**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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FORM 10-K

**ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**
| **For the fiscal year ended December 31, 2004** | **Commission  File No. 001-31333** |
|------------------------------------------------------|-----------------------------------------|

 

**EON LABS, INC.**

(Exact name of Registrantas specified in its charter)
| **Delaware**                                                                                                   | **13-3653818**                           |
|----------------------------------------------------------------------------------------------------------------|------------------------------------------|
| (State or other  jurisdiction of  incorporation or organization)                                               | (I.R.S. Employer  Identification Number) |
| **1999 Marcus Avenue  Lake Success, New York**                                                                 | **11042**                                |
| (Address of  principal executive offices)                                                                      | (Zip Code)                               |
| Registrant’s  telephone number, including area code:    **(516) 478-9700**                      |
| Securities  registered pursuant to Section 12(b) of the Act:   **None**                    |
| (Title of Class)                                                                                               |
| Securities  registered pursuant to Section 12(g) of the Act:  **Common  Stock, par value $.01** |
| (Title of Class)                                                                                               |

 

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Indicate by check mark whetherthe Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

Yes   x   No   o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§229.405 of this chapter) is not contained herein, and will not be contained,to the best of Registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K. o

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Act). Yes   x   No   o

Theaggregate market value of common stock held by non-affiliates of the registrantas of June 30, 2004 was $1,169,777,026, based upon the closing price ofthe Common Stock on that date, as reported by The NASDAQ National Market. Sharesof Common Stock known to be owned by directors and executive officers of theregistrant subject to Section 16 of the Securities Exchange Act of 1934are not included in the computation. No determination has been made that suchpersons are “affiliates” within the meaning of Rule 12b-2 under theExchange Act.
| **Common Stock, $.01 par value** |   | **88,850,364  shares**              |
|----------------------------------|--------|-------------------------------------|
| Class                            |   | Outstanding at  March 11, 2005 |

 

 

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**EON LABS, INC.**

**INDEXTO FORM 10-KFOR THE YEAR ENDED DECEMBER 31, 2004**
|           | **PART I**                                                                                                    |   |
|-----------|--------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.   | Business                                                                                                           | 1      |
| Item 2.   | Properties                                                                                                         | 23     |
| Item 3.   | Legal Proceedings                                                                                                  | 23     |
| Item 4.   | Submission of Matters to a Vote of  Security Holders                                                               | 28     |
|      | **PART II**                                                                                                   |   |
| Item 5.   | Market for Registrant’s Common  Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | 29     |
| Item 6.   | Selected Financial Data                                                                                            | 31     |
| Item 7.   | Management’s Discussion and  Analysis of Financial Condition and Results of Operation                         | 34     |
| Item  7A. | Quantitative and Qualitative  Disclosures About Market Risk                                                        | 44     |
| Item 8.   | Financial Statements and  Supplementary Data                                                                       | 44     |
| Item 9.   | Changes in and Disagreements With  Accountants on Accounting and Financial Disclosure                              | 44     |
| Item  9A. | Controls and Procedures                                                                                            | 44     |
| Item  9B. | Other Information                                                                                                  | 45     |
|      | **PART III**                                                                                                  |   |
| Item  10. | Directors and Executive Officers  of the Registrant                                                                | 45     |
| Item  11. | Executive Compensation                                                                                             | 50     |
| Item  12. | Security Ownership of Certain  Beneficial Owners and Management and Related Stockholder Matters                    | 53     |
| Item  13. | Certain Relationships and Related  Transactions                                                                    | 55     |
| Item  14. | Principal Accountant Fees and  Services                                                                            | 56     |
|      | **PART IV**                                                                                                   |   |
| Item  15. | Exhibits and Financial Statement  Schedules                                                                        | 56     |

 

 

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**PART I**

**Item 1.**                        Business.

**Overview**

Eon Labs, Inc. (the “Company”) is a genericpharmaceutical company engaged in developing, licensing, manufacturing, sellingand distributing a broad range of prescription pharmaceutical productsprimarily in the United States. The Company focuses primarily on drugs in abroad range of solid oral dosage forms, utilizing both immediate and sustainedrelease delivery, in tablet, multiple layer tablet, film-coated tablet andcapsule forms. The Company does not depend on any single drug or therapeuticcategory for a majority of its sales. For the year ended December 31,2004, the Company generated sales and operating income of approximately $431.0million and $172.6 million, respectively, and had total assets of approximately$545.2 million.

On June 11, 2002, the Company completed itsinitial public offering of common stock, which resulted in net proceeds of$139.2 million and the issuance of 20,401,626 shares of common stock. Upon theconsummation of the Company’s initial public offering, all of the previouslyoutstanding shares of the Company’s preferred stock were converted into60,000,000 shares of common stock, par value $0.01 per share (“Common Stock”)of the Company. (The foregoing share amounts have been adjusted to reflect a 2-for-1stock split effected by the Company on June 1, 2004.)

On February 20, 2005, the Company entered into anAgreement and Plan of Merger (the “Merger Agreement”) with NovartisCorporation, a New York corporation (“Novartis”), Zodnas Acquisition Corp., aDelaware corporation and wholly owned subsidiary of Novartis (“Merger Sub”),and, solely with respect to its guarantee of Novartis’s and Merger Sub’sobligations thereunder, Novartis AG (“Parent”). Pursuant to the MergerAgreement, Merger Sub will commence a tender offer (the “Offer”) to purchaseall of the issued and outstanding shares of the Company’s Common Stock, (otherthan those shares owned by Santo Holding (Deutschland) GmbH (“Santo”)), at a purchaseprice of $31.00 per share (the “Offer Price”).

In connection with the execution of the MergerAgreement, Novartis, Santo and Parent entered into an Agreement for Purchaseand Sale of Stock (the “Santo Agreement”), pursuant to which Novartis agreed topurchase, and Santo agreed to sell, all of the shares of Common Stock held bySanto (the “Santo Shares,” such transaction, the “Santo Purchase”),representing approximately 67.5% of the outstanding shares of Common Stock, for€1.3billion in cash on the terms and subject to the conditions set forth therein.

The Offer is not conditioned upon any minimum numberof shares being tendered, but is contingent upon the contemporaneous (orimmediately subsequent) closing of the Santo Purchase pursuant to the SantoAgreement. In addition to certain customary conditions, the closing of theSanto Purchase is conditioned on the acquisition by Novartis (Deutschland) GmbHof all of the outstanding shares and partnership interests of Hexal AG (“Hexal”),including shares held directly and indirectly by Dr. Thomas Strüngmann,the Chairman of the Board of Directors of the Company and an indirectsignificant stockholder of Santo, and Dr. Andreas Strüngmann, an indirect significantstockholder of Santo. Additionally, the Santo Purchase is subject to customaryregulatory approvals, including clearance under the Hart-Scott-Rodino AntitrustImprovements Act of 1976, as amended. Following the completion of the Offer andthe purchase of the Santo Shares, if a majority of the outstanding shares ofCommon Stock other than the Santo Shares are purchased in the Offer, inaccordance with Delaware General Corporation Law (the “DGCL”), Merger Sub willbe merged with and into the Company and any remaining shares of Common Stockwill be acquired by Merger Sub.

The Merger Agreement provides that upon consummationof the Offer, the Confidentiality Agreement, dated February 11, 2005,between the Company and Novartis (which currently restricts the ability ofNovartis and its affiliates to acquire shares of Common Stock other than theSanto Shares (the 

 

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“Public Shares”) withoutapproval of a majority of the special committee of independent board members,which was appointed to review the Offer and the Merger, and of the Company’sBoard of Directors) will be amended to provide that Novartis and its affiliateswill be permitted to make acquisitions of Public Shares that are voluntary tothe holders of Public Shares (such as by means of legally permissible openmarket purchases or tender offers), but, prior to February 11, 2006,Novartis and Merger Sub will not be permitted to cause a merger transaction (orother business combination) to be effected which would cancel Public Sharesunless (i) a majority of the outstanding Public Shares vote in favor ofsuch a transaction or (ii) Novartis and its subsidiaries, at that time,own at least 90% of the outstanding Common Stock; provided, that theconsideration to be received by the holders of Public Shares in any suchtransaction described in (ii) above must be at least equal to $31.00 perPublic Share. Following the completion of the Offer and until the earlier ofthe consummation of the Merger and February 11, 2006, Novartis and MergerSub are required to use their reasonable best efforts to keep the Common Stockquoted for trading on the NASDAQ National Market unless the Company is nolonger required to be registered under the Securities Exchange Act of 1934, asamended (the “Exchange Act”), or no longer satisfies NASDAQ’s listing standards(other than standards entirely within the Company’s control).

At the effective time of the Merger, each issued andoutstanding share of Common Stock (other than shares owned by Novartis, any ofits subsidiaries (including Merger Sub) or any of its affiliates, any sharesheld in the treasury of the Company and shares held by stockholders whoproperly demand appraisal and comply with the provisions of Section 262 ofthe DGCL, relating to dissenters’ rights of appraisal) will be converted intothe right to receive an amount equal to the Offer Price. Following theconsummation of the Merger, the Company will continue as the survivingcorporation and will be a wholly owned subsidiary of Novartis.

The Company wasincorporated under the laws of Delaware in 1992. Its principal executiveoffices are located at 1999 Marcus Avenue, Lake Success, New York 11042, andits telephone number is (516) 478-9700. The Company’s website is *www.eonlabs.com.*The Company’s annualreports on Form 10-K, along with all other reports and amendmentsfiled with or furnished to the Securities and Exchange Commission (the “SEC”)are publicly available free of charge on the investor relations section of theCompany’s website as soon as reasonably practicable after the Company filessuch materials with, or furnishes them to, the SEC. The information on theCompany’s website is not part of this or any other report the Company fileswith, or furnishes to, the SEC. The SEC maintains an Internet site (*http://www.sec.gov*) that contains reports, proxy andinformation statements, and other information regarding issuers that fileelectronically with the SEC.

**GenericPharmaceutical Industry**

***Overview And Demand For Generic Pharmaceuticals***

In recent years,the market for generic pharmaceuticals has grown dramatically. The Companybelieves this growth has been driven by several factors, including:

·       Theaging of the U.S. population and the resulting greater utilization ofprescription pharmaceutical products at affordable prices;

·       Effortsby the federal and state governments, employers, third-party payors andconsumers to control health care costs;

·       Increasedacceptance of generic products by physicians, pharmacists and consumers; and

·       Theincreasing number of pharmaceutical products whose patents have expired or willexpire over the next several years and are or will be subject to competitionfrom generic equivalents.

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The Company believes thesefactors will continue to increase demand for generic pharmaceuticals andaccelerate the growth of the generic pharmaceutical industry in future years. Dueto the pricing dynamics of the generic pharmaceutical industry described below,the expected annual sales for any particular pharmaceutical product decreasessignificantly following the introduction of competition from genericpharmaceuticals.

**ANDA ApprovalProcess**

Generic pharmaceutical products are the chemical andtherapeutic equivalent of a reference brand drug. Food and Drug Administration(“FDA”) approval of an Abbreviated New Drug Application (“ANDA”) for a genericproduct is required before a generic equivalent of an existing brand-name drugcan be marketed. In order to be approved by the FDA, generic pharmaceuticalproducts generally must undergo testing that shows that they are bioequivalentto their branded counterparts and are manufactured to the same qualitystandards. Demonstrating bioequivalence requires data showing that the genericformulation results in a product whose rate and extent of absorption are withinan acceptable range of the results achieved by the brand-name reference drug,which is typically determined by a blood level comparison of healthyvolunteers.

The timing of final FDA approval of an ANDA depends ona variety of factors, including whether the applicant challenges any listedpatents for the drug and whether the brand-name manufacturer is entitled to oneor more statutory exclusivity periods. Pending the resolution of any suchissues, the FDA final approval of the ANDAs for these generic products may bedelayed. According to the FDA, as of January 2005, the industry averagefor the length of time to secure FDA approval of an ANDA was approximately16 months from the date of filing.

Generic pharmaceutical products are typically launchedupon expiration of a branded product’s patent. In certain circumstances, aregulatory exclusivity period can extend beyond the life of a patent, and thusblock ANDAs from being approved on the patent expiration date. For example, theFDA may now extend the exclusivity of a product by six months past the date ofpatent expiry if the manufacturer undertakes studies on the effect of itsproduct in children (a so-called “pediatric extension”).

If there is a patentlisted in the FDA’s Approved Drug Products with Therapeutic EquivalenceEvaluation Book, which identifies drug products approved on the basis of safetyand effectiveness by the FDA (commonly referred to as the “Orange Book”), atthe time of filing an ANDA with the FDA and the generic drug company indicatesthat it intends to market the generic equivalent prior to the expiration ofthat patent, the generic company files with its ANDA a certification assertingthat the patent is invalid, unenforceable and/or not infringed (a so-called “Paragraph IVcertification”). A generic drug company that is the first to submit an ANDAwith a Paragraph IV certification to an Orange Book patent may be eligibleto receive a 180-day period of market exclusivity in connection with thatpatent, providing an opportunity for the company to increase its market sharebefore competitors enter the market. See “Government Regulation—PatentChallenge Process.”

***Generic Pharmaceutical Pricing Dynamics***

Although generic pharmaceuticalsmust meet the same quality standards as branded pharmaceuticals, they are soldat prices that are typically 20% to 80% below those of their brandedcounterparts. This discount tends to increase, and margins consequentlydecrease, as the number of generic competitors rises for a given brandedproduct. Because of this pricing dynamic, companies that are first to marketfor a generic pharmaceutical tend to earn higher margins than companies thatsubsequently enter the market for that product. Furthermore, the developer of ageneric product that is the first to submit an ANDA with a Paragraph IVcertification that a patent on the brand-name drug is invalid, unenforceableand/or not infringed may be eligible to receive a 180-day period ofgeneric market exclusivity. During that 180-day 

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period,the exclusive generic product would tend to earn higher margins on a highervolume of sales than in a market in which other generic competition was alsopresent. Products that are difficult to develop requiring difficult-to-sourceraw materials or representing smaller therapeutic niche markets, are generallymarketed by fewer companies and may also offer margins that are higher thanthose where barriers to entry do not exist. See “Government Regulation—PatentChallenge Process.”

**Product Development**

The Company obtains newgeneric pharmaceutical products primarily through internal product developmentand from strategic licensing or co-development arrangements with Hexal, as wellas with other companies.

***Timely Execution Of The Product Development Process***

The Company focuses on the timely execution of theproduct development process as it strives to be first to market with a genericproduct. Being first to market on a number of products has enabled the Companyto gain and maintain favorable market share for those products.

The Company’smanagement approach, particularly its emphasis on cross-functionalresponsibilities and teamwork, enables it to integrate the various steps of theproduct development process. As a result of the success of the Company’sintegrated approach to product development, it is able to commence themanufacture and marketing of commercial batches of its products in a timelymanner. This allows the Company at times to be first to market with a genericproduct. The product development process consists of multiple steps involved inidentifying and commercializing new generic products, including:

·       *Product Selection, Including Raw MaterialsProcurement*.   The first step in the process includes selectinga possible product and determining whether the Company can successfully developand eventually manufacture that product. The Company must review the quality,availability and pricing of the active pharmaceutical ingredient. The Company’sexperience in the generic pharmaceutical industry, particularly its knowledgeof the raw materials market, facilitates the development process and enables itto produce high-quality finished products in a timely manner. In the earlystages of development, the Company concentrates on creating a durableformulation that can eventually be manufactured in large quantities in order toavoid costly and time-consuming pilot plant activities.

·       *Patent Infringement Determination.  *Oncethe Company has procured sufficient raw materials, it must determine whether itcan formulate the product without infringing on any applicable patent(s) orwhether it has a viable challenge to the validity or enforceability of anyapplicable patent(s).

·       *Formulation and Testing.*   Thereafter, the Companyformulates and subsequently tests the product to confirm that all applicableFDA quality requirements, including stability, have been met. The Companyperforms biostudies to determine whether the product is bioequivalent to thereference brand drug.

·       *Filing and Approval.*   Once a bioequivalent producthas been successfully developed, the Company files an ANDA with the FDA seekingapproval of the product. The Company’s ANDAs are structured to meet all FDA requirementsin the first cycle of FDA review, which helps to facilitate the review processwith the FDA and to minimize the amount of time it takes to receive final FDAapproval.

·       *Validation.*   After approval is received, the Company is required toshow that the product can be produced in the same quality by validating themanufacturing processes of three subsequent batches.

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***Product Development Strategy***

The Company’sproduct development strategy focuses on products in both of the followingareas:

·       drugswith significant volume and high annual sales (including blockbuster drugs);and

·       drugsin smaller volume or therapeutic niche markets.

Products that are difficult to bring to market aremore likely to face limited competition, which should enable the Company toearn higher margins for a longer period of time.

The Company hasbeen successful in overcoming:

·       developmental,manufacturing or technological challenges, including difficult to source rawmaterials; and/or

·       patentswhich have not yet expired and which could be challenged by including aParagraph IV certification in the Company’s ANDA that the patent isinvalid, unenforceable or not infringed.

***Patent Challenges***

The Company actively challenges the patents protectingbranded pharmaceutical products (and/or their use) where it believes suchpatents are invalid, unenforceable or not infringed by its products (and/ortheir use). Under the generic drug approval provisions of the Federal Food,Drug and Cosmetic Act (often known as the Hatch-Waxman Act), the developer of abioequivalent drug which is the first to submit an ANDA with aParagraph IV certification that the patent is invalid, unenforceable ornot infringed, may be eligible to receive a 180-day period of genericmarket exclusivity in connection with that patent. Under some circumstances,the 180-day exclusivity period may have to be shared by two or moreapplicants. This period of market exclusivity provides the patent challengerwith the opportunity to earn a return on the risks taken and legal anddevelopment costs incurred, and to build its market share. In addition,subsequent generic entrants pursuant to successful Paragraph IV challengesfollowing the 180-day exclusivity period may benefit from continuingbarriers to entry of other competitors, including ongoing litigation ortechnological hurdles. Due to the pricing dynamics of the genericpharmaceutical industry, the expected annual sales for any particularpharmaceutical product decreases significantly following the introduction ofcompetition from generic pharmaceuticals. See “Government Regulation—PatentChallenge Process.”

As of March 8, 2005, the Company was involved inpatent litigation in connection with its Paragraph IV certifications forthe following six products: Gabapentin capsules and tablets; Itraconazolecapsules; Metaxalone tablets; Omeprazole capsules; Albuterol and IpratropiumInhalation Solution; and Metoprolol Succinate tablets.

While it is not possibleto determine with any degree of certainty the ultimate outcome of the followinglegal proceedings, the Company believes that it has meritorious defenses withrespect to the claims asserted against the Company, and it intends to defendvigorously its position. An adverse outcome in any one of these proceedingscould have a material adverse affect on the Company’s future financial positionand results of operations.

*Gabapentin*

In March 2001, Pfizer Inc. (“Pfizer”) filedsuit against the Company in the U.S. District Court for the District of NewJersey alleging that the Company infringed a patent held by Pfizer by filing anANDA to market the generic drug Gabapentin in capsule form. Fact and expertdiscovery have concluded and several dispositive motions have been filed byboth parties and are pending.

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In February 2004,Pfizer filed suit in the U.S. District Court for the Eastern District of NewYork alleging that the Company infringed a patent held by Pfizer by filing anANDA to market the generic drug Gabapentin in tablet form. This case has beenconsolidated with other related cases now pending in the U.S. District Courtfor the District of New Jersey.

*Itraconazole*

Shortly after the Companyfiled an ANDA for Itraconazole capsules in January 2001, JanssenPharmaceutica, Inc. (“Janssen”) filed suit against the Company in the U.S.District Court for the Eastern District of New York for patent infringement. InJuly 2004, the U.S. District Court for the Eastern District of New Yorkruled on the pending patent infringement case. The suit filed by Janssen in April 2001claimed that the Company’s filing of an ANDA for Itraconazole infringed itspatent. The District Court found that the Company’s ANDA product did notinfringe the patent, but the Court did not invalidate the patent. Janssen hasappealed the District Court’s decision of non-infringement. On February 9,2005, the Company began shipping Itraconazole 100mg capsules.

*Metaxalone*

In January 2003, ElanPharmaecuticals, Inc. filed suit against the Company in the U.S. DistrictCourt for the Eastern District of New York for patent infringement based on theCompany’s filing of an ANDA to market a generic Metaxalone tablet. The Companyasserted affirmative defenses and counterclaims alleging that the patents areinvalid and not infringed. No trial date has been set. The Company has amended itsANDA to include an 800mg tablet. In response, Elan has amended its priorcomplaint to add the 800mg tablet to its suit. The litigation for both the400mg and 800mg****tablets has beenconsolidated into a single case.

*Omeprazole*

In May 2000,AstraZeneca A.B. (“AstraZeneca”) filed suit against the Company in the U.S.District Court for the Southern District of New York alleging infringement ofsix patents based on the Company’s filing of an ANDA to market genericOmeprazole capsules. The Company denied AstraZeneca’s allegations and filedappropriate counterclaims. Subsequently, AstraZeneca has sought to withdraw itsclaims regarding four of these patents after three were held invalid and theother was found to be uninfringed in a related litigation against other genericdrug companies. The discovery process is nearing completion, but a trial datehas not yet been set.

*Albuterol andIpratropium*

In March 2004, Dey,L.P. (“Dey”) commenced a patent infringement action against the Company in theU.S. District Court for the Central District of California. The complaintalleges that the Company infringed a patent owned by Dey covering “Albuteroland Ipratropium Inhalation Solution, System, Kit and Methods for RelievingSymptoms of Chronic Obstructive Pulmonary Disease” by filing an ANDA for aproduct that allegedly uses methods covered by the patent and by using theinventions claimed in the patent. Discovery in this case is ongoing.

*MetoprololSuccinate*

In April 2004,AstraZeneca filed suit against the Company in the U.S. District Court ofDelaware, alleging that the Company infringed patents held by AstraZeneca byfiling an ANDA to market the generic drug Metoprolol Succinate in tablet form. Thecase has been consolidated for discovery purposes in the Eastern District ofMissouri (St. Louis). Discovery is ongoing. Motions for summary judgment ofpatent invalidity have been filed and are pending.

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***Steady Stream Of A Broad Range Of GenericPharmaceutical Products***

The Company has a higher likelihood of achievingfavorable market share when it is able to offer its customers numerous productsthat respond to their market-driven need for a variety of generic alternatives.As of December 31, 2004, the Company marketed over 140 genericpharmaceutical products. The Company develops and manufactures genericprescription pharmaceutical products in solid oral dosage forms, with bothimmediate and sustained release delivery, and is also developing severalgeneric products that utilize transdermal patch delivery technology with Hexaland is collaborating with third parties to develop injectables and opthalmicsproducts. The Company does not depend on any single drug or therapeuticcategory for a majority of its sales.

The Company’s integrated approach to productdevelopment has enabled it to be among the leaders in obtaining new productapprovals. During 2004, the Company received 10 final ANDA approvals, includingapproval of three applications that already had tentative approvals at December 31,2003.

The Company is currentlyinvolved in the development of approximately 40 pharmaceutical products,including products with applications pending with the FDA. As of December 31,2004, there were 25 ANDAs pending approval at the FDA and an additional 2tentative approvals that had been received. Other than the following products,no single product represented more than 10% of the Company’s net sales duringthe past three years: Bupropion, which was launched in 2004, represented 17.8%of the Company’s net sales in 2004 and Lovastatin, which represented 10.0%,14.8% and 6.6% of the Company’s net sales in 2004, 2003 and 2002, respectively.

***Strategic Relationships***

The Company has a strategic relationship with thesecond largest generic pharmaceutical company in Germany, Hexal, a company thatis under common control with Santo. Santo owns a majority of the Company’soutstanding common stock. Hexal’s line of generic products is represented inmarkets worldwide. In addition, Hexal owns patented technologies on a number ofpharmaceutical products and processes.

While the Company develops most of its productsinternally using its team of scientists and formulators, it develops certainproducts in conjunction with Hexal and other companies. In March 2002, theCompany entered into a technology agreement with Hexal that memorialized aprior relationship. Pursuant to that agreement, Hexal cooperates with theCompany with respect to the development, manufacture and sale in the U.S. of,and the sharing of certain information relating to, certain generic pharmaceuticalproducts that Hexal develops. At the Company’s request, it has the right offirst refusal to purchase or license from Hexal the U.S. sales and marketingrights with respect to all generic pharmaceutical products that Hexal develops.The Company also has entered into product-specific strategic alliances withHexal with respect to several products, including four products which havereceived FDA approval—Cyclosporine, Flutamide , Omeprazole and CitalopramHydrobromide. The Company has an ANDA pending for a sustained release productwhich is based on technology and a formulation provided by Hexal.

The Company and Hexal collaborate on the developmentof products that use transdermal patch delivery technology. The Company hasANDAs pending for two products that utilize patch technology. The first productfiled will be manufactured at the Company’s facility in Wilson, North Carolina;the second product will be sourced from Hexal. The Company has expanded itspatch manufacturing capacity located at its Wilson facility and now hassufficient manufacturing capacity to produce the product.

The Company also consults with Hexal regardingavailable sources of active pharmaceutical ingredients.

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The Company’sCyclosporine, USP (Modified), Leuprolide Acetate, Flutamide, USP and SucralfateUSP products are manufactured by third-party producers.

***Research and Development***

In 2004, the Company spent$21.7 million for research and development compared to $22.5 million in 2003and $13.2 million in 2002.

***Active Pharmaceutical Ingredients***

The active compounds for the Company’s products, alsocalled active pharmaceutical ingredients or APIs, are purchased fromspecialized manufacturers throughout the world and are essential to itsbusiness and success. Each individual API must be approved by the FDA as partof the ANDA approval process. API manufacturers are also regularly inspected bythe FDA.

When choosing a manufacturer for a specific API, themost important factors the Company considers are:

·       highquality standards, including current Good Manufacturing Practices (cGMPs);

·       cutting-edgechemical and process technologies;

·       patentknow-how; and

·       flexibleprocesses and capacities which enable it to offer competitive prices.

An in-depth knowledge ofthose factors and long-term experience and established relationships in thisarea by the Company’s key personnel (including its purchasing department)enable it to make the right choices in selecting the best suitable suppliersvery early in the product development process. The Company’s skills in thisarea also help it to identify unique opportunities for difficult to source APIs.The Company is proactive in maintaining good relationships with its APIsuppliers because it believes that these relationships allow it to save crucialtime and be cost competitive, to the mutual benefit of the Company and itssuppliers.

**Sales AndDistribution**

The Company’s sales aregenerated primarily by its own sales force, which is supported by its customerservice, sales and distribution employees. In 2004, the Company had over 100customers in the United States. Except for AmerisourceBergen Corporation andMcKesson Corporation, no other customers represented more than 10% of theCompany’s net sales during the past three years. AmerisourceBergen Corporation’snet sales represented 12.2%, 28.3% and 32.2% of total sales for the years 2004,2003, and 2002, respectively. McKesson Corporation’s net sales represented22.9%, 14.7% and 14.8% for the years 2004, 2003, and 2002, respectively. Salesto customers outside of the United States were less than 1% of the Company’saggregate net sales in each of the past three years.

**GovernmentRegulation**

All pharmaceuticalmanufacturers, including the Company, are subject to extensive regulation bythe federal government, principally by the FDA, and, to a lesser extent, by theU.S. Drug Enforcement Administration (the “DEA”), the U.S. EnvironmentalProtection Agency and state governments. The Federal Food, Drug and CosmeticAct, the Controlled Substances Act and other federal statutes and regulationsgovern or influence the testing, manufacturing, safety, labeling, storage,record-keeping, approval, pricing, advertising and promotion of the Company’sproducts. Noncompliance with applicable requirements can result in fines,recalls and seizure of products. Additionally, the FDA has the authority torevoke drug approvals previously granted.

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***ANDAProcess***

FDA approval is required before a generic equivalentof an existing brand-name drug can be marketed. The Company seeks approval forsuch products by submitting an ANDA to the FDA. While an ANDA is not requiredto contain complete clinical studies, it normally must contain bioavailabilityand/or bioequivalence studies. “Bioavailability” indicates the rate and extentof absorption and levels of concentration of a drug product at the site of drugaction needed to produce a therapeutic effect. “Bioequivalence” compares thebioavailability of one drug product with another and, when established,indicates that the rate of absorption and levels of concentration of a genericdrug in the body are the same as the previously approved brand-name drug. An ANDAmay be submitted for a drug on the basis that it is the equivalent to apreviously approved brand-name drug or, with FDA approval of a petition, a newdosage form, strength, or route of administration that is suitable for use forthe indications specified.

The timing of final FDA approval of ANDA applicationsdepends on a variety of factors, including whether the applicant challenges anylisted patents for the drug and/or its use and whether the brand-namemanufacturer is entitled to one or more statutory exclusivity periods. Pendingthe resolution of any such issues FDA final approval of generic products may bedelayed. In certain circumstances, a regulatory exclusivity period can extendbeyond the life of a patent, and thus block ANDAs from being approved on thepatent expiration date. For example, the FDA may now extend the exclusivity ofa product by six months past the date of patent expiry if the manufacturerundertakes studies on the effect of their product in children (a so-called “pediatricextension”). See “Government Regulation—Patent Challenge Process.”

Before approving a product, the FDA also requires thatthe Company’s procedures and operations conform to cGMP regulations, as definedin the U.S. Code of Federal Regulations. The Company must follow the cGMPregulations at all times during the manufacture of its products. The FDAconducts pre-approval and post-approval reviews and plant inspections todetermine whether the Company’s systems and processes are in compliance withcGMP and other FDA regulations. Following such inspections, the FDA may issuenotices on Form 483 and Warning Letters that could cause the Company tomodify certain activities identified during the inspection. A Form 483notice may be issued at the conclusion of an FDA inspection and listsconditions the FDA inspectors believe may violate cGMP or other FDA regulations.FDA guidelines specify that a Warning Letter is issued only for violations of “regulatorysignificance” for which the failure to adequately and promptly achievecorrection may be expected to result in an enforcement action.

If the FDA concludes thatall substantive ANDA requirements (chemistry, bioequivalency, labeling andmanufacturing) have been satisfied, but a final ANDA approval cannot be grantedbecause of patent or exclusivity-related considerations, the FDA may issue atentative approval.

***Patent Challenge Process***

The Hatch-Waxman Act provides incentives for genericpharmaceutical manufacturers to challenge patents on branded pharmaceuticalproducts and/or their methods of use, as well as to develop non-infringingforms of the patented subject matter. The Hatch-Waxman legislation placessignificant burdens on the challenger to ensure that such suits are notfrivolous, but also offers the opportunity for significant financial reward ifthe challenge is successful.

If there is a patent listed in the FDA’s Orange Bookand the generic drug company intends to market the generic equivalent prior tothe expiration of that patent, the generic company files with its ANDA aParagraph IV certification. After receiving notice from the FDA that itsapplication is acceptable for filing, the generic company sends the patentholder and the holder of the New Drug Application (“NDA”) for the brand-namedrug a notice explaining why it believes that the patent in question isinvalid, unenforceable or not infringed. Upon receipt of the notice from thegeneric company, the patent holder 

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has 45 days during whichto bring a patent infringement suit in federal district court against thegeneric company. The discovery, trial and appeals process in such suits cantake several years.

If a suit is commenced by the patent holder, theHatch-Waxman Act provides for an automatic stay on the FDA’s ability to grantfinal approval of the ANDA for the generic product under some circumstances. Ifapplicable, the period during which the FDA may not approve the ANDA and thepatent challenger therefore may not market the generic product is 30 months, orsuch shorter or longer period as may be ordered by the court. The 30-monthperiod may or may not, and often does not, coincide with the timing of theresolution of the lawsuit or the expiration of a patent, but if the patentchallenge is successful or the challenged patent expires during the 30-monthperiod, the FDA may approve the generic drug for marketing, assuming there areno other obstacles to approval such as exclusivities given to the NDA holder.

Under the Hatch-WaxmanAct, the developer of a proposed generic drug which is the first to submit an ANDAwith a Paragraph IV certification to a patent listed in the Orange Book, may beeligible to receive a 180-day period of generic market exclusivity inconnection with that patent. This period of market exclusivity may provide thepatent challenger with the opportunity to earn a return on the risks taken andits legal and development costs and to build its market share beforecompetitors can enter the market.

***DEA***

Because the Company sellsand develops products containing controlled substances, it must meet therequirements and regulations of the Controlled Substances Act which areadministered by the DEA. These regulations include stringent requirements formanufacturing controls and security to prevent diversion of or unauthorizedaccess to the drugs in each stage of the production and distribution process. TheDEA regulates allocation to the Company of raw materials used in the productionof controlled substances based on historical sales data. The Company believesit is currently in compliance with all applicable DEA requirements.

***Medicaid/Medicare***

In November 1990, a law regarding reimbursementfor prescribed Medicaid drugs was passed as part of the Congressional OmnibusBudget Reconciliation Act of 1990. The law requires drug manufacturers to enterinto a rebate contract with the Federal Government. All generic pharmaceuticalmanufacturers whose products are covered by the Medicaid program are requiredto rebate to each state a percentage of their average manufacturer’s price forthe products in question. Many states also have implemented supplemental rebateprograms that obligate manufacturers to pay rebates on average manufacturer’sprices in excess of those required under federal law. The Company accounts forfuture estimated rebates in its consolidated financial statements.

In December 2003, the Attorneys General in atleast six states sent letters to numerous pharmaceutical manufacturersinstructing them to maintain all records relating to their reporting of pricinginformation under the Medicaid Drug Rebate Statute. The letters state that thedocument retention demand is in furtherance of an ongoing investigation of themanufacturers’ compliance with Medicaid drug rebate program requirements. TheCompany received letters from some, but not all, of the states believed to beinvolved. The Company believes these letters may have been motivated, at leastin part, by a federal regulation published in August 2003 that, effective January 1,2004, would have limited the document retention provisions under the federalMedicaid Drug Rebate Statute to three years unless the records are the subjectof an audit or a government investigation of which the manufacturer is aware. Thatregulation was amended, effective January 6, 2004, to substitute a 10-yearrecord retention requirement. The Company has not received any subpoenas,informal document requests, or any other communications from 

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federal or stateenforcement authorities that suggest an investigation of its Medicaid drugrebate reporting practices is under way. The Company believes it operates incompliance with the requirements of the Medicaid Drug Rebate Statute.

In December 2003, the Medicare Prescription Drug,Improvement, and Modernization Act of 2003 was signed into law. It will makeprescription drug coverage available on a voluntary basis to all Medicarebeneficiaries beginning in 2006. Beneficiaries will elect coverage undermanaged care plans or prescription-drug-only plans that will negotiatediscounted purchase arrangements with manufacturers. Because individualseligible for coverage under both Medicare and Medicaid will receive drugcoverage through Medicare, the Company may experience a reduction in itsMedicaid drug rebate obligations once the Medicare drug benefit becomesavailable. The Company cannot predict the impact of the Medicare drug benefiton pricing or demand for its products or on its profitability.

The Company believes thatfederal and/or state governments may continue to enact additional measuresaimed at reducing the costs of drugs to the public. The Company cannot predictthe nature of such measures or their impact on its profitability.

***Other***

The Company is alsogoverned by federal, state and local laws of general applicability, such aslaws regulating intellectual property, including patents and trademarks,working conditions and equal employment opportunity.

***Competition***

The generic pharmaceutical industry is verycompetitive. The Company competes with the original manufacturers of thebrand-name equivalents of its generic products, other generic drugmanufacturers (including brand-name manufacturers that also manufacture genericdrugs) and manufacturers of new drugs that may compete with its generic drugs. TheCompany believes that, based on retail sales, it ranks within the top 15generic pharmaceutical companies in the United States that produce solid oralproducts. Certain of the Company’s competitors have greater financial,production and research and development resources and substantially greatername recognition than the Company.

The Company believes the primary factors drivingcompetition in the generic pharmaceutical industry are price, productdevelopment, timely FDA approval, manufacturing capabilities, product quality,customer service and reputation. The Company believes it competes favorablywith respect to each of these factors. Price is a key competitive factor in thegeneric pharmaceutical business. To compete effectively on the basis of priceand remain profitable, a generic drug manufacturer must manufacture itsproducts in a cost-effective manner. The Company’s management approach,particularly its emphasis on cross-functional responsibilities and teamwork,enables it to integrate the various steps of its product development process. TheCompany believes the success of its integrated approach to product development,its knowledge of the raw materials market and its manufacturing facility inWilson, North Carolina enable it to compete with its competitors effectivelybased on price. Additionally, the Company must maintain an adequate level ofinventories to meet customer demands. The Company believes it competeseffectively with respect to inventory levels. The competition the Companyexperiences varies among the markets and classes of customers. In accordance withindustry practice, the Company allows its customers the right to returnproducts under specific conditions and in compliance with the Company’s returnpolicy. Such returns relate primarily to returns of expiring products.

Other competitive factorsaffecting the Company’s business include the emergence of large buying groupsrepresenting independent retail pharmacies and the prevalence and influence ofmanaged care organizations and similar institutions, which are able to extractprice discounts on pharmaceutical 

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products.As the influence of these entities continues to grow, the Company may continueto face pricing pressure on the products it sells.

**Seasonality**

The Company’s business,taken as a whole, is not materially affected by seasonal factors.

**Backlog**

As of March 1, 2005,the Company’s gross sales value of backlog orders was $5.5 million compared to$22.3 million as of March 1, 2004. The gross sales value of backlog,however, may be substantially reduced by future allowances for contractpricing, rebates, returns and other sales allowances. Provision for such itemsare recorded at time of shipment. The Company expects the existing backlog willbe fully satisfied in 2005. Because of the relatively short lead time requiredin filling orders for the Company’s products and because of the magnitude offuture associated sales allowances, backlog amounts do not bear any significantrelationship to sales or income for any 12-month period.

**Environment**

The Company is subject to federal, state, and locallaws and regulations relating to the protection of the environment. Theseevolving laws and regulations may require expenditures over a long period oftime to control environmental impacts. The Company has established proceduresfor the ongoing evaluation of its operations to identify potentialenvironmental exposures and assure compliance with regulatory policy andprocedures.

The Company believes that its operations comply in allmaterial respects, except as set forth in the paragraph below, with applicablelaws and regulations concerning the environment. While it is impossible toaccurately predict the future costs associated with environmental complianceand potential compliance with environmental laws, any compliance is notexpected to require significant capital expenditures and has not had, and isnot presently expected to have, a material adverse effect on the Company’searnings or competitive position.

The Company is subject tovarious federal, state, and local laws and regulations relating to air qualitycontrol. These regulations are designed to control the release of variouscompounds and air pollutants. The Company has reported to the State of New Yorka minor exceedance of certain limits contained in its current State FacilityPermit. Anticipated increases in production of certain products will likelynecessitate modification of its air permits to ensure ongoing compliance. Managementdoes not believe that these will have a material adverse effect on the Company’sfinancial position, results of operations, or cash flow.

**ReorganizationalMergers**

Prior to thereorganizational mergers described below, Santo, a company organized inGermany, owned 100% of the outstanding capital stock of Hexal Pharmaceuticals, Inc.(“HPI”), a Delaware corporation. Santo is under common control with Hexal, thesecond largest generic pharmaceutical company in Germany. The Company is aparty to joint development and technology agreements with Hexal. In September 1995,HPI acquired 50% of the Company’s outstanding capital stock. In December 2000,HPI indirectly acquired the remaining 50% of the Company’s outstanding capitalstock through its acquisition of 100% of the outstanding capital stock of EonHoldings, Inc. (“EHI”). On May 21, 2002, the Company was combinedwith HPI and EHI into a single entity through a series of reorganizationalmergers. As a result, Santo owns a majority of the Company’s outstanding commonstock.

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**Employees**

As of December 31,2004, the Company employed 539 persons, 266 of whom worked at its thencorporate headquarters and manufacturing facility in Laurelton, New York and273 of whom worked at its manufacturing and research facility in Wilson, NorthCarolina. In January 2005, the Company relocated its corporateheadquarters to Lake Success, New York where it leases approximately 25,000square feet of office space. The production and maintenance employees at theCompany’s manufacturing facility in Laurelton, New York are represented by theDrug, Chemical, Cosmetic, Plastics and Affiliated Industries Warehouse EmployeesLocal 815, affiliated with the International Brotherhood of Teamsters,Chauffeurs, Warehousemen and Helpers of America under a labor contract thatexpires in November 2005. The Company believes that its relations with itsemployees are good and the Company has no history of work stoppages.

**RISK FACTORS**

*You should carefully consider the following risksregarding the Company. These and other risks could materially and adverselyaffect the Company’s business, operating results or financial condition. Youshould also refer to the other information contained or incorporated byreference in this report.*

**The Company’srevenues and profits from any particular generic pharmaceutical decline as itscompetitors introduce their own generic equivalents.**

Selling prices of genericdrugs typically decline, sometimes dramatically, as additional companiesreceive approvals for a given product and competition intensifies. To theextent that the Company succeeds in being first to market with a genericversion of a significant product, its sales and profitability can besubstantially increased in the period following the introduction of suchproduct and prior to additional competitors’ introduction of an equivalentproduct. The Company’s ability to sustain its sales and profitability on itsproducts over time is dependent on both the number of new competitors for suchproducts and the timing of their approvals. The Company’s overall profitabilitydepends on its ability to continuously introduce new products as to which it canbe first to market or otherwise can gain significant market share.

**The Company’ssuccess depends on its ability to successfully develop and commercializeadditional pharmaceutical products.**

The Company’s futureresults of operations depend to a significant degree upon its ability tosuccessfully commercialize additional generic pharmaceutical products in atimely manner. The Company focuses on developing and commercializing a steadystream of new generic products in multiple therapeutic categories in order tobroaden its product line. The Company’s customers prefer to purchase productsfrom generic manufacturers that offer a wide product selection. If the Companyis unable to offer its customers numerous products that respond to theirmarket-driven need for a variety of generic alternatives, its revenues andprofitability may be negatively impacted. If the Company is unable to introduceits products currently in development, then its future operating results willsuffer. All of the Company’s products must meet regulatory standards andreceive regulatory approvals. The development and commercialization process isboth time consuming and costly and involves a high degree of business risk. TheCompany’s products currently under development, if and when fully developed andtested, may not perform as expected, necessary regulatory approvals may not beobtained in a timely manner, if at all, and such products may not be able to besuccessfully and profitably produced and marketed. Delays in any part of theprocess or the Company’s inability to obtain regulatory approval of itsproducts could adversely affect its operating results by restricting itsintroduction of new products. The continuous introduction of new genericproducts is critical to the Company’s business.

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**Genericpharmaceuticals are sold to a limited number of customers, the loss of whosebusiness could materially affect the Company’s sales.**

The Company sells its products directly to nationalpharmacy chains, mail order customers, mass merchandisers and managed careproviders and through drug wholesalers and distributors who, in turn, supplyits products to pharmacies, mail order customers, mass-merchandisers, hospitalsand governmental agencies. Due to the ongoing consolidation of drug wholesalersand distributors and the growth of national pharmacy chains, there exists anincreasingly limited number of customers that comprise a significant share ofthe market. Sales to the Company’s top two customers represented approximately41% of its net sales in 2004. If the Company were to lose the business of anyof these customers, or if any were to experience difficulty in paying theCompany on a timely basis, there could be a material adverse effect on its netsales, profitability and cash flows.

The network through whichthe Company sells its products is continuing to undergo significantconsolidation, marked by mergers and acquisitions among drug wholesalers anddistributors, the growth of national pharmacy chains and the increasingimportance of mail order businesses. As a result, a small number of drugwholesalers, distributors and national pharmacy chains control a significantshare of the market. The Company expects that recent and future consolidationof drug wholesalers and retailers and the steady market share gain by mailorder businesses will increase pricing and other competitive pressures on itand could have a material adverse effect on sales of its products.

**The genericpharmaceutical industry in which the Company operates is competitive, and theCompany is particularly subject to the risks of such competition.**

The generic pharmaceutical industry in which theCompany operates is competitive in part because the products that are soldusually do not benefit from patent protection. The competition which theCompany encounters has an effect on its product prices, market share, revenuesand profitability. The Company may not be able to differentiate its productsfrom those of its competitors, successfully develop or introduce new productsthat are less costly or offer better performance than those of its competitorsor offer purchasers of its products payment and other commercial terms asfavorable as those offered by its competitors.

Because certain of the Company’s competitors havesubstantially greater financial, production, research and development resourcesand substantially greater name recognition than it has, it is particularlysubject to the risks inherent in competing with them. Several of the Company’sproducts face competition from a significant number of generic pharmaceuticalcompanies.

The Company alsocompetes with:

·       theoriginal manufacturers of the brand-name equivalents of its generic products,as is the case with Cyclosporine, USP (Modified); and

·       manufacturersof new drugs that may compete with its generic products, such as Oxaprozin andNabumetone, where it competes with newly developed cox-2 inhibitors.

Depending upon how theCompany responds to this competition, the effect of such competition may bematerially adverse to it.

**In somecircumstances, the Company grants credits against past sales of its products. Thismay result in reduced revenues and profitability.**

In accordance withindustry practice, following a reduction of the Company’s prices as a result ofcompetition, it grants its customers a “shelf stock credit” equal to thedecrease in unit price for the product multiplied by the number of units of theproduct a customer has in inventory at the time the price is 

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lowered.If new or existing competitors significantly lower the prices of any of theCompany’s products, it would have to provide significant credits that couldreduce its sales and gross margin. In the event that the Company grantssubstantial credits in the future, the credits might result in a material lossof revenues or profitability. If the Company chooses not to meet the lowerprice and not give a shelf stock credit, its customers may not sell the unitsof its product in their inventory and will return those units to it.

**The Company iscontrolled by Santo.**

At March 1, 2005, Santo owned approximately 67.5%of the Company’s outstanding common stock and Thomas Strüngmann, Ph.D., theChairman of the Company’s Board of Directors and the Co-Chief Executive Officerand Co-President of Hexal, together with his interests in Santo and Hexal,beneficially owned approximately 67.7% of the Company’s outstanding commonstock. Santo and Dr. Strüngmann are able to control the outcome ofstockholder votes, including votes concerning the election of the majority ofdirectors, the adoption or amendment of provisions in the Company’s certificateof incorporation or bylaws, the approval of mergers, decisions affecting itscapital structure and other significant corporate transactions.

The interests of Santo andDr. Strüngmann may conflict with your interests. Their control could alsohave the effect of deterring hostile takeovers, delaying or preventing changesin control or changes in management or limiting the ability of the Company’sstockholders to approve transactions that they may deem to be in their bestinterests.

**Some of the Company’sgeneric pharmaceutical products face competition from brand-name manufacturersthat sell their own generic products or successfully protect their brand-nameproducts in other ways.**

Competition in the genericpharmaceutical market continues to intensify as the pharmaceutical industryadjusts to increased pressures to contain health care costs. Brand-namemanufacturers continue to sell their products into the generic market directlyby acquiring or forming strategic alliances with generic pharmaceuticalcompanies. No regulatory approvals are required for a brand-name manufacturerto sell directly or through a third party to the generic market. Brand-namemanufacturers do not face significant barriers to entry into such markets. Inaddition, such companies continually seek new ways to defeat genericcompetition, such as obtaining new patents on drugs whose original patentprotection is about to expire, developing and marketing other dosage forms includingpatented controlled-release products or developing and marketing asover-the-counter products those branded products which are about to loseexclusivity and face generic competition.

**Patent litigationis common, can be expensive, may delay or prevent entry of the Company’sproducts into the market, and, in some cases, may result in damages.**

Litigation concerning patents, other forms ofintellectual property and proprietary technologies is becoming more widespreadand can be protracted and expensive and can distract management and other keypersonnel from performing their business duties for the Company.

Companies that seek to market generic versions ofbrand-name products can be sued for infringing patents that purportedly coversuch products and/or methods of using such products if the proposed marketingis to occur before such patents expire. More specifically, when the Companyfiles an ANDA with the FDA for approval of a generic drug, it may certify thatany patent listed by the FDA as covering the brand-name product and/or a methodof using that product will expire, in which case the ANDA will not becomeeffective until the expiration of such patent(s). On the other hand, theCompany may certify that any patent listed as covering the brand-name productand/or a method of using that product is invalid, is unenforceable, or will notbe infringed by the manufacture, sale or use of the generic drug for which the 

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ANDA is filed. In thatcase, the Company is required to notify the patent holder and NDA holder thatsuch patent is not infringed, is unenforceable, or is invalid. The patentholder has 45 days from receipt of the notice in which to sue for patentinfringement to obtain injunctive relief and, in some instances, to seekattorneys’ fees.

In the event litigation is commenced by the patentholder or NDA holder, final approval of the ANDA is delayed by 30 months, orsuch shorter or longer period as may be ordered by the court. The litigationmay be costly and time consuming, and these costs may be more easily borne bythe Company’s competitors than by it. The outcome of litigation is inherentlyuncertain. Litigation could result in removal from the market, or a substantialdelay in, or prevention of, the introduction of the product that is the subjectof the Company’s ANDA, any of which could have a material adverse effect on itsbusiness, financial condition, cash flows, or results of operations.

As of March 1, 2005, the Company was involved inpatent litigation in connection with its Paragraph IV certifications forthe following six products: Gabapentin capsules and tablets; Itraconazolecapsules; Metaxalone tablets; Omeprazole capsules; Albuterol and IpratropiumInhalation Solution; and Metoprolol Succinate tablets. The Company is unable topredict the outcome of any of these cases. If the Company is not successful inchallenging or cannot prove non-infringement of the patents with respect to abrand-name product (and/or its use), it may not be able to market its genericalternative until the expiration of the applicable patent, which is often notfor a number of years.

In January 2001, Janssen filed suit against theCompany in the U.S. District Court for the Eastern District of New York. Thesuit claims the Company’s filing of its ANDA for Itraconazole capsulesinfringed a Janssen patent. In July 2004, the Court found that the Company’sANDA product did not infringe the patent, but the Court did not invalidate thepatent. Janssen’s appeal of the District Court’s ruling is pending. In February 2005,the Company began selling Itraconazole capsules. A reversal of the DistrictCourt’s ruling by the Court of Appeals could result in the Company beingenjoined from marketing the product which could materially harm profits andcash flows, and result in paying damages, costs, and fees that could have amaterial adverse impact on the Company’s financial performance.

In the future, after the expiration of the 30-monthstay and after receiving final approval from the FDA, the Company may attemptto bring products to market without first obtaining non-infringement decisions.This practice is commonly referred to as “launching at risk.” Launching at riskmay allow generic manufacturers to bring a product to market without waitingfor lengthy patent infringement litigation to be completed. However, launchingat risk can also serve as a basis for claims by the patent holder of willfulinfringement against the Company. If the Company loses a patent infringementaction and willful infringement is found to exist, the damages owed by theCompany may be multiplied up to three times, at the Court’s discretion, due tosuch willful infringement. The Company may also be subject to injunctiverelief, attorneys’ fees, costs of litigation and such further relief as a courtdeems just and proper. Because damages in such instances may be calculatedaccording to the profit lost by the patent holder rather than the profit gainedby the Company, and because multiple damages may be awarded, such damages couldgreatly exceed the Company’s actual profits from marketing the infringing drugand could have a material adverse impact on the Company’s financial results.

In March 2004, Dey commenced a patentinfringement action against the Company in the U.S. District Court for theCentral District of California. The complaint alleges that the Companyinfringed a patent owned by Dey covering “Albuterol and Ipratropium InhalationSolution, System, Kit and Methods for Relieving Symptoms of Chronic ObstructivePulmonary Disease” by filing an ANDA for a product that allegedly uses methodscovered by the patent and by using the inventions claimed in the patent.

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In addition to the ANDA patent litigations stemmingfrom the Company’s Paragraph IV certifications, the Company is a defendant intwo patent litigations involving its generic Cyclosporine product. On August 30,2000, Novartis Pharmaceuticals Corporation (“Novartis Pharmaceuticals”) filed acomplaint in the U.S. District Court for the District of Delaware allegingamong other things that by selling a generic Cyclosporine product the Companyhas been and is infringing its patent. Novartis Pharmaceuticals is seekinginjunctive relief to prevent the alleged acts of infringement, as well asdamages, including lost profits, costs and expenses, reasonable attorneys’ feesand treble damages for willful infringement. The Company’s potential liabilityand expenses in this matter are not covered by insurance. In December 2002,the U.S. District Court for the District of Delaware granted the Company’smotion for summary judgment of non-infringement of the patent. In April 2004,the U.S. Court of Appeals for the Federal Circuit affirmed the judgment of theDelaware District Court that the Company’s generic Cyclosporine product doesnot infringe Novartis Pharmaceuticals’ patent. Novartis Pharmaceuticals’request for a rehearing by the U.S. Appeals Court is still pending. An adverseoutcome in this litigation could result in the Company being unable to marketCyclosporine, which could materially harm profits and cash flows and couldresult in paying damages, costs, expenses and fees that could have a materialadverse impact on the Company’s financial performance.

On January 26, 2001, Apotex Inc. (“Apotex”), aCanadian generic pharmaceutical company, filed a complaint in the U.S. DistrictCourt for the Eastern District of New York alleging, among other things, thatthe Company has been and is infringing its patent related to Cyclosporine. Apotexis seeking injunctive relief to prevent alleged acts of infringement, as wellas damages, including a reasonable royalty, costs, expenses, reasonableattorneys’ fees and treble damages for willful infringement. A trial isscheduled for May 2005. The Company’s potential liability and expenses inthis matter are not covered by insurance. The Company believes that it hasmeritorious defenses to Apotex’ claims and is vigorously defending itself. Anadverse outcome in this litigation could result in the Company being unable tomarket Cyclosporine, which could materially harm profits and cash flows andcould result in paying damages, costs, expenses and fees that could have amaterial adverse impact on the Company’s financial performance.

On October 29, 2004,the Company began shipping the generic drug Citalopram Hydrobromide. Earlier inOctober 2004, the Company received a notice from Forest Laboratories, Inc.(“Forest”) and H. Lundbeck A/S (“Lundbeck”) that requested certaininformation from the Company. The notice also included a list of patents thatthey hold which they allege covers Citalopram Hydrobromide. The Company has notbeen sued for patent infringement in connection with its sale of CitalopramHydrobromide.

**The Company facesthe risk of product liability claims, for which it may be inadequately insured.**

Manufacturing, selling and testing pharmaceuticalproducts involve a risk of product liability. Even unsuccessful product liabilityclaims could require the Company to spend money on litigation, divertmanagement’s time, damage its reputation and impair the marketability of itsproducts.

The Company has been named as a defendant in severalcases in which the plaintiff alleges injury from the use of Phentermine alone,and in one instance the Company was named as a third-party defendant in amedical malpractice case in which negligent prescription of Phentermine wasalleged. A number of these claims have been dismissed in the Company’s favor,and as of December 31, 2004 only one such claim remained pending.

The Company has been named as a defendant in severallawsuits in which plaintiffs allege that Company-manufactured Amiodarone causedinjury or death. As of December 31, 2004, two such claims were pending. Inone of the lawsuits, the plaintiffs allege generic Amiodarone manufactured bythe Company and several other pharmaceutical companies caused a wrongful death.In the second lawsuit, plaintiffs purporting to represent a class comprised ofusers of Amiodarone nationwide from 1985 to the present allege injury and seekclass certification, damages, refunds, medical monitoring, exemplary 

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damages and other relief,including injunctive relief, against several of the manufacturers of Amiodarone.As discovery in these cases has yet to begin, predicting the ultimate outcomeof these actions in not possible.

The Company has been named as a defendant in a lawsuitin which the plaintiff alleges injury from the use of Company-manufacturedLisinopril/HCTZ. As discovery in this case is just beginning, predicting theultimate outcome of this action is not possible.

The Company has been named as a defendant in severalproduct liability lawsuits in which plaintiffs allege that Company-manufacturedpharmaceuticals containing Phenylpropanolamine (PPA) caused injury. PPA wasremoved from the market in 2000 at the FDA’s request after a study appeared toshow a potentially increased risk of hemorrhagic stroke in certain patientcohorts. The Company previously manufactured two low-volume prescriptionproducts that contained PPA that were discontinued in 1999 and 2000,respectively.

To date, the Company has been named in five lawsuitsalleging injury or wrongful death from the use of Company-manufactured pharmaceuticalscontaining PPA. As of December 31, 2004, all but two PPA cases against theCompany had been dismissed or discontinued. As discovery in these lawsuits isongoing, predicting the ultimate outcome of these actions is not possible.

The Company’s insurance carriers did not renew productliability coverage for products containing PPA. The Company manufactured twolow-volume prescription products that contained PPA that were discontinued in1999 and 2000, respectively. Under the terms of the expiring insurancecontracts, the Company elected to purchase $80.0 million of supplementalextended reporting period (SERP) coverage. The SERP policy extends thereporting period for claims a minimum of five years, but only coversoccurrences that happened before the respective cancellation dates. Thecancellation date for the first $45.0 million of coverage is August 6,2002. The cancellation date on the remaining layers is June 22, 2001,except for a layer of $5.0 million in excess of $55.0 million, the cancellationdate of which is also August 6, 2002.

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

The Company’s productliability insurance, however, may not be adequate to remove the risk from someor all product liability claims and is subject to the limitations described inthe terms of the policies. The Company may not be able to obtain productliability insurance in the future with adequate coverage limits at commerciallyreasonable prices.

**The Company iscurrently a defendant in a number of multi-defendant lawsuits involving themanufacture and sale of Phentermine HCl and it has exhausted its insurancecoverage for those lawsuits.**

From May 1997 to December 31, 2004, theCompany was named a party and served in approximately 7,100 lawsuits inconnection with its manufacture of Phentermine Hydrochloride. As of December 31,2004, more than 92% of these cases had been dismissed. The actions generallyhave been brought in various state and federal jurisdictions by individuals intheir own right or on behalf of putative classes of persons who claim to havesuffered injury or claim that they may suffer injury in the future due to theuse of a combination of two prescription diet drugs, Fenfluramine andPhentermine, a combination popularly known as “fen-phen.” A few lawsuitscontain allegations of injury from the use of Phentermine alone, or incombination with other drugs.

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The “fen-phen” lawsuits typically allege that theshort- and long-term use of Fenfluramine in combination with Phenterminecauses, among other things, primary pulmonary hypertension, valvular heartdisease and/or neurological dysfunction. Some lawsuits allege emotionaldistress caused by the purported increased risk of injury in the future. Plaintiffstypically seek relief in the form of monetary damages (including economiclosses, medical care and monitoring expenses, loss of earnings and earningscapacity, other compensatory damages and punitive damages), generally inunspecified amounts, on behalf of an individual plaintiff or a class ofplaintiffs. Some actions seeking class certification ask for certain types ofequitable relief. The fen-phen lawsuits typically name as a defendant Wyeth(formerly American Home Products Corporation), the manufacturer of twoanti-obesity drugs, Fenfluramine and Dexfenfluramine, and also namemanufacturers and distributors and retailers of Phentermine. Certain companiesthat distributed or sold the Company’s Phentermine and are named as defendantsin certain of these lawsuits seek defense and indemnity from the Company.

As of December 31, 2004, there has been nofinding of liability for fen-phen injury against the Company and no payment bythe Company to settle any combination-related fen-phen lawsuit. There has beenno scientific testimony accepted by any court that establishes a connectionbetween the use of Phentermine either alone or in combination with Fenfluramineand/or Dexfenfluramine and the allegations made by plaintiffs in theselawsuits.

In the second quarter of2000, the Company exhausted its product liability insurance covering allcombination-related Phentermine lawsuits and any non-combination Phenterminelawsuits resulting from claims regarding the ingestion of Phentermine prior to June 1998.Since that time, the Company has funded its own defense in the fen-phen andPhentermine combination lawsuits, as well as certain Phentermine-only lawsuits.Additionally, pursuant to an October 1999 settlement with an insurancecarrier, the Company has made insurance coverage claims for fen-phen claimsfiled on or after June 22, 2003 which allege fen-phen use prior to June 1998.These claims were settled during the third quarter of 2004 for a one-timepayment of approximately $1.4 million that will defray future fen-phen defensecosts. The Company has agreed to fund or partially fund the defense of certainof its distributors, and to indemnify them provided certain conditions are met.Further, the Company has reached favorable defense agreements with severalretailers of Company Phentermine. See “Item 3. Legal Proceedings.”

**New developments byother pharmaceutical manufacturers could make the Company’s products ortechnologies non-competitive or obsolete.**

The markets in which theCompany competes and intends to compete are undergoing, and are expected tocontinue to undergo, rapid and significant technological change. The Companyexpects competition to intensify as technological advances are made, includingthe introduction of biotechnology products. New developments by others mayrender the Company’s products or technologies non-competitive or obsolete.

**If the Company isunable to obtain sufficient active pharmaceutical ingredients (APIs) from keysuppliers that in some cases may be the only source of finished products or rawmaterials, then its ability to deliver its products to market may be impeded.**

The active compounds for the Company’s products, alsocalled active pharmaceutical ingredients or APIs, are purchased fromspecialized manufacturers throughout the world and are essential to itsbusiness and its success. Some of the APIs used in its products, especially itsniche market products, are available only from one or a limited number ofsources. Those APIs are either difficult to produce or are needed in suchlimited quantities that additional suppliers are typically not available. Forhigh volume products, including blockbuster drugs, there are generally severalAPI suppliers available. However, even when more than one supplier for aproduct exists, the Company may elect to list, and in some cases has listed,only one supplier in its ANDAs for such product. The Company attempts toqualify alternative suppliers after it has 

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introduced a high volumeproduct into the market and has reached an economy of scale, but it may beunable to do so. In the event an existing supplier should lose its regulatorystatus as an acceptable source, the Company would attempt to locate a qualifiedalternative; however, it may be unable to obtain the required components orproducts on a timely basis or at commercially reasonable prices and any changein a supplier not previously approved in its ANDA must then be submittedthrough a formal approval process with the FDA.

In addition, becauseregulatory authorities must generally approve raw material sources forpharmaceutical products, changes in raw material suppliers may result in productiondelays, higher raw material costs and loss of sales and customers. From time totime, certain of the Company’s outside suppliers have experienced regulatory orsupply-related difficulties that have impeded their ability to deliver productsto it. To the extent such difficulties cannot be resolved within a reasonabletime and at a reasonable cost, the resulting delay could have a materialadverse effect on the Company’s business.

**If independentthird parties do not accept the Company’s products, it may be unable to marketthem successfully.**

The Company’s ability tomarket generic pharmaceutical products successfully depends, in part, on theacceptance of the products by independent third parties including pharmacies,government formularies and other retailers, as well as patients. The Companymanufactures a number of safe and effective prescription drugs which are mainlyused by patients who have severe health conditions. Although the brand-nameproducts generally have been marketed safely for many years prior to theCompany’s introduction of a generic alternative, there is a possibility thatone of its generic products could be alleged to produce an unanticipatedclinical side effect which could result in an adverse effect on its ability toachieve acceptance by managed care providers, pharmacies and other retailers,customers and patients. If these independent third parties do not accept theCompany’s products, it could have a material adverse effect on its revenues andprofitability.

**The Company is subjectto government regulation that increases its costs and, if it is unable toobtain regulatory approvals, it could prevent the Company from marketing orselling its products.**

The Company is subject to extensive pharmaceuticalindustry regulation. The Company cannot predict the extent to which it may beaffected by legislative and other regulatory developments concerning itsproducts.

The Company is dependent on obtaining timelyregulatory approvals before marketing its products. Any manufacturer failing tocomply with FDA or other applicable regulatory agency requirements may beunable to obtain approvals for the introduction of new products and, even afterapproval, initial product shipments may be delayed. The FDA also has theauthority to revoke drug approvals previously granted and remove from themarket previously approved drug products that are no longer regarded as safeand effective for their intended uses or not regarded as having been properlymanufactured. The Company’s major facilities and products are periodicallyinspected by the FDA, which has extensive enforcement powers over theactivities of pharmaceutical manufacturers, including the power to suspendapproval of new drug applications, seize, force to recall and prohibit the saleor import of non-complying products, and halt operations of and criminallyprosecute non-complying manufacturers.

Although the Companydevotes significant time, effort and expense to addressing the extensivegovernment regulations applicable to its business and obtaining regulatoryapprovals, it remains subject to the risk of being unable to obtain necessaryapprovals on a timely basis, if at all. Delays in receiving regulatoryapprovals could adversely affect the Company’s ability to market its products.

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**If brand-namemanufacturers’ legislative and regulatory efforts to limit the use of genericsare successful, then the Company’s sales of products subject to these effortsmay suffer.**

Many brand-namemanufacturers have increasingly used federal and state legislative andregulatory means to delay generic competition. These efforts have included:

·       pursuingnew patents for existing products which may be granted just before theexpiration of one patent which could extend patent protection for a number ofyears or otherwise delay the launch of generics;

·       submittingCitizen Petitions to request the Commissioner of Food and Drugs to takeadministrative action with respect to an ANDA approval;

·       seekingchanges to the United States Pharmacopeia, an industry recognized compendia ofdrug standards; and

·       attachingspecial patent extension amendments to non-related federal legislation.

In addition, some brand-name manufacturers haveengaged in state-by-state initiatives to enact legislation or adopt regulatoryrequirements that restrict the substitution of some brand-name drugs withgeneric drugs.

If these efforts to delaygeneric competition are successful, the Company may be unable to sell itsproducts that are subject to these efforts, which could have a material adverseeffect on its sales and profitability.

**Reforms in thehealth care industry and the uncertainty associated with pharmaceuticalpricing, reimbursement and related matters could adversely affect themarketing, pricing and demand for the Company’s products.**

Increasing expenditures for health care have been thesubject of considerable public attention. Both private and governmentalentities are seeking ways to reduce or contain health care costs. Numerousproposals that would effect changes in the health care system have beenintroduced or proposed in Congress and in some state legislatures. The Companycannot predict the nature of the measures that may be adopted or their impacton the marketing, pricing and demand for its products.

The Company’s ability tomarket its products depends, in part, on reimbursement levels for such productsand related treatment established by health care providers (includinggovernment authorities), private health insurers and other organizations,including health maintenance organizations and managed care organizations. Reimbursementmay not be available for some of the Company’s products and, even if granted,may not be maintained. Limits placed on reimbursement could make it moredifficult for people to buy the Company’s products and reduce, or possiblyeliminate, the demand for its products. The Company cannot predict the combinedeffects of changes in third-party reimbursement on its product sales or itsprofitability.

**The manufacture andstorage of pharmaceutical and chemical products is subject to environmentalregulation and risk.**

Because of the chemical ingredients of pharmaceuticalproducts and the nature of their manufacturing process, the pharmaceuticalindustry is subject to extensive environmental regulation and the risk of incurringliability for damages or the costs of remedying environmental problems. If theCompany fails to comply with environmental regulations, to use, discharge ordispose of hazardous materials appropriately or otherwise to comply with theconditions attached to its operating licenses, the licenses could be revokedand it could be subject to criminal sanctions and/or substantial liability orcould be required to suspend or modify its manufacturing operations.

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Environmental laws andregulations can require the Company to undertake or pay for investigation,clean-up and monitoring of environmental contamination identified at propertiesthat it currently owns or operates or that it formerly owned or operated. Further,they can require the Company to undertake or pay for such actions at offsitelocations where it may have sent hazardous substances for disposal. Theseobligations are often imposed without regard to fault. The Company believesthat its operations comply in all material respects with applicable laws andregulations concerning the environment. The Company may be required, however,to increase expenditures to comply with new, different, or increasinglystringent requirements to address modifications or increases in production, orto address contamination attributable to its business or properties.

**Provisions of theCompany’s charter documents and Delaware law could discourage a takeover youmay consider favorable or prevent the removal of the Company’s current board ofdirectors and management.**

Some provisions ofthe Company’s certificate of incorporation and bylaws may discourage, delay orprevent a merger or acquisition that you may consider favorable or prevent theremoval of the Company’s current board of directors and management. Theseprovisions:

·       authorizethe issuance of “blank check” preferred stock;

·       providefor a classified board of directors with staggered, three-year terms;

·       prohibitcumulative voting in the election of directors;

·       prohibitits stockholders from acting by written consent from and after the date thatSanto and its affiliates own fewer than 40% of the outstanding shares of itscommon stock;

·       limitthe persons who may call special meetings of stockholders; and

·       establishadvance notice requirements for nominations for election to the board ofdirectors or for proposing matters to be approved by stockholders atstockholder meetings.

**The Company’s certificate of incorporation prohibitsthe amendment of many of these provisions in its certificate of incorporationby its stockholders unless the amendment is approved by the holders of at least66**2¤3%of its shares of common stock.

Delaware law maydiscourage, delay or prevent someone from acquiring or merging with the Company.Section 203 of the DGCL prohibits a publicly held Delaware corporationfrom engaging in a “business combination” with an “interested stockholder” fora period of three years following the date the person became an interestedstockholder, unless:

·       theboard of directors approved the transaction in which the stockholder became aninterested stockholder prior to the date the interested stockholder attainedthat status; or

·       uponconsummation of the transaction that resulted in the stockholder becoming aninterested stockholder, the interested stockholder owned at least 85% of thevoting stock of the corporation outstanding at the time the transactioncommenced, excluding shares owned by persons who are directors and alsoofficers; or on or subsequent to that date, the business combination isapproved by the board of directors and authorized at an annual or specialmeeting of stockholders by the holders of at least two-thirds of theoutstanding voting stock that is not owned by the interested stockholder.

Generally, a business combination includes a merger,asset or stock sale, or other transaction resulting in a financial benefit tothe interested stockholder. Generally, an interested stockholder is a personwho, together with affiliates and associates, owns, or within three years priorto the determination of interested stockholder status did own, 15% or more of acorporation’s voting stock.

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**Item 2.**                        Properties.

In January 2005, the Company relocated itscorporate headquarters to 1999 Marcus Avenue, Lake Success, New York 11042,where it leases approximately 25,000 square feet of office space and willcontinue to operate from the two facilities that it owns. The Company’s 115,000square foot facility in Laurelton, New York will continue to operate as amanufacturing and distribution center. The 275,000 square foot facility inWilson, North Carolina operates as a manufacturing, distribution and researchfacility. At December 31, 2004, the Wilson facility accounted forapproximately 60% of total production. Production levels at the North Carolinafacility are expected to increase over time. Future production levels aredependent on a number of factors including new product introductions and thetiming of product transfers to the Wilson facility.

The Company believes thatits facilities are suitable for its business and will be adequate to meet itscurrent needs. In addition, the Wilson facility may be expanded, if required.

**Item 3.**                        LegalProceedings.

From time to time, theCompany is subject to lawsuits and claims which arise out of its operations inthe normal course of business, some of which involve claims for damages thatare substantial in amount.

*Fen-phen Litigation*

Since May 1997, the Company and certain of itscustomers have been named as defendants in numerous product liability lawsuits,some of which are class actions, filed in various state and federal courts inconnection with its manufacture of Phentermine Hydrochloride. These lawsuitstypically name as a defendant Wyeth (formerly American Home ProductsCorporation), the manufacturer of two anti-obesity drugs, Fenfluramine andDexfenfluramine, and also name manufacturers, distributors and retailers ofPhentermine. Fenfluramine and Phentermine were prescribed in combination in anoff-label use commonly called “fen-phen,” while Dexfenfluramine was generallyprescribed alone, but occasionally in combination with Phentermine. In September 1997,the manufacturer of Fenfluramine and Dexfenfluramine agreed with the FDA tovoluntarily withdraw both products from the market. The FDA has not requestedthat Phentermine be withdrawn from the market.

The plaintiffs in these cases (the “fen-phen cases”) typicallyallege that the short- and long-term use of Fenfluramine in combination withPhentermine causes, among other things, primary pulmonary hypertension,valvular heart disease and/or neurological dysfunction. Some lawsuits allegeemotional distress caused by the purported increased risk of injury in thefuture. Plaintiffs typically seek 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.

During 2000, the U.S. District Court for the EasternDistrict of Pennsylvania, the federal court before which all federal cases wereconsolidated for discovery, found that proposed anti-Phentermine “causation”testimony by two expert witnesses was not supported by scientific evidence andthus would be barred. These two experts were the only “national”anti-Phentermine “causation” experts identified in the consolidated federallitigation, and were to have been “generic” experts in hundreds of cases. TheCourt’s decision to curb their testimony substantially has resulted in manycases being dismissed. To date, there has been no scientific testimony acceptedby any court that establishes a connection between the use of 

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Phentermine, either aloneor in combination with Fenfluramine and/or Dexfenfluramine, and the allegationsof injury made by plaintiffs in these lawsuits.

In late 1999, Wyeth, the major defendant in thefen-phen litigation and the former manufacturer of both Fenfluramine andDexfenfluramine, announced a proposed settlement of all fen-phen claims againstit nationwide (excepting only claims for certain serious medical conditions). TheU.S. District Court for the Eastern District of Pennsylvania, which supervisesdiscovery of all federal fen-phen cases in a consolidated multidistrictlitigation, certified a nationwide settlement class and approved the proposedsettlement, which became final in January 2002. This settlement hasreduced the number of new cases in which the Company and its distributors havebeen named as defendants.

As of December 31, 2004, the Company had beennamed and served in over 7,100 fen-phen product liability cases. More than 92%of these cases have been dismissed, and the Company remains a defendant inapproximately 552 pending fen-phen cases. Since the beginning of the fen-phenlitigation, only one case has gone to trial with the Company and itsdistributors as defendants. In that instance, the case against the Company andall the Phentermine defendants, including other Phentermine manufacturers anddistributors, was dismissed on motion before the presentation of any evidence.

While the number oflawsuits being filed has decreased substantially, the Company expectsadditional, similar lawsuits to be filed. The Company and its outside counselbelieve that the Company has substantial defenses to these claims, though theultimate outcome cannot be determined. As of December 31, 2004, there hadbeen no finding of liability for fen-phen injury against the Company and nopayment by the Company to settle any combination-related fen-phen lawsuit.

*PhentermineLitigation*

The Company has been named as a defendant in severalcases in which the plaintiffs allege injury from the use of Phentermine alone,and in one instance the Company was named as a third-party defendant in amedical malpractice case in which negligent prescription of Phentermine wasalleged. A number of these claims have been dismissed in the Company’s favor,and as of December 31, 2004, only one such claim remained pending.

Because discovery has notbeen completed in this pending case, predicting the ultimate outcome of thisaction is not possible, and no provision for any related liability has beenreflected in the Company’s financial statements. The Company believes it hassubstantial defenses to this claim.

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

In or about April 2000, the Company exhausted itsproduct liability insurance covering all combination-related Phenterminelawsuits and any non-combination Phentermine lawsuits resulting from claimsregarding the ingestion of Phentermine prior to June 1998. Since thattime, the Company has funded its own defense in such lawsuits. However,pursuant to an October 1999 settlement with an insurance carrier, theCompany has made insurance coverage claims for fen-phen claims filed on orafter June 22, 2003, which allege fen-phen use prior to June 1998. Theseclaims were settled during the third quarter of 2004 for a one-time payment ofapproximately $1.4 million that will defray future fen-phen defense costs. Additionally,the Company agreed to fund or partially fund the defense of certain of itsdistributors and to indemnify them, provided certain conditions are met. Furthermore,the Company has reached favorable defense/indemnity agreements with severalretailers of the Company’s Phentermine products.

The Company currentlymaintains $75.0 million per claim and in the aggregate of claims-made productliability/completed operations insurance for its products, all of which isavailable for Phentermine-related claims (retroactive to June 1998),excluding fen-phen and Phentermine combination claims. Under 

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theCompany’s current product liability/completed operations insurance plan, theCompany has a self-insured retention of $10,0 million per claim not to exceed$10.0 million in the aggregate.

*Other ProductLiability Litigation*

The Company has been named as a defendant in severalother product liability lawsuits in which plaintiffs allege thatCompany-manufactured pharmaceuticals containing phenylpropanolamine (“PPA”)caused injury. PPA was removed from the market in 2000 at the FDA’s requestafter a study appeared to show a potentially increased risk of hemorrhagicstroke in certain patient cohorts. The Company previously manufactured two low-volumeprescription products that contained PPA that were discontinued in 1999 and2000.

To date, the Company has been named in five lawsuitsalleging injury or wrongful death from the use of Company-manufacturedpharmaceuticals containing PPA. As of December 31, 2004, all but two PPAcases against the Company had been dismissed or discontinued: lawsuit filed in2002 in the New York Supreme Court and a lawsuit filed in 2003 in the U.S.District Court for the Western District of Washington remain pending. Discoveryin these lawsuits is ongoing, and predicting the ultimate outcome of theseactions is not possible. The Company believes its product liability insuranceis adequate to cover existing PPA claims.

In April 2004, the Company was also named as adefendant in a lawsuit alleging injury from the use of Company-manufacturedDesipramine, which has been settled for nominal value.

In May 2004, the Company was also named defendantin a product liability lawsuit in the U.S. District Court for the NorthernDistrict of Ohio in which the plaintiff alleges injury from the use ofCompany-manufactured Lisinopril/HCTZ. As the Company product liabilityinsurance policy is a claims made policy, the insurance coverage available tothe Company is the amount that was in effect on the date the claim was made. Thepolicies in effect at time the claim was made provided for $50.0 million ofcoverage with a self-insured retention of $100,000. Discovery in this casecontinues, and the Company believes it would be premature to express a judgmentas to its outcome.

The Company has been namedas a defendant in several lawsuits in which plaintiffs allege thatCompany-manufactured Amiodarone caused injury or death. A lawsuit filed againstthe Company in 2003 alleging injury from the use of Company-manufacturedAmiodarone was settled in July 2004 for nominal value. As of December 31,2004, the Company remained a defendant in two Amiodarone-related lawsuits. Inthe first lawsuit, pending in the U.S. District Court for the Middle Districtof Florida, the plaintiffs allege generic Amiodarone manufactured by theCompany and several other pharmaceutical companies caused a wrongful death. Inthe second lawsuit, pending in the U.S. District Court for the District of NewJersey, plaintiffs purporting to represent a class comprised of users ofAmiodarone nationwide from 1985 to the present allege injury and seek classcertification, damages, refunds, medical monitoring, exemplary damages andother relief, including injunctive relief, against several of the manufacturersof Amiodarone. Discovery in these cases has not yet begun, and the Companybelieves it would be premature to express a judgment as to their outcomes.

*Patent InfringementLitigation*

On August 30, 2000, Novartis Pharmaceuticalsfiled a complaint in the U.S. District Court for the District of Delawarealleging, among other things, that the Company’s generic Cyclosporine productinfringes a patent owned by Novartis Pharmaceuticals. The Company obtained anon-infringement opinion with regard to its product prior to marketing it, andbelieves that there is no merit to the allegations in the complaint. NovartisPharmaceuticals is seeking injunctive relief to prevent the Company’s allegedacts of infringement, as well as an unspecified amount of damages, costs andexpenses, reasonable attorneys’ fees and treble damages for willfulinfringement. The Company’s potential liability and expenses in this matter 

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are not covered byinsurance. In December 2002, the U.S. District Court for the District of Delawaregranted the Company’s motion for summary judgment of non-infringement of thepatent. In April 2004, the U.S. Court of Appeals for the Federal Circuitaffirmed the judgment of the Delaware District Court that the Company’s genericCyclosporine product does not infringe Novartis Pharmaceuticals’ patent. NovartisPharmaceuticals’ request for a rehearing by the U.S. Appeals Court is stillpending. 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.

On January 26, 2001, Apotex, a Canadian genericpharmaceutical company, filed a complaint in the U.S. District Court for theEastern District of New York alleging, among other things, that the Company hasbeen and is infringing its patent related to Cyclosporine. Apotex is seekinginjunctive relief to prevent alleged acts of infringement, as well as damages,including a reasonable royalty, costs, expenses, reasonable attorneys’ fees andtreble damages for willful infringement. A trial is scheduled for May 2005.The Company’s potential liability and expenses in this matter are not coveredby insurance. The Company believes that it has meritorious defenses to Apotex’claims and is vigorously defending itself. An adverse outcome in thislitigation could result in the Company being unable to market Cyclosporine,which could materially harm profits and cash flows and could result in payingdamages, costs, expenses and fees that could have a material adverse impact onthe Company’s financial performance.

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

In January 2001, Janssen filed suit against theCompany in the U.S. District Court for the Eastern District of New York. Thesuit claims the Company’s filing of its ANDA for Itraconazole capsulesinfringed a Janssen patent. In July 2004, the Court found that the Company’sANDA product did not infringe the patent, but the Court did not invalidate thepatent. Janssen’s appeal of the District Court’s ruling is pending. In February 2005,the Company began selling Itraconazole capsules. A reversal of the DistrictCourt’s ruling by the Court of Appeals could result in the Company beingenjoined from marketing the product which could materially harm profits andcash flows, and result in paying damages, costs, and fees that could have amaterial adverse impact on the Company’s financial performance.

In August 2001, the Company was successful indefending itself in the U.S. District Court for the District of Massachusettsagainst a patent infringement claim involving Nabumetone. At the conclusion ofthe trial, the Company filed a motion to recover the legal fees it incurred indefending the action. The motion was stayed pending the appeal of the DistrictCourt’s ruling. The Court of Appeals affirmed the 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, theCompany was reimbursed $3.5 million for legal fees it had incurred in defendingitself. The $3.5 million recovery of legal fees has been reflected in theCompany’s other selling, general and administrative expenses in the quarterended June 30, 2003.

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In February 2004, the Company stipulated to anorder dismissing its complaint against Glaxo for malicious prosecution of Glaxo’searlier suit against the Company, which claimed that the Company’s Nabumetoneproduct infringed Glaxo’s patent. The Company received $10.0 million inexchange for agreeing to a dismissal of its complaint. The $10.0 millionpayment received has been recorded as other income in the quarter ended March 31,2004.

In February 2004, Pfizer filed suit in the U.S.District Court for the Eastern District of New York alleging that the Companyinfringed a patent held by Pfizer by filing an ANDA to market the generic drugGabapentin in tablet form. This case has been consolidated with other relatedcases now pending in the U.S. District Court for the District of New Jersey.

In March 2004, Dey commenced a patentinfringement action against the Company in the U.S. District Court for theCentral District of California. The complaint alleges that the Companyinfringed a patent owned by Dey covering “Albuterol and Ipratropium InhalationSolution, System, Kit and Methods for Relieving Symptoms of Chronic ObstructivePulmonary Disease” by filing an ANDA for a product that allegedly uses methodscovered by the patent and by using the inventions claimed in the patent. Discoveryin this case is ongoing.

In April 2004, AstraZeneca filed suit against theCompany in the U.S. District Court of Delaware, alleging that the Company infringedpatents held by AstraZeneca by filing an ANDA to market the generic drugMetoprolol Succinate in tablet form. The case has been consolidated fordiscovery purposes in the Eastern District of Missouri (St. Louis). Discoveryis ongoing. Motions for summary judgment of patent invalidity have been filedand are pending.

On October 29, 2004,the Company began shipping the generic drug Citalopram Hydrobromide. Earlier inOctober 2004, the Company received a notice from Forest and Lundbeck thatrequested certain information from the Company. The notice also included a listof patents that they hold which they allege covers Citalopram Hydrobromide. TheCompany has not been sued for patent infringement in connection with its saleof Citalopram Hydrobromide.

*Other Litigation*

In January 2005, the Company filed a declaratoryjudgment action against Pfizer regarding generic Azithromycin. The Companyfiled an ANDA to market 250mg, 500mg, and 600mg tablets. The complaint seeksdeclaration of non-infringement of Pfizer’s patent Nos. 6,268,489 and 5,605,889.The litigation is pending in the U.S. District Court for the Southern Districtof New York. On or about February 23, 2005, Pfizer filed a motion todismiss the complaint.

Subsequent to the public announcement of the executionof the Merger Agreement on February 21, 2005, eight purported classactions were filed—one in the Supreme Court of the State of New York and sevenin the Court of Chancery of the State of Delaware—naming as defendants the Company,Novartis AG, Thomas Strüngmann, Ph.D., Bernhard Hampl, Ph.D., Mark R.Patterson, Frank F. Beelitz and Douglas M. Karp. (In three of those actions, Novartiswas also named as a defendant, in two of those actions Merger Sub was alsonamed as a defendant and in one of those actions Santo was also named as adefendant.)

The actions, purportedly on behalf of all publicstockholders of the Company other than the defendants, in substance allege thatthe terms of the Offer and Merger are unfair to the Company’s publicstockholders because the value of the Company’s publicly held common stock isgreater than the $31 per share price that will be offered to the Company’spublic stockholders in the Offer and, if a majority of the Public Shares arepurchased in the Offer, will be paid for the remaining Public Shares in theMerger. All of the complaints assert claims for breach of fiduciary duty and,in their prayers for relief, seek, among other things, to enjoin the Offer andthe Merger.

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The seven Delaware actions are captioned as follows:Ellen Wiehl v. Eon Labs, Inc., et al., C.A. No. 1116-N (Del.Ch. Feb. 22, 2005); Paulena Partners LLC v. Eon Labs, Inc., et al.,C.A. No. 1117-N (Del. Ch. Feb. 22, 2005); RobertKemp, IRRA v. Eon Labs, Inc., et al., C.A. No. 1119-N (Del. Ch.Feb. 22, 2005); Peter J. Calcagno v. Eon Labs, Inc., et al.,C.A. No. 1125-N (Del. Ch. Feb. 23, 2005); Erste SparinvestKapitalanlagegesellschaft MBH v. Eon Labs, Inc., et al., C.A. No. 1134-N(Del. Ch. Mar. 1, 2005); Huntsinger v. Eon Labs, Inc., et al., C.A. No. 1136-N(Del. Ch. Mar. 1, 2005); and Jason Hung v. Eon Labs, Inc. et al.,C.A. No. 1139-N (Del. Ch. Mar. 3, 2005). The New York action iscaptioned as follows: Christopher Pizzo v. Novartis AG et al., No. 600680/05 (Sup.Ct. Feb. 23, 2005).

The plaintiff in the Huntsinger case filed a motionfor expedited proceedings, which was the subject of a scheduling conference on March 4,2005. The Court did not rule on the motion to expedite proceedings, andfurther indicated that it would hold a hearing on a motion forconsolidation and organization of plaintiffs’ counsel that had been filedearlier that day by counsel in the Wiehl, Calcagno, Kemp, Sparinvest and Hungcases. The Court heard arguments on the consolidation and organization motionon March 10, 2005, and took the matter under advisement.

The Company has until April 4, 2005, to answer, move,or otherwise respond to the complaint in the New York action.

The Company and itsdirectors believe that all of the actions are without merit and intend tovigorously defend them.

**Item 4.**                        Submissionof Matters to a Vote of Security Holders.

None.

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**PART II**

**Item 5.**                        Market forRegistrant’s Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities.

**Market Information**

TheCompany’s common stock is listed on The NASDAQ National Market trading underthe symbol ELAB. As of the close of business on March 11, 2005, there wereapproximately 23 holders of record of the Company’s common stock. The followingtable sets forth the high and low sales prices of the common stock for thefiscal periods indicated, as reported on The NASDAQ National Market:
| **2004**       | ** ** | ** **   | ** ** | **High**     | ** ** | **Low** | ** ** |
|----------------|------------|--------------|------------|--------------|------------|---------|------------|
| First Quarter  |       | $ 33.54 |       | $ 22.37 |       |
| Second Quarter |       | $ 44.46 |       | $ 32.40 |       |
| Third Quarter  |       | $ 40.08 |       | $ 21.70 |       |
| Fourth Quarter |       | $ 27.83 |       | $ 21.73 |       |

 
| **2003**       | ** ** | ** **   | ** ** | **High**     | ** ** | **Low** | ** ** |
|----------------|------------|--------------|------------|--------------|------------|---------|------------|
| First Quarter  |       | $ 13.49 |       | $ 9.98  |       |
| Second Quarter |       | $ 18.59 |       | $ 13.37 |       |
| Third Quarter  |       | $ 20.88 |       | $ 15.09 |       |
| Fourth Quarter |       | $ 27.39 |       | $ 19.07 |       |

 

**Dividends**

The Company did not paycash dividends on its common stock during 2004, 2003 or 2002 and does notintend to pay any cash dividends in the foreseeable future. Additionally, theMerger Agreement restricts the Company’s ability to declare, set aside or paydividends until the effective time of the Merger (other than dividends from itsdirect or indirect wholly owned subsidiaries to it or a wholly owned subsidiaryin the ordinary course of business).

**SecuritiesAuthorized for Issuance under Equity Compensation Plans**

Thefollowing table provides information as of December 31, 2004, regardingthe number of shares of Common Stock that may be issued under the Company’sequity compensation plans.
| **Plan Category**                                      | ** ** | ** ** | ** ** | **Number of securities to be  issued upon exercise of  outstanding options** | ** ** | **Weighted-average  exercise price of   outstanding options  ($)** | ** ** | **Number of securities remaining  available for future issuance under  equity compensation plans (excluding  securities reflected in the first column)** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders(1)  |       |       | 4,311,680  |                                                                                                                 |       |                                                                                   | 10.70      |                                                                                                                                                                                                                                |       |   | 1,480,800 | (2) |   |
| Equity compensation plans not approved by security  holders |       |       | —     |                                                                                                                 |       |                                                                                   | —     |                                                                                                                                                                                                                                |       |   | — |   |   |
| Total                                                       |       |       | 4,311,680  |                                                                                                                 |       |                                                                                   | 10.70      |                                                                                                                                                                                                                                |       |   | 1,480,800 |   |   |

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(1)          Includes the Company’s2001 Stock Option Plan, which was approved by the Company’s stockholders priorto its initial public offering, and the Company’s 2003 Stock Incentive Plan,which was approved by the Company’s stockholders at the Company’s 2003 AnnualMeeting of Stockholders.

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(2)          Consistsof 23,000 options available for future issuance under the Company’s 2001 StockOption Plan and 1,457,800 options available for future issuance under theCompany’s 2003 Stock Incentive Plan.

**Stock Option Plans**

The Company’s 2001 Stock Option Plan provides for thegranting of nonqualified stock options (options which are not tax-qualifiedunder Section 422 of the Internal Revenue Code of 1986, as amended) to theCompany’s employees, directors, consultants and advisors, and employees,directors, consultants and advisors of its affiliates of up to 6,000,000options (which amount is adjustable upon the occurrence of certain events) topurchase Common Stock, of which 23,000 options are available for future grantsas of December 31, 2004.

At the Company’s Annual Meeting of Stockholders heldon May 15, 2003, the Company’s 2003 Stock Incentive Plan was approved bythe stockholders, making available the issuance of a maximum of 2,000,000 sharesof Common Stock in connection with awards granted under such plan, providedthat no more than 400,000 shares of Common Stock be issued to any one personpursuant to awards of options or stock appreciation rights during any one year.At December 31, 2004, 1,457,800 options to purchase Common Stock wereavailable for grant under the 2003 Stock Incentive Plan.

The Option Subcommittee ofthe Compensation Committee of the Board of Directors administrates both the2001 Stock Option Plan and the 2003 Stock Incentive Plan. Pursuant to the termsof the plans, the exercise price for options granted thereunder will not beless than 100% of the fair market value of a share on the date of grant unlessthe Option Subcommittee in its discretion and due to special circumstancesdetermines otherwise. Options under the plans are generally granted for a10-year term, but may terminate earlier if the option holder’s employment withthe Company terminates before the end of such 10-year period. In the event of achange in control, under the 2001 Stock Option Plan, the Option Subcommittee,in its discretion, may provide that all outstanding options granted willimmediately vest, while under the 2003 Stock Incentive Plan, outstanding awardswill automatically vest.

**Use of Proceedsfrom Initial Public Offering**

In June 2002, the Company closed an initialpublic offering of its common stock. The Registration Statement on Form S-1(File No. 333-83638) was declared effective by the SEC on May 23,2002 and the Company commenced the offering on that date. After deductingunderwriting discounts and commissions and the offering expenses, net proceedsfrom the offering to the Company totaled approximately $139.2 million.

The Company has usedproceeds from the offering as follows: (i) $66.9 million has been used torepay debt due to Hexal; (ii) $10.0 million has been used to repay debtincurred in connection with the acquisition of EHI; and (iii) $2.0 millionhas been used for general working capital purposes. The remaining $60.3 millionof the proceeds to the Company from the offering are invested in cashinvestments and short-term investment grade debt securities. The Companyanticipates using the balance of the proceeds from the offering for generalcorporate purposes, including funding working capital, increasing research anddevelopment to expand the Company’s product offerings and the potentialacquisition of product lines or companies. The Company has no presentunderstandings, commitments or agreements with respect to any acquisitions. TheCompany has not determined the amounts it plans to spend on any of the areaslisted above or the timing of these expenditures.

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**Purchases of EquitySecurities by the Company**

During the quarter ended December 31,2004, the Company did not repurchase any shares of its Common Stock, either aspart of a publicly announced plan or program or otherwise. No publiclyannounced plans or programs are currently in place under which the Company maypurchase shares of its Common Stock.

**Item 6**.                        SelectedFinancial Data.

The following table sets forth selected historicalfinancial data as of and for the years ended December 31, 2004, 2003,2002, 2001, and 2000. The data are derived from the Company’s consolidatedfinancial statements, which have been audited by PricewaterhouseCoopers LLP,the Company’s independent registered public accounting firm (“PwC”). Theselected consolidated financial data should be read in conjunction with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,” theConsolidated Financial Statements and the Notes to Consolidated FinancialStatements included elsewhere in this report.

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Prior to thereorganization mergers described below, Santo owned 100% of the outstandingcapital stock of HPI. Santo is under common control with Hexal, the secondlargest generic pharmaceutical company in Germany. In September 1995, HPIacquired 50% of the Company’s capital stock. In December 2000, HPIindirectly acquired the remaining 50% of the Company’s capital stock throughits acquisition of 100% of the outstanding capital stock of EHI. On May 21,2002, a reorganization occurred in which EHI merged into HPI, whichsubsequently merged into the Company. As a result, Santo owns a majority of theCompany’s outstanding common stock. This reorganization has been accounted foras a merger of entities under common control and the accounts of the companieshave been combined in a manner similar to a pooling of interests, effective January 1,2000.
| ** **                                       | ** ** | **Year Ended December 31,**                                               | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2004**                                                                                 | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                       | ** ** | **(Dollars in thousands, except for per share data)** | ** ** |
| **CONSOLIDATED  STATEMENT OF INCOME DATA:**      |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| Net sales                                        |       | $    430,959                                                         |       | $    329,538 |   | $    244,269 |   | $    165,443 |   | $    119,693 |   |
| Cost of sales                                    |       | 190,602                                                                                  |       | 154,387 |   | 122,351 |   | 77,072 |   | 56,880 |   |
| Gross profit                                     |       | 240,357                                                                                  |       | 175,151 |   | 121,918 |   | 88,371 |   | 62,813 |   |
| Operating expenses                               |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative              |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| Amortization of goodwill                         |       | —                                                                                   |       | — |   | — |   | 3,360 |   | 318 |   |
| Deferred stock  appreciation rights compensation |       | —                                                                                   |       | — |   | — |   | 9,837 |   | 6,197 |   |
| Other selling, general and  administrative       |       | 46,043                                                                                   |       | 37,296 |   | 32,706 |   | 25,322 |   | 20,890 |   |
| Research and development                         |       | 21,666                                                                                   |       | 22,510 |   | 13,239 |   | 12,224 |   | 14,936 |   |
| Total operating expenses                         |       | 67,709                                                                                   |       | 59,806 |   | 45,945 |   | 50,743 |   | 42,341 |   |
| Operating income                                 |       | 172,648                                                                                  |       | 115,345 |   | 75,973 |   | 37,628 |   | 20,472 |   |
| Other income and  expense                        |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| Interest income                                  |       | 2,461                                                                                    |       | 1,411 |   | 854 |   | 462 |   | 1,311 |   |
| Interest expense                                 |       | —                                                                                   |       | (300 | ) | (3,857 | ) | (9,318 | ) | (1,892 | ) |
| Other income, net(2)                             |       | 13,046                                                                                   |       | 228 |   | 113 |   | 44 |   | 398 |   |
| Total other income  (expense)                    |       | 15,507                                                                                   |       | 1,339 |   | (2,890 | ) | (8,812 | ) | (183 | ) |
| Income before income  taxes                      |       | 188,155                                                                                  |       | 116,684 |   | 73,083 |   | 28,816 |   | 20,289 |   |
| Provision for income  taxes                      |       | 68,804                                                                                   |       | 46,549 |   | 29,820 |   | 13,025 |   | 9,300 |   |
| Net income(3)                                    |       | $    119,351                                                         |       | $      70,135 |   | $      43,263 |   | $      15,791 |   | $      10,989 |   |
| **PER  SHARE DATA(1)**                           |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| Basic                                            |       | $          1.34                        |       | $          0.79 |   | $          0.81 |   | $             — |   | $             — |   |
| Diluted                                          |       | $          1.32                        |       | $          0.77 |   | $          0.53 |   | $          0.25 |   | $          0.18 |   |
| Weighted average  common shares outstanding      |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| Basic                                            |       | 88,772,514                                                                               |       | 88,479,942 |   | 53,261,578 |   | — |   | — |   |
| Diluted                                          |       | 90,673,611                                                                               |       | 90,520,586 |   | 81,297,066 |   | 64,261,458 |   | 60,240,000 |   |
| **OTHER  DATA**                                  |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| Cash and investments                             |       | $    195,752                                                         |       | $    159,133 |   | $      87,284 |   | $      17,624 |   | $        6,378 |   |
| Total assets                                     |       | 545,174                                                                                  |       | 441,545 |   | 329,871 |   | 219,402 |   | 196,903 |   |
| Long-term debt including  current portion   |       | —                                                                                   |       | — |   | 4,530 |   | 116,867 |   | 123,110 |   |
| Total stockholders’  equity                 |       | 443,524                                                                                  |       | 328,780 |   | 258,154 |   | 46,991 |   | 11,895 |   |
| Net cash provided  by (used in)                  |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| Operating activities                             |       | $      60,957                                              |       | $      90,589 |   | $      32,598 |   | $      32,867 |   | $      14,206 |   |
| Investing activities                             |       | (35,404                                                                                  | )          | (102,883 | ) | (35,445 | ) | (4,916 | ) | (87,833 | ) |
| Financing activities                             |       | (10,100                                                                                  | )          | (6,177 | ) | 47,546 |   | (16,705 | ) | 58,910 |   |

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(1)           Per share data has been retroactively restated toreflect the impact of the 2-for-1 split with respect to the Company’sCommon Stock, effective as of June 1, 2004.

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(2)           In 2004, includes the receipt of a $10,000payment to settle all patent infringement litigation related to Nabumetone, or$0.07 per share, and the receipt of a $3,000 bond related to the settlement ofall patent infringement litigation involving Buproprion HCl, ER 100mg and 150mgtablets, or $0.02 per share.

(3)           In 2002, the Company adopted Statement ofFinancial Accounting Standard No. 142, “Goodwill and Other IntangibleAssets.” Had this pronouncement been retroactively applied, net income wouldhave increased approximately $3,200 and $300 and diluted earnings per sharewould have increased $0.05 and less than $0.01 in 2001 and 2000, respectively.

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**Item 7**.                        Management’s Discussionand Analysis of Financial Condition and Results of Operation.

The following discussionand analysis of our financial condition and results of operations should beread in conjunction with the “Selected Financial Data” and the Company’sconsolidated financial statements and related notes appearing elsewhere in thisannual report. This discussion and analysis contains forward-looking statementsbased on the Company’s current expectations, assumptions, estimates andprojections.

**Forward-Looking Statements**

This report containsforward-looking statements. To the extent that any statements made in thisreport contain information that is not historical, these statements areessentially forward-looking. Generally, these statements can be identifiedbecause they use words like “anticipates,” “believes,” “expects,” “future,” “intends,”“plans,” and similar terms. These statements are only the Company’s currentexpectations. Although the Company does not make forward-looking statementsunless it believes it has a reasonable basis for doing so, it cannot guaranteetheir accuracy, and actual results may differ materially from those itanticipated due to a number of uncertainties, many of which are unforeseen,including, among others, the risks it faces as described elsewhere in thisreport. You should not place undue reliance on these forward-lookingstatements, which apply only as of the date of this report.

**Overview**

The Company is a genericpharmaceutical company engaged in developing, licensing, manufacturing, sellingand distributing a broad range of prescription pharmaceutical productsprimarily in the United States. The Company focuses primarily on drugs in abroad range of solid oral dosage forms, utilizing both immediate and sustainedrelease delivery, in tablet, multiple layer tablet, film-coated tablet andcapsule forms. The Company does not depend on any single drug or therapeuticcategory for a majority of its sales.

**Proposed Merger**

On February 20, 2005,the Company entered into the Merger Agreement with Novartis, Merger Sub and,solely with respect to its guarantee of Novartis’s and Merger Sub’s obligationsthereunder, Parent. Pursuant to the Merger Agreement, Merger Sub will commencea tender offer to purchase all of the issued and outstanding shares of theCompany’s Common Stock (other than those shares owned by Santo), at $31.00 pershare.

In connection with theexecution of the Merger Agreement, Novartis, Santo and Parent entered into theSanto Agreement, pursuant to which Novartis agreed to purchase, and Santoagreed to sell, all of the Santo Shares, representing approximately 67.5% ofthe outstanding shares of Common Stock, for €1.3billion in cash on the terms and subject to the conditions set forth therein.

The Offer is notconditioned upon any minimum number of shares being tendered, but is contingentupon the contemporaneous (or immediately subsequent) closing of the SantoPurchase pursuant to the Santo Agreement. In addition to certain customaryconditions, the closing of the Santo Purchase is conditioned on the acquisitionby Novartis (Deutschland) GmbH of all of the outstanding shares and partnershipinterests of Hexal, including shares held directly and indirectly by Dr. ThomasStrüngmann, the Chairman of the Board of Directors of the Company and anindirect significant stockholder of Santo, and Dr. Andreas Strüngmann, anindirect significant stockholder of Santo. Additionally, the Santo Purchase issubject to customary regulatory approvals, including clearance under theHart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. Following thecompletion of the Offer and the purchase of the Santo Shares, if a majority ofthe outstanding shares of Common Stock other than the Santo Shares arepurchased in the Offer, in accordance with the DGCL, Merger Sub will be mergedwith and into the Company and any remaining shares of Common Stock will beacquired by Merger Sub.

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The Merger Agreementprovides that upon consummation of the Offer, the Confidentiality Agreement,dated February 11, 2005, between the Company and Novartis (which currentlyrestricts the ability of Novartis and its affiliates to acquire Public Shareswithout approval of a majority of the special committee of independent boardmembers, which was appointed to review the Offer and the Merger, and of theCompany’s Board of Directors) will be amended to provide that Novartis and itsaffiliates will be permitted to make acquisitions of Public Shares that arevoluntary to the holders of Public Shares (such as by means of legallypermissible open market purchases or tender offers), but, prior to February 11,2006, Novartis and Merger Sub will not be permitted to cause a mergertransaction (or other business combination) to be effected which would cancelPublic Shares unless (i) a majority of the outstanding Public Shares votein favor of such a transaction or (ii) Novartis and its subsidiaries, atthat time, own at least 90% of the outstanding Common Stock; provided, that theconsideration to be received by the holders of Public Shares in any suchtransaction described in (ii) above must be at least equal to $31.00 perPublic Share. Following the completion of the Offer and until the earlier ofthe consummation of the Merger and February 11, 2006, Novartis and MergerSub are required to use their reasonable best efforts to keep the Common Stockquoted for trading on the NASDAQ National Market unless the Company is nolonger required to be registered under the Exchange Act, or no longer satisfiesNASDAQ’s listing standards (other than standards entirely within the Company’scontrol).

At the effective time ofthe Merger, each issued and outstanding share of Common Stock (other thanshares owned by Novartis, any of its subsidiaries (including Merger Sub) or anyof its affiliates, any shares held in the treasury of the Company and sharesheld by stockholders who properly demand appraisal and comply with theprovisions of Section 262 of the DGCL, relating to dissenters’ rights ofappraisal) will be converted into the right to receive an amount equal to theOffer Price. Following the consummation of the Merger, the Company willcontinue as the surviving corporation and will be a wholly owned subsidiary ofNovartis.

**Critical Accounting Policies**

The Company’s criticalaccounting policies are those policies that are important to the portrayal ofits financial condition and results of operations and require management’ssubjective judgments. As a result, these judgments are subject to an inherentdegree of uncertainty. The Company bases its judgments on its experience andvarious other assumptions that the Company believes to be reasonable under thecircumstances. On an ongoing basis, the Company evaluates its estimates,including those related to revenues, returns, inventories, income taxes andlitigation. The Company’s actual results could differ from these estimatesunder different assumptions or conditions. The Company believes the followingaccounting policies to be critical:

***Revenue Recognition***

Sales are recognized whenthe products are received by the customer, which represents the point when therisks and rewards of ownership are transferred to the customer. When theCompany recognizes revenue from product sales, the Company records estimatesfor contract pricing adjustments, rebates, discounts, expected product returnsand other sales allowances. These allowances are recorded as a reduction ofproduct sales. Contract pricing adjustments, rebates and discounts are recordedas a reduction of sales based on agreed-upon terms with the Company’s customersat the time of sale.

***Reserves for Contract Pricing Adjustments, Rebates andDiscounts***

Reserves for contract pricing adjustments and rebatesrepresent the difference between prices wholesalers are billed by the Companyfor products sold and the contract prices billed by wholesalers to their customers (the Company’s indirectcustomers) for the products. These contract pricing and rebate reserveestimates are based on agreements between the Company and its indirectcustomers or between 

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the Company and thewholesalers and are recorded as a reduction in sales at the time of sale. Indetermining a reserve for contract pricing adjustments and rebates, the Companyestimates the amount of such pricing adjustments by product based on historicaltrends and changes in wholesaler or contract prices. As part of the Company’sreview of this estimation process, the Company obtains inventory reports fromkey wholesalers to determine the level of inventory in that distributionchannel to compare with inventory levels used in its estimation process. The Companycalculates a reserve for discounts based upon actual sales under such discountarrangements. No revisions were made to the methodology used in determiningthese provisions during the year ended December 31, 2004.

As of December 31,2004 and 2003, accounts receivable are presented net of allowances for contractpricing adjustments, rebates and discounts of $138.0 million and $94.7 million,respectively. When allowances against a specific customer account exceed thatcustomer’s receivable balance, the net credit balance for that customer isincluded in accrued liabilities. The amounts reclassified to accruedliabilities are $15.0 million and $20.8 million at December 31, 2004 and2003, respectively. The increase in aggregate allowances is due to an increasein sales, principally the result of new product introductions. No revisionswere made to the methodology used in determining these provisions during theyear ended December 31, 2004.

***Reserve for Product Returns***

The Company’s policy is toaccept customer returns of products, which consist primarily of products whoseexpiration date has been exceeded, upon appropriate approval by authorizedpersonnel of the Company. The majority of the Company’s products have a two tothree year expiration date. Estimates for returns, which are recorded as areduction of sales at the time of sale, relate primarily to products expectedto be returned upon expiration. The Company utilizes historical trends toestimate the amount of products expected to be returned. As of December 31,2004 and 2003, the Company has a reserve for product returns of $25.6 millionand $35.0 million, respectively. The decrease in the reserve is attributedprimarily to the issuance of credits for returns of specific products unrelatedto product expiration, but instead resulting from the loss of a significantcontract by a wholesaler. There were no revisions made to the methodology usedin determining these provisions during the year ended December 31, 2004.

***Pricing Adjustments, Promotions and Allowances andMedicaid Rebates***

Shelf stock adjustments are recorded following areduction in the price of the Company’s products due to changes in thecompetitive environment. Such adjustments are credited to the Company’scustomers based on their on-hand inventory quantities at the time of thereduction in price. Reserves are generally established when prices are actuallyreduced. As of December 31, 2004, there was a liability for a shelf stockadjustment of $0.8 million for which a credit had not yet been issued. As of December 31,2003 there were no liabilities recorded for shelf stock adjustments.

The Company typically provides sales incentives to itscustomers at the time of a new product launch to obtain distribution and marketshare. Since most of these promotional arrangements do not require a minimumpurchase level, they are recorded as a reduction of sales upon shipment of thecustomer’s initial order. The Company also participates in trade show and otherpromotions where additional discounts may be given as an incentive for thecustomer to purchase products. Such discounts and incentives are recorded as areduction of sales at the time of sale of the related product. Since theCompany allows customers to return short-dated or expired products withappropriate approval, it is in the Company’s interest to ensure that itscustomers do not maintain excess inventory levels. The Company evaluatesunusually large orders to ensure that customers’ inventories are not in excessof their ordinary course of business inventory levels.

As of December 31, 2004 and 2003, the reserve forpromotions and allowances was $18.0 million and $12.4 million, respectively. Theincrease in the reserve for promotions and allowances is attributed 

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primarily to promotionsfor new products launched during 2004. During the year ended December 31,2004, the Company recorded an adjustment to reduce its reserve related topromotions by $1.8 million. The reduction was attributed to certain promotionalprograms in the final stages of their program lives and for which an accrualwas no longer considered necessary.

All generic pharmaceuticalmanufacturers whose products are covered by the Medicaid program are requiredto rebate to each state a percentage of their average manufacturer’s price forthe products dispensed. Many states also have implemented supplemental rebateprograms that obligate manufacturers to pay rebates in excess of those requiredunder federal law. The Company estimates these rebates based on historicaltrends of sales for such products in each state. The reserve for Medicaidrebates at December 31, 2004 and 2003 was $8.0 million and $4.9 million,respectively.

***Reserve for Pending Litigation Claims***

In determining whetherliabilities should be recorded for pending litigation claims, the Company mustassess the allegations made and the likelihood that it will successfully defenditself. When the Company believes it is probable that it will not prevail in aparticular matter, it will then make an estimate of the amount of liabilitybased in part on advice of outside legal counsel. There were no liabilitiesrecorded for pending claims as of December 31, 2004 and 2003.

**Year Ended December 31,2004 Compared with Year Ended December 31, 2003**

**Net sales.****  **Net salesincreased 30.8% to $431.0 million in 2004 from $329.5 million in 2003. Theincrease in net sales is attributable to the introduction of new productsduring 2004. The most significant product was Bupropion HCl, ER 100mg and 150mg tablets. The introductions of Fosinopril, Benazepril HCl, Benazepril/HCTZand Citalopram and the full-year impact of products introduced in late 2003,such as Mirtazipine, Midodrine HCl and Metolazone USP, also contributed to thesales growth. The favorable impact of new product introductions was partiallyoffset by price declines on selected existing products.

**Gross profit.****  **Gross profitincreased $65.2 million to $240.4 million in 2004 from $175.2 million in 2003. Grossprofit as a percentage of net sales increased to 55.8% in 2004 from 53.2% in2003. The Company’s gross profit margins are dependent on several factors,including product sales mix, cost, volume and competitive activity. Theincrease in the 2004 gross profit is attributable primarily to the introductionof Bupropion during 2004, and an increase in utilization of manufacturingcapacity, offset by price decreases on selected products.

**Otherselling, general and administrative.**   Otherselling, general and administrative expenses increased $8.7 million to $46.0million in 2004 from $37.3 million in 2003.  Expenses for 2003 were reduced by the recoveryof $3.5 million in legal fees related to Nabumetone litigation. Excluding therecovery of legal fees, other selling, general and administrative expenses were$40.8 million for 2003. Excluding the recovery, the increase in expense was theresult of increases of $2.0 million in compensation costs, $2.2 million ininsurance expense due to higher product liability and directors and officerinsurance premiums, $0.9 million in professional fees for audit, tax, andconsulting principally due to compliance with the Sarbanes-Oxley Act of 2002and a net increase in other expenses of $0.1 million.

**Research and development.  **Researchand development expenses decreased $0.8 million to $21.7 million in 2004from $22.5 million in 2003. The decrease is principally attributed to decreasesin bio-study expenses, and contracted product development expensesrelating to the completion of defined milestones under third-party productdevelopment agreements, partially offset by other expenses. The decrease inthese expenses is related principally to the timing of such expenditures.

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**Operating income.  **Operatingincome increased $57.3 million to $172.6 million in 2004 from $115.3 millionin 2003. The increase in operating income is the result of increased sales andgross profit, partially offset by increases in total operating expenses.

**Interest income (expense).  **Interestincome was $2.5 million for 2004. Net interest income was $1.1 million in2003. Interest income was higher as a result of higher investment balances. Therewas no interest expense during 2004, as there was no outstanding debt.

**Other income, net.  **Otherincome for the year ended December 31, 2004 was $13.0 million, including a$10.0 million settlement received from Glaxo in exchange for the Companyagreeing to the dismissal of its complaint against Glaxo for the malicious prosecutionof its earlier suit against the Company, which claimed the Company’s Nabumetomeproduct infringed Glaxo’s patent. Other income for the period also includes a$3.0 million bond received from Glaxo to settle all patent infringementlitigation relating to Buproprion HCl, ER 100mg and 150mg tablets. Other incomefor the year ended December 31, 2003 was approximately $0.2 million.

**Taxes on income.  **Taxeson income increased $22.3 million to $68.8 million in 2004 from $46.5 millionin 2003. The increase is the result of higher pre-tax income during 2004. Theeffective tax rate decreased to 36.6% from 39.9%. The decrease in the effectivetax rate during 2004 is attributable to: the reversal of tax contingencies; lower local and state income taxes,resulting in part from the recognition of state tax credits; and the benefit ofinvesting in tax exempt securities. The reversal of tax contingencies totaling$1.6 million was recorded in connection with the acceptance of certainVoluntary Disclosure Agreements filed with various state and local taxjurisdictions.

**Netincome.  **Net income increased $49.2 million to $119.4million in 2004 from $70.1 million in 2003 for the reasons described above.

**Year Ended December 31,2003 Compared with Year Ended December 31, 2002**

**Net sales.  **Netsales increased 34.9% to $329.5 million in 2003 from $244.3 million in 2002. Theincrease in net sales is attributable primarily to the increase in unit volumeof several existing products, the full year impact of products introduced in2002 and sale of products introduced after December 31, 2002. Severalexisting products including Lovastatin, USP, Cholestyramine, USP, andLabetalol, HCl, had significant increases in unit volumes. Products introducedin 2002 that had increased unit volumes in 2003 due to the full year impactinclude Lisinopril, USP, Lisinopril/HCTZ, Tizanidine HCl, and aDextroamphetamine and Amphetamine Mixed Salts product. Nabumetone, a productalso introduced in early 2002, also had a significant increase in unit volume. Theincrease is primarily related to an increase in market share. Productsintroduced subsequent to December 31, 2002 include Mirtazipine, MidodrineHCl, Nefazodone HCl, and Metolazone USP.

**Gross profit.  **Grossprofit increased $53.2 million to $175.2 million in 2003 from $121.9 million in2002. Gross profit as a percentage of net sales increased to 53.2% in 2003 from49.9% in 2002. The Company’s gross profit margins are dependent on severalfactors, including product sales mix, cost, volume and competitive activity. In2003, the increase in margin percent is attributable primarily to an increasein utilization of manufacturing capacity, lower raw material costs and a $1.4million decrease in expense related to write-downs of slow-moving or unusableinventory. Inventory write-downs were lower in 2003 as compared to 2002, as2002 included a $2.4 million write-down of a raw material that will not beutilized in production.

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**Other selling, general and administrative.  **Otherselling, general and administrative expenses increased $4.6 million to $37.3million in 2003 from $32.7 million in 2002. Expenses for 2003 were reduced bythe recovery of $3.5 million in legal fees related to Nabumetone litigation. Excludingthe recovery of legal fees, other selling, general and administrative expenseswere $40.8 million for 2003, representing an increase of $8.1 million comparedto 2002. However, other selling, general and administrative expenses, excludingthe recovery of legal fees in 2003, decreased as a percentage of net sales to12.4% compared to 13.4% in 2002. The increase in expense was the result ofincreases of $1.0 million in compensation costs, $2.5 million in insuranceexpense due to higher premiums, $1.4 million in freight and sales commissions,$2.2 million in legal costs principally due to patent challenges and $1.0million in other expenses.

**Research and development.  **Researchand development expenses increased $9.3 million to $22.5 million in 2003from $13.2 million in 2002. The increase is attributable to an increase ingeneric product development costs of $9.8 million, offset by a decrease of $0.5million related to certain basic research contracts unrelated to the Company’sbusiness that were transferred in March 2002 to an unrelated entity. Theincrease in generic drug development costs is principally attributed toincreases in the number of bio-studies, materials and expenses relatingto the completion of defined milestones under third-party product developmentagreements. These increases reflect an acceleration of the Company’s productdevelopment program.

**Operating income.  **Operatingincome increased $39.4 million to $115.3 million in 2003 from $76.0 millionin 2002. The increase in operating income was the result of increased sales andgross profit, partially offset by increases in other selling, general andadministrative and research and development expenses.

**Interest income (expense).  **Netinterest income was $1.1 million in 2003 compared to net interest expense of$3.0 million in 2002. A decrease in outstanding debt, primarily attributable tothe elimination of $92.1 million of intercompany debt in June 2002,decreased interest expense by $3.6 million. Interest income increased by $0.6million as a result of higher investment balances.

**Taxes on income.  **Taxeson income increased $16.7 million to $46.5 million in 2003 from $29.8 millionin 2002. The increase was the result of higher pre-tax income during 2003. Theeffective tax rate decreased to 39.9% from 40.8%, principally due to lowerstate and local income taxes.

**Netincome.  **Net income increased $26.9 million to $70.1million in 2003 from $43.3 million in 2002 for the reasons described above.

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**Quarterly Resultsof Operations**

The following tablepresents a summary of the Company’s unaudited quarterly consolidated results ofoperations for each of the four quarters in 2004, 2003 and 2002. The unauditedinterim financial statements include all adjustments, consisting only of normalrecurring adjustments, necessary for a fair statement of such information whenread in conjunction with the Company’s audited consolidated financialstatements and related notes. Per share data has been retroactively restated toreflect the impact of the 2-for-1 split with respect to the Company’s CommonStock, effective as of June 1, 2004. The Company’s quarterly operatingresults have varied in the past, may continue to do so and are not necessarilyindicative of results for any future period. Additionally, future results maydiffer substantially from historical results pending the consummation of theoffer and the Merger.
| ** **             | ** ** | **First  Quarter(1)**                                                           | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|------------------------|------------|---------------------------------------------------------------------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| ** **             | ** ** | **(Dollars in thousands, except per share data)** | ** ** |
| **2004**               |       |                                                                            |       |                |       |               |       |                |       |
| Net sales              |       | $                                                                               | 104,229    |                | $          | 106,962            |       | $                   | 109,778    |   | $ | 109,990 |   |
| Gross profit           |       | $                                                                               | 61,308     |                | $          | 62,926             |       | $                   | 59,591     |   | $ | 56,532 |   |
| Net income             |       | $                                                                               | 32,317     |                | $          | 28,788             |       | $                   | 28,089     |   | $ | 30,156 |   |
| Earnings per  share(1) |       |                                                                            |       |                |       |               |       |                |       |
| Basic                  |       | $                                                                               | 0.36       | (3)                 | $          | 0.32               | (4)        | $                   | 0.32       |   | $ | 0.34 |   |
| Diluted                |       | $                                                                               | 0.36       | (3)                 | $          | 0.32               | (4)        | $                   | 0.31       |   | $ | 0.33 |   |
| **2003**               |       |                                                                            |       |                |       |               |       |                |       |
| Net sales              |       | $                                                                               | 70,857     |                | $          | 78,681             |       | $                   | 85,011     |   | $ | 94,989 |   |
| Gross profit           |       | $                                                                               | 37,472     |                | $          | 40,660             |       | $                   | 46,635     |   | $ | 50,384 |   |
| Net income             |       | $                                                                               | 15,107     |                | $          | 18,032             |       | $                   | 17,819     |   | $ | 19,177 |   |
| Earnings per  share(1) |       |                                                                            |       |                |       |               |       |                |       |
| Basic                  |       | $                                                                               | 0.17       |                | $          | 0.20               | (2)        | $                   | 0.20       |   | $ | 0.22 |   |
| Diluted                |       | $                                                                               | 0.17       |                | $          | 0.20               | (2)        | $                   | 0.20       |   | $ | 0.21 |   |
| **2002**               |       |                                                                            |       |                |       |               |       |                |       |
| Net sales              |       | $                                                                               | 48,198     |                | $          | 52,000             |       | $                   | 75,351     |   | $ | 68,720 |   |
| Gross profit           |       | $                                                                               | 22,273     |                | $          | 27,363             |       | $                   | 39,330     |   | $ | 32,952 |   |
| Net income             |       | $                                                                               | 6,346      |                | $          | 9,504              |       | $                   | 14,183     |   | $ | 13,230 |   |
| Earnings per  share(1) |       |                                                                            |       |                |       |               |       |                |       |
| Basic                  |       | $                                                                               | —     |                | $          | 0.26               |       | $                   | 0.16       |   | $ | 0.15 |   |
| Diluted                |       | $                                                                               | 0.09       |                | $          | 0.12               |       | $                   | 0.16       |   | $ | 0.15 |   |

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(1)          The sum of earnings pershare for the four quarters may not equal earnings per share for the full yeardue to changes in the average number of common shares outstanding.

(2)          Includes recovery of$3.5 million of legal fees, or $0.02 per share.

(3)          Includes the receipt of$10.0 million payment to settle all patent infringement litigation related toNabumetone, or $0.07 per share.

(4)          Includesthe receipt of $3.0 million bond related to the settlement of all patentlitigation involving Bupropion HCl, ER 100mg and 150mg tablets or $0.02 pershare.

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**Liquidity andCapital Resources**

Cash and cash equivalents were $59.5 million at December 31,2004, as compared to $43.9 million at December 31, 2003. Additionally, theCompany had investments in marketable debt securities of $136.3 million atDecember 31, 2004, as compared to $115.3 million at December 31,2003.

The Company’s initial public offering in June 2002generated proceeds of $139.2 million, net of offering expenses. The Company hasused the proceeds from the offering as follows: (i) $66.9 million has beenused to repay debt due to Hexal; (ii) $10.0 million has been used to repaydebt incurred in connection with the acquisition of EHI; and (iii) $2.0million has been used for general working capital purposes. At December 31,2004, the remaining balance of $60.3 million of the proceeds was available forgeneral corporate purposes.

The Company has a three-year $25 million creditfacility which expires on December 31, 2007. Under this facility, theCompany can borrow at the adjusted LIBOR rate plus 1.5%, the bank’s prime rateor a fixed rate (as set by the bank). The credit facility, which is for workingcapital purposes, had no outstanding borrowings against it at December 31,2004 and December 31, 2003.

Stockholders’ equity increased to $443.5 million at December 31,2004 from $328.8 million at December 31, 2003. The increase instockholders’ equity is comprised of: an increase of $6.4 million (includingtax benefits) from the exercise of stock options; net earnings of $119.4million for the year ended December 31, 2004; and amortization of deferredstock-based compensation costs of $0.2 million, offset by the net purchases of$11.2 million of treasury shares.

In 2004, cash increased by $15.6 million. Operationsgenerated $61.0 million of cash, comprised of net earnings of $119.4 million,non-cash items totaling $53.0 million offset by an increase in working capitalof $111.4 million. Working capital is defined as current assets (excluding cashand cash equivalents, investments and restricted cash) less current liabilities.The increase in working capital resulted primarily from increases in accountsreceivable of $75.7 million, inventory of $16.0 million, prepaid expenses andother assets of $12.6 million, and decreases in accounts payable and accruedliabilities of $7.3 million. The increases in accounts receivable and inventoryare attributed to increased sales. The increase in prepaid expenses and otherassets is primarily the result of prepaid taxes. The decrease in accountspayable and accrued liabilities is primarily due to a decrease in customerreturns and credits.

In 2003, cash decreased by $18.5 million. Operationsgenerated $90.6 million of cash, comprised of net earnings of $70.1 million,non-cash items totaling $20.3 million and a decrease in working capital of $0.1 million.The decrease in working capital resulted primarily from a decrease in prepaidexpenses and other assets totaling $2.5 million and increases in accountspayable and accrued liabilities of $43.1 million. The decrease in prepaidexpenses and other assets is primarily the result of a lower royalty receivableowed to the Company under a licensing arrangement. The increase in accountspayable and accrued liabilities is primarily due to an increase in customerreturns, credits and allowances. Increases in accounts receivable and inventoryof $31.0 million and $14.5 million, respectively, substantially offset thedecreases in working capital. The increases in accounts receivable andinventory are attributed to increased sales.

Investing activities consumed $35.4 million of cash in2004. Approximately $21.3 million was used to purchase short-term investmentgrade debt instruments and $14.1 million was used for capital expenditures. Thecapital expenditures included primarily the purchase of equipment to supportincreased production in the Company’s Wilson facility.

Investing activities consumed $102.9 million of cashin 2003. Approximately $90.4 million was used to purchase short-term investmentgrade debt instruments and $12.5 million was used for capital expenditures. Thecapital expenditures included primarily the purchase of equipment to supportincreased production in the Company’s Wilson facility.

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Financing activities consumed $10.1 million of cash in2004. The purchase of treasury shares consumed $11.2 million. Financingactivities generated $1.1 million, of which $1.0 million represents cashproceeds received from employees who exercised stock options, with theremaining proceeds related to other financing activities.

Financing activities consumed $6.2 million of cash in2003. Repayment of acquisition debt and the purchase of treasury sharesconsumed $4.8 million and $2.6 million, respectively. Financing activitiesgenerated $1.2 million, of which $0.6 million represents cash proceeds receivedfrom employees who exercised stock options, with the remaining proceeds relatedto other financing activities.

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

An adverse outcome in patent litigation with Novartisand Apotex involving the Company’s generic Cyclosporine product could result inthe Company not being able to market this product, which could materially harmits profits and cash flows and could result in the Company paying damages,costs, expenses and fees that could have a material adverse impact on itsfinancial performance. In December 2002, the U.S. District Court for theDistrict of Delaware granted the Company’s motion for summary judgment ofnon-infringement of the Novartis patent. In April 2004, the U.S. Court ofAppeals for the Federal Circuit affirmed the judgment of the Delaware DistrictCourt that the Company’s generic Cyclosporine product does not infringeNovartis’ patent. Novartis’ request for a rehearing by the U.S. Appeals Courtis still pending. An adverse outcome in this litigation could result in theCompany being unable to market Cyclosporine, which could materially harmprofits and cash flows and could result in paying damages, costs, expenses andfees that could have a material adverse impact on the Company’s financialperformance.

In January 2001, Janssen filed suit against theCompany in the U.S. District Court for the Eastern District of New York. Thesuit claims the Company’s filing of its ANDA for Itraconazole capsulesinfringed a Janssen patent. In July 2004, the Court found that the Company’sANDA product did not infringe the patent, but the Court did not invalidate thepatent. Janssen’s appeal of the District Court’s ruling is pending. In February 2005,the Company began selling Itraconazole capsules. A reversal of the DistrictCourt’s ruling by the Court of Appeals could result in the Company beingenjoined from marketing the product which could materially harm profits andcash flows, and result in paying damages, costs, and fees that could have amaterial adverse impact on the Company’s financial performance.

The Company does notcurrently have or anticipate any short-term funding requirements outside of theordinary course of its business, and the Company does not have or anticipateany liquidity concerns. The Company’s principal future cash requirements areassociated with increased working capital to support future growth, capitalexpenditures and legal defense costs. The Company anticipates that itsoperating cash flows and current cash balances together with its availableborrowings under its credit facility will be sufficient to meet all of its cashrequirements for both the short-term and foreseeable future.

**Impact of RecentlyIssued Accounting Standards**

The Company applies the recognition and measurementprinciples of Accounting Principles Board (“APB”) Opinion 25, “Accounting forStock Issued to Employees,” in accounting for its long-term stock-basedincentive plans. No compensation cost related to grants of stock options wasreflected in net income, as all options granted under the plans had an exerciseprice equal to the market price. In accordance with the recently issued FAS123(R), the Company will record an expense for the value of stock optionsbeginning in July 2005. The Company is reviewing the variousimplementation methods available under this pronouncement.

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In December 2004, the FASB issued SFAS No. 153,“Exchange of Nonmonetary Assets an amendment of APB Opinion No. 29.”  This Statement precludes companies from usingthe “similar productive assets” criteria to account for nonmonetary exchangesat book value with no gain or loss being recognized. Effective for fiscalperiods beginning after June 15, 2005, all companies will be required touse fair value for most nonmonetary exchanges, recognizing gain or loss, if thetransaction meets a commercial-substance criteria. The Company does not expectthis Standard to have a significant impact on its consolidated financial statements.

In December 2004, the FASB issued FSP FAS 109-1, “Applicationof FASB Statement No. 109, ‘Accounting for Income Taxes,’ to the TaxDeduction on Qualified Production Activities Provided by the American JobsCreation Act of 2004” to provide accounting guidance on the appropriatetreatment of tax benefits generated by the enactment of the Act. The FSPrequires that the manufacturer’s deduction be treated as a special deduction inaccordance with SFAS 109 and not as a tax rate reduction. The Company isawaiting final tax regulations from the IRS before completing its assessment ofthe impact of adopting FSP FAS 109-1 on its consolidated financial statements.

In November 2004, the FASB issued Statement No. 151,“Inventory Costs, an amendment of ARB 43, Chapter 4,” to clarify the accountingfor abnormal amounts of idle facility expense, freight, handling costs andwasted materials (spoilage). ARB 43 allowed some of these “abnormal costs” tobe carried as inventory whereas the new Standard requires that these costs berecognized in income as incurred. This Statement is effective for fiscal yearsbeginning after June 15, 2005. The Company is currently evaluating whateffect, if any, this Standard will have on its consolidated financialstatements.

In January 2003, theFASB issued Fin No. 46, “Consolidation of Variable Interest Entities” (asrevised by Fin No. 46R). This interpretation, as revised, providesguidance with respect to the consolidation of certain entities, referred to asvariable interest entities (“VIEs”), in which an investor is subject to amajority of the risk of loss from the VIEs’ activities, or is entitled toreceive a majority of the VIEs’ residual returns. This interpretation alsoprovides guidance with respect to the disclosure of VIEs in which an investormaintains an interest, but is not required to consolidate. The provisions ofthe interpretation were effective immediately for all VIEs created after January 31,2003, or in which the Company obtains an interest after that date. For VIEscreated before February 1, 2003, the provisions were effective July 1,2003. In November 2003, the Company invested $1.15 million****for 50% ownership in an entity formed toprovide research and development services for the Company as well as thirdparties. It has been determined that such investee is deemed a VIE, which hasbeen consolidated in the Company’s financial statements. The net assets andresult of operations of this entity were not material to the Company in 2004. Creditors,or beneficial interest holders, of the consolidated VIE have no recourse to thegeneral credit of the Company.

**Off-Balance SheetArrangements**

None.

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**Contractual Obligations**
| ** **                                                                            | ** ** | **Payments due by period**                 | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                            | ** ** | **Total**                                                 | ** ** | **Less than  1 year** | ** ** | **1-3  years** | ** ** | **3-5  years** | ** ** | **More  than 5  years** | ** ** |
| ** **                                                                            | ** ** | **(amounts in thousands of dollars)** | ** ** |
| Long-Term Debt  Obligations                                                           |       | —                                                    |       |   | — |   |   | — |   | — |   | — |   |
| Capital (Finance)  Lease Obligations                                                  |       | —                                                    |       |   | — |   |   | — |   | — |   | — |   |
| Operating Lease  Obligations                                                          |       | 9,476                                                     |       |   | 870 |   |   | 1,774 |   | 1,822 |   | 5,010 |   |
| Purchase  Obligations(1)                                                              |       | 55,214                                                    |       |   | 49,736 |   |   | 3,984 |   | 1,494 |   | — |   |
| Other Long-Term  Liabilities Reflected on the Company’s Balance Sheet under GAAP |       | —                                                    |       |   | — |   |   | — |   | — |   | — |   |
| Total                                                                                 |       | 64,690                                                    |       |   | 50,606 |   |   | 5,758 |   | 3,316 |   | 5,010 |   |

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(1)          Purchaseobligations include commitments of approximately $43 million relating toinventory items. The balance is attributable to non-inventory items, includingfixed assets, research and development materials, supplies and services.

**Item 7A**.                Quantitativeand Qualitative Disclosures About Market Risk.

The following discusses the Company’s exposure tomarket risk related to changes in interest rates, equity prices and foreigncurrency exchange rates. The Company does not believe that its exposure tomarket risk is material.

As of December 31, 2004, the Company had cash andcash equivalents of $59.5 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. In addition,the Company currently owns $136.3 million in publicly traded debt securitieswith an average maturity of approximately 116 days, which are subject to marketfluctuations.

These investments are subject to interest rate riskand will decrease in value if market interest rates increase. A hypotheticalincrease in the market interest rates by 10 percent from the rates ineffect on the date of this Form 10-K would cause the fair value of theseshort-term investments to decline by an immaterial amount. The Company has theability to hold these investments until maturity, and therefore it does notexpect the value of these investments to be affected to any significant degreeby the effect of a sudden change in market interest rates. Declines in interestrates over time will, however, reduce the Company’s interest income.

The Company currently doesnot have any significant foreign currency exchange rate risk.

**Item 8**.                        FinancialStatements and Supplementary Data.

The information requiredto be presented by this item is presented on pages F-1 through F-30 ofthis Form 10-K.

**Item 9**.                        Changesin and Disagreements With Accountants on Accounting and Financial Disclosure.

None.

**Item 9A**.                Controlsand Procedures.

**Evaluation ofDisclosure Controls and Procedures**

As of the end of theperiod covered by this report, the Company’s management performed anevaluation, under the supervision and with the participation of its ChiefExecutive Officer and Chief 

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FinancialOfficer, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Exchange Act. Based on that evaluation, the Company’smanagement, including its Chief Executive Officer and Chief Financial Officer,concluded that the Company’s disclosure controls and procedures were effectiveas of the end of the period covered by this report.

**Management’s Reporton Internal Control Over Financial Reporting**

The Company’s management is responsible forestablishing and maintaining adequate internal control over financial reporting(as defined in Rules 13a-15(f) and 15d-15(f) of the ExchangeAct). Under the supervision and with the participation of management, includingthe Company’s Chief Executive Officer and Chief Financial Officer, the Companyconducted an evaluation of the effectiveness of its internal control overfinancial reporting based on the framework in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.

Because of inherent limitations, internal controlsover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies and procedures maydeteriorate.

Based on the evaluationunder the aforementioned framework, the Company’s management concluded that theCompany’s internal control over financial reporting was effective as of December 31, 2004.PricewaterhouseCoopers LLP, the Company’s external auditor and an independentregistered public accounting firm, has attested to management’s assessment ofthe effectiveness of the Company’s internal control over financial reporting asof December 31, 2004, as stated in PricewaterhouseCoopers LLP’s reportwhich is included herein.

**Changes in InternalControl Over Financial Reporting**

There have been no changesin the Company’s internal control over financial reporting that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

**Item 9B**.               OtherInformation.

None.

**PART III**

**Item 10**.                 Directorsand Executive Officers of the Registrant.

The Board of Directors of the Company (the “Board”) iscomprised of Dr. Bernhard Hampl, Dr. Thomas Strüngmann, Mr. FrankBeelitz, Mr. Douglas Karp and Mr. Mark Patterson. The Board hasdetermined that Messrs. Karp and Patterson are independent as defined byapplicable listing standards of the National Association of Securities Dealers, Inc.(the “NASD”) and the standards set forth by the SEC. A majority of the Board isnot comprised of independent directors because, under NASD rules, a controlled companyis exempt from this requirement. The Company is a controlled company becausemore than 50% of the Company’s voting power is held by Santo.

Director nominees are selected by the entire Board inconnection with recommendations received from Board members and in accordancewith the Company’s Restated Certificate of Incorporation. The Company does nothave a separate nominating committee because, under NASD rules, a controlledcompany is not required to establish a separate nominating committee.

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The Company’s RestatedCertificate of Incorporation provides that the Board shall be divided intothree classes, each class of the same or nearly the same number of directorsand each elected for a three-year term. The term of Class IIIdirectors is scheduled to expire at the 2005 Annual Meeting of Stockholders,the term of Class I directors is scheduled to expire at the 2006 AnnualMeeting of Stockholders and the term of Class II directors is scheduled toexpire at the 2007 Annual Meeting of Stockholders.

**BiographicalInformation for Directors**

*Class IDirectors*

*Frank F. Beelitz***(age61) has been a Director since February 2002. Mr. Beelitz has been theGeneral Partner of Beelitz & Cie, an investment banking advisory firm,since July 2000. Mr. Beelitz was a Managing Director of LehmanBrothers Inc. and was a member of the management board and co-head of LehmanBrothers Bankhaus AG from July 1993 to July 2000. Prior to joiningLehman Brothers Inc., Mr. Beelitz was a Managing Director with SalomonBrothers Inc. and a member of the management board and co-head of SalomonBrothers AG for seven years. Mr. Beelitz received a degree in banking fromBethmann Schule and received a Certificat d’Etudes Francaises from theUniversite de Grenoble, France.

*DouglasM. Karp***(age 49) has been a Director since October 2002.Mr. Karp has been the Managing Partner and Co-Chief Executive Officer ofTailwind Capital Partners (and its predecessor Thomas Weisel Capital Partners)since April 2003. Mr. Karp was the Managing Partner of PacificPartners LLC, a private equity and advisory firm focused on communications,media and technology companies, from August 2000 until April 2003. Priorto joining Pacific Partners, Mr. Karp was a Managing Director and memberof the Operating Committee at E.M. Warburg Pincus & Co., LLC where hewas responsible for a private equity portfolio of approximately $14 billion andfocused on communications and media companies and financial restructurings fromMay 1991 to August 2000. Prior to joining Warburg, he served as aManaging Director of Mergers and Acquisitions at Salomon Brothers Inc. from October 1986to May 1991. In addition to the Company, Mr. Karp serves on the Boardof Directors of Primus Telecommunications Group, Inc. and several privatecompanies. Mr. Karp received a B.A. degree from Yale University and a J.D.from Harvard Law School.

*Class IIDirector*

*ThomasStrüngmann, Ph.D.*(age55) has served as the Company’s Chairman of the Board since September 1995.Dr. Strüngmann co-founded Hexal in 1986 and has served as its Co-ChiefExecutive Officer and Co-President since then. Dr. Strüngmann served asChief Executive Officer of Durachemie GmbH from April 1979 to May 1986.Dr. Strüngmann received a B.S. degree in economics from the University ofMunich and a Ph.D. from the University of Augsburg, Germany.

*Class IIIDirectors*

*Bernhard Hampl, Ph.D.*(age 55) has served as the Company’sChief Executive Officer since October 1995 and a Director since September 1995.In January 1996, Dr. Hampl became the Company’s President. From May 1995to October 1995, Dr. Hampl was employed by Hexal to evaluate thepossibility of establishing a U.S. subsidiary. From April 1980 until May 1995,Dr. Hampl held various positions with both Cyanamid GmbH and its businessunit Durachemie GmbH, including: Department Head of Research and Development, where he was responsiblefor research and development activities in Germany for the medical,agricultural and veterinary business of Cyanamid GmbH; Technical Director,where he was responsible for quality, manufacturing, logistics, research anddevelopment; and Plant Director. Dr. Hampl was significantly involved inan internal task force formed to restructure the European 

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operations of CyanamidGmbH. Dr. Hampl received his Bachelor’s Degree in Pharmaceutical Sciencesand a Ph.D. in Pharmaceutical Chemistry from Ludwig Maximillian University ofMunich.

*MarkR. Patterson***(age 53) has been a Director since October 2002.Mr. Patterson has served as the Chairman of MatlinPatterson AssetManagement LLC and MatlinPatterson Global Advisers LLC, which manages $3.8billion in distressed investment funds, since July 2002. From March 1994to July 2002, he was a Managing Director of Credit Suisse First BostonCorporation, and served as its Vice Chairman from 2000 to 2002. In addition tothe Company, Mr. Patterson is on the Board of Oxford Automotive, Inc.Mr. Patterson received degrees in law and economics from South Africa’sStellenbosch University and an MBA from New York University’s Stern School ofBusiness.

**BiographicalInformation for Non-Director Executive Officers and Other Members of SeniorManagement**

*William F. Holt*(age61) has served as the Company’s Vice President, Finance, Secretary, Treasurerand Chief Financial Officer since November 1995. Prior to joining theCompany, Mr. Holt was Chief Financial Officer for Pavion Limited and YorxInternational, Inc. and held a variety of financial positions withAmerican Cyanamid Company. Earlier, he was an audit manager with Coopers &Lybrand. Mr. Holt received a B.S. degree from Seton Hall University.

*Frank J. Della Fera, R.Ph.*(age47) has served as the Company’s Vice President, Sales and Marketing since October 1996.Prior to joining the Company, Mr. Della Fera held several positions in thefield of sales and marketing, including the position of Senior Regional SalesDirector for Dura Pharmaceuticals, Inc. from November 1990 to October 1996.Mr. Della Fera served in management and business development capacitiesfor Ben Venue Laboratories, Inc. and American Regent Laboratories Inc. Hebegan his career with Eli Lilly and Company as a field sales representative andwas promoted to Hospital Sales Specialist during his tenure. Mr. DellaFera received a B.S. degree in Pharmacy from the College of Pharmacy, St. John’sUniversity.

*Sadie M. Ciganek*(age54) has served as the Company’s Vice President, Regulatory Affairs since August 1995.From May 1993 to August 1995, Ms. Ciganek served as the Company’sDirector, Quality Assurance. Prior to joining the Company, Ms. Ciganekheld positions with American Cyanamid Company in the area of clinical supplies,including Manager, Global Clinical Supplies, from August 1982 to May 1993.Ms. Ciganek received a B.S. degree in chemistry from Slippery RockUniversity.

*Pranab K. Bhattacharyya, Ph.D.*(age66) has served as the Company’s Vice President, Quality Management andAnalytical Services since August 1996. From September 1995 to August 1996,Dr. Bhattacharyya served as the Company’s Vice President, QualityManagement. Dr. Bhattacharyya has over 25 years of experience in thepharmaceutical industry in quality control, compliance and regulatorysubmissions. Prior to joining the Company, Dr. Bhattacharyya was employedwith Hoffmann-LaRoche Inc. for 20 years, where he served in severalmanagerial positions in pharmaceutical research and quality control. Dr. Bhattacharyyareceived B.S. and M.S. degrees in Physics from Calcutta University, India and aPh.D. in Physical Chemistry from Columbia University.

*David H. Gransee*(age53) has served as the Company’s Controller and Assistant Secretary since itsinception in 1992. Prior to joining the Company, Mr. Gransee had over 15years of financial experience, including positions with Arthur Andersen &Co. as a Staff Auditor and with IC Industries. At IC Industries, Mr. Granseeheld positions in the Corporate Audit Department, as well as managementpositions with its multi-national subsidiary Abex Corporation. Mr. Granseereceived a B.S. degree in accounting from DePaul University.

*William B. Eversgerd*(age63) has served as one of the Company’s Vice Presidents since its inception in1992 and has served as the Company’s Vice President, Plant Facilities since December 1995.Prior to 

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joining the Company, Mr. Eversgerdhad over 20 years experience in various areas in the pharmaceutical industry.Mr. Eversgerd received a B.S. degree from Southern Illinois University.

*Jeffrey S. Bauer, Ph.D.*(age43) has served as the Company’s Vice President, Business Development since December 2001.Dr. Bauer served as Director, R&D/Strategic Development for IVAXPharmaceuticals, Inc. from January 2001 to December 2001. From November 1998to January 2001, he was Director, Technical Affairs for Zenith GoldlinePharmaceuticals, Inc. (a wholly owned subsidiary of IVAX Corporation).Dr. Bauer was Vice President, Active Pharmaceutical Ingredients for IVAXCorporation from 1997 to November 1998. Dr. Bauer held positions withApplied Analytical Industries, Inc. from January 1994 to December 1997,including most recently the position of Technical Director, New BusinessDevelopment. Dr. Bauer received a B.S. degree in Biology from TuftsUniversity, a M.S. degree in Forensic Toxicology from Duquesne University and aPh.D. in Pharmacology from the University of North Carolina at Chapel Hill.

*Leon Shargel, Ph.D., R.Ph.*(age 63) has served as the Company’sVice President, Biopharmaceutics since April 2001. Dr. Shargel hasbeen an Adjunct Associate Professor in the Department of PharmaceuticalSciences at the University of Maryland since July 1995. Prior to joiningthe Company, Dr. Shargel was Vice President and Technical Director withthe National Association of Pharmaceutical Manufacturers from November 1997to April 2001. From April 1996 to November 1997, Dr. Shargelwas Senior Research Pharmacist at Johns Hopkins Bayview Medical Center.Dr. Shargel has written over 100 publications, including severaltextbooks in pharmacy. Dr. Shargel received a B.S. in Pharmacy from theUniversity of Maryland and a Ph.D. degree in Pharmacology from the GeorgeWashington University Medical Center.

*Rathnam Kumar* (age 53) has served as the Company’sVice President, Manufacturing since August 2002. Mr. Kumar served asthe Company’s Director of Manufacturing and Validations from September 2000to August 2002, as the Company’s Director of Formulations and ProcessDevelopment from August 1996 to March 1999 and as the Company’sManager of New Technologies from April 1995 to August 1996. From April 1999to September 2000, he was Vice President of Research and Development withAble Laboratories, Inc. Mr. Kumar received a B.S. degree in Chemistryfrom the University of Bombay in India.

*ShashankUpadhye* (age35) has served as the Company’s Vice President, Intellectual Property Counselsince September 2004. Prior to joining the Company, Mr. Upadhye wasassociated with Lord, Bissell & Brook from June 2003 to August 2004,where he had extensive involvement in Hatch Waxman proceedings for patent andregulatory litigation and served as the primary appellate brief writer for twoSupreme Court and three Federal Circuit cases. From May 2000 to June 2003,Mr. Upadhye was associated with Sonnenschein, Nath & Rosenthalwhere he served as a brief writer in three Federal Circuit cases with extensiveinvolvement in ANDA generic drug patent infringement cases. From August 1998to April 2000, he served as the Patent and Trademark Counsel to Cook Group, Inc.Mr. Upadhye was an Adjunct Professor of Patent Law at Purdue University inthe latter half of 1999. Mr. Upadhye was Co-Editor of the Patent LawJournal (Aspen Law Press) and has eight full-length law review articles and onenewspaper article published. Mr. Upadhye received B.S. and B.A. degreesfrom Brock University of Ontario, Canada, a J.D. from the New England School ofLaw and a L.L.M. degree in Intellectual Property from The John Marshall LawSchool.

**Audit Committee**

Messrs. Karp and Patterson comprise the Company’sAudit Committee, both of whom are independent of the Company and itsmanagement, as defined by the applicable listing standards of the NASD and thestandards set forth by the SEC. The Board has determined that both members ofthe Audit Committee are audit committee financial experts, as defined byapplicable SEC guidelines, having attained 

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such expertise through theeducation and experience discussed in the respective member’s biographicalinformation under “Biographical Information for Directors.”  Mr. Beelitz was a member of the AuditCommittee until he resigned his position, effective as of March 11, 2005. OnMarch 15, 2005, the Company provided notice to NASDAQ that it was not incompliance with the requirement under NASD listing standards that listedcompanies maintain an audit committee of at least three members. Under thesestandards, the Company has until the earlier of its next annual stockholdermeeting or March 11, 2006 to comply with NASD audit committeerequirements.

The Audit Committee isempowered to exercise all powers and authority of the Board with respect to theCompany’s annual audit, accounting policies, financial reporting, transactionswith affiliates and internal control over financial reporting. In February 2004,the Board restated the Audit Committee’s charter. The charter specifies thescope of the Audit Committee’s responsibilities and how it carries out thoseresponsibilities. A copy of the restated charter is attached as Appendix A tothe Company’s annual proxy statement for its 2004 Annual Meeting ofStockholders.

**Section 16(a) BeneficialOwnership Reporting Compliance**

Section 16(a) of the Exchange Act, asamended, requires the Company’s directors and executive officers, and personswho own more than 10% of a registered class of the Company’s equity securities,to file with the SEC initial reports of ownership and reports of changes inownership of common stock and other equity securities of the Company. Executiveofficers, directors and greater-than-10% stockholders are required by SECregulations to furnish the Company with copies of all Section 16(a) formsthey file.

During the year ended December 31,2004, three Forms 4 were filed in an untimely manner on behalf of Frank F.Beelitz, relating to six transactions in Common Stock or options to purchaseCommon Stock. To the Company’s knowledge, based solely on a review of thecopies of such reports furnished to the Company or written representations thatany such reports were timely filed****orthat no such reports were required, during the year ended December 31,2004, all other Section 16(a) filing requirements applicable to itsexecutive officers, directors, and greater-than-10% beneficial ownerswere satisfied.

**Code of Conduct**

The Company has adopted aCode of Conduct, as defined under SEC rules, which is applicable to all of itsdirectors, officers and employees. The Code of Conduct can be found on theCompany’s web site at *www.eonlabs.com*.

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**Item 11**.                 ExecutiveCompensation.

**SummaryCompensation Table**

Thefollowing table sets forth summary information concerning the totalcompensation awarded to or earned by the Company’s chief executive officer andeach of the Company’s four other most highly compensated executive officerswhose total annual salary and bonus exceeded $100,000 (referred to herein as“Named Executive Officers”) in the years ended December 31, 2004, 2003 and2002.
|                                                | ** ** | ** ** | ** ** | ** **                                   | ** ** | **Long-Term**             | ** ** |
|------------------------------------------------|------------|------------|------------|----------------------------------------------|------------|---------------------------|------------|
| ** **                                     | ** ** | ** ** | ** ** | **Annual Compensation**                 | ** ** | **Compensation**          | ** ** |
| **Name and Principal Position** | ** ** | ** ** | ** ** | **   Year   ** | ** ** | **Paid Salary  ($)** | ** ** | **Bonus Earned  (Paid in   Subsequent Year)  ($)** | ** ** | **All Other  Compensation  ($)(1)** | ** ** | **Securities  Underlying  Options / SARs  (#)** | ** ** |
| Bernhard Hampl, Ph.D.,                         |       |       | 2004       |                                         |       |                      | 330,750    |   |   |   | 1,000,000 |   |   |   | 6,150 |   |   |   | 150,000 |   |   |
| President and Chief Executive Officer          |       |       | 2003       |                                         |       |                      | 313,343    |   |   |   | 1,250,000 |   |   |   | 6,000 |   |   |   | 65,000 |   |   |
|                                                |       |       | 2002       |                                         |       |                      | 298,154    |   |   |   | 1,000,000 |   |   |   | 5,500 |   |   |   | 60,000 |   |   |
| William F. Holt,                               |       |       | 2004       |                                         |       |                      | 211,996    |   |   |   | 290,000 |   |   |   | 6,150 |   |   |   | 60,000 |   |   |
| VP, Finance, Secretary, Treasurer and          |       |       | 2003       |                                         |       |                      | 199,190    |   |   |   | 350,000 |   |   |   | 6,000 |   |   |   | 40,000 |   |   |
| Chief Financial Officer                        |       |       | 2002       |                                         |       |                      | 177,077    |   |   |   | 330,000 |   |   |   | 5,500 |   |   |   | 35,000 |   |   |
| Frank J. Della Fera, R.Ph.,                    |       |       | 2004       |                                         |       |                      | 211,364    |   |   |   | 210,000 |   |   |   | 6,150 |   |   |   | 40,000 |   |   |
| Vice President, Sales and Marketing            |       |       | 2003       |                                         |       |                      | 200,930    |   |   |   | 200,000 |   |   |   | 6,000 |   |   |   | 40,000 |   |   |
|                                                |       |       | 2002       |                                         |       |                      | 181,962    |   |   |   | 185,000 |   |   |   | 5,500 |   |   |   | 35,000 |   |   |
| Jeffrey S. Bauer, Ph.D.,                       |       |       | 2004       |                                         |       |                      | 187,425    |   |   |   | 162,000 |   |   |   | 6,150 |   |   |   | 50,000 |   |   |
| Vice President, Business Development           |       |       | 2003       |                                         |       |                      | 177,520    |   |   |   | 190,000 |   |   |   | 6,000 |   |   |   | 25,000 |   |   |
|                                           |       |       | 2002       |                                         |       |                      | 169,424    |   |   |   | 70,000 |   |   |   | 25,500 | (2) |   |   | 50,000 |   |   |
| Sadie M. Ciganek,                              |       |       | 2004       |                                         |       |                      | 188,017    |   |   |   | 129,000 |   |   |   | 6,150 |   |   |   | 20,000 |   |   |
| Vice President, Regulatory Affairs             |       |       | 2003       |                                         |       |                      | 179,887    |   |   |   | 75,000 |   |   |   | 6,000 |   |   |   | 25,000 |   |   |
|                                                |       |       | 2002       |                                         |       |                      | 153,500    |   |   |   | 70,000 |   |   |   | 4,581 |   |   |   | 20,000 |   |   |
|                                                |            |            |            |                                              |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Consists ofcontributions to the Named Executive Officer’s 401(k) account.

(2)          Consistsof relocation reimbursement expenses.

**Stock Option GrantsTable**

Thefollowing table sets forth certain information concerning individual grants ofoptions to purchase Common Stock made to the Named Executive Officers during2004. These figures do not represent the Company’s estimate or projection offuture Common Stock prices.
| ** **                  | ** ** | **Stock Option Grants in 2004** | ** ** | ** **          | ** ** |
|-----------------------------|------------|-----------------------------------------------------|------------|---------------------|------------|
| ** **                  | ** ** | **Individual Grants**                          | ** ** | ** **          | ** ** |
| ** **                  | ** ** | ** **                                          | ** ** | **Percentage**      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Number of**                                  | ** ** | **of Total**   | ** ** | ** ** | ** ** | ** ** | ** ** | **Potential Realizable Value at** | ** ** |
| ** **                  | ** ** | **Securities**                                      | ** ** | **Options**         | ** ** | ** ** | ** ** | ** ** | ** ** | **Assumed Annual Rates of Stock ** | ** ** |
| ** **                  | ** ** | **Underlying**                                      | ** ** | **Granted to** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Price Appreciation for** | ** ** |
| ** **                  | ** ** | **Options**                                         | ** ** | **Employees**       | ** ** | **Price Per** | ** ** | ** ** | ** ** | **Option Term ($)** | ** ** |
| **Name**                    | ** ** | ** **                                          | ** ** | **Granted**         | ** ** | **in 2004(%)** | ** ** | **Share ($)** | ** ** | **Expiration Date** | ** ** | **          5**%           | ** ** | **          10**%           | ** ** |
| Bernhard Hampl,  Ph.D.      |       |                                                | 150,000    |                |       |   | 29.4118 |   |   |   | 29.32 |   |   |   | 2/23/2014 |   |   |   | 2,764,921 |   |   |   | 7,006,301 |   |   |
| William F. Holt             |       |                                                | 60,000     |                |       |   | 11.7647 |   |   |   | 29.32 |   |   |   | 2/23/2014 |   |   |   | 1,105,968 |   |   |   | 2,802,520 |   |   |
| Frank J. Della  Fera, R.Ph. |       |                                                | 40,000     |                |       |   | 7.8431 |   |   |   | 29.32 |   |   |   | 2/23/2014 |   |   |   | 737,312 |   |   |   | 1,868,347 |   |   |
| Jeffrey S. Bauer,  Ph.D.    |       |                                                | 50,000     |                |       |   | 9.8039 |   |   |   | 29.32 |   |   |   | 2/23/2014 |   |   |   | 921,640 |   |   |   | 2,335,434 |   |   |
| Sadie M. Ciganek            |       |                                                | 20,000     |                |       |   | 3.9216 |   |   |   | 29.32 |   |   |   | 2/23/2014 |   |   |   | 368,656 |   |   |   | 934,173 |   |   |
|                             |            |                                                     |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Aggregate StockOption Exercise Table**

Thefollowing table sets forth information regarding the exercise of options by theNamed Executive Officers during 2004. The table also shows the number and valueof unexercised options held by the Named Executive Officers as of December 31,2004. The values of unexercised options are based on a fair market value of$27.00 per share of Common Stock on December 31, 2004.
| ** **                  | ** ** | ** **             | ** ** | ** **            | ** ** | **Number of Securities **  | ** ** | **Value of Unexercised **    | ** ** |
|-----------------------------|------------|------------------------|------------|-----------------------|------------|-------------------------------------------|------------|---------------------------------------------|------------|
| ** **                  | ** ** | **Shares  ** | ** ** | **Value **       | ** ** | **Underlying Options at ** | ** ** | **In-The-Money Options at ** | ** ** |
| ** **                  | ** ** | **Acquired on**   | ** ** | **Realized**          | ** ** | **December 31, 2004(#)**        | ** ** | **December 31, 2004($)(2)**       | ** ** |
| **Name**                    | ** ** | ** **             | ** ** | **Exercise (#)** | ** ** | **(#)(1)**                                | ** ** | **Exercisable**                             | ** ** | **Unexercisable** | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Bernhard Hampl,  Ph.D.      |       |                   | 230,000    |                  |       | 7,042,653                                 |       | 1,121,000                                   |       |   | 326,000 |   |   | 28,611,732 |   |   | 2,274,480 |   |   |
| William F. Holt             |       |                   | 100,000    |                  |       | 2,888,350                                 |       | 495,000                                     |       |   | 166,000 |   |   | 12,520,814 |   |   | 1,358,430 |   |   |
| Frank J. Della  Fera, R.Ph. |       |                   | 84,000     |                  |       | 2,488,360                                 |       | 160,000                                     |       |   | 146,000 |   |   | 3,662,620 |   |   | 1,358,430 |   |   |
| Jeffrey S. Bauer,  Ph.D.    |       |                   | 20,000     |                  |       | 397,026                                   |       | 30,000                                      |       |   | 150,000 |   |   | 440,350 |   |   | 1,416,000 |   |   |
| Sadie M. Ciganek            |       |                   | 10,800     |                  |       | 393,863                                   |       | 36,800                                      |       |   | 84,000 |   |   | 661,210 |   |   | 808,800 |   |   |
|                             |            |                        |            |                       |            |                                           |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          The values realized arebased on the fair market value of Common Stock on the date of exercise less theoption exercise price.

(2)          Thevalues are based on the fair market value of Common Stock on December 31,2004, less the applicable option exercise price.

**DirectorCompensation**

Directors who are notemployed by the Company receive $4,000 for each Board meeting attended and$2,500 for each committee meeting held on a date different than a Board meeting.The Company also reimburses directors for reasonable expenses in connectionwith attending Company Board and committee meetings. The Company may, in itsdiscretion, grant stock options and other equity awards to non-employeedirectors from time to time pursuant to stock incentive plans. Additionally, Messrs. Karpand Patterson, who comprise the Special Committee of the Board formed inconnection with the Offer, the Merger and the Merger Agreement, are eachentitled to $45,000 for their service on such committee, in addition toreceiving $2,500 per meeting thereof.

**CompensationCommittee Interlocks and Insider Participation**

The CompensationCommittee, which is responsible for the compensation policies of the Companywith respect to its executive officers, was comprised during the year ended December 31,2004 of Drs. Strüngmann and Hampl and Messrs. Karp and Patterson.Dr. Hampl is the Company’s President and Chief Executive Officer.Dr. Strüngmann is the Co-Chief Executive Officer and Co-President of Hexal.See “Item 13. Certain Relationships and Related Transactions” for informationregarding certain transactions between the Company and Dr. Strüngmann. Becausethe Company is a controlled Company, it is exempt from the requirement underNASD rules that its Compensation Committee be composed solely ofindependent directors. None of these individuals serves as a member of theboard of directors or on the compensation committee of any company that hasanother individual who is an executive officer serving on the Board or itsCompensation Committee.

**EmploymentAgreements with CEO and Other Named Executive Officers**

As of February 11, 2005, the Company entered intoamended and restated employment agreements with Bernhard Hampl, Ph.D., WilliamF. Holt and Jeffrey S. Bauer, Ph.D. and an employment agreement with Frank J.Della Fera. Pursuant to the respective terms of these agreements:  Dr. Hampl, serves as the President, ChiefExecutive Officer and Director of the Company; Mr. Holt serves as the VicePresident Finance, Secretary, Treasurer and Chief Financial Officer of theCompany; Dr. Bauer serves as the 

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Vice President,Business Development of the Company; and Mr. Della Fera serves as the VicePresident, Sales and Marketing of the Company. Dr. Hampl’s, Mr. Holt’s,Dr. Bauer’s and Mr. Della Fera’s annual base salaries as of February 2,2004 were $330,750, $211,996, $187,425 and $211,364, respectively. Each currentemployment agreement provides the Board with the discretion to increase suchamounts. Each of these agreements provide for a three-year term of employmentcommencing on February 11, 2005.

Notwithstanding the employment term described above,each of the aforementioned executives’ employment will end on the earlier tooccur of:  (i) a termination oftheir employment due to death or disability; (ii) a termination by theCompany with or without cause; or (iii) a termination by the executivewith or without good reason.

Upon any termination of employment, Dr. Hampl, Mr. Holt,Dr. Bauer and Mr. Della Fera are each entitled to all amounts accruedbut unpaid through the date of termination with respect to salary, any unpaidbonus for the fiscal year that ended prior to the date of termination and anyaccrued but unused vacation days and unreimbursed expenses.

In addition to the payments in the previous paragraph,prior to a change in control, upon a termination of employment by the Companywithout cause or by the executive for good reason, Dr. Hampl, Mr. Holt,Dr. Bauer and Mr. Della Fera are each entitled to:  (i) an amount equal to 12 months’ salary(less any applicable withholding or similar taxes) at the rate in effect on thedate of such termination, such amount to be payable in substantially equalmonthly installments from the date of such termination through the date twomonths from end of the Company’s fiscal year following the year of suchtermination (the “Severance Term”); (ii) an aggregate amount equal to thebonus payable or paid to the executive in respect of the completed fiscal yearwhich has ended prior to the date of termination, payable in substantiallyequal monthly installments during the Severance Term; (iii) a lump-sumpayment equal to 12 times the monthly cost of health continuation coverage forthe executive and his dependents, as provided under COBRA and as determined onthe date of termination; and (iv) vesting of all options that would haveotherwise vested in the 12 months after such termination assuming notermination has occurred.

If such termination by the Company without cause or byDr. Hampl, Mr. Holt, Dr. Bauer or Mr. Della Fera with goodreason occurs in connection with, or following, a change in control, in lieu ofthe aforementioned amounts, the executives are each entitled to:  (i) a lump-sum payment equal to twotimes (a) current annual base salary and (b) the bonus received theyear prior to such termination; (ii) a lump-sum payment equal to 24times the monthly cost of health benefits; and (iii) immediate vesting ofall outstanding options. Good reason is defined to include delivery by theexecutive of written notice of resignation at any time and for any reasonduring the period commencing on the nine-month anniversary of a change incontrol and ending on the 11-month anniversary of such change in control.Dr. Hampl, Mr. Holt, Dr. Bauer and Mr. Della Fera are alsoentitled to full 280G gross-up protection such that they will receiveadditional gross-up payments to make them whole in the event that taxes areimposed under Section 4999 of the Internal Revenue Code of 1986, asamended.

Dr. Hampl’s, Mr. Holt’s, Dr. Bauer’sand Mr. Della Fera’s agreements also contain one- year non-competition andnon-solicitation provisions following a termination of employment.

Additionally, on February 11, 2005, the Companyentered into an amended and restated employment agreement with Sadie M. Ciganek.Pursuant to the terms of the amended and restated employment agreement, Ms. Ciganekserves as the Vice President, Regulatory Affairs of the Company. Ms. Ciganek’sannual base salary as of February 2, 2004 was $188,017 and her currentemployment agreement provides the Board with the discretion to increase suchamount. Ms. Ciganek’s agreement has a three-year term commencing on February 11,2005.

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Notwithstanding theemployment term described above, Ms. Ciganek’s employment will end on theearlier to occur of: (i) a termination of her employment due to death ordisability; or (ii) a termination by the Company with or without cause.

Upon any termination ofemployment, Ms. Ciganek is entitled to all amounts accrued but unpaidthrough the date of termination with respect to salary, any unpaid bonus forthe fiscal year that ended prior to the date of termination and any accrued butunused vacation days and unreimbursed expenses.

In addition to thepayments in the previous paragraph, upon a termination of employment by theCompany without cause prior to a change in control, Ms. Ciganek isentitled to: (i) an amount equal to 12 months salary (less any applicablewithholding or similar taxes) at the rate in effect on the date of suchtermination, such amount to be payable in substantially equal monthlyinstallments from the date of such termination through the Severance Term; (ii) anaggregate amount equal to the bonus payable or paid to Ms. Ciganek inrespect of the completed fiscal year which has ended prior to the date oftermination, payable in substantially equal monthly installments during theSeverance Term; (iii) a lump-sum payment equal to 12 times the monthlycost of health continuation coverage for Ms. Ciganek and her dependents,as provided under COBRA and as determined on the date of termination; and (iv) immediatevesting of all options that would have vested in the 12 months after suchtermination.

Upon a termination ofemployment by the Company without cause following a change in control, in lieuof the aforementioned amounts, Ms. Ciganek is entitled to:  (i) a lump-sum payment equal to twotimes (a) current annual salary and (b) the bonus received the yearprior to such termination; (ii) a lump-sum payment equal to 24 times themonthly cost of health benefits; and (iii) immediate vesting of alloutstanding options.

Ms. Ciganek’sagreement also contains one-year non-competition and non-solicitationprovisions following a termination of employment.

**Item 12**.                 SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters.

See “Market for Registrant’s Common Equity, RelatedStockholder Matters and Issues Purchases of Equity Securities” for informationregarding securities authorized for issuance under equity compensation plans.

The following tablesets forth certain information known to the Company regarding the beneficialownership of Common Stock as of March 11, 2005 for:

·       eachperson known by the Company to beneficially own more than 5% of Common Stock;

·       eachof the Company’s directors;

·       NamedExecutive Officers; and

·       allof the Company’s directors and executive officers as a group.

Beneficial ownership isdetermined in accordance with the rules of the SEC and generally includesvoting or investment power with respect to securities. In computing the numberof shares beneficially owned by a person and the percentage ownership of thatperson, shares of Common Stock that could be issued upon the exercise ofoutstanding options held by that person that are currently exercisable orexercisable within 60 days of March 11, 2005 are considered outstanding. Theseshares, however, are not considered outstanding when computing the percentageownership of each other person.

Except as indicated in the footnotes to this table andpursuant to state community property laws, each stockholder named in the tablehas sole voting and investment power for the shares shown as beneficially ownedby them. Percentage of ownership is based on 88,850,364 shares of Common Stockoutstanding on March 11, 2005.

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**Numberof Shares Beneficially Owned on March 11, 2005**
| **Name of Beneficial Owner**                                                 | ** ** | ** ** | ** ** | **Shares of   Common Stock   Beneficially   Owned (#)** | ** ** | **Percentage of   Common Stock   Beneficially   Owned (%)** | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------|------------|----------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| **Stockholders Owning  Approximately 5% or More**                                           |       |       |       |                                                                             |       |                                                                                 |       |   |   |
| Santo Holding (Deutschland) GmbH  Konigstrasse la  70173 Stuttgart, Germany                 |       |       | 60,000,000 |                                                                             |       |                                                                                 | 67.5       |   |   |
| Thomas Strüngmann, Ph.D.(1)  Industriestrasse 25, 83607  Holzkirchen, Germany          |       |       | 60,137,122 |                                                                             |       |                                                                                 | 67.7       |   |   |
| Andreas Strüngmann, M.D.(2)  Industriestrasse 25, 83607  Holzkirchen, Germany          |       |       | 60,137,122 |                                                                             |       |                                                                                 | 67.7       |   |   |
| **Current  Directors and Named Executive Officers(3)**                                      |       |       |       |                                                                             |       |                                                                                 |       |   |   |
| Bernhard Hampl, Ph.D.(4), (5)                                                               |       |       | 1,151,000  |                                                                             |       |                                                                                 | 1.3        |   |   |
| Thomas  Strüngmann, Ph.D.(1)                                                           |       |       | 60,137,122 |                                                                             |       |                                                                                 | 67.7       |   |   |
| William F.  Holt(4), (5)                                                                    |       |       | 507,000    |                                                                             |       |                                                                                 | *          |   |   |
| Frank J. Della Fera,  R.Ph.(4), (5)                                                         |       |       | 168,000    |                                                                             |       |                                                                                 | *          |   |   |
| Jeffrey S. Bauer,  Ph.D.(4), (5)                                                            |       |       | 40,000     |                                                                             |       |                                                                                 | *          |   |   |
| Sadie M. Ciganek(4),  (5)                                                                   |       |       | 40,800     |                                                                             |       |                                                                                 | *          |   |   |
| Frank F. Beelitz(4),  (5)                                                                   |       |       | 48,000     |                                                                             |       |                                                                                 | *          |   |   |
| Douglas M.  Karp(4), (5)                                                                    |       |       | 48,000     |                                                                             |       |                                                                                 |       |   |   |
| Mark R.  Patterson(4), (5), (6)                                                             |       |       | 71,000     |                                                                             |       |                                                                                 | *          |   |   |
| All of the Company’s  current executive officers and directors as a group (15 persons) |       |       | 62,350,022 |                                                                             |       |                                                                                 | 70.2       |   |   |

----

*                    Representsbeneficial ownership of less than one percent of Common Stock.

(1)          Includes 60,000,000 sharesheld by Santo and 137,122 shares held by Hexal. By virtue of his control ofSanto and Hexal, Thomas Strüngmann, Ph.D. may be deemed to be a beneficialowner of all shares held by Santo and Hexal. Dr. Thomas Strüngmanndisclaims beneficial ownership of these shares.

(2)          Includes 60,000,000shares held by Santo and 137,122 shares held by Hexal. By virtue of his controlof Santo and Hexal, Andreas Strüngmann, M.D. may be deemed to be a beneficialowner of all shares held by Santo and Hexal. Dr. Andreas Strüngmanndisclaims beneficial ownership of these shares.

(3)          Unless otherwiseindicated, the address of each director and named executive officer is c/o EonLabs, Inc., 1999 Marcus Avenue, Lake Success, New York 11042.

(4)          Includes shares ofCommon Stock issuable upon exercise of options granted under the Company’s 2001Stock Option Plan that are vested and exercisable within 60 days of March 11,2005.

(5)          Includes shares ofCommon Stock issuable upon exercise of options granted under the Company’s 2003Stock Incentive Plan that are vested and exercisable within 60 days of March 11,2005.

(6)          Includes23,000 shares Mr. Patterson purchased on the open market.

54

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**Changes in Control**

On February 20, 2005,the Company entered into the Merger Agreement with Novartis, Merger Sub, and,solely with respect to its guarantee of Novartis’s and Merger Sub’s obligationsthereunder, Parent. For additional detail regarding the Merger Agreement andrelated transactions, see “Item 7. Management’s Discussion and Analysis of FinancialCondition and Results of Operation.”

**Item 13**.                 CertainRelationships and Related Transactions.

Prior to the reorganizational mergers described below,Santo owned 100% of the outstanding capital stock of HPI. Santo is under commoncontrol with Hexal, the second largest generic pharmaceutical company inGermany. The Company is a party to joint development and technology agreementswith Hexal. In September 1995, HPI acquired 50% of the Company’soutstanding capital stock. In December 2000, HPI indirectly acquired theremaining 50% of the Company’s outstanding capital stock through itsacquisition of 100% of the outstanding capital stock of EHI. On May 21,2002, the Company was combined with HPI and EHI into a single entity through aseries of reorganizational mergers. As a result, Santo owns a majority of theoutstanding Common Stock.

Thomas Strüngmann, Ph.D.,the Chairman of the Board of the Company and the Co-Chief Executive Officer andCo-President of Hexal, is an indirect significant stockholder and director ofSanto, a privately held entity that owns 60,000,000 shares of Common Stock,representing approximately 67.5% of the Company’s outstanding capital stock.Dr. Strüngmann is an indirect significant stockholder and member of theboard of directors of Hexal, a privately held entity, which owns 137,122 sharesof Common Stock, representing ownership of approximately 0.15% of the Company’soutstanding capital stock. Therefore, Dr. Strüngmann may be deemed to bethe beneficial owner of 60,137,122 shares of Common Stock, representingownership of approximately 67.7% of the Company’s outstanding capital stock.Dr. Strüngmann disclaims beneficial ownership of these shares.

***Transactions between Eon Labs, Inc. and Hexal***

In 2004, the Company had net sales of $2.2 million ofproducts to subsidiaries of Hexal. The Company purchased products and suppliesfrom Hexal and its subsidiaries in the aggregate of $2.1 million in 2004.

The Company has an agreement with Hexal regardingCyclosporine. Pursuant to that agreement, the Company has been granted anexclusive and perpetual license to use patented technology from Hexal and paysHexal a royalty on its sales of Cyclosporine, which was developed using thatlicensed technology. Pursuant to that agreement’s royalty arrangement, theCompany expensed $3.2 million in 2004.

In March 2003, the Company memorialized itsagreement with Hexal regarding the sale of Cyclosporine products to a thirdparty. Pursuant to that agreement the Company has been granted an exclusivelicense to use patented technology from Hexal to sell Cyclosporine to the thirdparty outside of the United States, which was developed using that licensedtechnology. The Company makes royalty payments to Hexal on such sales asdescribed above. The Company also sells the active pharmaceutical ingredientcyclosporine to the third party and retains an administrative fee from suchsales, forwarding the remainder to Hexal. Pursuant to this agreement, theCompany was obligated to forward $0.6 million to Hexal in connection with suchsales made in 2004.

In March 2002, the Company entered into afive-year technology agreement with Hexal. Pursuant to that agreement, Hexalcooperates with the Company with respect to the development, manufacture andsale in the United States of, and the sharing of certain information relatingto, certain generic pharmaceutical products that Hexal develops. At the Company’srequest, it has the right of first refusal to purchase or license from Hexal,at a fair and reasonable price, the U.S. sales and marketing rights withrespect to any generic pharmaceutical products that Hexal develops. The Companyhas entered into 

55

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several underlying productagreements for the rights to several products. The Company expensed $1.0million in 2004 as provided in the underlying agreements.

During 2004, Hexal incurred certain miscellaneousexpenses on behalf of the Company totaling $0.1 million. The Company reimbursedHexal accordingly. Also during 2004, the Company incurred miscellaneousexpenses on behalf of Hexal and Santo of $0.6 million and $0.1 million,respectively. The Company has been reimbursed from Hexal and Santo for theseexpenditures.

It is the Company’scurrent policy that all transactions or series of transactions with officers,directors, 5% stockholders and their affiliates in which the amount exceeds$60,000 be entered into only if they are approved by the Audit Committee, areon terms no less favorable to the Company than could be obtained fromunaffiliated parties and are reasonably expected to benefit the Company.

**Item 14**.                 PrincipalAccountant Fees and Services.

**IndependentRegistered Public Accounting Firm Fees**

***Audit Fees***

Fees for the 2004 and 2003annual audit and the reviews of the 2004 and 2003 Forms 10-Q were $843,560 (ofwhich an aggregate of $393,560 was billed through December 31, 2004) and$568,308, respectively. The increase in audit fees is due to compliancerequirements related to the Sarbanes-Oxley Act of 2002.

***Audit-related Fees***

Audit-related fees for the calendar year 2004 were$365,758, which consisted of billing for services provided primarily related toassistance in connection with the implementation of Rule 404 of theSarbanes-Oxley Act of 2002 (relating to internal control over financialreporting) and the audit of the Company’s Savings Incentive Plan.

Audit-related fees for thecalendar year 2003 were $26,875, which consisted of the audit of the Company’sSavings Incentive Plan.

***Tax Fees***

During 2004 and 2003, PwCbilled the Company an aggregate of $360,028 and $393,280, respectively, in taxfees, which related primarily to assistance with the preparation of returns andtax consultations.

***All Other Fees***

During 2004 and 2003, PwC did not bill the Company forother fees.

All of the above serviceswere approved by the Company’s Audit Committee.

**PART IV**

**Item 15**.                 Exhibitsand Financial Statement Schedules.

Documents filed as part of this Form 10-K.

(1)         Financial Statements: Seepage F-1 of this Form 10-K, which includes an index to theconsolidated financial statements.

(2)         Financial StatementSchedules: None.

56

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(3)         Exhibits
| Exhibit No. | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | **Description** |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 2.1              |       | Agreement and Plan of  Merger, dated as of February 20, 2005, by and among Novartis Corporation,  Zodnas Acquisition Corp., Eon Labs, Inc. and for purposes of Section 10.12  thereof only, Novartis AG, was filed as Exhibit 2.1 to the Company’s  current report on Form 8-K, filed on February 22, 2005 and is  incorporated herein by reference.                                                |
| 3.1              |       | Restated Certificate of  Incorporation of Eon Labs, Inc. was filed as Exhibit 3.1 to the  Company’s June 30, 2002 Form 10-Q and is incorporated herein by  reference.                                                                                                                                                                                                                                    |
| 3.2              |       | Certificate of Amendment  to the Restated Certificate of Incorporation of Eon Labs, Inc. was filed  as Exhibit 3.1 to the Company’s June 30, 2004 Form 10-Q and is  incorporated herein by reference.                                                                                                                                                                                                    |
| 3.3              |       | Restated Bylaws of Eon Labs, Inc. was filed as  Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the  year ended December 31, 2002 and is incorporated herein by reference.                                                                                                                                                                                                                   |
| 4.1              |       | Form of Stock Certificate was filed as  Exhibit 4.1 to the Company’s Registration Statement on Form S-1/A  (Reg. No. 333-83638), filed on May 6, 2002 and is incorporated  herein by reference.                                                                                                                                                                                                     |
| 10.1             |       | Technology Agreement, dated as of March 20,  2002, by and between Hexal AG and Eon Labs, Inc. was filed as  Exhibit 10.4 to the Company’s Registration Statement on Form S-1/A  (Reg. No. 333-83638), filed on April 5, 2002 and is incorporated  herein by reference.                                                                                                                         |
| 10.2             |       | Amended and Restated Credit Agreement, dated as of  July 30, 2004, by and among Eon Labs, Inc., Eon Pharma, LLC and  JPMorgan Chase Bank was filed as Exhibit 10.1 to the Company’s  September 30, 2004 Form 10-Q and is incorporated herein by  reference.                                                                                                                                         |
| 10.3             |       | Eon Labs, Inc. Stock Option Plan was filed as  Exhibit 10.8 to the Company’s Registration Statement on Form S-1/A  (Reg. No. 333-83638), filed on March 1, 2002 and is incorporated  herein by reference.                                                                                                                                                                                           |
| 10.4             |       | Agreement, effective as of November 10, 2002,  by and between Eon Labs, Inc. and the Drug, Chemical, Cosmetic, Plastics  and Affiliated Industries Warehouse Employees Local 815, Affiliated with the  International Brotherhood of Teamsters was filed as Exhibit 10.9 to the  Company’s Annual Report on Form 10-K for the year ended  December 31, 2002 and is incorporated herein by reference. |
| 10.5             |       | Product Royalty Agreement, dated as of  March 20, 2002 between Hexal AG and Eon Labs, Inc. was filed as  Exhibit 10.11 to the Company’s Registration Statement on Form S-1/A  (Reg. No. 333-83638) filed on April 5, 2002 and is incorporated  herein by reference.                                                                                                                            |
| 10.6             |       | Joint Development Agreement, dated as of  March 20, 2002, between Hexal AG and Eon Labs, Inc. was filed as  Exhibit 10.12 to the Company’s Registration Statement on Form S-1/A  (Reg. No. 333-83638), filed on April 5, 2002 and is incorporated  herein by reference.                                                                                                                        |
| 10.7             |       | Amended and Restated Employment Agreement, dated as  of February 11, 2005, by and between Eon Labs, Inc. and Bernhard Hampl  was filed as Exhibit 10.1 to the Company’s current report on  Form 8-K, filed on February 17, 2005 and is incorporated herein by  reference.                                                                                                                                |
| 10.8             |       | Amended and Restated Employment Agreement, dated as  of February 11, 2005, by and between Eon Labs, Inc. and Jeffrey S.  Bauer was filed as Exhibit 10.2 to the Company’s current report on  Form 8-K, filed on February 17, 2005 and is incorporated herein by  reference.                                                                                                                         |

57

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| 10.9  |   | Amended and  Restated Employment Agreement, dated as of February 11, 2005, by and between  Eon Labs, Inc. and Pranab K. Bhattacharyya was filed as  Exhibit 10.3 to the Company’s current report on Form 8-K, filed on  February 17, 2005 and is incorporated herein by reference.                                                               |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.10 |   | Amended and Restated  Employment Agreement, dated as of February 11, 2005, by and between Eon  Labs, Inc. and Sadie M. Ciganek was filed as Exhibit 10.4 to  the Company’s current report on Form 8-K, filed on February 17,  2005 and is incorporated herein by reference.                                                                      |
| 10.11 |   | Employment Agreement, dated as of February 11, 2005,  by and between Eon Labs, Inc. and Frank J. Della Fera was filed as  Exhibit 10.5 to the Company’s current report on Form 8-K, filed on  February 17, 2005 and is incorporated herein by reference.                                                                                              |
| 10.12 |   | Amended and Restated Employment Agreement, dated as  of February 11, 2005, by and between Eon Labs, Inc. and William B.  Eversgerd was filed as Exhibit 10.6 to the Company’s current report on  Form 8-K, filed on February 17, 2005 and is incorporated herein by  reference.                                                                  |
| 10.13 |   | Amended and Restated Employment Agreement, dated as  of February 11, 2005, by and between Eon Labs, Inc. and David H.  Gransee was filed as Exhibit 10.7 to the Company’s current report on  Form 8-K, filed on February 17, 2005 and is incorporated herein by  reference.                                                                      |
| 10.14 |   | Amended and Restated Employment Agreement, dated as  of February 11, 2005, by and between Eon Labs, Inc. and William F.  Holt was filed as Exhibit 10.8 to the Company’s current report on  Form 8-K, filed on February 17, 2005 and is incorporated herein by  reference.                                                                       |
| 10.15 |   | Employment Agreement, dated as of February 11, 2005,  by and between Eon Labs, Inc. and Rathnam Kumar was filed as Exhibit 10.9  to the Company’s current report on Form 8-K, filed on February 17,  2005 and is incorporated herein by reference.                                                                                                    |
| 10.16 |   | Employment Agreement, dated as of February 11, 2005,  by and between Eon Labs, Inc. and Shashank Upadhye was filed as Exhibit 10.10  to the Company’s current report on Form 8-K, filed on February 17,  2005 and is incorporated herein by reference.                                                                                                |
| 10.17 |   | Agreement for Purchase and Sale of Stock, dated as  of February 20, 2005, by and among Novartis Corporation, Santo Holding (Deutschland)  GmbH and for purposes of Section 12 thereof only, Novartis AG, was filed  as Exhibit 10.1 to the Company’s current report on Form 8-K, filed  on February 22, 2005 and is incorporated herein by reference. |
| 10.18 |   | Confidentiality Agreement, dated as of February 11,  2005, by and between Novartis Corporation and Eon Labs, Inc., was filed  as Exhibit 10.2 to the Company’s current report on Form 8-K, filed  on February 22, 2005 and is incorporated herein by reference.                                                                                       |
| 21.1  |   | List of Subsidiaries was filed as Exhibit 21.1  to the Company’s Registration Statement on Form S-1/A (Reg.  No. 333-83638), filed on May 21, 2002 and is incorporated herein by  reference.                                                                                                                                                          |
| 23.1  |   | Consent of PricewaterhouseCoopers LLP filed  herewith.                                                                                                                                                                                                                                                                                                                         |
| 31.1  |   | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 filed herewith.                                                                                                                                                                                                                                                       |
| 31.2  |   | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 filed herewith.                                                                                                                                                                                                                                                       |
| 32.1  |   | Certification of the Chief Executive Officer pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002 filed herewith.                                                                                                                                                                                              |
| 32.2  |   | Certification of the Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 filed herewith.                                                                                                                                                                                              |

 

58

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|                                 | EON LABS, INC.                                    |
|---------------------------------|---------------------------------------------------|
|                            | By:                                               | /s/ BERNHARD HAMPL |
|                            | Bernhard Hampl, Ph.D.                             |
|                            | *President, Chief Executive Officer and Director* |
| Date:  March 16, 2005 |                                              |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant in thecapacities and on the dates indicated.
|                                | **Signature** | ** **                                           | ** ** | ** **          | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|--------------------------------|---------------|------------------------------------------------------|------------|---------------------|-----------|------------|------------|------------|----------|------------|
| /s/  BERNHARD  HAMPL           |          | President, Chief  Executive Officer and              |       | March 16, 2005 |
| Bernhard Hampl,  Ph.D.         |          | Director (Principal  Executive Officer)              |       |                |
| /s/  THOMAS  STRÜNGMANN   |          | Chairman of the Board of  Directors                  |       | March 16, 2005 |
| Thomas  Strüngmann, Ph.D. |          |                                                 |       |                |
| /s/  WILLIAM  F. HOLT          |          | Chief Financial Officer (Principal                   |       | March 16, 2005 |
| William F. Holt                |          | Financial Officer  and Principal Accounting Officer) |       |                |
| /s/  DAVID  H. GRANSEE         |          | Controller                                           |       | March 16, 2005 |
| David H. Gransee               |          |                                                 |       |                |
| /s/  FRANK  F. BEELITZ         |          | Director                                             |       | March 16, 2005 |
| Frank F. Beelitz               |          |                                                 |       |                |
| /s/  DOUGLAS  M. KARP          |          | Director                                             |       | March 16, 2005 |
| Douglas M. Karp                |          |                                                 |       |                |
| /s/  MARK  R. PATTERSON        |          | Director                                             |       | March 16, 2005 |
| Mark R. Patterson              |          |                                                 |       |                |

 

 

59

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**INDEXTO THE FINANCIAL STATEMENTS OF EON LABS, INC. AND SUBSIDIARIES**
|                                                                                                                                           | ** ** | **Page** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered  Public Accounting Firm                                                                                  | F-2        |
| Consolidated Balance Sheets as of  December 31, 2004 and 2003                                                                        | F-4        |
| Consolidated Statements of Income  for the years ended December 31, 2004, 2003 and 2002                                              | F-5        |
| Consolidated  Statements of Stockholders’ Equity and Comprehensive Income for the years  ended December 31, 2004, 2003 and 2002 | F-6        |
| Consolidated Statements of Cash  Flows for the years ended December 31, 2004, 2003 and 2002                                          | F-7        |
| Notes to Consolidated Financial  Statements                                                                                               | F-8        |

 

F-1

----

**Reportof Independent Registered**Public Accounting Firm

To the Board of Directors and Stockholders of EonLabs, Inc:

We have completed anintegrated audit of Eon Labs, Inc.’s 2004 consolidated financialstatements and of its internal control over financial reporting as of December 31,2004 and audits of its 2003 and 2002 consolidated financial statements inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Our opinions, based on our audits, are presented below.

*Consolidated financial statements*

In our opinion, the consolidated financial statements listed inthe accompanying index appearing under Item15(a)(1) present fairly, in all material respects, the financialposition of Eon Labs, Inc and Subsidiaries at December 31, 2004 and 2003,and the results of their operations and their cash flows for each of the threeyears in the period ended December 31, 2004 in conformity with accountingprinciples generally accepted in the United States of America. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements****based on our audits. We conducted ouraudits of these statements in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit of financialstatements includes examining, on a test basis, evidence supporting the amountsand disclosures in the financial statements, assessing the accountingprinciples used and significant estimates made by management, and evaluatingthe overall financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion.

*Internal controlover financial reporting*

Also, in our opinion, management’s assessment,included in Management’s Report on Internal Control over Financial Reportingappearing in Item 9A, that the Company maintained effective internal controlover financial reporting as of December 31, 2004 based on criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO), is fairly stated, in all material respects, based on those criteria. Furthermore,in our opinion, the Company maintained, in all material respects, effectiveinternal control over financial reporting as of December 31, 2004, basedon criteria established in *Internal Control—Integrated Framework*issued by the COSO. The Company’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express opinions on management’s assessment and onthe effectiveness of the Company’s internal control over financial reportingbased on our audit. We conducted our audit of internal control over financialreporting in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether effectiveinternal control over financial reporting was maintained in all materialrespects. An audit of internal control over financial reporting includesobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we consider necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinions.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (i) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the 

F-2

----

assets of the company; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.
| PricewaterhouseCoopers LLP |
|----------------------------|
| New York, New York         |
| March 14, 2005        |

 

F-3

----

 

**Eon Labs, Inc. and SubsidiariesConsolidated Balance SheetsDecember 31, 2004 and 2003(dollars in thousands, except per share amounts)**
| ** **                                                                                                                                                                                                       | ** ** | **2004**       | ** ** | **2003**       | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------|------------|----------------|------------|
| **Assets**                                                                                                                                                                                                       |       |           |       |           |       |
| **Current  assets**                                                                                                                                                                                              |       |           |       |           |       |
| Cash and cash equivalents                                                                                                                                                                                        |       | $ 59,500  |       | $ 43,852  |       |
| Investments                                                                                                                                                                                                      |       | 136,252        |       | 115,281        |       |
| Accounts receivable, net                                                                                                                                                                                         |       | 68,010         |       | 35,678         |       |
| Inventories                                                                                                                                                                                                      |       | 72,465         |       | 56,441         |       |
| Deferred tax assets, net                                                                                                                                                                                         |       | 62,955         |       | 56,439         |       |
| Prepaid expenses and other  current assets                                                                                                                                                                       |       | 20,788         |       | 8,096          |       |
| **Total current assets**                                                                                                                                                                                         |       | 419,970        |       | 315,787        |       |
| Property, plant and equipment,  net                                                                                                                                                                              |       | 52,481         |       | 50,409         |       |
| Goodwill                                                                                                                                                                                                         |       | 42,734         |       | 46,934         |       |
| Other intangible assets, net                                                                                                                                                                                     |       | 22,247         |       | 26,007         |       |
| Other assets                                                                                                                                                                                                     |       | 7,742          |       | 2,408          |       |
| **Total assets**                                                                                                                                                                                                 |       | $ 545,174 |       | $ 441,545 |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                                                                   |       |           |       |           |       |
| **Current  liabilities**                                                                                                                                                                                         |       |           |       |           |       |
| Accounts payable                                                                                                                                                                                                 |       | $ 11,987  |       | $ 13,612  |       |
| Accrued liabilities                                                                                                                                                                                              |       | 81,265         |       | 89,226         |       |
| **Total current  liabilities**                                                                                                                                                                                   |       | 93,252         |       | 102,838        |       |
| **Long-term liabilities**                                                                                                                                                                                        |       |           |       |           |       |
| Deferred tax liabilities,  net                                                                                                                                                                                   |       | 7,355          |       | 9,136          |       |
| Deferred revenue                                                                                                                                                                                                 |       | 151            |       | 200            |       |
| Other                                                                                                                                                                                                            |       | 892            |       | 591            |       |
| **Total liabilities**                                                                                                                                                                                            |       | 101,650        |       | 112,765        |       |
| Commitments and  contingencies (Notes 10 and 13)                                                                                                                                                                 |       |           |       |           |       |
| **Stockholders’ equity**                                                                                                                                                                                    |       |           |       |           |       |
| Common stock, par value  $.01 per share; 100,000,000 shares authorized; 88,982,924 and 44,361,912  shares issued; 88,830,564 and 44,299,812 shares outstanding at  December 31, 2004 and 2003, respectively |       | 890            |       | 444            |       |
| Preferred stock, par value  $.01 per share; 5,000,000 shares authorized; none issued                                                                                                                             |       | —         |       | —         |       |
| Additional paid-in capital                                                                                                                                                                                       |       | 192,767        |       | 194,951        |       |
| Retained earnings                                                                                                                                                                                                |       | 255,125        |       | 135,774        |       |
| Accumulated other comprehensive  (loss) income                                                                                                                                                                   |       | (8             | )          | 5              |       |
|                                                                                                                                                                                                             |       | 448,774        |       | 331,174        |       |
| Less: Unearned deferred  stock-based compensation                                                                                                                                                                |       | —         |       | (184           | )          |
| Treasury stock at cost;  152,360 and 62,100 shares at December 31, 2004 and 2003, respectively                                                                                                              |       | (5,250         | )          | (2,210         | )          |
| **Total stockholders’  equity**                                                                                                                                                                             |       | 443,524        |       | 328,780        |       |
| **Total liabilities and stockholders’ equity**                                                                                                                                                              |       | $ 545,174 |       | $ 441,545 |       |

 

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

F-4

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**Eon Labs, Inc. and SubsidiariesConsolidated Statements of IncomeFor the years ended December 31, 2004, 2003 and 2002(dollars in thousands, except per share amounts)**
| ** **                                  | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Net sales                                   |       | $          | 430,959    |       | $          | 329,538    |       | $ | 244,269 |   |
| Cost of sales                               |       | 190,602    |       | 154,387    |       | 122,351    |       |
| **Gross profit**                            |       | 240,357    |       | 175,151    |       | 121,918    |       |
| Operating  expenses                         |       |       |       |       |       |       |       |
| Selling, general and administrative         |       | 46,043     |       | 37,296     |       | 32,706     |       |
| Research and development                    |       | 21,666     |       | 22,510     |       | 13,239     |       |
| **Total operating expenses**                |       | 67,709     |       | 59,806     |       | 45,945     |       |
| **Operating income**                        |       | 172,648    |       | 115,345    |       | 75,973     |       |
| Other income and  expense                   |       |       |       |       |       |       |       |
| Interest income                             |       | 2,461      |       | 1,411      |       | 854        |       |
| Interest expense                            |       | —     |       | (300       | )          | (3,857     | )          |
| Other income, net                           |       | 13,046     |       | 228        |       | 113        |       |
| **Total other income (expense)**            |       | 15,507     |       | 1,339      |       | (2,890     | )          |
| Income before income taxes                  |       | 188,155    |       | 116,684    |       | 73,083     |       |
| Provision for  income taxes                 |       | 68,804     |       | 46,549     |       | 29,820     |       |
| **Net income**                              |       | $          | 119,351    |       | $          | 70,135     |       | $ | 43,263 |   |
| Net income per  common share (see Note 3)   |       |       |       |       |       |       |       |
| Basic                                       |       | $          | 1.34       |       | $          | 0.79       |       | $ | 0.81 |   |
| Diluted                                     |       | $          | 1.32       |       | $          | 0.77       |       | $ | 0.53 |   |
| Weighted average  common shares outstanding |       |       |       |       |       |       |       |
| Basic                                       |       | 88,772,514 |       | 88,479,942 |       | 53,261,578 |       |
| Diluted                                     |       | 90,673,611 |       | 90,520,586 |       | 81,297,066 |       |

 

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

F-5

----

**Eon Labs, Inc. and SubsidiariesConsolidated Statements of Stockholders’ Equity andComprehensive IncomeFor the years ended December 31, 2004, 2003 and 2002(dollars in thousands)**
| ** **                                                                                                      | ** ** | **Number  of Shares  Series A  Convertible  Preferred  Stock** | ** ** | **Series A  Convertible  Preferred  Stock** | ** ** | **Number  of Shares  Common  Stock** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained    Earnings  ** | ** ** | **Unearned  Deferred  Stock-Based  Compensation** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------------------------------|------------|---------------------------------------------------|------------|-----------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
| **Balance,  December 31, 2001**                                                                            |       | 30,000,000                                                               |       |                                             | $          | 300                                       |       |              | —     |                             |       | $                                              | —     |                                              |       |                                          | $          | 26,101              |       |                                  |       | $ | 22,376 |   |   |   | $ | (1,786 | ) |   |   | $ | — |   |   | $ | — |   |   | $ | 46,991 |   |   |
| Stock conversion                                                                                                |       | (30,000,000                                                              | )          |                                             | (300       | )                                         |       | 30,000,000        |       |                             | 300        |                                           |       |                                              |       |                                          |       |                |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Amortization of  unearned deferred stock-based compensation                                                     |       |                                                                     |       |                                             |       |                                      |       |              |       |                             |       |                                           |       |                                              |       |                                          |       |                |       |                                  |       |   | 1,154 |   |   |   |   |   |   |   |   |   | 1,154 |   |   |
| Shares issued  under initial public offering                                                                    |       |                                                                     |       |                                             |       |                                      |       | 10,200,813        |       |                             | 102        |                                           |       |                                              | 139,135    |                                          |       |                |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | 139,237 |   |   |
| Conversion of debt  to equity                                                                                   |       |                                                                     |       |                                             |       |                                      |       | 1,678,561         |       |                             | 17         |                                           |       |                                              | 25,161     |                                          |       |                |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | 25,178 |   |   |
| Warrants exercised                                                                                              |       |                                                                     |       |                                             |       |                                      |       | 1,680,528         |       |                             | 17         |                                           |       |                                              | (17        | )                                             |       |                |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | — |   |   |
| Shares issued  under stock option plan, including tax benefit from exercise of non-qualified  options of $1,904 |       |                                                                     |       |                                             |       |                                      |       | 517,380           |       |                             | 5          |                                           |       |                                              | 2,282      |                                          |       |                |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | 2,287 |   |   |
| Net income                                                                                                      |       |                                                                     |       |                                             |       |                                      |       |              |       |                             |       |                                           |       |                                              |       |                                          |       |                | 43,263     |                                  |       |   |   |   |   |   |   |   |   |   |   |   | 43,263 |   |   |
| Unrealized gains  on available-for-sale securities                                                              |       |                                                                     |       |                                             |       |                                      |       |              |       |                             |       |                                           |       |                                              |       |                                          |       |                |       |                                  |       |   |   |   |   |   | 44 |   |   | — |   |   | 44 |   |   |
| Comprehensive  Income                                                                                           |       |                                                                     |       |                                             |       |                                      |       |              |       |                             |       |                                           |       |                                              |       |                                          |       |                |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | $ | 43,307 |   |   |
| **Balance,  December 31, 2002**                                                                            |       | —                                                                   |       |                                             | $          |                                      |       |              | 44,077,282 |                             |       | $                                              | 441        |                                              |       |                                          | $          | 192,662             |       |                                  |       | $ | 65,639 |   |   |   | $ | (632 | ) |   |   | $ | 44 |   |   | $ | — |   |   | $ | 258,154 |   |   |
| Amortization of  unearned deferred stock-based compensation                                                     |       |                                                                     |       |                                             |       |                                      |       |              |       |                             |       |                                           |       |                                              |       |                                          |       |                |       |                                  |       |   | 448 |   |   |   |   |   |   |   |   |   | 448 |   |   |
| Shares issued  under stock option plan, including tax benefit from exercise of non-qualified  options of $2,110 |       |                                                                     |       |                                             |       |                                      |       | 284,630           |       |                             | 3          |                                           |       |                                              | 2,675      |                                          |       |                |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | 2,678 |   |   |
| Common stock  acquired for treasury                                                                             |       |                                                                     |       |                                             |       |                                      |       | (72,500           | )          |                             |       |                                           |       |                                              |       |                                          |       |                |       |                                  |       |   |   |   |   |   |   |   |   | (2,596 | ) |   | (2,596 | ) |   |
| Treasury shares  reissued in connection with stock options exercised                                            |       |                                                                     |       |                                             |       |                                      |       | 10,400            |       |                             |       |                                           |       |                                              | (386       | )                                             |       |                |       |                                  |       |   |   |   |   |   |   |   |   | 386 |   |   | — |   |   |
| Net income                                                                                                      |       |                                                                     |       |                                             |       |                                      |       |              |       |                             |       |                                           |       |                                              |       |                                          |       |                | 70,135     |                                  |       |   |   |   |   |   |   |   |   |   |   |   | 70,135 |   |   |
| Unrealized losses  on available-for-sale securities                                                             |       |                                                                     |       |                                             |       |                                      |       |              |       |                             |       |                                           |       |                                              |       |                                          |       |                |       |                                  |       |   |   |   |   |   | (39 | ) |   | — |   |   | (39 | ) |   |
| Comprehensive  Income                                                                                           |       |                                                                     |       |                                             |       |                                      |       |              |       |                             |       |                                           |       |                                              |       |                                          |       |                |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | $ | 70,096 |   |   |
| **Balance,  December 31, 2003**                                                                            |       | —                                                                   |       |                                             | $          |                                      |       |              | 44,299,812 |                             |       | $                                              | 444        |                                              |       |                                          | $          | 194,951             |       |                                  |       | $ | 135,774 |   |   |   | $ | (184 | ) |   |   | $ | 5 |   |   | $ | (2,210 | ) |   | $ | 328,780 |   |   |
| Amortization of  unearned deferred stock-based compensation                                                     |       |                                                                     |       |                                             |       |                                      |       |              |       |                             |       |                                           |       |                                              |       |                                          |       |                |       |                                  |       |   | 184 |   |   |   |   |   |   |   |   |   | 184 |   |   |
| Shares issued  under stock option plan, including tax benefit from exercise of non-qualified  options of $5,385 |       |                                                                     |       |                                             |       |                                      |       | 129,550           |       |                             | 1          |                                           |       |                                              | 6,412      |                                          |       |                |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | 6,413 |   |   |
| Common stock  acquired for treasury                                                                             |       |                                                                     |       |                                             |       |                                      |       | (187,130          | )          |                             |       |                                           |       |                                              |       |                                          |       |                |       |                                  |       |   |   |   |   |   |   |   |   | (11,191 | ) |   | (11,191 | ) |   |
| Treasury shares  reissued in connection with stock options exercised                                            |       |                                                                     |       |                                             |       |                                      |       | 208,100           |       |                             |       |                                           |       |                                              | (8,151     | )                                             |       |                |       |                                  |       |   |   |   |   |   |   |   |   | 8,151 |   |   | — |   |   |
| Stock split  (2-for-1)                                                                                          |       |                                                                     |       |                                             |       |                                      |       | 44,380,232        |       |                             | 445        |                                           |       |                                              | (445       | )                                             |       |                |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | — |   |   |
| Net income                                                                                                      |       |                                                                     |       |                                             |       |                                      |       |              |       |                             |       |                                           |       |                                              |       |                                          |       |                | 119,351    |                                  |       |   |   |   |   |   |   |   |   |   |   |   | 119,351 |   |   |
| Unrealized losses  on available-for-sale securities                                                             |       |                                                                     |       |                                             |       |                                      |       |              |       |                             |       |                                           |       |                                              |       |                                          |       |                |       |                                  |       |   |   |   |   |   | (183 | ) |   |   |   |   | (183 | ) |   |
| Gain on foreign  currency translation                                                                           |       |                                                                     |       |                                             |       |                                      |       |              |       |                             |       |                                           |       |                                              |       |                                          |       |                |       |                                  |       |   |   |   |   |   | 170 |   |   |   |   |   | 170 |   |   |
| Comprehensive  Income                                                                                           |       |                                                                     |       |                                             |       |                                      |       |              |       |                             |       |                                           |       |                                              |       |                                          |       |                |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | $ | 119,338 |   |   |
| **Balance,  December 31, 2004**                                                                            |       | —                                                                   |       |                                             | $          |                                      |       |              | 88,830,564 |                             |       | $                                              | 890        |                                              |       |                                          | $          | 192,767             |       |                                  |       | $ | 255,125 |   |   |   | $ | — |   |   |   | $ | (8 | ) |   | $ | (5,250 | ) |   | $ | 443,524 |   |   |

 

The accompanying notes arean integral part of these consolidated financial statements.

F-6

 

----

**Eon Labs, Inc. and SubsidiariesConsolidated Statements of Cash FlowsFor the years ended December 31, 2004, 2003 and 2002(dollars in thousands)**
| ** **                                                                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Cash flows from operating  activities**                                          |       |     |       |     |       |     |       |
| Net income                                                                         |       | $        | 119,351    |     | $          | 70,135   |       | $ | 43,263 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |     |       |     |       |     |       |
| Provision for customer allowances                                                  |       | 43,366   |       | 19,146   |       | 68,628   |       |
| Depreciation and amortization                                                      |       | 10,527   |       | 9,228    |       | 7,899    |       |
| Deferred income taxes                                                              |       | (6,215   | )          | (10,653  | )          | (24,064  | )          |
| Amortization of deferred compensation                                              |       | 184      |       | 448      |       | 1,154    |       |
| Amortization of deferred revenue                                                   |       | (200     | )          | (230     | )          | (230     | )          |
| Amortization of discount on note payable                                           |       | —   |       | 269      |       | 1,149    |       |
| Interest paid in-kind                                                              |       | —   |       | —   |       | 2,463    |       |
| Tax benefit from exercises of stock options                                        |       | 5,385    |       | 2,110    |       | 1,904    |       |
| Changes in assets  and liabilities:                                                |       |     |       |     |       |     |       |
| Accounts receivable                                                                |       | (75,698  | )          | (31,002  | )          | (65,160  | )          |
| Inventories                                                                        |       | (16,024  | )          | (14,495  | )          | (10,754  | )          |
| Prepaid expenses and other current assets                                          |       | (12,633  | )          | 2,527    |       | (5,116   | )          |
| Accounts payable                                                                   |       | (1,644   | )          | 2,638    |       | 544      |       |
| Accrued liabilities                                                                |       | (5,629   | )          | 40,468   |       | 10,918   |       |
| Other liabilities                                                                  |       | 187      |       | —   |       | —   |       |
| **Net cash provided by operating activities**                                      |       | 60,957   |       | 90,589   |       | 32,598   |       |
| **Cash  flows from investing activities**                                          |       |     |       |     |       |     |       |
| Capital expenditures                                                               |       | (14,133  | )          | (12,497  | )          | (10,557  | )          |
| Net purchases of short-term investments                                            |       | (21,271  | )          | (90,386  | )          | (24,888  | )          |
| **Net cash used in investing activities**                                          |       | (35,404  | )          | (102,883 | )          | (35,445  | )          |
| **Cash  flows from financing activities**                                          |       |     |       |     |       |     |       |
| Payments on seller note                                                            |       | —   |       | (4,799   | )          | (25,201  | )          |
| Other                                                                              |       | 63       |       | 650      |       | 69       |       |
| Decrease in loans payable to Hexal AG                                              |       | —   |       | —   |       | (66,942  | )          |
| Proceeds from initial public offering of common stock                              |       | —   |       | —   |       | 139,237  |       |
| Purchase of treasury shares, at cost                                               |       | (11,191  | )          | (2,596   | )          | —   |       |
| Proceeds from exercises of stock options                                           |       | 1,028    |       | 568      |       | 383      |       |
| **Net cash (used in) provided by financing  activities**                           |       | (10,100  | )          | (6,177   | )          | 47,546   |       |
| Effect of exchange rate changes on cash and cash  equivalents                      |       | 195      |       | —   |       | —   |       |
| **Net increase (decrease) in cash and cash  equivalents**                          |       | 15,648   |       | (18,471  | )          | 44,699   |       |
| Cash and cash  equivalents at beginning of year                                    |       | 43,852   |       | 62,323   |       | 17,624   |       |
| Cash and cash equivalents at end of year                                           |       | $        | 59,500     |     | $          | 43,852   |       | $ | 62,323 |   |
| Supplemental disclosure of cash flow information:                                  |       |     |       |     |       |     |       |
| Cash paid during the year for                                                      |       |     |       |     |       |     |       |
| Interest                                                                           |       | $        | —     |     | $          | 300      |       | $ | 11,173 |   |
| Income taxes                                                                       |       | 80,946   |       | 52,577   |       | 56,379   |       |
| See Note 16  for other supplemental cash flow information.                    |       |     |       |     |       |     |       |

 

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

F-7

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**Eon Labs, Inc.and Subsidiaries**

**Notesto Consolidated**Financial Statements

**(Dollarsin thousands, except per share amounts)**

**1.**   Nature of Operations

Eon Labs, Inc. and Subsidiaries (the “Company”)is a generic pharmaceutical company engaged in the development, licensing,manufacturing, selling and distribution of a broad range of prescriptionpharmaceutical products primarily in the United States. The Company’s productsare sold primarily to drug wholesalers, national drug chains and mail orderaccounts, as well as large HMOs. The Company operates in one business reportingsegment.

On February 20, 2005,the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”)with Novartis Corporation, a New York corporation (“Novartis”), Zodnas AcquisitionCorp., a Delaware corporation and a wholly owned subsidiary of Novartis (“MergerSub”), and, solely with respect to its guarantee of Novartis’s and Merger Sub’sobligations thereunder, Novartis AG, a Swiss corporation (“Parent”). See Note18 for additional information regarding the Merger Agreement.

**2.**   Basis of Presentation

The consolidated financialstatements of the Company include the accounts of Eon Labs, Inc., itswholly owned subsidiaries, and an investment in a variable interest entity. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

**Change of CompanyOwnership**

Prior to the reorganization described below, HexalPharmaceuticals, Inc. (“HPI”), a wholly owned United States subsidiary ofSanto, which is under common control with Hexal, owned 50% of the outstandingcapital stock of the Company. The remaining 50% was owned by Eon Holdings, Inc.(“EHI”), whose principal asset was its 50% ownership of the Company.

On December 5,2000, HPI acquired all of the outstanding stock of EHI, giving HPI effectiveownership of 100% of the Company. Prior to the acquisition, HPI and EHI wereunrelated entities. The purchase price HPI paid for EHI was approximately$109,000, consisting of $60,000 in cash, which was funded through a loan fromHexal, $44,000 in a non-interest-bearing note (net of $6,100 discount) andwarrants with an approximate value of $4,900 at the time of issuance. Theacquisition resulted in a step-up of the assets of the Company. Except forgoodwill, the step-up represents 50% of the difference between historical costand the fair value of the assets. Goodwill represents the excess of thepurchase price over the fair value of 50% of the adjusted net assets acquired. Theallocation of the purchase price to step-up of assets was as follows:
| Inventory                                     |   | $   2,365 |   |
|-----------------------------------------------|--------|--------------------------|--------|
| Property, plant  and equipment                |   | 2,615                    |   |
| Acquired  in-process research and development |   | 2,450                    |   |
| Value of existing  products                   |   | 37,600                   |   |
| Intangibles—workforce                    |   | 1,450                    |   |
| Goodwill                                      |   | 47,514                   |   |

 

The Company expensed the in-process research anddevelopment of $2,450 and recorded deferred income taxes of $13,577 for thedifference between the financial statement basis and tax basis of certainassets. The Company has recorded an increase in its deferred tax assets of$6,000 representing the tax 

F-8

----

benefit of net operatinglosses and other temporary differences which are available for use by theCompany on a consolidated basis.

Effective May 21,2002, in conjunction with an 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.

**3.   Summary ofSignificant Accounting Policies**

**Cash and CashEquivalents**

The Company considers allhighly liquid debt instruments purchased with original maturities of threemonths or less to be cash equivalents.

**Investments**

The Company invests in publicly traded debt securitieswhich are categorized as securities available-for-sale and are carried at fairvalue. Unrealized gains and losses related to such securities, net of taxes,are excluded from operating results and reported as accumulated other comprehensiveincome/loss in the Stockholders’ Equity section of the balance sheet. TheCompany periodically evaluates declines in the value of its investments todetermine if such declines are other-than-temporary and thus the investment isimpaired. A variety of factors are considered when determining whether declinesare other-than-temporary, including, among others, the financial condition ofthe investee, the length of time and magnitude of the decline, and the Company’sability and intent to hold the investment.

The book value of suchsecurities exceeded market value by $292 at December 31, 2004. The marketvalue of such securities exceeded book value by $7 and $73 at December 31,2003 and 2002, respectively.

**ComprehensiveIncome**

Statement of FinancialAccounting Standard No. 130, “Reporting Comprehensive Income” (“SFAS No. 130”),requires reporting and displaying comprehensive income and its components,which for the Company includes net income, unrealized gains and losses, net oftax, on available-for-sale securities and foreign currency translation gainsand losses. Total comprehensive income was $119,338, $70,096 and $43,307 forthe years ended December 31, 2004, 2003, and 2002, respectively. Inaccordance with SFAS No. 130, the accumulated unrealized gains (losses) onavailable-for-sale securities and gains (losses) on foreign currencytranslation are shown as a separate component of stockholders’ equity.

**Other Income**

Other income for the yearended December 31, 2004 includes the receipt of a $3,000 bond fromGlaxoSmithKline (“Glaxo”) to settle all patent infringement litigation relatedto the Company’s Bupropion HCl, ER 100 mg and 150 mg tablets, and the receiptof a $10,000 settlement from Glaxo, in exchange for the Company agreeing to thedismissal of its complaint against Glaxo for malicious prosecution of anearlier suit against the Company, which claimed the Company’s Nabumetoneproduct infringed Glaxo’s patent. See Note 13.

**Inventories**

Inventories are stated atthe lower of cost (on a first-in, first-out basis) or market.

F-9

----

**Property, Plant andEquipment**

Property, plant andequipment is stated at cost, less accumulated depreciation. Depreciation ofproperty, plant and equipment is calculated on a straight-line basis over theestimated useful lives of the assets. Useful lives of property, plant andequipment are as follows: building and improvements—25 years; andmachinery and equipment—5 to 7 years. Expenditures for repairs andmaintenance are expensed as incurred; expenditures for major renewals andbetterments are capitalized. When assets are sold or otherwise disposed of, thecost and related accumulated depreciation are removed from the accounts and again or loss on disposition is reflected in selling,general and administrative. Property, plant and equipment is reviewed forimpairment whenever events or changes in circumstances indicate that therelated carrying amount may not be recoverable. If such assets are determinedto be impaired, the impairment to be recognized is measured by the amount bywhich the carrying amount of the assets exceeds the fair value of the assets. Fairvalue is determined using current market prices or anticipated cash flowsdiscounted at a rate commensurate with the risks involved. Management does notbelieve that there are any impairments in property, plant and equipment at December 31,2004.

**Use of Estimates**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities atthe date of the financial statements and the reported amounts of revenues andexpenses during the reporting period. The most significant estimates relate tothe realizability of accounts receivable including contractual allowances,rebates and chargebacks and other estimates for long-lived assets, inventories,returns, Medicaid rebates and deferred tax assets. Actual results could differfrom those estimates.

**Concentration ofCredit Risk**

Financial instruments which potentially subject theCompany to concentration of credit risk consist of cash deposits, investments(publicly traded debt securities) and accounts receivable.

The Company performsperiodic credit evaluations of its customers’ financial condition and,generally, requires no collateral. The Company believes it partially mitigatesits risk with respect to accounts receivable by purchasing credit insurance invarying amounts on its larger customers. For the year ended December 31,2004, sales to customers individually accounting for more than 10% of total netsales were approximately 10.1% and 30.8%. For the year ended December 31,2003, sales to customers individually accounting for more than 10% of total netsales were approximately 28.3% and 14.7%. For the year ended December 31,2002, sales to customers individually accounting for more than 10% of total netsales were approximately 32.2% and 14.8%. The Company’s customers with balancesof more than 10% of net accounts receivable represented approximately 61% oftotal accounts receivable at December 31, 2004.

**Reliance onSuppliers**

Some materials used in theCompany’s manufactured products are currently available only from one or alimited number of suppliers. Even when more than one supplier for a productexists, the Company at times has listed only one supplier in the Company’sAbbreviated New Drug Application (“ANDA”) for some products. This includesproducts that have historically accounted for a significant portion of theCompany’s revenues. In the event an existing supplier named in the Company’sANDA application for a product should lose its regulatory status as anacceptable source, the Company would attempt to locate a qualified alternative;however, the Company may be unable to obtain the required components orproducts on a timely basis or at commercially reasonable prices. Additionally,any change in a supplier not 

F-10

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previouslyapproved in the Company’s ANDA must then be submitted through a formal approvalprocess with the Food and Drug Administration.

**Revenue Recognition**

Sales are recognized when the products are received bythe customer, which represents the point when the risks and rewards ofownership are transferred to the customer. Discounts, rebates and 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 calculatesa reserve for discounts and rebates based upon actual sales under sucharrangements. Reserves for contract pricing adjustments represent thedifference between the prices wholesalers are billed by the Company and thecontract prices billed by wholesalers to their customers. 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. Historical trends are adjusted for new productintroductions and changes in wholesaler or contract prices.

Included in net sales in 2004, 2003 and 2002 isroyalty income of $159, $292 and $3,434, respectively.

Accounts receivable is presented net of allowances fordiscounts, rebates, contract pricing adjustments and doubtful accounts, whichwere $138,022 and $94,656 at December 31, 2004 and 2003, respectively.

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

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

Accrued liabilitiesinclude $67,435 and $73,086 for returns, promotional incentives and Medicaidrebates at December 31, 2004 and 2003, respectively. During the year endedDecember 31, 2004, the Company recorded an adjustment to reduce itsreserve accrual related to promotions by $1,760. This reduction was attributedto certain promotional programs in the final stages of their program lives andfor which an accrual was no longer considered necessary.

**Research andDevelopment**

Research and developmentactivities are expensed as incurred. Theprincipal components of research and developmentare: salaries and related costs; research materials andsupplies; bio-study expense; and defined milestone payments under third-partyproduct development agreements.

**Advertising**

Advertising costs areexpensed as incurred. Advertising expenses for the years ended December 31,2004, 2003 and 2002 were approximately $859, $631 and $523, respectively.

**Legal Expense**

Legal costs are expensedas incurred.

**Income Taxes**

Deferred income taxes arerecognized for the future tax consequences of temporary differences between thetax basis of assets and liabilities and their financial reporting amounts at eachyear-end based 

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onenacted tax laws. Valuation allowances are established when necessary to reducedeferred tax assets to the amount expected to be realized. Income tax expenseis the tax payable for the period and the change during the period in deferredtax assets and liabilities.

**Long-Lived Assets**

The Company accounts forthe carrying values of long-lived assets and certain identifiable intangibleassets by evaluating the future cash flows expected to result from the use ofthe asset and its eventual disposition. If the sum of the expected futureundiscounted cash flows is less than the carrying amount of the asset, animpairment loss is recognized. Management does not believe there are anyimpairments in long-lived assets at December 31, 2004.

**Stock-BasedCompensation**

The Company has adopted Statement of FinancialAccounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFASNo. 123”). SFAS No. 123 allows companies which have stock-basedcompensation arrangements with employees to adopt a new fair-value basis ofaccounting for stock options and other equity instruments, or to continue toapply the existing accounting required by Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock Issued to Employees.” The Company continuesto account for stock-based compensation arrangements under APB Opinion No. 25and related interpretations in accounting for its stock-based compensation. TheCompany recognizes no compensation expense with respect to stock options if theexercise price equals or exceeds the fair value of the underlying security onthe date of grant and other terms are fixed. The Company has also adopted thedisclosure provisions of Statement of Financial Accounting Standards No. 148“Accounting for Stock-Based Compensation-Transition and Disclosure.” Thispronouncement requires prominent disclosures in both annual and interimfinancial statements about the method of accounting for stock-based employeecompensation and the effect of the method used on reporting results asdetermined through the use of the Black-Scholes option-pricing model.

Areconciliation of the Company’s net income to pro forma net income and therelated pro forma earnings per share amounts, for the years ended December 31,2004, 2003 and 2002 is provided below. For purposes of pro forma disclosure,stock-based compensation expense is recognized in accordance with theprovisions of SFAS No. 123.
| ** **                                                                                                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income, as  reported                                                                                    |       | $        | 119,351    |     | $          | 70,135   |       | $ | 43,263 |   |
| Add: Compensation  expenses included in net income, net of related tax effect                               |       | 112      |       | 269      |       | 704      |       |
| Less: Adjustment  to net income for pro forma stock-based compensation expenses, net of related  tax effect |       | (2,812   | )          | (823     | )          | (225     | )          |
| Pro forma net income                                                                                        |       | $        | 116,651    |     | $          | 69,581   |       | $ | 43,742 |   |
| As reported net  earnings per share:                                                                        |       |     |       |     |       |     |       |
| Basic                                                                                                       |       | $        | 1.34       |     | $          | 0.79     |       | $ | 0.81 |   |
| Diluted                                                                                                     |       | $        | 1.32       |     | $          | 0.77     |       | $ | 0.53 |   |
| Pro forma net earnings  per share:                                                                          |       |     |       |     |       |     |       |
| Basic                                                                                                       |       | $        | 1.31       |     | $          | 0.79     |       | $ | 0.82 |   |
| Diluted                                                                                                     |       | $        | 1.29       |     | $          | 0.77     |       | $ | 0.54 |   |

 

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**Stock RepurchaseProgram**

In April 2003, the Company’s Board of Directorsapproved the repurchase of up to 600,000 shares of the Company’s common stockover the next twelve months. In July 2003, the Company adopted a plan torepurchase up to 250,000 shares through December 31, 2003. In February 2004,the Company adopted a plan to repurchase up to 187,500 shares through March 31,2004. In April 2004, the Company adopted a plan to repurchase up to187,500 shares through June 30, 2004. Depending on market conditions, theCompany also expects to conduct purchases in the open market and in privatelynegotiated transactions from time to time during its normal trading window andmay enter into future plans to repurchase shares. The repurchased shares havebeen accounted for as treasury shares and will be used to offset potentialdilution from the exercise of outstanding stock options.

During the years ended December 31,2004 and 2003, in accordance with these plans, the Company repurchased 351,760and 145,000 shares of its outstanding common stock at an average price of$31.81 per share totaling $11,191 and $17.91 per share totaling $2,596,respectively. These transactions are accounted for under the cost method.

**Stock Split andDividends**

At the May 28, 2004 Annual Meeting ofStockholders, the stockholders approved an amendment to the Company’s RestatedCertificate of Incorporation to increase the number of shares of authorizedcommon stock from 70 million to 100 million. Conditioned on such approval, theBoard of Directors in April 15, 2004 had declared a 2-for-1 stock split****in the form of a 100% stock dividend,payable June 1, 2004, to stockholders of record on May 17, 2004. Thestock split has been recognized by reclassifying the $0.01 par value of theadditional shares resulting from the split from additional paid in capital tocommon stock. The effect of this stock split was not retroactively reflected inthe Consolidated Balance Sheetsor the Consolidated Statements of Stockholders’ Equity and Comprehensive Income for periodsprior to the split; therefore, in 2004, shares issued for option exerciseswhich occurred prior to the stock split have not been adjusted for the stocksplit. The effect of the stock split on such option exercises of 129,550 sharesis included in the line “Stock split (2-for-1).” All references to the numberof shares and per share amounts elsewhere in the financial statement andrelated footnotes have been restated to reflect the effect of the split for allperiods presented.

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

Also, in May 2002,the outstanding 60,000,000 preferred shares were converted to common stock. Inaddition, the Company changed the number of shares of authorized preferredstock to 5,000,000 and converted shares of non-voting common stock to shares ofa single class of common stock.

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**Net Income PerCommon Share**

Basicnet income per share is computed by dividing net income by the weighted-averagenumber of common shares outstanding for the period. Diluted earnings per sharereflects the potential dilution of stock options, warrants, and the conversionof preferred stock. Per share data has been retroactively restated to reflectimpact of the 2-for-1 stock split on June 1, 2004. Details of thecalculations are as follows:
| ** **                                     | ** ** | **Years Ended December 31,**                             | ** ** |
|------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **2004**                                                                | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Net  income per share—basic:**          |       |                                                                    |       |   |   |   |   |
| Net income                                     |       | $    119,351                                        |       | $      70,135 |   | $      43,263 |   |
| Weighted-average shares—basic             |       | 88,772,514                                                              |       | 88,479,942 |   | 53,261,578 |   |
| **Net  income per share—basic**           |       | $           1.34 |       | $           0.79 |   | $           0.81 |   |
| Net income per  share—diluted:            |       |                                                                    |       |   |   |   |   |
| Net income                                     |       | $    119,351                                        |       | $      70,135 |   | $      43,263 |   |
| Weighted-average shares outstanding—basic |       | 88,772,514                                                              |       | 88,479,942 |   | 53,261,578 |   |
| Effect of  preferred stock prior to conversion |       | —                                                                  |       | — |   | 23,342,466 |   |
| Effect of  warrants prior to conversion        |       | —                                                                  |       | — |   | 1,307,588 |   |
| Dilutive effect  of stock options              |       | 1,901,097                                                               |       | 2,040,644 |   | 3,385,434 |   |
| Weighted-average shares—diluted           |       | 90,673,611                                                              |       | 90,520,586 |   | 81,297,066 |   |
| Net income per  share—diluted             |       | $           1.32 |       | $           0.77 |   | $           0.53 |   |

 

**Shipping andHandling Costs**

The Company classifiesshipping and handling costs as part of selling, general and administrativeexpenses. Shipping and handling costs were $5,298, $4,669 and $3,202 in 2004,2003 and 2002, respectively.

**Goodwill andIntangibles**

In 2002, the Companyadopted Statement of Financial Accounting Standards No. 142, “Goodwill andOther Intangible Assets” (“SFAS No. 142”). SFAS No. 142 modifies theaccounting and reporting for acquired intangible assets at the time ofacquisition and in subsequent periods. Intangible assets, which have finitelives, must be amortized over their estimated useful lives. Intangible assetswith indefinite lives will not be amortized, but evaluated annually forimpairment. The Company has completed its impairment assessment and determinedthat there is no impairment of goodwill or identifiable intangibles uponinitial adoption of SFAS No. 142. SFAS No. 142 is effective forfiscal years beginning after December 15, 2001. The value of the Company’sexisting products is an intangible asset with a finite life that is beingamortized over 10 years. The Company’s goodwill and workforce intangibleswere amortized over 15 and 5 year lives, respectively, through December 31,2001. In 2002, the Company transferred the net book value of its workforceintangible of $1,100 to goodwill, resulting in goodwill of $47,000. Therecorded amount of the existing products intangible of $37,600, beforeaccumulated amortization of $15,400 as of December 31, 2004, will beamortized through 2010 with annual charges of $3,760. In prior years, thisamortization was included in selling, general and administrative. In 2004, theCompany determined it was more appropriate to include this item in cost ofsales. As such, amortization of $3,760 was reclassified from selling, generaland administrative to cost of sales for each of the years2003 and 2002.

**New AccountingPronouncements**

In December 2004, the FASB issued FASB Statement No. 123(R) (revisedDecember 2004), Share-Based Payments (“FAS 123(R)”), which requirescompanies to expense the value of employee and 

F-14

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director stock options andsimilar awards. FAS 123(R) is effective July 1, 2005. The Company isreviewing the various implementation methods under this pronouncement.

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

In December 2004, the FASB issued FSP FAS 109-1, “Applicationof FASB Statement No. 109, ‘Accounting for Income Taxes,’ to the TaxDeduction on Qualified Production Activities Provided by the American JobsCreation Act of 2004” to provide accounting guidance on the appropriatetreatment of tax benefits generated by the enactment of the Act. The FSPrequires that the manufacturer’s deduction be treated as a special deduction inaccordance with SFAS 109 and not as a tax rate reduction. The Company is awaitingfinal tax regulations from the IRS before completing its assessment of theimpact of adopting FSP FAS 109-1 on its consolidated financial statements.

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

In January 2003, theFASB issued Interpretation No. 46, “Consolidation of Variable InterestEntities” (as revised by Fin No. 46R). This interpretation, as revised,provides guidance with respect to the consolidation of certain entities,referred to as variable interest entities (“VIEs”), in which an investor issubject to a majority of the risk of loss from the VIEs’ activities, or isentitled to receive a majority of the VIEs’ residual returns. Thisinterpretation also provides guidance with respect to the disclosure of VIEs inwhich an investor maintains an interest, but is not required to consolidate. Theprovisions of the interpretation were effective immediately for all VIEscreated after January 31, 2003, or in which the Company obtains aninterest after that date. For VIEs created before February 1, 2003, theprovisions were effective July 1, 2003. In November 2003, the Companyinvested $1,150 for 50% ownership in an entity formed to provide research anddevelopment services for the Company as well as third parties. It has beendetermined that such investee is deemed a VIE, which has been consolidated inthe Company’s financial statements. The net assets and result of operations ofthis entity were not significant to the Company in 2004. Creditors, or beneficialinterest holders, of the consolidated VIE have no recourse to the generalcredit of the Company.

**Reclassifications**

Certain prior year amountshave been reclassified to conform to current year presentation.

F-15

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**4.   Inventories**

Inventoriesconsist of the following:
| ** **      | ** ** | **December 31,** | ** ** |
|-----------------|------------|-----------------------|------------|
| ** **      | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Raw material    |       | $ 39,279         |       | $ 24,745 |   |
| Work-in-process |       | 8,988                 |       | 7,529 |   |
| Finished goods  |       | 24,198                |       | 24,167 |   |
|            |       | $ 72,465         |       | $ 56,441 |   |

 

**5.   Property,Plant and Equipment**

Property,plant and equipment consists of the following:
| ** **                     | ** ** | **December 31,**    | ** ** |
|--------------------------------|------------|--------------------------|------------|
| ** **                     | ** ** | **2004**                 | ** ** | **2003** | ** ** |
| Land                           |       | $   2,711 |       | $   2,711 |   |
| Buildings and  improvements    |       | 30,012                   |       | 28,747 |   |
| Machinery and  equipment       |       | 49,213                   |       | 41,622 |   |
|                           |       | 81,936                   |       | 73,080 |   |
| Less accumulated  depreciation |       | 29,455                   |       | 22,671 |   |
|                           |       | $ 52,481            |       | $ 50,409 |   |

 

Depreciation expense was$6,767, $5,468 and $4,139 in 2004, 2003, and 2002, respectively.

**6.   Goodwilland Other Intangible Assets**

Intangibleassets consist of the following components:
| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Value of existing  products     |       | $ 37,600         |       | $ 37,600 |   |
| Less accumulated  amortization  |       | (15,353               | )          | (11,593 | ) |
| Value of existing products, net |       | 22,247                |       | 26,007 |   |
| Goodwill                        |       | 42,734                |       | 46,934 |   |
|                            |       | $ 64,981         |       | $ 72,941 |   |

 

The decrease in goodwill is the result of recognizinga $4,200 deferred tax asset when it was determined that certain of EHI netoperating losses would be utilized by the Company. The Company has not recordeda potential $5,800 million deferred tax asset representing the benefit ofadditional net operating losses of EHI, which may be available for use by theCompany on a consolidated basis. This additional benefit is pending approval bytaxing authorities. Upon approval, such amount will be recorded as a deferredtax asset with an offsetting reduction to goodwill.

Amortization expense was$3,760 in 2004, 2003 and 2002, respectively, and is included in cost of sales.

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**7.   IncomeTaxes**

Theprovision for income taxes consists of the following:
| ** **      | ** ** | **Years ended December 31,** | ** ** |
|-----------------|------------|---------------------------------------------|------------|
| ** **      | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Current:        |       |                                        |       |   |   |   |   |
| Federal         |       | $ 65,471                               |       | $ 48,607 |   | $ 46,224 |   |
| State and local |       | 9,548                                       |       | 8,595 |   | 7,660 |   |
| Deferred:       |       |                                        |       |   |   |   |   |
| Federal         |       | (4,611                                      | )          | (10,201 | ) | (20,614 | ) |
| State and local |       | (1,604                                      | )          | (452 | ) | (3,450 | ) |
|            |       | $ 68,804                               |       | $ 46,549 |   | $ 29,820 |   |

 

Reconciliationsbetween the statutory federal income tax rate and the Company’s effectiveincome tax rate are as follows:
| ** **                                            | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                    | ** ** | **     2003     ** | ** ** | **     2002     ** | ** ** |
| Federal income  tax statutory rates                   |       | 35.0                                        | %          | 35.0 | % | 35.0 | % |
| State and local  income taxes, net of federal benefit |       | 3.1                                         | %          | 4.8 | % | 5.0 | % |
| Reversal of tax  reserves                             |       | (0.8                                        | )%         | — |   | — |   |
| Other                                                 |       | (0.7                                        | )%         | 0.1 | % | 0.8 | % |
|                                                  |       | 36.6                                        | %          | 39.9 | % | 40.8 | % |

 

Thecomponents of the net deferred tax assets are as follows:
| ** **                                  | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Current deferred tax  assets:               |       |                  |       |   |   |
| Inventory capitalization and provisions     |       | $ 2,260          |       | $   2,169 |   |
| Provision for sales allowances and returns  |       | 58,938                |       | 53,013 |   |
| Start-up costs                              |       | —                |       | 591 |   |
| Prepaid insurance                           |       | (2,064                | )          | (1,481 | ) |
| Reserve for Medicaid rebates                |       | 2,783                 |       | 1,563 |   |
| Other assets                                |       | 341                   |       | 877 |   |
| Other liabilities, not currently deductible |       | 697                   |       | 298 |   |
|                                        |       | 62,955                |       | 57,030 |   |
| Less valuation  allowance                   |       | —                |       | (591 | ) |
| Deferred tax assets                         |       | 62,955                |       | 56,439 |   |
| Non-current  deferred tax liabilities       |       |                  |       |   |   |
| Property, plant and equipment               |       | (4,742                | )          | (3,566 | ) |
| Deferred compensation                       |       | 3,793                 |       | 4,782 |   |
| Step-up of fixed assets                     |       | (665                  | )          | (751 | ) |
| Step-up of intangibles                      |       | (9,119                | )          | (10,586 | ) |
| Net operating loss                          |       | 2,081                 |       | — |   |
| State tax credits                           |       | 1,274                 |       | 961 |   |
| Other noncurrent assets                     |       | 23                    |       | 24 |   |
| Deferred tax liabilities                    |       | (7,355                | )          | (9,136 | ) |
| Net deferred tax  assets                    |       | $ 55,600         |       | $ 47,303 |   |

 

F-17

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The lower effective rate for 2004 was attributable tothe reversal of the prior year tax contingencies as well as the recognition ofcertain income tax benefits including approximately $700 related to NorthCarolina state tax credits and approximately $700 related to the investment intax-exempt securities. In connection with the acceptance of certain VoluntaryDisclosure Agreements filed with various state and local tax jurisdictions theCompany reversed approximately $1,600 of prior years tax contingencies,reducing its provision for income taxes.

The Company has recordedapproximately $4,200 as a reduction of goodwill related to certain amountswhich represent the benefit of the net operating losses of EHI. The Company hasnot recorded a potential deferred tax asset of approximately $5,800 relating toadditional net operating losses of EHI as this benefit is pending approval bytaxing authorities. Upon approval, the Company will record the deferred taxasset with an offsetting reduction to goodwill.

**8.   NotesPayable**

In December 2000, in connection with theacquisition of EHI by HPI (see Note 2), the Company recorded a $50,000non-interest bearing note payable (the “Note”) issued by HPI to the sellers atits estimated present value of $44,000.

The Note provided for installment payments as follows:$10,000 on December 8, 2000, $10,000 on December 5, 2001, $10,000 on September 30,2002, $10,000 on September 30, 2003 and $10,000 on December 31, 2003.A payment of $10 million was made to the sellers pursuant to the terms of theNote on December 8, 2000 and December 5, 2001. The Note provided forprepayments to be applied against the last installment or installments in theevent the Company’s earnings before interest, taxes, depreciation andamortization (EBITDA), as defined therein, exceed $20,000 in calendar years2002 and 2001. If EBITDA exceeds $20,000 in either calendar year, then aprepayment was required on the Note equal to 50% of the amount in excess of$20,000 for such calendar year. In no event were the aggregate prepaymentsrequired by such calculations to exceed $20,000. In March 2002, theCompany made a payment with respect to the Note of $15,200. At December 31,2002, there was a remaining balance of $4,800, net of $300 of unamortized debtdiscounts. The Company paid the remaining $4,800 note balance in March 2003.

In connection with the December 2000 acquisitionof EHI, the Company borrowed $60,000 from Hexal, at a fixed rate of 8.75%. Inaddition, Hexal also provided advances to the Company and had allowed interestto accrue. Further, the Company had outstanding borrowings of $16,874 under a$20,000 loan agreement with Hexal. Interest on advances was calculated at LIBOR(as defined) plus 1.25%. In May 2002, following the closing of the Company’sinitial public offering, debt of $25,178 due to Hexal was converted into 3,357,122shares of common stock and debt of $66,942 due to Hexal was paid with theproceeds of the offering. The payment and stock conversion totaling $92,120fully paid the balance due at March 31, 2002 which was comprised of thetwo notes payable of $60,000 and $16,874, plus an additional intercompanypayable of $15,246.

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**9.   AccruedLiabilities**

Accruedliabilities include the following:
| ** **                                                      | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                      | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Payroll, vacation  and related costs                            |       | $                     | 4,770      |   | $ | 3,980 |   |
| Income taxes  payable                                           |       | —                |       | 2,056 |   |
| Liabilities for  customer returns, credits and other allowances |       | 68,119                |       | 73,584 |   |
| Accrued legal  costs                                            |       | 2,272                 |       | 3,289 |   |
| Other liabilities                                               |       | 6,104                 |       | 6,317 |   |
|                                                            |       | $                     | 81,265     |   | $ | 89,226 |   |

 

**10.   Commitmentsand Contingencies**

**Lease Commitments**

The Company hasobligations under various non-cancelable operating leases that have terms in excessof one year. Minimum lease payments for years 2005 through 2009 are $870, $888,$886, $896 and $926, respectively. Minimum lease payments after 2009 aggregate$5,010. The Company’s future lease obligations are primarily related to a 10year lease which runs through February 15, 2015 for its corporate offices.The above commitment also includes obligations under leases for certainautomobiles and office equipment. For the years ended December 31, 2004,2003 and 2002, expenses under operating leases were approximately $61, $41 and$37, respectively.

**Other Commitments**

The Company has open purchase orders as of December 31,2004 of approximately $48,000, including approximately $43,000 relating toinventory. The balance is attributable to non-inventory items, including fixedassets, research and development materials, supplies and services.

The Company has agreed topurchase research and development services from its consolidated variableinterest entity of approximately $1,295, $1,992, $1,992, and $1,494, in each ofthe years 2005 through 2008, respectively. The Company paid this entity $1,836for such services in 2004. In addition, third-party shareholders of this entityhave the right to require the Company to purchase their shares after November 2007based on a formula as provided for in the Shareholder Agreement.

**Line of Credit**

On February 8, 2002,the Company entered into a three-year $25,000 credit agreement, which wasamended and restated on July 30, 2004, extending the term of the agreementto December 31, 2007 and eliminating a security interest in the Company’saccounts receivable and inventories. 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 willdepend upon the terms of the selected borrowings. There is an annual commitmentfee of 0.2% on any unused portion of the line. The agreement has covenantswhich require the maintenance of certain financial ratios including leverage,consolidated debt and minimum consolidated net worth, as further describedtherein. At December 31, 2004 and 2003, there were no outstandingborrowings under the line of credit.

**Medicaid Rebates**

The Omnibus Budget Reconciliation Act of 1990,effective January 1, 1991, as amended, requires drug companies to enterinto a rebate agreement with the Centers for Medicare and Medicaid Services(formerly called the Health Care Financing Administration) of the federalgovernment. The rebate 

F-19

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agreement states that drugcompanies must pay rebates to states for drugs (prescription, non-prescriptionor biological products) sold to Medicaid recipients. At December 31, 2004and 2003, the estimated liability for Medicaid rebates of $7,135 and $4,009, respectively,are included in accrued liabilities.

In December 2003, theAttorneys General in at least six states, including the state of Florida, sentletters to numerous pharmaceutical manufacturers instructing them to maintainall records relating to their reporting of pricing information under theMedicaid Drug Rebate Statute. The letters state that the document retentiondemand is in furtherance of an ongoing investigation of the manufacturers’compliance with Medicaid drug rebate program requirements. The Company receivedletters from some, but not all, of the states believed to be involved,including the state of Florida. The Company believes these letters may havebeen motivated, at least in part, by a federal regulation published in August 2003that, effective January 1, 2004, would have limited the document retentionprovisions under the federal Medicaid Drug Rebate Statute to three years unlessthe records are the subject of an audit or a government investigation of whichthe manufacturer is aware. That regulation was amended, effective January 6,2004, to substitute a 10-year record retention requirement. The State ofFlorida issued subpoenas to six manufacturers requesting documents relating totheir pricing and discounting practices in July 2004. The Company has notreceived any subpoenas, informal document requests, or any other communicationsfrom federal or state enforcement authorities that suggest an investigation ofits Medicaid drug rebate reporting practices or its pricing practices is underway. The Company believes it operates in compliance with the requirements ofthe Medicaid Drug Rebate Statute.

**State MedicaidClaims**

EHI purchased Major Pharmaceuticals, Inc. (“Major”),a distributor of drug products in 1992 and 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 December 31,2004, the recorded liability for such claims is $817, which management believesis adequate to resolve such matters. The Company has approximately $686 as of December 31,2004, in an escrow account to fund any such claims.

**11.   EmployeeBenefit Plans**

**Savings IncentivePlan**

The Company has a definedcontribution Savings Incentive Plan (the “Savings Plan”) which is offered toall eligible employees and is qualified under Section 401(k) of theInternal Revenue Code. Employees are eligible for participation at the start ofany calendar quarter, provided the employee has attained 21 years of age. TheSavings Plan provides an employer matching contribution which will begin at thestart of the quarter coincident with or next following the one-year anniversaryof the participant’s hire date in an amount as defined in the Savings Plan. TheSavings Plan provides for matching contributions equal to 50% of theparticipant’s contribution, to the extent that the participant’s contributionsdo not exceed 6% of his other compensation. The cash contributions to theSavings Plan in 2004, 2003, and 2002 were $296, $235, $173, respectively.

**Stock Option Plan**

Effective September 30, 2001, the Companyconverted its Stock Appreciation Rights (“SAR”) Plan to a stock option plan(the “2001 Stock Option Plan”) pursuant to provisions for such conversion inthe SAR Plan. In connection with the conversion, each outstanding SAR wasconverted into an option to purchase one share of common stock at an exerciseprice equal to the original base value of the SAR at date of grant.

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As of the conversion date, the Company classifieddeferred compensation of $18,957 as additional paid-in capital. For optionawards not fully vested as of September 30, 2001, the remaining unrecordeddeferred compensation expense of $2,134 will be recognized over the remainingvesting period. The Company has amortized an additional $184, $448, and $1,154of deferred compensation into expense for the years ended December 31,2004, 2003 and 2002, respectively.

The 2001 Stock Option Plan provides for the grantingof up to 6,000,000 options to purchase common stock, of which 23,000 areavailable for future grants at December 31, 2004. At the Company’s AnnualMeeting of Stockholders held on May 15, 2003, the Company’s 2003 StockIncentive Plan (the “2003 Stock Incentive Plan”) was approved by thestockholders, making available the issuance of a maximum of 2,000,000 shares ofcommon stock, provided that no more than 400,000 shares of common stock beissued to any one person pursuant to awards of options or stock appreciationrights during any one year. At December 31, 2004, 1,457,800 options topurchase common stock were available for grant under the 2003 Stock IncentivePlan. Stock options granted under the plans are exercisable for up to 10 yearsfollowing the date of grant. Vesting provisions are determined by theCompensation Committee of the Board. Except for 60,000 options, which vestedimmediately, the options vest and become exercisable at the rate of 20% peryear.

Asummary of the Company’s stock options is as follows:
| ** **                        | ** ** | **Year ended  December 31, 2004** | ** ** | **Year ended  December 31, 2003** | ** ** | **Year ended  December 31, 2002** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **Shares**                                       | ** ** | **Weighted  Average  Exercise Price**       | ** ** | **Shares**                                       | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| Balance at  beginning of year     |       | 4,317,980                                        |       |                                             | $          | 6.92                                             |       |   | 3,862,240 |   |   | $ | 2.91 |   |   | 3,902,700 |   |   | $ | .58 |   |   |
| Exercised                         |       | (582,700                                         | )          |                                             | 1.76       |                                             |       | (590,060 | ) |   | .96 |   |   | (1,034,760 | ) |   | .37 |   |   |
| Forfeited or  cancelled           |       | (33,600                                          | )          |                                             | 15.45      |                                             |       | (75,200 | ) |   | 6.08 |   |   | (30,000 | ) |   | 9.13 |   |   |
| Granted                           |       | 610,000                                          |       |                                             | 29.24      |                                             |       | 1,121,000 |   |   | 17.55 |   |   | 1,024,300 |   |   | 9.39 |   |   |
| Outstanding at end  of year       |       | 4,311,680                                        |       |                                             | $          | 10.70                                            |       |   | 4,317,980 |   |   | $ | 6.92 |   |   | 3,862,240 |   |   | $ | 2.91 |   |   |
| Exercisable at  end of year  |       | 2,332,500                                        |       |                                             | $          | 4.11                                             |       |   | 2,222,700 |   |   | $ | 1.29 |   |   | 2,400,060 |   |   | $ | .58 |   |   |
|                                   |            |                                                  |            |                                                  |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing table summarizes options outstanding and exercisable atDecember 31, 2004:
| **Exercise Prices** | ** ** | ** ** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining Life  in Years** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|--------------------------|------------|------------|------------|-------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------|------------|--------------------------------------------|------------|
| $  0.12        |       | 143,000    |       |                    | 6.75       |                                                      |       |                                       | $          | 0.12                    |       |                                       | 143,000    |   |   | $ | 0.12 |   |   |
| $  0.60        |       | 864,500    |       |                    | 6.75       |                                                      |       |                                       | $          | 0.60                    |       |                                       | 864,500    |   |   | $ | 0.60 |   |   |
| $  1.05        |       | 762,200    |       |                    | 6.75       |                                                      |       |                                       | $          | 1.05                    |       |                                       | 753,200    |   |   | $ | 1.05 |   |   |
| $  9.13        |       | 658,480    |       |                    | 7.50       |                                                      |       |                                       | $          | 9.13                    |       |                                       | 243,100    |   |   | $ | 9.13 |   |   |
| $10.34                   |       | 190,700    |       |                    | 7.82       |                                                      |       |                                       | $          | 10.34                   |       |                                       | 58,700     |   |   | $ | 10.34 |   |   |
| $17.51                   |       | 1,062,800  |       |                    | 8.68       |                                                      |       |                                       | $          | 17.51                   |       |                                       | 206,000    |   |   | $ | 17.51 |   |   |
| $19.84                   |       | 20,000     |       |                    | 8.79       |                                                      |       |                                       | $          | 19.84                   |       |                                       | 4,000      |   |   | $ | 19.84 |   |   |
| $29.32                   |       | 540,000    |       |                    | 9.15       |                                                      |       |                                       | $          | 29.32                   |       |                                       | —     |   |   | $ | — |   |   |
| $29.36                   |       | 60,000     |       |                    | 9.17       |                                                      |       |                                       | $          | 29.36                   |       |                                       | 60,000     |   |   | $ | 29.36 |   |   |
| $24.05                   |       | 10,000     |       |                    | 9.70       |                                                      |       |                                       | $          | 24.05                   |       |                                       | —     |   |   | $ | — |   |   |
|                     |       | 4,311,680  |       |                    |       |                                                      |       |                                       | $          | 10.70                   |       |                                       | 2,332,500  |   |   | $ | 4.11 |   |   |

 

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The Company applies Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), andrelated interpretations in accounting for its stock-based compensation. Inaddition, the Company provides pro forma disclosure of stock-basedcompensation, as measured under the fair value requirements of Statement ofFinancial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation” and determined through the use of the Black-Scholes optionpricing model. These pro forma disclosures are provided in Note 3 as requiredunder Statement of Financial Accounting Standards No. 148, “Accounting forStock-Based Compensation—Transition and Disclosure.”

Thefair value of the options was determined using the Black-Scholes option pricingmodel with the following assumptions:
| ** **               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend yield           |       | 0        | %          | 0        | %          | 0        | %          |
| Volatility               |       | 45       | %          | 45       | %          | 45       | %          |
| Risk-free  interest rate |       | 3.41     | %          | 3.53     | %          | 3.80     | %          |
| Expected life            |       | 5 years  |       | 5 years  |       | 5 years  |       |

 

**12.**   Equity

**Initial PublicOffering and Stockholders’ Equity**

In June 2002, theCompany completed its initial public offering of common stock, which resultedin net proceeds of $139,236 and the issuance of 20,401,626 shares of commonstock. Upon the consummation of the Company’s initial public offering, all ofthe previously outstanding shares of the Company’s preferred stock wereconverted into 60,000,000 shares of common stock and warrants were exercised,resulting in the issuance of 3,361,056 shares of common stock. Immediatelyfollowing the closing of the Company’s initial public offering, debt of $25,178due to Hexal was converted into 3,357,122 shares of common stock and debt of$66,942 due to Hexal was paid with the proceeds of the offering.

**13.**   Litigation

**Product LiabilityLitigation**

*Fen-phen Litigation*

Since May 1997, the Company and certain of itscustomers have been named as defendants in numerous product liability lawsuits,some of which are class actions, filed in various state and federal courts inconnection with its manufacture of Phentermine Hydrochloride. These lawsuitstypically name as a defendant Wyeth (formerly American Home ProductsCorporation), the manufacturer of two anti-obesity drugs, Fenfluramine andDexfenfluramine, and also name manufacturers, distributors and retailers ofPhentermine. Fenfluramine and Phentermine were prescribed in combination in anoff-label use commonly called “fen-phen,” while Dexfenfluramine was generallyprescribed alone, but occasionally in combination with Phentermine. In September 1997,the manufacturer of Fenfluramine and Dexfenfluramine agreed with the U.S. Foodand Drug Administration (the “FDA”) to voluntarily withdraw both products fromthe market. The FDA has not requested that Phentermine be withdrawn from themarket.

The plaintiffs in these cases (the “fen-phen cases”)typically allege that the short- and long-term use of Fenfluramine incombination with Phentermine causes, among other things, primary pulmonaryhypertension, valvular heart disease and/or neurological dysfunction. Somelawsuits allege emotional distress caused by the purported increased risk ofinjury in the future. Plaintiffs typically seek relief in the form of monetarydamages (including economic losses, medical care and monitoring expenses, lossof earnings 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 

F-22

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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.

During 2000, the U.S. District Court for the EasternDistrict of Pennsylvania, the federal court before which all federal cases wereconsolidated for discovery, found that proposed anti-Phentermine “causation”testimony by two expert witnesses was not supported by scientific evidence andthus would be barred. These two experts were the only “national”anti-Phentermine “causation” experts identified in the consolidated federallitigation, and were to have been “generic” experts in hundreds of cases. TheCourt’s decision to curb their testimony substantially has resulted in manycases being dismissed. To date, there has been no scientific testimony acceptedby any court that establishes a connection between the use of Phentermine,either alone or in combination with Fenfluramine and/or Dexfenfluramine, andthe allegations of injury made by plaintiffs in these lawsuits.

In late 1999, Wyeth, the major defendant in thefen-phen litigation and the former manufacturer of both Fenfluramine andDexfenfluramine, announced a proposed settlement of all fen-phen claims againstit nationwide (excepting only claims for certain serious medical conditions). TheU.S. District Court for the Eastern District of Pennsylvania, which supervisesdiscovery of all federal fen-phen cases in a consolidated multidistrictlitigation, certified a nationwide settlement class and approved the proposedsettlement, which became final in January 2002. This settlement hasreduced the number of new cases in which the Company and its distributors havebeen named as defendants.

As of December 31, 2004, the Company had beennamed and served in over 7,100 fen-phen product liability cases. More than 92%of these cases have been dismissed, and the Company remains a defendant inapproximately 552 pending fen-phen cases. Since the beginning of the fen-phenlitigation, only one case has gone to trial with the Company and its distributorsas defendants. In that instance, the case against the Company and all thePhentermine defendants, including other Phentermine manufacturers anddistributors, was dismissed on motion before the presentation of any evidence.

While the number of lawsuitsbeing filed has decreased substantially, the Company expects additional,similar lawsuits to be filed. The Company and its outside counsel believe thatthe Company has substantial defenses to these claims, though the ultimateoutcome cannot be determined. As of December 31, 2004, there had been nofinding of liability for fen-phen injury against the Company and no payment bythe Company to settle any combination-related fen-phen lawsuit. No provisionfor any related liability has been reflected in the Company’s financialstatements.

*PhentermineLitigation*

The Company has been named as a defendant in severalcases in which the plaintiffs allege injury from the use of Phentermine alone,and in one instance the Company was named as a third-party defendant in amedical malpractice case in which negligent prescription of Phentermine wasalleged. A number of these claims have been dismissed in the Company’s favor,and as of December 31, 2004, only one such claim remained pending. Becausediscovery has not been completed in this pending case, predicting the ultimateoutcome of this action is not possible, and no provision for any relatedliability has been reflected in the Company’s financial statements. The Companybelieves it has substantial defenses to this claim.

Net sales of Phentermineby the Company were approximately $8 million, $11 million and $20 million forthe years ended December 31, 2004, 2003 and 2002, respectively.

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

In or about April 2000,the Company exhausted its product liability insurance covering allcombination-related Phentermine lawsuits and any non-combination Phenterminelawsuits resulting from claims regarding the ingestion of Phentermine prior to June 1998.Since that time, the Company has funded its own defense in such lawsuits. However,pursuant to an October 1999 settlement with an insurance carrier, theCompany has made insurance coverage claims for fen-phen claims filed on orafter June 22, 2003, which allege fen-phen use prior to June 1998. Theseclaims were settled during the third quarter of 2004 for a one-time payment ofapproximately $1.4 million that will defray future fen-phen defense costs. Additionally,the Company agreed to fund or partially fund the defense of certain of itsdistributors and to indemnify them, provided certain conditions are met. Furthermore,the Company has reached favorable defense/indemnity agreements with severalretailers of the Company’s Phentermine products. Fen-phen and Phenterminelitigation defense costs, and the costs of related defense agreements, arebeing expensed as incurred.

*Other ProductLiability Litigation*

The Company has been named as a defendant in severalother product liability lawsuits in which plaintiffs allege thatCompany-manufactured pharmaceuticals containing phenylpropanolamine (“PPA”)caused injury. PPA was removed from the market in 2000 at the FDA’s requestafter a study appeared to show a potentially increased risk of hemorrhagicstroke in certain patient cohorts. The Company previously manufactured twolow-volume prescription products that contained PPA that were discontinued in1999 and 2000.

To date, the Company has been named in five lawsuitsalleging injury or wrongful death from the use of Company-manufacturedpharmaceuticals containing PPA. As of December 31, 2004, all but two PPAcases against the Company had been dismissed or discontinued. Discovery inthese lawsuits is incomplete, and predicting the ultimate outcome of theseactions is not possible. The Company believes its product liability insuranceis adequate to cover existing PPA claims and, consequently, no provision forany related liability has been reflected in the Company’s financial statements.

In April 2004, the Company was also named as adefendant in a lawsuit alleging injury from the use of Company-manufacturedDesipramine, which has been settled for nominal value. In May 2004, theCompany was also named defendant in a product liability lawsuit in which theplaintiff alleges injury from the use of Company-manufactured Lisinopril/HCTZ. Discoveryin this case continues, and the Company believes it would be premature toexpress a judgment as to its outcome.

The Company was named as adefendant in several lawsuits in which plaintiffs allege thatCompany-manufactured Amiodarone caused injury or death. A lawsuit filed againstthe Company in 2003 alleging injury from the use of Company-manufacturedAmiodarone was settled in July 2004 for nominal value. As of December 31,2004, the Company remained a defendant in two Amiodarone related lawsuits. Inone of the lawsuits, the plaintiff alleges generic Amiodarone manufactured bythe Company and several other pharmaceutical companies caused a wrongful death.In the second lawsuit, plaintiffs purporting to represent a class comprised ofusers of Amiodarone nationwide from 1985 to the present seek classcertification, damages, refunds, medical monitoring, exemplary damages andother relief, including injunctive relief, against several of the manufacturersof Amiodarone. Discovery in these cases has not yet begun, and the Companybelieves it would be premature to express a judgment as to its outcome.

*Patent InfringementLitigation*

In August 2000, Novartis PharmaceuticalsCorporation (“Novartis Pharmaceuticals”) filed a complaint in the U.S. DistrictCourt for the District of Delaware alleging, among other things, that theCompany’s generic Cyclosporine product infringes a patent owned by NovartisPharmaceuticals. In 

F-24

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December 2002, theU.S. District Court for the District of Delaware granted the Company’s motionfor summary judgment of non-infringement of the patent. In April 2004, theU.S. Court of Appeals for the Federal Circuit affirmed the judgment of theDelaware district court that the Company’s generic Cyclosporine product doesnot infringe Novartis Pharmaceuticals’ patent. Novartis Pharmaceuticals’request for a rehearing by the U.S. Appeals Court is still pending. The Company’spotential liability and expenses in this matter are not covered by insurance. Anadverse outcome in this litigation could result in the Company being unable tomarket Cyclosporine, which could materially harm profits and cash flows, andcould result in paying damages, costs, expenses and fees that could have amaterial adverse impact on the Company’s financial performance.

In January 2001, Apotex, Inc. (“Apotex”)filed an action in the U.S. District Court for the Eastern District of New Yorkalleging that by manufacturing, selling and offering to sell Cyclosporinecapsules the Company is infringing a patent of which Apotex alleges it is theexclusive licensee. Apotex seeks injunctive relief as well as an unspecifiedamount of damages and has also asserted a claim that the alleged infringementwas willful, that the case is therefore exceptional and that Apotex shouldtherefore be awarded the attorney fees it has incurred and treble damages inthe action. The Company’s potential liability and expenses in this matter arenot covered by insurance. An adverse outcome in this litigation could result inthe Company being unable to market Cyclosporine, which could materially harmprofits and cash flows, and could result in paying damages, costs, expenses andfees that could have a material adverse impact on the Company’s financialperformance. The Company has denied that it has infringed any valid patentclaims asserted by Apotex, has alleged affirmatively, among other things, thatthe patent is invalid and unenforceable and that it is not infringed by theCompany’s manufacture, sale or offer to sell its Cyclosporine capsules. Theaction remains pending.

In November 2000, Glaxo filed suit against theCompany in the U.S. District Court for the Southern District of New Yorkalleging infringement of two patents based on the Company’s filing of an ANDAto market generic Bupropion Hydrochloride 100 mg and 150 mg ER (extendedrelease) tablets. In April 2004, a Stipulation and Order was entered inthe U.S. District Court for the Southern District of New York, terminating allpending claims and counterclaims in the patent infringement litigation thatGlaxo brought against the Company in November 2000, concerning the Company’sBupropion HCl, ER 100 mg and 150 mg tablets. Under the terms of the Stipulationand a separate Settlement Agreement, Glaxo agreed to drop any further effort topursue its claim that the Company’s Bupropion HCl, ER 100 mg and 150 mg tabletsinfringe Glaxo’s patents. The Company received $3,000 as part of the SettlementAgreement, which was recorded as other income in the quarter ended June 30,2004.

In July 2004, the U.S. District Court for theEastern District of New York ruled on a pending patent infringement case thatinvolved Itraconazole capsules. The suit, filed in April 2001 by JanssenPharmaceutica, N.V. (“Janssen”), claimed that the Company’s filing of an ANDAfor Itraconazole capsules infringed its patent. The District Court ruling foundthat the Company’s ANDA product did not infringe the patent, but the Court didnot invalidate the patent. On August 10, 2004, Janssen filed a Notice OfAppeal to the Federal Circuit Court of Appeals. Janssen’s appeal of theDistrict Court’s ruling is pending. In February 2005, the Company beganselling Itraconazole capsules. A reversal of the District Court’s ruling by theCourt of Appeals could result in the Company being enjoined from marketing theproduct which could materially harm profits and cash flows, and result inpaying damages, costs, and fees that could have a material adverse impact onthe Company’s financial performance. The Company and its outside counselbelieve that the Company has substantial defenses and counterclaims to theforegoing patent infringement actions, though the ultimate outcome cannot bedetermined.

On October 29, 2004, the Company began shippingthe generic drug Citalopram Hydrobromide. Earlier in October 2004, theCompany received a notice from Forest Laboratories, Inc. and H. LundbeckA/S that requested certain information from the Company. The notice alsoincluded a list of patents that 

F-25

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they hold which theyallege covers Citalopram Hydrobromide. The Company has not been sued for patentinfringement in connection with its sale of Citalopram Hydrobromide.

In addition, the Company has been named in severalother patent infringement actions alleging that the Company has infringedpatents by filing an application with the FDA for approval to market productsbefore the plaintiffs’ patents expire. In general, plaintiffs seek judgments precludingthe FDA from approving the Company’s application to market a product beforetheir respective patents expire and have asserted claims that the allegedinfringements were willful, the actions are therefore exceptional and theplaintiffs should therefore be awarded the attorney’s fees they have incurredin the actions.

The Company and its legalcounsel are unable to determine the ultimate outcome of these actions or theprobability that a material loss could be incurred. As such, no provision forany related liability has been reflected in the Company’s financial statements.

**NabumetoneSettlements**

In August 2001, theCompany was successful in defending itself in the U.S. District Court for theDistrict of Massachusetts against a patent infringement claim involvingNabumetone. At the conclusion of the trial, the Company filed a motion torecover the legal fees it incurred in defending the action. The motion wasstayed pending the appeal of the District Court’s ruling. The Court of Appealsaffirmed the District Court decision in August 2002. In May 2003, theCompany and the original plaintiff reached an agreement regarding the Company’smotion to recover legal fees. Under the agreement, the Company was reimbursed$3,500 for legal fees it had incurred in defending itself. The recovery oflegal fees was reflected in other selling, general and administrative expensesduring the quarter ended June 30, 2003. In February 2004, the Companystipulated to an order dismissing its complaint against Glaxo for maliciousprosecution of Glaxo’s earlier suit against the Company, which claimed theCompany’s Nabumetone product infringed Glaxo’s patent. In exchange for theCompany agreeing to the dismissal of its complaint, the Company received$10,000, which was included in other income in the quarter ended March 31,2004.

**Other Litigation**

Subsequent to the public announcement of the executionof the Merger Agreement on February 21, 2005, eight purported classactions were filed—one in the Supreme Court of the State of New York and seven inthe Court of Chancery of the State of Delaware—naming as defendants theCompany, Novartis AG, Thomas Strüngmann, Ph.D., Bernhard Hampl, Ph.D., Mark R.Patterson, Frank F. Beelitz and Douglas M. Karp. (In three of those actions,Novartis was also named as a defendant, in two of those actions Merger Sub wasalso named as a defendant and in one of those actions Santo was also named as adefendant.)

The actions, purportedly on behalf of all publicstockholders of the Company other than the defendants, in substance allege thatthe terms of the Offer and Merger are unfair to the Company’s publicstockholders because the value of the Company’s publicly held common stock isgreater than the $31 per share price that will be offered to the Company’spublic stockholders in the Offer and, if a majority of the Public Shares arepurchased in the Offer, will be paid for the remaining Public Shares in theMerger. All of the complaints assert claims for breach of fiduciary duty and,in their prayers for relief, seek, among other things, to enjoin the Offer andthe Merger.

The Company and its directors believe that all of theactions are without merit and intend to vigorously defend them.

The Company is involved inother litigation incidental to its business activities. The ultimatedisposition of such lawsuits will not materially affect the Company’s financialstatements.

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**14.   TransactionsBetween the Company and Related Parties**

Thefollowing is a summary of the Company’s related-party transactions:
| ** **                                                                                              | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net sales to  subsidiaries of Hexal AG                                                                  |       | $                                           | 2,157      |   | $ | 883 |   | $ | 113 |   |
| Purchase of products  and supplies from subsidiaries of Hexal AG                                        |       | 2,104                                       |       | 1,031 |   | 849 |   |
| Hexal AG  reimbursement to the Company for expenditures that were made on Hexal AG’s  behalf       |       | 574                                         |       | — |   | — |   |
| Company’s  reimbursement to Hexal AG for expenditures that were made on the Company’s  behalf |       | 90                                          |       | 86 |   | 100 |   |
| Company’s  expenditures made on behalf of Santo Holding (Deutschland) GmbH                         |       | 58                                          |       | — |   | — |   |
| Cyclosporine  agreements with Hexal AG(a)                                                               |       | 3,850                                       |       | 5,878 |   | 4,026 |   |
| Fees incurred  under product development agreements with Hexal AG                                  |       | 966                                         |       | 1,300 |   | — |   |
| Interest on intercompany  loans from Hexal AG                                                           |       | —                                      |       | — |   | 2,463 |   |
|                                                                                                         |            |                                             |            |  |  |  |  |  |  |  |

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(a)           Under agreements withHexal, the Company pays Hexal based on sales of a specific product, which wasdeveloped using Hexal’s patented technology.

In 2002 and 2001, HPI was a party to certain researchand development contracts with third parties for which Hexal loaned $700 and$1,600, respectively, to HPI for the payment of its obligations. During 2002,the research and development contracts, which were unrelated to the Company’sbusiness, were transferred to an entity unrelated to the Company.

At December 31, 2004 and 2003, the Company had apayable to Hexal of approximately $1,700 and $1,100, respectively, included inaccrued liabilities.

At December 31, 2004and 2003, the Company had receivables from subsidiaries of Hexal ofapproximately $100 each included in prepaid expenses and other current assets.

**15.   Selling,General and Administrative Expenses**

Included in selling, general and administrativeexpenses were legal defense costs for Phentermine litigation of approximately$1,200, $2,600 and $3,400 for the years 2004, 2003 and 2002, respectively.

Included in selling, general and administrativeexpenses for the years ended December 31, 2004, 2003 and 2002 wereapproximately $9,600, $5,600 (net of $3,500 recovery) and $6,300, respectively,of legal costs incurred in connection with patent challenges involving drugsmanufactured and sold by other companies.

Allowance for doubtfulaccounts was $1,500 at December 31, 2004 and 2003, respectively and $1.0million at December 31, 2002. In 2004 and 2002, the Company neither madeany additional provision nor wrote-off any bad debts. In 2003, the Company madea provision of $500.

**16.   OtherSupplemental Cash Flow Information**

Othersupplemental cash flow information is as follows:
| ** **                                                        | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| 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   |       |
|                                                                   |            |          |            |          |            |          |            |  |  |  |

 

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**17.   Unaudited Quarterly Financial Data**
| **2004**              | ** ** | ** ** | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|-----------------------|------------|------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| Net sales             |       |       | $          | 104,229            |       |                |       | $                  | 106,962    |                |       |   | $ | 109,778 |   |   |   | $ | 109,990 |   |   |
| Gross profit          |       |       | $          | 61,308             |       |                |       | $                  | 62,926     |                |       |   | $ | 59,591 |   |   |   | $ | 56,532 |   |   |
| Net income            |       |       | $          | 32,317             |       |                |       | $                  | 28,788     |                |       |   | $ | 28,089 |   |   |   | $ | 30,156 |   |   |
| Earnings per share(1) |       |       |       |               |       |                |       |               |       |                |       |   |   |   |   |   |   |
| Basic                 |       |       | $          | 0.36               | (3)        |                |       | $                  | 0.32       | (4)                 |       |   | $ | 0.32 |   |   |   | $ | 0.34 |   |   |
| Diluted               |       |       | $          | 0.36               | (3)        |                |       | $                  | 0.32       | (4)                 |       |   | $ | 0.31 |   |   |   | $ | 0.33 |   |   |

 
| **2003**              | ** ** | ** ** | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|-----------------------|------------|------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| Net sales             |       |       | $          | 70,857             |       |                |       | $                  | 76,681     |                |       |   | $ | 85,011 |   |   |   | $ | 94,989 |   |   |
| Gross profit          |       |       | $          | 37,472             |       |                |       | $                  | 40,660     |                |       |   | $ | 46,635 |   |   |   | $ | 50,384 |   |   |
| Net income            |       |       | $          | 15,107             |       |                |       | $                  | 18,032     |                |       |   | $ | 17,819 |   |   |   | $ | 19,177 |   |   |
| Earnings per share(1) |       |       |       |               |       |                |       |               |       |                |       |   |   |   |   |   |   |
| Basic                 |       |       | $          | 0.17               |       |                |       | $                  | 0.20       | (2)                 |       |   | $ | 0.20 |   |   |   | $ | 0.22 |   |   |
| Diluted               |       |       | $          | 0.17               |       |                |       | $                  | 0.20       | (2)                 |       |   | $ | 0.20 |   |   |   | $ | 0.21 |   |   |

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(1)          The sum of earnings pershare for the four quarters may not equal earnings per share for the total yeardue to changes in the average number of common shares outstanding.

(2)          Includes recovery of$3,500 of legal fees or $0.02 per share.

(3)          Includes the receipt of$10.0 million payment to settle all patent infringement litigation related toNabumetone or $0.07 per share.

(4)          Includesthe receipt of $3.0 million bond related to the settlement of all patentlitigation involving Bupropion HCl, ER 100mg and 150mg tablets or $0.02 pershare.

**18.   SubsequentEvents**

On February 20, 2005, the Company entered intothe Merger Agreement with Novartis, Merger Sub, and, solely with respect to itsguarantee of Novartis’s and Merger Sub’s obligations thereunder, Parent. Pursuantto the Merger Agreement, Merger Sub will commence a tender offer (the “Offer”)to purchase all of the issued and outstanding shares of the Company’s commonstock, par value $0.01 per share (the “Common Stock”) (other than those sharesowned by Santo Holding (Deutschland) GmbH (“Santo”)), at a purchase price of$31.00 per share (the “Offer Price”).

In connection with the execution of the MergerAgreement, Novartis, Santo and Parent entered into an Agreement for Purchaseand Sale of Stock (the “Santo Agreement”), pursuant to which Novartis agreed topurchase, and Santo agreed to sell, all of the shares of the Company held bySanto (the “Santo Shares,” such transaction, the “Santo Purchase”),representing approximately 67.5% of the outstanding shares of Common Stock, for€1.3billion (approximately $1.75 billion) in cash on the terms and subject to theconditions set forth therein.

The Offer is not conditioned upon any minimum numberof shares being tendered, but is contingent upon the contemporaneous (orimmediately subsequent) closing of the Santo Purchase pursuant to the SantoAgreement. In addition to certain customary conditions, the closing of theSanto Purchase is conditioned on the acquisition by Novartis (Deutschland) GmbHof all of the outstanding shares and partnership interests of Hexal AG (“Hexal”),including shares held directly and indirectly by Dr. Thomas Strüngmann,the Chairman of the Board of Directors of the Company and an indirectsignificant 

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stockholder of Santo, and Dr. AndreasStrüngmann, an indirect significant stockholder of Santo. Additionally, theSanto Purchase is subject to customary regulatory approvals, includingclearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, asamended. Following the completion of the Offer and the purchase of the SantoShares, if a majority of the outstanding shares of Common Stock other than theSanto Shares are purchased in the Offer, any remaining shares of Common Stockwill be acquired by Merger Sub and, in accordance with Delaware GeneralCorporation Law (the “DGCL”), Merger Sub will be merged with and into theCompany.

The Merger Agreement provides that upon consummationof the Offer, the Confidentiality Agreement, dated February 11, 2005,between the Company and Novartis (which currently restricts the ability ofNovartis and its affiliates to acquire shares of Common Stock other than theSanto Shares (the “Public Shares”) without approval of a majority of thespecial committee of independent board members, which was appointed to reviewthe Offer and the Merger, and of the Company’s Board of Directors) will beamended to provide that Novartis and its affiliates will be permitted to makeacquisitions of Public Shares that are voluntary to the holders of PublicShares (such as by means of legally permissible open market purchases or tenderoffers), but, prior to February 11, 2006, Novartis and Merger Sub will notbe permitted to cause a merger transaction (or other business combination) tobe effected which would cancel Public Shares unless (i) a majority of theoutstanding Public Shares vote in favor of such a transaction or (ii) Novartisand its subsidiaries, at that time, own at least 90% of the outstanding CommonStock; provided, that the consideration to be received by the holders of PublicShares in any such transaction described in (ii) above must be at leastequal to $31.00 per Public Share. Following the completion of the Offer anduntil the earlier of the consummation of the Merger and February 11, 2006,Novartis and Merger Sub are required to use their reasonable best efforts tokeep the Common Stock quoted for trading on the NASDAQ National Market unlessthe Company is no longer required to be registered under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), or no longer satisfiesNASDAQ’s listing standards (other than standards entirely within the Company’scontrol).

At the effective time of the Merger, each issued andoutstanding share of Common Stock (other than shares owned by Novartis, any ofits subsidiaries (including Merger Sub) or any of its affiliates, any sharesheld in the treasury of the Company and shares held by stockholders whoproperly demand appraisal and comply with the provisions of Section 262 ofthe DGCL, relating to dissenters’ rights of appraisal) will be converted intothe right to receive an amount equal to the Offer Price. Following theconsummation of the Merger, the Company will continue as the survivingcorporation and will be a wholly owned subsidiary of Novartis.

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