AKORN INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE YEAR ENDED DECEMBER 31, 2002

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

Commission File Number: 0-13976

AKORN, INC.
(Name of registrant as specified in its charter)

LOUISIANA 72-0717400
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)

2500 MILLBROOK DRIVE, BUFFALO GROVE, ILLINOIS 60089
(Address of principal executive offices and zip code)

REGISTRANT'S TELEPHONE NUMBER: (847) 279-6100

SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
None

SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
Common Stock, No Par Value
(Title of Class)

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act 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
- --- No

Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained in this form, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes
- --- No

The aggregate market value of the voting stock of the Registrant held by
non-affiliates (affiliates being, for these purposes only, directors, executive
officers and holders of more than 5% of the Registrant's common stock) of the
Registrant as of April 28, 2003 was approximately $12,882,647.

The number of shares of the Registrant's common stock, no par value per share,
outstanding as of May 12, 2003 was 19,729,759.

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FORWARD-LOOKING STATEMENTS AND FACTORS AFFECTING FUTURE RESULTS

Certain statements in this Form 10-K constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act.
When used in this document, the words "anticipate," "believe," "estimate" and
"expect" and similar expressions are generally intended to identify
forward-looking statements. Any forward-looking statements, including statements
regarding the intent, belief or expectations of the Company or its management
are not guarantees of future performance. These statements involve risks and
uncertainties and actual results may differ materially from those in the
forward-looking statements as a result of various factors, including but not
limited to:

- the Company's ability to restructure or refinance its debt to its senior
lenders, which is currently in default, but subject to a forbearance
agreement;

- the Company's ability to obtain further extensions of the forbearance
agreement which originally expired on January 3, 2003, but has
subsequently been extended for successive short-term periods, the latest
of which expires on June 30, 2003;

- the Company's ability to avoid further defaults under debt covenants;

- the Company's ability to generate cash from operations sufficient to
meet its working capital requirements;

- the Company's ability to obtain additional funding to operate and grow
its business;

- the Company's ability to resolve its Food and Drug Administration
compliance issues at its Decatur, Illinois facility;

- the effects of federal, state and other governmental regulation of the
Company's business;

- the Company's success in developing, manufacturing and acquiring new
products;

- the Company's ability to bring new products to market and the effects of
sales of such products on the Company's financial results;

- the effects of competition from generic pharmaceuticals and from other
pharmaceutical companies;

- availability of raw materials needed to produce the Company's products;
and

- other factors referred to in this Form 10-K and the Company's other
Securities and Exchange Commission filings.

See "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Factors That May Affect Future Results". The
Company does not intend to update these forward looking statements.

1

FORM 10-K TABLE OF CONTENTS

2

PART I

ITEM 1. DESCRIPTION OF BUSINESS

Akorn, Inc. ("Akorn" or the "Company") manufactures and markets diagnostic
and therapeutic pharmaceuticals in specialty areas such as ophthalmology,
rheumatology, anesthesia and antidotes, among others. Customers include
physicians, optometrists, wholesalers, group purchasing organizations and other
pharmaceutical companies. Akorn is a Louisiana corporation founded in 1971 in
Abita Springs, Louisiana. In 1997, the Company relocated its headquarters and
certain operations to Illinois.

As described more fully herein, the Company has had three consecutive years
of operating losses, is in default under its existing credit agreement and is a
party to governmental proceedings and potential claims by the Food and Drug
Administration ("FDA") that could have material adverse effect on the Company.
Although the Company has entered into a Forbearance Agreement with its senior
lenders and obtained extensions thereof through June 30, 2003, is working with
the FDA to favorably resolve such proceedings, has appointed a new interim chief
executive officer and implemented other management changes and has taken
additional steps to return to profitability, there is substantial doubt about
the Company's ability to continue as a going concern. The Company's ability to
continue as a going concern is dependent upon its ability to (i) continue to
finance it current cash needs, (ii) continue to obtain extensions of the
Forbearance Agreement, (iii) successfully resolve the ongoing governmental
proceeding with the FDA and (iv) ultimately refinance its senior bank debt and
obtain new financing for future operations and capital expenditures. See Item
7.- "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Financial Condition and Liquidity."

The Company classifies its operations into three identifiable business
segments, ophthalmic, injectable and contract services. These three segments are
discussed in greater detail below. For information regarding revenues and gross
profit for each of the Company's segments, see Note L "Segment Information" to
the consolidated financial statements included in Item 8 of this report.

Ophthalmic Segment. The Company markets a line of diagnostic and
therapeutic ophthalmic pharmaceutical products. Diagnostic products, primarily
used in the office setting, include mydriatics and cycloplegics, anesthetics,
topical stains, gonioscopic solutions, angiography dyes and others. Therapeutic
products, sold primarily to wholesalers and other national account customers,
include antibiotics, anti-infectives, steroids, steroid combinations, glaucoma
medications, decongestants/antihistamines and anti-edema medications.
Non-pharmaceutical products include various artificial tear solutions,
preservative-free lubricating ointments, lid cleansers, vitamin supplements and
contact lens accessories. The Company exited the surgical products business in
late 2002. The impact was not material to the Company's financial results.

Injectable Segment. The Company markets a line of specialty injectable
pharmaceutical products, including anesthesia and products used in the treatment
of rheumatoid arthritis and pain management. These products are marketed to
wholesalers and other national account customers as well as directly to medical
specialists.

Contract Services Segment. The Company manufactures products for third
party pharmaceutical and biotechnology customers based on their specifications.

Manufacturing. The Company has two manufacturing facilities located in
Decatur, Illinois and Somerset, New Jersey. See "Item 2. Description of
Property." The Company manufactures a diverse group of sterile pharmaceutical
products, including solutions, ointments and suspensions for its ophthalmic and
injectable segments. The Decatur facilities manufacture product for all three of
the Company's segments. The Somerset facility manufactures product for the
ophthalmic segment. The Company is also in the process of adding freeze-dried
(lyophilized) manufacturing capabilities at its Decatur facility. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Factors That May Affect Future Results -- Dependence on
Development of Pharmaceutical Products and Manufacturing Capabilities."

3

Sales and Marketing. While the Company is working to expand its proprietary
product base through internal development, the majority of current products are
non-proprietary. The Company relies on its efforts in marketing, distribution,
development and low cost manufacturing to maintain and increase market share.

The ophthalmic segment uses a three-tiered sales effort. Outside sales
representatives sell directly to physicians and group practices. In-house sales
(telemarketing) and customer service (catalog sales) sell to optometrists and
other customers. A national accounts group sells to wholesalers, retail chains
and other group purchasing organizations. This national accounts group also
markets the Company's injectable pharmaceutical products, which the Company also
sells through telemarketing and direct mail activities to individual specialty
physicians and hospitals. The contract services segment markets its contract
manufacturing services through direct mail, trade shows and direct industry
contacts.

Research and Development. As of December 31, 2002, the Company had 19
Abbreviated New Drug Applications ("ANDAs") for generic pharmaceuticals in
various stages of development. The Company filed 12 of these ANDAs along with a
New Drug Application ("NDA") supplement in 2002. See "Government Regulation."
The Company plans to continue to file ANDAs on a regular basis as pharmaceutical
products come off patent allowing the Company to compete by marketing generic
equivalents. However, unless and until the issues pending before the FDA with
respect to the Company are favorably resolved, it is doubtful that the FDA will
approve any NDAs or ANDAs submitted by the Company. The FDA approved the NDA for
Paremyd, on December 5, 2001, which was launched during the first quarter of
2002.

In the fourth quarter of 2002, the Company completed a phase 1 clinical
trial on nine patients using a new, patent pending formulation of indocyanine
green ("ICG") for the indication in Age Related Macular Degeneration ("AMD").
Additionally, in 2002, the Company was issued two U.S. patents, #6,351,663 and
#6,443,976 relating to ICG and the diagnosis and treatment of abnormal
vasculature. If the Company's developmental efforts are successful, the Company
currently anticipates filing an NDA within the next four years. The Company also
anticipates filing an NDA supplement within the next three years for an
indication for ICG for intra-ocular staining.

On February 18, 2003, the Company announced that it had received approval
from the FDA for its ANDA for Lidocaine Jelly, 2% ("Lidocaine Jelly"), a
bioequivalent to Xylocaine Jelly (R), a product of AstraZeneca PLC used
primarily as a topical anesthetic by urologists and hospitals. According to
industry sources, it is estimated that the total annual U.S. market for
comparable products was approximately $30 million in 2002. The Company
anticipates that its product, which will be manufactured at its Somerset, New
Jersey facility, will be commercially available in the second quarter of 2003.

Pre-clinical and clinical trials required in connection with the
development of pharmaceutical products are performed by contract research
organizations under the direction of Company personnel. No assurance can be
given as to whether the Company will file NDAs, or any ANDAs, when anticipated,
whether the Company will develop marketable products based on these filings or
as to the actual size of the market for any such products. See "Government
Regulation" and "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Factors That May Affect Future
Results -- Dependence on Development of Pharmaceutical Products and
Manufacturing Capabilities."

The Company also maintains a business development program that identifies
potential product acquisition or product licensing candidates. The Company has
focused its business development efforts on niche products that complement its
existing product lines and that have few or no competitors in the market. In
2000, the Company entered into an exclusive cross marketing agreement with
Novadaq Technologies, Inc. for cardiac angiography procedures employing ICG.
Under the terms of the agreement, as amended on January 25, 2002, Novadaq will
assume all further costs associated with development of the technology. The
Company, in consideration of foregoing any share of future net profits, obtained
an equity ownership interest in Novadaq and the right to be the exclusive
supplier of ICG for use in Novadaq's diagnostic procedures.

At December 31, 2002, 12 full-time employees of the Company were involved
in research and development and product licensing.

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Research and development costs are expensed as incurred. Such costs
amounted to $1,886,000, $2,598,000 and $4,132,000 for the years ended December
31, 2002, 2001 and 2000, respectively.

Patents and Proprietary Rights. The Company considers the protection of
discoveries in connection with its development activities important to its
business. The Company has sought, and intends to continue to seek, patent
protection in the United States and selected foreign countries where deemed
appropriate. As of December 31, 2002, the Company had received six U.S. patents
and had two additional U.S. patent applications and one international patent
application pending. In February of 2002, the U.S. Patent and Trademark Office
notified the Company that U.S. patent number 6,351,663 titled "Methods for
diagnosing and treating abnormal vasculature using fluorescent dye angiography
and dye enhanced photocoagulation" had been issued to the Company. Two of the
patents held by the Company cover ophthalmic products and processes under
development and the remaining four patents are methods patents relating to a
currently marketed injectable product.

The Company had also licensed two U.S. patents from the Johns Hopkins
University, Applied Physics Laboratory ("JHU/APL") for the development and
commercialization of AMD diagnosis and treatment using ICG. However, a dispute
arose between the Company and JHU/APL regarding the two patents licensed for AMD
and the Company's performance required by December 31, 2001 under the terms of
the applicable License Agreement. In July 2002, the Company and JHU/APL agreed
to terminate their license agreement and as a result, the Company no longer has
any rights to the JHU/APL patents. See "Item 3. Legal Proceedings." Although the
Company has relinquished its rights to the JHU/APL Patents, the Company is
actively pursuing alternative treatment methods for AMD using ICG. There can be
no assurance that the Company will obtain U.S. or foreign patents or, if
obtained, that they will provide substantial protection or be of commercial
benefit.

The Company also relies upon trademarks, trade secrets, unpatented
proprietary know-how and continuing technological innovation to maintain and
develop its competitive position. The Company enters into confidentiality
agreements with certain of its employees pursuant to which such employees agree
to assign to the Company any inventions relating to the Company's business made
by them while in the Company's employ. However, there can be no assurance that
others may not acquire or independently develop similar technology or, if
patents are not issued with respect to products arising from research, that the
Company will be able to maintain information pertinent to such research as
proprietary technology or trade secrets. See "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Factors That
May Affect Future Results -- Patents and Proprietary Rights".

Employee Relations. At December 31, 2002, the Company had 326 full-time
employees, 290 of whom were employed by Akorn and 36 by its wholly owned
subsidiary, Akorn (New Jersey), Inc. The Company enjoys good relations with its
employees, none of whom are represented by a collective bargaining agent.

Competition. The marketing and manufacturing of pharmaceutical products is
highly competitive, with many established manufacturers, suppliers and
distributors actively engaged in all phases of the business. Most of the
Company's competitors have substantially greater financial and other resources,
including greater sales volume, larger sales forces and greater manufacturing
capacity. See "Item 7. Management's Discussion and Analysis of Operations --
Factors That May Affect Future Results -- Competition; Uncertainty of
Technological Change."

The companies that compete with the ophthalmic segment include Alcon
Laboratories, Inc., Allergan Pharmaceuticals, Inc., Ciba Vision and Bausch &
Lomb, Inc. ("B&L"). The ophthalmic segment competes primarily on the basis of
price and service. The ophthalmic segment purchases some ophthalmic products
from B&L, who is in direct competition with the Company in several markets.

The companies that compete with the injectable segment include both generic
and name brand companies such as Abbott Laboratories, Gensia, American
Pharmaceutical Products, Elkin Sinn and American Regent. The injectable segment
competes primarily on the basis of price.

Competitors in the contract services segment include Cook Imaging (Baxter),
Chesapeake Biological Laboratories and Ben Venue. The contract services segment
competes primarily on the basis of price and
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technical capabilities. The manufacturing of products in all three segments must
be performed under government mandated Current Good Manufacturing Practices
("cGMP").

Suppliers and Customers. No supplier of products accounted for more than
10% of the Company's purchases in 2002, 2001 or 2000. The Company requires a
supply of quality raw materials and components to manufacture and package
pharmaceutical products for itself and for third parties with which it has
contracted. The principal components of the Company's products are active and
inactive pharmaceutical ingredients and certain packaging materials. Many of
these components are available from only a single source and, in the case of
many of the Company's ANDAs and NDAs, only one supplier of raw materials has
been identified. Because FDA approval of drugs requires manufacturers to specify
their proposed suppliers of active ingredients and certain packaging materials
in their applications, FDA approval of any new supplier would be required if
active ingredients or such packaging materials were no longer available from the
specified supplier. The qualification of a new supplier could delay the
Company's development and marketing efforts. If for any reason the Company is
unable to obtain sufficient quantities of any of the raw materials or components
required to produce and package its products, it may not be able to manufacture
its products as planned, which could have a material adverse effect on the
Company's business, financial condition and results of operations. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Factors That May Affect Future Results -- Dependence on Supply of
Raw Materials and Components".

A small number of large wholesale drug distributors account for a large
portion of the Company's gross sales, revenues and accounts receivable. Those
distributors are:

- AmerisourceBergen Corporation ("AmerisourceBergen"), which was formed in
2001 by the merger of AmeriSource Health Corporation and Bergen Brunswig
Corporation;

- Cardinal Health, Inc. ("Cardinal"); and

- McKesson Drug Company ("McKesson").

These three wholesale drug distributors accounted for approximately 57% of
total gross sales and 42% of revenues in 2002, and 61% of gross accounts
receivables as of December 31, 2002. The difference between gross sales and
revenue is that gross sales do not reflect the deductions for chargebacks,
rebates and product returns (See Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Critical Accounting Policies).
The percentages of gross sales, revenue and gross trade receivables attributed
to each of these three wholesale drug distributors for the years ended December
31, 2002 and December 31, 2001 were as follows:

AmerisourceBergen, Cardinal and McKesson are distributors of the Company's
products as well as a broad range of health care products for many other
companies. None of these distributors is an end user of the Company's products.
If sales to any one of these distributors were to diminish or cease, the Company
believes that the end users of its products would find little difficulty
obtaining the Company's products either directly from the Company or from
another distributor. However, the loss of one or more of these customers,
together with a delay or inability to secure an alternative distribution source
for end users, could have a material negative impact on the Company's revenue
and results of operations and lead to a violation of debt covenants. A change in
purchasing patterns, an increase in returns of the Company's products, delays in
purchasing products and delays in payment for products by one or more
distributors also could have a material negative impact on the Company's revenue
and results of operations and lead to a violation of debt covenants. See "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Factors That May Affect Future Results -- Dependence on Small
Number of Distributors."

6

Backorders. As of December 31, 2002, the Company had approximately $5.4
million of products on backorder as compared to approximately $4.0 million of
backorders as of December 31, 2001. This increase in backorders is due the fact
that one of the Company's production rooms at it's Decatur, Illinois facility
was not fully operational in the fourth quarter of 2002 pending requalification
under cGMP of that production room. The Company anticipates filling all open
backorders during 2003.

Government Regulation. Pharmaceutical manufacturers and distributors are
subject to extensive regulation by government agencies, including the FDA, the
Drug Enforcement Administration ("DEA"), the Federal Trade Commission ("FTC")
and other federal, state and local agencies. The federal Food, Drug and Cosmetic
Act (the "FDC Act"), the Controlled Substance Act and other federal statutes and
regulations govern or influence the development, testing, manufacture, labeling,
storage and promotion of products. The FDA inspects drug manufacturers and
storage facilities to determine compliance with its cGMP regulations,
non-compliance with which can result in fines, recall and seizure of products,
total or partial suspension of production, refusal to approve new drug
applications and criminal prosecution. The FDA also has the authority to revoke
approval of drug products.

FDA approval is required before any drug can be manufactured and marketed.
New drugs require the filing of an NDA, including clinical studies demonstrating
the safety and efficacy of the drug. Generic drugs, which are equivalents of
existing, off-patent brand name drugs, require the filing of an ANDA. An ANDA
does not, for the most part, require clinical studies since safety and efficacy
have already been demonstrated by the product originator. However, the ANDA must
provide data demonstrating the equivalency of the generic formulation in terms
of bioavailability. The time required by the FDA to review and approve NDA's and
ANDA's is variable and essentially beyond the control of the Company.

In October 2000, the FDA issued a warning letter to the Company following
the FDA's routine cGMP inspection of the Company's Decatur manufacturing
facilities. An FDA warning letter is intended to provide notice to a company of
violations of the laws administered by the FDA. Its primary purpose is to elicit
voluntary corrective action. The letter warns that if voluntary action is not
forthcoming, the FDA may use other legal means to compel compliance. These
include seizure of products and/or injunction of the company and responsible
individuals. The October, 2000 warning letter addressed several deviations from
regulatory requirements including general documentation and cleaning validation
issues and requested corrective actions be undertaken by the Company. The
Company initiated corrective actions and responded to the warning letter.
Subsequently, the FDA conducted another inspection in late 2001 and identified
additional deviations from regulatory requirements including cleaning validation
and process control issues. This led to the FDA leaving the warning letter in
place and issuing a Form 483 to document its findings. While no further
correspondence was received from the FDA, the Company responded to the
inspectional findings. This response described the Company's plan for addressing
the issues raised by the FDA and included improved cleaning validation, enhanced
process controls and approximately $2.0 million of capital improvements. In
August 2002, the FDA conducted an inspection of the Decatur facility and
identified deviations from cGMPs. The Company responded to these observations in
September 2002. In response to the Company's actions, the FDA conducted another
inspection of the Decatur facility during the period from December 10, 2002 to
February 6, 2003. This inspection identified deviations from regulatory
requirements including the manner in which the Company processes and
investigates manufacturing discrepancies and failures, customer complaints and
the thoroughness of equipment cleaning validations. Deviations identified during
this inspection had been raised in previous FDA inspections. The Company has
responded to these latest findings in writing and in a meeting with the FDA in
March 2003. The Company set forth its plan for implementing comprehensive
corrective actions, provided a progress report to the FDA on April 15 and May
15, 2003 and has committed to providing the FDA an additional periodic report of
progress on June 15, 2003.

As a result of the latest inspection and the Company's response, the FDA
may take any of the following actions: (i) accept the Company's reports and
response and take no further action against the Company; (ii) permit the Company
to continue its corrective actions and conduct another inspection (which likely
would not occur before the fourth quarter of 2003) to assess the success of
these efforts; (iii) seek to enjoin the Company from further violations, which
may include temporary suspension of some or all operations and

7

potential monetary penalties; or (iv) take other enforcement action which may
include seizure of Company products. At this time, it is not possible to predict
the FDA's course of action.

The Company believes that unless and until the FDA chooses option (i) or,
in the case of option (ii), unless and until the issues identified by the FDA
have been successfully corrected and the corrections have been verified through
reinspection, it is doubtful that the FDA will approve any NDAs or ANDAs that
may be submitted by the Company. This has adversely impacted, and is likely to
continue to adversely impact the Company's ability to grow sales. However, the
Company believes that unless and until the FDA chooses option (iii) or (iv), the
Company will be able to continue manufacturing and distributing its current
product lines.

If the FDA chooses option (iii) or (iv), such action could significantly
impair the Company's ability to continue to manufacture and distribute its
current product line and generate cash from its operations, could result in a
covenant violation under the Company's senior debt or could cause the Company's
senior lenders to refuse further extensions of the Company's senior debt, any or
all of which would have a material adverse effect on the Company's liquidity.
Any monetary penalty assessed by the FDA also could have a material adverse
effect on the Company's liquidity. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operation -- Financial Condition
and Liquidity".

In February of 2003, the Company recalled two products, Fluress and
Fluoracaine, due to container/ closure integrity problems resulting in leaking
containers. The recall has been classified by the FDA as a Class II recall,
which means that the use of, or exposure to, a violative product may cause
temporary or medically reversible adverse health consequences or that the
probability of serious health consequences as a result of such use or exposure
is remote. To date, the Company has not received any notification or complaints
from end users of the recalled products. Because the Company had curtailed the
production of these items due to the above container/closure integrity issues,
the financial impact to the Company of this recall is not expected to be
material.

In March of 2003, as a result of the most recent FDA inspection, the
Company recalled twenty-four lots of product produced from the period December
2001 to June 2002 in one of its production rooms at its Decatur, Illinois
facility. The majority of the lots recalled were for third party contract
customer products. Subsequent to this decision and after discussions with the
FDA, eight of the original twenty-four lots have been exempted from the recall
due to medical necessity. At this time, the FDA has not reached a conclusion on
the classification of this recall. To date, the Company has not received any
notification or complaints from end users of the recalled products. Due to the
passage of time between the production of theses lots and the recall, the
Company believes that its customers do not hold significant inventories of these
products. As a result, the Company believes the financial impact of this recall
will not be material.

The Company also manufactures and distributes several controlled-drug
substances, the distribution and handling of which are regulated by the DEA.
Failure to comply with DEA regulations can result in fines or seizure of
product. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Factors That May Affect Future Results --
Government Regulation".

On March 6, 2002, the Company received a letter from the United States
Attorney's Office, Central District of Illinois, Springfield, Illinois, advising
the Company that the DEA had referred a matter to that office for a possible
civil legal action for alleged violations of the Comprehensive Drug Abuse
Prevention Control Act of 1970, 21 U.S.C. sec. 801, et. seq. and regulations
promulgated under the Act. The alleged violations relate to record keeping and
controls surrounding the storage and distribution of controlled substances. On
November 6, 2002, the Company entered into a Civil Consent Decree with the DEA.
Under terms of the Civil Consent Decree, the Company, without admitting any of
the allegations in the complaint from the DEA, has agreed to pay a fine of
$100,000, upgrade its security system and to remain in substantial compliance
with the Comprehensive Drug Abuse Prevention Control Act of 1970. If the Company
does not remain in substantial compliance during the two-year period following
the entry of the Civil Consent Decree, the Company, in addition to other
possible sanctions, may be held in contempt of court and ordered to pay an
additional $300,000 fine. See Item 3. "Legal Proceedings".

8

The Company does not anticipate any material adverse effect from compliance
with federal, state and local provisions that have been enacted or adopted
regulating the discharge of materials into the environment, or otherwise
relating to the protection of the environment.

ITEM 2. DESCRIPTION OF PROPERTIES

Since August 1998, the Company's headquarters and certain administrative
offices, as well as a finished goods warehouse, have been located in leased
space at 2500 Millbrook Drive, Buffalo Grove, Illinois. The Company leased
approximately 24,000 square feet until June 2000 at which time it expanded to
the current occupied space of approximately 48,000 square feet. From May 1997 to
August 1998, the Company's headquarters and ophthalmic division offices were
located in approximately 11,000 square feet of leased space in Lincolnshire,
Illinois. The Company sublets portions of the space leased in Lincolnshire. The
Company's former headquarters, consisting of approximately 30,000 square feet
located on ten acres of land in Abita Springs, Louisiana, was sold in February
1999.

The Company owns a 76,000 square foot facility located on 15 acres of land
in Decatur, Illinois. This facility is currently used for packaging,
distribution, warehousing and office space. In addition, the Company owns a
55,000 square-foot manufacturing facility in Decatur, Illinois. The Decatur
facilities support all three of the Company's segments. The Company leases
approximately 7,000 square feet of office and warehousing space in San Clemente,
California, formerly used as a sales office to support the Injectable segment.
The Company successfully sublet this space through the term of the lease when
the San Clemente operations were closed and relocated to Buffalo Grove in July
of 2001. The Company's Akorn (New Jersey) subsidiary also leases approximately
40,000 square feet of space in Somerset, New Jersey. This space is used for
manufacturing, research and development and administrative activities related to
the ophthalmic segment. The Company does not have any idled manufacturing
facilities, however, the capacity utilization at both its Decatur and Somerset
facilities was approximately 50% during the year ended December 31, 2002. The
Company can produce approximately 65 batches, per month, at full capacity.
Operating the manufacturing facilities at the reduced level has contributed to
the generation of negative manufacturing variances.

The Company is in the process of completing an expansion of its Decatur,
Illinois facility to add capacity to provide Lyophilization manufacturing
services, which manufacturing capability the Company currently does not have.
Subject to the Company's ability to refinance its senior debt and obtain new
financing for future operations and capital expenditures, the Company
anticipates the completion of the Lyophilization expansion in the second half of
2004. As of December 31, 2002, the Company had spent approximately $16.4 million
on the expansion and anticipates the need to spend approximately $1.0 million of
additional funds (excluding capitalized interest) to complete the expansion. The
majority of the additional spending will be focused on validation testing of the
Lyophilization facility as the major capital equipment items are currently in
place. Once the Lyophilization facility is validated, the Company will proceed
to produce stability batches to provide the data necessary to allow the
Lyophilization facility to be inspected and approved by the FDA.

The current combined space is considered adequate to accommodate the
Company's manufacturing needs for the foreseeable future. Lyophilization
capabilities are not currently needed by the Company, but would give the Company
the capability to manufacture additional products for its contract customers and
allow the Company to internally produce one of its currently outsourced
products.

ITEM 3. LEGAL PROCEEDINGS

On March 27, 2002, the Company received a letter informing it that the
staff of the SEC's regional office in Denver, Colorado, would recommend to the
SEC that it bring an enforcement action against the Company and seek an order
requiring the Company to be enjoined from engaging in certain conduct. The staff
alleged that the Company misstated its income for fiscal years 2000 and 2001 by
allegedly failing to reserve for doubtful accounts receivable and overstating
its accounts receivable balance as of December 31, 2000. The staff alleged that
internal control and books and records deficiencies prevented the Company from
accurately recording, reconciling and aging its accounts receivable. The Company
also learned that certain of its former officers, as well as a then current
employee had received similar notifications. Subsequent to the issuance of the
Company's consolidated financial statements for the year ended December 31,
2001, management of the
9

Company determined it needed to restate the Company's financial statements for
2000 and 2001 to record a $7.5 million increase to the allowance for doubtful
accounts as of December 31, 2000, which it had originally recorded as of March
31, 2001.

On February 27, 2003, the Company reached an agreement in principle with
the staff of the SEC's regional office in Denver, Colorado, that would resolve
the issues arising from the staff's investigation and proposed enforcement
action as discussed above. The Company has offered to consent to the entry of an
administrative cease and desist order as proposed by the staff, without
admitting or denying the findings set forth therein. The proposed consent order
finds that the Company failed to promptly and completely record and reconcile
cash and credit remittances, including from its top five customers, to invoices
posted in its accounts receivable sub-ledger. According to the findings in the
proposed consent order, the Company's problems resulted from, among other
things, internal control and books and records deficiencies that prevented the
Company from accurately recording, reconciling and aging its receivables. The
proposed consent order finds that the Company's 2000 Form 10-K and first quarter
2001 Form 10-Q misstated its account receivable balance or, alternatively,
failed to disclose the impairment of its accounts receivable and that its first
quarter 2001 Form 10-Q inaccurately attributed the increased accounts receivable
reserve to a change in estimate based on recent collection efforts, in violation
of Section 13(a) of the Exchange Act and rules 12b-20, 13a-1 and 13a-13
thereunder. The proposed consent order also finds that the Company failed to
keep accurate books and records and failed to devise and maintain a system of
adequate internal accounting controls with respect to its accounts receivable in
violation of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act. The
proposed consent order does not impose a monetary penalty against the Company or
require any additional restatement of the Company's financial statements. The
Company has recently become aware of and informed the SEC staff of certain
weaknesses in its internal controls, which it is in the process of addressing.
It is uncertain at this time what effect these actions will have on the
agreement in principle currently pending with the SEC staff. The proposed
consent order does not become final until it is approved by the SEC.
Accordingly, the Company may incur additional costs and expenses in connections
with this proceeding.

The Company was party to a License Agreement with JHU/APL effective April
26, 2000, and amended effective July 15, 2001 (See Note C -- "Product and Other
Acquisitions" to the consolidated financial statements included in Item 8).
Pursuant to the License Agreement, the Company licensed two patents from JHU/APL
for the development and commercialization of a diagnosis and treatment for
age-related macular degeneration ("AMD") using Indocyanine Green ("ICG"). A
dispute arose between the Company and JHU/APL concerning the License Agreement.
Specifically, JHU/APL challenged the Company's performance required by December
31, 2001 under the License Agreement and alleged that the Company was in breach
of the License Agreement. The Company denied JHU/APL's allegations and contended
that it had performed in accordance with the terms of the License Agreement. As
a result of the dispute, on March 29, 2002, the Company commenced a lawsuit in
the U.S. District Court for the Northern District of Illinois, seeking
declaratory and other relief against JHU/APL. On July 3, 2002, the Company
reached an agreement with JHU/APL with regard to the dispute that had risen
between the two parties. The Company and JHU/APL mutually agreed to terminate
their license agreement. As a result, the Company no longer has any rights to
the JHU/APL patent rights as defined in the license agreement. In exchange for
relinquishing its rights to the JHU/APL patent rights, the Company received an
abatement of the $300,000 due to JHU/APL at March 31, 2002 and a payment of
$125,000 to be received by August 3, 2002. The Company also has the right to
receive 15% of all cash payments and 20% of all equity received by JHU/APL from
any license of the JHU/APL patent rights less any cash or equity returned by
JHU/APL to such licensee. The combined total of all such cash and equity
payments are not to exceed $1,025,000. The $125,000 payment is considered an
advance towards cash payments due from JHU/APL and will be credited against any
future cash payments due the Company as a result of JHU/APL's licensing efforts.
As a result of the resolved dispute discussed above, the Company recorded an
asset impairment charge of $1,559,500 in 2002. The impairment amount represents
the net value of the asset recorded on the balance sheet of the Company less the
$300,000 payment abated by JHU/APL and the $125,000 payment from JHU/APL. The
$125,000 payment was received on August 3, 2002. In the fourth quarter of 2002,
the Company learned that JHU/APL had licensed their two patents related to AMD
to Novadaq Technologies, Inc. ("Novadaq"). In connection with the settlement of
a

10

prior dispute with Novadaq in January 2002 (as discussed below), the Company had
previously acquired an equity interest in Novadaq. Pursuant to the settlement
with JHU/APL, the Company is entitled to 20% of all equity received by Johns
Hopkins from any license of the patent rights. Therefore, the Company received
an additional 132,000 shares of Novadaq, valued at $23,000 which was recorded as
a gain in the fourth quarter of 2002.

In October 2000, the FDA issued a warning letter to the Company following
the FDA's routine cGMP the inspection of the Company's Decatur manufacturing
facilities. This letter addressed several deviations from regulatory
requirements including cleaning validations and general documentation and
requested corrective actions be undertaken by the Company. The Company initiated
corrective actions and responded to the warning letter. Subsequently, the FDA
conducted another inspection in late 2001 and identified additional deviations
from regulatory requirements including process controls and cleaning
validations. This led to the FDA leaving the warning letter in place and issuing
a Form 483 to document its findings. While no further correspondence was
received from the FDA, the Company responded to the inspectional findings. This
response described the Company's plan for addressing the issues raised by the
FDA and included improved cleaning validation, enhanced process controls and
approximately $2.0 million of capital improvements. In August 2002, the FDA
conducted an inspection of the Decatur facility and identified cGMP deviations.
The Company responded to these observations in September 2002. In response to
the Company's actions, the FDA conducted another inspection of the Decatur
facility during the period from December 10, 2002 to February 6, 2003. This
inspection identified deviations from regulatory requirements including the
manner in which the Company processes and investigates manufacturing
discrepancies and failures, customer complaints and the thoroughness of
equipment cleaning validations. Deviations identified during this inspection had
been raised in previous FDA inspections. The Company has responded to these
latest findings in writing and in a meeting with the FDA in March 2003. The
Company set forth its plan for implementing comprehensive corrective actions,
has provided a progress report to the FDA on April 15, and May 15, 2003 and has
committed to providing the FDA an additional periodic report of progress on June
15, 2003.

As a result of the latest inspection and the Company's response, the FDA
may take any of the following actions: (i) accept the Company's reports and
response and take no further action against the Company; (ii) permit the Company
to continue its corrective actions and conduct another inspection (which likely
would not occur before the fourth quarter of 2003) to assess the success of
these efforts; (iii) seek to enjoin the Company from further violations, which
may include temporary suspension of some or all operations and potential
monetary penalties; or (iv) take other enforcement action which may include
seizure of Company products. At this time, it is not possible to predict the
FDA's course of action.

The Company believes that unless and until the FDA chooses option (i) or,
in the case of option (ii), unless and until the issues identified by the FDA
have been successfully corrected and the corrections have been verified through
reinspection, it is doubtful that the FDA will approve any NDAs or ANDAs that
may be submitted by the Company. This has adversely impacted, and is likely to
continue to adversely impact the Company's ability to grow sales. However, the
Company believes that unless and until the FDA chooses option (iii) or (iv), the
Company will be able to continue manufacturing and distributing its current
product lines.

If the FDA chooses option (iii) or (iv), such action could significantly
impair the Company's ability to continue to manufacture and distribute its
current product line and generate cash from its operations, could result in a
covenant violation under the Company's senior debt or could cause the Company's
senior lenders to refuse further extensions of the Company's senior debt, any or
all of which would have a material adverse effect on the Company's liquidity.
Any monetary penalty assessed by the FDA also could have a material adverse
effect on the Company's liquidity. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operation -- Financial Condition
and Liquidity".

On March 6, 2002, the Company received a letter from the United States
Attorney's Office, Central District of Illinois, Springfield, Illinois, advising
the Company that the DEA had referred a matter to that office for a possible
civil legal action for alleged violations of the Comprehensive Drug Abuse
Prevention Control Act of 1970, 21 U.S.C. sec. 801, et. seq. and regulations
promulgated under the Act. The alleged

11

violations relate to record keeping and controls surrounding the storage and
distribution of controlled substances. On November 6, 2002, the Company entered
into a Civil Consent Decree with the DEA. Under terms of the Consent Decree, the
Company, without admitting any of the allegations in the complaint from the DEA,
has agreed to pay a fine of $100,000, upgrade its security system and to remain
in substantial compliance with the Comprehensive Drug Abuse Prevention Control
Act of 1970. If the Company does not remain in substantial compliance during the
two-year period following the entry of the civil consent decree, the Company, in
addition to other possible sanctions, may be held in contempt of court and
ordered to pay an additional $300,000 fine.

On August 9, 2001, the Company was served with a Complaint, which had been
filed on August 8, 2001 in the United States District Court for The Northern
District of Illinois, Eastern Division. The suit named the Company as well as
Mr. Floyd Benjamin, the former president and chief executive officer of the
Company, and Dr. John N. Kapoor, the Company's current chairman of the board and
then interim chief executive officer as defendants. The suit, which was filed by
Michelle Golumbski, individually, and on behalf of all others similarly
situated, alleged various violations of the federal securities laws in
connection with the Company's public statements and filings with the SEC during
the period from February 20, 2001 through May 22, 2001. The plaintiff
subsequently voluntarily dismissed her claims against Akorn, Inc., Mr. Floyd
Benjamin and Dr. John N. Kapoor, and, in exchange for the Company's consent to
this voluntary dismissal, also provided, through counsel, a written statement
that the plaintiff would not reassert her claims against any of the defendants
in any subsequent actions. The Company did not provide the plaintiff with any
compensation in consideration for this voluntary dismissal.

On April 4, 2001, the International Court of Arbitration (the "ICA") of the
International Chamber of Commerce notified the Company that Novadaq had filed a
Request for Arbitration with the ICA on April 2, 2001. Akorn and Novadaq had
previously entered into an Exclusive Cross-Marketing Agreement dated July 12,
2000 (the "Agreement"), providing for their joint development and marketing of
certain devices and procedures for use in fluorescein angiography (the
"Products"). Akorn's drug indocyanine green ("ICG") would be used as part of the
angiographic procedure. The FDA had requested that the parties undertake
clinical studies prior to obtaining FDA approval. In its Request for
Arbitration, Novadaq asserted that under the terms of the Agreement, Akorn
should be responsible for the costs of performing the requested clinical trials,
which were estimated to cost approximately $4,400,000. Alternatively, Novadaq
sought a declaration that the Agreement should be terminated as a result of
Akorn's alleged breach. Finally, in either event, Novadaq sought unspecified
damages as a result of the alleged failure or delay on Akorn's part in
performing its obligations under the Agreement. In its response, Akorn denied
Novadaq's allegations and alleged that Novadaq had breached the agreement. On
January 25, 2002, the Company and Novadaq reached a settlement of the dispute.
Under terms of a revised agreement entered into as part of the settlement,
Novadaq will assume all further costs associated with development of the
technology. The Company, in consideration of foregoing any share of future net
profits, obtained an equity ownership interest in Novadaq, the right to be the
exclusive supplier of ICG for use in Novadaq's diagnostic procedures and the
right to designate a representative on the Novadaq Board of Directors. In
addition, Antonio R. Pera, Akorn's then President and Chief Operating Officer,
was named to Novadaq's Board of Directors. In conjunction with the revised
agreement, Novadaq and the Company each withdrew their respective arbitration
proceedings. Subsequent to the resignation of Mr. Pera on June 7, 2002, the
Company named Ben J. Pothast, its Chief Financial Officer, to fill the vacancy
on the Novadaq Board of Directors created by his departure.

On December 19, 2002 and January 22, 2003, the Company received demand
letters regarding claimed wrongful deaths allegedly associated with the use of
the drug Inapsine, which the Company produced. The total amount of the claims
asserted is $3.8 million. The Company has just begun the investigation of the
facts and circumstances surrounding these claims and cannot as of yet determine
the potential liability, if any, from these claims. The Company has submitted
these claims to its product liability insurance carrier. The Company intends to
vigorously defend itself in regards to these claims.

12

The Company is a party to legal proceedings and potential claims arising in
the ordinary course of its business. The amount, if any, of ultimate liability
with respect to such matters cannot be determined. Despite the inherent
uncertainties of litigation, management of the Company at this time does not
believe that such proceedings will have a material adverse impact on the
financial condition, results of operations, or cash flows of the Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the quarter
ended December 31, 2002.

13

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's Common Stock was traded on the NASDAQ National Market under
the symbol AKRN until June 24, 2002. The Company was notified on that day that,
due to non-compliance with the NASDAQ report filing requirements, the Company's
stock would cease being listed effective the opening of business on June 25,
2002. The non-compliance related to the Company's Form 10-K filing with the SEC
for the year ended December 31, 2001 that contained unaudited financial
statements. Subsequently, the Company's stock has traded in the Over-the-Counter
market and is listed on the Pink Sheets under the symbol AKRN.PK.

On April 28, 2003, there were approximately 609 holders of record of the
Company's Common Stock. This number does not include shareholders for which
shares are held in a 'nominee' or 'street' name. The closing price of the
Company's Common Stock on April 28, 2003 was $0.50 per share.

High and low bid prices for the periods indicated were:

The Company did not pay cash dividends in 2002, 2001 or 2000 and does not
expect to pay dividends on our common stock in the foreseeable future. Moreover,
the Company is currently prohibited by its credit agreement from making any
dividend payment.

14

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth selected consolidated financial information
for the Company for the years ended December 31, 2002, 2001, 2000, 1999 and
1998.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RESULTS OF OPERATIONS

The Company's revenues are derived from sales of diagnostic and therapeutic
pharmaceuticals by the ophthalmic segment, from sales of diagnostic and
therapeutic pharmaceuticals by the injectable segment, and from contract
services revenue. The following table sets forth the percentage relationships
that certain items

15

from the Company's Consolidated Statements of Income bear to revenues for the
years ended December 31, 2002, 2001 and 2000.

CRITICAL ACCOUNTING POLICIES

REVENUE RECOGNITION

The Company recognizes revenue upon the shipment of goods or upon the
delivery of goods, depending on the sales terms. Revenue is recognized when all
obligations of the Company have been fulfilled and collection of the related
receivable is probable. The Company records a provision at the time of sale for
estimated chargebacks, rebates and product returns. Additionally, the Company
maintains an allowance for doubtful accounts and slow moving and obsolete
inventory. These provisions and allowances are analyzed and adjusted, if
necessary, at each balance sheet date.

ALLOWANCE FOR CHARGEBACKS AND REBATES

The Company maintains an allowance for chargebacks and rebates. These
allowances are reflected as a reduction of accounts receivable.

The Company enters contractual agreements with certain third parties such
as hospitals and group-purchasing organizations to sell certain products at
predetermined prices. The parties have elected to have these contracts
administered through wholesalers. When a wholesaler sells products to one of the
third parties that is subject to a contractual price agreement, the difference
between the price to the wholesaler and the price under contract is charged back
to the Company by the wholesaler. The Company tracks sales and submitted
chargebacks by product number for each wholesaler. Utilizing this information,
the Company estimates a chargeback percentage for each product. The Company
reduces gross sales and increases the chargeback allowance by the estimated
chargeback amount for each product sold to a wholesaler. The Company reduces the
chargeback allowance when it processes a request for a chargeback from a
wholesaler. Actual chargebacks processed can vary materially from period to
period.

Prior to March 31, 2001, the Company used historical trends and actual
experience to estimate its chargeback allowance. In May 2001, management
obtained wholesaler inventory reports as of March 31, 2001 to aid in performing
a detailed business review in an effort to better understand its current cash
flow constraints. The Company assessed the reasonableness of its chargeback
allowance by applying the product chargeback percentage based on historical
activity to the quantities of inventory on hand per the wholesaler inventory
reports. The Company had not previously obtained these reports due to the cost
of obtaining such reports and also due to the fact that the Company had not seen
any indication that its historical trends analysis was not reasonable.
Previously management believed that wholesalers maintained limited inventory
levels to balance maintaining available stock for a given product with the cost
of storing such inventory. Accordingly, management previously considered recent
sales activity in estimating wholesaler on-hand inventory levels for

16

the purpose of assessing the reasonableness of the allowance. However, the
reports of wholesaler inventory information suggested that the wholesalers had
greater levels of on-hand inventory than had previously been estimated and the
Company used this new information to enhance its methodology of estimating the
allowance.

Similarly, the Company maintains an allowance for rebates related to
contract and other programs with the wholesalers. The rebate allowance also
reduces gross sales and accounts receivable by the amount of the estimated
rebate amount when the Company sells its products to the wholesalers. The
Company uses historical trends and actual experience to estimate its rebate
allowances. At each balance sheet date, the Company evaluates the allowance
against actual rebates processed and such amount can vary materially from period
to period.

The recorded allowances reflect the Company's current estimate of the
future chargeback and rebate liability to be paid or credited to the wholesaler
under the various contracts and programs. For the years ended December 31, 2002,
2001 and 2000, the Company recorded chargeback and rebate expense of
$15,418,000, $28,655,000, and $29,558,000, respectively. The allowance for
chargebacks and rebates was $4,302,000 and $4,190,000 as of December 31, 2002
and 2001, respectively.

Based upon the wholesaler's March 31, 2001 inventories and historical
chargeback and rebate activity, the Company recorded an allowance of $6,961,000,
which resulted in an expense of $12,000,000 for the three months ended March 31,
2001, as compared to an allowance of $3,296,000 recorded at December 31, 2000.

During the quarter ended June 30, 2001, the Company further refined its
estimates of the chargeback and rebate liability determining that an additional
$2,250,000 provision needed to be recorded. The additional increase to the
allowance was necessary to reflect the continuing shift of sales to customers
who purchase their products through group purchasing organizations and buying
groups. The Company had previously seen a greater level of list price business
than is occurring in the current business environment.

ALLOWANCE FOR PRODUCT RETURNS

The Company also maintains an allowance for estimated product returns. This
allowance is reflected as a reduction of accounts receivable balances. The
Company evaluates the allowance balance against actual returns processed. Actual
returns processed can vary materially from period to period. For the years ended
December 31, 2002, 2001, and 2000 the Company recorded a provision for product
returns of $2,574,000, $4,103,000, and $1,159,000, respectively. The allowance
for potential product returns was $1,166,000 and $548,000 at December 31, 2002
and 2001, respectively.

In addition to considering in process product returns and assessing the
potential implications of historical product return activity, the Company also
considers the wholesaler's inventory information to assess the magnitude of
unconsumed product that may result in a product return to the Company in the
future. Such wholesaler inventory information had not been historically
purchased and therefore, had not been considered in assessing the reasonableness
of the allowance prior to March 31, 2001. Historical returns had not been
significant. Based on the wholesaler's inventory information, which demonstrated
higher levels of on-hand product than previously estimated by management,
combined with increased levels of return activity, the Company increased its
allowance for potential product returns to $2,232,000 at March 31, 2001 from
$232,000 at December 31, 2000. The provision for the three months ended March
31, 2001 was $2,559,000.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

The Company maintains an allowance for doubtful accounts, which reflects
trade receivable balances owed to the Company that are believed to be
uncollectible. This allowance is reflected as a reduction of accounts receivable
balances. In estimating the allowance for doubtful accounts, the Company has:

- Identified the relevant factors that might affect the accounting
estimate for allowance for doubtful accounts, including: (a) historical
experience with collections and write-offs; (b) credit quality of
customers; (c) the interaction of credits being taken for discounts,
rebates, allowances and other adjustments; (d) balances of outstanding
receivables, and partially paid receivables; and
17

(e) economic and other exogenous factors that might affect
collectibility (e.g., bankruptcies of customers, "channel" factors,
etc.).

- Accumulated data on which to base the estimate for allowance for
doubtful accounts, including: (a) collections and write-offs data; (b)
information regarding current credit quality of customers; and (c)
information regarding exogenous factors, particularly in respect of
major customers.

- Developed assumptions reflecting management's judgments as to the most
likely circumstances and outcomes, regarding, among other matters: (a)
collectibility of outstanding balances relating to "partial payments;"
(b) the ability to collect items in dispute (or subject to
reconciliation) with customers; and (c) economic and other exogenous
factors that might affect collectibility of outstanding
balances -- based upon information available at the time.

For the years ended December 31, 2002, 2001 and 2000, the Company recorded
a provision (recovery) for doubtful accounts of ($55,000), $4,480,000, and
$8,127,000, respectively. The allowance for doubtful accounts was $1,200,000 and
$3,706,000 as of December 31, 2002 and 2001, respectively. As of December 31,
2002, the Company had a total of $2,592,000 of past due gross accounts
receivable, of which $674,000 was over 60 days past due. The Company performs
monthly a detailed analysis of the receivables due from its wholesaler customers
and provides a specific reserve against known uncollectible items for each of
the wholesaler customers. The Company also includes in the allowance for
doubtful accounts an amount that it estimates to be uncollectible for all other
customers based on a percentage of the past due receivables. The percentage
reserved increases as the age of the receivables increases. Of the recorded
allowance for doubtful accounts of $1,200,000, the portion related to the
wholesaler customers is $822,000 with the remaining $378,000 reserve for all
other customers.

ALLOWANCE FOR DISCOUNTS

The Company maintains an allowance for discounts, which reflects discounts
available to certain customers based on agreed upon terms of sale. This
allowance is reflected as a reduction of accounts receivable. The Company
evaluates the allowance balance against actual discounts taken. For the years
ended December 31, 2002 and 2001, the Company recorded a provision for discounts
of $1,014,000 and $886,000, respectively. Prior to 2001, the Company did not
grant discounts. The allowance for discounts was $172,000 and $143,000 as of
December 31, 2002 and 2001, respectively.

ALLOWANCE FOR SLOW-MOVING INVENTORY

The Company maintains an allowance for slow-moving and obsolete inventory
based upon recent sales activity by unit and wholesaler inventory information.
The Company estimates the amount of inventory that may not be sold prior to its
expiration. In 2001, upon obtaining the wholesaler's inventory reports, the
Company learned that the wholesalers had greater levels of on-hand inventory
than had been previously estimated. This provided the Company with greater
insight as to the potentially lower buying patterns of the wholesalers than had
been previously forecasted and contemplated in estimating the levels of
inventory in assessing the adequacy of the allowance. For the years ended
December 31, 2002, 2001 and 2000, the Company recorded a provision for inventory
obsolescence of $838,000, $1,830,000, and $3,983,000, respectively. The
allowance for inventory obsolescence was $1,206,000 and $1,845,000 as of
December 31, 2002 and 2001, respectively.

INCOME TAXES

The Company files a consolidated federal income tax return with its
subsidiary. Deferred income taxes are provided in the financial statements to
account for the tax effects of temporary differences resulting from reporting
revenues and expenses for income tax purposes in periods different from those
used for financial reporting purposes. The Company records a valuation allowance
to reduce the deferred tax assets to the amount that is more likely than not to
be realized. In performing its analysis of whether a valuation allowance to
reduce the deferred tax asset was necessary, the Company considered both
negative and positive evidence. Based upon this analysis, the negative evidence
outweighed the positive evidence in determining the amount of
18

the deferred tax assets that is more likely than not to be realized. Based upon
its analysis, beginning with the September 30, 2002 deferred tax assets, the
Company has established a valuation allowance to reduce the deferred tax assets
to zero. The expense of $9.2 million related to establishing the deferred tax
assets valuation allowance has been recorded in the income tax provision
(benefit).

INTANGIBLES

Intangibles consist primarily of product licensing and other such costs
that are capitalized and amortized on the straight-line method over the lives of
the related license periods or the estimated life of the acquired product, which
range from 17 months to 18 years. Accumulated amortization at December 31, 2002
and 2001 was $8,543,000 and $7,132,000, respectively. The Company annually
assesses the impairment of intangibles based on several factors, including
estimated fair market value and anticipated cash flows. On July 3, 2002, the
Company settled a License Agreement dispute with JHU/APL (See Note
M-"Commitments and Contingencies" to the consolidated financial statements in
Item 8) on two licensed patents. As a result of the resolved dispute, the
Company recorded an asset impairment charge of $1,559,500 in the second quarter
of 2002, representing the net value of the asset recorded on the balance sheet
of the Company less the $300,000 payment abated by JHU/APL and the $125,000
payment received from JHU/APL.

During the third quarter of 2002, the Company recorded an impairment charge
of $257,000 related to the product license intangible assets for the products
Sublimaze, Inapsine, Paradrine and Dry Eye test. The Company determined that
projected profitability on the products was not sufficient to support the
carrying value of the intangible asset. The recording of this charge reduced the
carrying value of the intangible assets related to these product licenses to
zero. These charges are reflected in the selling, general and administrative
expense category of the consolidated statement of operations. See Note
Q -- "Asset Impairment Charges" to the consolidated financial statements in Item
8.

COMPARISON OF TWELVE MONTHS ENDED DECEMBER 31, 2002 AND 2001

Consolidated revenues increased 23.8% for the year ended December 31, 2002
compared to the prior year. Results for 2002 exclude shipments made at or near
the end of the year for which shipping terms are FOB destination and,
accordingly, revenue is not recognized until delivery occurs. The revenue
related to these shipments recognized in the first quarter of 2003 was $601,000.
Prior year revenues reflect virtually all shipments to customers as virtually
all sales terms were FOB shipping point. See Note A -- "Summary of Significant
Accounting Policies" to the consolidated financial statements included in Item
8.

Ophthalmic segment revenues increased 74.7%, primarily reflecting lower
charges related to chargebacks and returns in 2002 (See Note A -- "Summary of
Significant Accounting Policies" to the consolidated financial statements
included in Item 8.) as compared to 2001, and, to a lesser extent, increased
angiography and ointment product sales. The 2002 sales mix reflects the
Company's shift in sales and marketing efforts within the Ophthalmic segment to
those key product lines that generate higher margins. Injectable revenues
increased 34.3% compared to the same period in 2001 primarily due to the lower
level of chargebacks and returns and a 52% increase in anesthesia and antidote
product sales in 2002. The Company believes the 2002 Ophthalmic and Injectable
revenues are sustainable for 2003. Contract Services revenues decreased 40.7%
compared to the same period in 2001 due mainly to customer concerns about the
status of the ongoing FDA issues at the Company's Decatur facility. The Company
anticipates that revenues from the Contract Services segment will continue to
lag historical levels and that Opthalmic and Injectable segment revenues are not
likely to grow until the issues surrounding the FDA review are resolved.

Consolidated gross margin increased to 39.9% from 15.4% for the prior year
due primarily to the aforementioned increase in revenues in 2002 as compared to
2001, as well as an increase in the reserve for slow-moving, unsaleable and
obsolete inventory items recorded in 2001. See Note E -- "Inventory" to the
consolidated financial statements in Item 8. Improvements in gross margin also
resulted from the Company's continued focus on shifting the product mix to
higher gross margin products in the angiography, antidote and ointment product
lines.

19

Selling, general and administrative ("SG&A") expenses increased 10.4% for
the year as compared to 2001. This is due to a $1,559,500 impairment charge
related to the JHU/APL settlement (See Note M -- "Commitments and Contingencies"
to the consolidated financial statements included in Item 8), a $545,000 asset
impairment charge related to abandoned construction projects, a $257,000
intangible asset charge and higher legal and marketing expenditures in 2002.
SG&A expenses in 2001 included $1,117,000 of restructuring-related charges
consisting primarily of severance and lease costs.

The provision for bad debt decreased from $4,480,000 in 2001 to a $55,000
recovery in 2002. The decrease is primarily related to the Company's increased
efforts to collect past due receivables. As a result of the Company's continued
collection efforts, the Company does not expect the provision for bad debts to
be material in 2003.

Amortization of intangibles decreased from $1,493,000 to $1,411,000, or
5.5% over the comparable period in the prior year, reflecting the exhaustion of
amortization for certain product intangibles due to the write-off of intangibles
which were determined to have been impaired in 2002, offset in part by inception
of the intangible amortization related to the product launch of Paremyd.

Research and development ("R&D") expense decreased 27.4% for the year
reflecting the Company's scaled back research activities to preserve capital and
to focus on strategic product niches such as controlled substances and
ophthalmic products which it believes will add greater value. The lower level of
R&D in 2002 also reflects the Company's refocusing of resources away from R&D to
resolve issues in the FDA's Form 483 notification.

Interest expense of $3,150,000 was 16.4% lower than the $3,768,000 recorded
in 2001, due to a lower debt balance and lower interest rates in 2002.

An income tax provision of $6,239,000 was recorded for 2002, compared to an
income tax benefit of $9,780,000 recorded in 2001. The 2002 income tax provision
primarily relates to the valuation allowance of $9,216,000 recorded during 2002.
In performing its analysis of whether a valuation allowance to reduce the
deferred tax asset was necessary, the Company considered both negative and
positive evidence, which could be objectively verified. Based upon this
analysis, the negative evidence, primarily the three consecutive years of
operating losses, outweighed the positive evidence in determining the amount of
the deferred tax assets that is more likely than not to be realized. Based upon
its analysis, beginning with the September 30, 2002 deferred tax assets, the
Company established a valuation allowance to reduce the deferred tax assets to
zero.

Net loss for 2002 was $12,952,000, or $0.66 per share, compared to a net
loss of $15,146,000, or $0.78 per share, for the prior year. The improvement in
revenue and gross profit was offset by the increase in the provision for income
taxes reflecting the reduction of deferred tax credits to zero.

COMPARISON OF TWELVE MONTHS ENDED DECEMBER 31, 2001 AND 2000

Consolidated revenues decreased 37.3% for the year ended December 31, 2001
compared to the prior year. Ophthalmic segment revenues decreased 38.9%,
primarily reflecting the decline in sales in the antibiotic, glaucoma and
artificial tear product lines. The remaining decline in ophthalmic revenues
reflects the effect of increases to the allowance for chargebacks and rebates
and returns discussed above. Ophthalmic revenues were also negatively impacted
by price competition for some of the Company's higher volume product lines. The
reduction in revenues was due to both declines in unit price as well as volume.
Injectable segment revenues decreased 61.3%, primarily due to the increases in
the allowances for chargebacks, rebates and returns and a 35% reduction in
anesthesia and antidote product sales. The sharp reduction is attributable to
excessive wholesaler inventories that were reduced during the year without
compensating purchases made by the wholesalers. Contract services revenues
increased 10.6% compared to the same period in 2000, primarily due to price
increases necessary to cover increasing production costs.

Consolidated gross profit decreased 77.3% for the year, with gross margins
decreasing from 42.5% to 15.4%. This reflects the effects of the aforementioned
decline in revenues, as well as an increase in the reserve for slow-moving,
unsaleable and obsolete inventory items. In addition, the Company incurred
unfavorable manufacturing variances at the Somerset, New Jersey facility and its
Decatur, Illinois facility, which eroded
20

the gross margin percentage. These variances were the result of reduced activity
in the plant, primarily caused by the previously discussed reduction in sales
that resulted from the wholesaler inventories being reduced without compensating
purchases.

SG&A expenses increased 17.5% for the year as compared to 2000, primarily,
due to asset impairment charges related to discontinued products of $2,132,000
and restructuring-related charges of $1,117,000 consisting primarily of
severance and lease costs.

The provision for bad debt decreased by 45.1% compared to 2000. The
decrease is primarily related to the Company's increased efforts to collect past
due receivables.

Amortization of intangibles decreased 1.6% for the year, reflecting the
exhaustion of certain product intangibles.

R&D expenses decreased 37.1%, primarily reflecting a scaling back of
research and development activities.

Interest expense increased 57.0% compared to 2000, reflecting higher
interest rates on higher average outstanding debt balances and amortization
related to the convertible debt issued during the year (See Note G -- "Financing
Arrangements" to the consolidated financial statements included in Item 8)
partially offset by capitalized interest related to the lyophilized
pharmaceuticals manufacturing line expansion.

Income tax benefit of $9,780,000 was recorded for the year compared to an
income tax benefit of $1,600,000 recorded in 2000 reflecting a greater level of
operating losses. The effective tax rate for the year was 39.5% compared to an
effective tax rate in 2000 of 39.9%.

Net loss for 2001 was $15,146,000, or $0.78 per share, compared to net loss
of $2,414,000, or $0.13 per share, for the prior year. The decrease in earnings
resulted from the aforementioned items.

FINANCIAL CONDITION AND LIQUIDITY

Overview

The Company has experienced losses from operations in 2002 and 2001 of $3.6
million and $21.2 million, respectively. The Company also recorded an operating
loss of $1.7 million in 2000.

As of December 31, 2002, the Company had cash and cash equivalents of
$364,000. The net working capital deficiency at December 31, 2002 was
$30,564,000 versus $24,359,000 at December 31, 2001, resulting primarily from a
decrease in the deferred tax assets from 2001 as a result of the valuation
allowance as described above. The negative working capital position reflects the
classification of the Company's senior debt obligation as a current liability,
the balance of which decreased from $45,072,000 at December 31, 2001 to
$35,859,000 as of December 31, 2002.

During the year ended December 31, 2002, the Company generated $9,359,000
in cash from operations, primarily from receivable collection efforts and the
collection of income tax refunds due to the Company. Investing activities, which
include the purchase of equipment required $5,315,000 in cash and included
$2,758,000 related to the lyophilized (freeze-dried) pharmaceuticals
manufacturing line expansion. Financing activities used $9,035,000 in cash
primarily for reduction of the outstanding senior bank debt.

The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. Accordingly, the financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amounts and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern.

As described more fully herein, the Company has had three consecutive years
of operating losses, is in default under its existing credit agreement and is a
party to governmental proceedings and potential claims by the FDA that could
have a material adverse effect on the Company. Although the Company has entered
into a Forbearance Agreement (as defined below) with its senior lenders and
obtained extensions thereof through

21

June 30, 2003, is working with the FDA to favorably resolve such proceedings,
has appointed a new interim chief executive officer and implemented other
management changes and has taken additional steps to return to profitability,
there is substantial doubt about the Company's ability to continue as a going
concern. The Company's ability to continue as a going concern is dependent upon
its ability to (i) continue to finance it current cash needs, (ii) continue to
obtain extensions of the Forbearance Agreement, (iii) successfully resolve the
ongoing governmental proceeding with the FDA and (iv) ultimately refinance its
senior bank debt and obtain new financing for future operations and capital
expenditures. If it is unable to do so, it may be required to seek protection
from its creditors under the federal bankruptcy code.

While there can be no guarantee that the Company will be able to continue
to finance its current cash needs, the Company generated positive cash flow from
operations in 2002. In addition, as of April 30, 2003, the Company had
approximately $400,000 in cash and equivalents and approximately $1.4 million of
undrawn availability under the second line of credit described below.

There also can be no guarantee that the Company will successfully resolve
the ongoing governmental proceedings with the FDA. However, the Company has
submitted to the FDA and begun to implement a plan for comprehensive corrective
actions at its Decatur, Illinois facility.

Moreover, there can be no guarantee that the Company will be successful in
obtaining further extensions of the Forbearance Agreement or in refinancing the
senior debt and obtaining new financing for future operations. However, the
Company is current on its interest payment obligations to its senior lenders,
management believes that the Company has a good relationship with its senior
lenders and, as required, the Company has retained a consulting firm, submitted
a restructuring plan and engaged an investment banker to assist in raising
additional financing and explore other strategic alternatives for repaying the
senior bank debt. The Company has also added key management personnel, including
the appointment of a new interim chief executive officer, and additional
personnel in critical areas, such as quality assurance. Management has reduced
the Company's cost structure, improved the Company's processes and systems and
implemented strict controls over capital spending. Management believes these
activities have improved the Company's profitability and cash flow from
operations and improved its prospects for refinancing its senior debt and
obtaining additional financing for future operations.

As a result of all of the factors cited in the preceding three paragraphs,
management believes that the Company should be able to sustain its operations
and continue as a going concern. However, the ultimate outcome of this
uncertainty cannot be presently determined and, accordingly, there remains
substantial doubt as to whether the Company will be able to continue as a going
concern. Further, even if the Company's efforts to raise additional financing
and explore other strategic alternatives result in a transaction that repays the
senior bank debt, there can be no assurance that the current common stock will
have any value following such a transaction. In particular, if any new financing
is obtained, it likely will require the granting of rights, preferences or
privileges senior to those of the common stock and result in substantial
dilution of the existing ownership interests of the common stockholders.

The Credit Agreement

In 1997, the Company entered into a $15 million revolving credit
arrangement with The Northern Trust Company, increased to $25 million in 1998,
and subsequently increased to $45 million in 1999, subject to certain financial
covenants and secured by substantially all of the assets of the Company. This
credit agreement, as amended effective January 1, 2002 (the "Credit Agreement"),
requires the Company to maintain certain financial covenants. These covenants
include minimum levels of cash receipts, limitations on capital expenditures, a
$750,000 per quarter limitation on product returns and required amortization of
the loan principal. The agreement also prohibits the Company from declaring any
cash dividends on its common stock and identifies certain conditions in which
the principal and interest on the Credit Agreement would become immediately due
and payable. These conditions include: (a) an action by the FDA which results in
a partial or total suspension of production or shipment of products, (b) failure
to invite the FDA in for re-inspection of the Decatur manufacturing facilities
by June 1, 2002, (c) failure to make a written response, within 10 days, to the
FDA, with a copy to the lender, to any written communication received from the
FDA

22

after January 1, 2002 that raises any deficiencies, (d) imposition of fines
against the Company in an aggregate amount greater than $250,000, (e) a
cessation in public trading of the Company's stock other than a cessation of
trading generally in the United States securities market, (f) restatement of or
adjustment to the operating results of the Company in an amount greater than
$27,000,000, (g) failure to enter into an engagement letter with an investment
banker for the underwriting of an offering of equity securities by June 15,
2002, (h) failure to not be party to such an engagement letter at any time after
June 15, 2002 or (i) experiencing any material adverse action taken by the FDA,
the SEC, the DEA or any other governmental authority based on an alleged failure
to comply with laws or regulations. The amended Credit Agreement required a
minimum payment of $5.6 million, which relates to an estimated federal tax
refund, with the balance of $39.2 million due June 30, 2002. The Company
remitted the $5.6 million payment on May 8, 2002. The Company is also obligated
to remit any additional federal tax refunds received above the estimated $5.6
million.

The Company's senior lenders agreed to extend the Credit Agreement to July
31, 2002 and then again to August 31, 2002. These two extensions contain the
same covenants and reporting requirements except that the Company is not
required to comply with conditions (g) and (h) above which relate to the
offering of equity securities. In both instances, the balance of $39.2 million
was due at the end of the extension term.

On September 16, 2002, the Company was notified by its senior lenders that
it was in default due to failure to pay the principal and interest owed as of
August 31, 2002 under the then most recent extension of the Credit Agreement.
The senior lenders also notified the Company that they would forbear from
exercising their remedies under the Credit Agreement until January 3, 2003 if a
forbearance agreement could be reached. On September 20, 2002, the Company and
its senior lenders entered into an agreement under which the senior lenders
would agree to forbear from exercising their remedies (the "Forbearance
Agreement") and the Company acknowledged its current default. The Forbearance
Agreement provides a second line of credit allowing the Company to borrow the
lesser of (i) the difference between the Company's outstanding indebtedness to
the senior lenders and $39,200,000, (ii) the Company's borrowing base and (iii)
$1,750,000, to fund the Company's day-to-day operations. The Forbearance
Agreement requires that, except for then-existing defaults, the Company continue
to comply with all of the covenants in its Credit Agreement and provides for
certain additional restrictions on operations and additional reporting
requirements. The Forbearance Agreement also requires automatic application of
cash from the Company's operations to repay borrowings under the new revolving
loan, and to reduce the Company's other obligations to the senior lenders. In
the event that the Company is not in compliance with the continuing covenants
under the Credit Agreement and does not negotiate amended covenants or obtain a
waiver thereof, then the senior lenders, at their option, may demand immediate
payment of all outstanding amounts due and exercise any and all available
remedies, including, but not limited to, foreclosure on the Company's assets.
This could result in the Company seeking protection from its creditors and a
reorganization under the federal bankruptcy code.

The Company, as required in the Forbearance Agreement, agreed to provide
the senior lenders with a plan for restructuring its financial obligations on or
before December 1, 2002 and agreed to retain a consulting firm by September 27,
2002, and, in furtherance of that commitment, on September 26, 2002, the Company
entered into an agreement (the "Consulting Agreement") with a consulting firm
(AEG Partners, LLC (the "Consultant")) whereby the Consultant would assist in
the development and execution of this restructuring plan and provide oversight
and direction to the Company's day-to-day operations. On November 18, 2002, the
Consultant notified the Company of its intent to resign from the engagement
effective December 2, 2002, based upon the Company's alleged failure to
cooperate with the Consultant, in breach of the Consulting Agreement. The
Company's senior lenders, upon learning of the Consultant's action, notified the
Company by letter dated November 18, 2002, that, as a result of the Consultant's
resignation, the Company was in default under terms of the Forbearance Agreement
and the Credit Agreement and demanded payment of all outstanding principal and
interest on the loan. This notice was followed by a second letter dated November
19, 2002, in which the senior lenders gave notice of their exercise of certain
remedies available under the Credit Agreement including, but not limited to,
their setting off the Company's deposits with the senior lenders against the
Company's obligations to the senior lenders. The Company immediately entered
into discussions with the Consultant which led, on November 21, 2002, to the
Consultant rescinding its notification of

23

resignation and to the senior lenders withdrawing their demand for payment and
restoring the Company's accounts.

During the Company's discussions with the Consultant, the Company agreed to
establish a special committee of the Board (the "Corporate Governance
Committee") consisting of Directors Ellis and Bruhl, with Mr. Ellis serving as
Chairman. The Consultant will interface with the Corporate Governance Committee
regarding the Company's restructuring actions. The Company also agreed that the
Consultant will oversee the Company's interaction with all regulatory agencies
including, but not limited to, the FDA. In addition, the Company has agreed to a
"success fee" arrangement with the Consultant. Under terms of the arrangement,
if the Consultant is successful in obtaining an extension to January 1, 2004 or
later on the Company's senior debt, the Consultant will be paid a cash fee equal
to 1 1/2% of the amount of the senior debt which is refinanced or restructured.
Additionally, the success fee arrangement provides that the Company will issue
1,250,000 warrants to purchase common stock at an exercise price of $1.00 per
warrant share to the Consultant upon the date on which each of the following
conditions have been met or waived by the Company: (i) the Forbearance Agreement
shall have been terminated, (ii) the Consultant's engagement pursuant to the
Consulting Agreement shall have been terminated and (iii) the Company shall have
executed a new or restated multi-year credit facility. All unexercised warrants
shall expire on the fourth anniversary of the date of issuance.

As required by the Forbearance Agreement, a restructuring plan was
developed by the Company and the Consultant and presented to the Company's
senior lenders in December 2002. The restructuring plan requested that the
senior lenders convert the Company's senior debt to a term note that would
mature no earlier than February 2004 and increase the current line of credit
from $1.75 million to $3 million to fund operations and capital expenditures. In
light of the FDA's re-inspection of the Decatur facility in early December 2002,
the Company and the senior lenders agreed to defer further discussions of that
request until completion of the re-inspection and the Company's response
thereto. As a result, the senior lenders have agreed to successive short-term
extensions of the Forbearance Agreement, the latest of which is an eleventh
amendment to the Forbearance Agreement expiring on June 30, 2003. Following
completion of the FDA inspection of the Decatur facility on February 6, 2003 and
issuance of the FDA findings, the senior lenders have indicated that they are
not willing to convert the senior debt to a term loan but discussions continue
regarding a possible increase in the revolving line of credit. As required by
the Company's senior lenders, on May 9, 2003, the Company engaged Leerink Swann,
an investment banking firm, to assist in raising additional financing and
explore other strategic alternatives for repaying the senior bank debt. Subject
to the absence of any additional defaults and subject to the senior lenders'
satisfaction with the Company's progress in resolving the matters raised by the
FDA and in obtaining additional financing and exploring other strategic
alternatives, the Company expects to continue obtaining short-term extensions of
the Forbearance Agreement. However, there can be no assurances that the Company
will be successful in obtaining further extensions of the Forbearance Agreement
beyond June 30, 2003.

FDA Proceeding

As discussed above, the Company is also a party to a governmental
proceeding by the FDA (See Item 3. "Legal Proceedings"). While the Company is
cooperating with the FDA and seeking to resolve the pending matter, an
unfavorable outcome such proceeding may have a material impact on the Company's
operations and its financial condition, results of operations and/or cash flows
and, accordingly, may constitute a material adverse action that would result in
a covenant violation under the Credit Agreement or cause the Company's senior
lenders to refuse to further extend the forbearance agreement, any or all of
which could have a material adverse effect on the Company's Liquidity.

Facility Expansion

The Company is in the process of completing an expansion of its Decatur,
Illinois facility to add capacity to provide Lyophilization manufacturing
services, which manufacturing capability the Company currently does not have.
Subject to the Company's ability to refinance its senior debt and obtain new
financing for future operations and capital expenditures, the Company
anticipates the completion of the Lyophilization expansion in the second half of
2004. As of December 31, 2002, the Company had spent approximately $16.4 million
on
24

the expansion and anticipates the need to spend approximately $1.0 million of
additional funds (excluding capitalized interest) to complete the expansion. The
majority of the additional spending will be focused on validation testing of the
Lyophilization facility as the major capital equipment items are currently in
place. Once the Lyophilization facility is validated, the Company will proceed
to produce stability batches to provide the data necessary to allow the
Lyophilization facility to be inspected and approved by the FDA.

Subordinated Debt

On July 12, 2001 the Company entered into a $5,000,000 subordinated debt
transaction with the John N. Kapoor Trust dtd. 9/20/89 (the "Trust"), the sole
trustee and sole beneficiary of which is Dr. John N. Kapoor, the Company's
Chairman of the Board of Directors. The transaction is evidenced by a
Convertible Bridge Loan and Warrant Agreement (the "Trust Agreement") in which
the Trust agreed to provide two separate tranches of funding in the amounts of
$3,000,000 ("Tranche A" which was received on July 13, 2001) and $2,000,000
("Tranche B" which was received on August 16, 2001). As part of the
consideration provided to the Trust for the subordinated debt, the Company
issued the Trust two warrants which allow the Trust to purchase 1,000,000 shares
of common stock at a price of $2.85 per share and another 667,000 shares of
common stock at a price of $2.25 per share. The exercise price for each warrant
represented a 25% premium over the share price at the time of the Trust's
commitment to provide the subordinated debt. All unexercised warrants expire on
December 20, 2006.

Under the terms of the Trust Agreement, the subordinated debt bears
interest at prime plus 3%, which is the same rate the Company pays on its senior
debt. Interest cannot be paid to the Trust until the repayment of the senior
debt pursuant to the terms of a subordination agreement, which was entered into
between the Trust and the Company's senior lenders. Should the subordination
agreement be terminated, interest may be paid sooner. The convertible feature of
the Trust Agreement, as amended, allows for conversion of the subordinated debt
plus interest into common stock of the Company, at a price of $2.28 per share of
common stock for Tranche A and $1.80 per share of common stock for Tranche B.

The Company, in accordance with Accounting Principles Board ("APB") Opinion
No. 14, recorded the subordinated debt transaction such that the convertible
debt and warrants have been assigned independent values. The fair value of the
warrants was estimated on the date of grant using the Black-Scholes option
pricing model with the following assumptions: (i) dividend yield of 0%, (ii)
expected volatility of 79%, (iii) risk free rate of 4.75%, and (iv) expected
life of 5 years. As a result, the Company assigned a value of $1,516,000 to the
warrants and recorded this amount as additional paid in capital. In accordance
with Emerging Issues Task Force Abstract 00-27, the Company has also computed
and recorded a value related to the "intrinsic" value of the convertible debt.
This calculation determines the value of the embedded conversion option within
the debt that has become beneficial to the owner as a result of the application
of APB Opinion No. 14. This value was determined to be $1,508,000 and was
recorded as additional paid in capital. The remaining $1,976,000 was recorded as
long-term debt. The resultant debt discount of $3,024,000, equivalent to the
value assigned to the warrants and the "intrinsic" value of the convertible
debt, is being amortized and charged to interest expense over the life of the
subordinated debt.

In December 2001, the Company entered into a $3,250,000 five-year loan with
NeoPharm, Inc. ("NeoPharm") to fund the Company's efforts to complete its
lyophilization facility located in Decatur, Illinois. Under the terms of the
Promissory Note, dated December 20, 2001, interest accrues at the initial rate
of 3.6% and will be reset quarterly based upon NeoPharm's average return on its
cash and readily tradable long and short-term securities during the previous
calendar quarter. The principal and accrued interest is due and payable on or
before maturity on December 20, 2006. The note provides that the Company will
use the proceeds of the loan solely to validate and complete the lyophilization
facility located in Decatur, Illinois and to address the issues set forth in the
Form 483 and warning letter received from the FDA. The Promissory Note is
subordinated to the Company's senior debt owed to The Northern Trust Company but
is senior to the Company's subordinated debt owed to the Trust. The note was
executed in conjunction with a Processing Agreement that provides NeoPharm, Inc.
with the option of securing at least 15% of the capacity of the Company's
lyophilization facility each year. Dr. John N. Kapoor, the Company's chairman is
also chairman of NeoPharm and holds a substantial stock position in NeoPharm as
well as in the Company.
25

Contemporaneous with the completion of the Promissory Note between the
Company and NeoPharm, the Company entered into an agreement with the Trust,
which amended the Trust Agreement. The amendment extended the Trust Agreement to
terminate concurrently with the Promissory Note on December 20, 2006. The
amendment also made it possible for the Trust to convert the interest accrued on
the $3,000,000 tranche into common stock of the Company. Previously, the Trust
could only convert the interest accrued on the $2,000,000 tranche. The terms of
the agreement to change the convertibility of the Tranche A interest and the
convertibility of the Tranche B interest for the extension of the term require
shareholder approval to be received by August 31, 2002, which was subsequently
extended to June 30, 2003. If the Company's shareholders do not approve these
changes, the Company would be in default under the Trust Agreement and, at the
option of the Trust, the Subordinated Debt could be accelerated and become due
and payable on June 30, 2003. Any default under the Trust Agreement would
constitute an event of default under both the Credit Agreement and the NeoPharm
Promissory Note. In the event of default amounts due under the Credit Agreement
and the NeoPharm Promissory Note could be declared to be due and payable,
notwithstanding the Forebearance Agreement which is presently in place between
the Company and its senior lender. The Company expects that it will reach
agreement with the Trust to extend, if necessary, the shareholder approval date
until the next shareholders meeting.

Other Indebtedness

In June 1998, the Company entered into a $3,000,000 mortgage agreement with
Standard Mortgage Investors, LLC of which there were outstanding borrowings of
$1,917,000 and $2,189,000 at December 31, 2002 and 2001, respectively. The
principal balance is payable over 10 years, with the final payment due in June
2007. The mortgage note bears an interest rate of 7.375% and is secured by the
real property located in Decatur, Illinois.

The fair value of the debt obligations approximated the recorded value as
of December 31, 2002. The promissory note between the Company and NeoPharm, Inc.
bears interest at a rate that is lower than the Company's current borrowing rate
with its senior lenders. Accordingly, the computed fair value of the debt, which
the Company estimates to be approximately $2,649,000, would be lower than the
current carrying value of $3,250,000.

CONTRACTUAL OBLIGATIONS
(In Thousands)

The following table details the Company's future contractual obligations
through 2008. The Company's ability to satisfy these obligations is primarily
dependent upon its ability to obtain additional financing or renegotiate its
current financing arrangement.

26

SELECTED QUARTERLY DATA
In Thousands, Except Per Share Amounts

FACTORS THAT MAY AFFECT FUTURE RESULTS

Existing Credit Obligations

At December 31, 2002, the Company had total outstanding indebtedness of
$43,658,000, or 69% of total capitalization. This significant debt load limits
the Company's operating flexibility and imposes numerous restrictive covenants
on the Company by its senior lenders, thereby significantly reducing the ability
of the Company to acquire or develop new products, increase its sales force and
expand and improve its facilities. In addition, the Company is currently in
default in the payment of principal under its Credit Agreement and has failed to
comply with many of the financial and other covenants required by the Credit
Agreement. Although the Company has negotiated a Forbearance Agreement with the
senior lenders which has been extended most recently through June 30, 2003 and,
as required by the senior lenders, has retained a consultant, submitted a
restructuring plan and engaged an investment banker to consider strategic
alternatives, to continue operations the Company will be required to negotiate
further extensions of the Forbearance Agreement and ultimately refinance its
senior debt. There can be no guarantee that the Company will be successful in
obtaining such further forbearance extensions or senior debt refinancing to
allow it to continue as a going concern. See Item 7. -- "Management's Discussion
and Analysis -- Financial Condition and Liquidity".

Ability to Obtain Additional Funding for Operations

In addition to refinancing its senior debt, the Company may require
additional funds to operate and grow its business. The Company may seek
additional funds through public and private financing, including equity and debt
offerings. However, adequate funds through the financial markets or from other
sources may not be available when needed or on terms favorable to the Company or
its stockholders. In addition, because the Company's Common Stock was delisted
from the NASDAQ National Market on June 25, 2002 and currently trades in the
Over-the-Counter market Pink Sheets (See Item 5. -- "Market for Common Equity
and Related Stockholder Matters"), the Company may experience further difficulty
accessing the capital markets. Without sufficient additional funding, the
Company may be required to delay, scale back or abandon some or all of its
product development, manufacturing, acquisition, licensing and marketing
initiatives. Further, such additional financing, if obtained, likely will
require the granting of rights, preferences or privileges senior to those of the
common stock and result in substantial dilution of the existing ownership
interests of the common stockholders.

27

Government Regulation

Federal and state government agencies regulate virtually all aspects of the
Company's business. The development, testing, manufacturing, processing,
quality, safety, efficacy, packaging, labeling, record keeping, distribution,
storage and advertising of the Company's products, and