| AKORN INC Regulation” on page seven and Item 1A Risk Factors — Our growth depends on our ability to timely develop additional pharmaceutical products and manufacturing capabilities |
| We also maintain a business development program that identifies potential product acquisition or product licensing candidates |
| We have focused our business development efforts on products that complement our existing product lines and that have few or no competitors in the market |
| 5 _________________________________________________________________ [55]Table of Contents At December 31, 2005, ten of our full-time employees were involved in product research and business development |
| Research and development costs are expensed as incurred |
| Such costs amounted to dlra4cmam510cmam000, dlra1cmam861cmam000, and dlra1cmam465cmam000, for the years ended December 31, 2005, 2004, and 2003, respectively |
| Patents, Trademarks and Proprietary Rights |
| We consider the protection of discoveries in connection with our development activities important to our business |
| We have sought, and intend to continue to seek, patent protection in the United States and selected foreign countries where deemed appropriate |
| As of December 31, 2005, we had received seven US patents and had four additional US patent applications pending |
| We also rely upon trademarks, trade secrets, unpatented proprietary know-how and continuing technological innovation to maintain and develop our competitive position |
| We enter into confidentiality agreements with certain of our employees pursuant to which such employees agree to assign to us any inventions relating to our business made by them while in our employ |
| However, there can be no assurance that others may not acquire or independently develop similar technology or, if patents are not issued with respect to products arising from research, that we will be able to maintain information pertinent to such research as proprietary technology or trade secrets |
| See Item 1A Risk Factors — Our patents and proprietary rights may not adequately protect our products and processes |
| At December 31, 2005, we had 327 full-time employees, 269 of whom were employed by us and 58 by our wholly owned subsidiary, Akorn (New Jersey), Inc |
| Akorn-Strides, LLC has no employees |
| We believe we enjoy good relations with our employees, none of whom are represented by a collective bargaining agent |
| The marketing and manufacturing of pharmaceutical products is highly competitive, with many established manufacturers, suppliers and distributors actively engaged in all phases of the business |
| Most of our competitors have substantially greater financial and other resources, including greater sales volume, larger sales forces and greater manufacturing capacity |
| See Item 1A Risk Factors — Our industry is very competitive; changes in technology could render our products obsolete |
| The companies that compete with our ophthalmic segment include Alcon Laboratories, Inc, Allergan Pharmaceuticals, Inc, Novartis and Bausch & Lomb, Inc |
| The ophthalmic segment competes primarily on the basis of price and service |
| The companies that compete with our injectable segment include both generic and name brand companies such as Hospira, Teva, American Pharmaceutical Partners and Baxter |
| The injectable segment competes primarily on the basis of price |
| Competitors in our contract services segment include Baxter, Hospira and Patheon |
| The contract services segment competes primarily on the basis of price and technical capabilities |
| Suppliers and Customers |
| No supplier of products accounted for more than 10prca of our purchases in 2003 |
| We require a supply of quality raw materials and components to manufacture and package pharmaceutical products for ourselves and for third parties with which we have contracted |
| The principal components of our products are active and inactive pharmaceutical ingredients and certain packaging materials |
| Many of these components are available from only a single source and, in the case of many of our ANDAs and NDAs, only one supplier of raw materials has been identified |
| Because FDA approval of drugs requires manufacturers to specify their proposed suppliers of active ingredients and certain packaging materials in their applications, FDA approval of any new supplier would be required if active ingredients or such packaging materials were no longer available from the specified supplier |
| The qualification of a new supplier could delay our development and marketing efforts |
| If for any reason we are unable to obtain sufficient quantities of any of the raw materials or components required to produce and package our products, we may not be able to manufacture our products as planned, which could have a material adverse effect on our business, financial condition and results of operations |
| A small number of large wholesale drug distributors account for a large portion of our gross sales, revenues and accounts receivable |
| Those distributors are: • AmerisourceBergen Corporation (“AmerisourceBergen”) • Cardinal Health, Inc |
| (“Cardinal”); and • McKesson Drug Company (“McKesson”) |
| 6 _________________________________________________________________ [56]Table of Contents These three wholesale drug distributors accounted for approximately 69prca of our total gross sales and 46prca of our revenues in 2005, and 76prca of our gross accounts receivable as of December 31, 2005 |
| The difference between gross sales and revenue is that gross sales do not reflect the deductions for chargebacks, rebates and product returns (See Item 7 |
| The percentages of gross sales, revenue and gross trade receivables attributed to each of these three wholesale drug distributors for the years ended December 31, 2005 and December 31, 2004 were as follows: 2005 2004 Gross Gross Accounts Gross Gross Accounts Sales Revenue Receivable Sales Revenue Receivable AmerisourceBergen 24 % 16 % 28 % 14 % 10 % 17 % Cardinal 28 % 19 % 29 % 25 % 20 % 51 % McKesson 17 % 11 % 19 % 18 % 16 % 6 % AmerisourceBergen, Cardinal and McKesson are distributors of our products as well as a broad range of health care products for many other companies |
| None of these distributors is an end user of our products |
| If sales to any one of these distributors were to diminish or cease, we believe that the end users of our products would find little difficulty obtaining our products either directly from us or from another distributor |
| However, the loss of one or more of these distributors, together with a delay or inability to secure an alternative distribution source for end users, could have a material negative impact on our revenue, business, financial condition and results of operations |
| We consider our business relationships with these three wholesalers to be in good standing and have fee for services contracts with Cardinal and McKesson |
| We have also established a fee for service contract with AmerisourceBergen, which began in January 2006 |
| A change in purchasing patterns, a decrease in inventory levels, an increase in returns of our products, delays in purchasing products and delays in payment for products by one or more distributors also could have a material negative impact on our revenue, business, financial condition and results of operations |
| See Item 1A Risk factors — We depend on a small number of distributors, the loss of any of which could have a material adverse effect Backorders |
| As of December 31, 2005, we had approximately dlra1cmam400cmam000 of products on backorder as compared to approximately dlra2cmam400cmam000 of backorders as of December 31, 2004 |
| This decrease in backorders is due to higher production levels in 2005 |
| We anticipate filling all current open backorders during 2006 |
| Government Regulation |
| Pharmaceutical manufacturers and distributors are subject to extensive regulation by government agencies, including the FDA, the Drug Enforcement Administration (“DEA”), the Federal Trade Commission (“FTC”) and other federal, state and local agencies |
| The federal Food, Drug and Cosmetic Act (the “FDC Act”), the Controlled Substance Act and other federal statutes and regulations govern or influence the development, testing, manufacture, labeling, storage and promotion of products that we manufacture and market |
| The FDA inspects drug manufacturers and storage facilities to determine compliance with its current Good Manufacturing Practices (“cGMP”) regulations, non-compliance with which can result in fines, recall and seizure of products, total or partial suspension of production, refusal to approve NDAs and criminal prosecution |
| The FDA also has the authority to revoke approval of drug products |
| FDA approval is required before any drug can be manufactured and marketed |
| New drugs require the filing of an NDA, including clinical studies demonstrating the safety and efficacy of the drug |
| Generic drugs, which are equivalents of existing, off-patent brand name drugs, require the filing of an ANDA An ANDA does not, for the most part, require clinical studies since safety and efficacy have already been demonstrated by the product originator |
| However, the ANDA must provide data demonstrating the equivalency of the generic formulation in terms of bioavailability |
| The time required by the FDA to review and approve NDAs and ANDAs is variable and beyond our control |
| The FDA issued a Warning Letter to us in October 2000 following a routine inspection of our Decatur manufacturing facility |
| An FDA Warning Letter is intended to provide notice to a company of violations of the laws administered by the FDA and to elicit voluntary corrective action |
| The Warning Letter cited violations of regulatory requirements identified during the 2000 inspection and requested that we take corrective actions |
| Under the terms of the Warning Letter, we were unable to obtain any approvals to market new products and government agencies were notified of our non-compliant status |
| Additional FDA inspections in 2002, 2003 and 2004 identified additional and recurring violations resulting in continuance of the Warning Letter |
| During this time, the FDA initiated no enforcement action |
| Since 2000, and in response to the violations cited by the FDA, we implemented a comprehensive systematic corrective action plan at our Decatur manufacturing facility |
| We maintained regular communications with the FDA and provided periodic progress reports |
| 7 _________________________________________________________________ [57]Table of Contents On December 13, 2005, the FDA notified us that we had satisfactorily implemented corrective actions and the FDA had determined that our Decatur manufacturing facility was in substantial compliance with cGMP regulations |
| Consequently, the restrictions of the Warning Letter were removed and we became eligible for new product approvals for products manufactured at our Decatur manufacturing facility |
| While under the Warning Letter restrictions from 2000 to 2005, our inability to fully utilize the capabilities of the Decatur manufacturing facility had a material adverse effect on our business, financial condition and results of operations |
| Product Recalls |
| In February 2003, we recalled two products, Fluress and Fluoracaine, due to container/closure integrity problems resulting in leaking containers |
| The recall was classified by the FDA as a Class II Recall, which means that the use of, or exposure to, a violative product may cause temporary or medically reversible adverse health consequences or that the probability of serious health consequences as a result of such use or exposure is remote |
| The financial impact of this recall was not material to us as our customers did not hold significant inventories of these products |
| In March 2003, as a result of the FDA inspections performed from December 10, 2002 to February 6, 2003, we recalled twenty-four lots of product produced from the period December 2001 to June 2002 in one of our production rooms at our Decatur manufacturing facility |
| The majority of the lots recalled were for third party contract customer products |
| Subsequent to this decision and after discussions with the FDA, eight of the original twenty-four lots were exempted from the recall due to medical necessity |
| The recall was classified by the FDA as a Class II Recall |
| The financial impact of this recall was not material to us as our customers did not hold significant inventories of these products |
| We also manufacture and distribute several controlled-drug substances, the distribution and handling of which are regulated by the DEA Failure to comply with DEA regulations can result in fines or seizure of product |
| On March 6, 2002, we received a letter from the United States Attorney’s Office, Central District of Illinois, Springfield, Illinois, advising us that the DEA had referred a matter to that office for a possible civil legal action for alleged violations of the Comprehensive Drug Abuse Prevention Control Act of 1970, 21 USC § 801 et |
| (“Comprehensive Drug Act”), and regulations promulgated thereunder |
| The alleged violations relate to record keeping and controls surrounding the storage and distribution of controlled substances |
| Without admitting to any of the allegations, on November 6, 2002, we entered into a Civil Consent Decree with the DEA (the “Civil Consent Decree”) |
| Under terms of the Civil Consent Decree, without admitting any of the allegations in the complaint from the DEA, we agreed to pay a fine of dlra100cmam000, upgrade our security system and to remain in substantial compliance with the Comprehensive Drug Act |
| If we failed to remain in substantial compliance during the two-year period following the entry of the Civil Consent Decree, we, in addition to other possible sanctions, might have been held in contempt of court and ordered to pay an additional dlra300cmam000 fine |
| We completed the upgrades to our security system in 2003 and have received no further notice from the DEA in connection with the Civil Consent Decree |
| The two-year compliance period lapsed on November 6, 2004 |
| We were inspected by the DEA in February 2005 and the DEA has not informed us of any further violations |
| We do not anticipate any material adverse effect from compliance with federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment |
| Foreign Sales |
| During 2005, 2004 and 2003, approximately dlra3cmam666cmam000, dlra5cmam435cmam000 and dlra3cmam151cmam000, respectively, of our revenues were from external customers located in foreign countries |
| Item 1A Risk Factors |
| We have experienced recent operating losses, working capital deficiencies and negative cash flows from operations, and these losses and deficiencies may continue in the future |
| Our recent operating losses, working capital deficiencies and negative cash flows from operations may continue in the future and there can be no assurance that our financial outlook will improve |
| For the years ended December 31, 2005 and 2004, our operating losses were dlra7cmam479cmam000 and dlra368cmam000, respectively |
| We experienced negative cash flows from operations for the years ended December 31, 2005 and 2004 of dlra148cmam000 and dlra3cmam461cmam000, respectively |
| There can be no assurance that our results of operations will improve in the future |
| If our results of operations do not improve in the future, an investment in our common stock could be negatively affected |
| We have invested significant resources in the development of lyophilization manufacturing capability, and we may not realize the benefit of these efforts and expenditures |
| 8 _________________________________________________________________ [58]Table of Contents We are in the process of completing an expansion of our Decatur, Illinois manufacturing facility to add capacity to provide lyophilization manufacturing services, a manufacturing capability we currently do not have |
| Validation and approval of the lyophilization facility by the FDA is anticipated in the second quarter of 2006 |
| As of December 31, 2005, we had spent approximately dlra19cmam691cmam000 on the lyophilization expansion and anticipate the need to spend approximately dlra1cmam000cmam000 of additional funds (excluding capitalized interest) which will primarily be used for testing and validation as the major capital equipment items are currently in place |
| In addition, we are working toward the development of an internal ANDA lyophilized product pipeline |
| Manufacturing capabilities for lyophilized products are projected to be in place by mid-2006 |
| However, there is no guarantee that we will be successful in completing development of lyophilization capability, or that other intervening events will not occur that reduce or eliminate the anticipated benefits from such capability |
| For instance, the market for lyophilized products could significantly diminish or be eliminated, or new technological advances could render the lyophilization process obsolete, prior to our entry into the market |
| There can be no assurance that we will realize the anticipated benefits from our significant investment into lyophilization capability at our Decatur manufacturing facility, and our failure to do so could significantly limit our ability to grow our business in the future |
| We depend on a small number of distributors, the loss of any of which could have a material adverse effect |
| A small number of large wholesale drug distributors account for a large portion of our gross sales, revenues and accounts receivable |
| The following three distributors, AmerisourceBergen, Cardinal and McKesson, accounted for approximately 69prca of total gross sales and 46prca of total revenues in 2005, and 76prca of gross trade receivables as of December 31, 2005 |
| In addition to acting as distributors of our products, these three companies also distribute a broad range of health care products for many other companies |
| The loss of one or more of these distributors, together with a delay or inability to secure an alternative distribution source for end users, could have a material negative impact on our revenue and results of operations and lead to a violation of debt covenants |
| A change in purchasing patterns, inventory levels, increases in returns of our products, delays in purchasing products and delays in payment for products by one or more distributors also could have a material negative impact on our revenue and results of operations |
| Certain of our directors are subject to conflicts of interest |
| John N Kapoor, Ph |
| D, our chairman of our board of directors, our chief executive officer from March 2001 to December 2002, and a principal shareholder, is affiliated with EJ Financial Enterprises, Inc |
| (“EJ Financial”), a health care consulting investment company |
| EJ Financial is involved in the management of health care companies in various fields, and Dr |
| Kapoor is involved in various capacities with the management and operation of these companies |
| The John N Kapoor Trust dated 9/20/89 (the “Kapoor Trust”), the beneficiary and sole trustee of which is Dr |
| Kapoor, is a principal shareholder of each of these companies |
| Kapoor does not devote his full time to our business |
| Although such companies do not currently compete directly with us, certain companies with which EJ Financial is involved are in the pharmaceutical business |
| Discoveries made by one or more of these companies could render our products less competitive or obsolete |
| The Kapoor Trust has also loaned us dlra5cmam000cmam000 resulting in Dr |
| Kapoor effectively becoming a major creditor of ours as well as a major shareholder |
| Potential conflicts of interest could have a material adverse effect on our business, financial condition and results of operations |
| We may require additional capital to grow our business and such funds may not be available to us |
| We may require additional funds to grow our business |
| However, adequate funds through the financial markets or from other sources may not be available when needed or on terms favorable to us due to our recent financial history |
| Further, the terms of such additional financing, if obtained, likely will require the granting of rights, preferences or privileges senior to those of our common stock and result in substantial dilution of the existing ownership interests of our common stockholders and could include covenants and restrictions that limit our ability to operate or expand our business in a manner that we deem to be in our best interest |
| Our growth depends on our ability to timely develop additional pharmaceutical products and manufacturing capabilities |
| Our strategy for growth is dependent upon our ability to develop products that can be promoted through current marketing and distributions channels and, when appropriate, the enhancement of such marketing and distribution channels |
| We may not meet our anticipated time schedule for the filing of ANDAs and NDAs or may decide not to pursue ANDAs or NDAs that we have submitted or anticipate submitting |
| Our internal development of new pharmaceutical products is dependent upon the research and development capabilities of our personnel and our strategic business alliance infrastructure |
| There can be no assurance that we or our strategic business alliances will successfully develop new pharmaceutical products or, if developed, successfully integrate new products into 9 _________________________________________________________________ [59]Table of Contents our existing product lines |
| In addition, there can be no assurance that we will receive all necessary FDA approvals or that such approvals will not involve delays, which adversely affect the marketing and sale of our products |
| Our failure to develop new products, to maintain substantial compliance with FDA compliance guidelines or to receive FDA approval of ANDAs or NDAs, could have a material adverse effect on our business, financial condition and results of operations |
| We have entered into several strategic business alliances which may not result in marketable products |
| We have entered several strategic business alliances that have been formed to supply us with low cost finished dosage form products |
| Since 2004, we have entered into various purchase and supply agreements, license agreements, and a joint venture that are all designed to provide finished dosage form products that can be marketed through our distribution pipeline |
| However, there can be no assurance that any of these agreements will result in FDA-approved ANDAs or NDAs, or that we will be able to market any such finished dosage form products at a profit |
| In addition, any clinical trial expenses that we incur may result in adverse financial consequences to our business |
| Our success depends on the development of generic and off-patent pharmaceutical products which are particularly susceptible to competition, substitution policies and reimbursement policies |
| Our success depends, in part, on our ability to anticipate which branded pharmaceuticals are about to come off patent and thus permit us to develop, manufacture and market equivalent generic pharmaceutical products |
| Generic pharmaceuticals must meet the same quality standards as branded pharmaceuticals, even though these equivalent pharmaceuticals are sold at prices that are significantly lower than that of branded pharmaceuticals |
| Generic substitution is regulated by the federal and state governments, as is reimbursement for generic drug dispensing |
| There can be no assurance that substitution will be permitted for newly approved generic drugs or that such products will be subject to government reimbursement |
| In addition, generic products that third parties develop may render our generic products noncompetitive or obsolete |
| There can be no assurance that we will be able to consistently bring generic pharmaceutical products to market quickly and efficiently in the future |
| An increase in competition in the sale of generic pharmaceutical products or our failure to bring such products to market before our competitors could have a material adverse effect on our business, financial condition and results of operations |
| Further, there is no proprietary protection for most of the branded pharmaceutical products that either we or other pharmaceutical companies sell |
| In addition, governmental and cost-containment pressures regarding the dispensing of generic equivalents will likely result in generic substitution and competition generally for our branded pharmaceutical products |
| We attempt to mitigate the effect of this substitution through, among other things, creation of strong brand-name recognition and product-line extensions for our branded pharmaceutical products, but there can be no assurance that we will be successful in these efforts |
| 10 _________________________________________________________________ [60]Table of Contents We can be subject to legal proceedings against us, which may prove costly and time-consuming even if meritless |
| In the ordinary course of our business, we can be involved in legal actions with both private parties and certain government agencies |
| To the extent that our personnel may have to spend time and resources to pursue or contest any matters that may be asserted from time to time in the future, this represents time and money that is not available for other actions that we might otherwise pursue which could be beneficial to our future |
| In addition, to the extent that we are unsuccessful in any legal proceedings, the consequences could have a negative impact on our business, financial |