UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
{X} QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
for the quarterly period ended September 30, 2004
{ } TRANSITION REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from __________ to _________
Commission File No. 0-24676
CARACO PHARMACEUTICAL LABORATORIES, LTD.
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2505723
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1150 ELIJAH MCCOY DRIVE, DETROIT, MICHIGAN 48202
(Address of principal executive offices) (Zip Code)
TELEPHONE: (313) 871-8400
Registrant's telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes {X} No { }
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes { } No {X}
As of October 18, registrant had 24,600,628 shares of common stock issued and
outstanding.
CARACO PHARMACEUTICAL LABORATORIES LTD.
BALANCE SHEETS
BALANCES AS AT
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------ ------------
UNAUDITED AUDITED
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,859,273 $ 4,206,282
Accounts receivable, net 1,723,408 4,538,473
Inventories 14,697,759 9,610,810
Prepaid expenses and deposits 1,268,746 562,030
------------ ------------
TOTAL CURRENT ASSETS 19,549,186 18,917,595
------------ ------------
PROPERTY, PLANT AND EQUIPMENT - AT COST
Land 197,305 197,305
Building and improvements 9,186,316 7,917,986
Equipment 8,528,690 6,991,024
Furniture and fixtures 551,864 364,140
------------ ------------
Total 18,464,175 15,470,455
Less: accumulated depreciation 6,579,697 5,963,780
------------ ------------
NET PROPERTY, PLANT & EQUIPMENT 11,884,478 9,506,675
------------ ------------
TOTAL ASSETS $ 31,433,664 $ 28,424,270
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY / (DEFICIT)
CURRENT LIABILITIES
Accounts payable $ 1,714,920 $ 1,386,161
Accounts payable - Sun Pharma 4,620,036 3,839,815
Accrued expenses 1,427,875 4,917,216
Current portion of bank loans payable 7,000,000 8,750,000
Current portion of EDC debt 0 1,115,213
------------ ------------
TOTAL CURRENT LIABILITIES 14,762,831 20,008,405
------------ ------------
LONG-TERM LIABILITIES
EDC debt 0 5,270,277
Bank loans payable 0 8,125,000
------------ ------------
TOTAL LONG-TERM LIABILITIES 0 13,395,277
------------ ------------
TOTAL LIABILITIES 14,762,831 33,403,682
------------ ------------
STOCKHOLDERS' EQUITY / (DEFICIT)
Common stock, no par value, authorized 50,000,000 shares;
issued and outstanding shares - 24,600,628 and 24,577,828 shares 41,464,227 41,442,311
Convertible Series B Preferred Stock, no par value, authorized
5,000,000 shares; issued and outstanding - 3,264,000 and -0- shares 21,282,490 0
Additional paid in capital 2,718,735 2,718,735
Accumulated deficit (48,794,619) (49,140,458)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY / (DEFICIT) 16,670,833 (4,979,412)
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY / (DEFICIT) $ 31,433,664 $ 28,424,270
============ ============
See accompanying notes
2
CARACO PHARMACEUTICAL LABORATORIES, LTD.
UNAUDITED STATEMENTS OF NET INCOME
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ---------------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
NET SALES $ 43,659,631 $ 32,905,662 $ 15,298,678 $ 12,294,125
Cost of goods sold 17,157,588 13,112,198 6,046,413 4,458,785
------------ ------------ ------------ ------------
Gross profit 26,502,043 19,793,464 9,252,265 7,835,340
------------ ------------ ------------ ------------
Selling, general and administrative expenses 3,576,514 5,689,566 883,436 2,599,746
R&D cost 4,037,282 2,018,029 1,543,452 491,310
R&D cost - affiliate (Note 7) 18,179,120 0 5,687,520 0
------------ ------------ ------------ ------------
Operating income 709,127 12,085,869 1,137,857 4,744,284
------------ ------------ ------------ ------------
Other income / (expense)
Interest expense (398,672) (1,041,382) (81,497) (223,660)
Interest income 34,767 24,790 18,142 17,747
Other income / (expense) 617 0 (12,418) 0
------------ ------------ ------------ ------------
Net other expense (363,288) (1,016,592) (75,773) (205,913)
------------ ------------ ------------ ------------
NET INCOME $ 345,839 $ 11,069,277 $ 1,062,084 $ 4,538,371
============ ============ ============ ============
NET INCOME PER COMMON SHARE
Basic 0.01 0.46 0.04 0.19
Diluted 0.01 0.44 0.04 0.18
See accompanying notes
3
CARACO PHARMACEUTICAL LABORATORIES, LTD.
UNAUDITED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR THE
NINE MONTHS ENDED SEPTEMBER 30, 2004
PREFERRED STOCK COMMON STOCK ADDITIONAL TOTAL
---------------------- ----------------------- PAID IN ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT EQUITY (DEFICIT)
--------- ----------- ---------- ----------- ----------- ------------ ----------------
BALANCES AT JANUARY 1, 2004 - - 24,577,828 $41,442,311 $ 2,718,735 $(49,140,458) $ (4,979,412)
Issuances of common stock
upon exercise of stock options 22,800 21,916 21,916
Issuances of preferred stock to
affiliate in exchange for product
technology transfers 3,264,000 21,282,490 21,282,490
Net income 345,839 345,839
--------- ----------- ---------- ----------- ----------- ------------ ---------------
BALANCES AT SEPTEMBER 30, 2004 3,264,000 $21,282,490 24,600,628 $41,464,227 $ 2,718,735 $(48,794,619) $ 16,670,833
========= =========== ========== =========== =========== ============ ===============
See accompanying notes
4
CARACO PHARMACEUTICAL LABORATORIES, LTD.
UNAUDITED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) / income $ 345,839 $ 11,069,277
Adjustments to reconcile net (loss) / income to
net cash provided by operating activities
Depreciation 615,915 422,180
Common shares issued in lieu of cash for compensation 0 262,450
Variable compensation expense for stock options 0 1,833,612
Preferred shares issued to affiliate for R&D cost 18,179,120 0
Changes in operating assets and liabilities
which provided / (used) cash:
Accounts receivable 2,815,065 (925,503)
Inventories (5,086,949) (1,867,348)
Prepaid expenses and deposits (706,714) (1,004,969)
Accounts payable 1,108,980 (648,115)
Accrued expenses (385,971) 210,663
------------ ------------
Net cash provided by operating activities 16,885,285 9,352,247
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, plant and equipment (2,993,720) (1,315,204)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from bank loans 10,000,000 1,600,000
Net bank loans paid (19,875,000) 0
Proceeds from exercise of stock options 21,916 790,591
Payment of preferred stock dividends 0 (350,380)
Payments of EDC debt (6,385,490) (909,651)
Net loans repaid to stockholders 0 (6,850,000)
------------ ------------
Net cash used in financing activities (16,238,574) (5,719,440)
------------ ------------
NET (DECREASE) / INCREASE IN CASH AND CASH EQUIVALENTS (2,347,009) 2,317,603
Cash and cash equivalents, beginning of period 4,206,282 534,228
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,859,273 $ 2,851,831
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
During the nine months ended September 30, 2004, 544,000 shares of preferred
stock were issued to Sun Global in satisfaction of the related liability for one
product transfer that had been accrued at December 31, 2003 in the amount of
$3,103,370.
See accompanying notes
5
CARACO PHARMACEUTICAL LABORATORIES, LTD.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The balance sheet as of December 31, 2003 is audited. All other financial
statements contained herein are unaudited. In the opinion of management, all
adjustments necessary for a fair presentation of such financial statements have
been included. Such adjustments consisted only of normal recurring items.
Interim results are not necessarily indicative of results for the full year.
The financial statements contained herein should be read in conjunction
with the financial statements and notes thereto included in the Corporation's
Annual Report on Form 10-KSB for the year ended December 31, 2003.
The accounting policies followed by the Corporation with respect to the
unaudited interim financial statements are consistent with those stated in the
2003 Caraco Pharmaceutical Laboratories, Ltd., Annual Report on Form 10-KSB.
2. ORGANIZATION AND NATURE OF BUSINESS
Caraco Pharmaceutical Laboratories, Ltd. ("Caraco," the "Company" or the
"Corporation" which is also referred to as we, us or our), is a Michigan
corporation engaged in the business of developing, manufacturing and marketing
generic drugs for the ethical (prescription) and over-the-counter
(non-prescription or "OTC") markets.
A generic drug is a pharmaceutical product, which is the chemical and
therapeutic equivalent of a brand-name drug as to which the patent and/or market
exclusivity has expired. Generics are well accepted for substitution of brand
products as they sell at a discount to the branded product's price and at their
equivalence in quality and bioavailability.
Our present product portfolio includes 18 products in 35 strengths in 82
package sizes. We are currently marketing 17 of the products in 33 strengths and
78 package sizes. The products are intended to treat a variety of disorders
including the following: hypertension, arthritis, epilepsy, diabetes, depression
and pain management.
A significant source of our funding has been from private placement
offerings and loans. Since August 1997, Sun Pharmaceutical Industries Limited, a
specialty pharmaceutical corporation organized under the laws of India ("Sun
Pharma"), has contributed equity capital and has advanced us loans. In addition,
among other things, Sun Pharma has acted as a guarantor on loans to Caraco, has
supplied us with a substantial portion of raw materials for our products, helped
us obtain machinery and equipment to enhance our production capacities at
competitive prices and transferred certain generic products to us. (See "Current
Status of the Corporation" and "Sun Pharmaceutical Industries, Limited" below.)
6
3. CURRENT STATUS OF THE CORPORATION
Net sales for the three months and nine months ended September 30, 2004
were $15.3 million and $43.7 million, respectively, as compared to $12.3 million
and $32.9 million, respectively, for the corresponding periods of 2003. We have
earned an operating income of $1.1 million and $0.7 million, respectively, for
the three months and nine months ended September 30,2004 as compared to
operating income of $4.7 million and $12.1 million, respectively, for the
corresponding periods of 2003. After interest expense, we have earned net income
of $1.1 million and $0.3 million, respectively, for the three months and nine
months ended September 30, 2004 as compared to net income of $4.5 million and
$11.1 million, respectively, for the corresponding periods of 2003. Net cash
generated from operating activities was $16.9 million for the nine months ended
September 30, 2004 as compared to $9.4 million for the corresponding period in
2003. At September 30, 2004, stockholders' equity increased to $16.7 million as
compared to a stockholders' deficit of $5.0 million at December 31, 2003. (See
"Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.")
Pursuant to our products agreement with Sun Pharma Global, Inc. ("Sun
Global"), a wholly-owned subsidiary of Sun Pharma, we have selected, during the
second quarter of 2004, eight additional products over and above the seven
products selected in the first quarter of 2004. This makes a selection of a
total of 15 products out of the 25 products to be transferred to us by Sun
Global. Of these, six products have passed bio-equivalency studies, including
five products during the nine months ended September 30, 2004. Under the
products agreement, Sun Global has earned 544,000 preferred shares for each such
product. (See "Sun Pharmaceutical Industries Limited" and " Item 2. - Future
Outlook" below.)
During the nine months ended September 30, 2004, we filed three ANDAs with
the FDA of the six above-mentioned products. This brings the total number of
ANDAs pending approval by the FDA to four. We anticipate that a majority of the
three pending ANDAs will be filed shortly.
One of the filed ANDAs is for a generic version of Ortho-McNeil
Pharmaceutical Inc.'s Ultracet(R), challenging its patent under a commonly known
procedure as a paragraph IV certification. We believe that we were the third
company to file a paragraph IV certification for the drug product and we do not
expect to get 180 days exclusivity. Ortho-McNeil Pharmaceutical Inc. has
instituted patent litigation against Caraco. (See "Litigation" below.)
During the nine months ended September 30, 2004, we received approvals for
an additional strength of one product in our portfolio and one new product from
the FDA. (See "Organization and Nature of Business" above).
During the nine months ended September 30, 2004, the Company repaid the
entire balance of $4.4 million due to ICICI Bank Limited and the $6.4 million
mortgage loan due to the Economic Development Corporation of the City of Detroit
(the "EDC"), and repaid $12.5 million due to the Bank of Nova Scotia. These
payoffs were funded from internal cash flow and
7
by utilizing a $10.0 million credit line arranged with Citibank, N.A. Of this
$10.0 million, the Company has repaid $3.0 million during the third quarter of
2004. This leaves a total outstanding balance of $7.0 million payable to
Citibank at September 30, 2004.
4. RECENT ACCOUNTING PRONOUNCEMENTS
In April 2003 the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 149, which amends and clarifies financial accounting and reporting
for derivative instruments, including certain derivative instruments imbedded in
other contracts and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." The subject matter of SFAS No.
149 is not currently applicable to the Corporation; accordingly, it is not
expected that the provisions of SFAS No. 149 will have a material impact on the
financial position, results of operations or cash flows of the Corporation.
In May 2003 the FASB issued SAFS No. 150, which establishes standards for
how an issuer classifies and measures certain financial instruments with
characteristics of both debt and equity. The subject matter of SFAS No. 150 is
not currently applicable to the Corporation; accordingly, it is not expected
that provisions of statement No. 150 will have a material impact on the
financial position, results of operations or cash flows of the Corporation.
5. COMPUTATION OF EARNINGS PER SHARE
Earnings per share is computed using the weighted average number of common
shares outstanding during each period and considers a dual presentation and
reconciliation of "basic" and "diluted" per share amounts. Diluted reflects the
potential dilution of all common stock equivalents.
The basic and diluted weighted average numbers of common shares
outstanding for the three months and nine months ended September 30, 2004 were
24,583,220 and 29,318,828, respectively. The basic and diluted weighted average
numbers of common shares outstanding for the three and nine months ended
September 30, 2003 were 23,977,673 and 25,317,464, respectively.
6. MORTGAGE NOTE WITH EDC
On April 13, 2004, the Company repaid the entire $6.1 million loan balance
due to the EDC (effective rate of interest of 3.36%). This was funded by
utilizing part of the $10.0 credit line arranged with Citibank, N.A. (effective
rate of interest of 2.25%). Accordingly, all liens and other restrictions
previously imposed on the Company by the EDC have been removed.
7. SUN PHARMACEUTICAL INDUSTRIES LIMITED
Pursuant to a stock purchase agreement, Sun Pharma had, as of December 31,
1998, remitted a total of $7.5 million to us for the purchase of 5.3 million
common shares.
Sun Pharma had assisted us, by acting as guarantor, in obtaining line of
credit loans from ICICI Bank Limited and The Bank of Nova Scotia in the amounts
of $5.0 million and $12.5
8
million, respectively. As of September 30, 2004, we have repaid all of such
loans. Sun Pharma also assisted us by acting as a guarantor of the Citibank
credit line (see Note 9 below).
In November 2002, we entered into a products agreement with Sun Global for
the transfer of the technology for 25 generic products over a period of 5 years.
Under such agreement, we conduct, at our expense, all tests including
bio-equivalency studies. Sun Global receives 544,000 shares of a new class of
Series B preferred stock (convertible into common stock after three years) for
each ANDA product transferred upon the ANDA successfully passing the
bio-equivalency studies. The preferred shares are non-voting and do not receive
dividends.
The new products agreement with Sun Global was amended by the Independent
Committee in the first quarter of 2004 to eliminate the provision requiring that
the Independent Committee concur in the selection of each product, and provides
instead, that each product satisfy certain objective criteria developed by
management and approved by the Independent Committee. Pursuant to such objective
criteria, we selected seven products during the first quarter of 2004 that we
had been working on during 2003, but had not been formally selected under the
products agreement prior to its amendment. Subsequently, during the second
quarter, we have selected eight additional products, making a total of 15
products. Of these, six products have passed bio-equivalency studies, including
five products during the nine months ended September 30, 2004. Sun Global has
thereby earned 544,000 preferred shares for each product.
Sun Pharma has established Research and Development Centers in Mumbai and
Baroda, India where the development work for products is performed.
Sun Pharma supplies us with a substantial portion of our raw materials and
certain formulations. In addition, Sun Pharma assists us in acquiring machinery
and equipment to enhance our production capacities.
Sun Pharma has also provided us with qualified technical professionals,
many of whom are currently working at our facility.
During the first quarter of 2004, Sun Pharma acquired 3,452,291 additional
shares of common stock and 1,329,066 stock options from two former directors and
a significant stockholder, thereby increasing its beneficial ownership from
approximately 48% to 63%. Based on the current number of shares of common stock
and options outstanding and if the 3,264,000 shares of Series B preferred stock
were converted to common stock, Sun Pharma's beneficial ownership would increase
to approximately 68%. The Series B preferred stock is convertible after three
years from the date of issuance or following a person (other than Sun Pharma and
its affiliates) acquiring control of the Corporation.
8. TERM LOANS FROM ICICI BANK AND THE BANK OF NOVA SCOTIA
During the nine months ended September 30, 2004, we have repaid the entire
loan due to ICICI Bank Limited out of funds generated from operations.
9
Also, during the nine months ended September 30, 2004, we have prepaid the
entire loan due to Bank of Nova Scotia partly out of funds generated from
operations and the balance from a line of credit from Citibank N.A (see note 9
below).
9. LINE OF CREDIT FROM CITIBANK N.A.
The Corporation has obtained a $10.0 million line of credit from Citibank,
N.A. with a secured irrevocable and unconditional standby letter of credit
provided by Sun Pharma. The line of credit is being used to finance working
capital requirements, higher cost debt redemption and for financing capital
expenditures. Interest payments are due monthly. The line of credit is revolving
and for 1 year. Outstanding balances on the line of credit may be repaid at any
time. The rate of interest is Libor + 125 basis points (current effective rate
being 2.25%). As of September 30, 2004, we have an outstanding balance of $7.0
million from Citibank, which has been classified as current on the accompanying
September 30, 2004 balance sheet.
10. COMMON STOCK ISSUANCES
We issued 22,800 and 724,896 shares of common stock to our employees upon
exercise of their stock options during the nine months ended September 30, 2004
and 2003, respectively. No common stock was issued to the directors as
compensation for attendance at board and committee meetings during the nine
months ended September 30, 2004 as compared to 31,000 shares issued during the
corresponding period of 2003.
11. PREFERRED STOCK ISSUANCES
We issued 3,264,000 shares of preferred stock to Sun Global during the
nine months ended September 30, 2004, of which 544,000 were earned in 2003. No
shares of preferred stock were issued to Sun Global during the corresponding
period in 2003.
12. SALES AND CUSTOMERS
Certain of our customers purchase our products through designated
wholesale customers, which act as intermediary distribution channels for our
products. For example, the Veterans Administration, which has entered into the
sales contract discussed below, has selected McKesson as its designated
wholesaler.
Shipments to two wholesale customers accounted for approximately 72% and
77% of gross sales during the nine months ended September 30, 2004 and September
30, 2003, respectively. Balances due from these wholesalers represented
approximately 61% of gross accounts receivable at September 30, 2004 and 66% of
gross accounts receivables at December 31, 2003. No other single customer
represented more than 10% of our gross sales during the past two years.
13. LITIGATION
On September 22, 2004, Ortho-McNeil Pharmaceutical, Inc. ("Ortho-McNeil")
filed a complaint in the United States District Court for the Eastern District
of Michigan alleging that
10
the Company's filing of an ANDA seeking approval to market its generic version
of Ortho-McNeil's Ultracet(R) drug product infringed Ortho-McNeil's patent,
which Ortho-McNeil claims expires on September 6, 2011. Ortho-McNeil seeks an
order from the Court which, among other things, directs the FDA not to approve
Caraco's ANDA any earlier than the claimed expiration date. As noted above under
"Current Status of the Corporation," the ANDA contained a paragraph IV
certification challenging the Ortho-McNeil patent. We believe that the
Ortho-McNeil patent is invalid and/or will not be infringed by Caraco's
manufacture, use or sale of the product, and we intend to vigorously defend this
action.
As previously disclosed, on February 12, 2003, C. Arnold Curry filed a
complaint in the Wayne County Circuit Court alleging breach of a written
employment agreement. Mr. Curry is seeking 175,000 shares of our common stock
(35,000 shares for each of the first five ANDAs approved by the FDA). We, and
plaintiff, have each filed a motion for summary disposition. A hearing on the
motions has been set for November 2004. No trial date has been scheduled. We
intend to vigorously defend ourselves against this claim, which we believe has
no merit.
We are involved in certain legal proceedings from time to time incidental
to our normal business activities. While the outcome of any such proceedings
cannot be accurately predicted, we do not believe the ultimate resolution of any
existing matters would have a material adverse effect on our financial position
or results of operations.
11
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
Stockholders and Board of Directors
Caraco Pharmaceutical Laboratories, Ltd.
Detroit, Michigan
We have reviewed the balance sheet of Caraco Pharmaceutical Laboratories,
Ltd. as of September 30, 2004 and the related statements of net income,
stockholders' equity (deficit) and cash flows for the three-month and nine-month
periods ended September 30, 2004 and September 30, 2003. These financial
statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States of
America, the objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to the accompanying financial statements in order for them to be
in conformity with accounting principles generally accepted in the United States
of America.
We have previously audited, in accordance with auditing standards
generally accepted in the United States of America, the balance sheet of Caraco
Pharmaceutical Laboratories, Ltd. as of December 31, 2003, and the related
statements of operations, stockholders' deficit and cash flows for the year then
ended (not presented herein), and in our report dated February 23, 2004, we
expressed an unqualified opinion on those financial statements.
REHMANN ROBSON
Troy, Michigan
October 18, 2004
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis provides information that management
believes is relevant to an understanding of the Corporation's results of
operations and financial condition. The discussion should be read in conjunction
with the financial statements and notes thereto and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in the
Company's 2003 annual report on Form 10-KSB and the unaudited interim financial
statements included in Item 1 of this Quarterly Report on Form 10-Q.
OVERVIEW
We have generated cash from operations of $16.9 million for the nine
months ended September 30, 2004 as compared to $9.4 million for the
corresponding period of 2003. This $16.9 million is the net cash generated after
$5.1 million utilized in increase of inventories. This cash was available and
used primarily to pay off Company debt and to fund our capital expenditures. We
earned net income of $0.3 million during the nine months ended September 30,
2004 compared to net income of $11.1 million during the corresponding period of
2003. The lower net income was primarily due to non-cash research and
development expense (R&D) of $18.2 million for the nine months ended September
30, 2004 compared to no similar expense during the corresponding period of 2003.
This non-cash R&D expense related to 5 products passing their bio-equivalency
studies during the nine months ended September 30, 2004 as compared to none
during the corresponding period of 2003.
FDA COMPLIANCE AND PRODUCT APPROVALS
During November 2002, the FDA conducted an inspection of our facility and
found us to be substantially in compliance with cGMP regulations. While the FDA
did issue us an FDA 483 list of observations, we do not believe they are
material and we have taken appropriate remedial actions.
We have submitted 18 ANDAs to the FDA for approval since August 1997,
including three filed during the nine months ended September 30, 2004. Of these,
14 have been approved and four are pending approval.
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED WITH THREE
MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2003
NET SALES
Net sales for the three months and nine months ended September 30, 2004
were $15.3 million and $43.7 million, respectively, as compared to $12.3 million
and $32.9 million, respectively for the corresponding periods of 2003,
reflecting increases of 24% and 33%, respectively. The increases are due to the
higher production and marketing of most of our products. In addition, with our
larger base of products, we have been able to attract both new customers and
larger orders. As of September 30, 2004, we manufacture and market all except
13
one of the approved products. Sales of three products accounted for 81% of our
net sales during the nine months ended September 30, 2004 as compared to 82%
during the nine months ended September 30, 2003.
GROSS PROFIT
We earned a gross profit of $9.3 million and $26.5 million during the
three months and nine months ended September 30, 2004, respectively, as compared
to a gross profit of $7.8 million and $19.8 million during the corresponding
periods in 2003, reflecting increases of 19% and 34%, respectively. The
improvement was primarily due to higher sales volumes, better-cost absorption of
operational overheads, and cost reductions.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the three months and nine
months ended September 30, 2004 were $0.9 million and $3.6 million,
respectively, as compared to $2.6 million and $5.7 million, respectively, for
the same periods in 2003. This represents decreases of 65% and 37%,
respectively. Selling, general and administrative expenses, as a percentage of
net sales, during the nine months ended September 30, 2004 have decreased to 8%
compared to 17% during the corresponding period of 2003. The decrease in
selling, general and administrative expenses was primarily due to the absence of
variable compensation expense during the three and nine months ended September
30, 2004.
RESEARCH AND DEVELOPMENT EXPENSES
Cash research and development expenses during the three months and nine
months ended September 30, 2004 were $1.5 million and $4.0 million,
respectively, as compared to $0.5 million and $2.0 million, respectively, during
the corresponding periods of 2003. The reason for the higher cash research and
development expenses was higher expenditures for bio-study costs during the
relevant periods of 2004 compared to none during the corresponding periods of
2003.
Non-cash research and development expenses of $5.7 million and $18.2
million (technology transfer costs) have been recorded for the three and nine
months ended September 30, 2004 for two and five product transfers,
respectively. There were no non-cash research and development expenses during
the corresponding periods of 2003.
OPERATING INCOME
We earned operating income of $1.1 million and $0.7 million during the
three months and nine months ended September 30, 2004 as compared to operating
income of $4.7 million and $12.1 million during the corresponding periods in
2003. The decreases were primarily due to higher non-cash research and
development expense of $5.7 million and $18.2 million, respectively, in 2004 as
compared to no similar expense during the corresponding periods in 2003.
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INTEREST EXPENSE
Interest expense on loans was $0.1 million and $0.4 million, respectively,
for the three months and nine months ended September 30, 2004 compared to $0.2
million and $1.0 million, respectively, for the corresponding periods of 2003.
The reduction in interest expense is primarily due to our repaying the loan of
$10 million to Sun Pharma and its affiliates during 2003, the loans of $4.4
million to ICICI Bank Limited, $6.4 million to the EDC and $12.5 million to The
Bank of Nova Scotia during 2004.
RESULTS OF OPERATIONS
We earned net income of $1.1 million and $0.3 million, respectively for
the three months and nine months ended September 30, 2004 as compared to earning
net income of $4.6 million and $11.1 million for the corresponding periods of
2003.
The significantly lower net income in the three and nine months ended
September 30, 2004 were primarily due to higher non-cash research and
development expense of $5.7 million and $18.2 million compared to no similar
expense in the corresponding periods of 2003.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 2004, we generated net cash
from operations of $16.9 million as compared to $9.4 million during the
corresponding period of 2003. The higher cash generation was primarily due to
higher sales and improved cost absorptions in our operations. This $16.9 million
is the net cash generated after $5.1 million utilized in increase of
inventories.
In addition to helping repay the entire balances of $4.4 million to ICICI
Bank Limited, $6.4 million to the EDC and $12.5 million to The Bank of Nova
Scotia, operations have generated cash sufficient to fund our capital
expenditures of $3.0 million during the nine months ended September 30, 2004.
The capital expenditures were primarily for augmenting manufacturing facilities.
At September 30, 2004, we have an outstanding balance of $7.0 million due
to Citibank N.A.
At September 30, 2004, the Corporation had positive working capital of
$4.8 million compared to a negative working capital of $1.1 million at December
31, 2003. The positive working capital position is primarily due to repayments
of our debt obligations classified as current at December 31, 2003 and
reductions in current liabilities from 2003 related primarily to technology
transfer costs.
FUTURE OUTLOOK
We are substantially cGMP compliant since 2001, and have received
approvals for twelve ANDAs during the last three years. We have expanded and
upgraded our facilities and expanded our customer base.
15
Management expects the trend of continued increases in sales and
improvement in cash flows during the remainder of 2004. Pricing pressures, due
to increased competition, have continued during 2004 and are expected to
continue in 2005, which may result in lower gross margins. Management has and
will continue to work diligently to counter the pricing pressures through
increased sales volumes, better-cost absorption of operational overheads, and
cost reductions. We are optimistic to achieve the higher of our previously
stated guidance of 20 to 25% revenue growth during 2004.
As disclosed, under the products agreement dated November 21, 2002,
between Sun Global and the Company, Sun Global has agreed to transfer the
technology for 25 products to the Company over a five year period in exchange
for 544,000 preferred shares (which are convertible after three years on a
one-to-one basis into common shares) per product, upon the passing of
bio-equivalency studies. Since the date of the products agreement, 15 products
have been selected for development by the Company and six of these products have
passed their respective bio-equivalency studies (one in 2003 and five in the
first nine months of 2004). If some of the remaining nine products pass their
bio-equivalency studies in 2004, the fair value of the preferred shares earned
by Sun Global in exchange for such products could cause our non-cash research
and development expenses to increase to an amount which would significantly
decrease profit or create a loss.
While the development of new products will increase our non-cash R&D
expense and will impact earnings per share, we anticipate that cash will be
available, among other things, to repay loans and reduce interest burden, meet
increased working capital requirements and finance capital investments. This in
turn will strengthen our balance sheet and build value for our stockholders.
The Company will continue to aggressively move forward on the development
of the products presented and to be presented for consideration by Sun Global
pursuant to the products agreement. We believe that receiving products from Sun
Global provides us with a partner who has a proven track record; one that
already has provided us with quality products. Moreover, Sun Pharma's increased
beneficial ownership in us, to approximately 63%, should, we believe, provide it
with the incentive to continue to help us succeed. Sun Pharma has already
provided us with millions of dollars in capital, loans, and guarantees of loans,
and with personnel, raw materials and equipment, which have significantly helped
us to date.
Management's plans for the remainder of 2004 include:
- Continued focus on FDA compliance.
- Continued research and development activities.
- Continued expenditures for capital investment including equipment
and expansion of capacity.
- Increased market share for certain existing products and recently
introduced new products and enhanced customer reach and
satisfaction.
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- Prompt introduction of new approved products to the market.
- Achieving further operational efficiencies by attaining economies of
scale and cost reduction per unit.
- Increasing the number of products, as well as anticipated volume
increases for existing products, which, in turn, will improve
manufacturing capacity utilization.
- Considering alternative ways of increasing cash flow including
developing, manufacturing and marketing ANDAs owned by Sun Pharma.
- Locating and utilizing facilities of contract-manufacturers to
enhance production and therefore sales.
- Further reducing debt, if adequately supported by positive cash
flows.
FORWARD LOOKING STATEMENTS
This report, other than the historical financial and business information,
may contain forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act. Without
limitation, the words "believes," "plans," "expects," and similar expressions
are intended to identify forward-looking statements. Those statements include
statements regarding our intent, belief, and current expectation. These
statements are not guarantees of future performance and are subject to risks and
uncertainties that cannot be predicted or quantified. Consequently, actual
results could differ materially from those expressed or implied by such
forward-looking statements.
Such risks and uncertainties include, but are not limited to: (i) that the
information is of a preliminary nature and may be subject to further adjustment;
(ii) not obtaining FDA approval for new products or delays in receiving FDA
approvals; (iii) governmental restrictions on the sale of certain products; (iv)
dependence on key personnel; (v) development by competitors of new or superior
products or cheaper products or new technology for the production of products or
the entry into the market of new competitors; (vi) market and customer
acceptance and demand for new pharmaceutical products; (vii) availability of raw
materials in a timely manner, at competitive prices, and in required quantities;
(viii) timing and success of product development and launch; (ix) integrity and
reliability of the Company's data; (x) lack of success in attaining full
compliance with regard to regulatory and cGMP compliance; (xi) experiencing
difficulty in managing our recent rapid growth and anticipated future growth;
(xii) dependence on limited customer base; (xiii) occasional credits to certain
customers reflecting price reductions on products previously sold to them and
still available as shelf-stock; (xiv) possibility of an incorrect estimate of
charge-backs and the impact of such an incorrect estimate on net sales, gross
profit and net income; (xv) dependence on few products generating majority of
sales; (xvi) product liability claims for which the Company may be inadequately
insured; (xvii) subjectivity in judgment of management in applying certain
significant accounting policies derived based on historical experience, terms of
contracts, our observations of trends of industry, information received from our
customers and other sources, to estimate revenues, accounts receivable
allowances including chargebacks, rebates, income taxes, values of assets and
inventories; (xviii)
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litigation involving claims of patent infringement; and (xix) other risks
identified in this report and identified from time to time in our reports and
registration statements filed with the Securities and Exchange Commission. These
forward-looking statements represent our judgment as of the date of this report.
We disclaim, however, any intent or obligation to update our forward-looking
statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not use any derivative financial instruments. All of our direct
sales are in the United States and denominated in U.S. dollars. Our exposure to
market risk for a change in interest rates relates primarily to our debt
instruments. Our debt instruments, at September 30, 2004, are subject to
variable interest rates, which float based upon a spread over LIBOR. Management
does not believe that any risk inherent in these instruments is likely to have a
material effect on our financial statements.
ITEM 4. CONTROLS AND PROCEDURES
a. The term "disclosure controls and procedures" is defined in Rules
13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the "Exchange
Act"). These rules refer to the controls and other procedures of a company that
are designed to ensure that information required to be disclosed by a company in
the reports that it files under the Exchange Act is recorded, processed,
summarized and reported within required time periods. Our Chief Executive
Officer, who is also our Chief Financial Officer, has evaluated the
effectiveness of our disclosure controls and procedures as of the end of the
period covered by this report (the "Evaluation Date"), and has concluded that,
as of the Evaluation Date, our disclosure controls and procedures are effective
in providing him with material information relating to the Corporation known to
others within the Corporation which is required to be included in our periodic
reports filed under the Exchange Act.
b. There have been no changes in the Corporation's internal controls
over financial reporting that occurred during registrant's last fiscal quarter
that has materially affected, or is reasonably likely to materially affect, the
Corporation's internal control over financial reporting.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information in note 14 of Part I, Notes to Financial Statements, is
incorporated herein by reference.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the quarter ended March 31, 2004, on March 31, 2004, registrant
issued 1,632,000 Series B preferred shares to Sun Global in exchange for the
transfer of three products pursuant to registrant's products agreement with Sun
Global. Such preferred shares were issued
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to Sun Global pursuant to exemptions from registration under Section 4(2),
Section 4(6) and Regulation D under the Securities Act of 1933.
During the quarter ended June 30, 2004, on May 21, 2004, registrant issued
544,000 Series B preferred shares to Sun Global in exchange for the transfer of
one product pursuant to registrant's products agreement with Sun Global. Such
preferred shares were issued to Sun Global pursuant to exemptions from
registration under Section 4(2), Section 4(6) and Regulation D under the
Securities Act of 1933.
During the quarter ended September 30, 2004, on each of August 22, 2004
and August 27, 2004, registrant issued 544,000 Series B preferred shares to Sun
Global in exchange for the transfer of one product pursuant to registrant's
products agreement with Sun Global. Such preferred shares were issued to Sun
Global pursuant to exemptions from registration under Section 4(2), Section 4(6)
and Regulation D under the Securities Act of 1933.
The above Series B preferred shares are convertible into common stock on a
one-for-one basis after three years from the date of issuance or following a
person (other than Sun Pharma and its affiliates) acquiring control of
registrant.
Pursuant to various stock and option purchase agreements between Sun
Pharma and three stockholders and their affiliates, Sun Pharma acquired in
January and February, 2004, 3,452,291 shares of common stock and rights to
acquire options for 1,679,066 shares of common stock. The shares were acquired
for $9.00 per share and the rights to the options were acquired for $9.00 less
the exercise price of each option.
ITEM 5. OTHER INFORMATION
The information in Item 2 relating to the sale of the Series B preferred
shares to Sun Global during the third quarter of 2004 is hereby incorporated by
reference.
ITEM 6. EXHIBITS
31.1 Certification of Chief Executive Officer and Chief Financial
Officer.
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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SIGNATURE
In accordance with the requirements of the Securities Exchange Act of
1934, the Corporation has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
CARACO PHARMACEUTICAL LABORATORIES, LTD.
By: /s/ Jitendra N. Doshi
-------------------------
Jitendra N. Doshi
Chief Executive Officer
and Chief Financial Officer
Dated: October 20, 2004
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EXHIBIT INDEX
31.1 Certification of Chief Executive Officer and Chief Financial
Officer.
32.1 Certification of Principal Executive Officer and Principal Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
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