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AKRX > SEC Filings for AKRX > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for AKORN INC


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

FORWARD-LOOKING STATEMENTS AND FACTORS AFFECTING FUTURE RESULTS

Certain statements in this Form 10-Q are forward looking statements and are intended to be "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act. These statements relate to future events or future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as "may," "should," "could," "expects," "plans," "intends," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of such terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. These statements are only predictions.

You should not place undue reliance on forward-looking statements because they involve known and unknown risks, uncertainties, and other factors that are, in some cases, beyond our control and that could materially affect actual results, levels of activity, performance or achievements. Factors that could materially affect our actual results, levels of activity, performance or achievements include, without limitation, those detailed under the caption "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, as filed with the SEC on March 15, 2012, and include the following items:

Our ability to comply with all of the requirements of the U.S. Food and Drug Administration ("FDA"), including current Good Manufacturing Practices regulations;

Our ability to obtain additional funding or financing to operate and grow our business;

The effects of federal, state and other governmental regulation on our business;

Our ability to obtain and maintain regulatory approvals for our products;

Our success in developing, manufacturing, acquiring and marketing new products;

Our ability to generate cash flow from operations sufficient to meet our working capital requirements;

The success of our strategic partnerships for the development and marketing of new products;

Our ability to bring new products to market and the effects of sales of such products on our financial results;

Our ability to successfully integrate acquired businesses and products;

The effects of competition from generic pharmaceuticals and from other pharmaceutical companies;

Availability of raw materials needed to produce our products; and

Other factors referred to in this Form 10-Q, our Form 10-K and our other Securities and Exchange Commission ("SEC") filings.

If any of these risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary significantly from what we projected. Any forward-looking statement you read in the following Management's Discussion and Analysis of Financial Condition and Results of Operations reflects our current views with respect to future events and is subject to these and other risks, uncertainties, and assumptions relating to our operations, results of operations, growth strategy, and liquidity. We assume no obligation to publicly update or revise these forward-looking statements for any reason, whether as a result of new information, future events, or otherwise.

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RESULTS OF OPERATIONS

The following table sets forth the amounts and percentages of total revenue for
certain items from our Condensed Consolidated Statements of Comprehensive Income
and our segment reporting information for the three and nine month periods ended
September 30, 2012 and 2011 (dollar amounts in thousands):

                                        Three months ended September 30,                         Nine months ended September 30,
                                        2012                        2011                         2012                         2011
                                              % of                        % of                          % of                        % of
                                Amount       Revenue        Amount       Revenue        Amount         Revenue        Amount       Revenue
Revenues:
Hospital drugs & injectables   $ 34,675          49.8 %    $ 13,816          37.6 %    $  92,335           50.0 %    $ 34,615          36.7 %
Ophthalmic                       28,153          40.4 %      19,730          53.8 %       75,114           40.7 %      48,972          51.9 %
Contract services                 6,806           9.8 %       3,157           8.6 %       17,189            9.3 %      10,708          11.4 %
Total revenues                   69,634         100.0 %      36,703         100.0 %      184,638          100.0 %      94,295         100.0 %
Gross profit:
Hospital drugs & injectables     22,278          64.3 %       7,206          52.2 %       58,132           63.0 %      18,162          52.5 %
Ophthalmic                       16,637          59.1 %      12,821          65.0 %       43,869           58.4 %      30,899          63.1 %
 Contract services                1,178          17.3 %       1,951          61.8 %        4,720           27.5 %       5,053          47.2 %
Total gross profit               40,093          57.6 %      21,978          59.9 %      106,721           57.8 %      54,114          57.4 %
Operating expenses:
  SG&A expenses                  12,346          17.7 %       8,669          23.6 %       33,625           18.2 %      22,983          24.4 %
  Acquisition-related costs         511           0.7 %         337           0.9 %        9,155            5.0 %         556           0.6 %
  R&D expenses                    2,874           4.1 %       3,109           8.5 %        9,824            5.3 %       7,763           8.2 %
  Amortization & write-down
of intangible assets              1,759           2.5 %         509           1.4 %        5,076            2.8 %       1,074           1.1 %
Operating income                 22,603          32.5 %       9,354          25.5 %       49,041           26.6 %      21,738          23.1 %
Other (expense) income, net      (2,380 )        (3.4 %)     (2,047 )        (5.6 %)      (7,205 )         (3.9 %)     10,288          10.9 %
Income before income taxes       20,223          29.0 %       7,307          19.9 %       41,836           22.7 %      32,026          34.0 %
Income tax provision
(benefit)                         6,470           9.3 %      (6,217 )       (16.9 %)      15,269            8.3 %      (5,254 )        (5.5 %)
Net income                     $ 13,753          19.7 %      13,524          36.8 %       26,567           14.4 %      37,280          39.5 %

THREE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2011

Our consolidated revenue was $69.6 million for the quarter ended September 30, 2012, representing an increase of $32.9 million, or 89.7%, over the quarter ended September 30, 2011. The increase in revenue was the result of product and business acquisitions, the launch of new and revived products, and price increases on continuing products. Of the $32.9 million increase in revenue, $19.4 million was related to acquisitions, $13.4 million was from the launch of new and revival products, including a full quarter of oral vancomycin, which was launched in the middle of the prior quarter, and $0.5 million was related to price increases for existing products, partially offset by a $0.4 million decline in sales volume, principally related to deemphasizing domestic contract manufacturing in favor of utilizing domestic plant capacities to support new and revival products. Hospital drugs and injectables segment revenues increased by $20.9 million, or 151.0%, over the prior year quarter, with this growth attributable to newly-acquired, newly-approved and re-launched products. Ophthalmic segment revenue increased by $8.4 million, or 42.7%, over the prior year quarter, with acquisition, new product launches and product revivals accounting for approximately two thirds of the increase, and sales volume increases accounting for the remaining third. Contract services revenue increased by $3.6 million, or 115.6%, as current year revenue from the Kilitch Acquisition in India was partially offset by a decline in U.S. contract services revenue.

Consolidated gross profit for the quarter ended September 30, 2012 was $40.1 million, or 57.6% of revenue, compared to $22.0 million, or 59.9% of revenue, in the corresponding prior year quarter. This decline was attributable to the lower margin contract services revenue added as a result of the Kilitch Acquisition in India. Our gross profit on domestic U.S. operations increased from 57.6% in the quarter ended September 30, 2011 to 61.8% in the quarter ended September 30, 2012. This domestic gross profit increase was related to our acquisitions of businesses and new products along with improve utilization of our plant capacities. The gross profit margin from our hospital drugs and injectables segment increased to 64.3% in the quarter ended September 30, 2012 from 52.2% in the quarter ended September 30, 2011. This increase was primarily related to the acquisition of higher margin products from the U.S. subsidiary of H. Lundbeck A/S ("Lundbeck"). Ophthalmic segment gross profit margin was 59.1% in the quarter ended September 30, 2012 compared to 65.0% in the prior year quarter. This decline in margin was primarily due to a shift in mix, in part due to increased sales of over-the-counter ophthalmic products. The contract segment gross profit margin was 17.3% in the quarter ended September 30, 2012 compared to 61.8% in the prior year quarter. This decline is related to the Kilitch Acquisition, as the acquired contract business in India generates lower margins than our domestic contract manufacturing business.

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Selling, general and administrative ("SG&A") expenses were $12.3 million, or 17.7% of revenues, in the quarter ended September 30, 2012 compared to $8.7 million, or 23.6% of revenues, in the prior year quarter. Of the $3.6 million increase, $2.8 million was in wages and related costs, as we expanded our sales force, added new positions to accommodate our growth, and built out a management team for our operations in India.

Acquisition-related expenses in the quarter ended September 30, 2012 were $0.5 million compared to $0.3 million in the prior year period. The current year expense was related to a milestone payment for services performed in relation to the Kilitch Acquisition, while the prior year expenses were primarily related to due diligence on the Kilitch Acquisition.

Research and development ("R&D") expense was $2.9 million in the quarter ended September 30, 2012, a decrease of $0.2 million compared to the corresponding prior year quarter. R&D expenses fluctuate quarter to quarter based on the amount of milestone payments that become payable to external development partners and the number of R&D batches produced. We anticipate an increase in R&D expenditures in the quarter ending December 31, 2012 related to milestone payments and internal development activity.

Amortization of intangible assets was $1.8 million in the quarter ended September 30, 2012 compared to $0.5 million in the quarter ended September 30, 2011. This increase was due to the amortization of finite-lived intangibles acquired through the Lundbeck acquisition in December 2011 and the Kilitch acquisition completed in February 2012.

In the quarter ended September 30, 2012, we recognized non-operating expenses totaling $2.4 million compared to non-operating expenses of $2.0 million in the quarter ended September 30, 2011. The expense in each period primarily consisted of cash and non-cash interest related to our 3.5% convertible senior notes due 2016, while the expense in the quarter ended September 30, 2012 also included non-cash interest accrued on the subsequent payment due in December 2014 related to the Lundbeck acquisition.

For the quarter ended September 30, 2012, our income tax provision was $6.5 million based on an effective tax provision rate of approximately 32.0% for the quarter. This provision rate included the impact of a 2011 R&D tax credit included on our 2011 federal and state tax returns that was not included within the prior year's estimated tax provision rate. It also includes an income tax benefit for India expenses incurred in the quarter ended March 31, 2012 that were initially expected to be non-deductible for tax purposes, but have subsequently been deemed deductible based on a recent Indian Supreme Court ruling. In the prior year, we recorded an income tax benefit of $6.2 million due to reversal of valuation allowances against our deferred tax assets, principal of which was our net operating loss carry-forward.

We reported net income of $13.8 million for the quarter ended September 30, 2012, representing a 19.8% net income margin on revenues. In the prior year quarter ended September 30, 2011, we reported net income of $13.5 million, representing 36.8% of revenue. The prior year net income percentage was significantly bolstered by the reversal of valuation allowances against our deferred tax assets.

NINE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2011

For the nine months ended September 30, 2012, consolidated revenue was $184.6 million, representing an increase of $90.3 million, or 95.8%, over consolidated revenue of $94.3 million for the nine months ended September 30, 2011. The increase in revenue was the result of product and business acquisitions, the launch of new and revived products, and volume increases on continuing products. Of the $90.3 million increase in revenue, $49.9 million was related to acquisitions, $30.8 million was from the launch of new and revival products, including oral vancomycin, $10.2 million was due to sales volume increases for existing products, offset slightly by a $0.6 million negative variance due to price changes. Hospital drugs and injectables segment revenues increased by $57.7 million, or 166.7%, over the prior year period, with the majority of this growth attributable to acquisitions, new approvals and re-launched products, and increased sales volume on continuing products. Ophthalmic segment revenue increased by $26.1 million, or 53.5%, over the prior year period, with acquisitions, new product launches and product revivals accounting for more than half of increase, and sales volume increases on existing products accounting for the remainder. Contract services revenue increased by $6.5 million, or 60.5%, over the prior year period, as revenue generated from the Kilitch Acquisition in India was partially offset by a decline in domestic contract manufacturing revenue, as we shifted our plant utilization toward manufacture of our own products.

Consolidated gross profit for the nine months ended September 30, 2012 was $106.7 million, or 57.8% of revenue, compared to $54.1 million, or 57.4% of revenue, in the nine months ended September 30, 2011. Our gross profit increase was related to our acquisitions of businesses and new products along with improved utilization of our plant capacities. The gross profit margin from our hospital drugs and injectables segment increased from 52.5% in the nine months ended September 30, 2011 to 63.0% in the nine months ended September 30, 2012 primarily as a result of our acquisition of higher margin products from Lundbeck in December 2011. The ophthalmic segment gross profit margin was 58.4% in the nine months ended September 30, 2012 compared to 63.1% in the prior year period. This decline in margin was primarily due to a shift in mix, in part due to increased sales of over-the-counter ophthalmic products as a result of the AVR acquisition. The contract segment gross profit margin was 27.5% in the nine months ended September 30, 2012 compared to 47.2% in the corresponding prior year period. This decline is primarily related to lower margin contract services business acquired through the Kilitch Acquisition completed in February 2012.

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Selling, general and administrative ("SG&A") expenses were $33.6 million, or 18.2% of revenues, in the nine months ended September 30, 2012 compared to $23.0 million, or 24.4% of revenues, in the corresponding prior year period. Of the $10.6 million increase, $6.7 million was attributable to wages and related costs, related to expansion of our sales force, incremental headcount to support our growth and the addition of a management team in India to support the Kilitch Acquisition. The remaining increase was related to acquired businesses and general growth of our business.

Acquisition-related expenses in the nine months ended September 30, 2012 were $9.2 million compared to $0.6 million in the prior year period. The current year expenses were primarily related to the Kilitch Acquisition, and included $6.7 million in fees paid and payable to the former owners of the Kilitch business for the achievement of an earn-out and various milestones, and $1.6 million in stamp duties for transfer of ownership of the land and buildings in Paonta Sahib, India to Akorn. The prior year expense was related to due diligence and other costs for the AVR and Kilitch acquisitions.

R&D expense was $9.8 million in the nine months ended September 30, 2012, an increase of $2.1 million over the prior year period. This increase was related to greater R&D activity in the current year, along with expansion of our R&D staff size and capabilities.

Amortization of intangible assets was $5.1 million in the nine months ended September 30, 2012 compared to $1.1 million in the corresponding prior year period. This increase is due to the amortization of finite-lived intangibles acquired through the AVR acquisition in May 2011, the Lundbeck acquisition in December 2011, and the Kilitch acquisition completed in February 2012.

In the nine months ended September 30, 2012, we recognized non-operating expenses totaling $7.2 million compared to non-operating income of $10.3 million in the prior year period. The current year expense of $7.2 million principally consisted of cash and non-cash interest related to our 3.5% convertible senior notes due 2016 (the "Notes"). The prior year income of $10.3 million included $14.5 million equity in the earnings of the Joint Venture Company, of which $13.4 million was related to the Joint Venture Company's sale of its ANDAs to Pfizer. This income was partially offset by $4.2 million of expenses including amortization and write-off of deferred financing costs and cash and non-cash interest expense on the Notes.

For the nine months ended September 30, 2012, our income tax provision was $15.3 million, representing 36.5% of income before income tax. In the corresponding prior year period, we recorded an income tax benefit of $5.3 million on income before income taxes of $32.0 million due to the reversal of valuation allowances against our deferred tax assets. Our effective rate for the current year is anticipated to be 38.1%. The actual year-to-date provision is lower as a result of a prior year adjustment related to R&D tax credits claimed on our 2011 tax returns that were not factored into our 2011 tax provision rate.

We reported net income of $26.6 million for the nine months ended September 30, 2012, representing a 14.4% net income margin on revenues. In the corresponding prior year period, we reported net income of $37.3, or 39.5% of revenue. Net income for the nine months ended September 30, 2011 was bolstered by the non-recurring gain of $13.4 million from the Joint Venture Company's sale of its principal operating assets and the income tax benefit that resulted from the reversal of valuation allowances against our deferred tax assets.

FINANCIAL CONDITION AND LIQUIDITY

Overview

During the nine month period ended September 30, 2012, we generated $21.3 million in cash from operations. This operating cash flow was primarily due to net income of $26.6 million, non-cash expenses of $17.5 million and an $11.5 million increase in accrued expenses and other liabilities, partially offset by a $17.2 million increase in trade receivables, and a $13.1 million increase in inventory. We used $70.0 million in cash in investing activities during the nine month period ended September 30, 2012, consisting of $55.2 million used to complete the Kilitch Acquisition, and $14.8 million used to acquire property, plant and equipment, primarily relating to expenditures for the expansion of our Somerset, New Jersey manufacturing plant. Financing activities generated $3.4 million in cash flow, of which $2.4 million was from excess tax benefits from stock-based compensation and $1.0 million was related to the exercise of stock options and employee participation in our ESPP.

During the nine-month period ended September 30, 2011, we generated $14.2 million in cash from operations, primarily due to net income of $37.3 million and non-cash expenses such as depreciation and stock compensation expense totaling $10.4 million, and an increase in trade accounts payable of $3.1 million, partially offset by $14.5 million in non-cash equity in earnings of the Joint Venture Company, an $8.0 million increase in accounts receivable, an $8.2 million increase in inventories and a $6.7 million increase in deferred tax assets. The increase in deferred tax assets was due to our reversal in the quarter ended September 30, 2011 of the valuation allowances against our deferred tax assets following our determination that projected future cash flows would be sufficient to allow full utilization of these deferred tax assets. Net cash used in investing activities was $46.9 million during the nine months ended September 30, 2011, including $26.7 million used to acquire AVR, $10.0 million used to acquire a minority stake of just below 20% in Aciex, $8.4 million used for the purchase of property, plant and equipment, primarily related to the expansion project at our Somerset, New Jersey manufacturing plant, and $5.7 million used to acquire NDA and ANDA rights, partially offset by $3.9 million in cash received in distributions from the Joint Venture Company. Financing activities generated $117.7 million in cash during the nine months ended September 30, 2011, primarily related to the $120.0 million in proceeds from issuance of the Notes less associated financing fees of $4.7 million. Warrant exercises and proceeds under employee stock plans contributed the remaining $2.3 million to financing cash flows.

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As of September 30, 2012, we had $38.4 million in cash and cash equivalents and no outstanding balance under our credit facility with Bank of America N.A. Of our $38.4 million in cash and cash equivalents at September 30, 2012, $34.5 million was in U.S. accounts and $3.9 million was in the Indian accounts of our wholly-owned subsidiary, Akorn India Private Limited.

The total loan commitment under our credit facility with Bank of America, N.A. is $20.0 million, of which $19.7 million was available as of September 30, 2012. We believe that operating cash flows and availability under our credit facility will be sufficient to meet our cash needs for the foreseeable future.

Liquidity and Capital Needs

We require certain capital resources in order to maintain and expand our business. We anticipate investing approximately $4 million in infrastructure projects during the quarter ending December 31, 2012, which includes expenditures to complete the expansion project at our Somerset, New Jersey manufacturing facility, among other projects. We believe that our cash reserves, operating cash flows and availability under our Credit Facility will be sufficient to meet our cash needs for the foreseeable future.

We continue to evaluate opportunities to grow and expand our business through the acquisition of new businesses, manufacturing facilities, or pharmaceutical product rights. Such acquisitions may require us to obtain additional sources of capital. We cannot predict the amount of capital that may be required to complete such acquisitions, and there is no assurance that sufficient financing for these activities would be available on terms acceptable to us, if at all.

Convertible Notes

On June 1, 2011, we completed our offering of $120.0 million aggregate principal amount of 3.50% Convertible Senior Notes due 2016 (the "Notes"), which includes $20.0 million of Notes issued in connection with the full exercise by the initial purchasers of their over-allotment option. The Notes are governed by our indenture with Wells Fargo Bank, National Association, as trustee (the "Indenture"). The Notes were offered and sold only to qualified institutional buyers. The net proceeds from the sale of the Notes were approximately $115.3 million, after deducting underwriting fees and other related expenses.

The Notes have a maturity date of June 1, 2016 and pay interest at an annual rate of 3.50% semiannually in arrears on June 1 and December 1 of each year, beginning on December 1, 2011. The Notes are convertible into our common stock, cash or a combination thereof at an initial conversion price of $8.76 per share, which is equivalent to an initial conversion rate of approximately 114.1553 shares per $1,000 principal amount of Notes. The conversion price is subject to adjustment for certain events described in the Indenture, including certain corporate transactions which will increase the conversion rate and decrease the conversion price for a holder that elects to convert its Notes in connection with such corporate transaction.

The Notes may be converted at any time prior to the close of business on the business day immediately preceding December 1, 2015 only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2011, if the closing sale price of the our common stock, for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the calendar quarter immediately preceding the calendar quarter in which the conversion occurs, is more than 130% of the conversion price in effect on each applicable trading day; (2) during the five consecutive trading-day period following any five consecutive trading-day period in which the trading price for the Notes per $1,000 principal amount of Notes for each such trading day was less than 98% of the closing sale price of our common stock on such date multiplied by the then-current conversion rate; or
(3) upon the occurrence of specified corporate events. On or after December 1, 2015 until the close of business on the business day immediately preceding the stated maturity date, holders may surrender all or any portion of their Notes for conversion at any time, regardless of the foregoing circumstances. Upon conversion, we will pay or deliver, at our option, cash, shares of our common stock, or a combination thereof. We may not redeem the Notes prior to the maturity date. If a fundamental change (as defined in the Indenture) occurs prior to the stated maturity date, holders may require us the purchase for cash all or a portion of their Notes.

For the three and nine months ended September 30, 2012 and 2011, we recorded the following expenses in relation to the Notes (in thousands):

. . .
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