            |   |
| August 12,  2003 | By:             | /s/ William  F. Holt |   |
|             |            | William F.  Holt |
|             |            | Chief  Financial Officer |
|                  |                 |  |  |  |

 

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