SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended January 3, 2004
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 0-11274
PHARMACEUTICAL FORMULATIONS, INC.
(Exact name of Registrant as Specified in its Charter)
| Delaware (State or Other Jurisdiction of Incorporation or Organization) |
22-2367644 (IRS Employer Identification No.) |
460 Plainfield Avenue, Edison, NJ 08818
(Address of principal executive offices, including zip code)
(732) 985-7100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.08 par value, and Common Stock Purchase Warrants
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such reporting requirements for the past 90 days. Yes / / No /X/
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. /X/
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes / /
No /X/
The aggregate market value of the voting stock (based on the average of the high and low bid prices) held by non-affiliates of the registrant as of June 28, 2003, which is the last business day of the registrant's most recently completed second fiscal quarter, was approximately $3,591,000. For purposes of this computation, ICC Industries Inc. and all executive officers and directors of the Registrant have been deemed to be affiliates. Such determination should not be deemed to be an admission that such persons are, in fact, affiliates of the Registrant.
As of March 31, 2004, there were 85,755,787 shares of Common Stock, par value $.08 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: None
PART I
Item 1. Business
Risk Factors
This Annual Report on Form 10-K contains forward-looking statements within the meaning of that term in the Private Securities Litigation Reform Act of 1995 (Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934). Additional written or oral forward-looking statements may be made by us from time to time, in filings with the Securities Exchange Commission or otherwise. Statements contained in this report that are not historical facts are forward-looking statements made pursuant to these safe harbor provisions. Forward-looking statements may include projections of revenue, income or loss and capital expenditures; statements regarding future operations, financing needs, compliance with financial covenants in loan agreements, plans for acquisition or sale of assets or businesses and consolidation of operations of newly acquired businesses, and plans relating to products or services; assessments of materiality; and predictions of future events and the effects of pending and possible litigation, as well as assumptions relating to these statements. In addition, when we use the words "anticipates," "believes," "estimates," "expects," and "intends," and "plans," and variations thereof and similar expressions, we intend to identify forward-looking statements.
Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified based on current expectations. Consequently, future events and actual results could differ materially from those set forth in, contemplated by, or underlying the forward-looking statements contained in this report. Statements in this report, particularly in "Item 1. Business", "Item 3. Legal Proceedings", the Notes to Consolidated Financial Statements and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," describe certain factors that could contribute to or cause such differences. Other factors that could contribute to or cause such differences include unanticipated developments in any one or more of the following areas:
| • | our ability, and the ability of certain of our vendors, to obtain and maintain approvals from the U.S. Food and Drug Administration for new products and other regulatory matters, our ability to qualify additional vendors for significant raw material and our ability to comply with regulations regarding the manufacturing of products, including the FDA's good manufacturing practices regulations and other matters discussed below under "Government Regulation;" |
| • | the receptivity of consumers to generic drugs, including the public's reaction to actions of governmental authorities, insurance companies and other groups to encourage or discourage the use of generic pharmaceutical products; |
| • | the rate of our new product introductions and the receptivity of our customers to such products; |
| • | competition, including pressures which may require us to reduce our prices such as consolidation of the drug distribution network; |
| • | our ability to develop and maintain collaborative relationships with others, including other pharmaceutical companies; |
| • | the number and nature of customers and their product orders, including material changes in orders from our most significant customers and the relative mix of sales to retailers and sales to other pharmaceutical companies; |
| • | the ability of our vendors including foreign vendors, to continue to supply our needs, especially with respect to our key products such as ibuprofen; |
| • | borrowing costs, and our ability to generate cash flow to pay interest and scheduled amortization payments as well as our ability to refinance such indebtedness or to sell assets when it comes due; |
| • | relations with our controlling shareholder, including its continuing willingness to provide financing and other resources; |
| • | our ability to have our shares quoted on the OTC Bulletin Board or another quotation system, stock exchange or stock market; |
| • | the continued involvement of key personnel or the ability to obtain suitable replacement personnel; |
| • | the level of sales to key customers; |
| • | actions by competitors; |
| • | fluctuations in the price and availability of raw materials; |
| • | our dependence on discreet manufacturing facilities; |
| • | our ability to protect our proprietary manufacturing technology; |
| • | our dependence on a limited number of suppliers; |
| • | an adverse outcome in litigation, claims and other actions against us including product liability risks and our ability to continue to obtain insurance coverage; |
| • | technological changes and introductions of new competing products; and |
| • | changes in market demand, productivity, weather and market and economic conditions in the areas in which we operate and market our products or from which we source our raw materials, particularly ibuprofen and Naproxen Sodium, |
as well as other risk factors which may be detailed from time to time in our Securities and Exchange Commission filings.
You are cautioned not to place undue reliance on any forward-looking statements contained in this report, which is accurate only as of the date of this report. We undertake no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date of this report or to reflect the occurrence of unexpected events
Introduction
Pharmaceutical Formulations, Inc., a Delaware corporation, is a publicly-traded private label manufacturer and distributor of nonprescription (sometimes called "over-the-counter" or "OTC") solid dose pharmaceutical products in the United States and powdered, dietary natural fiber supplements which are sold in the United States and several foreign countries. Such products, which are made in tablet, caplet, capsule or powdered form, are primarily sold under our customers' store brands or other private labels, manufactured under contract for national brand pharmaceutical companies or sold in bulk to others who repackage them for sale to small, typically independent, retailers and to other manufacturers who do not have government approval to manufacture certain formulas such as ibuprofen. We also sell generic products under our own brand names, including Konsyl®, Health+Cross® and Health Pharm®. The latter two brand names account for less than 1% of our total revenues.
We believe that the therapeutic benefits of our products are comparable to those of equivalent national brand name products because the chemical compositions of the active ingredients of the brand name products on which our products are patterned are identical to those of our products. We are subject to regulation by the U.S. Food and Drug Administration (FDA). Our largest retail customers include Target, Dollar General Stores, Costco Wholesale (Costco), CVS Corp. (CVS), and BJ's Wholesale Club.
Acquisition of Konsyl Pharmaceuticals, Inc.
On May 15, 2003, we completed our acquisition of the stock of Konsyl Pharmaceuticals, Inc. of Fort Worth, Texas. Konsyl is a manufacturer and distributor of powdered, dietary natural fiber supplements. The products are manufactured at its plant in Easton, Maryland and are sold, both domestically and internationally, to pharmaceutical wholesalers, drugstore chains, mass merchandisers, grocery store chains, and grocery distributors. Products are sold under both the "Konsyl®" brand name and various private labels. Our largest customers for colon health products include Wal-Mart, Walgreens, AmeriSource and McKesson. The consideration for the acquisition consisted of $6,502,000 of cash including transaction costs, Konsyl cash of $350,000 and a $2,500,000 seller note. In addition, as part of the purchase price, we issued warrants to purchase 1.2 million shares of our common stock at an exercise price of $.204 per share, valued at $244,000. The warrants are exercisable until April 15, 2010.
The transaction was financed by a combination of asset-based and term loan financing aggregating $3,700,000 from our existing lender, CIT Business Credit, as well as a loan of $1,627,000 from ICC, and $595,000 of equipment financing facilitated by ICC , the holder of approximately 74.5 million shares (approximately 87%) of our common stock, a five year note to the former stockholder of Konsyl in the amount of $2,500,000, Konsyl's own cash of $350,000 and a cash payment of $143,000.
In connection with our acquisition of Konsyl, PFI, Konsyl and Mr. Frank X. Buhler, the former majority stockholder of Konsyl, entered into a consultancy agreement for one year at $5,000 per month. In addition, Mr. Buhler was elected to our Board of Directors at the annual meeting of the stockholders on June 18, 2003. Konsyl also entered into a five-year lease with ANDA Investments Ltd., a company partially owned by Mr. Buhler, regarding the company's manufacturing facility in Maryland. Annual rent is $200,000, payable quarterly. In addition, Konsyl has an option to purchase the facility for $2,250,000. This option expires on May 14, 2006.
Change in Fiscal Year
During December 2002, we changed our fiscal year-end from the 52-53 week period which ends on the Saturday closest to June 30 to the 52-53 week period which ends on the Saturday closest to December 31. Our just-completed 2003 fiscal year was the 53 week period which ended January 3, 2004. The prior fiscal period consisted of the six-month transition period from June 29, 2002 to December 28, 2002 and is sometimes referred to as transition 2002. For fiscal years prior to this period, our fiscal year ended on the Saturday closest to June 30 of each year. We refer to such periods as fiscal 2002, and fiscal 2001. Konsyl's fiscal year ends on December 31.
Certain Relationships with ICC Industries Inc.
ICC Industries Inc. is our largest stockholder, currently holding 74,488,835 shares (87.3%) of our outstanding stock. Since we first entered into a relationship with ICC in 1991, we have engaged in various transactions with ICC.
Tax Sharing Agreement - Since December 21 2001, when ICC's ownership of our stock reached 87%, we have filed a consolidated Federal income tax return with ICC, and will continue to do so so long as ICC continues to own more than 80% of our common stock. As a result, we have entered into a tax sharing agreement whereby we will be credited for the cash savings generated by ICC's utilization of our current tax losses or utilization of tax loss carryforwards. Such compensation shall be as an offset against amounts due to ICC from PFI.
Purchase of Raw Materials - We purchased $7,511,000 of raw materials from ICC in fiscal 2003, $3,508,000 in the six months ended December 28, 2002, $1,438,000 in fiscal 2002, and $2,163,000 in fiscal 2001. We have purchased from ICC, and will likely in the future continue to purchase from ICC, to use its buying power to obtain more favorable price treatment. These purchases have been at ICC's cost plus a small markup; we believe that the price we pay ICC is less than what we would have to pay if we purchased the items directly from other vendors.
Shareholder Loans - On September 27, 2003 the Company modified its term loan and security agreement with ICC. The modification consisted of a reduction in the interest rate from prime + 1% to prime. The loan principal under this agreement was $21,289,000. Principal payments were due commencing in January, 2004 at $225,000 per month and in increasing amounts thereafter with a final payment of $18,139,000 in January, 2005. Interest is payable monthly at the prime rate (4% at January 3, 2004). The loan is secured by a secondary security interest in all of our assets.
On May 15, 2003, in connection with the acquisition of Konsyl Pharmaceuticals, Inc., the Company borrowed $500,000 from Brown Brothers, through ICC. Principal payments to Brown Brothers began on July 1, 2003 at $10,000 per month with a final payment of $320,000 in January 2005. Interest is payable monthly at 4.5%. The current portion of this obligation is included in due to ICC on the balance sheet
Support - ICC has committed to provide us with the necessary financing through March 31, 2005.
As of February 29, 2004, we owed ICC $32,500,000, including loans and accounts payable.
Products
Currently, we market more than 95 different types of generic OTC products (including different dosage strengths of the same chemical composition. These products include analgesics (such as ibuprofen, acetaminophen and naproxen sodium), cough-cold preparations, sinus/allergy products and gastrointestinal relief products and fiber colon health products. Sales of ibuprofen accounted for 28% in fiscal 2003, 28% in the six months ended December 28, 2002, 21% in fiscal 2002, and 26% in fiscal 2001 of our total revenues.
Generic pharmaceutical products are drugs which are sold under chemical names rather than brand names and possess chemical compositions (and, we believe, therapeutic benefits), equivalent to the brand name drugs on which they are patterned. OTC drugs are drugs which can be obtained without a physician's prescription. Generic drug products are subject to the same governmental standards for safety and efficacy (effectiveness) as their brand name equivalents and are typically sold at prices substantially below the brand name drug. We manufacture generic OTC products which we believe are chemically and therapeutically equivalent to such brand name products as Advil®, Aleve®, Anacin®, Tylenol®, Bufferin®, Ecotrin®, Motrin®, Excedrin®, Sominex®, Sudafed®, Comtrex®, Sinutab®, Dramamine®, Actifed®, Benadryl®, Allerest®, Tagament®, Metamucil®, and Citracel®among other products.1
The following table sets forth some of the over-the-counter pharmaceutical products marketed by us under store brand or private labels. Each retailer may have its own name for a store brand product. Also, as set forth, where meaningful, are the names of certain of the national brands with which these products compete.
__________________
| 1 | Such brand names, and other brand names mentioned in this report, are registered marks of companies unrelated to PFI, unless otherwise noted. |
ILLUSTRATIVE COMPETING
OUR PRODUCTS NATIONAL BRANDS
------------ ----------------------
Analgesics:
Ibuprofen Advil(R), Motrin(R)
Naproxen Sodium Aleve(R)
Aspirin Bayer(R)
Acetaminophen Tylenol(R)
Menstrual Pain Relief Midol(R), Pamprin(R)
Cough/Cold Tylenol(R), Sudafed(R)
Allergy/Sinus Sudafed(R)
Anti-Diarrheal/Acid Blockers/ Tagament HB(R), Mylanta Gelcap(R)
Anti-gas/Antacid
Colon health Correctol(R), Metamucil,Citracel(R)
Antifungal Aerosol Tinactin(R)
Alert/Sleep Aids/Travel Sickness Vivarin(R), Somnitabs(R), Dramamine(R)
Manufacturing
Our manufacturing facility in Edison, NJ operates two shifts on a five-day week work schedule and produces approximately one and a half million solid dose tablets/capsules per hour representing about 60% of available capacity. The manufacturing equipment operates very efficiently with little or no disruptions during the manufacturing process. The equipment has the ability to manufacture between five to six different formulations concurrently at the initial stages of production and about 20 different formulations at various stages throughout the production process.
Our Konsyl manufacturing facility in Easton, MD operates one shift on a five day work schedule, representing about 70% of capacity as currently configured. Equipment and other physical property of Konsyl which were acquired are used for the manufacture, marketing and distribution of powdered dietary natural supplements. We plan to continue to use these assets for the same purpose.
Average lead-time for a new customer from the time of submission of initial artwork to the final design of the packages, ordering of boxes, and delivery of the first orders of product to the customer is usually about one month. Turnaround of orders for existing customers usually ranges anywhere between 24 to 48 hours. In situations where customers need products replenished in a faster time frame, we usually have the staff and available capacity to fulfill this requirement. We employ approximately 391 people in the manufacturing process. We have been and we expect to continue to be, in full compliance with all FDA and other federal regulations applicable to our business.
In order to manufacture our products, we acquire raw materials from suppliers located in the United States and abroad. To date, we have had no significant difficulties obtaining the raw materials we need and expect that such raw materials will continue to be readily available in the future. Our raw materials are first placed in quarantine so that samples of each lot can be assayed for purity and potency. Incoming materials are also tested to assure that they are free of objectionable microorganisms and that they meet chemical and physical testing requirements. Throughout the manufacturing process, samples are taken by quality assurance inspectors for quality control testing. The raw materials must meet standards established by the United States Pharmacopoeia, the National Formulary and the FDA, as well as by us and our customers.
To produce capsules and tablets, we utilize specialized equipment which compresses tablets and fills powder and granules into hard gelatin capsules. At this stage, certain tablets are film- or sugar- coated to achieve an aesthetically appealing tablet. The customer chooses whether its order of generic OTC products will be delivered in bulk containers or in packages. Typically, we assist our customers in developing the size, design and graphics of the folding carton, label and container for the products. The package can be automatically placed into shipping containers of the customer's selection.
To produce Konsyl products, we use a variety of equipment including a grain mill for psyllium milling, two blenders, several fill tanks, a bottle unscrambler, a rotary fill head, a bottle capping machine, torquer, in-line check weigher, bottle labeler and cap labeler, and three packet filling machines.
In response to drug tampering problems affecting the industry generally, we have instituted certain tamper-evident features in our packaging operation. A tamper-evident package is one which readily reveals any violation of the packaging or possible contamination of the product. These include a foil inner-seal which is electronically sealed after the capping operation and, for some customers, a neck band or outer safety seal applied to the bottle and cap as an additional tamper-evident feature. In addition, we manufacture a banded capsule which contains a gelatin band in the center to deter ease of opening and/or closing the capsule product. Although we take steps to make our products tamper-resistant, we believe that no product is "tamper-proof." There can be no assurance that our products will not be tampered with. Any such tampering, even if it occurs in the retail outlets, may have a material adverse effect on our business. See "Insurance."
Customers
Our customers consist of over 50 retailers (including major national and regional drug, supermarket and mass-merchandise chains), wholesalers, club stores, distributors and brand-name pharmaceutical companies. Sales to our various categories of customers in fiscal 2003, the six months ended December 28, 2002, fiscal 2002 and fiscal 2001 by percentage of total sales were as follows:
Percentage of Sales
-----------------------------------------------
Fiscal Transition Fiscal Fiscal
Category 2003 2002 2002 2001
-------- ---- ---- ---- ----
Retail drug and supermarket chains and
mass merchandisers 82% 83% 79% 86%
Brand-name pharmaceutical companies 8% 10% 12% 6%
Wholesalers and distributors 10% 7% 9% 8%
Virtually all of these sales consisted of products which our customers sell under their own store brand or other labels.
Sales to customers which represented more than 10% of consolidated gross sales in any one or more of fiscal 2003, the six months ended December 28, 2002, fiscal 2002 and fiscal 2001 were as follows:
Sales ($ in thousands and percentage of total sales)
- ---------------------------------------------------------------------------------------
Fiscal Transition Fiscal Fiscal
Customer 2003 2002 2002 2001
- -------- ---- ---- ---- ----
Target $8,289 (11%) $4,010 (12%) $ 152 ( 0%) $ 15 ( 0%)
Dollar General $7,975 (10%) $3,282 ( 9%) $4,283 ( 8%) $4,566 ( 9%)
Costco $6,310 ( 8%) $4,054 (12%) $7,234 (14%) $6,692 (13%)
CVS $3,808 ( 5%) $2,119 ( 6%) $4,004 ( 7%) $6,566 (13%)
Other retail customers include Aldi's, a grocery chain; BJ Wholesale Club, a warehouse discounter; Drug Mart, a drug store chain; Eckerd, a drug store chain; Family Dollar, a discount chain; H.E. Butt, a food chain; Save-A-Lot, a discount chain; Wegmans, a food chain; and Wal-Mart, a mass merchandise chain.
Sales and Marketing
We had 20 employees in sales and customer service as of January 3, 2004. This staff and several independent brokers sell our products and our marketing services to current and potential customers. There are account teams servicing different geographic areas of the U.S., each headed by a sales director. A team is assigned to each retail customer, to focus on servicing that customer and making recommendations to help build retail store brand business.
Governmental Regulation
Pharmaceutical companies are subject to extensive regulation by the Federal government, primarily by the FDA, under the Federal Food, Drug and Cosmetic Act, the Controlled Substance Act and other federal statutes and regulations. These regulations govern or influence the testing, manufacture, safety, labeling, storage, record keeping, approval, pricing, advertising and promotion of our drug products. Failure to comply with FDA and other governmental requirements can result in a variety of adverse regulatory actions, including but not limited to the seizure of company products, demand for a product recall, total or partial suspension of manufacturing/production, refusal by FDA to approve new products, and withdrawal of existing product approvals.
The FDA requires all new pharmaceutical products to be proven safe and effective before they may be commercially distributed in the United States. In order to prove the safety and efficacy of most new pharmaceutical products, pharmaceutical companies are often required to conduct extensive preclinical (animal) and clinical (human) testing. Such testing is extensively regulated by the FDA.
Most prescription drug products obtain FDA marketing approval via either the "new drug application" (NDA) process or the "abbreviated new drug application" (ANDA) process. An NDA is submitted to the FDA in order to prove that a drug product is safe and effective. NDAs and ANDAs typically contain data developed from extensive clinical studies. The filing of an NDA or ANDA with the FDA provides no assurance that the FDA will approve the applicable drug product for marketing.
Generic drug products are capable of being approved for marketing by the FDA via the ANDA process. An ANDA is submitted to the FDA in order to demonstrate that a drug product is "bioequivalent" to a drug product that has already been approved by the FDA for safety and effectiveness (i.e., an "innovator" drug product). Unlike an NDA, an ANDA is not required to contain evidence of safety and effectiveness. Instead, ANDAs for orally administered dosage forms typically contain "bioavailability" studies to demonstrate "bio-equivalence." FDA approvals of ANDAs generally take 18 to 24 months to obtain. As with NDAs, the filing of an ANDA with the FDA provides no assurance that the FDA will approve the applicable drug product for marketing.
The current regulatory framework that governs generic drug approvals via the ANDA process was enacted as the Drug Price Competition and Patent Term Restoration Act of 1984 (commonly known as the Hatch-Waxman Act) which amended the Federal Food, Drug and Cosmetic Act. Under the Hatch-Waxman Act, companies are permitted to conduct studies required for regulatory approval notwithstanding the existence of patent protection relevant to the substance or product under investigation. Thus, "bioavailability" studies for a generic drug product may be conducted regardless of whether the related "innovator" product has patent protection.
A company generally may file an ANDA application with the FDA at any point in time. There are certain exceptions, however, such as when an innovator's drug product was granted five years of "marketing exclusivity" under the Hatch-Waxman Act. In such case, the ANDA application may not be filed with FDA until the five years of marketing exclusivity have expired. Such prohibition on filing does not apply, however, if the period of marketing exclusivity is three years.
When an ANDA application is filed, the FDA may immediately review the application regardless of whether the innovator's product has patent protection or is subject to marketing exclusivity. The FDA's ANDA approval, however, is conditional and does not become effective until the expiration of any applicable patent or marketing exclusivity periods. After the expiration of these periods, a generic product that has received conditional ANDA approval may be marketed immediately.
Manufacturers of patented drugs, however, will often list additional patents on drugs in the FDA's "Orange Book" as the original patent is due to expire and thereby prevent the marketing of generic drugs after the original patent has expired and even delay the ANDA approval process by an additional 30 months. A 2001 case in the Federal Circuit (Mylan v. Thompson), held that generic drug manufacturers have no right to protest the listing of the new patent even if the new patent has no relevance to the drug, which serves to allow the owner of the patent to bring an action for infringement if the generic drug manufacturer continues with the approval process and/or markets the drug. The generic drug manufacturer's only recourse is to raise the impropriety of the new patent as a defense to the infringement action.
Additionally, drug manufacturers may cause so-called citizen petitions to be filed with the FDA raising safety questions about potential competitors, thereby delaying introduction of the competitive products.
Some drug products that are intended for over-the-counter marketing require NDA or ANDA approval. Most OTC drug products, however, may be commercially distributed without obtaining FDA approval of an NDA or ANDA application. The FDA established the OTC Drug Review in the early 1970's, which led to the creation of OTC drug monographs that indicate whether certain drug ingredients are safe and effective for specific intended uses. Final OTC drug monographs have the force of law. Products that conform with the requirements of a final OTC drug monograph do not require NDA or ANDA approval, whereas OTC products not covered by a monograph must be approved via an NDA or ANDA.
Many OTC drug monographs have not yet been finalized. The FDA, however, generally permits the marketing of OTC drug products that conform to the proposed requirements of a non-final monograph. The FDA also permits the marketing of OTC products that do not conform to a non-final monograph subject to certain limitations. Normally, such products may be marketed, pending the effective date of the applicable final OTC drug monograph, if they are substantially similar to OTC drug products that were marketed OTC in the United States prior to December 4, 1975.
If the final drug monographs require us to expend substantial sums to maintain FDA compliance, we could be materially adversely affected. In the past, our generic OTC products (with the exception of ibuprofen) have not required approval of NDAs or ANDAs. Certain products which we recently introduced or are under development, however, require such approvals. The FDA has approved ANDAs in 200 mg., 300 mg., 400 mg., 600 mg. and 800 mg. dosage strengths for our ibuprofen product (although, at present, we sell our ibuprofen products in the 200 mg. strength only). We have also obtained FDA approval of certain different colors and shapes for our 200 mg. ibuprofen product. Our naproxen sodium product received ANDA approval in fiscal 1997 and our cimetidine product received ANDA approval in fiscal 1998. In addition, we received ANDA approval for an ibuprofen capsule in July 1998 and we received an ANDA approval for an ibuprofen-pseudophedrine product in April 2001.
The principal components of our products are active and inactive pharmaceutical ingredients and certain packaging materials. Many of these components are available only from a single source and our government approvals may be based on a single supplier, even in instances when multiple sources exist. Because FDA approval of drugs requires manufacturers to specify their proposed suppliers of active ingredients and certain packaging materials in their applications, FDA approval of any new supplier would be required if active ingredients or such packaging materials were no longer available from the specified supplier. The qualification of a new supplier could delay our development and marketing efforts. We do not manufacture any products containing ephedra.
All drug products, whether prescription or OTC, are required to be manufactured and processed in compliance with the FDA's "good manufacturing practices" (GMPs). GMPs are "umbrella" regulations that prescribe, in general terms, the methods to be used for the manufacture, packing, processing and storage of drug products to ensure that such products are safe and effective. Examples of GMP regulatory requirements include record-keeping requirements and mandatory testing of in-process materials and components. FDA inspectors determine whether a company is in compliance with GMPs. Failure to comply with GMPs may render a drug "adulterated" and could subject us to adverse regulatory actions.
The FDA regulates many other aspects of pharmaceutical product development and marketing, including but not limited to product labeling and, for prescription drug products, product advertising. The Federal Trade Commission is the primary Federal agency responsible for regulating OTC drug product advertising.
In addition to Federal regulation, pharmaceutical companies are subject to state regulatory requirements, which may differ from one state to another.
We believe that we are currently in compliance with FDA regulations. We undertook a major renovation and upgrade of our manufacturing plant, which was substantially completed in 1996. We believe this action will help to satisfy both present and future FDA regulations and guidelines as well as facilitate our ability to produce state-of-the-art products for our customers.
Federal and/or state legislation and regulations concerning various aspects of the health care industry are under almost constant review and we are unable to predict, at this time, the likelihood of passage of additional legislation, nor can we predict the extent to which we may be affected by legislative and regulatory developments concerning our products and the health care field generally.
Environmental Matters
The prior owner of our Edison, New Jersey manufacturing facility, Revco, conducted a soil and groundwater cleanup of such facility, under the New Jersey Industrial Site Recovery Act (ISRA), as administered by the New Jersey Department of Environmental Protection (NJDEP). NJDEP determined that the soil remediation was complete and approved the groundwater remediation plan, subject to certain conditions. Revco began operating a groundwater remediation treatment system in 1995. Although CVS (as the successor to Revco) is primarily responsible for the entire cost of the cleanup, we guaranteed the cleanup. In addition, we agreed to indemnify the owner of the facility under the terms of the 1989 sale lease-back. If CVS defaults in its obligations to pay the cost of the clean-up, and such costs exceed the amount of the bond posted by Revco, we may be required to make payment for any cleanup. The likelihood of CVS being unable to satisfy any claims which may be made against it in connection with the facility, however, are remote in our opinion. Accordingly, we believe that we will not have to bear any costs associated with remediation of the facility and we will not need to make any material capital expenditures for environmental control facilities.
Research and Development; New Products and Products in Development
We are engaged in a research and development program which seeks to develop and gain regulatory approval of products which are comparable to national brand products under the FDA OTC Drug Monograph process or the ANDA process. We are also engaged in R&D efforts related to certain prescription (sometimes referred to in the industry as "ethical") products and are exploring potential acquisition candidates or joint ventures to facilitate entry into other drug categories.
We maintain an experienced staff of four employees in our product development department, as well as other support staff to assist our customers. Our research and development activities are primarily related to the determination of the formula and specifications of the products desired by customers, as well as the potency, dosage, flavor, quality, efficacy, color, hardness, form (i.e. tablet, caplet or capsule) and packaging of such products, as well as costs related to new products in development including costs associated with regulatory approvals. Our research and development expenditures were $323,000 in fiscal 2003, $148,000 in transition 2002, $282,000 in fiscal 2002 and $443,000 in fiscal 2001. The rate of R&D expenditures fluctuates significantly from year to year depending primarily on what branded products are coming off patent in the near future and whether or not such products are appropriate for development by us. Expenditures in one year are not necessarily indicative of expenditures in future years. We expect to spend in calendar 2004 between $500,000 and $1,000,000 on research and development activities consistent with our goal of continually increasing and improving our product line.
Patents and Trademarks
Allerfed®, Leg Ease®, Health+Cross®, Health Pharm®, and Konsyl® are federally registered trademarks owned by us. To the extent that our packaging and labeling of generic OTC products may be considered similar to the brand name products to which they are comparable, and to the extent that a court may determine that such similarity may constitute confusion over the source of the product, we may be subject to legal actions under state and Federal statutes and case law to enjoin the use of the packaging and for damages.
Insurance
We may be subject to product liability claims by persons damaged by the use of our products. We maintain product liability insurance for our generic OTC products covering up to $10,000,000. Although there have been no material product liability claims made against us to date, there can be no assurance that such coverage will adequately cover any claims which may be made or that such insurance will not significantly increase in cost or become unavailable in the future. The inability to maintain necessary product liability insurance would significantly restrict our ability to sell any products and could result in a cessation of our business.
Competition
We compete not only with numerous manufacturers of generic OTC products, but also with brand name drug manufacturers and consumer goods manufacturers, most of which are well known to the public. In addition, our products compete with a wide range of products, including well-known name brand products, almost all of which are manufactured or distributed by major pharmaceutical companies or consumer goods manufacturers. Some of our competitors, including all of the manufacturers and distributors of brand name drugs, have greater financial and other resources than we have, and are therefore able to expend more effort than we do in areas such as product development and marketing. The crucial competitive factors are price, product quality, customer service and marketing. Although we believe that our present equipment and facilities render our operations competitive as to price and quality, many competitors may have far greater resources than we have, which may enable them to perform high quality services at lower prices than the services performed by us. Additionally, some of our customers may acquire the same equipment and technology used by us and perform for themselves the services which we now perform for them.
Employees
As of January 3, 2004, we employed approximately 480 full-time employees. Of such employees, approximately 391 are engaged in manufacturing and operational activities and approximately 297 are covered by a collective bargaining agreement between PFI and Local 522 affiliated with the International Brotherhood of Teamsters of New Jersey, which expires in October 2004. Additionally, three employees are represented by Local 68 of the International Union of Operating Engineers, affiliated with the AFL-CIO. We had 20 persons employed in sales, customer service and graphic arts, 21 administrative employees and 48 laboratory technicians and scientists. We believe that our relations with our employees are satisfactory.
Item 2. Properties
We lease approximately 214,000 square feet of office, manufacturing and warehousing space in Edison, New Jersey, under a lease which expires in 2019. The monthly rental is currently $147,500 per month and will increase on each 30th month after August 2009 by a cost of living increase. The rental during each of the renewal options, if any, will be the higher of the "fair rental value" (as that term is defined in the lease) of the premises at the commencement of each renewal option or the rent in effect at the end of the lease. In addition, we are obligated to pay all utilities, real estate taxes, assessments, repairs, improvements, maintenance costs and expenses in connection with the premises, comply with certain environmental obligations and maintain certain minimum insurance protection.
We also lease a 91,200 square foot building located adjacent to our present manufacturing facility, under a lease which expires March 2005. We have two additional five-year renewal options. Rent payments are $28,500 per month for the balance of the initial ten-year term. In addition, we are obligated to pay all utilities, real estate taxes, assessments, repairs, improvements, maintenance costs and expenses in connection with the premises, comply with certain environmental obligations and maintain certain minimum insurance protection.
In connection with our acquisition of Konsyl, PFI and Konsyl entered into a five-year lease with ANDA Investments Ltd., a company partially owned by Mr. Frank X. Buhler, the former majority stockholder of Konsyl, regarding Konsyl's manufacturing facility in Maryland. Annual rent is $200,000, payable quarterly. In addition, Konsyl has an option to purchase the facility for $2,250,000. This option expires on May 14, 2006.
We believe that each of these facilities provides the potential for increased expansion of manufacturing capacity, if necessary.
Item 3. Legal Proceedings
Fiorito v. PFI. In March 2002, action was brought against us in the United States District Court for the Southern District of New York seeking $20 million in damages and $40 million in punitive damages related to the sales of allegedly defective product. We believe the lawsuit is without merit and are vigorously defending against it.
Claims Related to Max Tesler. In May 1998, we brought an action in Middlesex County Superior Court, New Jersey against one of our former outside corporate counsels arising out of matters related to the late Dr. Tesler, a former President, seeking damages for conflict of interest, breaches of fiduciary duty and loyalty, negligence and malpractice during its representation of PFI. The action is still pending.
Apotex Corporation and Torpharm v. PFI. In July 2000, an action was instituted in the Circuit Court of Cook County, Illinois County Department, Chancery Division, against us by Apotex Corporation and Torpharm Inc. seeking an unspecified amount in damages and specific performance in the nature of purchasing a certain product from Apotex. The complaint alleges that we agreed to purchase a certain product exclusively from Apotex. The counts specified in the complaint include breach of contract, negligent misrepresentation, breach of implied covenant of good faith and fair dealing, breach of implied covenant to use best efforts, specific performance, breach of fiduciary duty, reformation and a UCC action for the price of 3 million tablets. Management believes the lawsuit is without merit and we are vigorously defending against it.
From time to time, we are a party to various other legal proceedings arising in the normal conduct of business. Management believes that the final outcome of these proceedings will not have a material adverse effect upon our financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
None
PART II
Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters
Our common stock is registered under Section 12(g) of the Securities Exchange Act of 1934 and is traded on the OTC Bulletin Board, symbol: PHFR. As of January 3, 2004, there were 1,378 holders of record of the common stock. The following table sets forth the range of high and low closing bid quotations for the common stock as reported by Pink Sheets LLC through January 3, 2004. These quotations represent prices between dealers, without adjustments for retail mark-ups, mark-downs or other fees or commissions, and may not represent actual transactions.
High Bid Low Bid
-------- -------
Year Ended June 29, 2002
First Quarter........................ $.20 $.04
Second Quarter....................... .20 .001
Third Quarter........................ .18 .01
Fourth Quarter....................... .20 .11
Six Months Ended December 28, 2002
First Quarter........................ $.14 $.08
Second Quarter....................... .17 .10
Year Ended January 3, 2004
First Quarter........................ $.22 $.10
Second Quarter....................... .40 .15
Third Quarter........................ .63 .295
Fourth Quarter....................... .66 .51
We have never paid dividends on our common stock. We anticipate that for the foreseeable future any earnings will be retained for use in our business or for other corporate purposes, and we do not anticipate that cash dividends will be paid. Furthermore, the agreement with our institutional lender prohibits the payment of dividends without the lender's consent.
Item 6. Selected Financial Data
In December 2002 we changed our fiscal year to the 52-53 week period ended on the Saturday closest to December 31. The selected consolidated financial data presented below for the fiscal year ended January 3, 2004, the six months ended December 28, 2002 and for each of the three years in the period ended June 29, 2002 are derived from our consolidated financial statements which financial statements have been audited by Grant Thornton LLP, independent certified public accountants for the fiscal year ended January 3, 2004 and by BDO Seidman, LLP, independent certified public accountants, for the six months ended December 28, 2002 and for each of the three years in the period ended June 29, 2002. The information as of December 28, 2002 and for the fiscal year then ended and as of Decmber 29, 2001 and for the six months then ended is unaudited. The selected consolidated financial data should be read in conjunction with the consolidated financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this report.
Fiscal Fiscal Six Six Fiscal Fiscal Fiscal
Year Months Months Year Year Year Year
Ended Ended Ended Ended Ended Ended Ended
January 3, December 28, December 28, December 29, June 29, June 30, July 1,
2004 2002 2002 2001 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
Statement of Operations Data:
Gross sales 74,519 $60,653 $33,756 $26,680 $53,577 $51,777 $82,869
Net sales 72,501 59,555 33,223 26,125 52,457 49,157 76,579
Net income (loss) (1,841) (1,398) 544 (4,946) (6,888) (14,592) (7,918)
Net income (loss) per share
of common stock:
Basic and diluted (.02) (.02) .01 (0.14) (.12) (.49) (.26)
Weighted average common
shares and dilutive securities
outstanding:
Basic and diluted 85,382 85,267 85,278 36,641 59,078 30,330 30,265
Balance Sheet Data:
Current assets 25,450 $24,029 $24,029 $19,810 $21,883 $19,174 $27,779
Current liabilities 27,265 23,234 23,234 31,671 21,510 36,944 25,214
Working capital (deficiency) (1,815) 795 795 (11,861) 373 (17,770) 2,565
Total assets 44,979 37,961 37,961 34,820 36,277 32,923 44,565
Long-term debt and capital
lease 36,426 32,032 32,032 19,063 32,621 21,952 30,732
obligations
Stockholders' equity
(deficiency) (18,712) (17,305) (17,305) (15,914) (17,854) (25,973) (11,381)
| Item 7. | Management's Discussion and Analysis of Financial Condition and Results of Operations |
During December 2002, we changed our fiscal year-end from the 52-53 week period which ends on the Saturday closest to June 30 to the 52-53 week period which ends on the Saturday closest to December 31. Our just-completed 2003 fiscal year was the 53 week period which ended January 3, 2004. The prior fiscal period consisted of the six-month transition period from June 29, 2002 to December 28, 2002 and is sometimes referred to as transition 2002. For fiscal years prior to this period, our fiscal year ended on the Saturday closest to June 30 of each year. We refer to such periods as fiscal 2002, and fiscal 2001. Operations of Konsyl have been included in our results from the May 15, 2003 date of acquisition.
Critical Accounting Policies and Estimates
Our critical accounting policies are more fully described in the Summary of Significant Accounting Policies in the notes to our consolidated financial statements. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying financial statements and related notes. In preparing these financial statements, our management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. We believe that the following critical accounting policies affect our more significant estimates used in the preparation of financial statements. Management has discussed the development and selection of the critical accounting estimates discussed below with our audit committee, and our audit committee has reviewed our disclosures relating to these estimates.
Revenue Recognition
Revenue from product sales is recognized, net of estimated provisions, when the merchandise is shipped to an unrelated third party pursuant to Staff Accounting Bulletin No. 104, "Revenue Recognition in Financial Statements." Accordingly, revenue is recognized when all four of the following criteria are met: (i) persuasive evidence that an arrangement exists; (ii) delivery of the product has occurred; (iii) the selling price is both fixed and determinable and (iv) collectibility is reasonably assured. Our customers consist primarily of large retailers. Provisions for sales discounts, allowances and returns are established as a reduction of product sales revenues at the time such revenues are recognized. These revenue reductions are established by us as its best estimate at the time of sale based on its historical experience adjusted to reflect known changes in the factors that impact such reserves. These revenue reductions are generally reflected either as a direct reduction to accounts receivable through an allowance or as an addition to accrued expenses if the payment will be settled through a direct payment to the customer.
We do not provide any price protection to its customers and generally accepts returns only if the goods are damaged.
Accounts Receivable and Concentration of Credit Risk
Financial instruments that potentially subject us to credit risk consist principally of trade receivables. Trade receivables consist of sales of products to retail customers. We extend credit to a substantial number of its customers and perform ongoing credit evaluations of those customers' financial condition while, generally, requiring no collateral. Customers that have not been extended credit by us are on a cash in advance basis only.
We review accounts receivable on a monthly basis to determine if any accounts receivable will potentially be uncollectible. We include any accounts receivable balances that are determined to be uncollectible, along with a general reserve, in our overall allowance for doubtful accounts. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. Based on the information available to us, we believe our allowance for doubtful accounts as of January 3, 2004 and December 28, 2002 is adequate. However, actual write-offs might exceed the recorded allowance.
Substantially all accounts receivable serves as collateral for our loan agreements.
Income Taxes
We account for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes," which requires the recognition of deferred tax liabilities and assets at currently enacted tax rates for differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. A valuation allowance has been recorded against amounts that we believe are not likely to be realized. Future changes in the valuation allowance will be recognized in the period of change.
Purchase Price Allocation
The fair values of these items were based upon management's estimates with the assistance of independent professional valuation firms. Certain of the acquired assets were intangible in nature, including trademarks. Management employed an independent valuation firm to assist in determining the fair value of these intangible assets. The excess purchase price over the amounts allocated to the assets was recorded as goodwill.
All such valuation methodologies, including the determination of subsequent amortization periods, involve significant judgments and estimates. Different assumptions and subsequent actual events could yield materially different results.
Inventory Valuation
Inventories are stated at the lower of cost or market with cost determined on a first in, first out (FIFO) basis. An allowance is established when management determines that certain inventories may not be saleable at normal sales prices. These allowances are based on management's judgements and may be subject to changes in the near term. Any changes in estimate would be recorded in the period of change.
As of January 3, 2004, our commitments are as follows:
Fiscal year ended: Operating Lease Capital Lease
Obligations Obligations1 Long-Term Debt Total
- -------------------------------------------------------------------------------------------------
2004 $ 2,312,000 $2,416,000 $ 6,296,000 $ 11,024,000
2005 2,141,000 1,914,000 20,264,000 24,319,000
2006 1,970,000 576,000 12,469,000 15,015,000
2007 1,970,000 287,000 750,000 3,007,000
2008 1,862,000 220,000 - 2,082,000
Thereafter 17,553,000 135,000 - 17,688,000
- -------------------------------------------------------------------------------------------------
Total Payments $27,808,000 $5,548,000 $39,779,000 $ 73,135,000
- -------------------------------------------------------------------------------------------------
1 Amounts include principal and interest payments
Liquidity and Capital Resources
At January 3, 2004, we had a working capital deficiency of $1,815,000 compared with working capital of $795,000 at December 28, 2002. Cash at January 3, 2004 was $363,000 compared with $17,000 at December 28, 2002. Total assets reached $44,979,000 at January 3, 2004 compared with $37,961,000 at December 28, 2002.
Current assets at January 3, 2004 include $9,662,000 of accounts receivable, of which $1,261,000 were Konsyl's, as compared to $9,334,000 at December 28, 2002. The decrease in the non-Konsyl accounts receivable of $933,000 reflects tighter controls. Current assets also include $14,052,000 of inventory, of which $1,617,000 was Konsyl's, as compared to $13,131,000 at December 28, 2002. The decrease in non-Konsyl inventory of $696,000 is related to lower cost of material. Current liabilities include accounts payable and accrued expenses of $10,239,000, of which $841,000 was Konsyl's, as compared to $9,477,000 at December 28, 2002. The current portion of long-term debt and capital lease obligations was $8,320,000 (including $3,150,000 due to ICC) compared with $6,730,000 (including $1,785,000 due to ICC) at December 28, 2002. The increases in current liabilities and in long term debt/capital lease obligations resulted primarily from debt incurred to finance the acquisition of Konsyl.
Cash increased $346,000 during the fiscal year ended January 3, 2004.
Total funds provided by operating activities were $6,597,000 for the fiscal year ended January 3, 2004. Cash used by the net loss for the year of $1, 841,000 and the non-cash deferred tax benefit of $369,000 were offset by non-cash charges of $2,932,000 for depreciation, amortization and stock based compensation. Sources of cash included a decrease of $996,000 in accounts receivable from tighter controls, and a decrease in inventories of $1,208,000 related to lower production levels over the year end holiday. Also, cash was provided by an increase of $2,776,000 in amounts due ICC resulting from purchases of raw materials (offset by benefits from our tax sharing agreement), an increase in accounts payable and accrued expenses of $362,000, and a reduction of $533,000 in other current assets.
Net cash used in investing activities for the fiscal year ended January 3, 2004 was $6,780,000 and was principally attributable to $6,009,000 for the acquisition of Konsyl net of cash acquired and $771,000 used for capital expenditures related to capacity expansion and facility upgrades.
Net cash provided by financing activities for the fiscal year ended January 3, 2004 was $529,000. We received $1,332,000 in loans from ICC during the period. In addition, we borrowed $5,327,000 from other lenders to support the acquisition. Of that amount, $3.7 million was borrowed from our existing lender, CIT Business Credit, and $1,627,000 from ICC. During the fiscal year, we repaid an aggregate of $2,093,000 of capital lease obligations and repaid $4,046,000 under our line of credit and other long-term debt.
Total shareholders' deficiency at January 3, 2004 was $18,712,000 compared to a deficiency of $17,305,000 at December 28, 2002. We recorded a net loss of $1,841,000 for the fiscal year ended January 3, 2004.
We have convertible subordinated debentures and capitalized lease obligations, which together with the line of credit borrowings have a substantial impact on the cash requirements in terms of principal and interest payments.
We have a deferred tax asset of approximately $15,769,000 against which we have applied a valuation allowance of $14,899,000 at January 3, 2004. The net deferred tax asset of $613,000 consists of various temporary differences that are realizable through the tax sharing agreement with ICC. Management has recorded this valuation allowance for state, federal, and capital loss carry forwards on the deferred tax asset. Reductions in the valuation allowance, which could benefit results of operations in the future, will be recorded when, in the opinion of management, our ability to generate taxable income is considered more likely than not. Any utilization of net operating loss carryforwards will reduce our future tax obligation. We also have a net deferred tax liability of $1,028,000 arising from tax basis differences from the Konsyl acquisition.
We intend to spend an estimated $1,500,000 to $2,000,000 for capital improvements in the 52-week period ending January 1, 2005 to increase manufacturing capacity and reduce costs. We anticipate that these capital expenditures will be funded through equipment lease financing and cash flow generated from future operations. While we have in the past had no difficulty in obtaining such financing, there can be no assurance that we will obtain the lease financing in the future.
We continue to address customer relationship issues and are continuing the process of rebuilding our sales base through the actions detailed below. We continue to pursue our plan to increase revenues and improve operational efficiencies to restore profitability. To carry out these plans, we have set forth the following objectives:
| • | Expanding our custom manufacturing for some major pharmaceutical companies. |
| • | Eliminating several unprofitable product lines consisting mainly of items purchased from third parties and repackaged end products for smaller customers and continuing to evaluate product line and customer profitability. |
| • | Increasing our business supplying other manufacturers with bulk tablets and capsules, taking advantage of higher volumes and better margins. |
| • | Expanding our product line through joint venture marketing agreements. |
| • | Expanding our international sales. |
These objectives, along with our objectives of sustaining market share and increasing sales, are projected to be driven by the following actions which we aim to take:
| • | Re-establishing strong relationships within our distribution network. |
| • | Controlling and reducing, where appropriate, our fixed and variable expenses. |
| • | Eliminating unprofitable product lines and customers. |
| • | Improving our manufacturing efficiencies. |
| • | Shortening delivery time. |
| • | Filing ANDAs for new products as they come to the OTC Market. |
| • | Obtaining marketing rights for products produced by other generic pharmaceutical manufacturers. |
We believe that cash flow from operations, our revolving credit facility and equipment and term loan financing, plus continued financial support from ICC (see note 1), will be sufficient to fund our currently anticipated operations, working capital, capital spending and debt service through March 31, 2005. On May 15, 2003, we reached an agreement with The CIT Group/Business Credit, Inc. to extend our existing revolving credit facilities to December 31, 2006 and the credit line with CIT was increased from $15 million to $20 million, including a term loan of $2 million to be repaid over forty months with interest at prime plus 0.75%. While no assurance can be given that cash flow will be sufficient to fund operations, ICC has committed to provide us with the necessary financing to continue our operations through March 31, 2005. ICC has supported us in the past by providing loans, replacing loans from our asset-based lenders and providing us with working capital.
The above agreement with CIT includes certain financial covenants including a requirement to maintain minimum tangible net worth, net worth for Konsyl, and minimum net income on a rolling three-month basis.
We were in violation of certain financial covenants (specifically the minimum tangible net worth and the minimum net income covenants) within our agreement with CIT as of January 3, 2004. We have obtained a waiver-dated March 25, 2004 from CIT stating that such breaches and defaults under the financing agreement shall not be deemed to be defaults or events of default under the financing agreement. The waiver states that on and after the date of the waiver, we shall be in compliance with all of the terms and provisions of the Financing Agreement. The waiver also states that it waives only the specific events of default noted in the waiver and does not waive any other existing events of default or future events of default. We do not believe that there are any other events of default under the agreement.
We are currently negotiating with CIT to amend the covenants. Additionally, on March 29, 2004, the President of ICC signed the waiver letter reaffirming ICC's guarantee of this debt. There can be no guarantees that we will not be in default on these covenants in the future.
Results of Operations for Fiscal 2003 Compared to the Fiscal Year Ended December 28, 2002 (unaudited)
Gross sales for fiscal 2003 were $74,519,000 compared with $60,653,000 for fiscal 2002, an increase of 23%. Of this increase, $6,568,000 is attributable to the inclusion of Konsyl from May 16, 2003. In addition, in July 2002 we significantly enhanced our relationship with a major national retailer to whom shipments were $8,289,000 in fiscal 2003 compared with $4,010,000 in transition 2002 and $152,000 in fiscal 2002. The remainder of the increase has come from organic growth in PFI's existing solid dose pharmaceutical business with existing customers, particularly the various "dollar" stores. Net sales for fiscal 2003 were $72,501,000 compared to $59,555,000 in the comparable period of the prior year, an increase of 22% due to the increase in gross sales. Sales discounts and allowances increased to $2.0 million in fiscal 2003 compared to $1.1 million in the prior year. This is reflective, in part, of the increasing price competition for business in the private label retail markets.
Cost of sales declined to 82.1% of net sales in fiscal 2003 compared to 84.4% in the fiscal year ended December 28, 2002. The decrease is principally attributable to the inclusion of Konsyl with its higher margin products. Cost of sales as a percentage of gross sales was 79.9% in fiscal 2003 compared with 82.9% in fiscal 2002.
Selling, general and administrative expenses were $13,032,000 or 18.7% of net sales for fiscal 2003 as compared to $9,357,000 or 15.7% of net sales in the 2002 period. The increase in costs reflects $2,100,000 from Konsyl, non-cash stock based compensation of $181,000, and the remainder of the increase principally resulted from higher commission expenses due to increased volume and higher legal expenses, especially related to the Apotex case.
Interest expense for fiscal 2003 was $3,527,000 compared with $3,872,000 in the 2002 period. The decrease is primarily attributable to lower interest rates offset by increased debt levels to finance the Konsyl acquisition.
In December 2001, ICC became an 85.6% owner of our common stock. As a result of the increase in ICC's ownership of PFI, we file a consolidated tax return with ICC. In accordance with a tax sharing agreement between the two companies, we will be reimbursed for the tax savings generated from ICC's use of our losses. In addition, the agreement provides for an allocation of the group's tax liability, based upon the ratio that each member's contribution of taxable income bears to the consolidated taxable income of the group. In connection with this tax sharing agreement, we recorded a tax benefit of $1, 861,000 for fiscal 2003 compared with a benefit of $2,350,000 for the fiscal year ended December 28, 2002
The net loss for fiscal 2003 was $1,841,000 or $0.02 per share compared to a net loss of $1,398,000 or $0.02 per share for the fiscal year ended December 28, 2002.
Results of Operations for the Six Months Ended December 28, 2002 Compared to the Six Months Ended December 29, 2001 (unaudited)
Gross sales for the six months ended December 28, 2002 were $33,756,000 compared with $26,680,000 in the same period of the prior year, an increase of 26.5%. In July 2002, we significantly enhanced our relationship with a major national retailer to whom shipments were $4,010,000 in the six months ended December 28, 2002. Also, during the six months ended December 28, 2002, sales to brand name pharmaceutical companies rose to 10% of total sales, compared with 6% in the prior year period. Net sales for the six months ended December 28, 2002 were $33,223,000 compared with $26,125,000 in the comparable prior period, an increase of 27.2%. The increase in net sales reflected the higher gross sales and a continued reduction in the relative impact of customer discount and rebate programs.
Cost of sales declined to 82.7% of net sales in the six months ended December 28, 2002 compared to 90.8% in the six months ended December 29, 2001. The decrease is attributable to a shift in product mix to higher margin products, lower material costs due in significant part to our increased purchases from ICC, improved manufacturing efficiency from higher volumes and longer production runs, and reduced product obsolescence costs. Cost of sales as a percentage of gross sales was 81.4% in the six months ended December 28, 2002 compared with 88.9% in the six months ended December 29, 2001.
Selling, general and administrative expenses were $4,543,000 or 13.7% of net sales for the six months ended December 28, 2002 as compared to $4,900,000 or 18.8% of net sales for the six months ended December 29, 2001. The respective decreases, in expense and percentages, reflect higher sales while controlling legal and consulting costs.
Interest expense was $1,786,000 for the six months ended December 28, 2002 compared to $2,623,000 for the six months ended December 29, 2001. The six months ended December 28, 2002 had the benefit of lower interest rates and lower debt levels as ICC converted $15 million debt into equity in December 2001.
In December 2001, ICC became an 85.6% owner of our common stock. As a result of the increase in ICC's ownership of PFI, we file a consolidated tax return with ICC. In accordance with a tax sharing agreement between the two companies, we will be reimbursed for the tax savings generated from ICC's use of our losses. In addition, the agreement provides for an allocation of the group's tax liability, based upon the ratio that each member's contribution of taxable income bears to the consolidated taxable income of the group. In connection with this tax sharing agreement, we recorded a tax benefit of $1,113,000 for the six months ended December 28, 2002 compared with a benefit of $123,000 for the six months ended December 29, 2001. The tax benefit recorded in the six months ended December 28, 2002 is disproportionate due to a reduction in our deferred tax asset valuation reserve of $715,000.
Net income for the six months ended December 28, 2002 was $544,000 or $0.01 per share compared to a net loss of $4,946,000 or $.14 per share for the six months ended December 29, 2001.
Results of Operations for Fiscal 2002 Compared to Fiscal 2001
Gross sales for the fiscal year ended June 29, 2002 were $53,577,000, an increase of 3.5% as compared to $51,777,000 in the prior fiscal year. During the year, sales to brand name pharmaceutical companies rose to 12% of total sales compared to 6% in the prior year, as we expanded our contract manufacturing activities to additional products, while sales to retail customers declined to 79% of the total from 86% in the prior year. During 2002, sales to two customers, CVS and Walgreens, were $4,470,000 or 8% of sales compared to $9,027,000 or 18% in the prior year. This reduction reflected the lingering problems from lost business and customers due to the after effects of production and shipping problems and other difficulties experienced by us during the installation of the new computer system in fiscal 1999. Net sales for the fiscal year ended June 29, 2002 were $52,457,000 as compared to $49,157,000 in the prior fiscal year. The increase in net sales reflected the higher gross sales and a continued reduction in customer discount and rebate programs.
Cost of sales declined to 88.7% of net sales in the fiscal year ended June 29, 2002 as compared to 95.4% in the prior fiscal year. The decrease is attributable to a shift in product mix to higher margin products, improved manufacturing efficiency from higher volumes and reduced product obsolescence costs. In addition, a reduction of sales discounts and allowances had a favorable effect. Cost of sales as a percentage of gross sales was 86.8% in the current year compared with 90.6% in the prior year.
Selling, general and administrative expenses were $9,714,000 or 18.5% of net sales for the fiscal year ended June 29, 2002 as compared to $10,961,000 or 22.3% of net sales for the prior fiscal year. The decrease was primarily the result of lower bad debt expense of $521,000, lower consulting fees of approximately $480,000, and staff reductions saving approximately $200,000.
Interest expense was $4,709,000 for the fiscal year ended June 29, 2002 as compared to $5,208,000 in the prior fiscal year. The net decrease resulted from lower debt levels due to ICC's conversion of debt into equity and lower interest rates.
Other income for the year ended June 29, 2002 was $511,000 compared with an expense of $250,000 in the prior year. The improvement resulted from $312,000 of additional income from subleasing a portion of our distribution center. In addition, the prior year included approximately $300,000 of various accruals for one-time non-operating items such as sales taxes.
In connection with the tax sharing agreement with ICC, we recorded a tax benefit of $1,360,000 for the current year. No provision for income tax was made for fiscal 2001.
Net loss for the fiscal year ended June 29, 2002 was $6,888,000 or $.12 per share as compared to $14,592,000 or $.49 per share in the prior fiscal year.
Recent Accounting Pronouncements
In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". FIN 45 requires a guarantor to recognize, at the inception of a qualified guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. FIN 45 is effective on a prospective basis for qualified guarantees issued or modified after December 31, 2002. The adoption of this Interpretation did not have a material impact on the Company's financial position or results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities". FIN 46 explains how to identify variable interest entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. This Interpretation requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. FIN 46 is effective immediately for variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. The adoption of this Interpretation did not have a material impact on the Company's financial position or results of operations.
Effects of Inflation
We do not believe that inflation had a material effect on our operations for fiscal year 2003, transition 2002 or fiscal years 2002, and 2001.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
We would be adversely affected by an increase in interest rates. Each 1% change in the prime rate will change the Company's annual expenditure by approximately $450,000.
| Item 8. | Financial Statements and Supplementary Data |
Financial Statements for the Fiscal Year Ended January 3, 2004, the Six Months Ended December 28, 2002, the Six Months Ended December 29, 2001 (unaudited) and for the Two Years Ended June 29, 2002 and June 30, 2001 respectively for Pharmaceutical Formulations, Inc. and Subsidiaries
| Report of Independent Certified Public Accountants | F-1 |
| Report of Independent Certified Public Accountants | F-2 |
| Consolidated Financial Statements |
| Balance Sheets at January 3, 2004 and December 28, 2002 | F-3 |
| Statements of operations for the Fiscal Year Ended January 3, 2004, the Six Months Ended December 28, 2002, the Six Months Ended December 29, 2001 (unaudited), and for the Two Years Ended June 29, 2002 and June 30, 2001 respectively | F-4 |
| Statements of Changes in Stockholders' (Deficiency) for the Year Ended January 3, 2004, Six Months Ended December 28, 2002 and Years Ended June 29, 2002 and June 30, 2001 | F-5 |
| Statements of Cash Flows for the Fiscal Year Ended January 3, 2004, the Six Months Ended December 28, 2002, the Six Months Ended December 29, 2001 (unaudited), and for the Two Years Ended June 29, 2002 and June 30, 2001 respectively | F-6 |
| Notes to Consolidated Financial Statements | F-7 thru F-34 |
Financial Statement Schedule
| Schedule II - Valuation and Qualifying Accounts | S-1 |
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
As previously reported in a Form 8-K dated December 10, 2003 (as amended) on December 10, 2003 we retained the services of Grant Thornton LLP as our independent auditors and dismissed BDO Seidman LLP as our independent auditors. This engagement and dismissal was approved by our Board of Directors on the recommendation of its Audit Committee. During our two most recent fiscal years and any subsequent interim period to December 10, 2003, we did not consult with Grant Thornton regarding any matters noted in Items 304(a)(2)(i) and (ii) of Regulation S-K.
There have been no "disagreements" within the meaning of Item 304(a)(1)(iv) of Regulation S-K, or any events of the type listed in Item 304(a)(1)(v)(A) through (D) of Regulation S-K, involving BDO Seidman that occurred within our two most recent fiscal years and the interim period to December 10, 2003. BDO Seidman‘s reports on our financial statements for the past two years did not contain any adverse opinions or disclaimers of opinion, and were not qualified or modified as to uncertainty, audit scope or accounting principles.
We provided BDO Seidman with a copy of the disclosures made pursuant to the Form 8-K (which disclosures are consistent with the disclosures noted above) and BDO Seidman furnished the Company with a letter addressed to the Commission stating that it agrees with the statements made by the Company in the Form 8-K filing, a copy of which was filed as an exhibit to the Form 8-K.
| Item 9A. | Controls and Procedures |
We have carried out an evaluation under the supervision of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of January 3, 2004, except as otherwise noted below, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports filed or submitted under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and include controls and procedures designed to ensure that information required to be disclosed by us in such reports is assembled and reported to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
Our new independent auditors, Grant Thornton LLP, have advised management and the audit committee of our board of directors of two matters that they considered to be material weaknesses in our internal controls, which constitute reportable conditions as that term is defined under standards established by the American Institute of Certified Public Accountants: (i) the lack of adequate preparation of account reconciliations and analysis necessary to accurately prepare annual financial statements and (ii) the lack of sufficient qualified personnel in our accounting department.
We considered these matters in connection with the year-end closing process and the preparation of the consolidated financial statements for the fiscal year ended January 3, 2004 included in this Form 10-K and believe that the concerns identified by our auditors have not impaired or prevented our ability to report accurately our financial condition and results of operation for the periods covered by this report. Management is actively working to assess and correct the conditions reported by our auditors and we plan to implement certain enhancements to our disclosure controls and our internal controls over financial reporting in 2004 which we believe should address the issues identified by Grant Thornton. Our efforts to-date have included reenforcing existing policies and procedures, undertaking timely accounting reconciliations, and actively assessing the qualifications of personnel needed in the accounting department.
PART III
| Item 10. | Directors and Executive Officers of the Registrant |
Our directors as of January 3, 2004 were as set forth below.
| • | RAY W. CHEESMAN, age 72, has been a director since July 1993. He was a consultant to KPMG Peat Marwick LLP, an international accounting firm from 1987 through June 1996. Prior thereto, Mr. Cheesman was a partner in such firm. Mr. Cheesman is a licensed Certified Public Accountant. |
| • | BALRAM ADVANI, age 60, has been a director since October 2001. He has been President of ADH Health Products, which specializes in custom formulations and contract manufacturing of dietary supplements and nutritional products, since 1976. |
| • | FRANK X. BUHLER, age 77, has been a director since June 2003. He was formerly President and Chief Executive Officer of Konsyl Pharmaceuticals, Inc. from 1984 to 2003. |
| • | JAMES C. INGRAM, age 63, has been a director since October 2000 and our Chairman and Chief Executive Officer since August 2003. Prior thereto, he was our President and Chief Operating Officer. Prior to joining us, he was Vice President of K.S.H. Corporation from 1986-1989, Vice President of Goodson Polymer Corp. from 1989-1991 and Executive Vice President of Primex Plastics Corp., a subsidiary of ICC from 1991 to 1996. |
| • | GUSTAV JACOFF, age 70, has been a director since October 2001. He was the founder and has been the President of Staff Medical Supply Inc., which is a professional pharmacy and medical company, since 1957; he established and operated Prescription Pharmacy Group and Prescription Centers Inc., which consisted of nine pharmacies, from 1964 until 1988. |
| • | JOHN L. ORAM, age 59, has been a director since July 1993 and was Chairman and Chief Executive Officer from December 1995 until August 2003. Mr. Oram has been President and Chief Operating Officer of ICC since 1987. ICC, our majority stockholder, is a major international manufacturer and marketer of chemical, plastic and pharmaceutical products. Since 1980, Mr. Oram has been a director of Electrochemical Industries (1952) Ltd. ("EIL"), an Israeli subsidiary of ICC listed on the Tel-Aviv Stock Exchange engaged in the manufacture and distribution of chemical products. From 1996, Mr. Oram has been a director of Frutarom Industries Limited, a company spun-off from EIL and listed on the Tel-Aviv Stock Exchange engaged in the flavor and fragrance industry. |
| • | MICHAEL A. ZEHER, age 57, has been a director and President and Chief Operating Officer since August 2003. Prior to joining PFI, from 1994 to 2002, he was President and Chief Executive Officer of Lander Co., Inc., an international manufacturer and marketer of private label and branded health and beauty care products. From 1972 to 1994, Mr. Zeher was employed by Johnson & Johnson in various sales and marketing positions, most recently as VP of Business Development for the Consumer Sector. Since 2001, he has been a Director of Matrixx Initiatives, Inc., which is engaged in the development, manufacture and marketing of over-the-counter (OTC) pharmaceuticals. Effective 2004, Mr. Zeher is a Director of the Consumer Health Care Products Association, a member-based association representing the leading manufacturers and distributors of nonprescription, over-the-counter (OTC) medicines. |
Our executive officers as of January 3, 2004 were as set forth below:
Name Positions
---- ----------
James Ingram Chairman, Chief Executive Officer and Director
Michael Zeher President, Chief Operating Officer and Director
Anthony Cantaffa Executive Vice President of PFI and
President of Konsyl
Brian Barbee Vice President, Scientific Affairs
Ward Barney Vice President, Operations
Walter Kreil * Vice President, Chief Financial Officer
Lenny Luongo Vice President, Private Label Sales and Marketing
Martin Reiss Vice President, Manufacturing Services
* Resigned as of February 18, 2004 His positions were assumed by A. Ernest Toth, Jr.
The business experience of our executive officers who are not directors is set forth below;
ANTHONY CANTAFFA, age 61, has been Executive Vice President since October 2002 and President of Konsyl Pharmaceuticals, Inc. since May 2003. Previously he was Vice President, New Business Development from 1997 to October 2002; Vice President, Operations from 1998 to 1999; Vice President, Mergers and Acquisitions from 1995 until 1997; Chief Financial Officer from 1988 until 1990 and from 1991 to 1995; and Chief Operating Officer from 1988 until 1995.
BRIAN BARBEE, age 53, has been Vice President, Scientific Affairs since 1995. He was Vice President, Quality Assurance/Quality Control and Regulatory between 1993 and 1995. He joined us in 1978 and became Director of Quality Assurance in 1982 and Director of Regulatory Affairs in 1988.
WARD BARNEY, age 52, has been Vice President, Operations since 1999. Prior to joining us, he was Vice President, Operations of Schein Pharmaceuticals, Inc. from 1997 to 1999 and Senior Vice President from 1994 to 1997 with McGaw Labs, and has been in operations and engineering in the pharmaceutical industry for over 25 years.
WALTER KREIL, CPA, age 56, was Vice President, Chief Financial Officer from August 2001 to February 18, 2004. From 1987 to 2001, he was Vice President and Chief Financial Officer of Ionbond, Inc., an international thin-film metal coatings company. Mr. Kreil resigned as CFO effective February 18, 2004.
LEONARD LUONGO, age 57, has been Vice President, Private Label Sales since October 2002, responsible for private label sales and new retail business. Previously he was Director of Sales Administration from 1996 to October 2002. Mr. Luongo also acted as a Sales Director from 1999 to April 2001. He has been in the Consumer Package Goods industry for over 30 years.
MARTIN REISS, age 53, has been Vice President, Manufacturing Services since September 2002. Previously, he was Director of Purchasing from 1997 to 2002. He has over 20 years supply chain management experience in the pharmaceutical industry.
A. ERNEST TOTH, JR., CPA, age 45, was elected Vice President and Chief Financial Officer effective February 18, 2004. From 2001 to 2003, he was Vice President and Chief Financial Officer of World Power Technologies, a leading worldwide provider of power quality analysis products and technical power system consulting services. From 2000 to 2001, he was Sr. Vice President and Chief Financial Officer of Athlete.com Inc., a youth sports network. For 15 years prior, he served in various financial positions at MacAndrews & Forbes Holdings Inc., a diversified holding company.
Section 16(a) of the Securities Exchange Act of 1934 requires our officers and directors and persons who own more than ten percent of a registered class of our equity securities to file reports of ownership and changes in ownership with the Securities and Exchange Commission ("SEC") and any exchange on which our securities may be traded. Officers, directors and greater than ten-percent stockholders are required by SEC regulation to furnish us with copies of all Section 16(a) forms they file. Based solely on our review of the copies of such forms received by us, or written representations from certain reporting persons that no Forms 5 were required for those persons, we believe that all such filing requirements for the fiscal year ended January 3, 2004 were complied with.
We have not at this time adopted a formal code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions. As a smaller public company, we have faced great financial burdens in addressing the numerous requirements imposed by recent changes in securities regulations and, in the interest of conserving cash, have limited our immediate expenditures to those required to meet mandatory requirements. We anticipate that such a code will be prepared in fiscal 2004 and we understand that such a code will be required if we are in a position to relist our shares on the Nasdaq Stock Market or a national stock exchange.
| Item 11. | Executive Compensation |
The following table contains compensation data for fiscal year 2003, transition 2002 (marked with a "T" after the year in the tables below) and fiscal years 2002, and 2001 for our (i) Chief Executive Officers and, (ii) our four most highly compensated executive officers other than the CEO who were serving as executive officers at January 3, 2004, to the extent that salary and bonuses exceeded $100,000 (together, these five people are sometimes referred to as the "Named Executive"):
Annual Compensation Long-Term Compensation
- ---------------------------------------------------------------------- ---------------------------------------------------
Awards Payouts
---------------------------------------------------
Other Restricted Securities All
Annual Stock Underlying LTIP Other
Name and Salary Bonus Compensation Awards Options Payouts Compensation
Principal Position Year $ $ $ $ # $ $
- ---------------------- ------ -------- ------- -------------- --------- ----------- --------- --------------
James Ingram 2003 250,000 --- 7,200 1 50,000 --- --- ---
Chairman, CEO3 2002 T 125,000 --- 3,600 1 50,000 400,000 --- ---
2002 244,231 --- 31,535 2 --- 125,000 --- ---
2001 141,541 --- --- --- 75,000 --- ---
John Oram 2003 --- --- --- --- --- --- ---
Former Chairman, 2002 T --- --- --- --- --- --- ---
and CEO3 2002 --- --- --- --- --- --- ---
2001 --- --- --- --- --- --- ---
Michael Zeher 2003 105,769 --- 3,046 1 100,000 250,000 --- ---
President and COO3 2002 T --- --- --- --- --- --- ---
2002 --- --- --- --- --- --- ---
2001 --- --- --- --- --- --- ---
Anthony Cantaffa 2003 186,146 --- --- 30,000 --- --- ---
Executive Vice 2002 T 90,000 --- --- --- 100,000 --- ---
President 2002 174,615 --- --- --- 50,000 --- ---
2001 170,000 --- --- --- 75,000 --- ---
Ward Barney 2003 180,000 --- 6,000 1 25,000 --- --- ---
Vice President, 2002 T 90,000 --- 6,000 1 --- 100,000 --- ---
Operations 2002 180,000 --- 6,520 1 --- 50,000 --- ---
2001 180,000 --- 6,000 1 --- 100,000 --- ---
Walter Kreil 2003 180,000 --- --- 25,000 --- --- ---
Vice President, 2002 T 90,000 --- --- --- 100,000 --- ---
Chief Financial 2002 150,230 --- --- --- 100,000 --- ---
Officer 2001 --- --- --- --- --- --- ---
__________________
| 1 | Car allowance |
| 2 | Mr. Ingram's car allowance of $6,535 and moving allowance of $25,000 |
| 3 | Effective August 1, 2003, Mr. Ingram assumed the positions of Chairman and CEO, Mr. Zeher assumed the positions of President and COO (a position formerly held by Mr. Ingram) and Mr. Oram ceased to hold the positions of Chairman and CEO. |
Option Grants in Fiscal 2003
The following table contains information concerning the grant of stock options to the Named Executives during the fiscal year ended January 3, 2004 (we have no outstanding stock appreciation rights -"SARs"- and granted no SARs during fiscal 2003):
Individual Grants
--------------------------------------------
Number of Percent of Potential Realizable Value At
Securities Total Options Assumed Annual Rates of Stock
Underlying Granted to Exercise Price Appreciation for Option Term1
Options Employees in Price Expiration -----------------------------------
Name Granted Fiscal Year ($/Share)2 Date 5%($) 10%($)
------ ------- ------------ ---------- ----- ----- --------
James Ingram --- --- --- --- --- ---
John Oram --- --- --- --- --- ---
Michael Zeher 250,000 89% $.535 Aug, 2008 $170,703 $215,406
Anthony Cantaffa --- --- --- --- --- ---
Ward Barney --- --- --- --- --- ---
Walter Kreil --- --- --- --- --- ---
_________________________
| 1 | Executives may not sell or assign any option grants, which have value only to the extent of stock price appreciation, which will benefit all stockholders commensurately. The amounts set forth are based on assumed appreciation rates of 5% and 10% as prescribed by the Securities and Exchange Commission rules and are not intended to forecast future appreciation, if any, of the stock price. We did not use an alternate formula for a grant date valuation as we are not aware of any formula which will determine with reasonable accuracy a present value based on future unknown or volatile factors. Actual gains, if any, on stock option exercises and common stock holdings are dependent on the future performance of the common stock and overall stock market conditions. There can be no assurance that the amounts reflected in this table will be achieved. |
| 2 | The exercise price is equal to or higher than the fair market value of our common stock on the date of the grant. |
Aggregated Option Exercises and Fiscal Year-End Option Values in Fiscal 2003
No options were exercised by any of our Named Executives during the fiscal year ended January 3, 2004. The following table sets forth information with respect to the Named Executives concerning unexercised options held at fiscal year-end:
Number of Value of
Unexercised-Securities Unexercised-In-the-
Underlying Money Options
Options at 01/03/04 at 01/03/04($)1
------------------- ---------------
Shares Realized
Acquired on Value
Name Exercise(#) ($) Exercisable Unexercisable E