XASE:PTX Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
FORM 10-Q
 
(Mark One)
 
   
þ
Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934
   
For the quarterly period ended: March 31, 2012
   
o
Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934
   
For the transition period from: ___________ to ___________
 
001-14494
Commission File Number
 
PERNIX THERAPEUTICS HOLDINGS, INC.
  (Exact name of Registrant as specified in its charter)
 
Maryland
 
33-0724736
(State or other jurisdiction
of incorporation or organization)
 
(I.R.S. Employer
Identification Number)
 
10003 Woodloch Forest Drive, The Woodlands, TX
 
  77380
  (Address of principal executive offices) 
 
  (Zip Code)
 
(832) 934-1825
(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 report(s)) and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨ .
 
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ   No ¨ .
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer
o
Accelerated filer
o
       
Non-accelerated filer 
o
Smaller reporting company
þ
(Do not check if a smaller reporting company)
   

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨ No  þ
 
On May 11, 2012, there were 29,068,163 shares outstanding of the Registrant’s common stock, par value $0.01 per share.
 


 
 

 
 
PERNIX THERAPEUTICS HOLDINGS, INC.
Quarterly Report on Form 10-Q
For the Three Months Ended March 31, 2012
 
INDEX
 
PART I. 
FINANCIAL INFORMATION
     
         
Item 1. 
Financial Statements 
       
 
Condensed Consolidated Balance Sheets as of March 31, 2012 (unaudited) and December 31, 2011
   
4
 
 
Condensed Consolidated Statements of Income and Comprehensive Income (unaudited) for the Three  Months Ended March 31, 2012 and 2011
   
5
 
 
Condensed Consolidated Statements of Stockholders’ Equity as of March 31, 2012 (unaudited)   
   
6
 
 
Condensed Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2012 and 2011
   
7
 
 
Notes to Condensed Consolidated Financial Statements 
   
8
 
Item 2. 
Management’s Discussion and Analysis of Financial Condition and Results of Operations 
   
24
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk 
   
35
 
Item 4.
Controls and Procedures
   
35
 
           
PART II. 
INFORMATION
       
           
Item 1. 
Legal Proceedings 
   
36
 
Item 1A. 
Risk Factors
   
36
 
Item 2. 
Unregistered Sales of Equity Securities and Use of Proceeds 
   
36
 
Item 3. 
Defaults upon Senior Securities    
36
 
Item 4. 
Mine Safety Disclosures
   
36
 
Item 5.  
Other Information 
   
36
 
Item 6.  
Exhibits
   
37
 
Signatures    
38
 
 
 
i

 
 
Cautionary Statement Regarding Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information, so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed in the statement. We desire to take advantage of these “safe harbor” provisions with regard to the forward-looking statements in this Form 10-Q and in the documents that are incorporated herein by reference. These forward-looking statements reflect our current views with respect to future events and financial performance. Specifically, forward-looking statements may include:
 
 
projections of revenues, expenses, income, income per share and other performance measures;

 
statements regarding expansion of operations, including entrance into new markets and development of products; and

 
statements preceded by, followed by or that include the words “estimate,” “plan,” “project,” “forecast,” “intend,” “expect,” “anticipate,” “believe,” “seek,” “target” or similar expressions.

These forward-looking statements express our best judgment based on currently available information and we believe that the expectations reflected in our forward-looking statements are reasonable.

By their nature, however, forward-looking statements often involve assumptions about the future. Such assumptions are subject to risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. As such, we cannot guarantee you that the expectations reflected in our forward-looking statements will actually be achieved. Actual results may differ materially from those in the forward-looking statements due to, among other things, the following factors:
 
 
changes in general business, economic and market conditions;

 
volatility in the securities markets generally or in the market price of our stock specifically; and

 
the risks outlined in the section entitled “Risk Factors” contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

We caution you not to place undue reliance on any forward-looking statements, which speak only as of the date of this Form 10-Q. Except as required by law, we do not undertake any obligation to publicly update or release any revisions to these forward-looking statements to reflect any events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
 
ii

 
 
PART I.   FINANCIAL INFORMATION
 
ITEM 1. 
FINANCIAL STATEMENTS
 
PERNIX THERAPEUTICS HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
   
(unaudited)
       
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 39,201,515     $ 34,551,180  
Accounts receivable, net
    16,401,767       20,601,360  
Inventory, net
    5,040,631       6,261,162  
Prepaid expenses and other current assets
    1,672,289       2,144,203  
Pepaid taxes
    807,174    
 
Deferred income taxes
    4,057,000       4,552,000  
Total current assets
    67,180,376       68,109,905  
Property and equipment, net
    1,057,105       911,948  
Other assets:
               
Investments
    5,869,320       4,451,831  
Intangible assets, net
    12,664,454       8,876,504  
Other long-term assets
    213,783       213,783  
Total assets
  $ 86,985,038     $ 82,563,971  
                 
LIABILITIES
               
Current liabilities:
               
Accounts payable
  $ 2,249,872     $ 2,987,913  
Accrued personnel expense
    1,371,517       2,044,121  
Accrued allowances
    14,905,179       17,006,409  
Income taxes payable
 
      585,931  
Other accrued expenses
    2,024,198       1,565,918  
Contracts payable
    3,415,725       1,290,000  
Line of Credit
    6,000,000       6,000,000  
Total current liabilities
    29,966,491       31,480,292  
Long-term liabilities:
               
Contracts payable
    300,000       600,000  
Deferred income taxes
    1,425,000       860,000  
Total liabilities
    31,691,491       32,940,292  
                 
Commitments and contingencies
               
                 
STOCKHOLDERS’ EQUITY
               
Common stock, $.01 par value, 90,000,000 shares authorized, 28,423,482 and 27,820,004 issued, and    26,350,672 and 25,749,137 outstanding at March 31, 2012 and December 31, 2011, respectively
    263,507       257,491  
Treasury stock, at cost (2,072,810 and 2,070,867 shares held at March 31, 2012 and December 31, 2011, respectively)
    (3,772,410 )     (3,751,890 )
Additional paid-in capital
    33,655,001       30,185,292  
Retained earnings
    23,034,581       21,843,418  
Other comprehensive income
    2,112,868       1,089,368  
                 
Total  stockholders’ equity
    55,293,547       49,623,679  
                 
Total liabilities and stockholders’ equity
  $ 86,985,038     $ 82,563,971  
 
See accompanying notes to condensed consolidated financial statements.
 
 
1

 
 
PERNIX THERAPEUTICS HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
 
   
Three Months Ended
March 31,
 
   
2012
   
2011
 
Net revenues
  $ 14,482,025     $ 10,094,975  
Costs and expenses:
               
Cost of product sales
    4,690,583       1,956,040  
Selling, general and administrative expenses
    6,824,262       5,219,740  
Research and development expense
    70,006       106,158  
Loss from the operations of the joint venture with SEEK
    240,195       330,000  
Royalties expense, net
 
      261,400  
Depreciation and amortization expense
    638,072       493,285  
Total costs and expenses
    12,463,118       8,366,623  
                 
Income from operations
    2,018,907       1,728,352  
                 
Other income (expense):
               
Other expense
    (4,807 )  
 
Interest expense, net
    (39,937 )     (30,177 )
Total other income, net
    (44,744 )     (30,177 )
Income before income taxes
    1,974,163       1,698,175  
                 
Income tax provision
    783,000       723,000  
                 
Net income
  $ 1,191,163     $ 975,175  
                 
Unrealized gain on securities, net of income tax of approximately $634,000
    1,023,500    
 
                 
Comprehensive income
  $ 2,214,663     $ 975,175  
                 
Net income per share, basic
  $ 0.05     $ 0.04  
Net income per share, diluted
  $ 0.04     $ 0.04  
                 
Weighted-average common shares, basic
    25,921,139       22,652,394  
Weighted-average common shares, diluted
    26,473,364       23,141,524  
 
  See accompanying notes to condensed consolidated financial statements.
 
 
2

 
 
PERNIX THERAPEUTICS HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited)
 
   
Common
Stock
   
Additional
Paid-In
Capital
   
Treasury
Stock
   
Retained
Earnings
   
Accumulated Other Comprehensive income
   
Total
 
Balance at December 31, 2011
   
257,491
     
30,185,292
     
(3,751,890
)
   
21,843,418
     
1,089,368
     
49,623,679
 
                                                 
Stock-based compensation
   
2,881 
     
493,317 
     
     
     
     
496,198 
 
Issuance of stock options for services from non-employees
   
     
188,365
     
     
     
     
188,365
 
Issuance of common stock, net of stock withheld for income tax liability
   
471
     
257,380
     
(20,520)
     
     
     
237,331
 
Income tax benefit on stock based awards
   
     
133,000
     
     
     
     
133,000
 
Issuance of common stock upon additional public offering, net of issuance costs of $185,871
   
2,664
     
2,397,647
     
     
     
     
2,400,311
 
Net income
   
     
     
     
1,191,163
             
1,191,163
 
Unrealized gain on securities, net
   
     
     
     
     
1,023,500
     
1,023,500
 
Balance at March 31, 2012
 
$
263,507
   
$
33,655,001
   
$
(3,772,410
)
 
$
23,034,581
   
$
2,112,868
   
$
55,293,547
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
3

 
 
PERNIX THERAPEUTICS HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
   
Three months ended
 
   
March 31,
 
   
2012
   
2011
 
Cash flows from operating activities:
           
Net income
 
$
1,191,163
   
$
975,175
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
    Depreciation
   
26,022
     
21,958
 
    Amortization
   
612,050
     
471,327
 
    Deferred income tax benefit
   
425,816
     
(978,000
)
    Loss on disposal of assets
   
4,807
     
 
    Stock compensation expense
   
496,198
     
211,275
 
    Expense from stock options issued in exchange for services
   
188,365
     
 
    Loss from the operations of the joint venture with SEEK
   
240,195
     
330,000
 
    Changes in operating assets and liabilities:
               
        Accounts receivable
   
4,199,593
     
3,441,855
 
        Inventory
   
1,220,531
     
48,374
 
        Prepaid expenses and other assets
   
471,915
     
(297,717
        Accounts payable
   
(738,041
   
(1,457,421
)
        Income taxes
   
(1,393,105
)
   
(92,478
        Accrued expenses
   
(2,115,784
   
2,337,867
 
    Net cash from operating activities
   
4,829,725
     
5,012,215
 
Cash flows from investing activities:
               
        Payments received on notes receivable
   
     
56,667
 
        Acquisition of gastroenterology product license
   
(2,400,000)
     
 
        Purchase of equipment
   
(20,261
)
   
(75,284
)
    Net cash from investing activities
   
(2,420,261
)
   
(18,617
)
Cash flows from financing activities:
               
        Proceeds from line of credit
   
     
1,000,000
 
        Payment on contracts payable
   
(330,000
)
   
(1,300,000
)
        Proceeds from issuance of stock in additional offering, net of issuance costs of $185,871
   
2,400,310
     
 
        Tax benefit on stock-based awards
   
133,000
     
 
        Proceeds from issuance of stock, net of stock withheld for payment of income tax liability
   
37,561
     
 
     Net cash from financing activities
   
2,240,871
     
(300,000
                 
Net increase in cash and cash equivalents
   
4,650,335
     
4,693,598
 
Cash and cash equivalents, beginning of period
   
34,551,180
     
8,260,059
 
Cash and cash equivalents, end of period
 
$
39,201,515
   
$
12,953,657
 
                 
Supplemental disclosure:
               
        Cash paid for income taxes
 
$
1,297,725
   
$
1,793,529
 
         Accrued 2011 bonus paid in unrestricted common stock
 
$
199,770
   
$
 
        Interest paid during the period
 
$
53,297
   
$
36,143
 
Non-cash transaction
               
        Acquisition of Omeclamox® license - contract payable
 
$
2,000,000
   
$
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
4

 
 
PERNIX THERAPEUTICS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2012
(Unaudited)
 
Note 1.
Company Overview

Pernix is a specialty pharmaceutical company focused on the sales, marketing and development of branded and generic pharmaceutical products for pediatric and adult indications in a variety of therapeutic areas. We expect to continue to execute our growth strategy which involves the horizontal integration of our branded prescription, generic and OTC businesses. We manage a portfolio of branded and generic prescription products and theobromine, a non-codeine, cough suppressant product candidate in development.  Our branded products for the pediatrics market include CEDAX®, an antibiotic for middle ear infections, NATROBA™, a topical treatment for head lice marketed under an exclusive co-promotion agreement with ParaPRO, LLC, REZYST IM™, a proprietary probiotic blend to promote dietary management and a family of prescription treatments for cough and cold (BROVEX®, ALDEX® and PEDIATEX®). The Company promotes its branded products through an established U.S. sales force. Pernix also markets generic products through its wholly-owned subsidiary, Macoven Pharmaceuticals. Founded in 1996, the Company is based in The Woodlands, TX.
 
Registered Direct Offering. On July 27, 2011, the Company completed an underwritten registered direct offering of 4,000,000 shares of common stock pursuant to the terms of that certain underwriting agreement dated July 21, 2011 by and among the Company, the selling stockholders named therein and the underwriters named on Schedule I thereto, for whom Stifel, Nicolaus & Company, Incorporated acted as representative.  As provided in the underwriting agreement, (i) the Company sold an aggregate of 3,000,000 shares of its common stock, and (ii) the selling stockholders sold 1,000,000 shares of common stock.  The public offering price was $7.00 per share, and the underwriters purchased the shares subject to the offering at a price of $6.58 per share.  The offering was led by Aisling Capital and OrbiMed Advisors, LLC. Net proceeds from the sale of the shares of common stock sold by the Company, after underwriting discounts and commissions and offering expenses, were approximately $19.3 million. The offering was made pursuant to an effective shelf registration statement filed with the Securities and Exchange Commission on May 31, 2011.

Controlled Equity Offering.  On February 10, 2012, the Company entered into a controlled equity offering sales agreement (the “Sales Agreement”) with Cantor Fitzgerald & Co. (“Cantor”) pursuant to which the Company could issue and sell shares of its common stock having an aggregate offering price of up to $25,000,000 from time to time through Cantor, acting as agent, but in no event more than 5,000,000 shares of common stock. Sales of the Company's common stock through Cantor were be made on the NYSE Amex by means of ordinary brokers’ transactions at market prices, in block transactions or as otherwise agreed by Cantor and the Company. Cantor  used its commercially reasonable efforts to sell the Company's common stock from time to time, based upon the Company's instructions (including any price, time or size limits or other customary parameters or conditions the Company may impose). The Company paid Cantor a commission rate of 3.0% of the gross sales price per share of any common stock sold through Cantor as agent under the Sales Agreement. The Company has also reimbursed Cantor for certain expenses incurred in connection with entering into the Sales Agreement and has provided Cantor with customary indemnification rights. The Company will use the proceeds of this financing to provide funding for future acquisitions and for general corporate purposes.  As of March 31, 2012, the Company has sold 266,400 shares of common stock under this controlled equity program for total net proceeds of approximately $2.5 million after deducting commissions.  See Note 12, Subsequent Events, for further discussion.
 
 
5

 

Note 2.
Basis of Presentation and Summary of Significant Accounting Policies

Interim Financial Statements
 
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principals in the United States (“GAAP”) and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
 
In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of these financial statements. Operating results for the three-month period ended March 31, 2012 are not necessarily indicative of the results for future periods or the full year.  

Principles of Consolidation

The condensed consolidated financial statements include the accounts of Pernix’s wholly-owned subsidiaries: Pernix Therapeutics, LLC, GTA GP, Inc., GTA LP, Inc., Gaine, Inc. and Macoven Pharmaceuticals, LLC. Transactions between and among the Company and its consolidated subsidiaries are eliminated.  

Management’s Estimates and Assumptions

The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The Company reviews all significant estimates affecting the condensed consolidated financial statements on a recurring basis and records the effect of any necessary adjustments prior to their issuance. Significant estimates of the Company include: revenue recognition, sales allowances such as returns on product sales, government program rebates, customer coupon redemptions, wholesaler/pharmacy discounts, product service fees, rebates and chargebacks, sales commissions, amortization, depreciation, stock-based compensation, the determination of fair values of assets and liabilities in connection with business combinations, and deferred income taxes.
   
Equity Method of Accounting
 
For the periods presented, the Company’s investment in the joint venture with SEEK is accounted for at cost and adjusted for the Company’s share (46%) of the joint venture’s undistributed earnings or losses.

Revenue Recognition

The Company’s consolidated net revenues represent the Company’s net product sales and collaboration revenues.  The following table sets forth the categories of the Company’s net revenues (in thousands) for the three months ended March 31, 2012 and 2011.

   
Three Months Ended
March 31,
(in thousands)
 
   
2012
   
2011
 
Gross product sales
 
$
20,268
   
$
18,252
 
Sales allowances
   
(6,283
)
   
(9,323
)
     Net product sales
   
13,985
     
8,929
 
Co-promotion and other revenue
   
497
     
1,166
 
     Net revenues
 
$
14,482
   
$
10,095
 
 
 
6

 
 
The Company records all of its revenue from product sales and co-promotion agreements when realized or realizable and earned.  Revenue is realized or realizable and earned when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller’s price to the buyer is fixed or determinable; and (4) collectability is reasonably assured.   The Company records revenue from product sales when the customer takes ownership and assumes risk of loss (free-on-board destination). Royalty revenue is recognized upon shipment from the manufacturer to the purchaser.  Co-promotion revenue is recognized in the period in which the product subject to the arrangement is sold.  At the time of sale, estimates for a variety of sales deductions, such as returns on product sales, government program rebates, price adjustments and prompt pay discounts are recorded.

The Company relies on certain materials used in its development and manufacturing processes, most of which are procured from a single source.  The Company purchases its pharmaceutical ingredients from a limited number of suppliers.  The failure of a supplier, including a subcontractor, to deliver on schedule could delay or interrupt the development or commercialization process and thereby adversely affect the Company’s operating results.  In addition, a disruption in the commercial supply of or a significant increase in the cost of the active pharmaceutical ingredient (“API”) from any of these sources could have a material adverse effect on the Company’s business, financial position and results of operations.
 
The Company’s customers consist of drug wholesalers, retail drug stores, mass merchandiser and grocery store pharmacies in the United States. The Company primarily sells its products directly to large national drug wholesalers, which in turn resell the products to smaller or regional wholesalers, retail pharmacies, chain drug stores, and other third parties.  The following tables list the Company’s customers that individually comprised greater than 10% of total gross product sales for the three months ended March 31, 2012 and 2011, or 10% of total accounts receivable as of March 31, 2012 and December 31, 2011.
 
   
Gross Product Sales
 
   
Three Months Ended
March 31,
 
   
2012
   
2011
 
Cardinal Health, Inc.
   
33
%
   
44
%
McKesson Corporation
   
24
%
   
26
%
AmerisourceBergen Drug Corporation
   
17
%
   
14
%
Morris & Dickson Co., LLC
   
11
%
   
7
%
Total
   
85
%
   
91
%
 
   
Accounts Receivable
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
Cardinal Health, Inc.
   
37
%
   
30
%
McKesson Corporation
   
23
%
   
32
%
Walgreens
   
14
%
   
8
%
AmerisourceBergen Drug Corporation
   
13
%
   
8
%
Total
   
87
%
   
78
%
 
Net Revenues

Product Sales

            The Company recognizes revenue from its product sales in accordance with its revenue recognition policy discussed above.  The Company sells its products primarily to large national wholesalers, which have the right to return the products they purchase.  The Company is required to estimate the amount of future returns at the time of revenue recognition.  The Company recognizes product sales net of estimated allowances for product returns, government program rebates, price adjustments, and prompt pay discounts.
 
 
7

 

  Product Returns

Consistent with industry practice, the Company offers contractual return rights that allow its customers to return the majority of its products within an 18-month period, commencing from six months prior to and up to twelve months subsequent to the product expiration date. The Company’s products have a 24 to 36-month expiration period from the date of manufacture.  The Company adjusts its estimate of product returns if it becomes aware of other factors that it believes could significantly impact its expected returns. These factors include its estimate of inventory levels of its products in the distribution channel, the remaining shelf life of the product, review of consumer consumption data as reported by external information management companies, actual and historical return rates for expired lots, the forecast of future sales of the product, competitive issues such as new product entrants and other known changes in sales trends. The Company estimated returns at 5% to 10% of sales of branded products during the first quarter of 2012.  This estimate is based upon historical data and other facts and circumstances that may impact future expected returns to derive an average return percentage of our products. Under our co-promotion arrangement with ParaPRO, certain returns of Natroba sold within the first year of launch may be reimbursed by ParaPRO up to 65%.  The Company estimated returns at 5% - 7% on sales of generic products on sales during the first quarter of 2012 depending on assumptions and/or facts and circumstances existing for certain products.  The returns reserve may be adjusted as we accumulate sales history and returns experience on this portfolio of products. The Company reviews and adjusts these reserves quarterly.
 
Government Program Rebates

 The liability for Medicaid, Medicare and other government program rebates is estimated based on historical and current rebate redemption and utilization rates contractually submitted by each state’s program administrator and assumptions regarding future Medicaid utilization for each product.  
 
Price Adjustments
 
 The Company’s estimates of price adjustments, which include customer rebates, service fees, chargebacks, and other fees and discounts, are based on our estimated mix of sales to various third-party payors who are entitled, either contractually or statutorily, to discounts from the listed prices of our products and contracted service fees with our wholesalers.  In the event that the sales mix to third-party payors or the contract fees paid to the wholesalers are different from the Company’s estimates, the Company may be required to pay higher or lower total price adjustments and/or incur chargebacks that differ from its original estimates and such difference may be significant.
 
 The Company’s estimates of discounts are applied pursuant to the contracts negotiated with certain customers and are primarily based on sales volumes.  The Company, from time to time, offers certain promotional product-related incentives to its customers. These programs include sample cards to retail consumers, certain product incentives to pharmacy customers and other sales stocking allowances. For example, the Company has initiated coupon programs for certain of its promoted products whereby the Company offers a point-of-sale subsidy to retail consumers. The Company estimates its liabilities for these coupon programs based on redemption information provided by a third party claims processing organization. The Company accounts for the costs of these special promotional programs as price adjustments, resulting in a reduction in gross revenue.

Any price adjustments that are not contractual or are non-recurring but that are offered at the time of sale or when a specific triggering event occurs, such as sales stocking allowances or price protection adjustments, are recorded as a reduction in revenue when the sales order is recorded or when the triggering event occurs.  These allowances may be offered at varying times throughout the year or may be associated with specific events such as a new product launch, the reintroduction of a product or product price changes.

Prompt Payment Discount
 
The Company typically requires its customers to remit payments within the first 30 days for branded products and within 60 to 120 days for generics, depending on the customer and the products purchased.  The Company offers wholesale distributors a prompt payment discount if they make payments within these deadlines.  This discount is generally 2%, but may be higher in some instances due to product launches and/or industry expectations.  Because the Company’s wholesale customers typically take the prompt pay discount, we accrue 100% of prompt pay discounts.  These discounts are based on the gross amount of each invoice at the time of our original sale to them.  Earned discounts are applied at the time of payment.  This allowance is recorded as a reduction of accounts receivable. 
   
See Note 8, Other Revenue Sharing Arrangements,  for further discussion of co-promotion and other revenue sharing arrangements.
 
 
8

 
 
Earnings per Share
 
Earnings per common share is presented under two formats: basic earnings per common share and diluted earnings per common share. Basic earnings per common share is computed by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period, plus the potentially dilutive impact of common stock equivalents (i.e. stock options). Dilutive common share equivalents consist of the incremental common shares issuable upon exercise of stock options. 
 
The following table sets forth the computation of basic and diluted net income per share:
 
   
Three Months Ended
March 31,
 
   
2012
   
2011
 
Numerator:
           
Net income
 
$
1,191,163
   
$
975,175
 
                 
Denominator:
               
Weighted-average common shares, basic
   
25,921,139
     
22,652,394
 
Dilutive shares
   
552,225
     
489,130
 
                 
Weighted-average common shares, diluted
   
26,473,364
     
23,141,524
 
                 
Net income per share, basic
 
$
0.05
   
$
0.04
 
                 
Net income per share, diluted  
0.04
   
0.04
 
 
Total outstanding options at March 31, 2012 are 1,980,499.  Options not included above of 1,428,274  are anti-dilutive as of March 31, 2012.  See Note 9, Employee Equity Compensation, for information regarding the Company’s outstanding options.
 
Investments in Marketable Securities and Other Comprehensive Income
 
The Company holds investment marketable equity securities as available-for-sale and the change in the market value gives rise to other comprehensive income.  The components of other comprehensive income are recorded in the consolidated statements of income and comprehensive income, net of the related income tax effect. 
 
On October 5, 2011, the Company acquired 2.6 million shares of TherapeuticsMD for a purchase price of $1.0 million, or $0.38 per share, representing approximately 3.2% of TherapeuticsMD’s outstanding common stock at that time.  The Company’s purchase was contingent upon TherapeuticsMD’s acquisition of VitaMedMD, which occurred on October 4, 2011. The Company has applied a 30% discount to the quoted market value of  its TherapeuticsMD stock, which represents the Company’s estimate of the discount for lack of marketability for its non-controlling interest.  In connection with the Company’s purchase of shares of TherapeuticsMD, the Company also entered into a software license agreement with VitaMedMD pursuant to which VitaMedMD granted the Company an exclusive license to use certain of its physician, patient and product data gathering software in the field of pediatric medicine for a period of five years for a monthly fee of $21,700.  Cooper Collins, the Company’s Chief Executive Officer, serves on the board of TherapeuticsMD.
 
   
As of March 31, 2012
 
TherapeuticsMD Common Stock
 
Cost
   
Appreciation
   
Discount
   
Fair Value
 
2,631,579 shares
 
$
1,000,000
   
5,315,789
   
(1,894,737
 
4,421,052
 
 
 
9

 
 
Reclassifications
 
Certain reclassifications have been made to prior period amounts in our consolidated statements of income to conform to the current period presentation.  These reclassifications related to the classification of cost of samples as a selling expense instead of including in cost of goods had no effect on net income as previously reported.  

Recent Accounting Pronouncements
  
There have been no other recent accounting pronouncements that have not yet been adopted by us that are expected to have a material impact on our condensed consolidated financial statements from the accounting pronouncements previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011.
 
Note 3.
Accounts Receivable

Accounts receivable consist of the following:
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
             
Trade accounts receivable
 
$
15,297,616
   
$
18,844,320
 
Less allowance for prompt pay discounts
   
(339,695
)
   
(393,174
)
Total trade receivables
   
14,957,921
     
18,451,146
 
Receivables from third parties – revenue sharing arrangements
   
1,371,419
     
2,146,214
 
Other miscellaneous receivables
   
72,427
     
4,000
 
Total account receivables
 
$
16,401,767
   
$
20,601,360
 
 
As of March 31, 2012 and December 31, 2011, no receivables were outstanding for longer than the agreed upon payment terms.  The net amount of accounts receivable was considered collectible and no allowance for doubtful accounts was recorded.      
 
Note 4.
Investment in Joint Venture

On December 17, 2010, the Company entered into a Joint Venture Agreement (the “JV Agreement”) with SEEK, a United Kingdom drug discovery group, to form a joint venture structured as a private company limited by shares incorporated in the United Kingdom (the “JV”).  The purpose of the JV is to develop and obtain regulatory approval in both Europe and the United States for products utilizing the JV's intellectual property. Pernix contributed approximately $1.5 million to the JV, in consideration for 50% of the voting interest and approximately 46% of the total economic interest in the JV. On September 26, 2011, the Company funded an additional $1.0 million in cash to the JV for continuing operations.
 
 
 
10

 
 
 Below is the condensed balance sheet of the JV:
 
Condensed Balance Sheet as of:
 
March 31,
   
December 31,
 
(unaudited) (in thousands)
 
2012
   
2011
 
Cash and other current assets
 
$
947
   
$
1,512
 
Intellectual property and other rights (including capitalized development costs)
   
1,719
     
1,719
 
Total assets
 
$
2,666
   
$
3,231
 
                 
Equity
 
 $
2,666
   
 $
3,231
 
 
    For the three months ended March 31,  
    2012     2011  
             
Loss from operations of the joint venture with SEEK
  $ 240     $ 330  
                 
Theobromine development costs were approximately $512,000 for the three months ended March 31, 2012. The Company recorded approximately 46% of these development costs, or $240,000 for the three months ended March 31, 2012, in loss from operations of our JV.  
 
For additional information, see Note 12, Subsequent Events, for further discussion.
  
Note 5.
Intangible Assets
 
License of Gastroenterology Product.   In January 2012, the Company entered into a license and supply agreement with a private company for a new FDA-approved prescription product to treat gastroenterology disease. Under the terms of the agreement, the Company obtained exclusive marketing rights to Omeclamox®  in the United States. The Company paid an up-front license fee of $2.0 million and will pay an additional fee of $2.0 million upon commercial launch of the product. In addition to these license fees, the agreement calls for the Company to pay royalties and milestone payments based on the sales of the product.  Pernix is currently establishing a gastroenterology sales force and plans to launch Omeclamox-Pak® in the summer of 2012.  Omeclamox-Pak® is a triple combination medication taken orally to treat Helicobacter pylori (H. pylori) infection and eradicate duodenal ulcer disease in adults.
 
 
11

 
 
Intangible assets consist of the following:
 
       
March 31,
   
December 31,
 
   
 
Life
 
2012
   
2011
 
Patents
 
12 - 15 years
 
$
1,442,000
   
$
1,442,000
 
Brand – CEDAX
 
8 years
   
3,887,000
     
3,887,000
 
Product licenses
 
1 – 10 years
   
4,520,000
     
120,000
 
Non-compete and supplier contract – Macoven
 
2 - 7 years
   
5,194,571
     
5,194,571
 
Trademark rights – BROVEX
 
Indefinite
   
238,758
     
238,758
 
Goodwill
 
Indefinite
   
1,406,591
     
1,406,591
 
         
16,688,920
     
12,288,920
 
                     
Accumulated amortization
       
(4,024,466
)
   
(3,412,416)
 
Total      
$
12,664,454
   
$
8,876,504
 
 
Estimated amortization expense related to intangible assets with definite lives for each of the five succeeding years and thereafter is as follows:
 
   
Amount
 
2012 (April – December)
 
$
1,113,000
 
2013
   
1,505,000
 
2014
   
1,505,000
 
2015
   
1,505,000
 
2016
   
1,505,000
 
Thereafter
   
3,886,105
 
Total  
$
11,019,105
 
 
Amortization expense is approximately $612,000 and  $471,000 for the three months ended March 31, 2012 and 2011, respectively.  See Note 12, Subsequent Events, for further discussion.  
 
Note 6.
Accrued Allowances
 
Accrued allowances consist of the following:
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
Accrued returns allowance
 
$
4,865,195
   
$
5,712,500
 
Accrued price adjustments
   
5,176,641
     
5,450,619
 
Accrued government program rebates
   
4,863,343
     
5,843,290
 
Total
 
$
14,905,179
   
$
17,006,409
 
 
 
12

 
 
Note 7.
Lines of Credit
        
On September 8, 2010, the Company entered into a Loan Agreement (the “Loan Agreement”) with Regions Bank (“Regions”).  The Loan Agreement provides for a $5 million secured revolving line of credit (the “RLOC”) and a $5 million secured guidance line of credit (the “GLOC” and together with the RLOC, the “Loans”). The RLOC may be used to fund working capital needs and the GLOC may be used for acquisitions approved by Regions. The Loans mature on September 8, 2012 and bear interest at LIBOR plus 2.5%.  

The Loan Agreement contains customary restrictive covenants and events of default, including breaches of representations and warranties and breaches of covenants. As of March 31, 2012, the Company was in compliance with all financial covenants.

In consideration for Regions entering into the Loan Agreement, the Company granted Regions a first priority security interest in substantially all of its assets except for all patents owned by Pernix as well as certain trademarks.  Regions is also entitled to a first priority security interest on any intellectual property assets acquired with proceeds from the GLOC.
 
The outstanding balances under the GLOC and the RLOC were $5,000,000 and $1,000,000, respectively, as of March 31, 2012 and December 31, 2011. 
 
Note 8.
Other Revenue Sharing Arrangements
 
Collaboration Arrangements
 
The Company enters into collaborative arrangements to develop and commercialize drug candidates. Collaborative activities might include research and development, marketing and selling (including promotional activities and physician detailing), manufacturing, and distribution. These collaborations often require royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the product. Revenues related to products sold by the Company pursuant to these arrangements are included in product sales, while other sources of revenue such as royalties and profit share receipts are included in collaboration, royalty and other revenue as further discussed below. Operating expenses for costs incurred pursuant to these arrangements are reported in their respective expense line item.
 
In March 2012, we entered into a product development agreement with a private company for a prescription product for the pediatrics market. Under the terms of the agreement, Pernix obtained exclusive marketing rights to this late-stage development product in the United States, and Pernix will pay the costs related to the development of the product. Pernix expects to invest approximately $6 million over an estimated 36-month period for development and regulatory expenses related to this product candidate, and Pernix’s development partner will manage the development program. Pernix and its development partner expect to commence pivotal phase III studies in the next 12 months.
 
Co-promotion Agreements
 
The Company seeks to enter into co-promotion agreements to enhance the promotional efforts and sales of products. The Company may enter into co-promotion agreements whereby it obtains rights to market other parties’ products in return for certain commissions or percentages of revenue on the sales Pernix generates. Alternatively, Pernix may enter into co-promotion agreements with respect to its products whereby it grants another party certain rights to market or otherwise promote one or more of its products.  Typically, the Company will enter into this type of co-promotion arrangement when a particular product is not aligned with its product focus or it lacks sufficient sales force representation in a particular geographic area. Co-promotion revenue is included in net revenues.  Expense from co-promotion agreements is included in cost of goods sold.
 
In addition to the co-promotion agreement that the Company has with ParaPRO, the Company also has a Supply and Distribution Agreement.  The cost that the Company pays for NATROBA pursuant to the Supply and Distribution Agreement with ParaPRO is significantly higher than the direct manufacturing cost that the Company pays on the other products in our portfolio which impacts our gross profit margin on product sales.  NATROBA was launched in August 2011.
 
   
Three Months Ended
March 31 ,
 
   
2012
   
2011
 
Pernix Consolidated Gross Margin   -   including Natroba
   
68
%
   
N/A
 
                 
Pernix Consolidated Gross Margin - excluding Natroba
   
73
%
   
81
%
 
 
13

 
 
Note 9.
Employee Compensation and Benefits
 
Stock Options
 
The Company’s 2009 Stock Incentive Plan (the “2009 Plan”) was approved concurrent with its merger with GTA on March 9, 2010.  The maximum number of shares that can be offered under this plan is 5,000,000.  Incentives may be granted under the 2009 Plan to eligible participants in the form of (a) incentive stock options, (b) non-qualified stock options, (c) restricted stock, (d) restricted stock units (“RSU”), (e) stock appreciation rights (“SARs”) and (f) other stock-based awards.

As of March 31, 2012, approximately 208,333 options remain outstanding that were issued to current officers and directors under prior incentive plans of GTA.  The remaining average contractual life of these options is approximately eleven months.
 
The Company currently uses the Black-Scholes-Merton option pricing model to determine the fair value of its stock options. The determination of the fair value of stock-based payment awards on the date of grant using an option pricing model is affected by the Company’s stock price, as well as assumptions regarding a number of complex and subjective variables. These variables include the Company’s expected stock price volatility over the term of the awards, actual employee exercise behaviors, risk-free interest rate and expected dividends.

The following table shows the weighted average of the assumptions used to value stock options on the date of grant, as follows:  
 
   
Three Months
 
   
Ended
 
   
March 31, 2012
 
Weighted average expected stock price volatility
   
65.0
%
Estimated dividend yield
   
0.0
%
Risk-free interest rate
   
1.2
%
Expected life of option (in years)
   
6.0
 
Weighted average fair value per share
   
5.52
 
 
 The Company has not paid and does not anticipate paying cash dividends; therefore, the expected dividend rate is assumed to be 0%. The expected stock price volatility for the stock options is based on historical volatility of a representative peer group of comparable companies selected using publicly available industry and market capitalization data. The risk-free rate was based on the U.S. Treasury yield curve in effect at the time of grant commensurate with the expected life assumption. The expected life of the stock options granted was estimated based on the historical exercise patterns over the option lives.  
 
The following table shows the option activity, described above, during the three months ended March 31, 2012:
 
Option Shares
 
Shares
   
Average
Exercise
Price
 
Outstanding at December 31, 2011(1)
   
1,848,491
   
$
4.55
 
Granted
   
170,000
     
9.36
 
Exercised
   
(25,826
)
   
2.25
 
Cancelled
   
(12,166
)
   
4.41
 
Expired
   
         
Outstanding at March 31, 2012
   
1,980,499
   
$
4.99
 
Vested and exercisable, end of period
   
507,996
   
$
4.09
 
 
(1)Includes 460,000 options granted to ParaPRO, LLC on August 3, 2011, that vest over seven years, pursuant to the commercial terms of the co-promotion arrangement between the Company and ParaPRO for the marketing and sale of Natroba.  For additional information, see Note 8, Other Revenue Sharing Arrangements.
 
 
14

 
 
The following table shows the details by range of exercise price for the total options outstanding at March 31, 2012:  
 
      Options Outstanding    
Options Exercisable
 
Range of Exercise Price
($)
   
Shares
   
Remaining Contractual Life
(years)
   
Shares
   
Price
($)
 
  1.94 - 2.20       25,833       .9       25,833       2.00  
  3.31 – 4.20 (1)     1,361,166       7.6       453,831       3.90  
  6.10       193,500       9.4      
     
 
  7.90 – 9.02       300,000       9.7       13,333       7.90  
  10.13 – 10.35       100,000       9.5       14,999       10.14  
          1,980,499       8.06       507,996       4.09  
 
(1)Includes 460,000 options granted to ParaPRO, LLC on August 3, 2011, that vest over seven years, pursuant to the commercial terms of the co-promotion arrangement between the Company and ParaPRO for the marketing and sale of Natroba.  For additional information, see Note 8, Other Revenue Sharing Arrangements.
 
As of March 31, 2012, the aggregate intrinsic value of 507,996 options outstanding and exercisable was approximately $2,511,000.
 
As of March 31, 2012, there was approximately $2,930,000 of total unrecognized compensation cost related to unvested stock options issued to employees and directors of the Company, which is expected to be recognized ratably over a weighted-average period of 2.3 years.
 
Restricted Stock

Amendment to Employment Agreement . On March 23, 2012, the Company, Macoven and John McMahon, Macoven’s Vice President of Product Sales, entered into an amendment to Mr. McMahon’s amended and restated employment agreement pursuant to which all provisions relating to quarterly bonuses and a bonus pool were removed.  The amendment also provided for the issuance of 165,000 shares of restricted stock pursuant to the Company’s 2009 Amended and Restated Stock Incentive Plan with certain volume limitations on the sale of such shares after vesting. 
 
Also on March 23, 2012, in connection with the amendment to Mr. McMahon’s agreement,  the Company granted Michael Venters, Macoven’s Executive Vice President of Corporate Development, 85,000 shares of restricted stock pursuant to the Company’s 2009 Amended and Restated Stock Incentive Plan with the same volume limitations as Mr. McMahon.  Both grants vest in equal installments on each of the first three anniversaries of the date of grant.
 
Director Compensation. On March 22, 2012, each non-executive director received a grant of options to purchase 10,000 shares of our common stock and a grant of 10,000 shares of restricted stock.  The options and restricted stock each vest one-third per year on the first three anniversaries of the grant date.  The options were granted at the market price of $9.02, the closing market price on March 21, 2012.  In addition, our Board approved a $5,000 increase in the annual cash compensation of the non-executive Chairman.
 
 
15

 

The following table shows the Company's nonvested restricted stock outstanding at March 31, 2012:
 
         
Weighted Average
 
         
Grant Date
 
Restricted Stock Shares
 
Shares
   
Fair Value
 
Nonvested at December 31, 2011
   
120,002
   
$
6.56
 
Granted
   
290,000
     
8.61
 
Vested
   
(48,335
)
   
6.11
 
Forfeited
   
         
Nonvested at March 31, 2012
   
361,667
   
$
8.27
 
 
During the three months ended March 31, 2012, 290,000 restricted common shares were issued as described above. Approximately $2,905,000 of total unrecognized compensation expense related to unvested restricted stock is expected to be recognized over a weighted-average period of 2.8 years.  
 
Employee Stock Purchase Plan

Effective July 22, 2010, the Company adopted the 2010 Employee Stock Purchase Plan to provide substantially all employees an opportunity to purchase shares of its common stock through payroll deduction, up to 10% of eligible compensation with a $25,000 maximum deferral.  Semi-annually (on May 1st and November 1st), participant account balances may be used to purchase shares of stock at the lesser of 85 percent of the fair market value of shares at the beginning or ending of such six-month period.  The Employee  Stock Purchase Plan expires on July 22, 2020.  A total of 1,000,000 shares are available for purchase under this plan.  Compensation expense related to the Employee Stock Purchase Plan and included in the table below for the three months ended March 31, 2012 was approximately $22,000.
  
Stock-Based Compensation Expense
 
The following table shows the approximate amount of total stock-based compensation expense recognized for employees and non-employees:
   
   
Three Months Ended
March 31,
 
   
2012
   
2011
 
Employees
  $ 338,000     $ 145,000  
Non-employees/Directors
    158,000       66,000  
                 
Total
  $ 496,000     $ 211,000  
 
 
16

 
 
Note 10.
Income Taxes

The income tax provision consisted of the income tax expense (benefit) for the three months ended March 31, 2012 and 2011, as presented in the table below.   
 
   
Three Months Ended
March 31,
 
   
2012
   
2011
 
Current:
           
Federal
 
$
310,000
   
$
1,458,000
 
State
   
47,000
     
243,000
 
     
357,000
     
1,701,000
 
Deferred:
               
Federal
   
(377,000
)
   
(833,000
)
State
   
(49,000
)
   
(145,000
)
     
(426,000
)
   
(978,000
)
                 
   
$
783,000
   
$
723,000
 
 
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of the assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.  The sources of the temporary differences and their effect on deferred taxes are as follows:
 
   
March 31,
   
December 31,
 
Deferred Tax Assets:
 
2012
   
2011
 
Accounts receivable
 
$
130,000
   
$
149,000
 
Inventory
   
10,000
     
 
Fixed assets
   
68,000
     
66,000
 
Accrued expenses and allowances
   
3,095,000
     
3,831,000
 
Stock awards
   
775,000
     
515,000
 
Investment in joint venture with SEEK
   
404,000
     
312,000
 
NOL Carryforwards
   
455,000
     
493,000
 
                 
Gross deferred tax assets
 
$
4,937,000
   
$
5,366,000
 
                 
Deferred Tax Liabilities:
               
Other
   
(109,000
)
   
(99,000
)
Intangibles
   
(887,000
)
   
(901,000
)
Investments
   
 (1,309,000
   
(674,000 
)
Gross deferred tax liability
 
$
(2,305,000
)
 
$
(1,674,000
)
                 
Net deferred tax asset
 
$
2,632,000
   
$
3,692,000
 
                 
Included in consolidated balance sheet:
               
Deferred income tax assets/deferred income tax liabilities - current
   
4,057,000
     
4,552,000
 
Deferred income tax assets/deferred income tax liabilities - long term
   
(1,425,000
)
   
(860,000
)
                 
Net deferred tax asset
 
$
2,632,000
   
$
3,692,000
 
 
 
17

 
 
 In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.  The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.  Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.  Based upon the level of historical taxable income and projections for future taxable income over the periods that the deferred tax assets are deductible, management believes that it is more likely than not that the Company will realize the benefits of these deductible differences.  The amount of the deferred tax assets are considered realizable based on the reversal of deferred tax liabilities and the Company’s projected levels of taxable income.

The effective income tax rate from continuing operations is different from the federal statutory rate for the three months ended March 31, 2012 and 2011 for the following reasons:
   
   
Three Months Ended
March 31,
   
2012
   
2011
 
Expected taxes at statutory rates
   
35.0
%
   
35.0
%
State taxes, net of federal tax benefit
   
3.2
%
   
3.8
%
Incentive stock options
   
     
3.4
%
Nondeductible expenses, including merger related expenses
   
1.6
%
   
0.4
%
Other
   
(0.1
%)
   
0.0
%
     
39.7
%
   
42.6
%

Note 11.
Commitments and Contingencies

Legal Matters
 
United States District Court for the Eastern District of Texas, Civil Action No. 6:12-cv-00027-LED.   On January 19, 2012, plaintiffs, Merck & Cie, South Alabama Medical Science Foundation, and Pamlab, L.L.C., filed suit seeking unspecified damages and injunctive relief against our wholly-owned subsidiary, Macoven Pharmaceuticals, for infringement of U.S. Patent Nos. 5,997,915, 6,254,904, 6,673,381, 7,172,778, 7,674,490, and 6,011,040 based on Macoven’s commercialization of the following products:  Vitaciric-B; ALZ-NAC; L-methylfolate PNV; L-methylfolate calcium 7.5 mg; and L-methylfolate calcium 15 mg. Macoven denies liability for infringement and has filed a counterclaim for non-infringement and patent invalidity. Formal discovery has not yet commenced and no trial date has been set.
 
Pernix is subject to various other claims and litigation arising in the ordinary course of business.  In the opinion of management, the outcome of such matters will not have a material effect on Pernix’s financial position or results of operations.

Purchase Commitments
 
Pursuant to the Supply and Distribution Agreement between the Company and ParaPRO, the Company has purchase commitments for NATROBA of approximately $33,830,000 during year 1, $51,740,000 during year 2 and $75,620,000 during year 3 of the supply and distribution agreement in order to retain its exclusive co-promotion rights, with the purchase commitment obligations commencing on August 3, 2011. The Company purchased approximately $10,671,000 under the agreement for the year ended December 31, 2011. The Supply and Distribution Agreement may be terminated pursuant to certain terms in conditions, including but not limited to, the failure of the parties to come to agreement on adjusted dispensed product minimums.
 
 
18

 
 
Stock Options Issued in Exchange for Services
 
Pursuant to an agreement for support services entered into between the Company and ParaPRO on August 27, 2010 which commenced upon the launch of NATROBA on August 3, 2011, 460,000 stock options were granted to ParaPRO. The options have an exercise price of $3.65 which is the closing price of the Company’s stock as of the date of the support services agreement. The options are exercisable in seven installments in the following amounts: (i) 30,000 on August 1, 2012; (ii) 40,000 on August 1, 2013; (iii) 50,000 on August 1, 2014; (iv) 60,000 on August 1, 2015; (v) 70,000 on August 1, 2016; (vi) 90,000 on August 1, 2017; and (vii) 120,000 on August 1, 2018. The options are exercisable for a period of five years from the date each becomes exercisable and are valued at approximately $2,841,000. These options were granted in a private offering under Rule 4(2) of the Securities Act of 1933. As of December 31, 2011, there was approximately $2,528,000 of total unrecognized compensation cost related to unvested stock options, which is expected to be recognized ratably over a weighted-average period of 4.7 years.

Leases
 
The Company leases it office facilities in The Woodlands, Texas under a lease with an unrelated third party.  The term of the current lease expires on May 8, 2015.  Pursuant to this lease, the Company pays rent of approximately $15,000 per month with stated annual escalators and shares in 2.49% of the excess operating expenses of the building.
 
The Company leases certain of its office and warehouse facilities under triple net leases with an entity owned by the former stockholders of  PTI.  The term of each lease is month to month and may be terminated by either party without penalty.  Pursuant to these leases, the Company pays rent of approximately $5,100 and $3,000 per month for the Texas and Louisiana facilities, respectively, with an annual CPI escalator. The Company believes these amounts reflect market rates that are as favorable to the Company as could be obtained with unrelated third parties.  
 
The Company leases it office facilities in South Carolina under a lease with an unrelated third party.  The term of the current lease expires April 1, 2013.  Pursuant to this lease, the Company pays rent of approximately $2,300 per month with annual escalators of 10%.
 
The Company leases certain equipment under operating leases pursuant to which future expected payments are approximately $7,000 in 2012, $6,000 in 2013 and $4,000 thereafter.

Acquisitions, License and Co-promotion Agreements
 
The Company has entered into certain revenue sharing arrangements that require payments based on a specified percentage of net sales or a specified cost per unit sold.  For the three months ended March 31, 2012 and 2011, we recognized approximately $1,114,000 and $136,000, respectively, in expense included in cost of goods sold from payments pursuant to co-promotion and other revenue sharing arrangements.
 
 
19

 
 
 
Other Contingencies
 
The Company is exposed to various risks of loss related to torts; theft of, damage to, and destruction of assets; errors and omissions; injuries to employees; and natural disasters for which the Company maintains a general liability insurance with limits and deductibles that management believes prudent in light of the exposure of the Company to loss and the cost of insurance.
 
For further details on commitments and contingencies, see Note 12, Subsequent Events.
 
Note 12.
Subsequent Events
 
Controlled Equity Offering 

On April 25, 2012, the Company sold approximately 2.7 million shares of common stock under the ATM Offering with Cantor for total net proceeds of approximately $21.3 million after deducting commissions.  Prior to this transaction, the Company had sold 269,500 shares of common stock under the ATM Offering for total net proceeds of approximately $2.5 million after deducting commissions.  No further sales of common stock will be made under the ATM Offering.  The Company intends to use the net proceeds from the ATM program to fund future acquisitions and for general corporate purposes.

Termination of Joint Venture

On May 14, 2012, the Company acquired the exclusive rights from SEEK, its joint venture partner, to commercialize and market products utilizing the intellectual property (IP) in the areas of cough, cold, sinus and allergy in the United States and Canada in connection with the termination of its joint venture with SEEK.   SEEK will retain exclusive rights to commercialize and develop the intellectual property outside the United States and Canada. Under the terms of the agreement, the Company paid SEEK $5 million in connection with the termination of its joint venture with SEEK, and will pay royalties to SEEK on sales of products utilizing the joint venture IP in the United States and Canada. Pernix will also receive royalties from SEEK product sales outside of the United States and Canada. As a result, the Company will no longer share in the development costs outside the United States and Canada.
 
 
20

 
 
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business and products, key factors that impact our performance and a summary of our operating results. You should read the following Management’s Discussion and Analysis of Financial Condition and Results of Operations together with our unaudited condensed consolidated financial statements and the related notes included in “Part I—Item 1. Financial Statements” of this Quarterly Report on Form 10-Q and the condensed consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2011. In addition to historical information, the following discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results could differ materially from those anticipated by the forward-looking statements due to important factors including, but not limited to, those set forth under “Part I—Item1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2011.
 
Executive Overview
 
Strategy

Pernix Therapeutics Holdings, Inc. (“Pernix” or the “Company”)  is a specialty pharmaceutical company focused on the sales, marketing and development of branded and generic pharmaceutical products for pediatric and adult indications in a variety of therapeutic areas.  We expect to continue to execute our growth strategy which includes the horizontal integration of our branded prescription, generic and over-the-counter ("OTC") businesses. We manage a portfolio of branded and generic products and theobromine, a non-codeine, cough suppressant product candidate in development.  Our branded products for the pediatrics market include CEDAX®, an antibiotic for middle ear infections, NATROBA™, a topical treatment for head lice marketed under an exclusive co-promotion agreement with ParaPRO, LLC and a family of prescription treatments for cough and cold (BROVEX®, ALDEX® and PEDIATEX®). We also market REZYST IM™, a proprietary probiotic blend to promote dietary management.  The Company promotes its branded products through an established U.S. sales force. Pernix also markets generic products through its wholly-owned subsidiary, Macoven Pharmaceuticals.
 
Pernix was incorporated in November 1996 and is headquartered in The Woodlands, Texas and employs approximately 85 people full-time. 

Our business strategy is to: 
 
● 
Promote products through our sales and marketing organization of approximately 55 sales representatives, plus our new gastro sales force of approximately 25 sales repesentatives, primarily in highly populated states, targeting pediatric and high-prescribing physicians.
 
● 
Develop and launch generic and authorized generic products through Macoven, our wholly-owned subsidiary.
 
● 
Launch new line extensions and new formulations of our currently marketed products.
 
● 
Maximize the value of our exclusive rights to the joint venture intellectual property assets in the United States and Canada.
 
● 
Continue to diversify and expand our product portfolio through acquisitions, co-promotions and in-licensing agreements.
 
● 
Leverage our business model by expanding into additional therapeutic areas.  We are currently establishing a sales force of approximately 30 representatives, consisting of new and existing representatives, dedicated to gastroenterology following our entry into the license agreement described below.
 
●  Adapt quickly to a rapidly changing pharmaceutical environment, and operate as a quick, nimble, and agile company.
 
We believe that if we continue to implement this strategy successfully, we can deliver consistent long-term revenue and earnings growth.
 
 
21

 

Certain products in our portfolio are marketed without a United States Food and Drug Administration (“FDA”) approved marketing application because we consider them to be identical, related or similar to products that have existed in the market without an FDA-approved marketing application, and which were thought not to require pre-market approval, or which were approved only on the basis of safety, at the time they entered the marketplace, subject to FDA enforcement policies established with the FDA’s Drug Efficacy Study Implementation, or DESI, program. On March 2, 2011, the FDA announced the removal of certain unapproved prescription cough, cold and allergy products from the U.S. market.   The FDA announcement has not resulted in a material adverse impact on our results of operations or financial condition, nor do we expect it to in future periods. 

Acquisitions and License Agreements, Co-Promotions and Collaborations

On May 14, 2012, we acquired the exclusive rights from SEEK, our joint venture partner, to commercialize and market products utilizing the intellectual property (IP) in the areas of cough, cold, sinus and allergy in the United States and Canada.   SEEK will retain exclusive rights to commercialize and develop Theobromine outside the United States and Canada in connection with the termination of our joint venture with SEEK. SEEK will retain exclusive rights to commercialize and develop the commercial property outside the United States and Canada. Under the terms of the agreement, we paid SEEK $5 million in connection with the termination of our joint venture with SEEK, and will pay royalties to SEEK on sales of products utilizing the joint venture IP in the United States and Canada.  We will also receive royalties from SEEK product sales outside of the United States and Canada. As a result, we will no longer share in the development costs outside the United States and Canada.

In January 2012, we entered into a license and supply agreement with a private company for Omeclamox®, a new FDA-approved prescription product to treat gastroenterology disease. Under the terms of the agreement, we obtained exclusive marketing rights to this product in the United States. We paid an up-front license fee of $2.0 million and expect to pay an additional fee of $2.0 million upon commercial launch of Omeclamox®. In addition to these license fees, the agreement calls for us to pay royalties and milestone payments based on the sales of the product. Pernix  is currently establishing a gastroenterology sales force and plans to launch Omeclamox-Pak® in the summer of 2012.  Omeclamox-Pak® is a triple combination medication taken orally to treat Helicobacter pylori (H. pylori) infection and eradicate duodenal ulcer disease in adults.

Omeclamox-Pak® is a ten-day therapy of omeprazole delayed-release capsules (20 mg), clarithromycin tablets (500 mg) and amoxicillin capsules (500 mg) for the treatment of Helicobacter pylori (H. pylori) infection and duodenal ulcer disease (active or one-year history) to eradicate H. pylori in adult patients. The product is co-packaged in twice-daily patient compliance packs and was approved by the U.S. Food and Drug Administration (FDA) in 2011.

H. pylori are a bacterium acquired largely by people living in developing countries. Researchers suspect the bacteria are passed through contact with human saliva and waste, or contaminated food and water. If H. pylori is left untreated, it can damage the stomach and small intestine wall causing peptic ulcer disease, specifically duodenal ulcers.  Symptoms of H. pylori-induced duodenal ulcers generally surface in adults and may include burning pain in the abdomen, nausea, vomiting, and bloating and weight loss. According to the National Institutes of Health, approximately 20 percent of people under 40 years old and half of adults over 60 years of age are infected.

We have and continue to grow our business through the use of acquisitions, license agreements, co-promotions and collaborations. We enter into acquisition, license and co-promotion agreements to acquire, develop, commercialize and market products and product candidates.  In certain of these agreements, we market the products of others and remit a specified profit share to them.  In certain other agreements, the contracted third party under the agreement markets products to which we have rights and remits a specified profit share to us.  Collaborative agreements often include research and development efforts and/or capital funding requirements of the parties necessary to bring a product candidate to market.  License, co-promotion and collaboration agreements may require royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the product, as well as expense reimbursements or payments to third-party licensors.
 
Collaborations
 
Development of Late-stage Pediatric Product.   In March 2012, we entered into a product development agreement with a private company for a prescription product for the pediatrics market. Under the terms of the agreement, Pernix obtained exclusive marketing rights to this late-stage development product in the United States, and Pernix will pay the costs related to the development of the product. Pernix expects to invest approximately $6 million over an estimated 36-month period for development and regulatory expenses related to this product candidate, and Pernix’s development partner will manage the development program. Pernix and its development partner expect to commence pivotal phase III studies in the next 12 months.
 
 
22

 
 
First Quarter 2012 Highlights
 
The following summarizes certain key financial measures as of, and for, the three months ended March 31, 2012:

Cash and cash equivalents totaled $39.2 million as of March 31, 2012.
 
Net revenues were approximately $14.5 million and $10.1 million for the three months ended March 31, 2012 and 2011, respectively.
 
Net income before taxes was approximately $ 2.0 million and $1.7 million for the three months ended March 31, 2012 and 2011, respectively.  Net income was approximately $1.2  million and $1.0 million for the three months ended March 31, 2012 and 2011, respectively.
 
    Opportunities and Trends
 
There continue to be unmet patient needs in the pediatric area as well as other therapeutic areas. We believe that we can systematically focus our efforts on developing and acquiring products or acquiring the assets of other companies whose products or assets can meet these needs. We also believe that future growth will be realized in the execution of branded and generic development opportunities outside the pediatric area.  We believe the combination of product development and acquisition will enhance our growth opportunities.  Additionally, we will continue to leverage our industry relationships to identify and take advantage of new product opportunities.
 
We are operating in challenging economic and industry environments. The challenges we face are compounded by the continued uncertainty around the impact of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, which we refer to collectively herein as Health Care Reform. Given this business climate, we will continue to focus on managing and deploying our available cash efficiently and strengthening our industry relationships in order to be well-positioned to identify and capitalize upon potential growth opportunities.
 
As we execute our strategy, we will monitor and evaluate success through the following measures:

Net product sales generated from our existing products;
   
Revenues generated from co-promotion agreements;
 
Progress of our development pipeline (as discussed below); and
 
Acquisition of products and product rights that align with our strategy and that offer potential for sustainable growth.
 
 See Notes 1 and 12 to our Condensed Consolidated Financial Statements for the three months ended March 31, 2012 and 2011 contained in Part I, Item 1 of this Quarterly Report on Form 10-Q for our discussion of net proceeds received from our registered direct offering in July 2011 and our controlled equity offering in April 2012 that is expected to fund future acquisitions and for general corporate purposes.
 
Financial Operations Overview
 
The discussion in this section describes our income statement categories.  For a discussion of our results of operations, see “Results of Operations” below.
  
  Net Revenues

 Pernix’s net revenues consist of net product sales and revenue from co-promotion and other revenue sharing arrangements. Pernix recognizes product sales net of estimated allowances for product returns, price adjustments (customer rebates, service fees, chargebacks and other discounts), government program rebates (Medicaid, Medicare and other government sponsored programs)  and prompt pay discounts.  The primary factors that determine Pernix’s net product sales are the level of demand for Pernix’s products, unit sales prices, the applicable federal and supplemental government program rebates, contracted rebates, services fees, and chargebacks and other discounts that Pernix may offer. In addition to our own product portfolio, we have entered into co-promotion agreements and other revenue sharing arrangements with various parties in return for a percentage of revenue on sales we generate or on sales they generate.
 
 
23

 
  
The following table sets forth a summary of Pernix’s net revenues for the three months ended March 31, 2012 and 2011:

   
Three Months Ended
March 31,
 
   
2012
   
2011
 
             
Upper respiratory, allergy and antibiotic products
 
$
11,552
   
$
17,662
 
Dietary supplements and medical food products
   
3,031
     
212
 
Dermatology products (including Natroba)
   
1,500
     
378
 
Other generic products
   
4,088
     
-
 
Co-promotion and other revenue
   
594
     
1,166
 
Gross Revenues
   
20,765
     
19,418
 
    Sales Allowances
   
(6,283
)
   
(9,323
)
Net Revenues
 
$
14,482
   
$
10,095
 
 
During the three months ended March 31, 2012, Macoven’s sales of generic products accounted for approximately 39% of total gross product sales revenue. 

Allowances for Prompt Pay Discounts, Product Returns, Price Adjustments,  and Medicaid Rebates
 
The following table sets forth a summary of our allowances for product returns, government rebate programs and price adjustments as of March 31, 2012.   Prompt pay discounts are recorded as a reduction of accounts receivable and revenue and, therefore, are not included in the table below. The allowance for prompt pay discounts as of March 31, 2012 and December 31, 2011 was approximately $340,000 and $393,000, respectively.

   
Product
Returns
    Government
Program
Rebates
   
Price
Adjustments
 
   
(in thousands)
    (in thousands)     (in thousands)  
Balance at December 31, 2010
  $ 4,313     $ 4,432     $ 1,744  
Adjustments to provision for prior year sales
    498       1,137       300  
Provision – current year sales
    4,784       9,969       12,311  
Payments and credits
    (3,883 )     (9,695 )     (8,904 )
Balance at December 31, 2011
    5,712       5,843       5,451  
Provision – current year sales
    1,077       1,728       3,051  
Payments and credits
    (1,924 )     (2,708 )     (3,325 )
Balance at March 31, 2012
  $ 4,865     $ 4,863     $ 5,177  
 
 
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Product Returns. Consistent with industry practice, we offer contractual return rights that allow our customers to return the majority of our products within an 18-month period, from six months prior to and up to twelve months subsequent to the expiration date of our products. Most of our products have a 24 to 36–month shelf life from the date of manufacture.  We adjust our estimate of product returns if we become aware of other factors that we believe could significantly impact our expected returns. These factors include our estimate of inventory levels of our products in the distribution channel, the remaining shelf life of the product, review of consumer consumption data as reported by external information management companies, actual and historical return rates for expired lots, the forecast of future sales of the product and competitive issues such as new product entrants and other known changes in sales trends. We estimated returns at  5% to 10% of sales of branded products (currently 7% on sales of NATROBA) during the first quarter of 2012 and  5% to 7% for generic products based upon historical data and other facts and circumstances that may impact future expected returns to derive the average return percentages of our products. Under our co-promotion agreement with ParaPRO, certain returns of Natroba sold within the first year of launch will be reimbursed by ParaPRO up to 65%. We review the reserve quarterly and adjust it accordingly.   If estimates regarding product demand are inaccurate, if changes in the competitive environment affect demand for certain products, or if other unforeseen circumstances effect a product’s salability, actual returns could differ and such differences could be material.  For example, a 1% difference in our provision assumptions for the three months ended March 31, 2012 would have affected pre-tax earnings by approximately $203,000.

Government Program Rebates. The liability for government program rebates is estimated based on historical and current rebate redemption and utilization rates contractually submitted by each state’s program administrator and assumptions regarding future Medicaid utilization for each product sold.  As we become aware of changing circumstances regarding the Medicaid and Medicare coverage of our products, we will continue to incorporate such changing circumstances into the estimates and assumptions that we use to calculate government program rebates. If our estimates and assumptions prove inaccurate, we may be subject to higher or lower government program rebates.  For example, with respect to the provision for the three months ended March 31, 2012, a 1% difference in the provision assumptions based on utilization would have effected pre-tax earnings by approximately $40,000 and a 1% difference in the provisions based on  reimbursement rates would have affected pre-tax earnings by approximately $20,000.
 
Price Adjustments.  Our estimates of price adjustments which include customer rebates, service fees, chargebacks and other discounts are based on our estimated mix of sales to various third-party payors who are entitled either contractually or statutorily to discounts from the listed prices of our products and contracted service fees with our wholesalers.  In the event that the sales mix to third-party payors or the contract fees paid to the wholesalers are different from our estimates, we may be required to pay higher or lower total price adjustments than originally estimated.  For example, for the three months ended March 31, 2012, a 1% difference in the assumptions based on the applicable sales would have affected pre-tax earnings by approximately $333,000.
 
 We, from time to time, offer certain promotional product-related incentives to our customers. These programs include sample cards to retail consumers, certain product incentives to pharmacy customers and other sales stocking allowances. For example, we have initiated coupon programs for certain of our promoted products whereby we offer a point-of-sale subsidy to retail consumers. We estimate our liabilities for these coupon programs based on redemption information provided by a third party claims processing organization. We account for the costs of these special promotional programs as a reduction of gross revenue when applicable products are sold to the wholesalers or other retailers.  Any price adjustments that are not contractual but that are offered at the time of sale are recorded as a reduction of revenue when the sales order is recorded.  These adjustments are not accrued as they are offered on a non-recurring basis at the time of sale and are recorded as an expense at the time of the sale. These allowances may be offered at varying times throughout the year or may be associated with specific events such as a new product launch or to reintroduce a product.  Approximately 20% of the provision relates to point-of-sale discounts to the wholesaler.
 
Prompt Payment Discounts. We typically require our customers to remit payments within the first 30 days for branded products (60 to 120 days for generics, depending on the customer and the products purchased).  We offer wholesale distributors a prompt payment discount if they make payments within these deadlines.  This discount is generally 2%, but may be higher in some instances due to product launches and/or industry expectations.  Because our wholesale distributors typically take advantage of the prompt pay discount, we accrue 100% of the prompt pay discounts, based on the gross amount of each invoice, at the time of our original sale, and apply earned discounts at the time of payment.  This allowance is recorded as a reduction of accounts receivable and revenue. We adjust the accrual periodically to reflect actual experience.  Historically, these adjustments have not been material.  We do not anticipate that future changes to our estimates of prompt payment discounts will have a material impact on our net revenue. 
  
Cost of Product Sales
 
Our cost of product sales is primarily comprised of the costs of manufacturing and distributing Pernix’s pharmaceutical products and samples and collaboration expense related to co-promotional agreements with third parties. In particular, cost of product sales includes third-party manufacturing, packaging and distribution costs and the cost of certain pharmaceutical ingredients. Pernix partners with third parties to manufacture all of its products and product candidates.
 
 
25

 
 
Most of our manufacturing arrangements are not subject to long-term agreements and generally may be terminated by either party without penalty at any time. Changes in the price of raw materials and manufacturing costs could adversely affect Pernix’s gross margins on the sale of its products. Changes in Pernix’s mix of products sold also affect its cost of product sales.

The cost of NATROBA is included in our cost of product sales from August 2011 (the month of launch).  We pay wholesale average cost less a nominal discount when we purchase NATROBA inventory and then receive a contracted cost of goods rebate when the product ships to retailers in our specified territories, resulting in significantly lower margins on sales of NATROBA as compared to the other products we market.

Selling, General and Administrative Expenses
 
Our selling, general and administrative expenses consist primarily of salaries, benefits and commissions as well as public company costs, professional and consulting fees, sales data costs, insurance, and Company overhead. 
 
Research and Development Expenses
 
Research and development expenses consist of costs incurred in identifying, developing and testing products and product candidates. Pernix either expenses research and development costs as incurred or if Pernix pays manufacturers a prepaid research and development fee, Pernix will expense such fee ratably over the term of the development. Pernix believes that significant investment in research and development is important to its competitive position and may, in the future, increase its expenditures for research and development to realize the potential of the product candidates that it is developing or may develop, including products utilizing our IP acquired in connection with the termination of our joint venture with SEEK in the areas of cough, cold, sinus and allergy in the United States and Canada. See Note 12, Subsequent Events, to our Condensed Consolidated Financial Statements for the three months ended March 31, 2012 and 2011 contained in Part I, Item I of this Quarterly Report on From 10-Q for a discussion of our acquisition of the exclusive rights to the theobromine intellectual property in the United States and Canada.

Loss from the Operations of the Joint Venture

See Note 4, Investment in Joint Venture, to our Condensed Consolidated Financial Statements for the three months ended March 31, 2012 and 2011 contained in Part I, Item 1 of this Quarterly Report on Form 10-Q.  
 
Other Income and Expenses
 
Depreciation Expense.  Depreciation expense is recognized for our property and equipment, which depreciates over the estimated useful life of the asset using the straight-line method.

Amortization Expense.  Amortization expense is recognized for certain of our intangible assets, consisting primarily of  licensing and acquisition agreements, including the gastroenterology license acquired in February 2012,  CEDAX in March 2010 and Macoven in September 2010, which are amortized over their estimated useful lives using the straight-line method.
 
Income Taxes.  Deferred taxes are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rates applicable to future years to the difference between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred taxes for a change in tax rates is recognized in income in the period that includes the enactment date.  Pernix will recognize future tax benefits to the extent that realization of such benefits is more likely than not.

Critical Accounting Estimates
 
For information regarding our critical accounting policies and estimates please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” contained in our annual report on Form 10-K for the year ended December 31, 2011 and Note 2 to our condensed consolidated financial statements contained therein. There have been no material changes to the critical accounting policies previously disclosed in that report. 
 
 
26

 
 
Results of Operations
 
Comparison of the Three Months Ended March 31, 2012 and 2011
 
Net Revenues.   Net revenues were approximately $14,482,000 and $10,095,000 for the three months ended March 31, 2012 and 2011, respectively, an increase of approximately $4,387,000, or 43.5%. The increase in net revenues during the three months ended March 31, 2012 was due to a combination of reductions in Medicaid rebate expense of approximately $3,400,000 and in chargebacks of approximately $519,000 and an increase in gross product sales of approximately $2,016,000 offset by a decrease in collaboration and other revenue of approximately $668,000 and an increase in other gross-to-net deductions such as returns and other price adjustments (rebates, discounts, etc.)  of approximately $862,000.  The increase in gross product sales was due to an increase in the sales of generic products through our subsidiary, Macoven. The decrease in Medicaid rebate expense was due to a change in the product mix sold during the current period compared to the prior year period, changes in Medicaid coverage and related supplemental reimbursement rates and the fact that the Medicaid provision in the three months ended March 31, 2011 included a provision on 2010 sales of approximately $1,137,000.  The decrease in chargebacks was due to a higher percentage of generic sales that were direct to retailers in the current period.  The increase in the other gross-to-net deductions was due to the increase in sales of generic products and an increase in the returns allowance for certain generic products.
   
  Cost of Product Sales.  Cost of product sales was approximately $4,691,000 and $1,956,000 for the three months ended March 31, 2012 and 2011, respectively, an increase of approximately $2,735,000, or 139.8%. The increase in cost of product sales was primarily the result of the launch of the Natroba product line in August of 2011.  The cost that the Company pays for Natroba pursuant to the Supply and Distribution Agreement with ParaPRO is significantly higher than the direct manufacturing cost that we pay on the other products in our portfolio. See Note 8, Other Revenue Sharing Arrangements, to our Condensed Consolidated Financial Statements for the three months ended March 31, 2012 and 2011 contained in Part I, Item 1 of this Quarterly Report on Form 10-Q for a comparison of our gross margin.  Collaboration expense included in cost of sales was approximately $1,114,000 and $136,000, an increase of approximately $978,000 for the three months ended March 31, 2012 and 2011, respectively.  The increase in the collaboration expense was primarily due to profit sharing arrangements on a number of our generic products.
 
Selling, General and Administrative Expenses.  Selling, general and administrative expenses were approximately $6,824,000 and $5,220,000 for the three months ended March 31, 2012 and 2011, respectively, an increase of approximately $1,604,000, or 30.7%.  Salaries, bonuses, commissions, incentives and stock compensation expense ("overall compensation expense") represented approximately $3,182,000, or 46.6%, and $3,019,000, or 57.8%, of total selling, general and administrative expenses for the three months ended March 31, 2012 and 2011, respectively.  The increase in overall compensation expense is primarily due to an increase in salaries related to the hiring of several new positions (including two executive positions in December 2011) after March 31, 2011 and an increase in stock compensation expense due to options and restricted stock awarded after March 31, 2011, offset by a decrease in commissions due to a change in the product mix coupled with a change in the sales commission structure.  Other selling, general and administrative expenses were approximately $3,642,000 and $2,200,000 for the three months ended March 31, 2012 and 2011, respectively, an increase of approximately $1,442,000 or 65.5%. This increase in other selling, general and administrative expenses was primarily due to an increase in professional and consulting fees (legal, market research/analysis, government program consulting, etc.),  the cost of product samples which are expensed when purchased, stock compensation expense for stock issued to ParaPRO in exchange for services related to NATROBA, regulatory and license fees, insurance, leases, sales reporting expenses, freight, information technology expenses, certain public company costs and investor relations expenses, and increased overhead (such as travel, telephone, and vehicle expenses).
 
Royalty Expenses, net .  Royalty expenses were approximately $508,000 offset by royalty revenue of approximately $247,000 during the three months ended March 31, 2011.  We did not recognize any royalty revenue or incur any royalty expenses during the three months ended March 31, 2012.
 
Research and Development Expense, net.   Research and development expenses were approximately $70,000 and $106,000 for the three months ended March 31, 2012 and 2011, respectively.
 
Loss from the Operations of the Joint Venture.  The loss from the operations of our joint venture was approximately $240,000 and $330,000 for the three months ended March 31, 2012 and 2011, respectively, which primarily relates to research and development costs.
 
 
27

 
  
Other Expenses
 
Depreciation and Amortization Expense.  Depreciation expenses were approximately $26,000 and $22,000 for the three months ended March 31, 2012 and 2011, respectively. The increase of approximately $4,000, or 18.2%, was due to information technology and furniture purchases.
 
Amortization expense was approximately $612,000 and $471,000 for the three months ended March 31, 2012 and 2011.  The increase of approximately $141,000 was due to the amortization of certain of our licensing and acquisition agreements, including the gastroenterology license acquired in February 2012,  CEDAX in March 2010 and Macoven in September 2010.  For further discussion, see Note 5, Intangible Assets, to our Condensed Consolidated Financial Statements for the three months ended March 31, 2012 and 2011 contained in Part I, Item I of this Quarterly Report on Form 10-Q.
 
Interest Expense, net. Interest income was approximately $13,000 and $6,000 for the three months ended March 31, 2012 and 2011, respectively.  Interest expense was approximately $53,000 and $36,000 for the three months ended March 31, 2012 and 2011, respectively.  The increase in interest expense was related to the outstanding balance under our line of credit and certain insurance financing arrangements.
 
Liquidity and Capital Resources
 
Sources of Liquidity
 
Pernix’s net income before income taxes was approximately $1,974,000 and $1,698,000 for the three months ended March 31, 2012 and 2011, respectively.
 
Pernix requires cash to meet its operating expenses and for capital expenditures, acquisitions, and in-licenses of rights to products.  Historically, Pernix has funded its operations primarily from product sales.  As described  in Notes 1 and 12 to our Condensed Consolidated Financial Statements for the three months ended March 31, 2012 and 2011 contained in Part I, Item 1 of this Quarterly Report on Form 10-Q we received net proceeds of approximately $19.3 million from our underwritten registered offering in July 2011 and net proceeds of approximately $23.8 million from our controlled equity offering that commenced in February 2012 and concluded in April 2012.  We expect to utilize the proceeds from these equity offerings, together with proceeds from product sales and available funds under our line of credit, to fund future acquisitions and for general corporate purposes.

Additionally, in September 2010, we obtained a $10 million line of credit from Regions Bank, consisting of a $5 million revolver and a $5 million guidance line of credit for certain acquisitions pre-approved by Regions Bank.  The line of credit currently has a balance of $6.0 million leaving $4.0 million available to draw from the revolver.  Certain intangible assets and other investments have been funded or partially funded from the proceeds of the offering and/or the line of credit.

As of May 11, 2012, Pernix had approximately $57.8 million in cash and cash equivalents which is net of the $5 million for the SEEK transaction which was held in escrow until closing. 
 
Cash Flows
 
The following table provides information regarding Pernix’s cash flows for the three months ended March 31, 2012 and 2011:

   
Three Months Ended
 
   
March 31,
 
   
(rounded)
 
   
2012
   
2011
 
Cash provided by (used in)
           
Operating activities
 
$
4,829,725
   
$
5,012,215
 
Investing activities
   
(2,420,261
)
   
(18,617
)
Financing activities
   
2,240,871
     
(300,000
Net increase in cash and cash equivalents
 
$
4,650,335
   
$
4,693,598
 
 
 
28

 
 
Net Cash Provided By Operating Activities
 
Net cash provided by operating activities for the three months ended March 31, 2012 and 2011 was approximately $4,830,000 and $5,012,000, respectively.  Net cash provided by operating activities for the three months ended March 31, 2012 reflected Pernix’s net income of approximately $1,191,000, adjusted by non-cash expenses totaling approximately $1,994,000 including a provision for deferred income taxes of approximately $426,000 and approximately $1,645,000 in net changes in accounts receivable, inventories, accrued expenses and other operating assets and liabilities.   Non-cash expenses also included amortization of approximately $612,000,  depreciation of approximately $26,000, stock compensation expense of approximately $476,000, stock option expense for options issued to ParaPRO of approximately $188,000 and expenses from our joint venture with SEEK of approximately $240,000. Net cash provided by operating activities for the three months ended March 31, 2011 primarily reflected Pernix’s net income of approximately $975,000, adjusted by non-cash expenses totaling approximately $1,035,000 and net changes in  accounts receivable, inventories, accrued expenses and other operating assets and liabilities of approximately $3,980,000 partially offset by a non-cash deferred income  tax benefit of approximately $978,000.  Non-cash expenses included amortization of approximately $472,000, depreciation of approximately $22,000, and stock compensation expense of approximately $211,000 and approximately $330,000 representing the net operating loss of our joint venture with SEEK..
 
Accounts receivable at March 31, 2012, decreased approximately $4,200,000 from December 31, 2011 primarily attributable to the seasonal decrease in sales when comparing December to March.  Inventories decreased approximately $1,220,000 due to a normal decrease in stocking going into the off-season for the majority of our current product portfolio.  Prepaid expenses and other assets decreased approximately $472,000 due to a decrease in deposits on inventory orders.  Accounts payable decreased approximately $738,000 due to seasonal fluctuations in inventory orders resulting in a decrease in inventory payables at March 31, 2012 than December 31, 2011.  Accrued allowances and expenses decreased approximately $2,116,000 primarily due to the timing of  payments of government program rebates and other price adjustments during the three months ended March 31, 2012.
  
  Net Cash Used in Investing Activities
 
Net cash used in investing activities for the three months ended March 31, 2012 and 2011 was approximately $2,420,000 and $18,000, respectively.  The cash flow from investing activities for the three months ended March 31, 2012 consisted of  $2,400,000 to acquire the license for Omeclamox® and purchases of office furniture and computer equipment of approximately $20,000.  The $18,000 used in the three months ended March 31, 2011 was for purchases of office furniture and equipment.  
 
 Net Cash Used in Financing Activities
 
Net cash provided by financing activities for the three months ended March 31, 2012 was approximately $2,241,000 compared to net cash used in financing activities for the three months ended March 31, 2011 of approximately $300,000.  The cash provided by financing activities for the three months ended March 31, 2012  consisted of approximately (i) $2,400,000 in net proceeds from our controlled equity offering, (ii) $133,000 tax benefit on stock-based awards, (iii) $38,000 in net proceeds from the issuance of stock to employees offset by approximately $330,000 in payments on contracts payable.  The cash used in financing activities for the three months ended March 31, 2011 was $300,000 in payments on a contract payable.

 
 
29

 
   
  Funding Requirements
 
As of May 11, 2012,  Pernix has $57.8 million in cash, net of the $5 million for the SEEK transaction which was held in escrow until closing, and a revolving credit line with approximately $4.0 million available for working capital.   Pernix’s future capital requirements will depend on many factors, including:
 
●    
the level of product sales of its currently marketed products and any additional products that Pernix may market in the future;
   
 ●     the extent to which Pernix acquires or invests in products, businesses and technologies;
   
●    
the level of inventory purchase commitments under supply, manufacturing, license and/or co-promotion agreements;
   
●    
the scope, progress, results and costs of development activities for Pernix’s current product candidates;
   
●    
the costs, timing and outcome of regulatory review of Pernix’s product candidates;
   
●    
the number of, and development requirements for, additional product candidates that Pernix pursues;
   
●    
the costs of commercialization activities, including product marketing, sales and distribution;
   
●    
the costs and timing of establishing manufacturing and supply arrangements for clinical and commercial supplies of Pernix’s product candidates and products;
   
●    
the extent to which Pernix chooses to establish collaboration, co-promotion, distribution or other similar arrangements for its marketed products and product candidates; and
   
●    
the costs of preparing, filing and prosecuting patent applications and maintaining, enforcing and defending claims related to intellectual property owned by or licensed to Pernix.
 
To the extent that Pernix’s capital resources are insufficient to meet its future capital requirements, Pernix will need to finance its cash needs through public or private equity offerings, debt financings, corporate collaboration and licensing arrangements or other financing alternatives. Equity or debt financing, or corporate collaboration and licensing arrangements, may not be available on acceptable terms, if at all.
 
As of May 11, 2012,  Pernix believes that its existing cash, which includes approximately $23.8 million from the recently completed controlled equity offering, revenues from product sales and the available line of credit proceeds will be sufficient to continue to fund its existing level of operating expenses and general capital expenditure requirements through 2012.
 
 
30

 

Off-Balance Sheet Arrangements
 
Since its inception, Pernix has not engaged in any off-balance sheet arrangements, including structured finance, special purpose entities or variable interest entities.
   
Effects of Inflation
 
Pernix does not believe that inflation has had a significant impact on its revenues or results of operations since inception.
 
 Contractual Obligations
 
Contractual obligations represent future cash commitments and liabilities under agreements with third parties and exclude contingent contractual liabilities for which we cannot reasonably predict future payment, including contingencies related to potential future development, financing, royalty payments and/or scientific, regulatory, or commercial milestone payments under development agreements. Further, obligations under employment agreements contingent upon continued employment are not included in the table below. The following table summarizes our contractual obligations as of March 31, 2012 (in thousands):  
 
   
Payments Due by Period
 
   
Total
   
Less than
1 Year
   
1-3 Years
   
3-5 Years
   
More than
5 Years
 
                               
Operating leases(1)
 
 $
827
   
 $
219
   
 $
391
   
 $
216
   
 
Purchase obligations(2)
   
143,027
     
48,986
     
94,019
     
23
     
 
Line of credit(3)
   
6,084
     
6,084
     
     
     
 
License Agreements(4)
   
2,060
     
2,060
     
     
     
 
Other long-term debt obligations (5)
   
1,500
     
1,200
     
300
     
     
 
                                         
Total contractual obligations
 
$
153,498
   
$
58,550
   
$
94,710
   
$
239
   
$
 
 
(1)
Operating leases include minimum payments under leases for our facilities and certain equipment.
   
(2)
Purchase obligations include fixed or minimum payments under manufacturing and supply agreements with third-party manufacturers and other providers of goods and services.  The contractual obligations table set forth above does not reflect certain minimum sales requirements related to our co-promotion agreements.  Our failure to satisfy minimum sales requirements under our co-promotion agreements generally allows the counterparty to terminate the agreement and/or results in a loss of our exclusivity rights.  For example, our co-promotion agreement with ParaPRO for NATROBA requires that we meet certain annual sales targets.  In the event we are unable to meet these requirements, ParaPRO may revoke our exclusivity to market NATROBA and/or terminate the co-promotion agreement.  In addition to minimum sales requirements under our co-promotion agreements, the table above does not include commitments under open purchase orders for inventory that can be cancelled without penalty, which are approximately $2.5 million.
 
Pursuant to the Supply and Distribution Agreement between the Company and ParaPRO, the Company has purchase commitments for NATROBA of approximately $43,729,000 in 2012, $61,690,000 in 2013 and $44,112, 000 in 2014 in order to retain its exclusive co-promotion rights. The Supply and Distribution Agreement may be terminated pursuant to certain terms in conditions, including but not limited to, the failure of the parties to come to agreement on adjusted dispensed product minimums.
 
(3)
For further discussion, see Note 7, Lines of Credit, to our Condensed Consolidated Financial Statements for the three months ended March 31, 2012 and 2011 contained in Part I, Item I of this Quarterly Report on Form 10-Q.
   
(4)
License agreements include payments due under certain product license arrangements for which payments are not contingent on sales or other sales achievements.  This amount includes the $2.0 million payment due at the launch of Omeclanox® expected to be summer 2012.  See Note 5, ntangible Assets,, to our Condensed Consolidated Financial Statements for the three months ended March 31, 2012 and 2011 contained in Part I, Item I of this Quarterly Report on Form 10-Q.
   
(5)
Other long-term liabilities represent the payments due under a privately negotiated stock repurchase executed in September 2010.
 
 
31

 
 
In addition to the material contractual cash obligations included the chart above, we have committed to make potential future milestone payments to third parties as part of licensing, distribution, acquisition and development agreements. Payments under these agreements generally become due and payable only upon achievement of certain development, regulatory and/or commercial milestones. Because the achievement of milestones is neither probable nor reasonably estimable, such contingent payments have not been recorded on our consolidated balance sheets and have not been included in the table above.     

Recent Accounting Pronouncements
 
There have been no other recent accounting pronouncements that have not yet been adopted by us that are expected to have a material impact on our condensed consolidated financial statements from the accounting pronouncements previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011.
 
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Not applicable.
 
ITEM 4.
CONTROLS AND PROCEDURES
 
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
 
As of March 31, 2012, we evaluated, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)). Management concluded that as of March 31, 2012, our disclosure controls and procedures were effective.
 
There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.  
 
 
32

 
 
PART II.   OTHER INFORMATION
 
ITEM 1.
LEGAL PROCEEDINGS
 
See Legal Matters under Note 11 to our Condensed Consolidated Financial Statements for the three months ended March 31, 2012 and 2011 contained in Part I, Item 1 of this Quarterly Report on Form 10-Q.   Also, information regarding reportable legal proceedings is contained in Part I, “Item 3. Legal Proceedings” in our Annual Report on Form 10-K for the year ended December 31, 2011.

Pernix is subject to various other claims and litigation arising in the ordinary course of business.  In the opinion of management, the outcome of such matters will not have a material effect on Pernix’s financial position or results of operations.
 
ITEM 1A.
RISK FACTORS
 
There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011.

ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None. 
 
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
 
None.
 
ITEM 4.
MINE SAFETY DISCLOSURES
 
 
None.

ITEM 5.
OTHER INFORMATION
 
None. 
 
 
33

 
  
ITEM 6.
EXHIBITS
 
EXHIBIT INDEX

Exhibit No.
 
Description
     
3.1
 
Articles of Incorporation of Pernix Therapeutics Holdings, Inc. (previously filed as Exhibit 3.1 to our Current Report on Form 8-K filed on March 15, 2010 and incorporated herein by reference).
     
3.2
 
Bylaws of Pernix Therapeutics Holdings, Inc.  (previously filed as Exhibit 3.2 to our Current Report on Form 8-K filed on March 15, 2010 and incorporated herein by reference).
     
10.1
 
Amendment No. 1 to Amended and Restated Employment and Non-Compete Agreement, dated March 23, 2012, by and between Pernix Therapeutics Holdings, Inc. and John McMahon (previously filed as Exhibit 10.19 to our Annual Report on Form 10-K filed on March 29, 2012 and incorporated herein by reference).
     
10.2   Sales Agreement dated February 10, 2012 between Pernix Therapeutics Holdings, Inc. and Cantor Fitzgerald & Co. (previously filed as Exhibit 10.1 to our Current Report on Form 8-K filed on February 10, 2012 and incorporated herein by reference.)
     
 
Certification of the Registrant’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
 
Certification of the Registrant’s Principal Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
 
Certification of the Registrant’s Chief Executive Officer and Principal Accounting Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
     
     
101*   Attached as Exhibit 101 to this report are the following items formatted in XBRL (Extensible Business Reporting Language):
    (i)     Condensed Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011;
    (ii)    Condensed Consolidated Statements of Income and Comprehensive Income for the Three Months Ending March 31, 2012 and 2011;
    (iii)   Condensed Consolidated Stockholders’ Equity as of March 31, 2012;
   
(iv)   Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011; and
    (v)    Notes to Condensed Consolidated Financial Statements.
 
________________________
* Filed herewith.
 
 
34

 
 
 SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
PERNIX THERAPEUTICS HOLDINGS, INC.
 
       
Date: May 15, 2012
By:  
/s/ COOPER C. COLLINS
 
   
Cooper Collins
 
   
Chief Executive Officer and President
 
       
       
Date: May 15, 2012
By:
/s/ DAVID P. BECKER
 
   
David P. Becker
 
   
Chief Financial Officer
 
 
 
 
38
 
 

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