UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________
FORM 10-Q
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 3, 1999
Commission File Number 1-10827
PHARMACEUTICAL RESOURCES, INC.
(Exact name of registrant as specified in its charter)
NEW JERSEY 22-3122182
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
One Ram Ridge Road, Spring Valley, New York 10977
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (914) 425-7100
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 twelve 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
------ ------
29,408,378
Number of shares of Common Stock outstanding as of May 13, 1999.
This is page 1 of 92 pages. The exhibit index is on page 16.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PHARMACEUTICAL RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
(Unaudited)
April 3, December 31,
ASSETS 1999 1998
------ -------- ------------
Current assets:
Cash and cash equivalents $ 2,684 $ 6,424
Accounts receivable, net of allowances of
$2,906 and $2,226 16,544 14,513
Inventories 15,151 15,611
Prepaid expenses and other current assets 2,172 2,597
------- -------
Total current assets 36,551 39,145
Property, plant and equipment, at cost less
accumulated depreciation and amortization 22,526 22,789
Deferred charges and other assets 1,535 1,405
Non-current deferred tax benefit, net 14,608 14,608
------- -------
Total assets $75,220 $77,947
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current portion of long-term debt $ 200 $ 225
Accounts payable 8,310 10,411
Accrued salaries and employee benefits 1,848 1,705
Accrued expenses and other current
liabilities 1,911 2,596
-------- --------
Total current liabilities 12,269 14,937
Long-term debt, less current portion 1,062 1,102
Accrued pension liability 717 717
Shareholders' equity:
Common Stock, par value $.01 per share;
authorized 90,000,000 shares;
issued and outstanding 29,389,366 and
29,322,659 shares 294 293
Additional paid in capital 88,344 88,036
Accumulated deficit (27,248) (26,920)
Additional minimum liability related to
defined benefit pension plan (218) (218)
Total shareholders' equity 61,172 61,191
-------- --------
Total liabilities and shareholders'
equity $ 75,220 $ 77,947
======== ========
The accompanying notes are an integral part of these statements.
--2--
PHARMACEUTICAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
(In Thousands, Except Per Share Amounts)
(Unaudited)
Three Months Ended
---------------------
April 3, March 28,
1999 1998
--------- ---------
Net sales $ 20,164 $ 13,574
Cost of goods sold 16,248 12,945
-------- --------
Gross margin 3,916 629
Operating expenses:
Research and development 1,186 861
Selling, general and administrative 3,222 2,724
-------- --------
Total operating expenses 4,408 3,585
-------- --------
Operating loss (492) (2,956)
Other income 117 11
Interest income (expense) 47 (198)
-------- --------
Net loss (328) (3,143)
Accumulated deficit, beginning of period (26,920) (12,522)
Accumulated deficit, end of period $(27,248) $(15,665)
--------- ---------
--------- ---------
Basic and diluted net loss per share of common stock $(.01) $(.17)
Weighted average number of common and
common equivalent shares outstanding 29,354 18,883
======== ========
The accompanying notes are an integral part of these statements.
--3--
PHARMACEUTICAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
Three Months Ended
---------------------
April 3, March 28,
1999 1998
--------- ----------
Cash flows from operating activities:
Net loss $ (328) $(3,143)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 683 782
Allowances against accounts receivable 680 (182)
Write-off of inventories 235 202
Other 66 (1)
Changes in assets and liabilities:
Increase in accounts receivable (2,711) (1,673)
Decrease in inventories 225 35
Decrease (increase) in prepaid expenses and other assets 295 (806)
Decrease in accounts payable (2,101) (602)
(Decrease) increase in accrued expenses and other liabilities (542) 513
------- -------
Net cash used in operating activities (3,498) (4,875)
Cash flows from investing activities:
Capital expenditures (452) (264)
Proceeds from sale of fixed assets 30 -
------- -------
Net cash used in investing activities (422) (264)
Cash flows from financing activities:
Proceeds from issuances of Common Stock 245 9
Net proceeds from revolving credit line - 5,203
Principal payments under long-term debt and other borrowings (65) (58)
---- ------
Net cash provided by financing activities 180 5,154
Net (decrease) increase in cash and cash equivalents (3,740) 15
Cash and cash equivalents at beginning of period 6,424 52
------- -------
Cash and cash equivalents at end of period $ 2,684 $ 67
======= =======
The accompanying notes are an integral part of these statements.
--4--
PHARMACEUTICAL RESOUCES, INC.
NOTES TO FINANCIAL STATEMENTS
April 3, 1999
(Unaudited)
Pharmaceutical Resources, Inc. (the "Company" or "PRI") operates in one
business segment, the manufacture and distribution of generic pharmaceuticals in
the United States. Marketed products are principally in solid oral dosage form
(tablet, caplet and two-piece hard-shell capsule). The Company also distributes
products in the semi-solid form of a cream, reconstituted suspensions/solutions
and transdermal delivery systems.
Basis of Preparation:
The accompanying financial statements at April 3, 1999 and December 31, 1998
and for the three-month periods ended April 3, 1999 and March 28, 1998 are
unaudited; however, in the opinion of management of PRI, such statements include
all adjustments (consisting of normal recurring accruals) necessary to a fair
statement of the information presented therein.
Pursuant to accounting requirements of the Securities and Exchange Commission
applicable to quarterly reports on Form 10-Q, the accompanying financial
statements and these notes do not include all disclosures required by generally
accepted accounting principles for audited financial statements. Accordingly,
these statements should be read in conjunction with PRI's most recent annual
financial statements.
Results of operations for interim periods are not necessarily indicative of
those to be achieved for full fiscal years. Certain items on the consolidated
financial statements for the prior years have been reclassified to conform to
the current year financial statement presentation.
In December 1998, the Company changed its annual reporting period to a fiscal
year ending December 31 from a fiscal year ending September 30. Accordingly,
the current fiscal year began on January 1, 1999 and will end on December 31,
1999, and subsequent fiscal quarters will end on July 3, 1999, October 2, 1999
and December 31, 1999.
Strategic Alliance:
On June 30, 1998, the Company completed a strategic alliance with Merck KGaA,
a pharmaceutical, laboratory and chemical company located in Darmstadt, Germany
("Merck KGaA"). Pursuant to a Stock Purchase Agreement, dated March 25, 1998,
Merck KGaA, through its subsidiary Lipha Americas, Inc. ("Lipha"), purchased
10,400,000 newly issued shares of the Company's Common Stock for $20,800,000.
In addition, the Company issued to Merck KGaA and Genpharm, Inc. ("Genpharm"), a
Canadian subsidiary of Merck KGaA, five-year options to purchase an aggregate of
1,171,040 shares of the Company's Common Stock at an exercise price of $2.00 per
share in exchange for consulting services. The options expire in April 2003 and
become exercisable commencing in July 2001. As part of the alliance, the
Company received the exclusive United States distribution rights to the
portfolio of products covered by a distribution agreement with Genpharm (see "--
Distribution Agreements-Genpharm, Inc."). Merck KGaA also purchased 1,813,272
shares of the Company's Common Stock from Clal Pharmaceutical Industries Ltd.
("Clal"), PRI's largest shareholder prior to the transaction. Clal has the
right to cause Merck KGaA and/or the Company to purchase an additional 500,000
shares of Common Stock from Clal at a price of $2.50 per share in July 2001.
Development Agreement:
The Company, Israel Pharmaceutical Resources L.P. ("IPR") and Generics (UK)
Ltd. ("Generics"), a subsidiary of Merck KGaA, have a development agreement (the
"Development Agreement"), dated as of August 11, 1998, pursuant to which
Generics agreed to fund one-half the costs of the operating budget of IPR, the
Company's research and development operation in Israel, in exchange for the
exclusive distribution rights outside of the United States to products developed
by IPR after the date of the Development Agreement. The Development Agreement
has an initial term of five years and automatically renews for additional
periods of one year or earlier termination upon six months notice in certain
circumstances. Pursuant to the Development Agreement, Generics paid the Company
an initial fee of $600,000 in August 1998 and had fulfilled their funding
requirements through April 3, 1999. Under the Development Agreement, Generics
is not required to fund more than $1,000,000 in any one calendar year.
--5--
PHARMACEUTICAL RESOUCES, INC.
NOTES TO FINANCIAL STATEMENTS
April 3, 1999
(Unaudited)
Profit Sharing Agreement:
In January 1999, the Company entered into a profit sharing agreement with
Genpharm (the "Genpharm Profit Sharing Agreement") pursuant to which PRI will
receive a portion of the profits and will bear a portion of the expenses
resulting from a separate agreement between Genpharm and an unaffiliated United
States based pharmaceutical company in exchange for a non-refundable fee of
$2,500,000. The date PRI will pay Genpharm the fee is subject to negotiation.
The agreement between Genpharm and the unaffiliated third party covers fifteen
products which are not included as part of the Genpharm Distribution Agreement
(see "--Distribution Agreements-Genpharm, Inc.").
Lease Agreement:
On March 17, 1999, Par Pharmaceutical, Inc. ("Par"), the Company's operating
subsidiary, entered into an agreement to lease (the "Lease Agreement") its
manufacturing facility and related machinery and equipment located in Congers,
New York (the "Congers Facility") to Halsey Drug Co., Inc. ("Halsey"), a
manufacturer of generic pharmaceutical products. The Lease Agreement has an
initial term of three years, subject to an additional two year renewal period
and contains a purchase option enabling Halsey to purchase the Congers Facility
and substantially all the equipment at any time during the lease terms for a
specified amount. The Lease agreement provides for annual fixed rent during the
initial term of $500,000 per year and $600,000 per year during the renewal
period. Pursuant to the Lease Agreement, Halsey paid the purchase option of
$100,000 in March 1999. Under the Halsey Supply Agreement (as hereinafter
defined), Halsey will perform certain manufacturing operations for the Company
at the Congers Facility. Pursuant to the Lease Agreement, Par agreed that if its
purchases under the Halsey Supply Agreement are less than $1,150,000, the amount
of the deficiency will be credited against rent payments due under the Lease
Agreement (see "--Distribution Agreements-Halsey Drug Co., Inc.").
Distribution Agreements:
Halsey Drug Co., Inc.
On March 17, 1999, Par entered into a Manufacturing and Supply Agreement with
Halsey (the "Halsey Supply Agreement"). The Halsey Supply Agreement requires
Halsey to contract manufacture exclusively for Par certain products previously
manufactured by Par at the Congers Facility prior to the agreement. The Halsey
Supply Agreement has an initial term of three years subject to earlier
termination upon the occurrence of certain events as provided therein. Pursuant
to the Lease Agreement, Par agreed to purchase not less than $1,150,000 worth of
the products during the initial eighteen months of the Halsey Supply Agreement.
Halsey cannot manufacture, supply, develop or distribute the products for anyone
other than Par for a period of three years.
Genpharm, Inc.
The Company has a distribution agreement with Genpharm (the "Genpharm
Distribution Agreement") pursuant to which Genpharm granted exclusive
distribution rights to the Company within the United States and certain other
United States territories with respect to approximately 40 generic
pharmaceutical products currently being developed or identified for development,
some of which have obtained U.S. Food and Drug Administration ("FDA") approval
and others of which have been or will be submitted to the FDA for approval.
Products may be added to or removed from the Genpharm Distribution Agreement by
mutual agreement of the parties. Genpharm is required to use commercially
reasonable efforts to develop the products, which are subject to the Genpharm
Distribution Agreement, and is responsible for the completion of product
development and for obtaining all applicable regulatory approvals. The Company
will pay Genpharm a percentage of the gross profits attributable to the sales of
such products by the Company.
--6--
PHARMACEUTICAL RESOUCES, INC.
NOTES TO FINANCIAL STATEMENTS
April 3, 1999
(Unaudited)
BASF Corporation
In April 1997, Par entered into a Manufacturing and Supply Agreement (the
"BASF Supply Agreement") with BASF Corporation ("BASF"), a manufacturer of
pharmaceutical products. Under the BASF Supply Agreement, Par agreed to
purchase certain minimum quantities of certain products manufactured by BASF at
one of its facilities, and phase out Par's manufacturing of those products.
BASF agreed to discontinue its direct sale of those products. The agreement has
an initial term of three years (subject to earlier termination upon the
occurrence of certain events as provided therein) and thereafter renews
automatically for successive two-year periods to December 31, 2005, if Par has
met certain purchase thresholds. In each of the first three years of the
initial term of the BASF Supply Agreement, Par agreed to purchase at least
$24,500,000 worth of three products. Further, if Par does not purchase at least
$29,000,000 worth of one of those products in the third and final year of the
agreement, BASF has the right to terminate the agreement with a notice period of
one year.
Elan Corporation
On September 29, 1998, the Company and Elan Transdermal Technologies, Inc.,
formerly known as Sano Corporation, and Elan Corporation, plc (collectively
"Elan") entered into a termination agreement (the "Termination Agreement") with
respect to their prior distribution agreement. Pursuant to the Termination
Agreement Par has the exclusive right to distribute in the United States a
transdermal nicotine patch manufactured by Elan until May 31, 1999. Par must pay
Elan a certain percentage of gross profits from the sale of the nicotine patch
through the termination date. In exchange for relinquishing long-term
distribution rights for the nicotine patch and a nitroglycerin patch, PRI
received a cash payment of $2,000,000 in October 1998 and will receive an
additional payment of $2,000,000, upon the termination of the Company's
distribution rights, less any gross profit generated by sales of the product
subject to a minimum payment of $1,000,000. Pursuant to the Termination
Agreement, Elan agreed to pay Par a perpetual royalty for all non-prescription
sales of the transdermal nicotine patch by Elan in the United States and Israel.
The Company began selling Elan's nicotine patch in January 1998.
Short-Term Debt:
In December 1996, Par entered into a Loan and Security Agreement (the "Loan
Agreement") with General Electric Capital Corporation ("GECC") which provided
Par with a three-year revolving line of credit. Pursuant to the Loan Agreement,
as amended, Par is permitted to borrow up to the lesser of (i) the borrowing
base established under the Loan Agreement or (ii) $20,000,000. The borrowing
base is limited to 85% of eligible accounts receivable plus 50% of eligible
inventory of Par, each as determined from time to time by GECC. The interest
rate charge on the line of credit is based upon a per annum rate of 2 1/4% above
the 30-day commercial paper rate for high-grade unsecured notes adjusted
monthly. The line of credit with GECC is secured by the assets of Par and PRI
other than real property and is guaranteed by PRI. In connection with such
facility, GECC can require the Company and its affiliates to establish a cash
management system pursuant to which all cash and cash equivalents received by
any of such entities are deposited into a lockbox account over which GECC has
sole operating control. On June 30, 1998, the Company paid all remaining
outstanding revolving credit advances pursuant to the Loan Agreement with GECC
with a portion of the proceeds from an equity investment and GECC relinquished
operating control over the Company's cash receipts. As of April 1999, the
borrowing base was approximately $12,600,000 and no amounts were outstanding
under the line of credit. The revolving credit facility is subject to covenants
based on various financial benchmarks.
Income Taxes:
Based on the Company's recent performance and uncertainty of the generic
business in which it operates, management believes that future operating income
might not be sufficient to recognize fully the net operating loss carryforwards
of the Company. Therefore, the Company did not recognize a benefit for its
operating losses in either of the three-month periods ended April 3, 1999 or
March 28, 1998. If the Company is unable to generate sufficient taxable income
in the future, the Company expects that increases in the valuation allowance
will be required through a charge to expense.
--7--
PHARMACEUTICAL RESOUCES, INC.
NOTES TO FINANCIAL STATEMENTS
April 3, 1999
(Unaudited)
Earnings Per Share:
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"),
which is effective for financial statements for periods ending after December
15, 1997, and requires replacement of primary and fully diluted earnings per
share with basic and diluted earnings per share including retroactive
restatement of all prior earnings per share data. Under SFAS 128, the dilutive
effect of stock options is excluded from the calculation of basic earnings per
share but included in diluted earnings per share. The Company adopted the
accounting standard during the quarter ended December 27, 1997 and, accordingly,
has presented all earnings per share data to conform to the requirements of SFAS
128.
Outstanding options and warrants of 333,700 as of April 3, 1999 and 812,200
as of March 28, 1998 were not included in the computation of diluted earnings
per share because the exercise prices were greater than the average market price
of the Common Stock in the respective periods. In addition, incremental shares
from assumed conversions of 1,072,326 as of April 3, 1999 and 219,145 as of
March 28, 1998 were excluded from diluted earnings per share because they were
non-dilutive.
Comprehensive Income:
During the period ended December 31, 1998, the Company adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"), which establishes standards for the reporting and display of
comprehensive income and its components. For the three-month period ended April
3, 1999, there was no impact on the financial statements as a result of the
adoption of SFAS 130.
Commitments, Contingencies and Other Matters:
Retirement Plans:
The Company has a defined contribution, social security integrated Retirement
Plan (the "Retirement Plan") providing retirement benefits to eligible employees
as defined in the Retirement Plan. The Company suspended employer contributions
to the Retirement Plan effective December 30, 1996. Consequently, participants
in the Retirement Plan will no longer be entitled to any employer contributions
under such plan for 1996 or subsequent years. The Company also maintains a
Retirement Savings Plan (the "Retirement Savings Plan") whereby eligible
employees are permitted to contribute from 1% to 12% of pay to the Retirement
Savings Plan. The Company contributes an amount equal to 50% of the first 6% of
the pay contributed by the employee. In fiscal year 1998, the Company merged
the Retirement Plan into the Retirement Savings Plan.
Legal Proceedings:
The Company is involved in certain litigation matters, including certain
product liability actions and actions by a former officer for, among other
things, breach of contract. Such actions seek damages from the Company,
including compensatory and punitive damages. The Company intends to defend
these actions vigorously. The Company believes that these actions are
incidental to the conduct of its business and that the ultimate resolution
thereof will not have a material adverse effect on its financial condition or
liquidity.
Asset Impairment/Restructuring:
In an attempt to reduce operating losses, the Company continued to implement
previously announced measures in 1999 to reduce costs and increase operating
efficiencies. The Company discontinued six unprofitable products from its
product line, eliminated approximately 40 positions with a layoff in January
1999, primarily in manufacturing and various manufacturing support functions,
and reduced certain related expenses. These measures resulted in a charge of
$1,906,000 in the three-month transition period ended December 31, 1998, which
included approximately $1,200,000 for write-downs related to the impairment of
assets affected by the termination of the six products and a provision of
$706,000 for severance payments and other employee termination benefits.
Additionally, the Company established inventory reserves of $630,000 relating to
the six discontinued products which was recorded in cost of goods sold during
the transition period. At April 3, 1999, the remaining provisions for the
severance payments and other employee
--8--
PHARMACEUTICAL RESOUCES, INC.
NOTES TO FINANCIAL STATEMENTS
April 3, 1999
(Unaudited)
termination benefits and discontinued product inventory amounted to $330,000 and
$412,000, respectively. The Company expects the remaining reserves are
sufficient and will be fully utilized.
The Company recorded a charge of $1,212,000 in the fiscal year ended
September 30, 1998 for asset impairment of its Congers Facility as a result of
outsourcing the manufacture of most of the products from such facility. The
charge was based on the difference between the appraised value of the property
less the net book value at September 30, 1998. In March 1999, the Company
entered into an agreement with Halsey to lease, with an option to purchase, the
Congers Facility and related machinery and equipment.
--9--
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Certain statements in this Form 10-Q constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995,
including those concerning management's expectations with respect to future
financial performance and future events, particularly relating to sales of
current products as well as the introduction of new manufactured and distributed
products. Such statements involve known and unknown risks, uncertainties and
contingencies, many of which are beyond the control of the Company, which could
cause actual results and outcomes to differ materially from those expressed
herein. Factors that might affect such forward-looking statements set forth in
this Form 10-Q include, among others, (i) increased competition from new and
existing competitors and pricing practices from such competitors, (ii) pricing
pressures resulting from the continued consolidation by the Company's
distribution channels, (iii) the amount of funds continuing to be available for
internal research and development and research and development joint ventures,
(iv) research and development project delays or delays in obtaining regulatory
approvals, (v) continuation of distribution rights under significant agreements,
(vi) the effectiveness of restructuring measures to reduce losses and increase
efficiencies and (vii) the continued ability of distributed product suppliers to
meet future demand. The Company disclaims any obligations or intent to update or
review any forward-looking statements or information whatsoever.
RESULTS OF OPERATIONS
General
The Company reduced its operating loss to $492,000 for the three-month period
ended April 3, 1999 from $2,956,000 for the three-month period ended March 28,
1998. Net sales growth of 49%, primarily from price and volume increases on
certain existing products and additional sales of new distributed products,
produced significantly higher gross margins. The improved results were achieved
despite increased spending on product development and sales and marketing, as
described below. The Company recently implemented measures, including a work
force reduction following a decision to discontinue six unprofitable
manufactured products and the leasing of an under-utilized facility, in an
attempt to lower costs, increase operating efficiencies and reduce operating
losses (see "Notes to Financial Statements-Commitments, Contingencies and Other
Matters-Asset Impairment/Restructuring"). The Company plans to continue to
search for additional measures to improve results in addition to continue
seeking new products through joint ventures, distribution and other agreements
with pharmaceutical companies located throughout the world. If current sales or
gross margin levels are not increased by sales of substantially profitable new
distributed or manufactured products or continued price and volume increases on
existing products, the Company will continue to experience losses.
In an effort to improve the Company's growth prospects through the
introduction of new products at profitable pricing and strengthen its financial
condition, PRI entered into a strategic alliance with Merck KGaA, which was
completed on June 30, 1998. As part of the alliance, the Company received the
sole rights to the portfolio of products covered by the Genpharm Distribution
Agreement, granting the Company exclusive United States distribution rights for
up to approximately 40 generic pharmaceutical products currently being developed
or identified for development, some of which have obtained FDA approval and
others of which have been or are expected to be submitted to the FDA for
approval. Genpharm pays the research and development costs associated with the
products and PRI will pay Genpharm a certain percentage of the gross margin on
sales of the products (see "Notes to Financial Statements-Strategic Alliance"
and "-Distribution Agreements-Genpharm, Inc."). The alliance provides the
Company with a significant number of potential products for its product
development pipeline without the substantial resource commitment, including
financial, it would normally take to develop such a pipeline, working capital
for possible business expansion, improved financial condition through
elimination of certain significant outstanding debt and access to Merck KGaA's
expertise and experience in the industry. To date, five products introduced
under the Genpharm Distribution Agreement have had only a minimal positive
effect on the Company's operating results.
The generic drug industry in the United States continues to be highly
competitive. The factors contributing to the intense competition and affecting
both the introduction of new products and the pricing and profit margins of the
Company, include, among other things; (i) introduction of other generic drug
manufacturer's products in direct competition with the Company's significant
products, (ii) consolidation among distribution outlets, (iii) increased ability
of generic competitors to enter the market after patent expiration, diminishing
the amount and duration of significant profits, (iv) willingness of generic drug
customers, including wholesale and retail customers, to switch among
pharmaceutical manufacturers (v) competition from brand name drug manufacturers
selling generic versions of their
--10--
drugs, and (vi) price increases and product deletions by competitors.
Critical to any significant improvement in the Company's financial condition
is the introduction and acquisition of new manufactured and distributed products
at selling prices that generate significant gross margin. In addition to new
product introductions expected as part of the strategic alliance with Merck
KGaA, the Company plans to continue to invest in research and development
efforts and pursue additional products for sale through new and existing
distribution agreements. The Company is engaged in efforts, subject to FDA
approval and other factors, to introduce new products as a result of its
research and development efforts and distribution and development agreements.
No assurance can be given that any additional products for sale by the Company
will occur or that sales of additional products will reduce losses or return the
Company to profitability. Continuing losses will adversely affect the Company's
liquidity and, accordingly, its ability to fund research and development or
ventures relating to the sale of new products and market existing products (see
"--Financial Condition-Liquidity and Capital Resources").
Net Sales
Net sales increased $6,590,000, or 49% to $20,164,000 for the three months
ended April 3, 1999 from sales of $13,574,000 for the three-month period ended
March 28, 1998. The significant sales growth was primarily attributable to
price or volume increases on several existing products and sales of new
products. Net sales of distributed product, which consist of contract
manufactured and licensed product, increased to approximately 67% of the
Company's total net sales for the most recent three-month period compared to
approximately 31% of the total for the same period of the prior year continuing
the trend of greater reliance upon sales of distributed product. The increased
percentage of distributed product is primarily due to increased sales of
products manufactured under the BASF Supply Agreement. The Company is
substantially dependent upon distributed products for its sales and, as the
Company introduces new distributed products under its distribution agreements,
it is expected that this trend will continue. Any inability by suppliers to
meet expected demand could adversely affect future sales. Pursuant to the
Termination Agreement with Elan, the Company will no longer distribute Elan's
transdermal nicotine patch after May 31, 1999. As a result of the continued
evaluation of the existing product line, the Company discontinued six
unprofitable products during 1999 and will sell off all remaining inventory for
those products. It is expected that the termination of the transdermal nicotine
patch distribution rights and, to a lesser extent, the discontinued manufactured
products will adversely affect the Company's annual net sales. Although there
can be no assurance, it is anticipated that new product introductions and the
effect of recent price and volume increases on certain products can offset these
expected net sales decreases.
Levels of sales are principally dependent upon, among other things, (i)
pricing levels and competition, (ii) market penetration for the existing product
line, (iii) the continuation of existing distribution agreements, (iv)
introduction of new distributed products, (v) approval of abbreviated new drug
applications ("ANDAs") and introduction of new manufactured products, and (vi)
the level of customer service.
Gross Margin
The Company's gross margin of $3,916,000 (19% of net sales) for the three
months ended April 3, 1999 improved significantly from $629,000 (5% of net
sales) in the corresponding period of the prior fiscal year primarily due to
increased pricing or volumes on certain products. Unfavorable manufacturing
variances due to excess capacity caused by outsourcing or discontinuing
manufactured products in prior periods adversely affected the gross margin in
the current period. The Company has attempted to address its excess capacity by
leasing its under-utilized Congers facility in March 1999, layoffs of
manufacturing personnel in January 1999 and the write-down of certain assets
which will be under-utilized as a result of discontinuing certain products (see
"Notes to Financial Statements-Asset Impairment/Restructuring").
Inventory write-offs amounted to $235,000 and $202,000 for the three-month
periods ended April 3, 1999 and March 28, 1998, respectively. The inventory
write-offs, taken in the normal course of business, are related primarily to
work in process inventory not meeting the Company's quality control standards
and the disposal of finished products due to short shelf life.
The termination of the transdermal nicotine patch distribution rights,
discussed above, will negatively affect the Company's gross margin. Although
there can be no assurance, it is anticipated that the gross margins generated by
sales of new products and the effect of recent price and volume increases on
certain products can offset this expected decrease.
Operating Expenses
Research and Development
--11--
Research and development expenses of $1,186,000 for the three-month period
ended April 3, 1999 increased $325,000 from the three-month period ended March
28, 1998. The Company conducts a significant part of its research and
development in Israel through IPR. Following the acquisition of the remaining
interests of IPR in 1997, the Company's domestic research and development
program was integrated with that of IPR. The increased costs in the most recent
period were primarily due to payments for development work and patent research
performed for PRI by unaffiliated companies. Research and development expenses
at IPR of $484,000 for the current period were partially offset by $313,000 in
funding, which included a prior period adjustment, from Generics compared to
expenses of $287,000 in the prior year. Generics, a subsidiary of Merck KGaA,
the Company and IPR have an agreement pursuant to which Generics will share one-
half of the costs of IPR's operating budget in exchange for the exclusive
distribution rights outside of the United States to the products developed by
IPR after the date of the agreement (see "Notes to Financial Statements-
Development Agreement").
The Company has ANDAs for three potential products pending with the FDA and
awaiting approval. The Company expects to commence biostudies for seven
additional product submissions in 1999. In 1999, PRI has received FDA approval
of its ANDAs for two products which the Company began marketing in March 1999.
As part of the Genpharm Distribution Agreement, Genpharm pays the research
and development costs associated with the products covered by the Genpharm
Distribution Agreement. To date, the Company has introduced five products under
the Genpharm Distribution Agreement and anticipates introducing several more in
1999 (see "Notes to Financial Statements-Distribution Agreements-Genpharm,
Inc.").
Selling, General and Administrative
Selling, general and administrative costs for the three-month period ended
April 3, 1999 of $3,222,000 (16% of net sales) increased $498,000 from
$2,724,000 (20% of net sales) for the corresponding period in the prior fiscal
year. The higher costs in the current period were primarily attributable to
strengthening the sales force and expanding marketing efforts in anticipation of
product introductions and further market penetration of the existing product
line, and to a lesser extent, higher professional fees and shipping costs.
Other Income
Other income for the three-month period of $117,000 included a purchase
option payment from Halsey related to leasing the Company's manufacturing
facility in Congers, New York (see "Notes to Financial Statements-Leasing
Agreement").
Income Taxes
Management has determined, based on the Company's recent performance and
uncertainty of the generic business in which the Company operates, that future
operating income might not be sufficient to recognize fully the net operating
loss carryforwards of the Company. Therefore, the Company did not recognize a
benefit for its operating losses in either of the three-month periods ended
April 3, 1999 or March 28, 1998 (see "Notes to Financial Statements-Income
Taxes").
FINANCIAL CONDITION
Liquidity and Capital Resources
Working capital was $24,282,000 at April 3, 1999 compared to $24,208,000 at
December 31, 1998. The working capital ratio of 2.98x in the most recent period
improved from 2.62x at December 31, 1998.
On March 17, 1999, the Company entered into an agreement to lease its
manufacturing facility in Congers, New York to Halsey. Halsey paid the Company
a purchase option of $100,000 and is obligated to pay rent of $500,000 annually
during the initial term of the lease. In future periods, the rent is expected
to cover the Company's fixed costs of the facility. Under the purchase option,
Halsey may purchase the facility and substantially all the machinery and
equipment at any time during the lease for a specified amount (see "Notes to
Financial Statements-Leasing Agreement").
In January 1999, the Company entered into the Genpharm Profit Sharing
Agreement pursuant to which PRI will receive a portion of the profits and will
bear a portion of the expenses resulting from a separate agreement between
Genpharm and an unaffiliated United States based pharmaceutical company in
exchange for a non-refundable fee of $2,500,000. The date PRI will pay Genpharm
the fee is subject to negotiation (see "Notes to Financial Statements-Profit
Sharing Agreement").
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The Company, IPR and Generics have entered into an agreement, dated August
11, 1998, pursuant to which Generics will fund one-half of the costs of IPR's
operating budget in exchange for the exclusive distribution rights outside of
the United States to the products developed by IPR after the date of the
agreement. The funding commenced in the three-month period ended December 31,
1998. Generics is not required to fund more than $1,000,000 in any one calendar
year (see "Notes to Financial Statements-Development Agreement").
On September 29, 1998, the Company and Elan entered into the Termination
Agreement in which the Company would retain the exclusive distribution rights in
the United States to a transdermal nicotine patch until May 31, 1999. Pursuant
to the Termination Agreement, PRI received a cash payment of $2,000,000 in
October 1998 and will receive an additional $2,000,000 upon the termination of
the Company's distribution rights, less any gross profit generated by sales of
the product subject to a minimum payment of $1,000,000. In future periods, the
Company will not receive any additional funds from the sale of product rights to
Elan (see "Notes to Financial Statements-Distribution Agreements-Elan
Corporation").
The Company expects to fund its operations, including research and
development activities and its obligations under the existing distribution and
development arrangements discussed herein, out of its working capital and if
necessary with borrowings against its line of credit, to the extent then
available (see "Financing"). If, however, the Company continues to experience
significant losses over the next year, its liquidity and, accordingly, its
ability to fund research and development or ventures relating to the
distribution of new products would likely be materially and adversely affected.
Financing
At April 3, 1999, the Company's total outstanding long-term debt, including
the current portion, amounted to $1,262,000. The amount consists primarily of
an outstanding mortgage loan with a bank and capital leases for computer
equipment.
In December 1996, Par entered into the Loan Agreement with GECC which
provided Par with a three-year revolving line of credit. Pursuant to the Loan
Agreement, as amended, Par is permitted to borrow up to the lesser of (i) the
borrowing base established under the Loan Agreement or (ii) $20,000,000. The
borrowing base is limited to 85% of eligible accounts receivable plus 50% of
eligible inventory of Par, each as determined from time to time by GECC. The
interest rate charge on the line of credit is based upon a per annum rate of 2
1/4% above the 30-day commercial paper rate for high-grade unsecured notes
adjusted monthly. The line of credit with GECC is secured by the assets of Par
and PRI other than real property and is guaranteed by PRI. In connection with
such facility, GECC can require the Company and its affiliates to establish a
cash management system pursuant to which all cash and cash equivalents received
by any of such entities are deposited into a lockbox account over which GECC has
sole operating control. On June 30, 1998, the Company paid all remaining
outstanding revolving credit advances pursuant to the Loan Agreement with a
portion of the proceeds from the equity investment by Merck KGaA. As of April
1999, the borrowing base was approximately $12,600,000 and no amounts were
outstanding under the line of credit. The revolving credit facility is subject
to covenants based on various financial benchmarks.
Year 2000
The Company has completed an assessment of its internal systems related to
Year 2000 compliance and is in the process of evaluating the status of its
customers, suppliers and banks. The Company has implemented a plan it believes
will enable its computerized information systems to be Year 2000 compliant
without any material disruption in business. The costs of addressing this issue
have been expended when incurred and have not, and the Company believes will not
in the future, have a materially adverse effect on its financial condition.
However, if third parties upon which the Company relies are unable to address
this issue in a timely manner, it could result in a material financial risk to
the Company. The Company anticipates devoting all resources necessary to
resolve any additional significant Year 2000 issues in a timely manner.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
PART II. OTHER INFORMATION
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Item 6. Exhibits and Reports on Form 8-K.
- ------ --------------------------------
(a) Exhibits:
10.1 - Agreement of Lease, dated as of March 17, 1999, between Par
Pharmaceutical, Inc. and Halsey Drug Co., Inc.
10.2 - Manufacturing and Supply Agreement, dated as of March 17, 1999,
between Par Pharmaceutical, Inc. and Halsey Drug Co., Inc.
10.3 - Letter Agreement, dated as of January 21, 1999, between the
Registrant and Genpharm, Inc. *
27 - Financial Data Schedule.
(b) Reports on Form 8-K:
None.
* Certain portions of Exhibit 10.3 have been omitted and have been filed with
the Securities and Exchange Commission pursuant to a request for
confidential treatment thereof.
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SIGNATURE
Pursuant to the requirements 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.
PHARMACEUTICAL RESOURCES, INC.
------------------------------
(Registrant)
May 18, 1999 /s/ Kenneth I. Sawyer
------------------------------
Kenneth I. Sawyer
President and Chief Executive Officer
(Principal Executive Officer)
May 18, 1999 /s/ Dennis J. O'Connor
----------------------------------------------
Dennis J. O'Connor
Vice President - Chief Financial Officer and
Secretary
(Principal Accounting and Financial Officer)
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EXHIBIT INDEX
-------------
Exhibit Number Description
-------------- ------------
10.1 Agreement of Lease, dated as of March 17, 1999, between Par
Pharmaceutical, Inc. and Halsey Drug Co., Inc.
10.2 Manufacturing and Supply Agreement, dated as of March 17, 1999,
between Par Pharmaceutical, Inc. and Halsey Drug Co., Inc.
10.3 Letter Agreement, dated as of January 21, 1999, between the
Registrant and Genpharm, Inc. *
27 Financial Data Schedule.
* Certain portions of Exhibit 10.3 have been omitted and have been filed
with the Securities and Exchange Commission pursuant to a request for
confidential treatment thereof.
--16--