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AKRX > SEC Filings for AKRX > Form 10-K on 14-Mar-2014All Recent SEC Filings

Show all filings for AKORN INC

Form 10-K for AKORN INC


14-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

We manufacture and market a full line of diagnostic and therapeutic ophthalmic pharmaceuticals as well as niche hospital drugs and injectable pharmaceuticals. We manufacture and/or offer products in various specialty areas, including ophthalmology, antidotes, anti-infectives, controlled substances for pain management and anesthesia, and vaccines, among others. We also manufacture and market a line of over-the-counter ("OTC") dry eye and eye health products under the brand name TheraTears®, as well as various private-labeled OTC products for major drugstore chains.

We have three identified operating segments:

§ Ophthalmic - sales of diagnostic and therapeutic ophthalmic drugs and over-the-counter eye care products

§ Hospital Drugs & Injectables - sales of diagnostic and therapeutic injectables and other hospital drugs, as well as biologics and vaccines

§ Contract Services - sales of various drugs that we manufacture for others to be sold under their own brand names

Acquisitions:

Hi-Tech Pharmacal Co. Inc.

On August 27, 2013, we entered into a definitive agreement to acquire Hi-Tech Pharmacal Co, Inc. ("Hi-Tech") for a total purchase price of approximately $640 million, or $43.50 per outstanding share of Hi-Tech common stock. The acquisition has been approved by the shareholders of Hi-Tech, but is subject to review by the Federal Trade Commission pursuant to provisions of the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. We expect the acquisition to close early in the second quarter of 2014. Upon closing, Akorn Enterprises, Inc., a wholly-owned subsidiary of the Company, will be merged with and into Hi-Tech, which will then be a wholly-owned subsidiary of the Company.

We believe that the Hi-Tech acquisition will strengthen Akorn's current position as the third largest company in the U.S. generic ophthalmic market, and broaden the Company's product offering to include other niche dosage forms such as oral liquids, topical creams and ointments, nasal sprays and otics. Also, this transaction is expected to significantly increase our retail presence in both prescription and OTC products, and expand our R&D pipeline.

Merck Product Acquisition

On November 15, 2013, we acquired from Merck the U.S. rights to three branded ophthalmic products - AzaSite®, Cosopt® and Cosopt® PF - for a cash purchase price of $52.8 million. We began selling Cosopt® and Cosopt® PF during the fourth quarter of 2013 and began selling AzaSite® in the first quarter of 2014. This acquisition is expected to strengthen our position as a leader in U.S. ophthalmology products and allows us to leverage our existing ophthalmic sales force and physician relationships. The acquired products are anticipated to generate 2014 revenue in the range of $34 million to $38 million and be accretive to earnings.

New Product Development:

We continued the expansion of our product pipeline during 2013, as we submitted 15 new NDAs/ANDAs to the FDA in the year, bringing to 63 the total number of filings currently under FDA review. During 2013, we received FDA approval on two ANDAs and tentative approval on another. During the year, we also moved our R&D center from Skokie, Illinois to a new, larger facility in Vernon Hills, Illinois, just a few miles away from our corporate offices. We continue to develop new products internally, as well as opportunistically partnering with other drug companies for products that we would not intend to manufacture ourselves. R&D expense in 2013 was $19.9 million compared to $15.9 million in the prior year.

Revenue & Gross Profit:

Our revenue increased to $317.7 million in 2013, an increase of 24% over revenue of $256.2 million in 2012. Of this $61.6 million increase, approximately 71% was related to new products released, approved or acquired since the start of 2012. This includes progesterone capsules and tetanus-diphtheria vaccine ("Td vaccine"), which together accounted for $28.3 million of the revenue increase. We also saw increased revenue from existing products, as we continue to increase our market penetration. Our gross profit increased by $23.2 million in 2013. Our overall gross profit margin was 54.1% in 2013 compared to 58.0% in 2012. The lower margin is primarily due to an increase in sales of products that are not manufactured by us and/or which have profit sharing agreements with co-developers, along with increased competitive pricing pressure for certain products.


RESULTS OF OPERATIONS

For the years 2013, 2012 and 2011, we have identified and reported operating results for three distinct business segments: Hospital drugs & injectables; Ophthalmic; and Contract services. Our reported results by segment are based upon various internal financial reports that disaggregate certain operating information. Our chief operating decision maker, as defined in Accounting Standards Codification ("ASC") Topic 280, Segment Reporting, is our CEO. Our CEO oversees operational assessments and resource allocations based upon the results of our reportable segments, all of which have available discrete financial information.

The following table sets forth amounts and percentages of total revenue for certain items from our Consolidated Statements of Operations and our segment reporting information for the years ended December 31, 2013, 2012 and 2011 (dollar amounts in thousands):

                                  2013                         2012                         2011
                                         % of                         % of                         % of
                         Amount        Revenue        Amount        Revenue        Amount        Revenue
Revenues:
Hospital drugs &
injectables             $ 179,625           56.5 %   $ 129,723           50.6 %   $  55,077           40.2 %
Ophthalmic                114,515           36.1 %     103,765           40.5 %      68,591           50.1 %
Contract services          23,571            7.4 %      22,670            8.9 %      13,252            9.7 %
Total revenues            317,711          100.0 %     256,158          100.0 %     136,920          100.0 %
Gross profit and
gross margin
percentage:
Hospital drugs &
injectables               104,473           58.2 %      83,413           64.3 %      30,057           54.6 %
Ophthalmic                 63,481           55.4 %      58,785           56.7 %      43,054           62.8 %
Contract services           3,950           16.8 %       6,494           28.6 %       6,578           49.6 %
Total gross profit        171,904           54.1 %     148,692           58.0 %      79,689           58.2 %
Operating expenses:
Selling, general &
administrative
expenses                   53,508           16.8 %      48,053           18.8 %      32,392           23.7 %
Research and
development expenses       19,858            6.3 %      15,858            6.2 %      11,555            8.4 %
Amortization of
intangibles                 7,422            2.3 %       6,870            2.7 %       1,733            1.3 %
Acquisition-related
costs                       2,912            0.9 %       9,155            3.6 %         743            0.5 %
Operating income        $  88,204           27.8 %   $  68,756           26.8 %   $  33,266           24.3 %

Net income              $  52,362           16.5 %   $  35,378           13.8 %   $  43,013           31.4 %

COMPARISON OF YEARS ENDED DECEMBER 31, 2013 AND 2012

Our revenues were $317.7 million in 2013, an increase of $61.6 million, or 24.0%, compared to 2012. This increase in revenue was primarily from increased sales of new and revived products, defined as products that we began selling during 2012 or 2013, which accounted for approximately $48.5 million of the increase. Sales of existing products accounted for $12.0 million of the increase, with a $14.7 million increase related to volume gains being partially offset by a $2.7 million decline from a slight reduction in average sale prices. Business and product acquisitions accounted for an increase of $1.1 million, as new revenue from products acquired late in 2013 more than offset lower revenue from our subsidiary in India, in part due to weakening of the Indian rupee against the U.S. dollar.

In terms of reportable segments, 2013 revenues from our hospital drugs & injectables segment were $179.6 million, an increase of $49.9 million, or 38.5%, over the prior year. This increase was primarily related to sales of new and revived products, with more than half of the $49.9 million increase attributable to progesterone capsules and Td vaccine. Increased dollar sales of existing products accounted for approximately $6.4 million of the increase. Ophthalmic segment revenues were $114.5 million, an increase of $10.8 million, or 10.4%, over the prior year. Of the $10.8 million increase, approximately 42% was related to increases in OTC product sales of TheraTears branded products and private label products, while 19% was related to sales of products acquired late in 2013 from Merck. The remainder was from increased sales of existing products. Contract services revenue was $23.6 million in 2013, an increase of $0.9 million, or 4.0%, over the prior year. An increase of $1.8 million in domestic contract services revenue was partially offset by a $0.9 decrease in revenue of our subsidiary in India, in part due to unfavorable changes in currency exchange rates.

Our 2013 revenues of $317.7 million was net of adjustments totaling $210.9 million for chargebacks, rebates, administration fees, returns, discounts and allowances, and coupons and advertising. Chargeback and rebate expense for 2013 was $183.4 million, or 34.7% of gross revenue, compared to $112.2 million, or 29.0% of gross revenue, in 2012. The $71.2 million increase in chargeback and rebate expense was due to higher gross sales volume and increases in WAC for various products in 2013. The increase in chargeback and rebate expense as a percentage of gross sales was attributable to an overall increase in the gap between WAC and contract price. Our products returns provision in 2013 was $5.0 million, or 0.9% of gross sales, compared to $3.8 million, or 1.0% of gross sales, in 2012. The slight decrease in percentage was due to favorable historical product return trends.


Our consolidated gross profit for 2013 was $171.9 million, or 54.1% of revenue, compared to $148.7 million, or 58.0% of revenue, in 2012. This $23.2 million, or 15.6%, increase in gross profit was principally due to our revenue growth from new and revived products. The decrease in our overall gross profit margin was primarily due to the fact that a significant percentage of our revenue growth was in products that are contract manufactured and which may also involve margin sharing arrangements with development partners. Pricing pressure for various products was also a contributing factor to the overall decrease in gross profit margin. The gross profit margin from sales of hospital drugs & injectables was 58.2% in 2013 compared to 64.3% in 2012. Our sales growth in this segment was heavily weighted toward products that are manufactured by third parties and have profit sharing arrangements, resulting in a decrease in the overall gross profit margin of the segment. Pricing pressures on certain existing products also contributed to the margin contraction. The gross profit margin on ophthalmic segment sales was 55.4% in 2013 compared to 56.7% in the prior year. This slight decrease was due to a variety of factors, including an increase in sales or products subject to margin sharing arrangements with development partners, and pricing pressure on certain products, and introduction of new, lower margin products. The gross profit margin on contract services decreased to 16.8% in 2013 from 28.6% in 2012 primarily due to lower margins generated by our Indian subsidiary, which increased its manufacturing infrastructure costs in preparation for obtaining FDA certification.

Total operating expenses were $83.7 million in 2013, an increase of $3.8 million, or 4.7%, over the prior year. Increases in selling, general and administrative ("SG&A") expenses, R&D expenses and amortization of intangibles were partially offset by a decline in acquisition-related expenses.

Selling, general and administrative ("SG&A") expenses were $53.5 million in 2013, an increase of $5.4 million, or 10.1%, over the prior year expense of $48.1 million. The $5.4 million increase included a $1.5 million increase related to expanding our sales force, an increase of $1.0 million in FDA fees and a $1.0 million increase in legal costs, including settlements. As a percentage of sales, SG&A expenses declined to 16.8% compared to 18.8%, evidence of an improved leveraging of sales.

Research and development ("R&D") expenses were $19.9 million in 2013, an increase of $4.0 million over the R&D expense of $15.9 million recorded in the prior year. This increase was related to the continued growth in our investment in R&D. Among the largest components of the increase in expense were a $1.0 million increase in R&D exhibit batch expense and a $0.7 million increase in FDA fees.

Amortization of intangibles consists of the amortization of NDA and ANDA drug acquisition costs over the anticipated market lives of the acquired products, as well as the amortization of other intangible assets acquired through business combinations. Amortization of intangibles was $7.4 million in 2013 compared to $6.9 million in 2012. This increase of $0.5 million was primarily related to the fourth quarter acquisition of three ophthalmic products from Merck.

We recorded $2.9 million of acquisition-related costs during 2013 compared to $9.2 million in 2012. Of the current year expenses, $1.7 million was related to the Hi-Tech acquisition, $0.5 million was related to milestone achievement payments to the former owners of the business we acquired from Kilitch Drugs
(India) Limited, and $0.7 million was related to the Merck Product Acquisition and other acquisition activities. In the prior year, acquisition-related expenses were exclusively related to the Kilitch acquisition.

Amortization of deferred financing costs totaled approximately $0.8 million in both 2013 and 2012. The expense in each year was related to amortizing the deferred financing costs related to our Notes and our BoA Credit Facility.

Total interest expense was $8.6 million in 2013 compared to $10.4 million in the prior year. In 2013, we recorded non-cash interest expense of $4.6 million compared to $6.4 million of non-cash interest in the prior year. Our non-cash interest expense was related to the debt discount on our Notes and to the change in fair value of our additional consideration of $15 million payable to Lundbeck in December 2014 related to our acquisition of various injectable products from them in December 2011. The year to year decline was primarily related to a decrease in interest accrued on the Lundbeck additional consideration. Our net cash interest expense in each year principally consisted of interest payable on our Notes.

In the fourth quarter of 2013, we recorded a $3.7 million gain from our "bargain purchase" of three ophthalmic products from Merck. The bargain purchase was largely derived from the excess of the fair value of acquired net deferred tax assets over their economic value as calculated by discounting their future cash flows. We also recognized income of $0.2 million in relation to foreign currency forward contracts designed to hedge future capital expenditures at AIPL against strengthening of the Indian rupee against the U.S. dollar.


COMPARISON OF YEARS ENDED DECEMBER 31, 2012 AND 2011

Our revenues were $256.2 million in 2012, an increase of $119.2 million, or 87.1%, compared to 2011. This increase in revenue was related to a number of factors, including the acquisitions, sales of new and revived products and increased sales of existing products. Of the $119.2 million increase in revenues, $67.1 million was related to business combinations and products acquisitions completed since the start of 2011, $45.1 million was from a combination of newly-approved products and re-launch products in response to more favorable market conditions, and $9.3 million was related to sales volume increases for continuing products, partially offset by a $2.3 million reduction attributable to price changes on continuing products.

In terms of reportable segments, 2012 revenues from our hospital drugs & injectables segment were $129.7 million, an increase of $74.6 million, or 135.5%, over the prior year. The increase was principally attributable to sales of products acquired through the Lundbeck acquisition, and sales of newly-approved and revived products. Ophthalmic segment revenues were $103.8 million, an increase of $35.2 million, or 51.3% over the prior year. The three main factors contributing to this increase were sales from new and revived products, a full year's revenue from the AVR acquisition, and sales increases from existing ophthalmic products. Contract services revenue was $22.7 million in 2012, an increase of $9.4 million, or 71.1%, over the prior year. This increase was related to the $16.7 million revenue generated from the Kilitch Acquisition, partially offset by a decline in U.S. contract business of $7.3 million due to a shift in manufacturing toward Akorn products.

Our 2012 revenues of $256.2 million was net of adjustments totaling $130.8 million for chargebacks, rebates, administration fees, returns, discounts and allowances, and coupons and advertising. Chargeback and rebate expense for 2012 was $112.2 million, or 29.0% of gross revenue, compared to $68.1 million, or 31.5% of gross revenue, in 2011. The $44.1 million increase in chargeback and rebate expense was due to higher gross sales volume in 2012. The slight decrease in chargeback and rebate expense as a percentage of gross sales was attributable to increases in sales outside the wholesale channel. Our products returns provision in 2012 was $3.8 million, or 1.0% of gross sales, compared to $2.7 million, or 1.3% of gross sales, in 2011. The slight decrease in percentage was due to favorable historical product return trends and a higher percentage of sales of non-returnable products.

Our consolidated gross profit for 2012 was $148.7 million, or 58.0% of revenue, compared to $79.7 million, or 58.2% of revenue, in 2011. This gross profit increase of $69.0 million, or 86.6%, was principally due to our revenue growth from acquisitions, new product introductions and product revivals. The slight decrease in overall profit margin was due to lower margin business, such as the contract revenue of Akorn India, which offset higher-margin business, such as the sales of products acquired through Lundbeck Acquisition. The gross profit margin on ophthalmic segment sales was 56.7% in 2012 compared to 62.8% in 2011, this decline being primarily attributable to increased sales of over-the-counter ophthalmic products by our subsidiary, AVR, which was acquired in May 2011. The gross profit margin on hospital drugs & injectables increased to 64.3% in 2012 from 54.6% in 2011 primarily due to the higher gross margin on the Lundbeck products. The gross profit margin on contract services decreased to 28.6% in 2012 from 49.6% in 2011 primarily due to lower margin business from our Indian subsidiary.

Selling, general and administrative ("SG&A") expenses were $48.1 million in 2012, an increase of $15.7 million, or 48.3%, over the prior year SG&A expenses of $32.4 million. This increase was due primarily to compensation-related costs resulting from higher headcount supporting our growth, operating expenses associated with our India operations that were acquired during the first quarter of 2012 and marketing costs associated with our AVR business. As a percentage of sales, SG&A expense was 18.8%, down from 23.7% in 2011.

Research and development ("R&D") expenses were $15.9 million in 2012 compared to $11.6 million in 2011. This increase of $4.3 million was the result of continued increases in R&D activities, both internally and through strategic partnerships and includes $1.2 million of expenses associated with the FDA's backlog and new filing fees that went into effect in the fourth quarter of 2012.

Amortization of intangibles consists of the amortization of NDA and ANDA drug acquisition costs over the anticipated market lives of the acquired products, as well as the amortization of other intangible assets acquired through business combinations. Amortization of intangibles was $6.9 million in 2012 compared to $1.7 million in 2011. This increase of $5.2 million was primarily due to amortization of the product rights acquired through the Lundbeck Acquisition, and amortization of intangible assets acquired through the Kilitch Acquisition.

Amortization of deferred financing costs totaled $0.8 million in 2012 compared to $1.9 million in 2011. The 2012 expense was related to amortizing the financing costs on our Notes and our BoA Credit Facility. The 2011 expense included a $1.2 million write-off of the unamortized deferred financing costs to our EJ Credit Facility, which we elected to early terminate in June 2011. Our 2011 expense also included $0.4 million in amortization of deferred financing costs related to our Notes.


In 2012, we recorded non-cash interest expense of $6.4 million compared to $2.1 million in prior year. Our non-cash interest expense was related to the debt discount on our Notes and to the change in fair value of our contingent consideration payable related to the acquisition of Lundbeck products.

Cash interest expense was $4.0 million in 2012 compared to $2.3 million in 2011. Our cash interest in each year was principally related to the Notes, which were issued effective June 1, 2011.

We are a 50% partner in Akorn-Strides LLC (the "Joint Venture Company"), which we account for using the equity method. During 2011, we recorded $14.6 million of equity in income from this unconsolidated joint venture, of which $13.4 million was related to our share of the gain from Joint Venture Company's sale of its ANDAs to Pfizer on December 29, 2010, and the remaining $1.2 million was from the Joint Venture Company's operations. The Joint Venture Company essentially ceased operations in 2011 and no income was recorded in 2012.

In 2011, we recorded a non-operating expense of $0.2 million related to an option agreement we entered into to protect ourselves from a negative movement in the foreign exchange rate between U.S. dollars and Indian rupees. We entered into this option agreement in October 2011 following our entry into an agreement to buy certain assets from Kilitch in India, as the purchase price for the Kilitch Acquisition was established in Indian rupees. We incurred no similar expenses in 2012.

FINANCIAL CONDITION AND LIQUIDITY

Cash Flow

As of December 31, 2013, we had cash and cash equivalents of $34.2 million, which is $6.6 million lower than our cash and cash equivalents balance of $40.8 million as of December 31, 2012. This decrease in cash and cash equivalents was primarily related to the $52.8 million we used to acquire three branded ophthalmic products from Merck in the fourth quarter of 2013, and the $11.6 million spent to acquire property, plant and equipment, more than offsetting our positive operating cash flow for the year. Our net working capital was $107.6 million at December 31, 2013 compared to $115.4 million at December 31, 2012. This $7.8 million decrease in working capital closely paralleled our decrease in cash during the year.

During 2013, we generated $57.3 million in cash flow from operations. This positive operating cash flow was primarily the result of our net income of $52.4 million and non-cash expenses of $19.2 million, partially offset by a $14.3 million increase in accounts receivable and a $3.8 million increase in inventory. In 2012, we generated $26.2 million in positive cash flow from operations. This positive operating cash flow was primarily the result of our net income of $35.4 million and non-cash expenses of $20.6 million, partially offset by a $23.9 million increase in accounts receivable and a $15.4 million increase in inventory.

In 2013, we used $66.9 million cash in investing activities. Of this total, $55.5 million was used for product acquisitions, including $52.8 million used to acquire three branded ophthalmic products from Merck, and $11.6 million was used to acquire property, plant and equipment. These uses of cash were partially offset by $0.2 million received in distribution from our non-consolidated Joint Venture Company. In the prior year, we used $75.5 million in investing activities, of which $54.2 million was used to complete the Kilitch Acquisition in February of 2012 and $20.5 million was used to acquire property, plant and equipment, principally as part of the expansion project at our Somerset, New Jersey manufacturing plant.

Financing activities generated $3.1 million in cash during 2013, which included $6.1 million generated from stock option exercises and participation in the employee stock purchase plan ("ESPP"), partially offset by $3.0 million in debt financing costs. During 2012, we generated $6.4 million in cash through financing activities, all of which was related to stock option exercises and participation in the ESPP.

Liquidity and Capital Needs

On August 26, 2013, we entered into an Agreement and Plan of Merger to acquire Hi-Tech Pharmacal Co., Inc. ("Hi-Tech") for a purchase price of approximately $640 million in cash, or $550 million net of Hi-Tech's projected cash reserves at closing. Concurrent with negotiating this acquisition, we obtained a loan commitment from JP Morgan Chase Bank, N.A. ("JP Morgan") for a $600 million term loan to finance the acquisition (the "JPM Term Loan") and a $75 million revolving credit facility (the "JPM Revolver") to fund working capital needs and other corporate purposes. The JPM Term Loan was syndicated to a number of investors during the fourth quarter of 2013. As negotiated, the JPM Term Loan will mature in seven (7) years and accrue interest at a variable margin over either prime or LIBOR. Full or partial prepayments of principal will be allowed. The JPM Revolver will carry a term of five (5) years and a total loan commitment of $75 million, or up to $150 million at our election, if oversubscribed by participating lenders. Our $60 million revolving Loan and Security Agreement with Bank of America, N.A. (the "B of A Credit Agreement"), as described below, will be terminated when we enter into a final JPM Revolver agreement. (For further details regarding JP Morgan's commitments to us regarding the JPM Term Loan and JPM Revolver, please refer to Exhibit 4 to the Company's Schedule 13D filed with the SEC on September 5, 2013.)


JP Morgan completed syndication of the loan in the quarter ended December 31, 2013. We expect that the JPM Term Loan agreement will be signed after we receive FTC clearance for the Hi-Tech Acquisition and once a closing date has been agreed upon by the parties. The loan itself will take place upon closing the Hi-Tech Acquisition. We believe that the $600 million term loan and the approximately $90 million of cash reserves expected to be on Hi-Tech's balance sheet at closing will be sufficient to finance the Hi-Tech acquisition and all applicable deal-related costs.

We require certain capital resources in order to maintain and expand our business. Our future capital expenditures may include substantial projects undertaken to upgrade, expand and improve our manufacturing facilities, both in the U.S. and India. We believe that our cash reserves, operating cash flows, the . . .

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