f10q_081114.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
     
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
     FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2014
 
o
 
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: 001-32360
 
 AKORN, INC.
(Exact Name of Registrant as Specified in its Charter)
     
LOUISIANA
 
72-0717400
(State or Other Jurisdiction of
 
(I.R.S. Employer
Incorporation or Organization)
 
Identification No.)
     
1925 W. Field Court, Suite 300
   
Lake Forest, Illinois
 
60045
(Address of Principal Executive Offices)
 
(Zip Code)
 
(847) 279-6100
 (Registrant’s telephone number, including area code)
 
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 þ            No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes þ            No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer þ
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company  o
       
(Do not check if a smaller reporting company)
   
         
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o            No þ
 
At August 8, 2014, there were 104,133,724 shares of common stock, no par value, outstanding.
 
[1]

 
   
 
Page
 
 
 
   
 
 
 
[2]

 
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
 
 
 
AKORN, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Per Share Data)
(Unaudited)

   
June 30,
2014
   
December 31,
2013
 
ASSETS:
           
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 107,907     $ 34,178  
Trade accounts receivable, net
   
139,973
      64,998  
Inventories, net
    108,914       55,982  
Deferred taxes, current
    23,266       7,945  
Prepaid expenses and other current assets
    17,120       5,753  
TOTAL CURRENT ASSETS
   
397,180
      168,856  
PROPERTY, PLANT AND EQUIPMENT, NET
    135,695       82,108  
OTHER LONG-TERM ASSETS:
               
Goodwill
    196,016       29,831  
Product licensing rights, net
    429,621       115,900  
Other intangible assets, net
    34,803       14,605  
Deferred financing costs
    16,463       5,676  
Long-term investments
    10,965       10,006  
Deferred taxes, non-current
    2,451       1,643  
Other
    579       3,180  
TOTAL OTHER LONG-TERM ASSETS
    690,898       180,841  
TOTAL ASSETS
  $
1,223,773
    $ 431,805  
LIABILITIES AND SHAREHOLDERS’ EQUITY:
               
CURRENT LIABILITIES:
               
Trade accounts payable
  $ 37,794     $ 22,999  
Purchase consideration payable
    20,514       14,728  
Accrued compensation
    11,058       7,692  
Accrued royalties
    7,071       6,004  
Income taxes payable
    675       1,459  
Accrued expenses and other liabilities
   
22,165
      8,363  
Current maturities of long-term debt
   
4,500
     
 
TOTAL CURRENT LIABILITIES
   
103,777
      61,245  
LONG-TERM LIABILITIES:
               
Long-term debt
    706,420       108,750  
Deferred tax liability
    117,277      
 
Lease incentive obligation and other long-term liabilities
    1,830       1,630  
TOTAL LONG-TERM LIABILITIES
    825,527       110,380  
TOTAL LIABILITIES
   
929,304
      171,625  
SHAREHOLDERS’ EQUITY:
           
 
 
Common stock, no par value – 150,000,000 shares authorized; 104,088,199 and 96,569,186 shares issued and outstanding at June 30, 2014 and December 31, 2013, respectively
    271,584       239,235  
Warrants to acquire common stock
          17,946  
Retained earnings
    33,700       15,366  
Accumulated other comprehensive loss
    (10,815 )     (12,367 )
TOTAL SHAREHOLDERS’ EQUITY
    294,469       260,180  
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
  $
1,223,773
    $ 431,805  
 
See notes to condensed consolidated financial statements.
 
 
[3]

 
AKORN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands, Except Per Share Data)
 (Unaudited)
 
   
THREE MONTHS ENDED
JUNE 30,
   
SIX MONTHS ENDED
JUNE 30,
 
   
2014
   
2013
   
2014
   
2013
 
Revenues
  $ 150,749     $ 77,012     $ 241,371     $ 150,866  
Cost of sales (exclusive of amortization of intangibles included below)
    74,078       34,920       115,044       69,629  
GROSS PROFIT
    76,671       42,092       126,327       81,237  
Selling, general and administrative expenses
    21,976       13,113       38,562       25,448  
Acquisition-related costs
    20,773             21,227       519  
Research and development expenses
    9,052       5,051       13,471       11,020  
Amortization of intangibles
    8,607       1,677       13,364       3,410  
                                 
TOTAL OPERATING EXPENSES
    60,408       19,841       86,624       40,397  
                                 
OPERATING INCOME
    16,263       22,251       39,703       40,840  
Amortization of deferred financing costs
    (2,436 )     (207 )     (8,590 )     (411 )
Interest expense, net
    (7,917 )     (2,028 )     (10,078 )     (4,232 )
Gain from product divestiture
   
8,968
     
     
8,968
     
 
Other (expense) income, net
   
(566
)     (34 )    
1
      42  
                                 
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
    14,312       19,982       30,004       36,239  
Income tax provision
    5,303       7,345       11,167       12,760  
                                 
INCOME FROM CONTINUING OPERATIONS
  $ 9,009     $ 12,637     $ 18,837     $ 23,479  
(Loss) from discontinued operations, net of tax
    (503 )           (503 )      
NET INCOME
  $ 8,506     $ 12,637     $ 18,334     $ 23,479  
NET INCOME PER SHARE:
                               
Income from continuing operations, basic
  $ 0.09     $ 0.13     $ 0.19     $ 0.24  
(Loss) from discontinued operations, basic
  $ (0.01 )         $ (0.01 )      
NET INCOME, BASIC
  $ 0.08     $ 0.13     $ 0.18     $ 0.24  
                                 
Income from continuing operations, diluted
  $ 0.08     $ 0.11     $ 0.16     $ 0.21  
(Loss) from discontinued operations, diluted
  $ (0.01 )         $ (0.00 )      
NET INCOME, DILUTED
  $ 0.07     $ 0.11     $ 0.16     $ 0.21  
                                 
SHARES USED IN COMPUTING NET INCOME (LOSS) PER SHARE:
                               
BASIC
    103,183       96,122       99,926       96,025  
DILUTED
    118,092       112,328       117,576       112,010  
                                 
COMPREHENSIVE INCOME:
                               
Consolidated net income
  $
8,506
    $ 12,637     $ 18,334     $ 23,479  
Foreign currency translation (loss) income, net of tax
    (153 )     (4,979 )     1,552       (4,621 )
COMPREHENSIVE INCOME
  $ 8,353     $ 7,658     $ 19,886     $ 18,858  
 
See notes to condensed consolidated financial statements.

 
[4]

 
AKORN, INC.
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2014
 (In Thousands)
 (Unaudited)

   
Shares
   
Amount
   
Warrants
to acquire
Common
Stock
   
Retained
Earnings
   
Other
Comprehensive
(Loss) Income
   
Total
 
BALANCES AT DECEMBER 31, 2013
    96,569     $ 239,235     $ 17,946     $ 15,366     $ (12,367 )   $ 260,180  
Net income
                      18,334             18,334  
Exercise of stock options
    238       1,242                         1,242  
Employee stock purchase plan issuances
    73       829                         829  
Compensation and share issuances related to restricted stock awards
    16       153                         153  
Stock-based compensation expense
          3,175                        
3,175
 
Foreign currency translation adjustment
                            1,552       1,552  
Excess tax benefit – stock compensation
          833                         833  
Conversion of warrants
    7,192       26,117       (17,946 )                 8,171  
                                                 
BALANCES AT JUNE 30, 2014
   
104,088
      271,584             33,700       (10,815 )     294,469  
 
See notes to condensed consolidated financial statements.
 
 
[5]

 
 AKORN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)

   
SIX MONTHS ENDED
 JUNE 30,
 
   
2014
   
2013
 
OPERATING ACTIVITIES:
           
Consolidated net income
  $ 18,334     $ 23,479  
Loss from discontinued operations
    503        
Adjustments to reconcile consolidated net income to net cash provided by operating activities:
               
Depreciation and amortization
    18,865       6,651  
Amortization of debt financing costs
   
8,589
      411  
Amortization of favorable (unfavorable) contracts
    35       (318 )
Amortization of inventory step-up
    3,559        
Non-cash stock compensation expense
    3,331       4,244  
Non-cash interest expense
    2,655       2,263  
Gain from product divestiture
    (8,968 )      
Deferred income taxes, net
    (9,959 )     1,201  
Excess tax benefit from stock compensation
    (831 )     (745 )
Non-cash settlement of product warranty liability
          (1,299 )
Equity in earnings of unconsolidated joint venture
          (76 )
Changes in operating assets and liabilities:
               
Trade accounts receivable
   
(27,991
)     (6,908 )
Inventories
    (4,213 )     (4,428 )
Prepaid expenses and other current assets
   
4,329
      538  
Trade accounts payable
    4,965       (151 )
Accrued expenses and other liabilities
   
8,799
      (3,464 )
NET CASH PROVIDED BY OPERATING ACTIVITIES
   
22,002
      21,398  
INVESTING ACTIVITIES:
               
Payments for acquisitions and equity investments, net of cash acquired
    (579,315 )     (513 )
Proceeds from disposal of assets
    57,750        
Payments for other intangible assets
    (6,300 )      
Purchases of property, plant and equipment
    (11,929 )     (5,159 )
NET CASH USED IN INVESTING ACTIVITIES
    (539,794 )     (5,672 )
FINANCING ACTIVITIES:
               
Proceeds under stock option and stock purchase plans
    2,071       1,265  
Debt financing costs
   
(19,654
)      
Proceeds under Borrowings
    600,000        
Proceeds from warrant exercises
    8,171        
Excess tax benefit from stock compensation
    831       745  
NET CASH PROVIDED BY FINANCING ACTIVITIES
   
591,419
      2,010  
Effect of exchange rate changes on cash and cash equivalents
    102       (105 )
INCREASE IN CASH AND CASH EQUIVALENTS
    73,729       17,631  
Cash and cash equivalents at beginning of period
    34,178       40,871  
                 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 107,907     $ 58,412  
SUPPLEMENTAL DISCLOSURES:
               
Amount paid for interest
  $
2,105
    $ 2,152  
Amount paid for income taxes
  $
16,449
    $ 11,936  
 
See notes to condensed consolidated financial statements.
 
 
[6]

 
AKORN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
NOTE 1 — BUSINESS AND BASIS OF PRESENTATION
 
Business: Akorn, Inc. and its wholly-owned subsidiaries (collectively, the “Company”) through its Prescription Pharmaceuticals reportable segment manufactures and markets a full line of diagnostic, therapeutic and disease specific ophthalmic pharmaceuticals, antidotes, anti-allergics, anti-infectives, vaccines, and controlled substances for pain management and anesthesia as well as niche hospital drugs of various dosage forms and injectable pharmaceuticals.  In addition, through its Consumer Health reportable segment, the Company manufactures and markets a line of over-the-counter (“OTC”) ophthalmic products for the treatment of dry eye under the TheraTears® brand name, as well as a portfolio of private label OTC ophthalmic products and other consumer health products.  As of June 30, 2014, the Company operated pharmaceutical manufacturing plants in the U.S. at Decatur, Illinois, Somerset, New Jersey, and Amityville, New York, and internationally at Paonta Sahib, Himachal Pradesh, India, as well as a central distribution warehouse in Gurnee, Illinois, an R&D center in Vernon Hills, Illinois and corporate offices in Lake Forest, Illinois, Ann Arbor, Michigan, Amityville, New York, and Gurgaon, India.  Customers of the Company’s products include group purchasing organizations and their member hospitals, chain drug stores, wholesalers, distributors, physicians, optometrists, alternate site providers, and other pharmaceutical companies.
 
Basis of Presentation: The Company’s financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and accordingly do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments of a normal and recurring nature considered necessary for a fair presentation have been included in these financial statements. Operating results for the three and six month periods ended June 30, 2014 are not necessarily indicative of the results that may be expected for the full year. For further information, refer to the consolidated financial statements and footnotes for the year ended December 31, 2013, included in the Company’s Annual Report on Form
10-K filed March 14, 2014.
 
The Company has considered the accounting and disclosure of events occurring after the balance sheet date through the filing date of this Form 10-Q.
 
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Consolidation:  The accompanying condensed consolidated financial statements include the accounts of the Company.  All inter-company transactions and balances have been eliminated in consolidation.

Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.

Significant estimates and assumptions for the Company relate to the allowances for chargebacks, rebates, product returns, coupons, promotions and doubtful accounts, as well as the reserve for slow-moving and obsolete inventories, the carrying value and lives of intangible assets, the useful lives of fixed assets, the carrying value of deferred income tax assets and liabilities, the assumptions underlying share-based compensation, accrued but unreported employee benefit costs and assumptions underlying accounting for business combinations.
 
Revenue Recognition:  Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the sales price is fixed or determinable, and collectability is reasonably assured. Revenue from product sales is recognized when title and risk of loss have passed to the customer.
 
Provision for estimated chargebacks, rebates, discounts, managed care rebates, product returns and doubtful accounts is made at the time of sale and is analyzed and adjusted, if necessary, at each balance sheet date.

 
[7]

 
Chargebacks and Rebates: The Company enters into contractual agreements with certain third parties such as hospitals, group-purchasing and managed care organizations to sell certain products at predetermined prices. The parties have elected to have these contracts administered through wholesalers that buy the product from the Company and subsequently sell it to these third parties. When a wholesaler sells products to one of these third parties that are subject to a contractual price agreement, the difference between the price paid to the Company by the wholesaler and the price under the specific contract is charged back to the Company by the wholesaler. The Company tracks sales and submitted chargebacks by product number and contract for each wholesaler. Utilizing this information, the Company estimates a chargeback percentage for each product and records an allowance as a reduction to gross sales when the Company records its sale of the products. The Company reduces the chargeback allowance when a chargeback request from a wholesaler is processed.  Actual chargebacks processed by the Company can vary materially from period to period based upon actual sales volume through the wholesalers. However, the Company’s provision for chargebacks is fully reserved for at the time when sales revenues are recognized.

Management obtains certain wholesaler inventory reports to aid in analyzing the reasonableness of the chargeback allowance. The Company assesses the reasonableness of its chargeback allowance by applying the product chargeback percentage based on historical activity to the quantities of inventory on hand at the wholesaler per the wholesaler inventory reports.  In accordance with its accounting policy, the Company estimates the percentage amount of wholesaler inventory that will ultimately be sold to third parties that are subject to contractual price agreements based on a six-quarter trend of such sales through wholesalers. The Company uses this percentage estimate until historical trends indicate that a revision should be made. On an ongoing basis, the Company evaluates its actual chargeback rate experience, and new trends are factored into its estimates each quarter as market conditions change.  

In calculating its chargeback expense, the Company estimated that 94.5% and 90.0% of its sales to wholesalers and distributors in the six month periods ended June 30, 2014 and June 30, 2013 respectively, would be subject to chargebacks.
 
Sales Returns: Certain of the Company’s products are sold with the customer having the right to return the product within specified periods and guidelines for a variety of reasons, including but not limited to, pending expiration dates. Provisions are made at the time of sale based upon tracked historical experience, by customer in some cases.  Historical factors such as one-time events as well as pending new developments that would impact the expected level of returns are taken into account to determine the appropriate reserve estimate at each balance sheet date. As part of the evaluation of the balance required, the Company considers actual returns to date that are in process, the expected impact of any product recalls and the wholesaler’s inventory information to assess the magnitude of unconsumed product that may result in sales returns to the Company in the future. The sales returns level can be impacted by factors such as overall market demand and market competition and availability for substitute products which can increase or decrease the end-user pull through for sales of the Company’s products and ultimately impact the level of sales returns. Actual returns experience and trends are factored into the Company’s estimates each quarter as market conditions change. Actual returns processed can vary materially from period to period.

Allowance for Coupons, Promotions and Co-Pay discount cards:   The Company issues coupons from time to time that are redeemable against certain of our Consumer Health products.  Upon release of coupons into the market, the Company records an estimate of the dollar value of coupons expected to be redeemed.  This estimate is based on historical experience and is adjusted as needed based on actual redemptions.  In addition to couponing, from time to time the Company authorizes various retailers to run in-store promotional sales of its products.  Upon receiving confirmation that a promotion was run, the Company accrues an estimate of the dollar amount expected to be owed back to the retailer.  This estimate is trued up to actual upon receipt of the invoice from the retailer. Additionally, the Company provides consumer co-pay discount cards, administered through outside agents to provide discounted products when redeemed. Upon release of the cards into the market, the Company records an estimate of the dollar value of co-pay discounts expected to be utilized.  This estimate is based on historical experience and is adjusted as needed based on actual usage.
 
Advertising and Promotional Allowances to Customers: The Company routinely sells its non-prescription ophthalmic and other drug products to major retail drug chains.  From time to time, the Company may arrange for these retailers to run in-store promotional sales of the Company’s products.  The Company reserves an estimate of the dollar amount owed back to the retailer, recording this amount as a reduction to revenue at the later of the date on which the revenue is recognized or the date the sales incentive is offered. When the actual invoice for the sales promotion is received from the retailer, the Company adjusts its estimate accordingly.  Advertising and promotional expenses paid to customers are expensed as incurred in accordance with ASC 605-50, Customer Payments and Incentives.

Inventories: Inventories are stated at the lower of cost (average cost method) or market (see Note 5 — “Inventories”). The Company maintains an allowance for slow-moving and obsolete inventory as well as inventory with a carrying value in excess of its net realizable value (“NRV”). For finished goods inventory, the Company estimates the amount of inventory that may not be sold prior to its expiration or is slow moving based upon review of recent sales activity and wholesaler inventory information. The Company also analyzes its raw material and component inventory for slow moving items.

The Company capitalizes inventory costs associated with its products prior to regulatory approval when, based on management judgment, future commercialization is considered probable and future economic benefit is expected to be realized.  The Company assesses the regulatory approval process and where the product stands in relation to that approval process including any known constraints or impediments to approval.  The Company also considers the shelf life of the product in relation to the product timeline for approval.

 
[8]

 
Intangible Assets: Intangible assets consist primarily of goodwill and in-process research and development, which are carried at initial value and subject to evaluation for impairment, product licensing costs, trademarks and other such costs, which are capitalized and amortized on a straight-line basis over their useful lives, ranging from four (4) years to thirty (30) years.  The Company regularly assesses its intangible assets for impairment based on several factors, including estimated fair value and anticipated cash flows.  If the Company incurs additional costs to renew or extend the life of an intangible asset, such costs are added to the remaining unamortized cost of the asset, if any, and the sum is amortized over the extended remaining life of the asset.

Goodwill is tested for impairment annually or more frequently if changes in circumstances or the occurrence of events suggest that impairment may exist. The Company uses widely accepted valuation techniques to determine the fair value of its reporting units used in its annual goodwill impairment analysis. The Company’s valuation is primarily based on qualitative and quantitative assessments regarding the fair value of goodwill relative to its carrying value. The Company modeled the fair value of the reporting unit based on actual projected earnings and cash flows of the reporting unit.

Income taxes:  Income taxes are accounted for under the asset and liability method.  Deferred income tax assets and liabilities are recognized for the tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities, and net operating loss and other tax credit carry-forwards. These items are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company records a valuation allowance to reduce the recognized deferred tax assets to the amount that is more likely than not to be realized. 
 
Fair Value of Financial Instruments:  The Company applies ASC Topic 820, which establishes a framework for measuring fair value and clarifies the definition of fair value within that framework. ASC Topic 820 defines fair value as an exit price, which is the price that would be received for an asset or paid to transfer a liability in the Company’s principal or most advantageous market in an orderly transaction between market participants on the measurement date. The fair value hierarchy established in ASC Topic 820 generally requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect the assumptions that market participants would use in pricing the asset or liability and are developed based on market data obtained from sources independent of the reporting entity. Unobservable inputs reflect the entity’s own assumptions based on market data and the entity’s judgments about the assumptions that market participants would use in pricing the asset or liability, and are to be developed based on the best information available in the circumstances.
 
The valuation hierarchy is composed of three levels.  The classification within the valuation hierarchy is based on the lowest level of input that is significant to the fair value measurement.  The levels within the valuation hierarchy are described below:

-  
 Level 1—Assets and liabilities with unadjusted, quoted prices listed on active market exchanges.  Inputs to the fair value measurement are observable inputs, such as quoted prices in active markets for identical assets or liabilities.  The carrying value of the Company‘s cash and cash equivalents are considered Level 1 assets.

-  
Level 2—Inputs to the fair value measurement are determined using prices for recently traded assets and liabilities with similar underlying terms, as well as directly or indirectly observable inputs, such as interest rates and yield curves that are observable at commonly quoted intervals.  The market value of the Company’s forward contracts to hedge against changes in currency translation rates between U.S. dollars and Indian rupees is a Level 2 asset.

-  
Level 3—Inputs to the fair value measurement are unobservable inputs, such as estimates, assumptions, and valuation techniques when little or no market data exists for the assets or liabilities.  The additional consideration payable related to the Company’s acquisition of three branded, injectable drug products from the U.S. subsidiary of H. Lundbeck A/S (the “Lundbeck Acquisition”) on December 22, 2011 is a Level 3 liability, as is the additional consideration payable to Santen Pharmaceutical Co. Ltd. (“Santen”) in relation to the Company’s acquisition of the U.S. New Drug Application (“NDA”) rights to Betimol® on January 2, 2014.

The following table summarizes the basis used to measure the fair values of the Company’s financial instruments (amounts in thousands):

 
[9]

 
         
Fair Value Measurements at Reporting Date, Using:
 
Description
 
June 30,
2014
   
Quoted Prices
in Active
Markets for
Identical Items
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Cash and cash equivalents
  $ 107,907     $ 107,907     $     $  
Foreign currency forward contracts
    630             630        
   Total assets
  $ 108,537     $ 107,907     $ 630     $  
                                 
Purchase consideration payable
  $ 20,514     $     $     $ 20,514  
   Total liabilities
  $ 20,514     $     $     $ 20,514  
 
Description
 
December 31,
2013
   
Quoted Prices
in Active
Markets for
Identical Items
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Cash and cash equivalents
  $ 34,178     $ 34,178     $     $  
Foreign currency forward contracts
    208             208        
   Total assets
  $ 34,386     $ 34,178     $ 208     $  
                                 
Purchase consideration payable
  $ 14,728     $     $     $ 14,728  
   Total liabilities
  $ 14,728     $     $     $ 14,728  
 
The carrying amount of the purchase consideration payable was initially determined based on the terms of the underlying contracts and the Company’s subjective evaluation of the likelihood of the additional purchase consideration becoming payable.  The purchase consideration payable is principally related to the Company’s obligation to pay additional consideration related to the acquisition of selected assets from H. Lundbeck A/S (“Lundbeck”) on December 22, 2011.  The underlying obligation was long-term in nature, and therefore was discounted to present value based on an assumed discount rate.  The additional consideration of $15.0 million, contingently payable to Lundbeck on December 22, 2014, was initially discounted to $11.3 million based on a discount rate of 10.0%, and subsequently adjusted in final acquisition accounting to $11.6 million based on applying a 9.0% discount rate.  The Company performed evaluations of the fair value of this liability at June 30, 2014 and December 31, 2013 based on utilizing significant unobservable inputs to derive discount rates of 2.27% and 1.85%, respectively.  As of June 30, 2014, the Company determined the fair value of this liability to be $14.8 million.  The increase in fair value of approximately $0.1 million from December 31, 2013 to June 30, 2014 was recorded as non-cash interest expense within the Company’s condensed consolidated statement of comprehensive income for the six months ended June 30, 2014.
 
The fair value of the contingent consideration payable to Lundbeck is based upon the likelihood of achieving the underlying revenue targets and a derived cost of debt based on the remaining term.  The Company initially determined that there was a 100% likelihood of the purchase consideration ultimately becoming payable, and reaffirmed this determination as of June 30, 2014 and December 31, 2013.  Should subjective and objective evidence lead the Company to change this assessment, an adjustment to the carrying value of the liability would be recorded as “other income” in the Company’s condensed consolidated statements of comprehensive income.
 
As of June 30, 2014 and December 31, 2013, the purchase consideration payable to Lundbeck was classified as a current liability on the Company’s condensed consolidated balance sheets as of those dates, since the additional consideration of $15.0 million is due to be paid on December 22, 2014.
 
The carrying amount at June 30, 2014 of purchase consideration payable also includes estimated consideration due to Santen related to the Company’s acquisition of U.S. NDA rights to Betimol® on January 2, 2014.  The liability was initially discounted based on the Company’s assumed discount rate and revalued at June 30, 2014 using this same discount rate.  The Company identified no events that would cause its calculated assumed discount rate to change between the acquisition date and June 30, 2014.  The additional consideration contingently payable to Santen on January 2, 2015, was initially estimated at $4.5 million discounted to $4.0 million based on a discount rate of 12.6%.  The Company performed evaluations of the fair value of this liability at June 30, 2014 based on utilizing significant unobservable inputs and determined the fair value of this liability to be $4.6 million, discounted to $4.4 million. The increase in fair value during the six months ended June 30, 2014 of approximately $0.4 million has been recorded as non-cash interest expense within the Company’s condensed consolidated statement of comprehensive income for the six months ended June 30, 2014.  The change in fair value of the additional consideration is sensitive to the passage of time and to changes in observable and unobservable inputs, such as the Company’s calculated discount rate.
 
 
[10]

 
The Company entered into three non-deliverable forward contracts in October 2013 to protect against unfavorable trends with regard to currency translation rates between U.S. dollars (“USD”) and Indian rupees (“INR”) for planned capital expenditures at Akorn India Private Limited (“AIPL”), of which one of the forward contracts matured and was redeemed during the quarter.  The remaining two forward contracts were based on current and future anticipated investments of USD $3.3 million on each of July 3, 2014 and September 30, 2014 in AIPL, the Company’s subsidiary in India.  These forward contracts include projected currency translation rates between INR and USD.  Any difference between the actual and projected foreign currency translations rates on the respective settlement dates will result in payment from the counterparty to the Company, or vice versa, as the case may be.  As of June 30, 2014 and December 31, 2013, the Company was provided with reports of the fair market value of the three forward contracts from the counterparty.  Due to continued strengthening of the Indian rupee against the U.S. dollar, the contracts had positive fair values to the Company of $0.6 million and $0.2 million as of June 30, 2014 and December 31, 2013, respectively.  The Company recorded the $0.4 million gain in fair value during the six months ended June 30, 2014 as “other income” in its consolidated statements of comprehensive income and has included the asset value within “prepaid expenses and other current assets” in its condensed consolidated balance sheets.
 
As of June 30, 2014 and December 31, 2013, the Company was carrying long-term cost basis investments valued at $11.0 million.  The fair value of the cost basis investments is not estimated, as there are no identified events or changes in circumstances that may have a significant adverse effect of the fair value of the investment, and it is not practicable to estimate the fair value of the investments.
 
Business Combinations:  Business combinations are accounted for in accordance with ASC 805, Business Combinations, using the acquisition method of accounting. The acquisition method of accounting requires an acquirer to recognize the assets acquired and the liabilities assumed at the acquisition date measured at their fair values as of that date.  Fair value determinations are based on discounted cash flow analyses or other valuation techniques.  In determining the fair value of the assets acquired and liabilities assumed in a material acquisition, the Company may utilize appraisals from third party valuation firms to determine fair values of some or all of the assets acquired and liabilities assumed, or may complete some or all of the valuations internally.  In either case, the Company takes full responsibility for the determination of the fair value of the assets acquired and liabilities assumed.  The value of goodwill reflects the excess of the fair value of the consideration conveyed to the seller over the fair value of the net assets received.  Under the acquisition method of accounting, the Company will identify the acquirer and the closing date and apply applicable recognition principles and conditions.
 
Acquisition-related costs are costs the Company incurs to effect a business combination. The Company accounts for acquisition-related costs as expenses in the periods in which the costs are incurred.
 
Discontinued Operations:  During the three and six month periods ended June 30, 2014 and subsequent to the Hi-Tech acquisition the Company divested the ECR Pharmaceuticals subsidiary (see Note 11 – Business Combinations, Dispositions and Other Strategic Investments). As a result of the sale the Company will have no continuing involvement or cash flows from the operations of this business. In accordance with FASB ASC Topic 205 Presentation of Financial Statements, and to allow for meaningful comparison of our continuing operations, the operating results of this business are reported as “discontinued operations.” All other operations are considered “continuing operations.” As the ECR Pharmaceuticals subsidiary had not previously been reported within the condensed and consolidated balance sheets as of December 31, 2013 no reclassification of amounts previously reported in the condensed consolidated balance sheets have been made. Unless noted otherwise, discussion in these notes to the financial statements pertain to our continuing operations.
 
NOTE 3 — STOCK BASED COMPENSATION
     
Stock-based compensation cost is estimated at grant date based on the fair value of the award, and the cost is recognized as expense ratably over the vesting period. The Company uses the Black-Scholes model for estimating the grant date fair value of stock options. Determining the assumptions to be used in the model is highly subjective and requires judgment. The Company uses an expected volatility that is based on the historical volatility of its common stock. The expected life assumption is based on historical employee exercise patterns and employee post-vesting termination behavior. The risk-free interest rate for the expected term of the option is based on the average market rate on U.S. treasury securities of similar term in effect during the quarter in which the options were granted. The dividend yield reflects the Company’s historical experience as well as future expectations over the expected term of the option. The Company estimates forfeitures at the time of grant and revises the estimate in subsequent periods, if necessary, if actual forfeitures differ from initial estimates.

 
[11]

 
At the Company’s 2014 Annual Meeting of Shareholders, which took place May 2, 2014, the Company’s shareholders approved the adoption of the Akorn, Inc. 2014 Stock Option Plan (the “2014 Plan”).  The 2014 Plan set aside up to 7.5 million shares for issuance based on the grant of stock options, restricted shares, or various other instruments to directors, employers and consultants.  The 2014 Plan replaces the 2003 Stock Option Plan (the “2003 Plan”), which expired on November 6, 2013 although previously granted awards remain outstanding under the 2003 Plan.
 
The Company uses the single-award method for allocating compensation cost related to stock options to each period.  The following table sets forth the components of the Company’s stock-based compensation expense for the three and six month periods ended June 30, 2014 and 2013 (in thousands):

   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
Stock options and employee stock purchase plan
   
1,954
      2,191      
3,175
      3,830  
Restricted stock awards
   
92
      350      
153
      414  
Total stock-based compensation expense
   
2,047
      2,541      
3,329
      4,244  
 
The weighted-average assumptions used in estimating the grant date fair value of the stock options granted under the 2014 Plan and the 2003 plan during the three and six month periods ended June 30, 2014, and 2013, respectively along with the weighted-average grant date fair values, are set forth in the table below.

   
Three months ended
June 30,
   
Six months ended
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
Expected volatility
    54 %     58 %     54 %     59 %
Expected life (in years)
    4.2       4.0       4.2       4.0  
Risk-free interest rate
    1.79 %     0.73 %     1.79 %     0.74 %
Dividend yield
    %     %     %     %
Fair value per stock option
  $ 10.77     $ 6.81     $ 10.77     $ 6.77  
Forfeiture rate
    8 %     8 %     8 %     8 %
 
The table below sets forth a summary of activity within the 2014 and 2003 Plan for the six months ended June 30, 2014: 
 
   
Number of
Options 
(in thousands)
   
Weighted Average Exercise Price
   
Weighted Average Remaining Contractual Term (Years)
   
Aggregate
Intrinsic Value (in thousands)
 
Outstanding at December 31, 2013
   
9,228
   
$
4.45
     
1.61
   
$
186,169
 
Granted
   
991
     
24.75
                 
Exercised
   
(238)
     
5.26
                 
Forfeited
   
(19)
     
15.48
                 
Outstanding at June 30, 2014
   
9,962
   
6.42
     
2.75
   
$
267,200
 
Exercisable at June 30, 2014
   
8,136
   
3.47
     
2.24
   
$
242,324
 
 
The aggregate intrinsic value for stock options outstanding and exercisable is defined as the difference between the market value of the Company’s common stock as of the date indicated and the exercise price of the stock options. During the three and six month periods ended June 30, 2014, approximately 182,000 and 238,000 stock options were exercised resulting in cash payments due to the Company of approximately $1.1 million and $ 1.3 million, respectively.   These stock option exercises generated tax-deductible expenses totaling approximately $3.9 million and $5.0 million, respectively.  During the three and six month periods ended June 30, 2013, 93,000 and 270,000  stock options were exercised resulting in cash payments to the Company of approximately $0.4 million and $0.7 million, respectively.  These option exercises generated tax-deductible expenses of approximately $1.0 million and $3.1 million, respectively.
 
The Company also may grant restricted stock awards to certain employees and members of its Board of Directors (“Directors”). Restricted stock awards are valued at the closing market price of the Company’s common stock on the day of grant and the total value of the award is recognized as expense ratably over the vesting period of the grants.  On May 4, 2013, the Company granted a total of 31,899 restricted shares to its Directors, of which 15,946 shares vested immediately upon issuance and the remaining 15,953 shares vested on May 4, 2014.  On May 2, 2014, the Company granted a total of 71,582 restricted shares to senior management which vest at 25% per year on the anniversary date of the grant ending May 2, 2018.
 
 
[12]

 
        The following is a summary of non-vested restricted stock activity:
 
   
Number of Shares
(in thousands)
 
Weighted Average
Grant Date Fair Value
Non-vested at December 31, 2013
   
16
   
 $
15.36
 
Granted
   
72
     
24.74
 
Forfeited
   
     
 
Vested
   
(16)
     
15.36
 
Non-vested at June 30, 2014
   
72
   
  $
24.74
 
 
NOTE 4 — ACCOUNTS RECEIVABLE ALLOWANCES
 
The nature of the Company’s business inherently involves, in the ordinary course, significant amounts and substantial volumes of transactions and estimates relating to allowances for product returns, chargebacks, rebates, doubtful accounts and discounts given to customers. This is a natural circumstance of the pharmaceutical industry and is not specific to the Company. Depending on the product, the end-user customer, the specific terms of national supply contracts and the particular arrangements with the Company’s wholesaler customers, certain rebates, chargebacks and other credits are deducted from the Company’s accounts receivable. The process of claiming these deductions depends on wholesalers reporting to the Company the amount of deductions that were earned under the terms of the respective agreement with the end-user customer (which in turn depends on the specific end-user customer, each having its own pricing arrangement, which entitles it to a particular deduction). This process can lead to partial payments against outstanding invoices as the wholesalers take the claimed deductions at the time of payment.
 
With the exception of the provision for doubtful accounts, which is reflected as part of selling, general and administrative expense, the provisions for the following customer reserves are reflected as a reduction of revenues in the accompanying condensed consolidated statements of comprehensive income. The ending reserve balances are included in trade accounts receivable, net in the Company’s condensed consolidated balance sheets.
 
Net trade accounts receivable consists of the following (in thousands):
 
   
JUNE 30,
2014
   
DECEMBER 31,
2013
 
Gross accounts receivable
 
$
220,165
   
$
88,165
 
Less reserves for:
               
Chargebacks and rebates
   
(49,330
)
   
(12,882
)
Product returns
   
(18,561
)
   
(8,164
)
Discounts and allowances
   
(11,597
)
   
(1,644
)
Advertising and promotions
   
(566
)
   
(452
)
Doubtful accounts
   
(138
)
   
(25
)
Trade accounts receivable, net
 
$
139,973
   
$
64,998
 
 
The current period increases in gross accounts receivable, chargebacks and rebates and cash discounts were primarily related to the acquisition of Hi-Tech Pharmacal Co. Inc. (“Hi-Tech”) during the six month period ended June 30, 2014, which acquisition is further described in Note 11 – Business Combinations, Dispositions and Other Strategic Investments.
 
 
[13]

 
For the three and six month periods ended June 30, 2014 and 2013, the Company recorded the following adjustments to gross sales (in thousands):
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2014
   
2013
   
2014
   
2013
 
Gross sales
  $ 283,842     $ 126,113     $ 433,142     $ 249,930  
Less adjustments for:
                               
Chargebacks and rebates
    (116,845 )     (42,966 )     (168,718 )     (86,729 )
Product returns
    (2,318 )     (482 )     (3,204 )     (1,713 )
Discounts and allowances
    (5,700 )     (1,947 )     (8,135 )     (3,922 )
Admin fees
    (5,393 )     (2,358 )     (7,545 )     (4,320 )
Advertising and promotions
    (2,836 )     (1,348 )     (4,168 )     (2,380 )
Revenues, net
  $ 150,749     $ 77,012     $ 241,371     $ 150,866  
 
 The increase, year over year, in the provisions for chargebacks and rebates, product returns, discounts and allowances, admin fees, and advertising and promotion were related to the 124.9% and 73.2% increase in gross sales in the three and six month periods ended June 30, 2014, respectively compared to the corresponding prior year quarter and year to date period.
 
 NOTE 5 — INVENTORIES
 
The components of inventories are as follows (in thousands):
 
   
JUNE 30,
2014
   
DECEMBER 31,
2013
 
Finished goods
 
$
45,813
   
$
22,886
 
Work in process
   
4,846
     
3,883
 
Raw materials and supplies
   
58,255
     
29,213
 
Inventories, net 
 
$
108,914
   
$
55,982
 
 
The Company maintains reserves and records provisions for slow-moving and obsolete inventory as well as inventory with a carrying value in excess of its net realizable value.  Finished goods inventory at June 30, 2014 and December 31, 2013 was reported net of these reserves of $4.1 million and $2.9 million, respectively.
 
The current period increases in finished goods, work in process, raw materials and supplies were primarily related to the acquisition of Hi-Tech during the six month period ended June 30, 2014.
 
NOTE 6 — PROPERTY, PLANT AND EQUIPMENT
 
Property, plant and equipment consist of the following (in thousands):
 
   
JUNE 30,
2014
   
DECEMBER 31,
2013
 
Land and land improvements
 
$
8,678
   
$
2,606
 
Buildings and leasehold improvements
   
60,474
     
46,281
 
Furniture and equipment
   
109,687
     
76,536
 
Sub-total
   
178,839
     
125,423
 
Accumulated depreciation
   
(59,966)
     
(54,470
)
Property, plant and equipment placed in service, net
   
118,873
     
70,953
 
Construction in progress 
   
16,822
     
11,155
 
Property, plant and equipment, net
 
$
135,695
   
$
82,108
 
 
Property, plant, and equipment, net increased $53.6 million principally as a result of the acquisition of Hi-Tech during the six month period ended June 30, 2014.

A portion of the Company’s property, plant and equipment is located outside the United States.  At June 30, 2014 and December 31, 2013, property, plant and equipment, net, with a net carrying value of $22.5 million and $21.1 million, respectively, was located outside the United States at the Company’s manufacturing facility and regional corporate offices in India.

The Company recorded depreciation expense of approximately $3.6 million and $1.6 million during the three month periods ended June 30, 2014 and 2013, respectively and approximately $5.5 million and $3.2 million during the six month periods ended June 30, 2014 and 2013, respectively.
 
 
[14]

 
NOTE 7 — GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill:
The following table provides a summary of the activity in goodwill by segment for the six months ended June 30, 2014 (in thousands):

   
Consumer
Health
   
Prescription Pharmaceuticals
   
Total
 
Balances at December 31, 2013
  $ 11,863     $ 17,968     $ 29,831  
Currency translation adjustments
 
      550       550  
Acquisitions
    4,854       172,236       177,089  
Dispositions
 
      (11,454 )     (11,454 )
Balances at June 30, 2014
  $ 16,717     $ 179,299     $ 196,016  
 
Goodwill acquired in the three and six month period ended June 30, 2014 is wholly related to the acquisition of Hi-Tech, while Goodwill dispositions in the period are the result of the Watson product disposition and ECR divestiture as further discussed in Note 11 — Business Combinations, Dispositions and Other Strategic Investments.

Goodwill acquired prior to April 1, 2014 attributed to the Consumer Health segment was due to the Company’s acquisition of Advanced Vision Research, Inc. in May 2011, while Goodwill attributed to the Prescription Pharmaceuticals segment relates to the Company’s acquisition of selected assets of Kilitch Drugs (India) Limited (“KDIL”) in February 2012, principally KDIL’s manufacturing facility in Paonta Sahib, India.

Product Licensing Rights, In-Process Research and Development (“IPR&D”), and Other Intangible Assets:
The following table sets forth information about the net book value of the Company’s other intangible assets as of June 30, 2014 and December 31, 2013, and the weighted average remaining amortization period as of June 30, 2014 and December 31, 2013 (dollar amounts in thousands):
 
   
Gross
Amount
   
Accumulated
Amortization
   
Net
Balance
   
Wgtd Avg Remaining
Amortization Period
(years)
 
JUNE 30, 2014
                       
Product licensing rights
  $ 476,659     $ (47,038 )   $ 429,621       13.8  
IPR&D
    9,400    
      9,400      
N/A - Indefinite lived
 
Trademarks
    15,000       (1,128 )     13,872       19.9  
Customer relationships
    6,561       (2,002 )     4,559       9.0  
Other Intangibles
    6,000       (68 )     5,932       4.8  
Non-compete agreement
    2,552       (1,512 )     1,040       1.7  
    $ 516,172     $ (51,748 )   $ 464,424          
                                 
DECEMBER 31, 2013
                               
Product licensing rights
  $ 151,504     $ (35,604 )   $ 115,900       9.8  
IPR&D
 
   
   
     
 
Trademarks
    9,500       (844 )     8,656       27.4  
Customer relationships
    6,166       (1,528 )     4,638       9.8  
Other Intangibles
 
   
   
     
 
Non-compete agreement
    2,428       (1,117 )     1,311       2.2  
    $ 169,598     $ (39,093 )   $ 130,505          
 
Intangible assets other than goodwill, gross increased $346.6 million as a result of the acquisition of Hi-Tech, the disposal of previously acquired assets to Watson, the divestiture of ECR, the acquisition of Zioptan® and the acquisition of Betimol during the six month period ended June 30, 2014.

The Company recorded amortization expense of approximately $8.6 million and $1.7 million during the three month periods ended June 30, 2014 and 2013, respectively and approximately $13.4 million and $3.4 million during the six month periods ended June 30, 2014 and 2013, respectively, related to its product licensing rights and other intangible assets.
 
 
[15]

 
NOTE 8 — FINANCING ARRANGEMENTS
 
Term Loan

Concurrent with the closing of its acquisition of Hi-Tech (the “Hi-Tech Acquisition”), Akorn, Inc. and its wholly owned domestic subsidiaries (the “Akorn Loan Parties”) entered into a $600.0 million Term Facility (the “Term Facility”) pursuant to a Loan Agreement dated April 17, 2014 (the “Term Loan Agreement” or “Existing Term Loan Agreement”) between the Akorn Loan Parties as borrowers, and JPMorgan Chase Bank, N.A. (“JPMorgan”), as lender and as administrative agent for certain other lenders.  Akorn may increase the loan amount up to an additional $150.0 million, or more, provided certain financial covenants and other conditions are satisfied.  The proceeds received pursuant to the Term Loan Agreement were used to finance the Hi-Tech Acquisition, as further described below in Note 11, Business Combinations, Dispositions and Other Strategic Investments.

The Term Facility is secured by all of the assets of the Akorn Loan Parties, including springing control of the Company’s primary deposit account pursuant to a Deposit Account Control Agreement.

The Term Loan Agreement requires quarterly principal repayment equal to 0.25% of the initial loan amount of $600.0 million beginning with the second full quarter following the closing date of the Term Loan Agreement, with a final payment of the remaining principal balance due at maturity seven (7) years from the date of closing of the Term Loan Agreement.  The Company may prepay all or a portion of the remaining outstanding principal amount under the Term Loan Agreement at any time, or from time to time, subject to prior notice requirement to the lenders and payment of applicable fees.  Prepayment of principal will be required should the Company incur any indebtedness not permitted under the Term Loan Agreement, or effect the sale, transfer or disposition of any property or asset, other than in the ordinary course of business.  To the extent the Term Facility is refinanced within the first six (6) months of closing, a 1.00% prepayment fee will be due. As of June 30, 2014 outstanding debt under the term loan facility was $600.0 million and the Company was in full compliance with all applicable covenants.

Interest will accrue based, at the Company’s election, on an adjusted prime/federal funds rate (“ABR Loan”) or an adjusted LIBOR (“Eurodollar Loan”) rate, plus a margin of 2.50% for ABR Loans, and 3.50% for Eurodollar Loans.  Each such margin will decrease by 0.25% in the event Akorn’s senior debt to EBITDA ratio for any quarter falls to 2.25:1.00 or below.  During an event of default, as defined in the Term Loan Agreement, any interest rate will be increased by 2.00% per annum.  Per the Term Loan Agreement, the interest rate on LIBOR loans cannot fall below 4.50%.
 
For the three and six month periods ended June 30, 2014, the Company recorded interest expense of $5.5 million in relation to the Term Loan.
 
 As of June 30, 2014, in connection with entering into the $600.0 million term loan with JPMorgan, the Company incurred approximately $20.3 million in deferred financing fees.  Approximately $7.4 million of this total represented loan commitment fees, of which $1.2 million and $7.1 million was amortized to expense during the three and six month periods ended June 30, 2014, respectively. The $7.1 million of loan commitment fees amortized in the six month period ended June 30, 2014 consisted of $5.0 million in ticking fees and $2.1 million in commitment fee amortization.  The Company will amortize the remaining deferred financing fees using the effective interest method over the term of the Term Loan Agreement.
 
Convertible Notes
 
On June 1, 2011, the Company issued $120.0 million aggregate principal amount of 3.50% Convertible Senior Notes due 2016 (the “Notes”) which included $20.0 million in aggregate principal amount of the Notes issued in connection with the full exercise by the initial purchasers of their over-allotment option. The Notes are governed by the Company’s indenture with Wells Fargo Bank, National Association, as trustee (the “Indenture”).  The Notes were offered and sold only to qualified institutional buyers.  The net proceeds from the sale of the Notes were approximately $115.3 million, after deducting underwriting fees and other related expenses.
  
 
[16]

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

The Notes are not listed on any securities exchange or on any automated dealer quotation system, but are traded on a secondary market made by the initial purchasers.  The initial purchasers of the Notes advised the Company of their intent to make a market in the Notes following the offering, though they are not obligated to do so and may discontinue any market making at any time.

As of June 30, 2014, the Notes were trading at approximately 381% of their face value, resulting in a total market value of $456.8 million compared to their face value of $120.0 million.  The actual conversion value of the Notes is based on the product of the conversion rate and the market price of the Company’s common stock at conversion, as defined in the Indenture.  On June 30, 2014, the Company’s common stock closed at $33.25 per share, resulting in a pro forma conversion value for the Notes of approximately $455.5 million.  Increases in the market value of the Company’s common stock increase the fair value of the Company’s obligation accordingly.  There is no upper limit placed on the possible conversion value of the Notes.
 
The Notes may be converted at any time at the option of the holders prior to the close of business on the business day immediately preceding December 1, 2015 under the following circumstances:  (1) during any calendar quarter commencing after September 30, 2011, if the closing sale price of the Company’s common stock, for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the calendar quarter immediately preceding the calendar quarter in which the conversion occurs, is more than 130% of the conversion price in effect on each applicable trading day; (2) during the five consecutive trading-day period following any five consecutive trading-day period in which the trading price for the Notes per $1,000 principal amount of Notes for each such trading day was less than 98% of the closing sale price of the Company’s common stock on such date multiplied by the then-current conversion rate; or (3) upon the occurrence of specified corporate events.  On or after December 1, 2015 until the close of business on the business day immediately preceding the stated maturity date, holders may surrender all or any portion of their Notes for conversion at any time, regardless of the foregoing circumstances. Upon conversion, the Company will pay or deliver, at the Company’s option, cash, shares of the Company’s common stock, or a combination thereof.  If a “fundamental change” (as defined in the Indenture) occurs prior to the stated maturity date, holders may require the Company to purchase for cash all or a portion of their Notes.
 
The Notes became convertible effective April 1, 2012 as a result of the Company’s common stock closing above the required price of $11.39 per share for 20 of the last 30 consecutive trading days in the quarter ended March 31, 2012.  In each subsequent quarterly period, this trading price requirement has also been met.  Accordingly, the Notes have remained convertible and will continue to be convertible at least through September 30, 2014.
 
The Notes are being accounted for in accordance with ASC 470-20.  Under ASC 470-20, issuers of convertible debt instruments that may be settled in cash upon conversion, including partial cash settlement, are required to separately account for the liability (debt) and equity (conversion option) components.
 
The application of ASC 470-20 resulted in the recognition of $20.5 million as the value for the equity component.  At June 30, 2014 and December 31, 2013, the net carrying amount of the liability component and the remaining unamortized debt discount were as follows (in thousands): 
 
   
JUNE 30,
2014
   
DECEMBER 31,
2013
 
Carrying amount of equity component
  $ 20,470     $ 20,470  
Carrying amount of the liability component
    110,920       108,750  
Unamortized discount of the liability component
    9,080       11,250  
Unamortized deferred financing costs
    1,642       2,034  
 
For the three and six month periods ended June 30, 2014 and 2013, the Company recorded the following expenses in relation to the Notes (in thousands):

 
[17]

 
   
Three months ended
June 30,
   
Six months ended
June 30,
 
Expense Description
 
2014
   
2013
   
2014
   
2013
 
Interest expense at 3.5% coupon rate (1)
  $ 1,050     $ 1,050     $ 2,100     $ 2,100  
Debt discount amortization (1)
    1,095       1,019       2,170       2,020  
Amortization of deferred financing costs
    198       184       392       365  
    $ 2,343     $ 2,253     $ 4,662     $ 4,485  

(1)  Included within “Interest expense, net” on the Condensed Consolidated Statements of Comprehensive Income.
 
 
JPMorgan Credit Facility

On April 17, 2014, the Akorn Loan Parties entered into a Credit Agreement (the “JPM Credit Agreement”) with JPMorgan Chase Bank, N.A. as administrative agent, and Bank of America, N.A., as syndication agent for certain other lenders (at closing, Bank of America, N.A. and Wells Fargo Bank, N. A.) for a $150.0 million revolving credit facility (the “JPM Revolving Facility”).  Upon entering into the JPM Credit Agreement, the Company terminated its $60.0 million revolving credit facility with Bank of America, N.A., as further described below.

Subject to other conditions in the JPM Credit Agreement, advances under the JPM Revolving Facility will be made in accordance with a borrowing base consisting of the sum of the following:
 
(a)  
85% of eligible accounts receivable;
(b)  
The lesser of:
a.  
65% of the lower of cost or market value of eligible raw materials and work in process inventory, valued on a first in first out basis, and
b.  
85% of the orderly liquidation value of eligible raw materials and work in process inventory, valued on a first in first out basis;
(c)  
The lesser of:
a.  
75% of the lower of cost or market value of eligible finished goods inventory, valued on a first in first out basis, and
b.  
85% of the orderly liquidation value of eligible finished goods inventory, valued on a first in first out basis up to 85% of the liquidation value of eligible inventory (or 75% of market value finished goods inventory); and
(d)  
Less any reserves deemed necessary by the administrative agent, and allowed in its permitted discretion.

The total amount available under the JPM Revolving Facility includes a $10.0 million letter of credit facility.

Under the terms of the JPM Credit Agreement, if availability under the JPM Revolving Facility falls below 12.5% of commitments or $15.0 million for more than 30 consecutive days, the Company may be subject to cash dominion, additional reporting requirements, and additional covenants and restrictions.  The Company may seek additional commitments to increase the maximum amount of the JPM Revolving Facility to $200.0 million.

Unless cash dominion is exercised by the lenders in connection with the JPM Revolving Facility, the Company will be required to repay the JPM Revolving Facility upon its expiration five (5) years from issuance, subject to permitted extension, and will pay interest on the outstanding balance monthly based, at the Company’s election, on an adjusted prime/federal funds rate (“ABR”) or an adjusted LIBOR (“Eurodollar”), plus a margin determined in accordance with the Company’s consolidated fixed charge coverage ratio (EBITDA to fixed charges) as follows:

Fixed Charge Coverage Ratio
Revolver ABR Spread
Revolver Eurodollar Spread
Category 1
> 1.50 to 1.0
0.50%
1.50%
Category 2
> 1.25 to 1.00 but
< 1.50 to 1.00
0.75%
1.75%
Category 3
< 1.25 to 1.00
1.00%
2.00%
 
 
[18]

 
In addition to interest on borrowings, the Company will pay an unused line fee of 0.250% per annum on the unused portion of the JPM Revolving Facility.
 
During an event of default, as defined in the JPM Credit Agreement, any interest rate will be increased by 2.00% per annum.
 
The JPM Revolving Facility is secured by all of the assets of the Akorn Loan Parties, including springing control of the Company’s primary deposit account pursuant to a Deposit Account Control Agreement. The financial covenants require the Akorn Loan Parties to maintain the following on a consolidated basis:
 
(a)  
Minimum Liquidity, as defined in the JPM Credit Agreement, of not less than (a) $120.0 million plus (b) 25% of the JPM Revolving Facility commitments during the three month period preceding the June 1, 2016 maturity date of Akorn’s $120.0 million of senior convertible notes.
 
(b)  
Ratio of EBITDA to fixed charges of no less than 1.00 to 1.00 (measured quarterly for the trailing 4 quarters).
 
As of June 30, 2014 the Company was in full compliance with all covenants applicable to the JPM Revolving Facility.
 
The Company intends to use any proceeds from borrowings under the JPM Revolving Facility for working capital needs and for the general corporate purposes of the Company and its subsidiaries, and to otherwise replace letters of credit that were outstanding upon the termination of the Company’s prior revolving credit facility with Bank of America, N.A.  At June 30, 2014, there were no outstanding borrowings and one outstanding letter of credit in the amount of approximately $0.5 million under the credit facility with JPM. Availability under the facility as of June 30, 2014 was approximately $142.7 million.
 
The JPM Credit Agreement contains representations, warranties and affirmative and negative covenants customary for financings of this type.  The JPM Credit Agreement places customary limitations on indebtedness, distributions, liens, acquisitions, investments, and other activities of the Akorn Loan Parties in a manner designed to protect the collateral while providing flexibility for growth and the historic business activities of the Company and its subsidiaries.

Bank of America Credit Facility
 
On October 7, 2011, the Company and its domestic subsidiaries (the “Borrowers”) entered into a Loan and Security Agreement (the “B of A Credit Agreement”) with Bank of America, N.A. (the “Agent”) and other financial institutions (collectively with the Agent, the “B of A Lenders”) through which it obtained a $20.0 million revolving line of credit, which included a $2.0 million letter of credit facility.  On October 4, 2013, the Company and the B of A Lenders entered into an amendment which increased the total credit commitment from $20.0 million to $60.0 million.  The amendment modified certain restrictions and fixed charge ratio coverage requirements regarding Permitted Foreign Investments, as defined in the B of A Credit Agreement. This facility was scheduled to mature in March 2016.  On April 17, 2014, concurrent with the Company entering into the JPM Credit Agreement, the Company and Bank of America, N.A. agreed to early terminate the B of A Credit Agreement, without penalty.

NOTE 9 — EARNINGS PER SHARE

Basic net income per common share is based upon the weighted average number of common shares outstanding during the period. Diluted net income per common share is based upon the weighted average number of common shares outstanding, including the dilutive effect, if any, of potentially dilutive securities using the treasury stock method.
 
The Company’s potentially dilutive securities consist of: (i) vested and unvested stock options that are in-the-money, (ii) warrants that are in-the-money, (iii) unvested restricted stock awards (“RSAs”), and (iv) shares issuable on conversion of convertible notes.  Information about the computation of basic and diluted earnings per share is detailed below (in thousands, except per share data): 

 
[19]

 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
Income from continuing operations
  $ 9,009     $ 12,637     $ 18,837     $ 23,479  
Income from continuing operations per share:
                               
     Basic
  $ 0.09     $ 0.13     $ 0.19     $ 0.24  
     Diluted
  $ 0.08     $ 0.11     $ 0.16     $ 0.21  
(Loss) from discontinued operations, net of tax
  $ (503 )  
    $ (503 )  
 
(Loss) from discontinued operations per share
                               
     Basic
  $ (0.01 )  
    $ (0.01 )  
 
     Diluted
  $ (0.01 )  
    $ (0.01 )  
 
 
                               
Shares used in computing net income (loss) per share:
                               
Weighted average basic shares outstanding
    103,183       96,122       99,926       96,025  
Dilutive securities:
                               
     Stock option and unvested RSAs
    5,038       4,380       5,008       4,383  
     Stock warrants
    749       6,614       3,779       6,564  
     Shares issuable upon conversion of convertible notes (1)
    9,122       5,212       8,863       5,038  
Total dilutive securities
    14,909       16,206       17,650       15,985  
                                 
Weighted average diluted shares outstanding
    118,092       112,328       117,576       112,010  
                                 
Shares subject to stock options omitted from the calculation of income per share as their effect would have been anti-dilutive
    598       1,373       336       1,289  

(1)  
The number of shares issuable upon conversion of the Notes is based on the assumption that the Company would repay the principal of the Notes in cash and pay any incremental value in shares of common stock.

Stock Warrant Exercise

On April 10, 2014, the Company’s chairman, John N. Kapoor, Ph.D., exercised all of his 7.2 million outstanding stock warrants for cash.  These warrants were issued at various dates in 2009 and were scheduled to expire in 2014.  The Company received cash proceeds of approximately $8.2 million from the warrant exercise during the three and six month periods ended June 30, 2014.

NOTE 10 — SEGMENT INFORMATION

During the three and six month periods ended June 30, 2014, the Company acquired Hi-Tech and as a result, underwent a change in the organizational and reporting structure of the Company's reportable segments, establishing two reporting segments that each report to the Chief Operating Decision Maker (CODM), as defined in ASC Topic 280, Segment Reporting, and Chief Executive Officer (CEO), Raj Rai. Our performance will be assessed and resources will be allocated by the CODM based on the following two reportable segments:

- Prescription Pharmaceuticals
- Consumer Health

Prior to the realignment the Company managed the business as three distinct reporting segments; Ophthalmics, Hospital Drugs and Injectables, and Contract Services.

The changes combine operations that have a similar product type, serve comparable customers and address similar business issues and industry dynamics. The new segment reporting structure provides shareholders and other users of our financial statements with more useful information about our segments.
 

     
Current Segments
     
Prescription Pharmaceuticals
Consumer Health
Former Segments
Akorn
Ophthalmics
X
   X (a)
Hospital Drugs and Injectables
X
 
Contract Services
X
 
Hi-Tech
Generic Pharmaceuticals  (“Hi-Tech Generic”)
X
 
OTC Branded Pharmaceuticals  (“HCP”)
 
   X (b)
Prescription Brands (“ECR”)
     X (c)
 

 
[20]

 
(a)  
Represents the previous acquisition of Advanced Vision Research, Inc./TheraTears
(b)  
Represents the previous Hi-Tech reportable segment HCP (“Health Care Products”)
(c)  
Represents the previous Hi-Tech reportable segment ECR which was divested during the three and six month periods ended June 30, 2014 and whose results have been included within discontinued operations.

The Consumer Health segment manufactures, markets and distributes a line of branded OTC dry eye treatment products, a portfolio of private label OTC ophthalmic products and other consumer health products. The Prescription Pharmaceuticals segment manufactures, markets and distributes general and disease specific ophthalmic drugs and injectable pharmaceuticals, primarily in niche markets, as well as certain antidotes, antiallergics, anti-infectives, vaccines, and controlled substances for pain management and anesthesia, in various dosage forms.  The Prescription Pharmaceuticals segment also includes the operating results of the Company’s subsidiary in India – Akorn India Private Limited.

Financial information about the Company’s reportable segments is based upon internal financial reports that aggregate certain operating information. The Company’s CEO oversees operational assessments and resource allocations based upon the results of the Company’s reportable segments, which have available and discrete financial information.
 
Selected financial info by reporting segment is presented below (in thousands). The Company has restated prior periods including the three and six month periods ended June 30, 2013 to reflect the strategic realignment described above.
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
Revenues:
                       
Prescription Pharmaceuticals
  $ 136,231     $ 67,362     $ 218,079     $ 132,508  
Consumer Health
    14,518       9,650       23,292       18,358  
                                 
Total revenues
    150,749       77,012       241,371       150,866  
                                 
Gross Profit:
                               
Prescription Pharmaceuticals
    68,012       36,743       113,296       70,766  
Consumer Health
    8,659       5,349       13,031       10,471  
                                 
Total gross profit
    76,671       42,092       126,327       81,237  
                                 
Operating expenses
    60,408       19,841       86,624       40,397  
                                 
Operating income
    16,263       22,251       39,703       40,840  
Other (expense)
    (1,951 )     (2,269 )     (9,699 )     (4,601 )
                                 
Income from continuing operations before income taxes
  $ 14,312     $ 19,982     $ 30,004     $ 36,239  
 
The Company manages its business segments to the gross profit level and manages its operating and other costs on a company-wide basis. Inter-segment activity at the revenue and gross profit level has been minimal. The Company does not identify total assets by segment for internal purposes, as the Company’s CODM does not assess performance, make strategic decisions, or allocate resources based on assets.
 
NOTE 11 — BUSINESS COMBINATIONS, DISPOSITIONS AND OTHER STRATEGIC INVESTMENTS

VPI Holdings Corp.

On May 9, 2014, the Company entered into an Agreement and Plan of Merger (the “VP Merger Agreement”) to acquire VPI Holdings Corp. (“VPI”), the parent company of VersaPharm Incorporated (“VersaPharm”) for approximately $440 million in cash, subject to various post-closing adjustments related to working capital, cash, transaction expenses and funded indebtedness.  The acquisition was approved by the Federal Trade Commission (FTC) on August 5, 2014 following review pursuant to provisions of the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (“HSR”). The approval is pursuant to an order of product divestment to Watson Laboratories, Inc., a wholly owned subsidiary of Actavis plc., to divest all rights and assets related to one product marketed under a pending Abbreviated New Drug Application – Rifampin (“Akorn Rifampin Product Assets”). The Company expects the acquisition to close in the third quarter of 2014. Upon completion of the merger, Akorn Enterprises II, Inc., a wholly owned subsidiary of the Company (the “Acquisition Subsidiary”), will be merged with and into VPI, such that after the merger VPI will be a wholly owned subsidiary of the Company.

 
[21]

 
VersaPharm is a privately-held developer and marketer of multi-source prescription pharmaceuticals, with a focus in the niche therapeutic categories of dermatology, tuberculosis and hemophilia.   VersaPharm operates a corporate office in Marietta, GA, a research and development, quality control and assurance facility in Warminster, PA, and an operations center in Tarrytown, NY.

The VersaPharm Acquisition is expected to complement and expand the Company’s product portfolio by further diversifying its offering to generic dermatology therapeutic products, and further enhancements of the Company’s existing product portfolio.  The VersaPharm Acquisition is also expected to enhance the Company’s new product pipeline, including 11 ANDA’s currently filed with the FDA.

Akorn intends to fund the transaction principally through a $445 million incremental term loan. JPMorgan has committed financing for the transaction.  The Company anticipates that the incremental term loan agreement will be signed during the third quarter of 2014.  The Incremental Term Loan is expected to bear interest, at Akorn’s option, at rates equal to an adjusted Eurodollar rate or an alternate base rate, in each case, plus a spread. As of June 30, 2014, the Company recorded $1.7 million of commitment fees associated with the incremental term loan and for the three and six month periods ended June 30, 2014 recorded $0.5 million in amortization expense associated with the commitment fees.

The VP Merger Agreement contains termination rights for VPI, Akorn and Acquisition Subsidiary.    The VP Merger Agreement provides that Akorn will be required to pay VPI a termination fee of $22.0 million if, on or prior to November 5, 2014 (subject to certain circumstances in which such date is extended to December 5, 2014) (as such date may be extended, the “Termination Date”), the VP Merger Agreement is terminated by VPI as a result of a Financing Failure (as defined in the Merger Agreement).  In the event that Akorn exercises its right to terminate the VP Merger Agreement due to the transaction not having closed as of the Termination Date, but at such time VPI would have been able to terminate the VP Merger Agreement as a result of a Financing Failure, Akorn will also be required to pay VPI a termination fee of $22.0 million.
 
Further, the Merger Agreement provides directors and officers of VPI with certain indemnification rights following the Merger.

During the three and six month periods ended June 30, 2014, the Company recorded approximately $1.0 million in acquisition related expenses in connection with the VersaPharm acquisition.
 
Hi-Tech Pharmacal Co., Inc.

On April 17, 2014, the Company completed its acquisition of Hi-Tech for a total purchase price of approximately $650 million (the “Hi-Tech Acquisition”).  This purchase price was based on acquiring all outstanding shares of Hi-Tech common stock for $43.50 per share, buying out the intrinsic value of Hi-Tech’s stock options, and paying the single-trigger separation payments to various Hi-Tech executives due upon change in control.  The total consideration paid is net of Hi-Tech’s cash acquired subsequent to Hi-Tech’s payment of $44.6 million of stock options and single trigger separation payments as of April 17, 2014.

On August 27, 2013, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) to acquire Hi-Tech.  Subject to the terms and conditions of the Merger Agreement, upon completion of the merger on April 17, 2014, each share of Hi-Tech’s common stock, par value $0.01 per share, issued and outstanding and held by non-interested parties at the time of the merger (the “Hi-Tech Shares”), was cancelled and converted into the right to receive $43.50 in cash, without interest, less any applicable withholding taxes, upon surrender of the outstanding Hi-Tech Shares.

The acquisition was approved by the shareholders of Hi-Tech on December 19, 2013, and was approved by the Federal Trade Commission (“FTC”) on April 11, 2014 following review pursuant to provisions of HSR.  In connection with the Hi-Tech Acquisition, the Company entered into an agreement (the “Divestment Agreement”) with Watson Laboratories, Inc., a wholly owned subsidiary of Actavis plc, to divest certain rights and assets - see below for further consideration.

 
[22]

 
Hi-Tech is a specialty pharmaceutical company which develops, manufactures and markets generic and branded prescription and OTC products.  Hi-Tech specializes in difficult to manufacture liquid and semi-solid dosage forms and produces and markets a range of oral solutions and suspensions, as well as topical ointments and creams, nasal sprays, otics, sterile ophthalmics and sterile ointment and gel products. Hi-Tech’s Health Care Products division is a developer and marketer of OTC products, and their ECR Pharmaceuticals subsidiary (“ECR”) markets branded prescription products.  Hi-Tech operates a manufacturing facility and corporate offices in Amityville, New York, and ECR maintains its corporate offices in Richmond, Virginia.

The Hi-Tech Acquisition is expected to complement and expand the Company’s product portfolio by diversifying its offering to its retail customers beyond ophthalmics to other niche dosage forms such as oral liquids, topical creams and ointments, nasal sprays and otics.  The Hi-Tech Acquisition is also expected to enhance the Company’s new product pipeline.  Further, the Hi-Tech Acquisition will add branded OTC products in the categories of cough and cold, nasals, and topicals to the Company’s existing TheraTears® brand of eye care products, and will provide additional domestic manufacturing capacity for the Company.

The Hi-Tech Acquisition was principally funded through a $600.0 million term loan with JPMorgan entered into concurrent with completing the acquisition, and through Hi-Tech cash assumed through the acquisition.  For further details on the term loan financing, please refer to the description in Note 8 – Financing Arrangements.

During the three and six month periods ended June 30, 2014, the Company recorded approximately $19.6 million and $20.0 million in acquisition-related expenses in connection with the Hi-Tech Acquisition.  These expenses principally consisted of various legal fees and other acquisition costs which have been recorded within “acquisition related costs” as part of operating expenses in the Company’s condensed consolidated statement of comprehensive income in the applicable periods.

The following table sets forth the consideration paid for the Hi-Tech Acquisition and the fair values of the acquired assets and assumed liabilities (in millions) as of the acquisition date.  The figures below are preliminary and subject to review of the facts and assumptions used to determine the fair values of the acquired assets developed utilizing an income approach.
 
Consideration:
     
Amount of cash paid to Hi-Tech stockholders
  $ 605.0  
Amount of cash paid to vested Hi-Tech option holders
    40.5  
Amount of cash paid to key executives under single-trigger separation payments upon change-in-control
    4.1  
    $ 649.6  
         
Recognized amounts of identifiable assets acquired and liabilities assumed:
       
Cash and cash equivalents
  $ 89.7  
Accounts receivable
    48.5  
Inventory
    53.7  
Other current assets
    23.9  
Property and equipment
    45.6  
Product licensing rights
    343.5  
IPR&D
    9.4  
Customer Relationships
    0.3  
Trademarks
    5.5  
Goodwill
    177.1  
Other non-current assets
    0.6  
Total assets acquired
  $ 797.8  
Assumed current liabilities
    (23.5 )
Assumed non-current liabilities
    (2.8 )
Deferred tax liabilities
    (121.9 )
Total liabilities assumed
  $ (148.2 )
    $ 649.6  
 
Goodwill represents expected synergies resulting from the combination of the entities and other intangible assets that do not qualify for separate recognition, while IPR&D assets represent ongoing in-process research and development projects obtained through the acquisition.  The Company does not anticipate being able to deduct any of the associated incremental value of goodwill and other intangible assets for income tax purposes, but expects to be able to deduct approximately $18.5 million of value associated with pre-existing Hi-Tech goodwill and other intangible assets for income tax purposes in future periods. See Note 7 – Goodwill and Other Intangible Assets for further discussion of goodwill allocated to each reportable segment. As of June 30, 2014, the Company has not completed the allocation of goodwill acquired in the acquisition to reporting units.
 
 
[23]

 
Weighted average remaining amortization period of intangible assets acquired other than goodwill and IPR&D through the Hi-Tech acquisitions as of the closing date was 15.6 years in aggregate, 15.7 years for product licensing rights, 1 year for customer relationships and 9 years for trademarks.
 
During the three and six month periods ended June 30, 2014, the Company recorded net revenue of approximately $51.5 million, respectively related to sales of the Hi-Tech products existing subsequent to the disposition and divestiture noted below.

Watson Product Disposition

In connection with the Hi-Tech Merger, Akorn entered into an agreement (the “Disposition Agreement”) with Watson Laboratories, Inc., (“Watson”) a wholly owned subsidiary of Actavis plc, to dispose of certain rights and assets related to three Hi-Tech products marketed under Abbreviated New Drug Applications — Ciprofloxacin Hydrochloride Ophthalmic Solution, Levofloxacin Ophthalmic Solution and Lidocaine Hydrochloride Jelly — and one Akorn product marketed under a New Drug Application: Lidocaine/Prilocaine Topical Cream, collectively “the products”.  The Divestment Agreement further included one product under development. Net revenues for the Akorn product marketed under a New Drug Application: Lidocaine/Prilocaine Topical Cream were approximately $0.3 million and $1.4 million in the three month periods ended June 30, 2014 and 2013, respectively, and approximately $1.5 million and $2.4 million in the six month periods ended June 30, 2014 and 2013, respectively. This disposition was required pursuant to a proposed consent order accepted by vote of the Federal Trade Commission on April 11, 2014.   The closing of the disposition agreement, which was contingent upon the consummation of Akorn’s acquisition of 50% or more of the voting securities of Hi-Tech, took place on April 17, 2014. Under the terms of the disposition the Company received $16.8 million for the intangible product rights, associated goodwill, and saleable inventory of the products denoted above. The Company recorded a gain of $9.0 million in Other (expense) income, net in the three and six month periods ended June 30, 2014, resulting from the difference of the consideration received and assets disposed, see below.

Calculation of gain from Watson product disposition (in millions)
       
Consideration received
  $
16.8
 
Intangible assets disposed
   
(5.9
)
Goodwill disposed
   
(1.1
)
Other assets disposed
   
(0.8
)
Pre-Tax Gain recognized
  $
9.0
 
 
Upon completing the Watson product disposition, the Company entered into a Master Supply Agreement with Watson whereby the Company will continue manufacturing the products for a transitional period not to exceed two years.  The parties also entered into a Transition Services Agreement, the purpose of which is to affect a smooth transfer of all intellectual property and necessary historical data to complete the ownership transfer to Watson.

ECR Divestiture

On June 20, 2014, the Company divested its subsidiary, ECR Pharmaceuticals (“ECR”), net of three branded products (specifically Cormax®, VoSol® HC, and Zolvit® Oral Solution otherwise known as “Lortab”) to Valeant Pharmaceuticals (“Valeant”) for $41 million in cash and assumption of certain liabilities. Through the divestiture, the Company recognized a nominal gain on the sale of the intangible product rights, associated goodwill, saleable inventory and other assets of ECR. ECR, which promotes certain branded pharmaceuticals through its sales force, was acquired through the acquisition of Hi-Tech. As the Company has divested a component of the combined entity and do not expect material continuing cash flows, ECR results which included net revenues of $3.4 million and a net (loss) from discontinued operations of ($0.5) million for the period from acquisition to disposition (which both occurred during the three and six month periods ended June 30, 2014) have been included within discontinued operations in the condensed consolidated statements of comprehensive income, see below.

Calculation of gain/(loss) from ECR Divestiture (in millions)
     
Consideration received
  $ 41.0  
Intangible assets divested
    (33.6 )
Goodwill divested
    (10.4 )
Other assets divested
    (1.2 )
Assumed liabilities divested
    5.1  
Pre-Tax Gain recognized
  $
0.9
 
 
 
[24]

 
The unaudited pro forma results presented below reflect the consolidated results of operations inclusive of the Hi-Tech acquisition, Watson product disposition and ECR divestiture (“Hi-Tech transactions”) occurring during the quarter, as if the transactions had taken place at the beginning of the period presented below.  The pro forma results include amortization associated with the acquired tangible and intangible assets and interest on debt incurred for the acquisition.  The unaudited pro forma financial information presented below does not reflect the impact of any actual or anticipated synergies expected to result from the acquisition.  Accordingly, the unaudited pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transaction been effected on the assumed date (amounts in thousands, except per share data):
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
Revenue
  $ 157,405     $ 124,558     $ 306,358     $ 256,493  
Net income (loss)
    18,953       (13,897 )     37,947       (499 )
Net income (loss) per diluted share
  $ 0.16     $ (0.14 )   $ 0.32     $ (0.00 )
 
Zioptan Acquisition

On April 1, 2014, the Company acquired the U.S. NDA rights to Zioptan®, a prescription ophthalmic eye drop indicated for reducing elevated intraocular pressure in patients with open-angle glaucoma or ocular hypertension, from Merck, Sharp and Dohme Corp. (“Merck”). The Company’s acquisition of U.S. NDA rights to Zioptan® (the “Zioptan Acquisition”) is being accounted for as a business combination in accordance with ASC 805 – Business Combinations.  The purpose of the Zioptan Acquisition is to expand the Company’s product portfolio of prescription pharmaceuticals.  The total consideration at closing was $11.2 million, all of which was recognized as product licensing rights as of the acquisition date.

Upon completing the Zioptan Acquisition, the Company entered into a Master Supply Agreement with Merck whereby Merck will continue manufacturing Zioptan® for a transitional period not to exceed two years, during which time the Company will work to transfer manufacturing.  The transfer price, per the terms of the Supply Agreement, will equal Merck’s historical product cost.  The parties also entered into a Transition Services Agreement, the purpose of which is to affect a smooth transfer of all intellectual property and necessary historical data to complete the ownership transfer to the Company.

The U.S. NDA rights to Zioptan® are included within product licensing rights, net on the Company’s condensed consolidated balance sheet as of June 30, 2014.  From sales of Zioptan®, the Company recorded revenue of $3.8 million during the three and six month periods ended June 30, 2014.

The Company has not provided pro forma revenue and earnings of the Company as if the Zioptan Acquisition was completed as of January 1, 2014 because to do so would be impracticable.  The acquired Zioptan rights were not managed as a discrete business by Merck.  Accordingly, determining the pro forma revenue and earnings of the Company including the Zioptan Acquisition would require significant estimates of amounts, and it is impossible to distinguish objectively information about such estimates that provides evidence of circumstances that existed on the dates at which those amounts would be recognized and measured, and would have been available when the financial statements for that prior period were issued.

Betimol Acquisition

On January 2, 2014, the Company acquired the NDA rights to Betimol®, a prescription ophthalmic eye drop for the reduction of eye pressure in glaucoma patients, from Santen Pharmaceutical Co., Ltd., a Japanese corporation (“Santen”).  The Company’s acquisition of U.S. NDA rights to Betimol® (the “Betimol Acquisition”) is being accounted for as a business combination in accordance with ASC 805 – Business Combinations.  The purpose of the Betimol Acquisition is to expand the Company’s product portfolio of prescription pharmaceuticals.  The total consideration will be equal to 1.5 times the Company’s net sales of Betimol® in the first year following acquisition, such year starting upon the Company’s first sale of the product.  The Company paid $7.5 million upon completing the acquisition and will pay any remaining amount 60 days following the first year post-acquisition.  There is also a provision for a $2.0 million increase to the total consideration should net sales of Betimol exceed $14.0 million in any one of the first five years following acquisition, though the Company deems this extremely unlikely.  There is no provision for reducing the purchase price below the initial $7.5 million paid.

Upon completing the Betimol Acquisition, the Company entered into a Supply Agreement with Santen whereby Santen will continue manufacturing Betimol® for a transitional period not to exceed two years, during which time the Company will work to site transfer manufacturing to one of its plants.  The transfer price, per the terms of the Supply Agreement, will equal Santen’s cost of API plus actual cost of manufacturing the product, making this a favorable contract pursuant to ASC 805.  The parties also entered into a Transition Services Agreement, the purpose of which is to affect a smooth transfer of all intellectual property and necessary historical data to complete the ownership transfer to the Company.

 
[25]

 
The following table sets forth the consideration paid for the Betimol Acquisition and the fair values of the acquired assets and assumed liabilities (in millions).  The figures below are preliminary and subject to review of the facts and assumptions used to determine the fair values of the acquired assets:

Betimol Acquisition:
       
Consideration paid in cash at closing
  $  7.5  
Purchase consideration payable
    4.0  
    $ 11.5  
         
Fair value of acquired assets:
       
   U.S. NDA rights to Betimol®
  $ 11.4  
   Favorable supply agreement
    0.1  
    $ 11.5  

The U.S. NDA rights to Betimol® are included within product licensing rights, net on the Company’s condensed consolidated balance sheet as of June 30, 2014.  The favorable supply agreement is included within other long-term assets on the Company’s condensed consolidated balance sheet as of June 30, 2014.

The Company estimated that it would owe additional consideration to Santen of approximately $4.5 million.  Since this is a performance-based earn-out payment, this additional consideration was discounted to approximately $4.0 million.  During the three and six month periods ended June 30, 2014 the Company recorded $0.1 million of other operating expense reflecting a fair value adjustment to increase the estimated additional consideration obligation as a result of revised operating expectations.

From sales of Betimol®, the Company recorded revenue of $1.6 million and $4.4 million during the three and six month periods ended June 30, 2014.

The Company has not provided pro forma revenue and earnings of the Company as if the Betimol Acquisition was completed as of January 1, 2014 because to do so would be impracticable.  The acquired Betimol rights were not managed as a discrete business by Santen.  Accordingly, determining the pro forma revenue and earnings of the Company including the Betimol Acquisition would require significant estimates of amounts, and it is impossible to distinguish objectively information about such estimates that provides evidence of circumstances that existed on the dates at which those amounts would be recognized and measured, and would have been available when the financial statements for that prior period were issued.

Merck Products Acquisition

On November 15, 2013, the Company acquired from Merck the U.S. rights to three branded ophthalmic products for $52.8 million in cash (the “Merck Acquisition”).  The acquired assets met the definition of a business, and accordingly, have been accounted for as a business combination in accordance with ASC 805 – Business Combinations.  Through the Merck Acquisition, the Company purchased Inspire Pharmaceuticals, Inc., a wholly-owned subsidiary of Merck.  This legal entity owns the U.S. rights to AzaSite, a prescription eye drop used to treat bacterial conjunctivitis.  The U.S. rights to the other two products involved in the acquisition, Cosopt and Cosopt PF (preservative free), were purchased directly from Merck.  The Cosopt products are prescription sterile eye drop solutions used to lower the pressure in the eye in people with open-angle glaucoma or ocular hypertension.  The acquisition of these products expands the Company’s ophthalmic product portfolio to include branded, prescription eye drops, and is complementary to the Company’s existing portfolio of products.  The Company believes that this acquisition leverages its existing sales force and ophthalmic and optometric physician relationships.

The following table sets forth the consideration paid for the Merck Acquisition and the fair values of the assets acquired and the liabilities assumed (in millions):
 
Product rights:
     
AzaSite
  $ 13.8  
Cosopt
    21.6  
Cosopt PF
    20.3  
Product rights total
  $ 55.7  
Prepaid expenses
    0.1  
Deferred tax assets, net
    0.7  
Total fair value of acquired assets
  $ 56.5  
Consideration paid
  $ 52.8  
Gain from bargain purchase
  $ 3.7  
 
 
[26]

 
Through its acquisition of Inspire Pharmaceuticals, Inc. the Company assumed that entity’s net operating loss carry-forwards (“NOLs”) and unamortized start-up costs.  The “deferred tax assets, net” listed above represents the difference between the acquired deferred tax assets, the NOLs, and unamortized start-up costs, and the acquired deferred tax liabilities, which represent the book versus tax basis differences in the product rights.  The bargain purchase amount was largely derived from the difference between the fair value and the economic value, as calculated through discounted cash flow analysis, of the deferred tax assets, net.  In particular, due to the long-term nature of the NOLs acquired, the book value of the resulting deferred tax asset significantly exceeded its discounted cash flow value.

The Company anticipates amortizing the acquired products on a straight-line basis from the Merck Acquisition date through December 31, 2019.  The Merck Acquisition agreement specified the tax values assigned to each product.  The tax value of AzaSite product rights will not be amortizable for tax purposes, as these rights were obtained through the stock acquisition of Inspire Pharmaceuticals, Inc.  That Company anticipates that the assigned tax values of Cosopt and Cosopt PF will be amortizable for tax purposes over a 15-year period.

During the three and six month periods ended June 30, 2014, the Company recorded net revenue of approximately $6.4 million and $15.8 million, respectively related to sales of the three products acquired through the Merck Acquisition.

The Company has not provided pro forma revenue and earnings of the Company as if the Merck Acquisition was completed as of January 1, 2013 because to do so would be impracticable.  The products acquired from Merck were not managed as a discrete business by Merck.  Accordingly, determining the pro forma revenue and earnings of the Company including the Merck Acquisition would require significant estimates of amounts, and it is impossible to distinguish objectively information about such estimates that provides evidence of circumstances that existed on the dates at which those amounts would be recognized and measured, and would have been available when the financial statements for that prior period were issued.

Other Strategic Investments

On August 1, 2011, the Company entered into a Series A-2 Preferred Stock Purchase Agreement (the “Aciex Agreement”) to acquire a minority ownership interest in Aciex Therapeutics Inc. (“Aciex”), based in Westborough, MA, for $8.0 million in cash.  Subsequently, on September 30, 2011, the Company entered into Amendment No. 1 to Series A-2 Preferred Stock Purchase Agreement (the “Aciex Amendment”) to acquire additional shares of Series A-2 Preferred Stock in Aciex for approximately $2.0 million in cash.  On April 17, 2014, the Company entered into a Secured Note and Warrant Purchase Agreement (“Aciex Warrant Purchase Agreement”) to acquire secured, convertible promissory notes of Aciex for approximately $0.4 million in cash.  On June 27, 2014, the Company entered into a second Secured Note and Warrant Purchase Agreement (“2nd Aciex Warrant Purchase Agreement”) to acquire additional secured, convertible promissory notes of Aciex for an additional amount of approximately $0.4 million. The Company’s aggregate investment in Aciex of $10.8 million is being carried at cost on the Company’s condensed consolidated Balance Sheet.  Aciex is an ophthalmic drug development company focused on developing novel therapeutics to treat ocular diseases. Aciex’s pipeline consists of both clinical stage assets and pre-Investigational New Drug stage assets.  The investments detailed above have provided the Company with an ownership interest in Aciex of below 20%.  The Aciex Agreement and Aciex Amendment contain certain customary rights and preferences over the common stock of Aciex and further provide that the Company shall have the right to a seat on the Aciex board of directors.  The Company performs an impairment test of its investment in Aciex annually, or more frequently if there is any indication of possible impairment.  The most recent impairment review was completed in the fourth quarter of 2013 and no impairment was identified.
 
 
NOTE 12 — COMMITMENTS AND CONTINGENCIES

Payments Due under Strategic Business Agreements

The Company has entered into strategic business agreements for the development and marketing of finished dosage form pharmaceutical products with various pharmaceutical development companies.  Each strategic business agreement includes a future payment schedule for contingent milestone payments.  The Company will be responsible for contingent milestone payments to these strategic business partners based upon the occurrence of future events.  Each strategic business agreement defines the triggering event for any required future payments, such as meeting product development progress timelines, successful product testing and validation, successful clinical studies, various U.S. Food and Drug Administration (“FDA”) and other regulatory approvals and other factors as negotiated in each agreement.  None of the contingent milestone payments is expected to be individually material to the Company.  The Company’s estimate of future milestone payments may vary significantly from period to period.  When realized, milestone payments related to events prior to FDA approval will be reported as part of research and development expense in the Company’s condensed consolidated statement of comprehensive income.  Milestone payments due upon receipt of FDA approval will be capitalized as intangible assets.
 
 
[27]

 
Based on the agreements the Company has in place with strategic business partners as of June 30, 2014, the table below sets forth the approximate timing and dollar amount of payments that would be due under those agreements, assuming the underlying milestones are achieved in the years indicated (in thousands):

Year of Payment
 
Amount
   
2014
  $
4,522
   
2015
   
4,892
   
2016
   
3,226
   
2017
   
14
   
Total
  $
12,654
   

Business Combinations

The Company entered into an agreement with H. Lundbeck A/S on December 22, 2011 to acquire its rights to the New Drug Applications (“NDAs”) of three off-patent, branded injectable products (the “Lundbeck Agreement”).  Pursuant to the terms of the underlying Asset Sale and Purchase Agreement, the Company paid $45.0 million paid in cash at closing and is obligated to pay $15.0 million in additional consideration on the third anniversary of the closing date.  Both the initial $45.0 million closing payment and subsequent $15.0 million in additional consideration are subject to claw-back provisions should sales of the acquired products fail to reach the required levels.  The Company has recorded the estimated present value of the $15.0 million as a current liability on its condensed consolidated balance sheets as of June 30, 2014 and December 31, 2013.

On January 2, 2014 the Company acquired the U.S. NDA rights to Betimol® from Santen.  The total consideration payable will equal 1.5 times the Company’s net sales of Betimol® in the first year following acquisition.  The Company paid consideration of $7.5 million upon closing this transaction and expects to owe an additional $4.6 million in consideration, which will become payable in the first quarter of 2015.  The Company has recorded the estimated present value of this $4.4 million as a current liability on its condensed consolidated balance sheet as of June 30, 2014.
       
Purchase Commitments

On October 17, 2012, the Company entered into an exclusive distribution agreement with the Massachusetts Biological Laboratory of the University of Massachusetts (“MBL”) for the Company’s marketing of MBL-manufactured tetanus-diphtheria vaccine (“Td vaccine”) over an initial contract term of two (2) years.   On July 1, 2014, the Company terminated and renegotiated the distribution agreement for an additional contract term of (1) year. The agreement commits the Company to acquire $2.5M of Td vaccine during the remainder of the fiscal year ended December 31, 2014 and $4.8M of Td vaccine in the first six months of the fiscal year ended December 31, 2015.

The Company is party to a supply agreement with Hospira for its provision of two of the injectable pharmaceuticals acquired by the Company from Lundbeck on December 21, 2011.  This agreement requires the Company to acquire product with an estimated total cost of approximately $2.1 million in each of 2014 and 2015.

Legal Proceedings

We are party to other legal proceedings and potential claims arising in the ordinary course of our business. Such legal proceedings include Akorn’s Paragraph IV challenges to other drug manufacturers’ proprietary rights, and the counter-suits filed by those drug manufacturers in response.  The amount, if any, of ultimate liability with respect to legal proceedings involving the Company cannot be determined.  Despite the inherent uncertainties of litigation, at this time the Company does not believe that such proceedings will have a material adverse impact on our financial condition, results of operations, or cash flows.

Set forth below is a listing of potentially material legal proceedings of both Akorn and Hi-Tech in existence as of the date of filing this Quarterly Report on Form 10-Q.
 
On September 11, 2013, the Attorney General of the State of Louisiana filed a lawsuit in Louisiana state court against Hi-Tech, and numerous other pharmaceutical companies, under various state laws, alleging that each defendant caused the state’s Medicaid agency to provide reimbursement for drug products that allegedly were not approved by the FDA and therefore allegedly not reimbursable under the federal Medicaid program. Through its lawsuit, the state seeks unspecified damages, statutory fines, penalties, attorney’s fees and costs. On October 15, 2013, the defendants removed the lawsuit to the U.S. District Court for the Middle District of Louisiana. On November 14, 2013, the state filed a motion to remand the lawsuit to the Louisiana state court. On December 9, 2013, the defendant’s filed their opposition to the state’s motion to remand and a request for oral argument on such motion. While the Company cannot predict the outcome of the lawsuit at this time, it could be subject to material damages, penalties and fines. The Company intends to vigorously defend against all claims in the lawsuit.

 
[28]

 
In connection with the Agreement and Plan of Merger (the “Merger Agreement”) with Akorn Inc. (“Akorn”) and Akorn Enterprises, Inc., providing for the merger of Akorn Enterprises, Inc. with and into the Company (the “Merger”), a putative class action lawsuit was filed in the Court of Chancery of the State of Delaware on August 30, 2013, captioned Karant v. Hi-Tech Pharmacal Co., Inc., et al., C.A. No. 8854-VCP, alleging, among other things, that Hi-Tech and Hi-Tech’s board of directors breached their fiduciary duties and that Akorn aided and abetted the alleged breaches. The Karant complaint sought, among other things, injunctive relief enjoining the defendants from completing the Merger and directing the defendants to account to the plaintiff and the purported class for damages allegedly sustained, and an award of fees, expenses and costs. In addition, a putative class action lawsuit was filed in Suffolk County, New York, captioned Wackstein v. Hi-Tech Pharmacal Co., Inc., et al., Index No. 063450/2013, similarly alleging, among other things, that Hi-Tech and Hi-Tech’s board of directors breached their fiduciary duties and that Akorn aided and abetted the alleged breaches. The Wackstein complaint sought, among other things, injunctive relief enjoining the defendants from completing the Merger and directing the defendants to account to the plaintiff and the purported class for damages.  The defendants entered into a memorandum of understanding with plaintiff’s counsel, dated November 26, 2013, in connection with the Karant and Wackstein actions (the “Memorandum of Understanding”), pursuant to which Hi-Tech, Akorn, the other named defendants and Wackstein agreed to dismiss the Wackstein action with prejudice effective with the settlement and dismissal of the Karant lawsuit. On July 30, 2014 the Delaware Court entered judgment, granted final settlement approval, and dismissed the action.

In May 2013, Inspire received a Notice Letter that Mylan Pharmaceuticals, Inc (“Mylan”), had filed an ANDA with the FDA seeking marketing approval for a 1% azithromycin ophthalmic solution (the “Mylan Product’) prior to the expiration of the five U.S. patents licensed to us and listed in the Orange Book for AzaSite.  On June 14, 2013, Insite, Merck, Inspire and Prizer filed a complaint against Mylan and a related entity alleging that their proposed product infringes the listed patents.  The Company intends to vigorously contest any Mylan assertions that these patents are invalid or unenforceable.
 
On December 12, 2012, plaintiff Linda Hoover, on behalf of herself and all others similarly situated, brought a class action lawsuit against Hi-Tech in the Superior Court for the State of California, which Hi-Tech removed to the U.S. District Court for the Central District of California, Civil Action No. 5:2013-0097, alleging that Hi-Tech’s marketing and sales of its Nasal Ease ®  product is a violation of various state statutes, including the Consumer Legal Remedies Act, California’s False Advertising Law and Unlawful, Fraudulent & Unfair Business Practices Act. Hi-Tech answered the complaint on January 14, 2013. The parties have reached a settlement in this action as set forth in the Class Action Settlement Agreement, dated as of August 15, 2013. On April 8, 2014 the Court entered judgment, granted final settlement approval, and dismissed the action.

As previously disclosed, on September 12, 2012, Fera Pharmaceuticals, LLC (“Fera”) filed a civil complaint against the Company and certain individual defendants in the Supreme Court of New York. On October 15, 2012, the case was removed to the Federal District Court for the Southern District of New York, and subsequently, Fera filed an amended complaint. The complaint alleges, among other things, breach of manufacturing and confidentiality agreements, fraud in the inducement and misappropriation of the plaintiff’s trade secrets.  The Company intends to vigorously defend these allegations. However, no assurance may be given regarding the ultimate outcome of this lawsuit.
 
On June 8, 2012, plaintiff Mathew Harrison, on behalf of himself and all others similarly situated, brought a class action lawsuit, Civil Action No. 12-2897, in the U.S. District Court for the Eastern District of New York, against Wayne Perry, Dynova Laboratories, Inc., Sicap Industries, LLC, Walgreens Co. and Hi-Tech. On May 16, 2012, plaintiff David Delre, on behalf of himself and all others similarly situated, brought a class action lawsuit, Civil Action No. 12-2429, in the U.S. District Court for the Eastern District of New York, against Wayne Perry, Dynova Laboratories, Inc., Sicap Industries, LLC, and Hi-Tech. Each complaint alleges, among other things, that their Sinus Buster ® products are improperly marketed, labeled and sold as homeopathic products, and that these allegations support claims of fraud, unjust enrichment, breach of express and implied warranties and alleged violations of various state and federal statutes. Hi-Tech answered the complaints on July 17, 2012 and June 26, 2012, respectively, and asserted cross-claims against the other defendants, except Walgreens which was dismissed from this case. The Court consolidated these two cases into one action entitled Sinus Buster Products Consumer Litigation. Discovery commenced in the consolidated case. Dynova has filed for bankruptcy. The case has now been settled by Hi-Tech with plaintiffs by Agreement dated December 16, 2013. A motion for preliminary approval was submitted on December 16, 2013. A motion for reconsideration was submitted on January 24, 2014. The Court has preliminarily approved the settlement by a revised Order dated February 4, 2014.

In April 2011, Inspire Pharmaceuticals, Inc., a wholly-owned subsidiary of Akorn, Inc. acquired through a business combination on November 15, 2013 (“Inspire”), received a Notice letter from Sandoz, Inc. (“Sandoz”) providing notice that Sandoz has filed an Abbreviated New Drug Application (ANDA) with the FDA seeking marketing approval for a 1% azithromycin ophthalmic solution prior to the expiration of the five U.S. patents licensed to us and listed in the Orange Book for AzaSite.  On May 26, 2011, Merck, Insite Vision Incorporated (“InSite”) and Pfizer filed a complaint against Sandoz and related entities in the district court of New Jersey alleging that their proposed product infringes the listed patents.  On October 4, 2013, the court issued judgment in favor of Inspire and the other plaintiffs finding all the asserted claims of the patents in the litigation valid and infringed by Sandoz and related entities.  Sandoz has appealed this decision.  The Company intends to vigorously contest any Sandoz assertions that these patents should have been found not infringed, invalid or unenforceable.
 
[29]

 
On February 9, 2010, in the United States District Court for the District of Massachusetts (the “Federal District Court”), a “Partial Unsealing Order” was issued and unsealed in a civil case, that was subsequently amended naming several pharmaceutical companies as defendants under the qui tam provisions of the federal civil False Claims Act (the “Qui Tam Complaint”).  The Complaint alleges that several pharmaceutical companies submitted false records or statements to the United States through the Center for Medicare and Medicaid Services (“CMS”) and thereby caused false claims for payments to be made through state Medicaid Reimbursement programs for unapproved or ineffective drugs or for products that are not drugs at all. The Complaint alleges that the drugs were “New Drugs” that the FDA had not approved and that are expressly excluded from the definition of “Covered Outpatient Drugs”, which would have rendered them eligible for Medicaid reimbursement. The Complaint alleges these actions violate the federal civil False Claims Act. The Revised Corrected Seventh Amended Complaint did not name Hi-Tech as a defendant.
 
On February 9, 2010, the Court also unsealed the “United States’ Notice of Partial Declination” in which the government determined not to intervene On July 25, 2011, the Court issued an order stating, among other things, that all parties agreed that the only defendant against whom the United States has elected to intervene is the previously unnamed defendant.  On February 25, 2013, the Court issued a decision granting the motion that had been filed by Hi-Tech and other defendants to dismiss the Complaint, which could be subject to appeal.
 
NOTE 13 — CUSTOMER AND SUPPLIER CONCENTRATION

Customer Concentrations

A significant percentage of the Company’s sales are to three (3) large wholesale drug distributors:  AmerisourceBergen Health Corporation; Cardinal Health, Inc.; and McKesson Drug Company.  These three wholesalers (the “Big 3 Wholesalers”) are all distributors of the Company’s products, as well as suppliers of a broad range of health care products.  The following table sets forth the percentage of the Company’s gross accounts receivable as of June 30, 2014 and December 31, 2013, and the gross and net sales for the three and six month periods ended June 30, 2014 and 2013, attributable to the Big 3 Wholesalers:
 
   
Three months ended June 30,
   
Six months ended June 30,
 
Big 3 Wholesalers combined:
 
2014
   
2013
   
2014
   
2013
 
Percentage of gross sales
    70 %     57 %     67 %     58 %
Percentage of net sales revenues
    53 %