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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-10113
HALSEY DRUG CO., INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
NEW YORK 11-0853640
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
695 NORTH PERRYVILLE ROAD, CRIMSON BUILDING NO. 2, ROCKFORD, ILLINOIS 61107
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (815) 399-2060
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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COMMON STOCK, PAR VALUE $0.01 THE AMERICAN STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
(TITLE OF CLASS)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of March 15, 1999, the registrant had 14,260,711 shares of Common Stock,
par value $0.01, outstanding. Based on the closing price of the Common Stock on
March 15, 1999 ($1 3/16), the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $16,890,000.
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE REGISTRANT'S PROXY STATEMENT FOR THE 1999 ANNUAL MEETING OF
SHAREHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III. SUCH PROXY STATEMENT
WILL BE FILED WITHIN 120 DAYS AFTER THE END OF THE FISCAL YEAR COVERED BY THIS
ANNUAL REPORT ON FORM 10-K.
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CONTENTS
PAGE
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PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 12
Item 3. Legal Proceedings........................................... 12
Item 4. Submission of Matters to a Vote of Security Holders......... 14
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 14
Item 6. Selected Financial Data..................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 16
Item 8. Financial Statements and Supplementary Data................. 21
Item 9. Changes in and Disagreement with Accountants on Accounting
and Financial Disclosure.................................... 21
PART III
Item 10., Directors and Executive Officers of the
Registrant; Item 11., Executive Compensation;
Item 12., Security Ownership of Certain Beneficial Owners
and Management; and Item 13., Certain Relationships and
Related Transactions are incorporated by reference to the
Company's definitive Proxy Statement for its 1999 Annual
Meeting of Shareholders.
PART IV
Item
14. Exhibits, Financial Statement Schedules and Reports on Form
8-K Signatures.............................................. 21
Index to Consolidated Financial Statements.................. F-1
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Report under the captions Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations," Item
1, "Business", Item 3, "Legal Proceedings" and elsewhere in this Report
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995 (the "Reform Act"). Such
forward-looking statements involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance or achievements of
Halsey Drug Co., Inc. ("Halsey" or the "Company"), or industry results, to be
materially different from any future results, performance, or achievements
expressed or implied by such forward-looking statements. Such factors include,
among others, the following: changes in general economic and business
conditions; loss of market share through competition; introduction of competing
products by other companies; the timing of regulatory approval and the
introduction of new products by the Company; changes in industry capacity;
pressure on prices from competition or from purchasers of the Company's
products; regulatory changes in the generic pharmaceutical manufacturing
industry; regulatory obstacles to the introduction of new products that are
important to the Company's growth; availability of qualified personnel; the loss
of any significant customers; and other factors both referenced and not
referenced in this Report. When used in this Report, the words "estimate,"
"project," "anticipate," "expect," "intend," "believe," and similar expressions
are intended to identify forward-looking statements.
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PART I
ITEM 1. BUSINESS.
GENERAL
The Company, a New York corporation established in 1935, and its
subsidiaries, are engaged in the manufacture, sale and distribution of generic
drugs. A generic drug is the chemical and therapeutic equivalent of a brand-name
drug for which patent protection has expired. A generic drug may only be
manufactured and sold if patents (and any additional government-granted
exclusivity periods) relating to the brand-name equivalent of the generic drug
have expired. A generic drug is usually marketed under its generic chemical name
or under a brand name developed by the generic manufacturer. The Company sells
its generic drug products under its Halsey label and under private-label
arrangements with drugstore chains and drug wholesalers. While subject to the
same governmental standards for safety and efficacy as its brand-name
equivalent, a generic drug is usually sold at a price substantially below that
of its brand-name equivalent.
The Company manufactures its products at facilities in New York and
Indiana. During the last several years, the Company has sought to diversify its
businesses through strategic acquisitions and through the development,
manufacture and sale of bulk chemical products used by others as raw materials
in the manufacture of finished drug forms.
RECENT EVENTS
Regulatory Compliance
During the past several years, the Company's business has been adversely
affected by the discovery of various manufacturing and record keeping problems
identified with certain products manufactured at its Brooklyn, New York plant.
In October 1991, the U.S. Food and Drug Administration (the "FDA") placed the
Company on the FDA's Application Integrity Policy list and its restrictions
(collectively, the "AIP"). Under the AIP, the FDA suspended all of the parent
company's applications for new drug approvals, including Abbreviate New Drug
Applications ("ANDAs") and Supplements to ANDAs. During the period that
followed, the U.S. Department of Justice ("DOJ") conducted an investigation into
the manufacturing and record keeping practices at the Company's Brooklyn plant.
As a consequence, on June 21, 1993, the Company entered into a plea agreement
(the "Plea Agreement") with the DOJ to resolve the DOJ's investigation. Under
the terms of the Plea Agreement, the Company agreed to plead guilty to five
counts of adulteration of a single drug product shipped in interstate commerce
and related record keeping violations. The Plea Agreement also required the
Company to pay a fine of $2,500,000 over five years in quarterly installments of
$125,000 commencing in September 1993. As of February 28, 1998, the Company was
in default of the payment terms of the Plea Agreement and had made payments
aggregating $350,000. On March 27, 1998, the Company and the DOJ signed a Letter
Agreement serving to amend the Plea Agreement relating to the terms of the
Company's satisfaction of the fine assessed under the Plea Agreement. The Letter
Agreement provides, among other things, that the Company will satisfy the
remaining $2,150,000 of the fine through the payment of $25,000 on a monthly
basis commencing June 1, 1998, plus interest on the outstanding balance. See
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Liquidity and Capital Resources" for a more detailed
description of the Letter Amendment to the Plea Agreement between the DOJ and
the Company.
On June 29, 1993, the Company entered into a consent decree (the "Consent
Decree") with the U.S. Attorney for the Eastern District of New York on behalf
of the FDA that resulted from the FDA's investigation into the Brooklyn plant's
compliance with the FDA's Current Good Manufacturing Practices ("CGMP")
regulations. Under the terms of the Consent Decree, the Company was enjoined
from shipping any solid dosage drug products (i.e., excluding liquid drug
formulations) manufactured at the Brooklyn plant until the Company established,
to the satisfaction of the FDA, that the methods used in, and the facilities and
controls used for, manufacturing, processing, packing, labeling and holding any
drug, were established, operated, and administered in conformity with the
Federal Food, Drug, and Cosmetic Act and all CGMP
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Regulations. As part of satisfying these requirements, the Company was required
to validate the manufacturing processes for each solid dosage drug product prior
to manufacturing and shipping the drug product.
On October 23, 1996, the Company withdrew four of its ANDAs, including its
ANDA (the "Capsules ANDA") for acetaminophen/oxycodone capsules (the
"Capsules"), and halted sales of the affected products. Net sales derived from
the withdrawn Capsule ANDA were approximately $3 million and $8 million for the
years ended December 31, 1996 and December 31, 1995, respectively, and accounted
for approximately 24% and 40% of the Company's total net sales during such
twelve month periods. The Company instituted the withdrawal of the Capsule ANDA
at the suggestion of the FDA and in anticipation of its release from the AIP. At
the FDA's suggestion, the Company retained outside consultants to perform
validity assessments of its drug applications. Thereafter, in October 1996, the
FDA recommended that several applications, including the Capsule ANDA, be
withdrawn. As a basis for its decision, the FDA cited questionable and
incomplete data submitted in connection with the applications. The FDA indicated
that the withdrawal of the four ANDAs was necessary for the release of the
Company from the AIP. The FDA further required submission by the Company of a
Corrective Action Plan, which was prepared and submitted by the Company and
accepted by the FDA.
On December 19, 1996, the FDA released the Company from the AIP. As a
consequence, for the first time since October 1991, the Company was permitted to
submit ANDAs to the FDA for review. Since its release from the AIP in December
1996, through the fiscal year ended December 31, 1998, the Company submitted 13
ANDAs for review by the FDA, including a new ANDA with respect to the Capsules.
During the period from the Company's release from the AIP to March 15, 1999, the
Company received the following ANDA approvals, all of which relate to ANDA
filings made with the FDA subsequent to the Company's release from the AIP:
PRODUCT NAME
(DRUG CLASS) STRENGTH TRADE NAME STATUS
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Hydrocodone Bitartate and..... 5mg/500mg Vicodin(R)(1) FDA approval of ANDA received
Acetaminophen Tablets September 26, 1997.
(narcotic analgesic)
Hydrocodone Bitartate and..... 7.5mg/750mg VicodinES(R)(1) FDA approval of ANDA received
Acetaminophen Tablets September 26, 1997.
(narcotic analgesic)
Hydrocodone Bitartate and..... 7.5mg/650mg Lorcet FDA approval of ANDA received
Acetaminophen Tablets, CIII Plus(R)(2) November 26, 1997.
(narcotic analgesic)
Hydrocodone Bitartrate and.... 10mg/650mg Lorcet(R)(2) FDA approval of ANDA received
Acetaminophen Tablets, CIII November 26, 1997.
(narcotic analgesic)
Oxycodone HCI and............. 5mg/50mg Tylox(R)(3) FDA approval of ANDA received
Acetaminophen Capsules, CII January 22, 1998.
(narcotic analgesic)
Oxycodone HCI/Oxycodone....... 4.5mg/325mm Percodan(R)(4) FDA approval of ANDA received
Terephthalate Tablets, CII July 24, 1998
(narcotic analgesic)
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(1) Registered trademark of Knoll Pharmaceutical Co.
(2) Registered trademark of Forest Laboratories, Inc.
(3) Registered trademark of McNeil Consumer Products Company
(4) Registered Trademark of DuPont Merck
As of March 15, 1999, the Company had submitted one ANDA for review by the
FDA in fiscal 1999 and anticipates the submission of five additional ANDAs
during the balance of fiscal 1999. Although the Company has been successful in
receiving the ANDA approvals described above since its release from the AIP in
December 1996, there can be no assurance that any of its newly submitted ANDAs,
or those contemplated to
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be submitted, will be approved by the FDA. The Company will not be permitted to
market any new product unless and until the FDA approves the ANDA relating to
such product. Failure to obtain FDA approval for the Company's pending ANDAs, or
a significant delay in obtaining such approval, would adversely affect the
Company's business operations and financial condition.
Private Offerings and Bridge Financing
On March 10, 1998, the Company completed a private offering of securities
(the "Offering") to Galen Partners III, L.P., Galen Partners International III,
L.P., Galen Employee Fund III, L.P., (collectively, "Galen") and each of the
Purchasers listed on the signature page to a certain Debenture and Warrant
Purchase Agreement dated March 10, 1998 between the Company and such Purchasers
(inclusive of Galen, collectively the "Galen Investor Group"). The securities
issued in the Offering consisted of 5% convertible senior secured debentures
(the "Debentures") and common stock purchase warrants (the "Warrants")
exercisable for an aggregate of 4,202,020 shares of the Company common stock.
The net proceeds to the Company from the Offering, after the deduction of
related Offering expenses, was approximately $19.6 million. In addition, in
accordance with the terms of the Debenture and Warrant Purchase Agreement
pursuant to which the Offering was completed, the Company granted the Galen
Investor Group an option to invest an additional $5 million in the Company at
any time within 18 months from the date of the closing of the Offering in
exchange for Debentures and Warrants having terms identical to those issued in
the Offering (the "Galen Option"). In June 1998, the Galen Investor Group
exercised this option.
The net proceeds of the Offering have, in large part, been used to satisfy
a substantial portion of the Company's liabilities and accounts payable.
Additionally, pursuant to agreements reached with other large creditors in
anticipation of the completion of the Offering, including the Company's landlord
and the DOJ, the Company has been able to bring these creditors current and will
be in compliance with installment payment agreements providing favorable terms
to the Company. The net proceeds from the exercise of the Galen Option have been
used, in large part, to fund working capital, including the purchase of raw
materials, payroll expenses and other Company expenses.
In addition to the net proceeds from the Offering and the exercise of the
Galen Option, the Company secured bridge financing from Galen and certain
investors in the Offering in the aggregate amount of $9,504,111 funded through
seven separate bridge loan transactions between the period from August through
and including December, 1998, as well as an additional bridge loan in March,
1999 (collectively, the "Bridge Loans"). The Bridge Loans were consolidated on
December 2, 1998 pursuant to an Amended, Restated and Consolidated Bridge Loan
Agreement (the "Consolidated Bridge Loan"). The Consolidated Bridge Loan bears
interest at 10% per annum, is secured by a first lien on all of the Company's
assets and has a maturity date of May 30, 1999. Approximately $9,120,000 in the
principal amount of the Consolidated Bridge Loan was advanced by Galen with the
balance of approximately $384,000 advanced by certain investors in the Offering.
The Consolidated Bridge Loan was secured by the Company in order to provide
necessary working capital. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" for a more detailed discussion of
the Consolidated Bridge Loan transaction.
Lease of Congers, New York Facility
Effective March 22, 1999, the Company leased, as sole tenant, a
pharmaceutical manufacturing facility located in Congers, New York (the "Congers
Facility") from Par Pharmaceuticals, Inc. ("Par") pursuant to an Agreement to
Lease (the "Lease"). The Congers Facility contains office, warehouse and
manufacturing space and is approximately 35,000 square feet. The Lease provides
for a term of three years, with a two year renewal option and provides for
annual fixed rent of $500,000 per year during the primary term of the Lease and
$600,000 per year during the option period. The Lease also covers certain
manufacturing and related equipment previously used by Par in its operations at
the Congers Facility (the "Leased Equipment"). In connection with the execution
of the Lease, the Company and Par entered into a certain Option Agreement
pursuant to which the Company may purchase the Congers Facility and the Lease
Equipment at any time during the lease term for $5 million.
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As part of the execution of the Lease, the Company and Par entered into a
certain Manufacturing and Supply Agreement (the "M&S Agreement") having a
minimum term of twenty seven months. The M&S Agreement provides for the
Company's contract manufacture of certain designated products manufactured by
Par at the Congers Facility prior to the effective date of the Lease. The M&S
Agreement also provides that Par will purchase a minimum of $1,150,000 in
product during the initial 18 months of the Agreement. The M&S Agreement further
provides that the Company will not manufacture, supply, develop or distribute
the designated products to be supplied by the Company to Par under the M&S
Agreement to or for any other person for a period of three years.
Cessation of California Operations
On March 20, 1998, the Company discontinued the operations of H.R. Cenci
Laboratories, a wholly-owned subsidiary. H.R. Cenci Laboratories had been a
manufacturer of drug products in liquid preparations. Continuing operating
losses and the Company's inability to leverage the manufacturing capacity of
Cenci Laboratories were among factors considered by the Board and Management in
its determination to cease such operations.
On March 30, 1998, the Company completed the sale of substantially all of
the non-real property assets of Cenci Powder Products, a wholly-owned
subsidiary, to Zuellig Botanical. The purchase price for the assets consisted of
the forgiveness by Zuellig Botanical of approximately $262,000 in indebtedness
owed by Cenci Powder to Zuellig Botanical related to the purchase of raw
materials. The Agreement provided further that Zuellig Botanical would satisfy
the manufacture and delivery requirements of Cenci Powder at its located
facility in Fresno, California, under an existing third party supply contract.
On December 4, 1998, the Company disposed of the real property owned by Cenci
Powder in Fresno, California to an unrelated third party for a net sales price
of approximately $73,000. Continuing operating losses and the Company's
inability to leverage the manufacturing capacity of Cenci Powder were among the
factors considered by the Board and Management in its determination to terminate
the operations of Cenci Powder.
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PRODUCTS AND PRODUCT DEVELOPMENT
Generic Drug Products
The Company historically has manufactured and sold a broad range of
prescription and over-the-counter drug products. The Company's pharmaceutical
product list currently includes a total of approximately 28 products, consisting
of 18 dosage forms and strengths of prescription drugs and 10 dosage forms and
strengths of over-the-counter drugs. Each dosage form and strength of a
particular drug is considered in the industry to be a separate drug product. The
Company's drug products are sold in various forms, including liquid and powder
preparations, compressed tablets and two-piece, hard-shelled capsules.
Most of the generic drug products manufactured by the Company can be
classified within one of the following categories:
1. Antibiotics,
2. Narcotic analgesics,
3. Anti-infective and anti-tubercular drugs,
4. Antihistamines and antihistaminic decongestants, or
5. Antitussives.
During fiscal 1998, sales of antitussives and narcotic analgesics accounted
for approximately 75% of total net sales during such year. The Company
anticipates that sales of antitussives and narcotic analgesics will continue to
represent a significant portion of the Company's revenue.
The Company's development strategy for new drug products has been to focus
on the development of a broad-range of generic form drugs, each of which (i) has
developed a solid market acceptance with a wide base of customers, (ii) can be
sold on a profitable basis notwithstanding intense competition from other drug
manufacturers, and (iii) is no longer under patent protection. The Company has
also diversified its current product line to include some less widely prescribed
drugs as to which limited competition might be expected. In addition, the
Company will continue to pursue the development of its existing pharmaceutical
business as well as the development of the chemical products business of its
Houba subsidiary.
Development activities for each new generic drug product begin several
years in advance of the patent expiration date of the brand-name drug
equivalent. This is because the profitability of a new generic drug usually
depends on the ability of the Company to obtain FDA approval to market that drug
product upon or immediately after the patent expiration date of the equivalent
brand-name drug. Being among the first to market a new generic drug product is
vital to the profitability of the product. As other off-patent drug
manufacturers receive FDA approvals on competing generic products, prices and
revenues typically decline. Accordingly, the Company's ability to attain
profitable operations will, in large part, depend on its ability to develop and
introduce new products, the timing of receipt of FDA approval of such products
and the number and timing of FDA approvals for competing products.
Active Pharmaceutical Ingredients
In the last few years, the Company has increased its efforts to develop and
manufacture active pharmaceutical ingredients also known as bulk chemical
products. The development and sale of active pharmaceutical ingredients
generally is not subject to the same level of regulation as is the development
and sale of drug products; accordingly, active pharmaceutical ingredients may be
brought to market substantially sooner than drug products. While the Company
currently is focusing on the development and manufacture of active
pharmaceutical ingredients for use in production of finished dosage products at
the Company's Brooklyn and Congers, New York facilities, active pharmaceutical
ingredients eventually may be marketed and sold to third parties.
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RESEARCH AND DEVELOPMENT
The Company conducts research and development activities at each of its
Brooklyn and Indiana facilities. The Company's research and development
activities consist primarily of new generic drug product development efforts and
manufacturing process improvements, as well as the development for sale of new
chemical products. New drug product development activities are primarily
directed at conducting research studies to develop generic drug formulations,
reviewing and testing such formulations for therapeutic equivalence to brand
name products and additional testing in areas such as bioavailability,
bioequivalence and shelf-life. For fiscal years 1998, 1997 and 1996, total
research and development expenditures were $651,000, $979,000 and $1,854,000,
respectively. During 1999, the Company's research and development efforts will
cover products in a variety of therapeutic applications.
As of March 15, 1999, the Company maintained a full-time staff of five in
its Research and Development Departments.
MARKETING AND CUSTOMERS
The application of the AIP to the Company's operations until December 1996,
combined with the Company's continuing operating losses and lack of adequate
working capital during fiscal 1997 and the first quarter of 1998 resulted in the
Company's inability to maintain sufficient raw materials and finish goods
inventories to permit the Company to actively solicit customer orders, and when
orders were received, to fill such orders promptly. Following the completion of
the Offering, new Management adopted a marketing strategy focused on developing
and maintaining sufficient raw materials and finish goods inventories so as to
permit a targeted sales effort by the Company to a core customer group, with an
emphasis on quality, prompt product delivery and excellent customer service. The
Company's products are sold by Stephanie Heitmeyer, Vice President of Sales, and
three salaried sales persons. Sales of the Company's drugs in dosage form are
made primarily to drug wholesalers, drugstore chains, distributors and other
manufacturers and are not concentrated in any specific region.
During 1998, the Company had net sales to one customer aggregating 11.5% of
total sales. The sales to such customer were made pursuant to a certain contract
manufacturing agreement entered into with the Company as part of the Company's
sale of its ANDA for oxycodone HCI/325 mg acetaminophen tablets in March, 1995.
The Company anticipates that net sales to this customer (which aggregated
approximately 22.3% of total sales in 1997) will continue to decline during 1999
and thereafter. The Company does not believe that the continuing decline of net
sales to this customer will have a material adverse effect on the Company.
Also during 1998, the Company had net sales to two customers aggregating
approximately 19.1% of total sales. The Company believes that the loss of these
customers would have a material adverse effect on the Company. During 1997 the
Company had net sales to one customer in excess of 10% of total sales,
aggregating 22.3% of total sales. During 1996, the Company had net sales to one
customer in excess of 10% of total sales, aggregating 10% of total sales.
The estimated dollar amount of the backlog of orders for future delivery as
of March 15, 1999 was approximately $500,000 as compared with approximately
$800,000 as of March 15, 1998. Although these orders are subject to
cancellation, management expects to fill substantially all orders by the second
quarter of 1999. The decline in the Company's backlog as of March 15, 1999
compared to that in 1998 is largely a function of the Company's increased
efficiency in the processing and filling of customer orders.
GOVERNMENT REGULATION
General
All pharmaceutical manufacturers, including the Company, are subject to
extensive regulation by the Federal government, principally by the FDA, and, to
a lesser extent, by state and local governments. Additionally, the Company is
subject to extensive regulation by the DEA as a manufacturer of controlled
substances. The Company cannot predict the extent to which it may be affected by
legislative and other
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regulatory developments concerning its products and the healthcare industry
generally. The Federal Food, Drug, and Cosmetic Act, the Generic Drug
Enforcement Act of 1992, the Controlled Substance Act and other Federal statutes
and regulations govern or influence the testing, manufacture, safe labeling,
storage, record keeping, approval, pricing, advertising, promotion, sale and
distribution of pharmaceutical products. Noncompliance with applicable
requirements can result in fines, recall or seizure of products, criminal
proceedings, total or partial suspension of production, and refusal of the
government to enter into supply contracts or to approve new drug applications.
The FDA also has the authority to revoke approvals of new drug applications. The
ANDA drug development and approval process now averages approximately eight
months to two years. The approval procedures are generally costly and time
consuming.
FDA approval is required before any "new drug," whether prescription or
over-the-counter, can be marketed. A "new drug" is one not generally recognized
by qualified experts as safe and effective for its intended use. Such general
recognition must be based on published adequate and well controlled clinical
investigations. No "new drug" may be introduced into commerce without FDA
approval. A drug which is the "generic" equivalent of a previously approved
prescription drug also will require FDA approval. Furthermore, each dosage form
of a specific generic drug product requires separate approval by the FDA. In
general, as discussed below, less costly and time consuming approval procedures
may be used for generic equivalents as compared to the innovative products.
Among the requirements for drug approval is that the prospective manufacturer's
methods must conform to the CGMPs. CGMPs apply to the manufacture, receiving,
holding and shipping of all drugs, whether or not approved by the FDA. CGMPs
must be followed at all times during which the drug is manufactured. To ensure
full compliance with standards, some of which are set forth in regulations, the
Company must continue to expend time, money and effort in the areas of
production and quality control. Failure to so comply risks delays in approval of
drugs, disqualification from eligibility to sell to the government, and possible
FDA enforcement actions, such as an injunction against shipment of the Company's
products, the seizure of noncomplying drug products, and/or, in serious cases,
criminal prosecution. The Company's manufacturing facilities are subject to
periodic inspection by the FDA.
In addition to the regulatory approval process, the Company is subject to
regulation under Federal, state and local laws, including requirements regarding
occupational safety, laboratory practices, environmental protection and
hazardous substance control, and may be subject to other present and future
local, state, Federal and foreign regulations, including possible future
regulations of the pharmaceutical industry.
Drug Approvals
There are currently three ways to obtain FDA approval of a new drug.
1. New Drug Applications ("NDA"). Unless one of the procedures discussed
in paragraph 2 or 3 below is available, a prospective manufacturer must conduct
and submit to the FDA complete clinical studies to prove a drug's safety and
efficacy, in addition to the bioavailability and/or bioequivalence studies
discussed below, and must also submit to the FDA information about manufacturing
practices, the chemical make-up of the drug and labeling.
2. Abbreviated New Drug Applications ("ANDA"). The Drug Price Competition
and Patent Term Restoration Act of 1984 (the "1984 Act") established the ANDA
procedure for obtaining FDA approval for those drugs that are off-patent or
whose exclusivity has expired and that are bioequivalent to brand-name drugs. An
ANDA is similar to an NDA, except that the FDA waives the requirement of
conducting complete clinical studies of safety and efficacy, although it may
require expanded clinical bioavailability and/or bioequivalence studies.
"Bioavailability" means the rate of absorption and levels of concentration of a
drug in the blood stream needed to produce a therapeutic effect.
"Bioequivalence" means equivalence in bioavailability between two drug products.
In general, an ANDA will be approved only upon a showing that the generic drug
covered by the ANDA is bioequivalent to the previously approved version of the
drug, i.e., that the rate of absorption and the levels of concentration of a
generic drug in the body are substantially equivalent to those of a previously
approved equivalent drug. The principle advantage of this approval mechanism is
that an ANDA applicant is not required to conduct the same preclinical and
clinical studies to demonstrate that the product is safe and effective for its
intended use.
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The 1984 Act, in addition to establishing the ANDA procedure, created new
statutory protections for approved brand-name drugs. In general, under the 1984
Act, approval of an ANDA for a generic drug may not be made effective until all
product and use patents listed with the FDA for the equivalent brand name drug
have expired or have been determined to be invalid or unenforceable. The only
exceptions are situations in which the ANDA applicant successfully challenges
the validity or absence of infringement of the patent and either the patent
holder does not file suit or litigation extends more than 30 months after notice
of the challenge was received by the patent holder. Prior to enactment of the
1984 Act, the FDA gave no consideration to the patent status of a previously
approved drug. Additionally, under the 1984 Act, if specific criteria are met,
the term of a product or use patent covering a drug may be extended up to five
years to compensate the patent holder for the reduction of the effective market
life of that patent due to federal regulatory review. With respect to certain
drugs not covered by patents, the 1984 Act sets specified time periods of two to
ten years during which approvals of ANDAs for generic drugs cannot become
effective or, under certain circumstances, ANDAs cannot be filed if the
equivalent brand-name drug was approved after December 31, 1981.
3. "Paper" NDA. An alternative NDA procedure is provided by the 1984 Act
whereby the applicant may rely on published literature and more limited testing
requirements. While that alternative sometimes provides advantages over the ANDA
procedure, it is not frequently used.
Generic Drug Enforcement Act
As a result of hearings and investigations concerning the activities of the
generic drug industry and the FDA's generic drug approval process, Congress
enacted the Generic Drug Enforcement Act of 1992 (the "Generic Drug Act"). The
Generic Drug Act confers significant new authority upon the FDA to impose
debarment and civil penalties for individuals and companies who commit certain
illegal acts relating to the generic drug approval process.
The Generic Drug Act requires the mandatory debarment of companies or
individuals convicted of a federal felony for conduct relating to the
development or approval of any ANDA, and gives the FDA discretion to debar
corporations or individuals for similar conduct resulting in a federal
misdemeanor or state felony conviction. The FDA may not accept or review during
the period of debarment (one to ten years in the case of mandatory, or up to
five years in the case of permissive, debarment of a corporation) any ANDA
submitted by or with the assistance of the debarred corporation or individual.
The Generic Drug Act also provides for temporary denial of approval of generic
drug applications during the investigation of crimes that could lead to
debarment. In addition, in more limited circumstances, the Generic Drug Act
provides for suspension of the marketing of drugs under approved generic drug
applications sponsored by affected companies. The Generic Drug Act also provides
for fines and confers authority on the FDA to withdraw, under certain
circumstances, approval of a previously granted ANDA if the FDA finds that the
ANDA was obtained through false or misleading statements. The Company was not
debarred as a result of the FDA investigation and settlement and the Consent
Decree with the FDA makes no provision therefor.
Healthcare Reform
Several legislative proposals to address the rising costs of healthcare
have been introduced in Congress and several state legislatures. Many of such
proposals include various insurance market reforms, the requirement that
businesses provide health insurance coverage for all their employees,
significant reductions in the growth of future Medicare and Medicaid
expenditures, and stringent government cost controls that would directly control
insurance premiums and indirectly affect the fees of hospitals, physicians and
other healthcare providers. Such proposals could adversely affect the Company's
business by, among other things, reducing the demand, and the prices paid, for
pharmaceutical products such as those produced and marketed by the Company.
Additionally, other developments, such as (i) the adoption of a nationalized
health insurance system or a single payor system, (ii) changes in needs-based
medical assistance programs, or (iii) greater prevalence of capitated
reimbursement of healthcare providers, could adversely affect the demand for the
Company's products.
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COMPETITION
The Company competes in varying degrees with numerous companies in the
health care industry, including other manufacturers of generic drugs (among
which are divisions of several major pharmaceutical companies) and manufacturers
of brand-name drugs. Many of the Company's competitors have substantially
greater financial and other resources and are able to expend more money and
effort than the Company in areas such as marketing and product development.
Although a company with greater resources will not necessarily receive FDA
approval for a particular generic drug before its smaller competitors,
relatively large research and development expenditures enable a company to
support many FDA applications simultaneously, thereby improving the likelihood
of being among the first to obtain approval of at least some generic drugs.
One of the principal competitive factors in the generic pharmaceutical
market is the ability to introduce generic versions of brand-name drugs promptly
after a patent expires. The Company believes that it was at a competitive
disadvantage until its release from the AIP program and the FDA's resumption of
review of ANDAs submitted by the Company's Brooklyn plant. See "Government
Regulation -- Generic Drug Enforcement Act" above. Other competitive factors in
the generic pharmaceutical market are price, quality and customer service
(including maintenance of sufficient inventories for timely deliveries).
RAW MATERIALS
The raw materials essential to the Company's business are bulk
pharmaceutical chemicals purchased from numerous sources. Raw materials are
generally available from several sources. The Federal drug application process
requires specification of raw material suppliers. If raw materials from a
supplier specified in a drug application were to become unavailable on
commercially acceptable terms, FDA supplemental approval of a new supplier would
be required. During 1998, the Company purchased approximately $2,583,000 of its
raw materials (constituting 29% of its aggregate purchases of raw materials)
from Mallinckrodt. Although the Company is now able to submit Supplements to the
FDA in order to allow the Company to purchase raw materials from alternate
sources, there can be no assurance that if the Company were unable to continue
to purchase raw materials from this supplier, that the Company would be
successful in receiving FDA approval to such Supplement or that it would not
face difficulties in obtaining raw materials on commercially acceptable terms.
Failure to receive FDA approval for, and to locate, an acceptable alternative
source of raw materials would have a material adverse effect on the Company.
The United States Drug Enforcement Administration (the "DEA") limits the
quantity of the Company's inventories of certain raw materials used in the
production of controlled substances based on historical sales data. In view of
the Company's recently depressed sales volume, these DEA limitations could
increase the likelihood of raw material shortages and of manufacturing delays in
the event the Company experiences increased sales volume or is required to find
new suppliers of these raw materials.
SUBSIDIARIES
The Company's Indiana manufacturing operations are conducted by Houba,
Inc., an Indiana corporation and wholly-owned subsidiary of the Company. Halsey
Pharmaceuticals, Inc., a Delaware corporation, is a wholly-owned subsidiary
which is currently inactive. The Company also has the following additional
subsidiaries, each of which is currently inactive and anticipated to be
dissolved during the remainder of the 1999 fiscal year: Indiana Fine Chemicals
Corporation, a Delaware corporation, H.R. Cenci Laboratories, Inc., a California
corporation, Cenci Powder Products, Inc., a Delaware corporation, Blue Cross
Products, Inc., a New York corporation, and The Medi-Gum Corporation, a Delaware
corporation.
EMPLOYEES
As of March 15, 1999, the Company had approximately 160 full-time
employees. Approximately 39 employees are administrative and professional
personnel and the balance are in production and shipping. Among the professional
personnel, 5 are engaged in research and product development. Approximately 45
employees at the Company's Brooklyn plant are represented by a local collective
bargaining unit. The collective bargaining agreement between the Company and the
union was extended on March 5, 1998
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(retroactive to July 2, 1997) and expires June 30, 2000. Management believes
that its relations with its employees and the union are satisfactory.
ITEM 2. PROPERTIES.
Halsey leases, as sole tenant, a pharmaceutical manufacturing facility of
approximately 35,000 square feet located at 77 Brenner Drive, Congers, New York.
The Agreement of Lease, with an unaffiliated third party, contains a three year
term with a two year renewal option and provides for annual fixed rent of
$500,000 per year during the primary term of the Lease and $600,000 per year
during the renewal period. The primary term of the Lease expires on March 21,
2002. The Leased facility houses a portion of the Company's manufacturing
operations and includes office and warehouse space. The Lease also contains an
option pursuant to which the Company may purchase the leased premises and
improvements (including certain production and related equipment) for a purchase
price of $5 million, exercisable at any time during the Lease term.
Halsey leases, as sole tenant, a total of approximately 112,300 square feet
in three buildings on Pacific Street and Dean Street in Brooklyn, New York. Each
of these leases is between Halsey and unaffiliated lessors. The approximate
aggregate minimum rental commitments under these operating leases are as
follows: $1,023,000 for the year 1999, $1,075,000 for the year 2000 and
$1,128,000 for the year 2001. These leases expire on December 31, 2005. The
buildings leased by Halsey in Brooklyn house its research and development
operations and a portion of its manufacturing operations.
Halsey leases approximately 4,700 square feet of office space located at
695 North Perryville Road, Building No. 2, Rockford, Illinois. The lease is
between the Company and an unaffiliated lessor. The lease has a term of two
years expiring March 30, 2000 and calls for annual rental, including maintenance
and common area expense, of approximately $50,000 per year. This leased facility
houses the Company's principal executive offices, including its sales,
administration and finance operations.
Houba owns approximately 45,000 square feet of building space on
approximately 30 acres of land in Culver, Indiana, which includes a 15,000
square foot manufacturing facility. This manufacturing facility houses separate
plants for the production of Doxycycline raw materials, Doxycycline capsules and
tablets. In 1996, in conjunction with a settlement with two former employees,
the Company acquired real property, improved by a residential property, in
Culver, Indiana adjacent to the manufacturing facility.
ITEM 3. LEGAL PROCEEDINGS.
GOVERNMENTAL PROCEEDINGS
By letter dated October 23, 1995, the Company was notified by the New York
State Education Department (the "Department") that the Professional Conduct
Officer of the Office of Professional Discipline had determined that there was
sufficient evidence of professional misconduct on the Company's part to warrant
a disciplinary proceeding under New York law. Upon contacting the Deputy
Director of the Office of Professional Discipline, counsel for the Company was
advised that the alleged misconduct related to the same activities that were the
subject of the DOJ investigation. The Company submitted a written response to
the Department on November 16, 1995. The Company and the Department entered into
a consent order effective July 18, 1997, concluding any disciplinary
proceedings. The consent order requires that the Company pay $175,000 in fines
over a period of five years. The consent order also provides that the Company's
registration as a manufacturer of drugs in New York State is revoked, but such
revocation is stayed and the Company has been placed on probation for a maximum
period of five years. The Company has the right to apply for removal from
probation two years after the effective date of the consent order. At December
3, 1998, the Company is current in its payment obligations and the remaining
balance is $140,000.
Immediately prior to the completion of the Offering, the Company was in
default under the consent order with the Department for failure to satisfy two
of the monthly installments of the fine as provided in the consent order. Prior
to the completion of the Offering, the Company advised the Department as to the
existence of the default and that such deficiencies would be corrected upon the
completion of the Offering. The Company has
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satisfied these outstanding amounts and is now current under the consent order
with the Department. Based on discussions between representatives of the
Department and the Company's outside counsel handling this matter, the Company
has been advised that the revocation of the Company's registration as a
manufacturer of drugs in the State of New York will remain stayed and that the
Company continues to have the right to apply for removal from probation after
two years from the effective date of the consent order.
Reference is also made to the discussion of the Company's Plea Agreement
and Letter Agreement with the DOJ contained in "Item 1. Business -- Recent
Events" and "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations."
OTHER LEGAL PROCEEDINGS
Beginning in 1992, actions were commenced against the Company and numerous
other pharmaceutical manufacturers in the Pennsylvania Court of Common Pleas,
Philadelphia Division, in connection with the alleged exposure to
diethylstilbestrol ("DES"). The defense of all of such matters was assumed by
the Company's insurance carrier, and a substantial number have been settled by
the carrier. Currently, five actions remain pending with the Company as a
defendant, and the insurance carrier is defending each action. Similar actions
were brought in Ohio, and have been dismissed based on Ohio law. The Company
does not believe any of such actions will have a material impact on the
Company's financial condition.
The Company has been named as a defendant in four additional actions, each
of which has been referred to the Company's insurance carrier and has been
accepted for defense. The first action, Alonzo v. Halsey Drug Co., Inc. and
K-Mart Corp., No. 64DOT-95111-CT-2736 (Indiana Superior Court, Porter County),
was commenced on November 7, 1995 and involves a claim for unspecified damages
relating to the alleged ingestion of "Doxycycline 100." At this early stage of
the proceedings, the Company is unable to predict with any degree of certainty
the likely outcome of these claims and whether they will have a material adverse
effect on the Company's financial condition. The second action, Files v. Halsey
Drug Co., Index No. 198787/93 (New York Supreme Court, Suffolk County),
commenced on September 16, 1993, seeking $10,000,000 in damages for wrongful
death allegedly caused by the ingestion of Isoniazid. Halsey has been dismissed
from this action on motion for summary judgment. The third and fourth actions,
entitled Hunt v. Halsey Drug Co., Inc., and McCray v. Halsey Drug Co., Inc. (New
York State Supreme Court, Kings County), were commenced on October 21, 1993,
seeking the recovery of $8,000,000 for alleged personal injuries suffered by two
Well Fargo security guards who responded to an alarm and were shot, resulting in
the death of one and the injury to the other. The Company is being defended by
its insurance carrier. The Company has impleaded the former security service
used by the Company as a third-party defendant. These actions were settled at a
conference before the Court on December 21, 1998. The settlement documents have
been executed, and the settlement is expected to be consummated shortly.
The Company has been named as a defendant in a complaint filed with the
United States District Court, Eastern District of New York, on June 30, 1998
(the "Complaint") by Quality Products and Services, L.L.C. The Complaint alleges
the existence of a Joint Venture Agreement between the Plaintiff and the Company
concerning the development, manufacture and marketing of a single product. The
Complaint also alleges that the Company has breached the Agreement by failing to
satisfy its respective obligations defined in the Agreement. The Complaint seeks
monetary damages of approximately $20 million. The Company believes that the
allegations contained in the Complaint are without basis in fact, and that is
has meritorious defenses to each of the allegations. The Company has retained
counsel and intends to vigorously defend this action. This matter is currently
in discovery. The Company has filed a third-party complaint against Rosendo
Ferran, the Company's former President, in connection with the Complaint.
The Company has been named as a defendant in an action in Suffolk County,
New York, by Designed Laboratories, Inc., for construction work allegedly
performed at the Company's facilities in Brooklyn. Plaintiffs is seeking
approximately $148,000. The Company has no records of work being performed by
this entity, and is therefore defending the action.
The Company's former President, Rosendo Ferran, has instituted an
arbitration against the Company, seeking sums allegedly due under his employment
contract in the amount of $225,000.00, deferred salary in
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the approximate amount of $100,000.00, and unspecified damages upon allegations
of age, ethnic and religious discrimination. The Company believes it has
meritorious defenses to the allegations claimed in the arbitration. The Company
does not believe this claim will have a material adverse effect on the Company's
financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth
quarter of 1998.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER
MATTERS.
MARKET AND MARKET PRICES OF COMMON STOCK
The Company's Common Stock is listed on the American Stock Exchange (the
"Exchange") under the symbol "HDG." Set forth below for the periods indicated
are the high and low sales prices for the Common Stock as reported on the
Exchange.
PERIOD HIGH LOW
- ------ ---- ---
1999 Fiscal Year
First Quarter (through March 15, 1999).................... 1 9/16 1
1998 Fiscal Year
First Quarter............................................. 3 5/8 1 1/4
Second Quarter............................................ 3 1/8 2 3/8
Third Quarter............................................. 2 3/4 1 1/2
Fourth Quarter............................................ 1 7/8 1
1997 Fiscal Year
First Quarter............................................. 6 4 3/8
Second Quarter............................................ 5 1/8 2 9/16
Third Quarter............................................. 4 13/16 2 5/16
Fourth quarter............................................ 4 13/16 1 5/16
The Company does not meet certain of the Exchange's criteria for continued
listing. Accordingly, there can be no assurance that the Company's common stock
will remain listed on the American Stock Exchange or that the Exchange will not
commence a review of the Company's continued listing eligibility. If the Common
Stock should become delisted from the Exchange, trading, if any, in the Common
Stock would continue on the OTC Bulletin Board, an NASD-sponsored inter-dealer
quotation system, or in what is commonly referred to as the "Pink Sheets". In
such event, a shareholder may find it more difficult to dispose of, or to obtain
accurate quotations as to the market value of the Common Stock.
HOLDERS
There were 827 holders of record of the Company's common stock on March 15,
1999. This number, however, does not reflect the ultimate number of beneficial
holders of the Company's common stock.
DIVIDEND POLICY
The payment of cash dividends from current earnings is subject to the
discretion of the Board of Directors and is dependent upon many factors,
including the Company's earnings, its capital needs and its general financial
condition. The terms of the Company's 5% convertible senior secured debentures
and the Consolidated Bridge Loan prohibit the Company from paying cash
dividends. The Company does not intend to pay any cash dividends in the
foreseeable future.
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PRIVATE OFFERINGS
The Company secured bridge financing from Galen and certain investors in
the Offering in the aggregate amount of $9,504,111, funded through seven
separate bridge loan transactions between the period August through and
including December, 1998, as well as an additional bridge loan completed in
March, 1999 (collectively, the "Bridge Loans"). The Bridge Loans were
consolidated on December 2, 1998 pursuant to an Amended, Restated and
Consolidated Bridge Loan Agreement, as amended to permit the March, 1999 bridge
loan (the "Consolidated Bridge Loan"). The Consolidated Bridge Loan is evidenced
by ten (10%) percent convertible senior secured promissory notes which are
convertible at any time prior to the maturity date of May 30, 1999 into shares
of the Company's Common Stock at a conversion price of approximately $1.368 per
share with respect to approximately $7,820,000 of such indebtedness, $1.331 per
share with respect to approximately $284,000 of such indebtedness, and $1.197
per share with respect to approximately $1,400,000 of such indebtedness, for an
aggregate of 7,099,338 shares of Common Stock (such conversion prices equal the
fair market value of the Common Stock at the date of issuance of the convertible
promissory notes). In addition, in consideration for the initial extension for
the Bridge Loans and the extension of the maturity dates of the Bridge Loans
pursuant to the consolidation of such loans on December 2, 1998, the Company
issued common stock purchase warrants to the lenders in the Consolidated Bridge
Loan to purchase an aggregate of approximately 1,009,909 shares of the Company's
Common Stock. The Bridge Loan warrants are substantially identical to those
issues in the debenture and warrant offering completed March 10, 1998.
Each of the lenders in the Consolidated Bridge Loan transaction are
accredited investors as defined in Rule 501(a) of Regulation D promulgated under
the Securities Act of 1933, as amended (the "Act"). The convertible notes and
warrants issued in connection with the Consolidated Bridge Loan were issued
without registration under the Act in reliance upon Section 4(2) of the Act and
Regulation D promulgated thereunder.
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial data presented on the following pages
for the years ended December 31, 1998, 1997, 1996, 1995 and 1994 are derived
from the Company's audited Consolidated Financial Statements. The Consolidated
Financial Statements as of December 31, 1998 and December 31, 1997, and for each
of the years in the three year period ended December 31, 1998, and the report
thereon, are included elsewhere herein. The selected financial information as of
and for the years ended December 31, 1995 and 1994 are derived from the audited
Consolidated Financial Statements of the Company not presented herein.
The information set forth below is qualified by reference to, and should be
read in conjunction with, the Consolidated Financial Statements and related
notes thereto included elsewhere in this Report and "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations."
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YEARS ENDED DECEMBER 31,
----------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATING DATA:
Net sales.......................... $ 8,841 $ 9,088 $ 12,379 $ 20,225 $ 24,182
Costs and expenses
Cost of sales.................... 12,712 15,407 16,826 18,097 21,584
Research and development........... 651 979 1,854 818 502
Selling, general and
administrative................... 8,078 6,308 7,486 6,098 7,128
Interest expense................... 1,946 1,144 1,708 1,307 735
Loss (Gain) on sale of assets...... (1,822) 264 (1,000) (2,288) --
Income (loss) before provision for
income taxes..................... (12,724) (15,014) (14,495) (3,807) (5,767)
Provision (benefit) for
income taxes..................... -- -- -- 296 --
Net income (loss).................. (12,724) $ (15,014) $ (14,495) $ (4,103) $ (5,767)
=========== =========== ========== ========== ==========
Net income (loss) per share........ $ (.92) $ (1.12) $ (1.49) $ (.52) $ (.80)
=========== =========== ========== ========== ==========
Weighted average common shares
outstanding...................... 13,812,529 13,434,215 9,724,106 7,886,101 7,173,908
=========== =========== ========== ========== ==========
DECEMBER 31,
-------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
BALANCE SHEET DATA:
Working capital (deficiency)......... $ (6,665) $(22,304) $(12,201) $ (7,393) $(4,451)
Total assets......................... 15,913 7,667 11,982 18,862 19,276
Total liabilities.................... 44,866 27,524 19,063 20,402 19,924
Retained earnings
(accumulated deficit).............. (57,221) (44,497) (29,484) (14,989) (10,886)
Stockholders' equity (deficit)....... (28,953) (19,857) (7,081) (1,540) (468)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Certain statements set forth under this caption constitute "forward-looking
statements" within the meaning of the Reform Act. See "Special Note Regarding
Forward-Looking Statements " on page 1 of this Report for additional factors
relating to such Statements.
OVERVIEW
The Company reported a net loss of $12,724,000 or $.92 per share for the
year ended December 31, 1998 as compared with the net loss of $15,015,000 or
$1.12 per share for 1997. Sales for the year ended December 31, 1998 were
approximately $8,841,000 as compared to sales of approximately $9,088,000 for
1997. Notwithstanding these results, the Company had the following achievements
in 1998:
- Received infusion of capital enabling the Company to settle past
obligations and provide for future opportunities.
- Reestablished itself in the marketplace as a dependable supplier of
quality products, expanded its customer base and reduced reliance upon a
single customer.
- Reestablished relationships with suppliers.
- Received approval from the FDA of two ANDA's, submitted five others for
approval and continued development on additional products for submission
in 1999.
- Discontinued certain non-core operations and reduced the workforce by
approximately 25%.
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RESULTS OF OPERATIONS
The following chart reflects expenses, earnings, income, losses and profits
expressed as a percentage of net sales for the years 1998, 1997 and 1996.
PERCENTAGE CHANGE
YEAR-TO-YEAR
INCREASE (DECREASE)
PERCENTAGE OF NET SALES YEARS ENDED
YEAR ENDED DECEMBER DECEMBER 31,
-------------------------- ----------------------------
1998 1997 1996 1997 TO 1998 1996 TO 1997
------ ------ ------ ------------ ------------
Net sales.............................. 100% 100% 100.0% (2.7) (26.6)
Cost of Goods.......................... 143.8 169.5 135.9 (17.5) (8.47)
Gross Profit........................... (43.8) (69.5) (35.9) (38.7) 42.1
Research & Development................. 7.4 10.8 15.0 (33.5) 47.2
Selling, general and administrative
expense.............................. 91.4 69.4 60.5 29.5 (15.7)
(Loss) from operations................. (142.5) (149.7) (111.4) (6.7) (1.3)
Interest expense....................... 22.0 12.6 13.9 70.1 (33.0)
Other (income) expenses................ (20.6) 2.9 (8.2) -- (126.4)
(Loss) before income taxes............. (143.9) (165.2) (117.1) (14.6) 3.6
Net (loss)............................. (143.9)% (165.2)% (117.1)% (14.6)% 3.6%
====== ====== ======
NET SALES
Net sales for 1998 of $8,841,000 represents a decrease of $247,000 as
compared to net sales for 1997. The decrease is attributable in part to a
reduction in toll manufacturing revenue from Mallinckrodt of approximately
$878,000 from the prior year. Additionally, the Company was unable to market
successfully to the retail pharmacy marketplace until the third quarter of 1998
because during fiscal 1996 and 1997, the Company had failed to pay required
rebates to state Medicaid agencies. This caused those states to deny medicaid
reimbursement to the retail pharmacies on their sales of the Company's products.
Commensurate with the infusion of new capital and personnel in March, 1998, the
Company began reestablishing itself in good standing with all states. This task
was completed by July, 1998. Also during much of 1988, the Company experienced
difficulty in obtaining certain raw materials which reduced sales. These
shortages were remedied by December 31, 1998.
Net sales for 1997 of $9,088,000 represents a decreased of $3,291,000 as
compared to net sales for 1996. This decrease is primarily attributable to a
lack of sufficient working capital necessary to purchase raw materials. Without
adequate inventory, the Company was unable to satisfy customer orders in a
timely fashion and caused customers to procure products from competitors.
GROSS MARGINS
The Company's gross margin for 1998 of (43.8)% is a 38.7% improvement over
gross margin for 1997. This improvement is due, in part, to the elimination of
non-core manufacturing operations in California, tighter inventory controls and
a general reduction in manufacturing labor. Additionally, the Company's revenues
in 1998 from sales to Mallinckrodt under a toll manufacturing agreement
decreased by approximately $878,000. The gross margins on these products were
substantially less than on the Company's other products.
The Company's gross margin for 1997 of (69.5)% is a 42.1% reduction over
gross margin for 1996. This deterioration occurred because the Company failed to
react quickly enough to falling sales by decreasing manufacturing expenses.
Additionally, the Company incurred approximately $1,572,000 of manufacturing
costs in operating non-core facilities that generated sales of only $495,000.
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RESEARCH & DEVELOPMENT EXPENSES
For 1998, research and development expenses amounted to $651,000 as
compared to $979,000 for 1997. The decrease primarily reflects the costs of
biostudies performed in 1997 that were not duplicated in 1998.
For 1997, research and development expenses amounted to $979,000 as
compared to $1,854,000 for 1996. This decrease was a result of reductions in
personnel necessitated by the Company's liquidity crisis.
The Company expects research and development expenses to increase
significantly in 1999 consistent with its plans to increase the number of ANDA
submissions as compared to 1998.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative costs were $8,078,000 (91.4% of net
sales) for 1998 compared to $6,308,000 (69.4% of net sales) for 1997. This
increase is primarily due to costs associated with capital financing, legal
expenses and settlement costs of certain litigation, severance costs associated
with personnel reductions, installation of a new information system and costs
associated with expanded regulatory and compliance departments.
Selling, general and administrative costs were $6,308,000 (69.4% of net
sales) for 1997 compared to $7,486,000 (60.5% of net sales) for 1996. This
decrease is due primarily to a reduction in legal expenses and litigation
settlements as compared to 1996.
INTEREST EXPENSE
Interest expense for 1998 increased by 62% over that of 1997 reflecting the
substantial new debt in the form of $25,800,000 of convertible debentures that
was added in 1998 [include bridge loan debt?]. Interest expense for 1997
decreased 33.0% as compared to 1996 due primarily to the conversion in the
latter part of 1996 of $7,740,000 of convertible debentures bearing interest at
10% into common stock. Interest expense for 1996 increased 77.8% as compared to
1995 as a result of a higher level of borrowings due to the issuance of
convertible subordinated debentures, as well as fees payable to the Company's
banks.
OTHER INCOME
Included in other income for 1998 is $1,900,000 realized from the sale of
certain assets to Mallinckrodt. This transaction was entered into in 1997 but
the conditions for realization of the gain from the sale were not met until
1998.
PROVISION FOR INCOME TAXES
The Company had no tax (benefit) provision for 1998, 1997 and 1996 since
the available loss carry back to prior years was completely utilized by the net
operating loss for 1993 carry back to the prior three years. At December 31,
1998, the Company has a Federal tax refund claim of approximately $1,000,000
pending before the tax authorities. In the meantime, the IRS is holding up
action to collect approximately $1,300,000 of past due payroll taxes.
Additionally, the Company has negotiated payment plans for approximately
$500,000 of past due state and local taxes. The Company has net operating loss
carryforwards of approximately $45,600,000 which expire in the years 2011
through 2018.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, the Company had cash and cash equivalents of
$1,850,000 as compared to $26,000 at December 31, 1997. The Company had a
working capital deficit at December 31, 1998 of $(6,665,000).
On March 10, 1998, the Company completed the Offering to Galen Partners
III, L.P., Galen Partners International III, L.P., Galen Employee Fund III, L.P.
(collectively, "Galen") and each of the Purchasers (along with Galen,
collectively the "Galen Investor Group") listed on the signature page to a
certain Debenture and Warrant Purchase Agreement dated March 10, 1998 (the
"Purchase Agreement"). The net
18
20
proceeds to the Company from the Offering, after deduction of related Offering
expenses, were approximately $19.6 million. The securities issued in the
Offering consisted of 5% convertible senior secured debentures (the
"Debentures") and common stock purchase warrants (the "Warrants") exercisable
for an aggregate of 4,202,020 shares of the Company's common stock. In addition,
in accordance with the terms of the Purchase Agreement, the Company granted the
Galen Investor Group an option to invest an additional $5 million in the Company
at any time within 18 months from the date of the closing of the Offering in
exchange for Debentures and Warrants having terms identical to those issued in
the Offering (the "Option"). In June 1998, the Galen Investor Group exercised
the Option.
The net proceeds of the Offering were, in large part, used to satisfy a
substantial portion of the Company's liabilities and accounts payable. Such
liabilities include the full satisfaction of the Company's Bank indebtedness and
related fees, payment of arrearages in rent to the landlord of the Brooklyn
facility and satisfaction of outstanding judgments and liens. Additionally,
pursuant to agreements reached with other large creditors in anticipation of the
completion of the Offering, including the Department of Justice, the Company has
been able to bring these creditors current and bring the Company into compliance
with installment payment agreements providing more favorable terms to the
Company. The Offering proceeds also allowed the Company to satisfy its
outstanding state and Federal payroll tax obligations and meet current payroll
tax obligations. The net proceeds from the exercise of the Option were used to
fund working capital, including the purchase of raw materials, payroll expenses
and other Company expenses.
Prior to the completion of the Offering, the Company was in negotiations
with the DOJ to restructure the payment of the $2,500,000 fine that had been
levied under the Plea Agreement in order to address the Company's failure to
satisfy the $125,000 quarterly installments provided for under the Plea
Agreement. On March 30, 1998, the Company and the DOJ signed a Letter Agreement
serving to amend the Plea Agreement relating to the terms of the Company's
satisfaction of the fine assessed under the Plea Agreement. Specifically, the
Letter Agreement provides that the Company will satisfy the remaining $2,150,000
of the fine through the payment of $25,000 on a monthly basis commencing June 1,
1998, plus interest on such outstanding balance (at the rate calculated pursuant
to 28 U.S.C. Section 1961)(currently 5.319%). Such payment schedule would result
in the full satisfaction of the DOJ fine in January, 2006. The Letter Agreement
also provides certain restrictions on the payment of salary or compensation to
any individual in excess of $150,000 without the written consent of the United
States District Court for the District of Maryland, subject to certain
exceptions. In addition, the Letter Agreement requires the prepayment of the
outstanding fine to the extent of 25% of the Company's after tax profit and 25%
of the net proceeds received by the Company on any sale of a capital asset for a
sum in excess of $10,000.
During the period from May 1997 through July 1997, the Company borrowed
approximately $3 million from Mylan Laboratories, Inc. pursuant to five
unsecured, demand promissory notes. The advances made by Mylan Laboratories,
Inc. were part of a proposed investment by Mylan Laboratories, Inc. in the
Company, including the proposed purchase of the Company's Houba Indiana facility
as well as a partial tender offer for the Company's common stock. The Company
used the proceeds of these borrowings for working capital. To date, $236,000 has
been paid by the Company to Mylan against such indebtedness in the form of
product deliveries to Mylan. Pursuant to an agreement reached between the
parties, the Company is required to satisfy interest on the outstanding
indebtedness on an annual basis while the indebtedness remains outstanding and
to satisfy the principal amount of such indebtedness in the form of product
deliveries to Mylan until such time as the indebtedness is satisfied in full.
The Company secured bridge financing from Galen and certain investors in
the Offering in the aggregate amount of $9,504,111, funded through seven
separate bridge loan transactions between the period from August through and
including December, 1998, as well as an additional bridge loan in March, 1999
(collectively, the "Bridge Loans"). The Bridge Loans were consolidated on
December 2, 1998 pursuant to an Amended, Restated and Consolidated Bridge Loan
Agreement, as amended to permit the March, 1999 bridge loan (the "Consolidated
Bridge Loan"). The Consolidated Bridge Loan bears interest at 10% per annum, is
secured by a first lien on all of the Company's assets and has a maturity date
of May 30, 1999. Approximately $9,120,000 in the principal amount of the
Consolidated Bridge Loan was advanced by Galen with the balance of approximately
$384,000 advanced by certain investors in the Offering. The Consolidated Bridge
Loan is
19
21
evidenced by 10% convertible senior secured promissory notes which are
convertible at any time prior to maturity into shares of the Company's Common
Stock at a conversion price of approximately $1.368 per share with respect to
approximately $7,820,000 of such indebtedness, $1.331 per share with respect to
approximately $284,000 of such indebtedness, and $1.197 per share with respect
to approximately $1,400,000 of such indebtedness, for an aggregate of 7,099,338
shares of common stock (such conversion prices equal the fair market value of
the Common Stock at the date of issuance of the convertible promissory notes).
In addition, in consideration for the initial extension of the Bridge Loans and
the extension of the maturity dates of the Bridge Loans pursuant to the
consolidation of such loans on December 2, 1998, as amended to permit the March,
1999 bridge loan, the Company issued common stock purchase warrants to Galen and
the other investors in the Consolidated Bridge Loan, to purchase an aggregate of
approximately 1,009,909 shares of the Company's common stock (representing
warrants to purchase 50,000 shares of Common Stock for each $1,000,000 in
principal amount of Bridge Loan having a term of 90 days from the date of the
making of the Bridge Loan). The Bridge Loan warrants are substantially identical
to those issued by the Company in its Debenture and Warrant Offering completed
on March 10, 1998.
The Consolidated Bridge Loan was obtained by the Company in order to
provide necessary working capital. In view of the Company's current cash
reserves and projections for revenues through May 30, 1999, the Company will be
unable to satisfy the Consolidated Bridge Loan in full at the stated maturity
date of May 30, 1999. Galen, the holder of approximately 96% of such
indebtedness, has indicated to the Company a willingness to cooperate in the
restructuring of the indebtedness evidenced by the Consolidated Bridge Loan to
extend the maturity date of such debt and/or convert the debt into common stock
or longer-term convertible indebtedness. The terms of such restructuring will
depend, to a large extent, on the terms and timing of any third-party
investment, as described below. Accordingly, the terms of any such restructuring
have yet to be agreed to by the parties and will be subject to the negotiation
and preparation of definitive agreements.
The Company is in preliminary discussions with an unaffiliated third party
concerning the terms of a proposed investment in the Company in an amount of up
to $15 million, to be funded in three equal increments based on the achievement
of certain milestones. The structure of the investment will likely take the form
of convertible debentures and common stock purchase warrants, similar in many
respects to the debentures and warrants issued by the Company in its March 10,
1998 offering. The discussions with this third party investor are in the
preliminary stages and no assurance can be given that final terms acceptable to
the Company will result and/or that if consummated, that the Company will be
successful in achieving the milestones necessary to fund all or any portion of
the proposed investment.
In the event the Company is successful in restructuring the Consolidated
Bridge Loan and completing a third party investment of the type and size
described above, the Company will have sufficient cash reserves to satisfy its
working capital requirements for at least the next 12 months. The Company is
also seeking to secure a senior revolving line of credit from a banking
institution. There can be no assurance, however, that the Company will be able
to obtain such third party investment or a bank facility. If the Company is
unable to complete the third party investment described above or obtain other
sources of working capital, including a bank line of credit or proceeds from the
issuance of debt and/or equity securities, the Company's cash reserves will be
sufficient to satisfy the Company's working capital requirements for
approximately two to three months. Failure to obtain a third party investment of
the type described above, a bank line of credit or alternative sources of
financing of a comparable amount in the near term will materially adversely
affect the Company's working capital position and financial condition and
results of operations.
CAPITAL EXPENDITURES
The Company's capital expenditures during 1998, 1997 and 1996 were
$1,545,000, $85,000 and $390,000. The increase in capital expenditures in 1998
as compared to prior years is attributable to the implementation of certain
equipment and facility upgrades that had been delayed in prior years due to the
Company's cash conservation measures in those years.
20
22
YEAR 2000 COMPLIANCE
The Company is aware of issues associated with the programming code in
existing computer systems as the Year 2000 approaches and has undertaken a
compliance program to assess the Company's potential exposure to business
interruptions due to the possible Year 2000 computer software failures,
including necessary remediation and testing. In 1999, the Company installed a
new information system, including hardware and software, which the Company
believes, based on its testing, is Year 2000 compliant.
At this time, the Company is not aware of any material Year 2000 issues
with respect to dealings with third parties, however, the assessment phase of
such risks of third parties is in the early stage of review.
In the event the Year 2000 issues were to disrupt the Company and its
operations, such disruption may have a material impact on the Company and its
results of operations. Given that no significant issues have arisen based on the
assessments to date, the Company has identified a preliminary contingency plan
and is prepared to make necessary corrections to its systems in the event a
problem should occur. The Company will continue to assess the Year 2000
compliance issue on an on-going basis in an effort to resolve any Year 2000
issues in a timely manner.
IMPACT OF INFLATION
The Company believes that inflation did not have a material impact on its
operations for the periods reported. Significant increases in labor, employee
benefits and other expenses could have a material adverse effect on the
Company's performance.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The response to this item is submitted as a separate section of this Report
commencing on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not Applicable.
PART III
In accordance with General Instruction G(3) of Form 10-K, the information
called by Item 10, Directors and Executive Officers of the Registrant, Item 11,
Executive Compensation, Item 12, Security Ownership of Certain Beneficial Owners
and Management, and Item 13, Certain Relationships and Related Transactions, of
Part III of this Report is incorporated by reference to the Company's definitive
Proxy Statement for its 1999 Annual Meeting of Shareholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Financial Statements -- See Index to Financial Statements.
(b) Reports on Form 8-K
No reports on Form 8 K were filed during the last quarter of the fiscal
year covered by this Annual Report on Form 10-K.
(c) Exhibits
The following exhibits are included as a part of this Annual Report on Form
10-K or incorporated herein by reference.
21
23
EXHIBIT
NUMBER DOCUMENT
------- --------
*3.1 Certificate of Incorporation and amendments.
3.2 Restated Bylaws (incorporated by reference to Exhibit 3.1 to
the Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1993).
*3.3 Restated By-Laws
10.1 Credit Agreement, dated as of December 22, 1992, among the
Registrant and The Chase Manhattan Bank, N.A. (incorporated
by reference to Exhibit 10.1 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1992
(the "1992 Form 10-K")).
10.2 Amendment Two, dated as of January 12, 1994, to Credit
Agreement among the Registrant and The Chase Manhattan Bank,
N.A., together with forms of Stock Warrant and Registration
Rights Agreement (incorporated by reference to Exhibit 10.1.
to the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1993 (the "1993 Form 10-K")).
10.3 Amendment Three, dated as of May 31, 1994, to Credit
Agreement among the Registrant and The Chase Manhattan Bank,
N.A. (incorporated by reference to Exhibit 6(a) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1994).
10.4 Amendment Four, dated as of July 1994, to Credit Agreement
among the Registrant and The Chase Manhattan Bank, N.A.
(incorporated by reference to Exhibit 6(a) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1994).
10.5 Amendment Five, dated as of March 21, 1995, to Credit
Agreement among the Registrant and The Chase Manhattan Bank,
N.A. (incorporated by reference to Exhibit 10.7 to the
Registrant's Current Report on Form 8-K dated March 21, 1995
(the "March 8-K")).
10.5(l) Form of Warrants issued to The Bank of New York, The Chase
Manhattan Bank, N.A. and the Israel Discount Bank
(incorporated by reference to Exhibit 10.5(i) to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1995 (the "1995 Form 10-K")).
10.5(2) Letter Agreement, dated July 10, 1995, among Halsey Drug
Co., Inc., The Chase Manhattan Bank, N.A., The Bank of New
York and Israel Discount Bank of New York (incorporated by
reference to Exhibit 6(a) to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1995 (the
"June 10-Q")).
10.5(3) Letter Agreement, dated November 16, 1995, among Halsey Drug
Co., Inc., The Chase Manhattan Bank, N.A., The Bank of New
York and Israel Discount Bank of New York (incorporated by
reference to Exhibit 10.25(iv) to the 1995 10-K).
10.5(4) Amendment 6, dated as of August 6, 1996, to Credit Agreement
among Halsey Drug Co., Inc., The Chase Manhattan Bank, N.A.,
The Bank of New York and Israel Discount Bank of New York
(incorporated by reference to Exhibit 10.1 to Amendment No.
1 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1996 (the "June 1996 10-Q").
10.5(5) Letter Agreement, dated March 25, 1997 among Halsey Drug
Co., Inc., The Chase Manhattan Bank, as successor in
interest to The Chase Manhattan Bank (National Association),
The Bank of New York and Israel Discount Bank.
10.6 Agreement Regarding Release of Security Interests dated as
of March 21, 1995 by and among the Company, Mallinckrodt
Chemical Acquisition, Inc. and The Chase Manhattan Bank,
N.A. (incorporated by reference to Exhibit 10.9 of the March
8-K).
10.7 Consulting Agreement dated as of September, 1993 between the
Registrant and Joseph F. Limongelli (incorporated by
reference to Exhibit 10.6 to the 1993 Form 10-K).
10.8 Employment Agreement, dated as of January 1, 1993, between
the Registrant and Rosendo Ferran (incorporated by reference
to Exhibit 10.2 to the 1992 Form 10-K).
10.10(1) Halsey Drug Co., Inc. 1984 Stock Option Plan, as amended
(incorporated by reference to Exhibit 10.3 to the 1992 Form
10-K).
10.10(2) Halsey Drug Co., Inc. 1995 Stock Option and Restricted Stock
Purchase Plan (incorporated by reference to Exhibit 4.1 to
the Registrant's Registration Statement on Form S-8, File
No. 33-98396).
10.10(3) Halsey Drug Co., Inc. Non-Employee Director Stock Option
Plan.
22
24
EXHIBIT
NUMBER DOCUMENT
------- --------
10.11 Leases, effective February 13, 1989 and January 1, 1990,
respectively, among the Registrant and Milton J. Ackerman,
Sue Ackerman, Lee Hinderstein, Thelma Hinderstein and
Marilyn Weiss (incorporated by reference to Exhibits 10.6
and 10.7, respectively, to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1989).
10.12 Lease, effective as of April 15, 1988, among the Registrant
and Milton J. Ackerman, Sue Ackerman, Lee Hinderstein,
Thelma Hinderstein and Marilyn Weiss, and Rider thereto
(incorporated by reference to Exhibit 10.12 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1987).
10.12(l) Lease, as of October 31, 1994, among Registrant and Milton
J. Ackerman, Sue Ackerman, Lee Hinderstein, Thelma
Hinderstein and Marilyn Weiss, together with Modification,
Consolidation and Extension Agreement (incorporated by
reference to Exhibit 10. 12(i) to the 1995 Form 10-K).
10.13 Asset Purchase Agreement dated as of March 21, 1995 among
Mallinckrodt Chemical Acquisition, Inc. ("Acquisition"),
Mallinckrodt Chemical, Inc., as guarantor and the Registrant
(incorporated by reference to Exhibit 10.1 to the March
8-K).
10.14 Toll Manufacturing Agreement for APAP/Oxycodone Tablets
dated as of March 21, 1995 between Acquisition and the
Registrant (incorporated by reference to Exhibit 10.2 to the
March 8-K).
10.15 Capsule ANDA Option Agreement dated as of March 21, 1995
between Acquisition and the Registrant (incorporated by
reference to Exhibit 10.3 to the March 8-K).
10.16 Tablet ANDA Noncompetition Agreement dated as of March 21,
1995 between the Registrant and Acquisition (incorporated by
reference to Exhibit 10.4 to the March 8-K).
10.17 Subordinated Non-Negotiable Promissory Term Note in the
amount of $1,200,00 dated March 21, 1995 issued by the
Registrant to Acquisition (incorporated by reference to
Exhibit 10.5 to the March 8-K).
10.18 Term Note Security Agreement dated as of March 21, 1995
among the Company, Houba, Inc. and Acquisition (incorporated
by reference to Exhibit 10.6 to the March 8-K).
10.19 Amendment dated March 21, 1995 to Subordination Agreement
dated as of July 21, 1994 between Mallinckrodt Chemical,
Inc., Mallinckrodt Chemical Acquisition, Inc., the
Registrant, The Chase Manhattan Bank (National Association),
Israel Discount Bank of New York, The Bank of New York, and
The Chase Manhattan Bank (National Association)
(incorporated by reference to Exhibit 10.8 to the March
8-K).
10.20 Agreement dated as of March 30, 1995 between the Registrant
and Zatpack, Inc. (incorporated by reference to Exhibit
10.10 to the March 8-K).
10.21 Waiver and Termination Agreement dated as of March 30, 1995
between Zuellig Group, W.A., Inc. and Indiana Fine Chemicals
Corporation (incorporated by reference to Exhibit 10.11 to
the March 8-K).
10.22 Convertible Subordinated Note of the Registrant dated
December 1, 1994 issued to Zatpack, Inc. (incorporated by
reference to Exhibit 10.12 to the March 8-K).
10.23 Agreement dated as of March 30, 1995 among the Registrant,
Indiana Fine Chemicals Corporation, Zuellig Group, N.A.,
Inc., Houba Inc., Zetapharm, Inc. and Zuellig Botanical,
Inc. (incorporated by reference to Exhibit 10.13 to the
March 8-K).
10.24 Supply Agreement dated as of March 30, 1995 between Houba,
Inc. and ZetaPharm, Inc. (incorporated by reference to
Exhibit 10.14 to the March 8-K).
10.25 Form of 10% Convertible Subordinated Debenture (incorporated
by reference to Exhibit 6(a) to the June 10-Q).
10.26 Form of Redeemable Common Stock Purchase Warrant
(incorporated by reference to Exhibit 6(a) to the June
10-Q).
10.27 Form of 10% Convertible Subordinated Debenture (incorporated
by reference to Exhibit 4.1 to the Registrant's Current
Report on Form 8-K dated December 4, 1995 (the "December
8-K")).
10.28 Form of Redeemable Common Stock Purchase Warrant
(incorporated by reference to Exhibit 4.2 to the December
8-K).
10.29 Form of 10% Convertible Subordinated Debenture (incorporated
by reference to Exhibit 99 to the June 1996 10-Q).
23
25
EXHIBIT
NUMBER DOCUMENT
------- --------
10.30 Form of Redeemable Common Stock Purchase Warrant
(incorporated by reference to Exhibit 4.1 to Amendment No. 1
to the June 1996 10-Q).
10.31 Form of 5% Convertible Senior Secured Debenture
(incorporated by reference to Exhibit 4.1 to the
Registrant's Current Report on Form 8-K dated March 24, 1998
(the "March 1998 8-K")).
10.32 Form of Common Stock Purchase Warrant (incorporated by
reference to Exhibit 4.2 to the March 1998 8-K).
10.33 Debenture and Warrant Purchase Agreement dated March 10,
1998, by and among the Registrant, Galen Partners III, L.P.
and the other Purchasers listed on the Signature Page
thereto (incorporated by reference to Exhibit 10.1 to the
March 1998 8-K).
10.34 Form of General Security Agreement of Halsey Drug Co., Inc.
dated March 10, 1998 (incorporated by reference to Exhibit
10.2 to the March 1998 8-K).
10.35 Form of Agreement of Guaranty of Subsidiaries of Halsey Drug
Co., Inc. dated March 10, 1998 (incorporated by reference to
Exhibit 10.3 to the March 1998 8-K).
10.36 Form of Guarantor General Security Agreement dated March 10,
1998 (incorporated by reference to Exhibit 10.4 to the March
1998 8-K).
10.37 Stock Pledge Agreement dated March 10, 1998 by and between
the Registrant and Galen Partners III, L.P., as agent
(incorporated by reference to Exhibit 10.5 to the March 1998
8-K).
10.38 Form of Irrevocable Proxy Agreement (incorporated by
reference to Exhibit 10.6 to the March 1998 8-K).
10.39 Agency Letter Agreement dated March 10, 1998 by and among
the Purchasers a party to the Debenture and Warrant Purchase
Agreement, dated March 10, 1998 (incorporated by reference
to Exhibit 10.7 to the March 1998 8-K).
10.40 Press Release of Registrant dated March 13, 1998
(incorporated by reference to Exhibit 99.1 to the March 1998
8-K).
10.41 Current Report on Form 8-K as filed by the Registrant with
the Securities and Exchange Commission on March 24, 1998.
10.42 Letter Agreement between the Registrant and the U.S.
Department of Justice dated March 27, 1998 relating to the
restructuring of the fine assessed by the Department of
Justice under the Plea Agreement dated June 21, 1993.
10.43 Employment Agreement dated as of March 10, 1998 between the
Registrant and Michael K. Reicher.
10.44 Employment Agreement dated as of March 10, 1998 between the
Registrant and Peter Clemens.
*10.45 Amended, Restated and Consolidated Bridge Loan Agreement
dated as of December 2, 1998 between the Company, Galen
Partners III, L.P., Galen Partners International III, L.P.,
Galen Employee Fund III, L.P. and the other signatures
thereto.
*10.46 First Amendment to Amended, Restated and Consolidated Bridge
Loan Agreement dated December 7, 1998 between the Company
and the lenders listed on the signature page thereto.
*10.47 Second Amendment to Amended, Restated and Consolidated
Bridge Loan Agreement dated March 8, 1999 between the
Company and the lenders listed on the signature page
thereto.
*10.48 Form of 10% Convertible Secured Note due May 30, 1999.
*10.49 Form of Common Stock Purchase Warrant issued pursuant to be
Amended, Restated and Consolidated Bridge Loan Agreement.
*10.50 Amended and Restated General Security Agreement dated
December 2, 1998 between the Company and Galen Partners III,
L.P., as Agent.
*10.51 Subordination Agreement dated December 2, 1998 between the
Registrant and Galen Partners III, L.P., as Agent.
*10.52 Agency Letter Agreement dated December 2, 1998 by and among
the lenders a party to the Amended, Restated and
Consolidated Bridge Loan Agreement, as amended.
*10.53 Lease Agreement dated March 17, 1999 between the Registrant
and Par Pharmaceuticals, Inc.
24
26
EXHIBIT
NUMBER DOCUMENT
------- --------
*10.54 Lease Agreement dated September 1, 1998 between the
Registrant and Crimson Ridge Partners.
*10.55 Manufacturing and Supply Agreement dated March 17, 1999
between the Registrant and Par Pharmaceuticals, Inc.
*10.56 Halsey Drug Co., Inc. 1998 Stock Option Plan.
21 Subsidiaries of the Registrant (incorporated by reference to
Exhibit 22 to the 1993 Form 10-K).
*23.1 Consent of Grant Thornton LLP, independent certified public
accountants.
*27 Financial Data Schedule, which is submitted electronically
to the Securities and Exchange Commission for informational
purposes only and not filed.
- ---------------
* Filed herewith.
25
27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HALSEY DRUG CO., INC.
By: /s/ MICHAEL REICHER
------------------------------------
Michael Reicher, President and
Chief Executive Officer (Principal
Executive
Officer)
Date: March 31, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ WILLIAM G. SKELLY Chairman and Director March 31, 1999
- -----------------------------------------------------
William G. Skelly
/s/ MICHAEL REICHER President, Chief Executive March 31, 1999
- ----------------------------------------------------- Officer and Director
Michael Reicher (Principal Executive
Officer)
/s/ PETER CLEMENS Vice President, Chief March 31, 1999
- ----------------------------------------------------- Financial Officer
Peter Clemens (Principal Financial and
accounting Officer) and
Director
/s/ ALAN J. SMITH Director March 31, 1999
- -----------------------------------------------------
Alan J. Smith
/s/ BRUCE F. WESSON Director March 31, 1999
- -----------------------------------------------------
Bruce F. Wesson
/s/ WILLIAM SUMNER Director March 31, 1999
- -----------------------------------------------------
William Sumner
/s/ SRINI CONJEEVARAM Director March 31, 1999
- -----------------------------------------------------
Srini Conjeevaram
/s/ ZUBEEN SHROFF Director March 31, 1999
- -----------------------------------------------------
Zubeen Shroff
26
28
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Report of Independent Certified Public Accountants.......... F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations....................... F-4
Consolidated Statement of Stockholders' Equity.............. F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-8 - F-24
F-1
29
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Halsey Drug Co., Inc.
We have audited the accompanying consolidated balance sheets of Halsey Drug
Co., Inc. and Subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Halsey Drug
Co., Inc. and Subsidiaries as of December 31, 1998 and 1997, and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles.
GRANT THORNTON LLP
New York, New York
March 5, 1999
F-2
30
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
--------------------
1998 1997
-------- --------
(IN THOUSANDS)
CURRENT ASSETS
Cash...................................................... $ 1,850 $ 26
Accounts receivable -- trade, net of allowances for
doubtful accounts of $280 and $542 in 1998 and 1997,
respectively........................................... 1,439 62
Inventories............................................... 6,354 2,456
Prepaid insurance and other current assets................ 148 274
-------- --------
Total current assets.............................. 9,791 2,818
PROPERTY, PLANT AND EQUIPMENT, NET.......................... 4,787 4,630
DEFERRED PRIVATE OFFERING COSTS............................. 1,335 219
-------- --------
$ 15,913 $ 7,667
======== ========
CURRENT LIABILITIES
Notes payable............................................. $ 10,850 $ 4,825
Bank overdraft............................................ 159
Due to banks.............................................. 2,476
Convertible subordinated debentures....................... 2,244
Accounts payable.......................................... 1,834 6,086
Accrued expenses.......................................... 3,972 7,232
Deferred gain............................................. 1,900
Other current liabilities................................. 300 200
-------- --------
Total current liabilities.............................. 16,956 25,122
LONG-TERM DEBT, NET......................................... 26,186
OTHER LIABILITIES........................................... 2,224 2,402
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock -- $.01 par value; authorized, 40,000,000
shares; issued 14,443,212 shares and 14,029,718 shares
in 1998 and 1997, respectively......................... 144 140
Additional paid-in capital................................ 29,113 25,489
Accumulated deficit....................................... (57,221) (44,497)
-------- --------
(27,964) (18,868)
Less treasury stock -- at cost (439,603 shares in 1998 and
1997, respectively).................................... (989) (989)
-------- --------
(28,953) (19,857)
-------- --------
$ 15,913 $ 7,667
======== ========
The accompanying notes are an integral part of these statements.
F-3
31
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales.................................................. $ 8,841 $ 9,088 $ 12,379
Cost of goods sold......................................... 12,712 15,406 16,826
-------- -------- --------
Gross margin.......................................... (3,871) (6,318) (4,447)
Research and development................................... 651 979 1,854
Selling, general and administrative expenses............... 8,078 6,308 7,486
-------- -------- --------
Loss from operations.................................. (12,600) (13,605) (13,787)
Interest expense........................................... (1,946) (1,144) (1,708)
Other income (expense)..................................... 1,802 (264) 1,000
-------- -------- --------
NET LOSS.............................................. $ 12,724 $(15,013) $(14,495)
======== ======== ========
Basic loss per common share................................ $ (.92) $ (1.12) $ (1.49)
======== ======== ========
Weighted average number of outstanding shares.............. 13,813 13,434 9,724
======== ======== ========
The accompanying notes are an integral part of these statements.
F-4
32
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
COMMON STOCK, TREASURY STOCK,
$.01 PAR VALUE ADDITIONAL AT COST
--------------- PAID-IN ACCUMULATED ----------------
SHARES AMOUNT CAPITAL DEFICIT SHARES AMOUNT TOTAL
------ ------ ---------- ----------- ------ ------- --------
(IN THOUSANDS)
Balance at January 1, 1995............. 8,974 $ 90 $14,459 $(14,989) (500) $(1,100) $ (1,540)
Issuance of common stock conversion of
debentures........................... 3,504 35 6,724 6,759
Issuance of shares as settlement....... 60 262 25 56 318
Issuance of warrants with convertible
subordinated debentures.............. 355 355
Exercise of warrants of convertible
debentures........................... 589 6 1,363 1,369
Stock options exercised................ 49 153 153
Net loss for the year ended December
31, 1996............................. (14,495) (14,495)
------ ---- ------- -------- ------ ------- --------
Balance at December 31, 1996........... 13,176 131 23,316 (29,484) (475) (1,044) (7,081)
Issuance of common stock -- conversion
of debentures........................ 643 7 1,529 1,536
Issuance of shares as payment of
interest............................. 69 1 224 225
Sale of treasury stock................. 25 45 35 55 100
Exercise of warrants of convertible
debentures........................... 22 72 72
Stock options exercised................ 95 1 303 304
Net loss for the year ended December
31, 1997............................. (15,013) (15,013)
------ ---- ------- -------- ------ ------- --------
Balance at December 31, 1997........... 14,030 140 25,489 (44,497) (440) (989) (19,857)
Issuance of common stock -- conversion
of notes payable..................... 110 1 213 214
Issuance of shares as payment of
interest............................. 263 3 592 595
Issuance of common stock -- settlement
of trade payables.................... 40 55 55
Deferred debt discount on warrants
issued with convertible debentures... 2,264 2,264
Net loss for the year ended December
31, 1998............................. (12,724) (12,724)
------ ---- ------- -------- ------ ------- --------
Balance at December 31, 1998........... 14,443 $144 $28,613 $(57,221) (440) $ (989) $(29,453)
====== ==== ======= ======== ====== ======= ========
The accompanying notes are an integral part of this statement.
F-5
33
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Cash flows from operating activities
Net loss................................................. $(12,724) $(15,013) $(14,495)
Adjustments to reconcile net loss to net cash used in
operating activities
Depreciation and amortization......................... 1,774 1,733 1,906
Provision for losses on accounts receivable........... (262) 118 144
Provision for loss on investment...................... 500
(Gain) loss on disposal of assets..................... 170 38 (1,000)
Changes in assets and liabilities
Accounts receivable................................. (1,115) 45 1,319
Inventories......................................... (3,898) 1,302 3,958
Prepaid insurance and other current assets.......... 126 165 (96)
Accounts payable.................................... (4,197) 1,851 1,029
Deferred gain....................................... (1,900)
Accrued expenses.................................... (2,665) 4,553 2,913
-------- -------- --------
Total adjustments..................................... (11,967) 9,805 10,673
-------- -------- --------
Net cash used in operating activities................. (24,691) (5,208) (3,822)
-------- -------- --------
Cash flows from investing activities
Capital expenditures..................................... (1,545) (85) (390)
Net proceeds from sale of assets......................... 96
Collection of notes receivable........................... 1,000
-------- -------- --------
Net cash (used in) provided by investing activities... (1,449) 915 (390)
-------- -------- --------
Cash flows from financing activities
Proceeds from issuance of notes payable.................. $ 6,495 $ 3,881 $ 25
Proceeds from issuance of common stock................... 318
Reissuance of treasury stock............................. 70
Payments to Department of Justice........................ (178)
Bank overdraft........................................... (159) (127) 73
Due to banks............................................. (2,476)
Payments to minority stockholders........................ (206)
Proceeds from issuance of convertible subordinated
debentures............................................ 25,800 2,500
Proceeds from exercise of stock options and warrants..... 305 153
Proceeds from exercise of warrants....................... 72 1,369
Deferred private offering costs.......................... (1,518) (255)
-------- -------- --------
Net cash provided by financing activities............. 27,964 4,201 3,977
-------- -------- --------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS......................................... 1,824 (92) (235)
Cash and cash equivalents at beginning of year............. 26 118 353
-------- -------- --------
Cash and cash equivalents at end of year................... $ 1,850 $ 26 $ 118
======== ======== ========
F-6
34
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
YEAR ENDED DECEMBER 31,
(IN THOUSANDS)
Supplemental disclosures of noncash activities:
Year ended December 31, 1998
1. The Company issued 262,836 shares of common stock as payment for
$593,313 in accrued interest.
2. The Company reissued 20,000 shares of common stock as payment for
$25,000 in legal fees and 20,000 shares of common stock as payment for
$30,000 in trade payables.
3. The Company issued 110,658 shares of common stock as payment of
outstanding notes payable in amounts of $214,000 and $1,782 in accrued
interest.
4. The Company issued approximately 4,202,020 warrants (Note A) and
1,009,909 warrants (Note A) valued and recorded in aggregate as
$3,118,000 of unamortized debt discount and a reduction in the related
amount of the obligation.
Year ended December 31, 1997
1. The Company issued 642,407 shares of common stock to Zatpack, Inc. as
payment for an outstanding note payable in the amount of $1,536,000.
2. The Company reissued 25,000 shares of treasury stock as payment for
$30,000 in consulting fees and the receipt of $70,000 in cash.
3. The Company issued 25,000 shares of common stock as payment for
$225,452 in accrued interest.
4. The Company recorded the satisfaction of $1,400,000 of subordinated
promissory notes, related accrued interest of $200,000 and accounts
payable of $300,000 due to Mallinckrodt, in lieu of Mallinckrodt paying
$1,900,000 owed to the Company as described in Note E.
Year ended December 31, 1996
1. The issuance of 3,504,000 shares of the Company's common stock upon
conversion of $6,759,000 of convertible subordinated debentures is
included in common stock and additional paid-in capital.
2. The valuation of the warrants issued in 1996 of $355,000 with
convertible subordinated debentures is included in additional paid-in
capital.
3. The issuance in 1996 of 59,550 shares of the Company's common stock is
valued at $318,000 in connection with litigation settlements.
The accompanying notes are an integral part of these statements.
F-7
35
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
NOTE A -- SUMMARY OF ACCOUNTING POLICIES
Halsey Drug Co., Inc. (the "Company"), a New York-based corporation
established in 1935, and its subsidiaries are engaged in the manufacture, sale
and distribution of generic drugs. The Company sells its generic drug products
under its Halsey label and under private-label arrangements with drug store
chains and drug wholesalers throughout the United States.
A summary of the significant accounting policies consistently applied in
the preparation of the accompanying consolidated financial statements follows.
1. Principles of Consolidation and Basis of Presentation
The consolidated financial statements include 100% of the accounts of the
Company and its wholly-owned subsidiaries, Blue Cross Products Co., Inc., Houba,
Inc., Halsey Pharmaceuticals, Inc., and Indiana Fine Chemicals Corporation, The
Medi-Gum Corporation (100% owned). The Medi-Gum Corporation and Halsey
Pharmaceuticals have not commenced operations. All material intercompany
accounts and transactions have been eliminated.
2. Liquidity Matters
As of December 31, 1998, the Company has a working capital deficiency of
approximately $6,665,000, has an accumulated deficit of approximately
$57,221,000 and has incurred a loss of approximately $12,724,000 for the year
then ended.
On March 10, 1998, the Company completed a private offering (the
"Offering") of securities to an investor group ("Galen") consisting of 5%
convertible senior secured debentures due March 15, 2003, and common stock
purchase warrants (with a 5 year life) exercisable for 2,101,010 shares of the
Company's common stock at an exercise price of $1.50 and 2,101,010 shares at an
exercise price of $2.375. The unamortized discount resulting from the issuance
of such warrants ($2,618,000) has Been recorded as a reduction of the related
obligation. The net proceeds to the Company from the Offering, after the
deduction of related offering expenses, was approximately $19.6 million. In
addition, in accordance with the terms of the private offering, during June
1998, Galen invested an additional $5 million in the Company in exchange for
debentures and warrants having terms identical to those issued in the Offering.
The net proceeds from the Offering and the additional investment have
primarily been used to satisfy a substantial portion of the Company's
liabilities and accounts payable. Such liabilities include the full satisfaction
of the Company's bank indebtedness and related fees, payment to the landlord of
the Brooklyn facility and satisfaction of outstanding judgments and liens.
Further, pursuant to agreements reached with other large creditors in
anticipation of the completion of the offering, including the Company's landlord
and the Department of Justice ("DOJ"), the Company has been able to bring these
creditors current and bring the Company in compliance with installment payment
agreements providing more favorable terms to the Company. The offering proceeds
also allowed the Company to satisfy its outstanding state and Federal payroll
tax obligations and meet current payroll tax obligations. The net proceeds from
the exercise of the option were used to fund working capital, including the
purchase of raw materials, payroll expenses and other Company expenses.
The Company secured bridge financing from Galen and certain investors in
the Offering in the aggregate amount of $9,504,111, funded through seven
separate bridge loan transactions between the period from August through and
including December 1998, as well as an additional bridge loan in March 1999
(collectively, the "Bridge Loans"). The Bridge Loans were consolidated on
December 2, 1998 pursuant to an Amended, Restated and Consolidated Bridge Loan
Agreement, as amended to permit the March 1999 bridge loan (the "Consolidated
Bridge Loan"). The Consolidated Bridge Loan bears interest at 10% per annum, is
F-8
36
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
secured by a first lien on all of the Company's assets and has a maturity date
of May 30, 1999. Approximately $9,120,000 in the principal amount of the
Consolidated Bridge Loan was advanced by Galen with the balance of approximately
$384,000 advanced by certain investors in the Offering. The Consolidated Bridge
Loan is evidenced by 10% convertible senior secured promissory notes which are
convertible at any time prior to maturity into shares of the Company's Common
Stock at a conversion price of approximately $1.368 per share with respect to
approximately $7,820,000 of such indebtedness, $1.331 per share with respect to
approximately $284,000 of such indebtedness, and $1.197 per share with respect
to approximately $1,400,000 of such indebtedness, for an aggregate of 7,099,338
shares of common stock (such conversion prices equal the fair market value of
the Common Stock at the date of issuance of the convertible promissory notes).
In addition, in consideration for the initial extension of the Bridge Loans and
the extension of the maturity dates of the Bridge Loans pursuant to the
consolidation of such loans on December 2, 1998, as amended to permit the March
1999 bridge loan, the Company issued common stock purchase warrants to Galen and
the other investors in the Consolidated Bridge Loan, to purchase an aggregate of
approximately 1,009,909 shares of the Company's common stock (representing
warrants to purchase 50,000 shares of Common Stock for each $1,000,000 in
principal amount of Bridge Loan having a term of 90 days from the date of the
making of the Bridge Loan). The unamortized discount resulting form the issuance
of such warrants ($500,000) has been recorded as a reduction of the related
obligation. The Bridge Loan warrants are substantially identical to those issued
by the Company in its Debenture and Warrant Offering completed on March 10,
1998.
The Consolidated Bridge Loan was obtained by the Company in order to
provide necessary working capital. In view of the Company's current cash
reserves and projections for revenues through May 30, 1999, the Company will be
unable to satisfy the Consolidated Bridge Loan in full at the stated maturity
date of May 30, 1999. Galen, the holder of approximately 96% of such
indebtedness, has indicated to the Company a willingness to cooperate in the
restructuring of the indebtedness evidenced by the Consolidated Bridge Loan to
extend the maturity date of such debt and/or convert the debt into common stock
or longer-term convertible indebtedness. The terms of such restructuring will
depend, to a large extent, on the terms and timing of any third-party
investment, as described below. Accordingly, the terms of any such restructuring
have yet to be agreed to by the parties and will be subject to the negotiation
and preparation of definitive agreements.
The Company is in preliminary discussions with an unaffiliated third party
concerning the terms of a proposed investment in the Company in an amount of up
to $15 million, to be funded in three equal increments based on the achievement
of certain milestones. The structure of the investment will likely take the form
of convertible debentures and common stock purchase warrants, similar in many
respects to the debentures and warrants issued by the Company in its March 10,
1998 offering. The discussions with this third-party investor are in the
preliminary stages and no assurance can be given that final terms acceptable to
the Company will result and/or that if consummated, that the Company will be
successful in achieving the milestones necessary to fund all or any portion of
the proposed investment.
In the event the Company is successful in restructuring the Consolidated
Bridge Loan and completing the third-party investment of the type and size
described above, the Company will have sufficient cash reserves to satisfy its
working capital requirements for at least the next twelve months. The Company is
also seeking to secure a senior revolving line of credit from a banking
institution. There can be no assurance, however, that the Company will be able
to obtain such third-party investment or a bank facility. If the Company is
unable to complete the third-party investment described above or obtain other
sources of working capital, including a bank line of credit or proceeds from the
issuance of debt and/or equity securities, the Company's cash reserves will be
sufficient to satisfy the Company's working capital requirements for
approximately two to three months. Failure to obtain a third-party investment of
the type described above, a bank line of credit or alternative sources of
financing of a comparable amount in the near term will materially adversely
affect the Company's working capital position and financial condition and
results of operations.
F-9
37
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. Inventories
Inventories are stated at the lower of cost or market; cost is determined
using the first-in, first-out method.
4. Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated
depreciation and amortization. Depreciation and amortization are provided for in
amounts sufficient to relate the cost of depreciable assets to operations over
their estimated service lives, principally on a straight-line basis. The
estimated lives used in determining depreciation and amortization are:
Buildings................................................... 25 years
Machinery and equipment..................................... 5-10 years
Leasehold improvements...................................... 5-10 years
Leasehold improvements are amortized over the lives of the respective
leases or the service lives of the improvements, whichever is shorter.
5. Income Taxes
The Company accounts for income taxes utilizing an asset liability method
for financial accounting and reporting for income taxes. Under this method,
deferred tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse.
6. Statements of Cash Flows
For purposes of the statements of cash flows, the Company considers all
highly liquid debt instruments purchased with an original maturity of three
months or less to be cash equivalents. The Company paid no substantial income
taxes for the years ended December 31, 1998, 1997 and 1996. In addition, the
Company paid interest of approximately $1,946,000, $1,113,000, $1,173,000,
respectively, for the years ended December 31, 1998, 1997 and 1996.
7. Use of Estimates in Consolidated Financial Statements
In preparing consolidated financial statements in conformity with generally
accepted accounting principles, management makes estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements, as well as the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
8. Research and Development Costs
All research and development costs, including payments related to licensing
agreements on products under development and research consulting agreements are
expensed when incurred.
9. Impairment of Long-Lived Assets
The Company reviews long-lived assets and certain identifiable intangibles
held and used for possible impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable (Note I).
F-10
38
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. Stock-Based Compensation
The Company accounts for stock-based compensation under Statement of
Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for
Stock-Based Compensation," and continues to apply APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations in
accounting for its plans and does not recognize compensation expense for its
stock-based compensation plans other than for restricted stock (Note K).
Equity instruments issued to nonemployees in exchange for goods and/or
services are accounted for under the fair value method of SFAS No. 123.
11. New Pronouncements
Earnings (Loss) Per Share
In 1997, the Company adopted Statement of Financial Accounting Standards
No. 128 ("SFAS No. 128"), "Earnings Per Share," which requires public companies
to present basic earnings (loss) per share and, if applicable, diluted earnings
per share. All comparative periods have been restated in accordance with SFAS
No. 128.
The computation of basic earnings (loss) per share of common stock is based
upon the weighted average number of common shares outstanding during the period.
Diluted earnings per share is equal to basic earnings per share for all years
presented as the effect of other potentially dilutive securities would be
antidilutive.
Reporting Comprehensive Income
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130 ("SFAS No. 130"), "Reporting
Comprehensive Income," which is effective for the Company's year ended December
31, 1998. The statement addresses the reporting and displaying of comprehensive
income and its components. Earnings per share is only reported for net income
and not for comprehensive income and its components. At December 31, 1998, 1997
and 1996, the Company had no items of other comprehensive income.
12. Reclassifications
Certain reclassifications have been made to the 1997 and 1996 presentations
to conform to the 1998 presentation.
NOTE B -- FAIR VALUE OF FINANCIAL INSTRUMENTS
Long-term and Short-term Debt and Convertible Subordinated Debentures
The fair value of the Company's long-term and short-term debt and
convertible subordinated debentures is estimated based upon the quoted market
prices for the same or similar issues or on the current rates offered to the
Company for debt of the same outstanding maturities. Accordingly, the carrying
amount of these financial instruments approximates their fair value at December
31, 1998 and 1997.
F-11
39
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE C -- INVENTORIES
Inventories consist of the following:
DECEMBER 31,
----------------
1998 1997
------ ------
(IN THOUSANDS)
Finished goods.............................................. $2,675 $ 789
Work-in-process............................................. 1,166 263
Raw materials............................................... 2,513 1,404
------ ------
$6,354 $2,456
====== ======
NOTE D -- PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are summarized as follows:
DECEMBER 31,
------------------
1998 1997
------- -------
(IN THOUSANDS)
Machinery and equipment..................................... $12,278 $11,478
Leasehold improvements...................................... 6,103 5,967
Building.................................................... 747 997
Land........................................................ 44 265
------- -------
19,172 18,707
Less accumulated depreciation and amortization.............. 14,385 14,077
------- -------
$ 4,787 $ 4,630
======= =======
Depreciation expense for the years ended December 31, 1998, 1997 and 1996
was approximately $1,122,000, $1,640,000, and $1,562,000, respectively.
NOTE E -- DEBT
Due to Banks
At December 31, 1997 the Company had $2,476,000 under a line of credit
agreement with three participating banks for which the average borrowing rate
for the year then ended was 11.9 %. The agreement contained certain financial
covenants, for which the Company was not in compliance at December 31, 1997.
During March 1998, the Company completely satisfied its bank indebtedness and
terminated the line of credit agreement with its banks.
Notes Payable
At December 31, 1998 and 1997, notes payable consisted of the following:
DECEMBER 31,
-----------------
1998 1997
------- ------
(IN THOUSANDS)
Unsecured promissory demand notes........................... $ 2,817
Subordinated promissory notes............................... $4,825
Bridge Loans (Note A)....................................... 7,533
------- ------
$10,350 $4,825
======= ======
F-12
40
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During 1997, the Company borrowed from and issued to several debenture
holders and shareholders unsecured, demand promissory notes in the amount of
$1,125,000, bearing interest at 12% per annum, with interest payable quarterly.
These notes were paid in full in 1998.
During the period from May 1997 through July 1997, the Company borrowed
approximately $3 million from Mylan Laboratories, Inc. ("Mylan") pursuant to
five unsecured, demand promissory notes. The advances made by Mylan
Laboratories, Inc. were part of a proposed investment by Mylan in the Company,
including the proposed purchase of the Company's Houba Indiana facility as well
as a partial tender offer for the Company's common stock. The Company used the
proceeds of these borrowings for working capital. To date, $236,000 has been
paid by the Company to Mylan against such indebtedness in the form of product
deliveries to Mylan. Pursuant to an agreement reached between the parties, the
Company is required to satisfy interest on the outstanding indebtedness on an
annual basis while the indebtedness remains outstanding and to satisfy the
principal amount of such indebtedness in the form of product deliveries to Mylan
until such time as the indebtedness is satisfied in full. In 1998, the Company,
in exchange for extending the loan, agreed to grant a warrant to purchase 50,000
shares of the Company's common stock at a price of $1.94 per share.
Additionally, the Company began reducing the loan by supplying product to Mylan.
At December 31, 1998, the loan balance was $2,817,000.
During the fourth quarter of 1997, the Company received $500,000 from an
investor of a proposed joint venture, a demand promissory note bearing interest
at 10% per annum which was secured by the property of Houba. In addition, as
part of a proposed financing agreement, the Company received $200,000 as a
promissory note bearing interest at 8% per annum during the fourth quarter of
1997. Both of these promissory notes were paid in full in 1998.
NOTE F -- CONVERTIBLE SUBORDINATED DEBENTURES AND STOCK WARRANTS
In connection with certain 1995 amendments to the line of credit agreement
described in Note E, the Company issued stock warrants to the bank, expiring
July 17, 2000, to purchase up to 699,696 shares of the Company's common stock at
exercise prices ranging from $1.98 to $2.07 per share. The fair value of the
warrants, $200,000, as determined by the Company's Board of Directors, was
recorded by the Company in 1994 as additional paid-in capital and a discount to
bank debt which was fully amortized through the maturity date, August 31, 1995.
On July 18, 1995, the Company issued 408 units, at $10,000 per unit, in a
private placement of its securities ("July Private Placement"). Each unit
consisted of: (i) a 10% convertible subordinated debenture due July 18, 2000 in
the principal amount of $10,000, interest payable quarterly, and convertible
into shares of the Company's common stock at a conversion price of $2.00 per
share, subject to antidilution provisions, and (ii) 750 redeemable common stock
purchase warrants ("warrants"). Each warrant entitled the holder to purchase one
share of common stock for $2.00, subject to adjustment during the five-year
period commencing July 18, 1995. The warrants were redeemable by the Company at
a price of $.01 per warrant at any time commencing July 18, 1996, provided that
at July 18, 1996, the fair market value of the Company's common stock equals or
exceeds $2.00 per share for the 20 consecutive trading days ending on the third
day prior to the notice of redemption to the holders of the warrant. The
debentures were converted into 2,040,000 shares of common stock in August 1996.
On November 29, 1995, the Company issued 366 units, at $10,000 per unit, in
a private placement of its securities ("November Private Placement"). Each unit
consisted of (i) a 10% convertible subordinated debenture due November 29, 2000
in the principal amount of $10,000, interest payable quarterly, and convertible
into shares of the common stock, at a conversion price of $2.50 per share,
subject to dilution, and (ii) 600 redeemable common stock purchase warrants. The
terms and conditions of the warrants issued in connection with the November
Private Placement are similar to those issued in the July Private Placement,
F-13
41
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
except that the exercise price of the warrant pursuant to the November Private
Placement is $2.50 per share. These debentures were converted into 1,464,000
shares of common stock in December 1996.
On August 6, 1996, the Company issued 250 units, at $10,000 per unit, in a
private placement of its securities ("August Private Placement"). Each unit
consisted of: (i) a 10% convertible subordinated debenture due August 6, 2001 in
the principal amount of $10,000, interest payable quarterly, and convertible
into shares of the Company's common stock at a conversion price of $3.25 per
share, subject to dilution, and (ii) 750 redeemable common stock purchase
warrants ("warrants"). Each warrant entitled the holder to purchase one share of
common stock for $3.25, subject to adjustment during the five-year period
commencing August 6, 1996. Pursuant to the agreement, the Company was required
to establish an escrow account to repay interest in the outstanding convertible
debenture, which was fully paid during 1997.
NOTE G -- ACCRUED EXPENSES
Accrued expenses are summarized as follows:
DECEMBER 31,
----------------
1998 1997
------ ------
(IN THOUSANDS)
Payroll taxes payable (Note H).............................. $1,714 $3,290
Interest.................................................... 619 1,018
Professional fees........................................... 539 537
Accrued pension and welfare................................. 15 501
Medicaid rebates payable.................................... 169 481
Accrued payroll............................................. 92 420
Directors' fees............................................. 126 90
New York State Department of Education...................... 140 134
Medical claims.............................................. 149
Commissions................................................. 30 42
Property taxes.............................................. 94
Accrued chargeback liability................................ 40
Accrued equipment purchase.................................. 56
Other....................................................... 189 719
------ ------
$3,972 $7,232
====== ======
At December 31, 1998, payroll taxes payable include approximately
$1,373,000 and $275,000 of delinquent payroll taxes (including penalties and
interest) due to the Internal Revenue Service and the State of New York,
respectively, all of which liability was incurred in 1997 and 1996. The Company
expects that the Federal liability will be substantially offset by income tax
refund claims which were filed and are pending before the IRS. Until such time
as the IRS completes its review, the Company has not recorded any expected tax
refund claims. The Company has negotiated a payment plan with the State of New
York and the balance will be paid by the end of 1999.
F-14
42
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE H -- INCOME TAXES
The actual income tax expense varies from the Federal statutory rate
applied to consolidated operations as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1998 1997 1996
---------------- ---------------- ----------------
AMOUNT % AMOUNT % AMOUNT %
------- ----- ------- ----- ------- -----
(IN THOUSANDS)
Federal statutory rate............... $(4,326) (34.0)% $(5,105) (34.0)% $(4,928) (34.0)%
Loss for which no tax benefit was
provided........................... 4,247 33.8 4,924 32.8 4,233 29.1
Losses of subsidiaries with no tax
benefit............................ 424 3.0
Amortization of Warrants............. 24 .2 32 .2
Goodwill amortization................ 12 .1 73 .5
Department of Justice settlement..... 42 .1 57 .4
Other................................ 37 .1 145 .9 109 .8
------- ----- ------- ----- ------- -----
Actual tax expense................... $ -- --% $ -- --% $ -- --%
======= ===== ======= ===== ======= =====
The Company has net operating loss carryforwards aggregating approximately
$45,572,700, expiring during the years 2011 through 2018. In addition, certain
of the Company's subsidiaries filed separate Federal income tax returns in prior
years and have separate net operating loss carryforwards aggregating
approximately $4,062,758 expiring during the years 1999 through 2018.
The tax loss carryforwards of the Company and its subsidiaries are subject
to limitation by Section 382 of the Internal Revenue Code with respect to the
amount utilizable each year. This limitation reduces the Company's ability to
utilize net operating loss carryforwards included above each year. The amount of
the limitation has not been quantified by the Company.
F-15
43
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the Company's deferred tax assets (liabilities), pursuant
to SFAS No. 109, are summarized as follows:
DECEMBER 31,
--------------------
1998 1997
-------- --------
(IN THOUSANDS)
Deferred tax assets
Net operating loss carryforwards.......................... $ 21,831 $ 15,125
Allowance for doubtful accounts........................... 75 304
Research and development tax credit....................... 212 212
Reserve for inventory..................................... 169 886
Litigation settlement..................................... 73 195
Rent...................................................... 231 172
Reserve for Medicaid...................................... 71 209
Capital loss carryforwards................................ 210
Reserve for property, plant and equipment................. 111
Other..................................................... 15 24
-------- --------
Gross deferred tax assets.............................. 22,677 17,448
-------- --------
Deferred tax liabilities
Depreciation.............................................. (332) (828)
Installment sale gain..................................... (798)
Other..................................................... (42) (42)
-------- --------
(374) (1,668)
-------- --------
Net deferred tax assets before valuation allowance..... 22,303 15,780
Valuation allowance......................................... (22,303) (15,780)
-------- --------
Net deferred tax assets................................ $ -- $ --
======== ========
SFAS No. 109 requires a valuation allowance against deferred tax assets if,
based on the weight of available evidence, it is more likely than not that some
or all of the deferred tax assets may not be realized. The valuation allowance
at December 31, 1998 primarily pertains to uncertainties with respect to future
utilization of net operating loss carryforwards.
NOTE I -- OTHER INCOME (EXPENSE)
Cessation of California Operations
During 1997, management decided to shut down its California operations
which comprised two of its subsidiaries, Cenci Powder Products, Inc. and H.R.
Cenci Laboratories, Inc. The Company had not incurred any significant costs to
exit these operations other than minimal vacation compensation and salary paid
to a former plant employee to manage the exit process. Continuing operating
losses and the inability to leverage the manufacturing capacity were among
factors considered by the Board and Management in their determination to cease
such operations.
At December 31, 1997, the net assets of H.R. Cenci Laboratories, Inc.,
consisted primarily of building, equipment and land with a net carrying value of
$528,000 and inventory with a total net carrying value of $93,000. Accordingly,
during 1997 the Company recorded a charge of $264,000 to reduce the fixed assets
to their then estimated net realizable value, and a $93,000 charge to write off
the remaining inventory. In 1998,
F-16
44
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the Company disposed of the remaining assets and recorded a charge of $191,000.
For the years ended December 31, 1998, 1997 and 1996, these subsidiaries, in
aggregate, accounted for revenues of approximately $160,000, $495,000, and
$290,000, respectively.
On March 30, 1998, the Company completed the sale of substantially all of
the non-real property assets of Cenci Powder Products to Zuellig Botanical. The
purchase price for the assets consisted of the forgiveness by Zuellig Botanical
of approximately $262,000 in indebtedness owed by Cenci Powder to Zuellig
Botanical related to the purchase of raw materials. The Agreement provided
further that Zuellig Botanical would satisfy the manufacture and delivery
requirements of Cenci Powder at its facility located at Fresno, California,
under an existing third party supply contract.
Sale of Assets
On March 21, 1995, the Company sold its Abbreviated New Drug Application
("ANDA") for 5mg Oxycodone HCL/325mg Acetaminophen Tablets ("Tablets") and
certain equipment used in the production of the Tablets for up to $5.4 million
to Mallinckrodt. The Company received $500,000 of the proceeds in July 1994,
which was recorded as deferred income on the Company's 1994 consolidated balance
sheet. Mallinckrodt also paid the Company $2,000,000 on March 21, 1995 and the
remainder was to be payable as follows: (i) $1,000,000 upon the Company
receiving general clearance from the FDA for unrestricted operations at its
Brooklyn facility and written notice from the FDA that it is in compliance with
certain provisions of the consent degree dated June 29, 1993 and (ii) $1,900,000
at the earlier of (a) Mallinckrodt receiving certain authorizations from the FDA
or (b) September 21, 1997. Mallinckrodt also agreed to defer $1,200,000 of the
Company's trade debt due to an affiliate of Mallinckrodt (Note E). Pursuant to
the release of the Company from the FDA's Application Integrity Policy list and
its Restrictions (collectively, the "AIP") by the FDA on December 19, 1996, the
Company recorded a gain of $1,000,000. On January 9, 1997, Mallinckrodt tendered
this amount to the Bank Group. Pursuant to the agreement of September 21, 1997,
the Company recorded $1,900,000 as a deferred gain which was recognized on March
21, 1998.
In connection with the agreement, the Company agreed to manufacture Tablets
for Mallinckrodt for a period of three years and Mallinckrodt agreed to order a
minimum number of Tablets from the Company for two years ending March 21, 1997.
The Company and Mallinckrodt entered into a noncompetition agreement pursuant to
which the Company agreed not to compete with Mallinckrodt and its affiliates
with respect to the Tablets until March 21, 2000.
NOTE J -- PENSION EXPENSE
1. Management Pension Plan
The Company had maintained a defined benefit plan covering substantially
all nonunion employees which was terminated in November 1996. Subsequently, all
Plan assets were converted to cash and held in a money market fund (to continue
the Trust) from which all vested participant interests were to be paid. Based on
information provided by the Company's actuary, the total liability of the Plan
as of the plan year ended November 30, 1997 was $398, 281. The actuary
determined that this amount was sufficient to pay the vested interests of all of
the participants who were in the Plan as of November 30, 1996, and for any
participants who had terminated with previously vested interests that had not
yet been paid. Included in the Plan's assets as of November 30, 1997, were
receivables from the Company and the Insurer for $54,631 and $57,468,
respectively, which were subsequently paid in March 1998. No additional
contributions were required to be paid to the Trust for the period ended
November 30, 1997.
In 1998 the Company received approval to terminate the Plan by the Pension
Benefit Guarantee Corporation, all assets were distributed to the vested
participants, the Trust was terminated and a final filing was made with the
Internal Revenue Service.
F-17
45
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. Employees' Pension Plan
The Company contributed approximately $421,000, $407,000, and $492,000 in
1998, 1997 and 1996, respectively, to a multiemployer pension plan for employees
covered by collective bargaining agreements. This plan is not administered by
the Company and contributions are determined in accordance with provisions of
negotiated labor contracts. Information with respect to the Company's
proportionate share of the excess, if any, of the actuarially computed value of
vested benefits over the total of the pension plan's net assets is not available
from the plan's administrator.
The Multiemployer Pension Plan Amendments Act of 1980 (the "Act")
significantly increased the pension responsibilities of participating employers.
Under the provision of the Act, if the plans terminate or the Company withdraws,
the Company could be subject to a "withdrawal liability."
NOTE K -- STOCK OPTION PLAN
In June 1998, the stockholders of the Company approved the adoption of a
stock option and restricted stock purchase plan (the "1998 Option Plan"). The
1998 Option Plan replaces the 1995 Option Plan which was terminated in 1998. The
1998 Option Plan provides for the granting of (i) nonqualified options to
purchase the Company's common stock at not less than the fair market value on
the date of the option grant, (ii) incentive stock options to purchase the
Company's common stock at not less than the fair market value on the date of the
option grant and (iii) rights to purchase the Company's common stock on a
"Restricted Stock" basis, as defined, at not less than the fair market value on
the date the right is granted. As of December 31, 1998, there was no exercise of
rights to purchase any common stock on a restricted stock basis. The total
number of shares which may be sold pursuant to options and rights granted under
the 1998 Option Plan is 2,600,000. No option can be granted under the 1998
Option Plan after April, 2008 and no option can be outstanding for more than ten
years after its grant.
The Company has adopted the disclosure provisions of Statement of Financial
Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for Stock-Based
Compensation." It applies APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations in accounting for its plans and does not
recognize compensation expense for its stock-based compensation plans other than
for restricted stock. If the Company had elected to recognize compensation
expense based upon the fair value at the grant date for awards under these plans
consistent with the methodology prescribed by SFAS No. 123, the Company's net
income and earnings per share would be reduced to the pro forma amounts
indicated below:
YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
(THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net loss
As reported...................................... $(12,724) $(15,013) $(14,495)
Pro forma........................................ (13,663) (15,323) (14,180)
Loss per share
As reported...................................... $ (.92) $ (1.12) $ (1.49)
Pro forma........................................ (.98) (1.14) (1.46)
These pro forma amounts may not be representative of future disclosures
because they do not take into effect pro forma compensation expenses related to
grants made before 1995. The fair value of these options was estimated at the
date of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions for the years ended December 31, 1998, 1997 and
1996, respectively: expected volatility of 67%, 65%, and 82% ; risk-free
interest rates of 5.6%, 6.0%, and 6.6% ; and expected lives of 10 years, 4 years
and 4.6 years. At the date of grant, all exercise prices equaled the market
value of the stock.
F-18
46
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair market estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
Transactions involving stock options are summarized as follows:
WEIGHTED WEIGHTED
STOCK AVERAGE AVERAGE
OPTIONS EXERCISE FAIR
OUTSTANDING PRICE VALUE
----------- -------- --------
Balance at January 1, 1996........................... 600,500 $3.49
Granted.............................................. 126,000 4.77
Exercised............................................ (49,159) 3.12
Cancelled............................................ (21,334) 4.39
---------
Balance at December 31, 1996......................... 656,007 3.53
Exercised............................................ (89,300) 3.22 $3.39
Cancelled............................................ (84,968) 5.16 3.39
---------
Balance at December 31, 1997......................... 481,739 3.60
=========
Granted.............................................. 2,254,850 2.37 1.71
Cancelled............................................ (511,303) 3.16 2.08
---------
Balance at December 31, 1998......................... 2,225,286 2.46
=========
The following table summarizes information concerning currently outstanding
and exercisable stock options:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- -------------------------
WEIGHTED
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE
RANGES OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICES 1998 LIFE PRICE 1998 PRICE
- --------------- -------------- ----------- -------- -------------- --------
$1.19 - $2.00 70,000 8.10 $1.55 20,000 $1.97
2.01 - 3.00 2,025,350 9.19 2.40 348,750 2.38
3.01 - 4.88 129,936 7.32 3.86 80,036 3.74
--------- -------
2,225,286 448,786
========= =======
NOTE L -- COMMITMENTS
The Company occupies plant and office facilities under noncancellable
operating leases which expire in December 2005. These operating leases provide
for scheduled base rent increases over the term of the lease, however, the total
amount of the base rent payments will be charged to operations using the
straight-line method over the term of the lease. The leases provide for payment
of real estate taxes based upon a percentage of the annual increase. In
addition, the Company rents certain equipment under operating leases, generally
for terms of four years. Total rent expense for the years ended December 31,
1998, 1997 and 1996 was approximately $1,243,000, $884,000 and $659,000,
respectively.
F-19
47
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31,1998, the approximate minimum rental commitments under
these operating leases are as follows:
(IN THOUSANDS)
Twelve months ending December 31,
1999......................................... $1,023
2000......................................... 1,075
2001......................................... 1,128
2002......................................... 1,186
2003 and thereafter.......................... 3,921
------
Total minimum payments required........... $8,333
======
Employment Contracts
During March 1998, the Company entered into employment contracts with each
of two new officers/employees of the Company which cover a five-year and a
three-year period, respectively. The contracts provide for, among other things:
(i) annual salaries of $170,000 and $140,000 to be paid over the five-year and
three-year periods, respectively and (ii) an aggregate of 1,300,000 options
(included in the 1998 grants -- Note K) to purchase the Company's stock at an
exercise price of $2.38 per common share that vest evenly over a
three-to-five-year service period and expire in ten years.
NOTE M -- CONTINGENCIES
The Company currently is a defendant in several lawsuits involving product
liability and other claims. The Company's insurance carriers have assumed the
defense for all product liability and other actions involving the Company. None
of the lawsuits is brought as a class action. The ultimate outcome of these
lawsuits cannot be determined at this time, and accordingly, no adjustment has
been made to the consolidated financial statements.
On October 23, 1996, the Company withdrew four of its Abbreviated New Drug
Applications ("ANDAs") including its ANDA for acetaminophen/oxycodone capsules
(the "Capsule ANDA"), and halted sales of the affected products. The Company
instituted the withdrawal at the suggestion of the FDA and in anticipation of
its release from the FDA's Application Integrity Policy ("AIP"). The FDA has
placed the Company on the AIP, in October 1991, in connection with its
investigation of the Company's operations which culminated in the 1993 consent
decree. Under the AIP, the FDA suspended all of the parent company's (i.e.,
Halsey Drug Co.'s) applications for new drug approvals, including ANDAs and
supplements to ANDAs. At the FDA's suggestion, the Company retained outside
consultants to perform validity assessments of its drug applications.
Thereafter, in October 1996, the FDA recommended that several applications,
including the Capsule ANDA, be withdrawn. As a basis of its decision, the FDA
cited questionable and incomplete data submitted in connection with the
applications. The FDA indicated that withdrawal of the four ANDAs was necessary
for the release of the Company from the AIP. The FDA further required submission
by the Company of a Corrective Action Plan. Said Plan was prepared and submitted
by the Company and accepted by the FDA during 1997.
On December 19, 1996, the FDA released the Company from the AIP. As a
consequence, for the first time since October 1991, the Company was permitted to
submit ANDAs to the FDA for review. Since its release from the AIP in December
1996, through the fiscal year ended December 31, 1998, the Company submitted
thirteen ANDAs for review by the FDA, including a new ANDA with respect to the
Capsules. During the period from the Company's release from the AIP to March 15,
1999, the Company received six ANDA approvals, all of which relate to ANDA
filings made with the FDA subsequent to the Company's release from the AIP.
As of March 15, 1999, the Company had submitted one additional ANDA for
review by the FDA in fiscal 1999 and anticipates the submission of five
additional ANDAs during the balance of fiscal 1999.
F-20
48
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Although the Company has been successful in receiving the ANDA approvals
described above since its release from the AIP in December 1996, there can be no
assurance that any of its newly submitted ANDAs, or those contemplated to be
submitted, will be approved by the FDA. The Company will not be permitted to
market any new product unless and until the FDA approves the ANDA relating to
such product. Failure to obtain FDA approval for the Company's pending ANDAs, or
a significant delay in obtaining such approval, would adversely affect the
Company's business operations and financial condition.
On June 21, 1993, the Company entered into a Plea Agreement with the DOJ to
resolve the DOJ's investigation into the manufacturing and record keeping
practices of the Company's Brooklyn plant. Under the terms of the Plea
Agreement, the Company agreed to plead guilty to five counts of adulteration of
drug products shipped in interstate commerce. Each count involved product
adulteration, and record keeping deficiencies relating to a single drug product,
Quinidine Gluconate (324mg tablets), manufactured at the Brooklyn plant. The
Plea Agreement also required the Company to pay a fine of $2,500,000 over five
years in quarterly installments of $125,000, commencing on or about September
15, 1993. The Company's plea was entered and the terms of the Plea Agreement
were approved by the United States District Court for the District of Maryland
on July 13, 1993. As of February 28, 1998, the Company was in default of the
payment terms of the Plea Agreement and had made payments aggregating $350,000.
On March 27, 1998, the Company and the DOJ signed the Letter Agreement serving
to amend the Plea Agreement relating to the terms of the Company's satisfaction
of the fine assessed under the Plea Agreement Specifically, the Letter Agreement
provided that the Company will satisfy the remaining $2,150,000 of the fine
through the payment of $25,000 on a monthly basis commencing June 1, 1998, plus
interest on such outstanding balance (at the rate calculated pursuant to 28
U.S.C Section 1961)(currently 5.319%). Such payment schedule will result in the
full satisfaction of the DOJ fine in December, 2005. The Letter Agreement also
provides certain restrictions on the payment of salary or compensation to any
individual in excess of $150,000 without the written consent of the United
States District Court for the District of Maryland, subject to certain
exceptions. In addition, the Letter Agreement requires the repayment of the
outstanding fine to the extent of 25% of the Company's after-tax profit or the
remaining balance owed and 25% of the net proceeds received by the Company on
any sale of a capital asset for a sum in excess of $10,000. If, at any time, the
Company does not make the payments required under the Letter Agreement in a
timely fashion, the United States will be free to declare that the fine is
delinquent and/or in default, and exercise all legal process to immediately
collect the full amount of the fine, interest and applicable penalties.
By letter dated October 23, 1995, the Company was notified by the New York
State Education Department (the "Department") that the Professional Conduct
Officer of the Office of Professional Discipline had determined that there was
sufficient evidence of professional misconduct on the Company's part to warrant
a disciplinary proceeding pursuant to New York law. Upon contacting the Deputy
Director of the Office of Professional Discipline, counsel for the Company was
advised that the alleged misconduct related to the same activities that were the
subject of the DOJ investigation, indictment and plea. The Company submitted a
written response on November 16, 1995. The Company and the Department have
agreed to the entry of a Consent Order concluding any disciplinary proceedings.
The Company will pay $175,000 in fines over five years. In addition, the
Company's registration as a manufacturer of drugs in New York State is revoked,
but such revocation is stayed and the Company has been placed on probation for a
maximum of five years. The Company has the right to apply for removal from
probation after two years. At December 31, 1998, the Company is current in its
payment obligations with a remaining obligation of $140,000.
The Company's Common Stock is listed on the American Stock Exchange (the
"Exchange") under the symbol "HDG."
The Company does not meet certain of the Exchange's criteria for continued
listing. Accordingly, there can be no assurance that the Company's common stock
will remain listed on the Exchange or that the Exchange will not commence a
review of the Company's continued listing eligibility. If the Common Stock
should become delisted from the Exchange, trading, if any, in the Common Stock
would continue on the OTC
F-21
49
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Bulletin Board, an NASD-sponsored inter-dealer quotation system, or in what is
commonly referred to as the "Pink Sheets." In such event, a shareholder may find
it more difficult to dispose of, or to obtain accurate quotations as to the
market value of the Common Stock.
Immediately prior to the completion of the Offering, the Company was in
default under the consent order with the Department for failure to satisfy two
of the monthly installments of the fine as provided in the consent order. Prior
to the completion of the Offering, the Company advised the Department as to the
existence of the default and that such deficiencies would be corrected upon the
completion of the Offering. The Company has satisfied these outstanding amounts
and is now current under the consent order with the Department. Based on
discussions between representatives of the Department and the Company's outside
counsel handling this matter, the Company has been advised that the revocation
of the Company's registration as a manufacturer of drugs in the State of New
York will remain stayed and that the Company continues to have the right to
apply for removal from probation after two years from the effective date of the
consent order.
Other Legal Proceedings
Beginning in 1992, actions were commenced against the Company and numerous
other pharmaceutical manufacturers in the Pennsylvania Court of Common Pleas,
Philadelphia Division, in connection with the alleged exposure to
diethylstilbestrol ("DES"). The defense of all of such matters was assumed by
the Company's insurance carrier, and a substantial number have been settled by
the carrier. Currently, five actions remain pending with the Company as a
defendant, and the insurance carrier is defending each action. Similar actions
were brought in Ohio, and have been dismissed based on Ohio law. The Company and
its legal counsel do not believe any of such actions will have a material impact
on the Company's financial condition.
The Company has been named as a defendant in four additional actions, each
of which has been referred to the Company's carrier and has been accepted for
defense. The first action, Alonzo v. Halsey Drug Co., Inc. and K-Mart Corp., No.
64DOT-95111-CT-2736 (Indiana Superior Court, Porter County), was commenced on
November 5, 1995 and involves a claim for unspecified damages relating to the
alleged ingestion of "Doxycycline 100." At this early stage of the proceedings,
the Company is unable to predict with any degree of certainty the likely outcome
of these claims and whether they will have a material adverse effect on the
Company's financial condition. The second action, Files v. Halsey Drug Co.,
Index No. 198787193 (New York Supreme Court, Suffolk County), commenced on
September 16, 1993, seeking $10,000,000 in damages for wrongful death allegedly
caused by the ingestion of Isoniazid. Halsey has been dismissed from this action
on motion for summary judgment. The third and fourth actions, entitled Hunt v.
Halsey Drug Co., Inc., and McCray v. Halsey Drug Co., Inc. (New York State
Supreme Court, Kings County), were commenced on October 21, 1993, seeking the
recovery of $8,000,000 for alleged personal injuries suffered by two Wells Fargo
security guards who responded to an alarm and were shot, resulting in the death
of one and the injury to the other. The Company's insurance carrier and the
plaintiffs in these matters have agreed in principle to a settlement providing
for the payment by the Company's insurance carrier of the sum of $600,000 to the
estate of John McCray and the sum of $150,000 to Joseph Hunt in full and final
settlement of all their respective claims against the Company.
The Company has been named as a defendant in a complaint filed with the
United States District Court, Eastern District of New York, on June 30, 1998
(the "Complaint") by Quality Products and Services, L.L.C. The Complaint alleges
the existence of a Joint Venture Agreement between the Plaintiff and the Company
concerning the development, manufacture and marketing of a single product. The
Complaint also alleges that the Company has breached the Agreement by failing to
satisfy its respective obligations defined in the Agreement. The Complaint seeks
monetary damages of approximately $20 million. The Company believes that the
allegations contained in the Complaint are without basis in fact, and that it
has meritorious defenses to each of the allegations. The Company has retained
counsel and intends to vigorously defend this action. This matter is currently
in discovery. The Company has filed a third-party complaint against Rosendo
Ferran, the Company's former President, in connection with the Complaint.
F-22
50
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has been named as a defendant in an action in Suffolk County,
New York, by Designed Laboratories, Inc., for construction work allegedly
performed at the Company's facilities in Brooklyn. Plaintiff is seeking
approximately $148,000. The Company has no records of work being performed by
this entity, and is therefore defending the action.
The Company's former President, Rosendo Ferran, has instituted an
arbitration against the Company, seeking sums alleged due under his employment
contract in the amount of $225,000, deferred salary in the approximate amount of
$100,000, and unspecified damages upon allegations of age, ethnic and religious
discrimination. The Company believes it has meritorious defenses to the
allegations claimed in the arbitration. The Company and its legal counsel do not
believe this claim will have a material adverse effect on the Company's
financial condition.
NOTE N -- SIGNIFICANT CUSTOMERS AND SUPPLIERS
The Company sells its products to a large number of customers who are
primarily drug distributors, drugstore chains and wholesalers and are not
concentrated in any specific region. The Company performs ongoing credit
evaluations of its customers and generally does not require collateral. During
1998, the Company had net sales to one customer in excess of 10% of total sales,
aggregating 11.5% of total sales. During 1997, the Company had net sales to two
customers in excess of 10% of total sales. One customer (Mallinckrodt) accounted
for 22.1% of total sales and another customer (Warner Chilcott) accounted for
10% of total sales. During 1996, the Company had net sales to one customer
aggregating 10% of total sales.
During 1998 and 1997, the Company purchases approximated $2,583,000 and
$1,187,000, respectively, representing approximately 29% and 25%, respectively,
of total purchases for those years.
NOTE O -- SUBSEQUENT EVENTS
Lease of Congers, New York Facility
Effective March 22, 1999, the Company leased, as sole tenant, a
pharmaceutical manufacturing facility located in Congers, New York (the "Congers
Facility") from Par Pharmaecutical, Inc. ("Par") pursuant to an Agreement to
Lease (the "Lease"). The Congers Facility contains office, warehouse and
manufacturing space and is approximately 35,000 square feet. The Lease provides
for a term of three years, with a two-year renewal option and provides for
annual fixed rent of $500,000 per year during the primary term of the Lease and
$600,000 per year during the option period. The Lease also covers certain
manufacturing and related equipment previously used by Par in its operations at
the Congers Facility (the "Leased Equipment"). In connection with the execution
of the Lease, the Company and Par entered into a certain Option Agreement
pursuant to which the Company may purchase the Congers Facility and the Lease
Equipment at any time during the lease term for $5 million.
As part of the execution of the Lease, the Company and Par entered into a
certain Manufacturing and Supply Agreement (the "M&S Agreement") having a term
of two years. The M&S Agreement provides for the Company's contract manufacture
of certain designated products manufactured by Par at the Congers Facility prior
to the effective date of the Lease. The M&S Agreement also provides that Par
will purchase a minimum of $1,150,000 in product during the initial 18 months of
the Agreement. The M&S Agreement further provides that the Company will not
manufacture, supply, develop or distribute the designated products to be
supplied by the Company to Par under the M&S Agreement to or for any other
person for a period of three years.
F-23
51
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated March 5, 1999, accompanying the
consolidated financial statements included in the Annual Report of Halsey Drug
Co., Inc. on Form 10-K for the year ended December 31, 1998. We hereby consent
to the incorporation by reference of said report in the Registration Statements
of Halsey Drug Co., Inc. on Form S-8 (File No. 33-98396, effective October 19,
1995).
GRANT THORNTON LLP
New York, New York
March 5, 1999
F-24
52
EXHIBIT INDEX
Exhibit 3.1
Certificate of Incorporation and amendments
Exhibit 3.3
Restated By-Laws
Exhibit 10.45
[Amended, Restated and Consolidated Bridge Loan Agreement dated as of
December 2, 1998 between the Company, Galen Partners III, L.P., Galen
Partners International III, L.P., Galen Employee Fund III, L.P.
and the other signatures thereto]
Exhibit 10.46
[First Amendment to Amended, Restated and Consolidated Bridge Loan Agreement
dated December 7, 1998 between the Company and the lenders listed
on the signature page thereto]
Exhibit 10.47
[Second Amendment to Amended, Restated, Consolidated Bridge Loan
Agreement dated March 8, 1999 between the Company and the
lenders listed on the signature pages thereto]
Exhibit 10.48
[Form of 10% Convertible Secured Note due May 30, 1999]
Exhibit 10.49
[Form of Common Stock Purchase Warrant issued pursuant to the Amended,
Restated and Consolidated Bridge Loan Agreement]
Exhibit 10.50
[Amended and Restated General Security Agreement dated December 2, 1998
between the Company and Galen Partners III, L.P., as Agent]
Exhibit 10.51
[Subordination Agreement dated December 2, 1998 between the Registrant
and Galen Partners III, L.P., as Agent]
53
Exhibit 10.52
[Agency Letter Agreement dated December 2, 1998 by and among the lenders a party
to the Amended, Restated and Consolidated Bridge Loan Agreement, as amended]
Exhibit 10.53
[Lease Agreement dated March 17, 1998 between the
Registrant and Par Pharmaceuticals Inc.]
Exhibit 10.54
[Lease Agreement dated September 1, 1998 between the Registrant and Crinson
Ridge Partners]
Exhibit 10.55
[Manufacturing and Supply Agreement dated March 17, 1999 between
the Company and Par Pharmaceuticals Inc.]
Exhibit 10.56
[Halsey Drug Co., Inc. 1998 Stock Option Plan]
Exhibit 23.1
[Consent of Grant Thornton LLP, independent certified public accountants]
Exhibit 27
[Financial Data Schedule, which is submitted electronically to the Securities
and Exchange Commission for informational purposes only and not filed]