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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 26, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-19725
PERRIGO COMPANY
(Exact name of registrant as specified in its charter)
Michigan 38-2799573
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
515 Eastern Avenue 49010
Allegan, Michigan (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (269) 673-8451
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock (without par value)
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark 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 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 Rule 12b-2 of the Exchange Act). YES [X] NO [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sale price of the common stock on December
26, 2003 as reported on The NASDAQ Stock Market(R), was approximately
$811,784,797. Shares of common stock held by each executive officer and director
and by each person who owns 5% or more of the outstanding common stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.
As of July 26, 2004 the registrant had outstanding 70,945,126 shares of common
stock.
Documents incorporated by reference: Portions of the Registrant's Proxy
Statement for its Annual Meeting on October 29, 2004 are incorporated by
reference into Part III.
PART I.
Item 1. Business. (Dollar and share amounts in thousands, except per share
amounts)
GENERAL
Perrigo Company (the Company), established in 1887, is the largest manufacturer
of store brand over-the-counter (OTC) pharmaceutical and nutritional products in
the United States. Store brand products are sold under a retailer's own label
and compete with nationally advertised brand name products. The Company
attributes its leadership position in the store brand market to its commitment
to product quality, customer service, retailer marketing support and its
comprehensive product assortment and low cost production.
The Company's principal executive offices are located at 515 Eastern Avenue,
Allegan, Michigan 49010, its telephone number is (269) 673-8451 and its fax
number is (269) 673-7535. The Company's website address is www.perrigo.com,
where the Company makes available free of charge the Company's reports on Forms
10-K, 10-Q and 8-K, as well as any amendments to these reports, as soon as
reasonably practicable after they are electronically filed with or furnished to
the Securities and Exchange Commission.
The Company operates primarily through two wholly owned domestic subsidiaries,
L. Perrigo Company and Perrigo Company of South Carolina, Inc., and four wholly
owned foreign subsidiaries, Perrigo de Mexico S.A. de C.V., Quimica y Farmacia,
S.A. de C.V. (Quifa), Wrafton Laboratories Limited (Wrafton), and Perrigo UK
Limited, formerly Peter Black Pharmaceuticals Ltd. (Peter Black). As used
herein, "the Company" means Perrigo Company, its subsidiaries and all
predecessors of Perrigo Company and its subsidiaries.
The Company's customers are major national and regional retail drug, supermarket
and mass merchandise chains such as Wal-Mart, CVS, Walgreens, Albertson's,
Kroger, Safeway, and Dollar General and major wholesalers such as McKesson and
Supervalu.
The Company currently manufactures and markets certain products under brand
names, such as Good Sense(R) and Dr. Rosenblatt. The Company also manufactures
products under contract for marketers of national brand products.
The Company has realigned its segment reporting with the acquisition of Peter
Black. The Company has four reportable segments: Consumer Healthcare,
Pharmaceuticals, UK Operations and Mexico Operations. Consumer Healthcare
includes the U.S. operations supporting the sale of OTC pharmaceutical and
nutritional products. This reportable segment markets a broad line of products
that are comparable in quality and effectiveness to national brand products.
These products include analgesics, cough and cold remedies, gastrointestinal and
feminine hygiene products; as well as vitamins, nutritional supplements and
nutritional drinks. The cost to the retailer of a store brand product is
significantly lower than that of a comparable nationally advertised brand name
product. The retailer therefore can price a store brand product below the
competing national brand product while still realizing a greater profit margin.
Generally, the retailers' dollar profit per unit of store brand product sold is
greater than the dollar profit per unit of the comparable national brand
product. The consumer benefits by receiving a quality product at a price below a
comparable national brand product. This reportable segment includes
approximately 90% of the Company's revenues. Pharmaceuticals include the
development and eventual sale of prescription drug products. UK Operations
support the sale of OTC pharmaceutical and nutritional products in the United
Kingdom and includes the newly acquired Peter Black. UK Operations is a supplier
of store brand products to major grocery and pharmacy retailers and a contract
manufacturer of OTC pharmaceutical and nutritional products. Mexico Operations
support the sale of OTC and
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prescription drug products to retail, wholesale and governmental customers in
Mexico. See Notes A and J of the consolidated financial statements for
additional segment and geographic information.
SIGNIFICANT DEVELOPMENTS DURING FISCAL 2004
Consumer Healthcare -- Drug Application Approvals and New Product Introductions
In fiscal 2004, the Company received approval from the United States Food and
Drug Administration (FDA) for seven drug applications. The applications were for
the following products: famotidine 10 mg chewable tablet, two for loratadine
tablets 10 mg, ibuprofen chewable tablets 50 mg and 100 mg,
ibuprofen-pseudoephedrine oral suspension, naproxen-pseudoephedrine caplets and
miconazole nitrate cream.
The Company launched several new products, most notably loratadine syrup,
loratadine quick-dissolve tablets and children's ibuprofen-pseudoephedrine oral
suspension, comparable to the national brands Claritin(R), Alavert(R) and
Children's Motrin(R) Cold. In addition, the Company launched Dr. Rosenblatt's
Starch Blocker and experienced continued strong sales of loratadine and
pseudoephedrine sulfate 10 mg/240 mg tablets, newly launched in late fiscal
2003, comparable to Claritin-D(R) 24 Hour Extended Release tablets. The revenues
generated in fiscal 2004 from new products were approximately $70,000.
Pharmaceuticals -- Growth Strategy
In fiscal 2003, the Company announced its intent to enter the market for generic
prescription drug products as a focus for future growth complementing its strong
position in the OTC pharmaceutical market. In fiscal 2004, the Company invested
$4,000, primarily in increased research and development costs, for the
development of generic pharmaceutical products. The Company currently has
several products in development and three Abbreviated New Drug Applications
(ANDA) that have been filed with the FDA. The Company does not expect the
revenues for generic pharmaceutical products to be material in fiscal 2005.
The Company has reviewed potential acquisition opportunities as a means of
accelerating its entry into this market. The Company purchased an option to
acquire a controlling interest in Lannett Company, Inc., a manufacturer of
generic pharmaceutical products. However, upon further review, the Company
determined that this acquisition would not be in the best long-term interests of
its shareholders and the option has since expired. The Company continues to seek
acquisition opportunities that will further its development of this market and
increase shareholder value.
The Company is building its organizational structure to support its generic
pharmaceutical products business. During fiscal 2004, several key positions have
been filled, including vice presidents for scientific affairs and sales.
Additionally, the Company appointed directors for various functions, including
pharmaceutical operations, pharmaceutical business development and
pharmaceutical contract management.
Acquisition
In December 2003, the Company acquired Peter Black for $12,061 in cash, plus
contingent consideration that is not expected to be material. Peter Black,
located in the United Kingdom, is the largest manufacturer of store brand
vitamin and nutritional supplement products for grocery stores, pharmacies and
contract customers in the United Kingdom. Peter Black is included in the UK
Operations segment. The assets and liabilities, which are not considered
significant to the
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Company, were added to the Company's consolidated balance sheet beginning
December 27, 2003. No goodwill was recorded as a result of the acquisition.
Results of operations were included beginning in the third quarter of fiscal
2004.
Quarterly Cash Dividend
The Company paid quarterly dividends of $9,136, or $0.13 per share, during
fiscal 2004. The declaration and payment of dividends and the amount paid, if
any, is subject to the discretion of the Board of Directors and will depend on
the earnings, financial condition and capital and surplus requirements of the
Company and other factors the Board of Directors may consider relevant.
In the second quarter of fiscal 2004, the Board of Directors increased the
dividend from $0.025 per share to $0.035 per share, an increase of 40%, and
continued the higher dividend rate throughout the remainder of fiscal 2004.
Tax Examination
In January 2004, the Company was notified by the Internal Revenue Service that
it had concluded the routine Federal tax examination of tax years 1998, 1999 and
2000. As a result, the Company recorded a one-time income tax benefit of $13,100
in the second quarter of fiscal 2004, reducing its income tax accrual associated
with these audits. The Company believes it has appropriately accrued for
probable Federal income tax exposures subsequent to 2000.
FTC Investigation
The United States Federal Trade Commission (FTC) is investigating a 1998
agreement between Alpharma, Inc. and the Company related to a children's
ibuprofen suspension product. The agreement is no longer in effect. The Company
is currently negotiating with the FTC to close this investigation. Because of
the likelihood that the Company will enter into a settlement agreement with the
FTC, the Company has recorded a $4,750 charge in the fourth quarter of fiscal
2004 which is expected to resolve all claims by the FTC and state governments.
The Company continues to cooperate with the FTC to finalize the settlement
agreement; however, the inquiry could result in the Company being involved in
further proceedings with the FTC, state attorneys general or private litigants.
BUSINESS STRATEGY
The Company attributes its sustained leadership position in the store brand
market to its implementation of several focused business strategies that reflect
the Company's commitment to its customers and employees. The strategy is
outlined below.
Product Quality and Product Assortment
The Company is committed to consistently providing a high quality product to the
customer. Substantially all products are developed using ingredients and
formulas comparable to those of national brand products. Packaging is designed
to make the product visually appealing to the consumer. The Company offers a
comprehensive product assortment in order to fill customers' needs while
minimizing their product sourcing costs. High quality standards are maintained
throughout all phases of production, testing, warehousing and distribution by
adhering to "Current Good Manufacturing Practices" (cGMP) promulgated by the
FDA.
The Company is dedicated to being the first manufacturer to develop and market
key new store brand products. As a result, the Company has a research and
development staff that management
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believes is one of the most experienced in the industry at developing products
comparable to national brand products. This staff also responds to changes in
existing national brand products by reformulating existing Company products. In
the OTC pharmaceutical market, certain new products are the result of changes in
product status from "prescription only" (Rx) to OTC (non-prescription). These
"Rx switch" products require approval by the FDA through either its ANDA process
or its New Drug Application (NDA) process. To accelerate the approval process,
the Company relies on both internal development and strategic product
development agreements with outside sources.
Customer Service and Marketing Support
The Company seeks to establish customer loyalty by providing superior customer
service and marketing support. This includes providing (1) a comprehensive
assortment of high quality, value priced products, (2) timely processing,
shipment and delivery of orders, (3) assistance in managing customer inventories
and (4) support in managing and building the customer's store brand business.
The Company provides marketing support that is directed at developing customized
marketing programs for the customers' store brand products. The primary
objective of this store brand management approach is to enable customers to
increase sales of their own brand name products by communicating store brand
quality and value to the consumer. The Company's marketing personnel assist in
the development and introduction of new store brand products and promotion of
customers' ongoing store brand products by performing consumer research,
providing market information and establishing individualized promotions and
marketing programs.
Low Cost Supplier
The Company continually strives to improve its manufacturing capabilities and
technology to provide the manufacturing flexibility necessary to meet its
customers' changing needs and to achieve a low cost supplier position. Education
of the work force and a team approach enhances employees' skills to generate and
implement programs to increase the Company's productivity, improve quality and
better serve customers. Continuous improvement programs are utilized to improve
efficiency by eliminating waste from all phases of Company operations.
The Company strives to develop partnerships with its suppliers to ensure
reliable and competitively priced raw materials and packaging supplies.
Initiatives to control supply costs include volume purchases, global sourcing,
inventory and supply management, and quality and delivery measurements.
PRODUCTS
The Company currently markets approximately 1,200 store brand products to
approximately 300 customers. The Company includes as separate products multiple
sizes, flavors and product forms of certain products. The Company has a leading
market share in certain of its products in the store brand market.
Net sales related to new products were approximately $70,000 for fiscal 2004,
$45,000 for fiscal 2003 and $35,000 for fiscal 2002. A product is considered new
if it was added to the Company's product lines in the two most recent fiscal
years that net sales are recorded.
The following table illustrates net sales for the Company's two product lines
from fiscal 2000 through fiscal 2004. Excluded from this table is the Company's
personal care business, which was sold in August 1999.
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Net Sales(1) by Product Line
Fiscal Year
---------------------------------------------------------------
2004 2003 2002 2001 2000
---------------------------------------------------------------
OTC Pharmaceuticals $737,299 $688,480 $683,451 $624,495 $597,996
Nutritional 160,905 145,620 151,612 138,590 137,790
-------- -------- -------- -------- --------
$898,204 $834,100 $835,063 $763,085 $735,786
======== ======== ======== ======== ========
(1) Net sales were increased by broker commissions that were reclassified to
selling and administration expenses. The amounts reclassified for 2004,
2003, 2002, 2001 and 2000 were $8,121, $8,113, $8,741, $9,597 and $9,202,
respectively. See Note A.
Listed below are major consumer healthcare product categories under which the
Company markets products for store brand labels, the annual retail market size
for food, drug and mass merchandise retailers in the United States, excluding
Wal-Mart, according to Information Resources Inc., and the names of certain
national brands against which the Company's products compete.
Retail
Market Size
Product Categories (Billions) Comparable National Brands
- ------------------ ---------- --------------------------
Cough/Cold/Allergy/Sinus $3.5 Advil(R)Cold & Sinus, Afrin(R), Alavert(R), Aleve(R) Cold &
Sinus, Benadryl(R), Claritin(R), Dimetapp(R), NyQuil(R),
PediaCare(R), Robitussin(R), Sudafed(R), Tavist(R), Triaminic(R),
Tylenol(R)
Analgesics $2.2 Advil(R), Aleve(R), Bayer(R), Excedrin(R), Motrin(R), Tylenol(R)
Gastrointestinal $1.9 Alka-Seltzer(R), Citrucel(R), Correctol(R), Ex-Lax(R), Fibercon(R),
Imodium A-D(R), Maalox(R), Metamucil(R), Mylanta(R), Pepcid(R)AC,
Pepto Bismol(R), Phillips(R), Senokot(R), Tagamet HB(R), Tums(R),
Zantac(R) 75
Vitamins/Nutritional $2.9 Centrum(R), Flintstones(R), One-A-Day(R)/Caltrate(R),
Supplements/Diet Aids Osteo Bi-Flex(R), Ensure(R)
RESEARCH AND DEVELOPMENT
Research and development is a key component of the Company's business strategy.
The Company focuses on developing store brand products comparable in
formulation, quality and effectiveness to existing national brand products. As
part of the product development process, the Company considers the possibility
of any potential patent infringement and develops alternative formulations or
processes so as not to infringe any valid patent.
The Company has FDA approval to manufacture and distribute products such as
children's ibuprofen-pseudoephedrine oral suspension, loperamide hydrochloride
and tioconazole ointment, which are products comparable to the national brands
Children's Motrin(R) Cold, Imodium A-D(R) and 1-Day(TM), respectively.
The Company has the rights to distribute, through use of strategic alliance
agreements, products such as ibuprofen & pseudoephedrine tablets, acid reducer
tablets and loratadine and
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pseudoephedrine sulfate extended release tablets, products that are comparable
to the national brands Advil(R) Cold & Sinus, Pepcid(R) AC and Claritin(R) D-24,
respectively.
The Company estimates that products for which marketing exclusivity is expiring
through the year 2007 represent a substantial potential market. The Company
actively pursues all avenues to offer store brand products comparable to certain
of these products; however, there can be no assurance that it will be successful
in obtaining the right to distribute additional products in the future.
The Company spent $27,721, $23,315 and $25,689 for research and development
during fiscal 2004, 2003 and 2002, respectively. The Company anticipates that
research and development expenditures will be higher than the fiscal 2004 level
in the foreseeable future, primarily due to its entry into the generic
pharmaceutical market.
SALES AND MARKETING
The Company employs its own sales force to service larger customers and uses
industry brokers for some retailers. Field sales employees, with support from
marketing and customer service, are assigned to specific customers in order to
understand and work most effectively with the customer. They assist in
developing in-store marketing programs and optimizing communication of
customers' needs to the rest of the Company. Industry brokers provide a
distribution channel for some products, primarily those marketed under the Good
Sense(R) label.
In contrast to national brand manufacturers who incur considerable advertising
and marketing expenditures that are directly targeted to the end consumer, the
Company's primary marketing efforts are channeled through its customers, the
retailers and wholesalers, and reach the consumer through in-store marketing
programs. These programs are intended to increase visibility of store brand
products and to invite comparisons to national brand products in order to
communicate store brand value to the consumer. Merchandising vehicles such as
floor displays, bonus sizes, coupons, rebates, store signs and promotional packs
are incorporated into customers' programs. Because the retailer profit margin
for store brand products is generally higher than for national brand products,
retailers and wholesalers often commit funds for additional promotions. The
Company's marketing efforts are also directed at new product introductions and
conversions and providing market research data. Market analysis and research is
used to monitor trends for products and categories and develop category
management recommendations.
Wal-Mart accounted for 28% of net sales for fiscal 2004, 27% for fiscal 2003 and
25% for fiscal 2002. Should Wal-Mart's current relationship with the Company
change adversely, the resulting loss of business would have a material adverse
impact on the Company's consolidated operating results and financial position.
Such a change is not anticipated in the foreseeable future. No other customer
individually accounted for more than 10% of net sales.
MANUFACTURING AND DISTRIBUTION
The Company has manufacturing facilities located in the United States, the
United Kingdom and Mexico at June 26, 2004. The Company supplements its
production capabilities with the purchase of product from outside sources and
will continue to do so in the future. During fiscal 2004, the average capacity
utilization was 60% for OTC pharmaceuticals and 65% for nutritional facilities.
The capacity of these facilities may be fully utilized at certain times due to
the seasonal nature of the consumer healthcare business. The Company may elect
to utilize available capacity by contract manufacturing for national brand
companies.
The Company's manufacturing operations are designed to allow low cost production
of a wide variety of products of different quantities, sizes and packaging while
maintaining a high level of customer service and quality. Flexible production
line changeover capabilities and fast cycle times
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allow the Company to respond quickly to changes in manufacturing schedules.
The Company has logistics facilities located in the United States, the United
Kingdom and Mexico. Both contract freight and common carriers are used to
deliver products.
COMPETITION
The market for store brand OTC pharmaceutical and nutritional products is highly
competitive. Competition is based primarily on price, quality and assortment of
products, customer service, marketing support and availability of new products.
The Company believes it competes favorably in all of these areas.
The Company is the largest manufacturer of store brand OTC pharmaceutical
products in the United States. The Company's direct competition in store brand
products consists primarily of independent, privately owned companies and is
highly fragmented in terms of both geographic market coverage and product
categories. Additionally, competition is growing from generic prescription drug
manufacturers in the Rx to OTC switch products market. The Company competes in
the nutritional area with a number of public and private companies, some of
which have broader product lines and larger sales volumes.
The Company's products also compete with nationally advertised brand name
products. Most of the national brand companies have resources substantially
greater than those of the Company. National brand companies could in the future
seek to compete more directly in the store brand market by manufacturing store
brand products or by lowering prices of national brand products. The Company
believes that the manufacturing methods and business approach used by national
brand companies are not easily adapted to the requirements of the store brand
market. These requirements include the ability to produce many different package
designs and product sizes. In addition, the marketing focus of national brand
companies is directed towards the consumer rather than toward the retailer.
MATERIALS SOURCING
Raw materials and packaging supplies are generally available from multiple
suppliers. Certain components and finished goods are purchased rather than
manufactured because of temporary production limitations, FDA restrictions or
economic and other factors. In the past, supplies of certain raw materials, bulk
tablets and components were limited, or were available from one or only a few
suppliers. Historically, the Company has been able to react to situations that
require alternate sourcing. Should alternate sourcing be required, the nature of
the FDA restrictions placed on products approved through the ANDA or NDA process
could substantially lengthen the approval process for an alternate source and
adversely affect financial results. The Company has good, cooperative working
relationships with substantially all of its suppliers and has historically been
able to capitalize on economies of scale in the purchase of materials and
supplies due to its volume of purchases.
In December 2002, a supplier of tablet/caplet gelatin coating processing
confirmed its intention to discontinue selling its services to the Company as of
March 31, 2003. Sales related to these products have decreased $12,000 in fiscal
2004 compared to fiscal 2003. No further reduction in future sales is expected.
The Company has arranged alternative coating sources to service customer
requirements. In May 2004, the Company's former supplier filed a patent
infringement suit against the Company relating to its replacement products. The
Company does not expect the outcome of this suit to have a material adverse
effect on its operations or financial results.
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TRADEMARKS AND PATENTS
The Company owns certain trademarks and patents; however, its business as a
whole is not materially dependent upon its ownership of any one trademark or
patent, or group of trademarks or patents.
SEASONALITY
The Company's sales of OTC pharmaceutical and nutritional products are subject
to the seasonal demands for the cough/cold/flu and allergy products in the
second and third quarters. The second quarter of fiscal 2004 saw higher sales
for these products reflecting the earlier than usual peak of the cough/cold/flu
season in the U.S. market. However, sales for the entire season were relatively
unchanged from the prior year. Historically, the Company's sales of
cough/cold/flu products have varied from year to year based in large part on the
severity and length of the cough/cold/flu season. While the Company believes
that the severity and length of the cough/cold/flu season will continue to
impact its sales of cough/cold/flu products, there can be no assurance that the
Company's future sales of those products will necessarily follow historical
patterns.
PRODUCT LIABILITY
Over the last ten years the aggregate amount paid in settlement of liability
claims has not been material, and the Company is unaware of any suits that would
exceed its insurance limits. The Company believes that, currently, its product
liability coverage is adequate to cover anticipated lawsuits.
In November 2000, at the request of the FDA, the Company voluntarily withdrew
from the U.S. market its products containing Phenylpropanolamine (PPA), an
ingredient used in the manufacture of certain OTC cough/cold and diet products.
Numerous individual PPA-related lawsuits have been filed alleging that the
plaintiffs suffered injury, generally some type of stroke, from ingesting the
Company's PPA-containing products. At this time, the outcome of these suits is
not determinable. See "Item 3. Legal Proceedings" and "Additional Item.
Cautionary Note Regarding Forward-Looking Statements - Exposure to Product
Liability Claims."
ENVIRONMENTAL
The Company is subject to various federal, state and local environmental laws
and regulations. The Company believes that the costs for complying with such
laws and regulations will not be material to the business of the Company. The
Company does not have any material remediation liabilities outstanding.
GOVERNMENT REGULATION
The manufacturing, processing, formulation, packaging, labeling, testing,
storing, distributing, advertising and sale of the Company's products are
subject to regulation by one or more United States agencies, including the FDA,
the FTC, the Drug Enforcement Administration (DEA) and the Consumer Product
Safety Commission (CPSC), as well as by foreign agencies. Various agencies of
the states and localities in which the Company's products are sold also regulate
these activities. In addition, the Company manufactures and markets certain of
its products in accordance with the guidelines designated by voluntary standard
setting organizations, such as the United States Pharmacopoeia Convention, Inc.
(USP) and NSF International (NSF). The Company believes that its policies,
operations and products comply in all material respects with existing
regulations.
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Food and Drug Administration
The FDA has jurisdiction over the Company's (1) marketing of ANDA, NDA, and OTC
monograph drug products and (2) marketing of dietary supplements, which are
regulated as foods. The FDA's jurisdiction extends to the manufacturing,
testing, labeling, packaging, and distribution of these products.
OTC Pharmaceuticals. The majority of the Company's OTC pharmaceuticals are
regulated under the OTC Monograph System and subject to certain FDA regulations.
Under the OTC Monograph System, selected OTC drugs are generally recognized as
safe and effective and do not require the submission and approval of an NDA or
ANDA prior to marketing. The FDA OTC Monograph System includes well-known
ingredients and specifies requirements for permitted indications, required
warnings and precautions, allowable combinations of ingredients and dosage
levels. Drug products marketed under the OTC Monograph System must conform to
specific quality and labeling requirements; however, these products generally
can be developed with fewer regulatory hurdles than those products that require
the filing of an NDA or ANDA. It is, in general, less costly to develop and
bring to market a product produced under the OTC Monograph System. From time to
time, adequate information may become available to the FDA regarding certain
drug products that will allow the reclassification of those products as
generally recognized as safe and effective and not misbranded and, therefore, no
longer requiring the approval of an NDA or ANDA prior to marketing. For this
reason, there may be increased competition and lower profitability related to a
particular product should it be reclassified to the OTC Monograph System. In
addition, regulations may change from time to time, requiring formulation,
packaging or labeling changes for certain products.
The Company also markets products that have switched from prescription to OTC
status. These Rx to OTC switch products require approval by the FDA through its
NDA or ANDA process before they can be commercialized. Based on current FDA
regulations, all chemistry, manufacturing and control issues, bioequivalence and
labeling related to these products are addressed by the information included in
the NDA or ANDA. The ANDA process generally requires less time and expense for
FDA approval compared to the NDA process. For approval of an ANDA, the Company
must demonstrate that the product is essentially the same as a product that has
previously been approved by the FDA and is on the market and that the Company's
manufacturing process and other requirements meet FDA standards. This approval
process may require that bioequivalence and/or efficacy studies be performed
using a small number of subjects in a controlled clinical environment. Approval
time is generally about eighteen months to four years from the date of
submission of the application. Changes to a product marketed under an ANDA or
NDA are governed by specific FDA regulations and guidelines that define when
proposed changes, if approved by the FDA, can be implemented.
Under the Drug Price Competition and Patent Term Restoration Act of 1984 (the
Hatch-Waxman Amendments to the Federal Food, Drug and Cosmetic Act) a company
can obtain a three-year period of marketing exclusivity for an Rx to OTC switch
product if the Company does a clinical study that is essential to FDA approval.
This exclusivity would prevent other companies from obtaining approval of
applications for the switch product. Unless the Company establishes
relationships with the companies having exclusive marketing rights, or the
Company conducts its own clinical trials, the Company's ability to market Rx to
OTC switch products and offer its customers products comparable to the national
brand products would be delayed until the expiration of the three-year
exclusivity granted to the company initiating the switch. There can be no
assurance that, in the event that the Company applies for FDA approvals, the
Company will obtain the approvals to market Rx to OTC switch products or,
alternatively, that the Company will be able to obtain these products from other
manufacturers.
Under the FDA Modernization Act of 1997, a manufacturer may obtain an additional
six months
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(which, under certain circumstances, may be extended to one year) of exclusivity
if the innovator conducts pediatric studies on the product. This exclusivity
will, in certain instances, delay sales by the Company of certain products.
If the Company is first to file its ANDA and meets certain requirements, the
Company may be entitled to a 180-day exclusivity for that product. When a
company submits an ANDA, the company is required to include a patent
certification to certain patents that cover the innovator product. If the ANDA
applicant challenges the validity of the innovator's patent or certifies that
its product does not infringe the patent, the product innovator may sue for
infringement. The legal action would not result in material damages but could
result in the Company being prevented from introducing the product if it is not
successful in the legal action. The Company would, however, incur the cost of
defending the legal action, and that action would have the effect of triggering
a statutorily mandated delay in FDA approval of the ANDA for a period of up to
30 months.
If the Company is not first to file its ANDA, the FDA may grant 180-day
exclusivity to another company, thereby effectively delaying the launch of the
Company's product. In addition, if exclusivity is granted to the Company, there
can be no assurance that the beginning of the exclusivity period will coincide
with the ability of the Company to market the product. The Company may forfeit
its exclusivity as the result of events that are outside of the Company's
control.
All facilities where NDA, ANDA, and OTC drugs are manufactured, tested, packed,
warehoused or distributed must comply with FDA cGMPs. All of the Company's NDA,
ANDA, and OTC drug products are manufactured, tested, packaged, stored and
distributed according to cGMP regulations. The FDA performs periodic audits to
ensure that the Company's facilities remain in compliance with all appropriate
regulations. The failure of a facility to be in compliance may lead to a breach
of representations made to private label customers or to regulatory action
against the products made in that facility, including seizure, injunction or
recall.
The Company is also subject to the requirements of the Comprehensive
Methamphetamine Control Act of 1996, a law designed to allow the DEA to monitor
transactions involving chemicals that may be used illegally in the production of
methamphetamine. The Comprehensive Methamphetamine Control Act of 1996
establishes certain registration and recordkeeping requirements for
manufacturers of OTC cold, allergy, asthma and diet medicines that contain
ephedrine, pseudoephedrine or PPA. While certain of the Company's OTC drug
products contain pseudoephedrine, the Company's U.S. products contain neither
ephedrine, a chemical compound that is distinct from pseudoephedrine, nor PPA.
Pseudoephedrine is a common ingredient in decongestant products manufactured by
the Company and other pharmaceutical companies. The Company believes that its
products are in compliance with all applicable DEA requirements.
Dietary Supplements. The Dietary Supplement Health and Education Act of 1994
(DSHEA) was enacted on October 25, 1994 and amended the Federal Food, Drug, and
Cosmetic Act to, among other things: (1) define dietary supplements and dietary
ingredients, (2) require ingredient and nutrition labeling, (3) permit
"structure/function" statements for dietary supplements and (4) permit the
display of certain published literature where supplements are sold. Although
dietary supplements are regulated as foods, the FDA is prohibited from
regulating the dietary ingredients in supplements as food additives. In
addition, the FDA is generally prohibited from regulating dietary supplements as
drugs unless the supplements bear drug or disease claims.
DSHEA provides for specific nutritional labeling requirements for dietary
supplements that are slightly different than those for conventional foods. All
supplements must bear a "Supplement Facts" box, which must list all of the
supplement's dietary ingredients using nomenclature as specified in FDA
regulations. DSHEA also permits dietary supplements to bear statements (1)
claiming a benefit related to a classical nutrient deficiency disease, provided
the prevalence of the
-10-
disease in the United States is disclosed, (2) describing the role of a nutrient
or dietary ingredient intended to affect the structure or function in humans,
(3) characterizing the documented mechanism by which a nutrient or dietary
ingredient acts to maintain such structure or function and (4) describing
general well-being from consumption of a nutrient or dietary ingredient.
On January 6, 2000, the FDA published a Final Rule clarifying the types of
statements permissible in dietary supplement labeling. The statements cannot
state expressly or implicitly that a dietary supplement has any effect on a
"disease," which the FDA defines in the Final Rule. However, dietary supplements
may bear certain statements from several OTC drug monographs (e.g., relief of
occasional sleeplessness).
Another type of claim that may be permitted by the FDA in dietary supplement
labeling is a "health claim," which characterizes the role of a nutrient to a
disease or health-related condition. There are three types of health claims: (1)
health claims authorized by FDA regulations based on significant scientific
agreement among experts qualified by scientific training and experience to
evaluate such claims (2) health claims based on an authoritative statement of a
scientific body of the United States Government or National Academy of Sciences
and not objected to by the FDA and (3) "qualified health claims," which are a
result of litigation and which may be made with a lower level of substantiation,
provided that the FDA does not object to the claims.
Structure/function claims, health claims, and qualified health claims give
industry more latitude in marketing dietary supplements and provide information
to consumers about the use and benefits of dietary supplements.
The FDA has proposed regulations for cGMP requirements for dietary supplements.
Although the Company cannot predict the specific content of the final cGMPs or
the timing of issuance, it believes the changes will have minimal impact on its
business. Until the final dietary supplement cGMPs are in place, the Company is
following the FDA food cGMPs for its supplement products. In addition, as
explained below, the Company also follows the NSF Good Manufacturing Practices
Dietary Supplement Program.
The Company cannot determine what effect the FDA future regulations will have on
its business. Future regulations could, among other things, require expanded
documentation of the properties of certain products or scientific substantiation
regarding ingredients, product claims or safety. In addition, the Company cannot
predict whether new legislation regulating the Company's activities will be
enacted or what effect any legislation would have on the Company's business.
Consumer Product Safety Commission
The CPSC has authority, under the Poison Prevention Packaging Act, to designate
those products, including vitamin products and OTC pharmaceuticals, that require
child resistant closures to help reduce the incidence of accidental poisonings.
The CPSC has adopted regulations requiring numerous OTC pharmaceuticals and
iron-containing dietary supplements to have these closures and has adopted rules
regarding the testing of these closures by both children and adults. The
Company, working with its packaging suppliers, believes that it is in compliance
with all CPSC requirements.
Federal Trade Commission
The FTC exercises primary jurisdiction over the advertising and other
promotional practices of marketers of dietary supplements and OTC
pharmaceuticals and often works with the FDA regarding these practices. The FTC
considers whether a product's claims are substantiated, truthful and not
misleading.
-11-
The FTC is investigating a 1998 agreement between Alpharma, Inc. and the Company
related to a children's ibuprofen suspension product. The agreement is no longer
in effect. The Company is currently negotiating with the FTC to close this
investigation. Because of the likelihood that the Company will enter into a
settlement agreement with the FTC, the Company has recorded a $4,750 charge in
the fourth quarter of fiscal 2004 which is expected to resolve all claims by the
FTC and state governments. The Company continues to cooperate with the FTC to
finalize the settlement agreement; however, the inquiry could result in the
Company being involved in further proceedings with the FTC, state attorneys
general or private litigants.
State Regulation
All states regulate foods and drugs under laws that generally parallel federal
statutes. The Company is also subject to other state consumer health and safety
regulations, such as California Proposition 65 and Oklahoma House Bill 2176,
that could have a potential impact on the Company's business if the Company is
ever found not to be in compliance. The Company is not engaged in any material
state governmental enforcement or other regulatory actions and is not aware of
material non-compliance with state regulations.
United States Pharmacopoeial Convention
The USP is a non-governmental, voluntary standard-setting organization. Its drug
monographs and standards are incorporated by reference into the Federal Food,
Drug, and Cosmetic Act as the standards that must be met for the listed drugs,
unless compliance with those standards is specifically disclaimed. USP standards
exist for most OTC pharmaceuticals. The FDA typically requires USP compliance as
part of cGMP compliance.
NSF International
NSF is an independent, not-for-profit, non-governmental organization providing
risk management services in public health and safety. Its services include
standards development, product certification, safety audits, management systems
registration and education programs. NSF is accredited by the American National
Standards Institute, the Occupational Safety and Health Administration and the
Standard Council of Canada. These accreditations attest to the competency of
services provided by NSF and compliance with established national and
international standards for third-party certification.
The NSF Good Manufacturing Practices Dietary Supplement Program enables
manufacturers to become independently registered by NSF as conforming to
guidelines that provide a system of processes, procedures and documentation to
assure the product produced has the strength, composition, quality and purity
represented on the product label. The Company's nutritional facility has earned
NSF registration.
Foreign Regulation
The Company manufactures, packages and distributes OTC pharmaceuticals and
nutritional products in the United Kingdom and provides contract manufacturing
and packaging services for major pharmaceutical and healthcare companies in the
United Kingdom. The manufacturing, processing, formulation, packaging, testing,
labeling, advertising and sale of these products are subject to regulation by
one or more United Kingdom agencies, including the Medicines and Healthcare
Products Regulatory Agency, the Department of Health, the Department of the
Environment, Her Majesty's Customs and Excise, the Department of Trade and
Industry, the Health and Safety Executive and the Department of Transport.
-12-
The Company manufactures, packages and distributes Rx pharmaceutical, OTC
pharmaceutical and nutritional products in Mexico. The manufacturing,
processing, formulation, packaging, labeling, testing, advertising and sale of
these products are subject to regulation by one or more Mexican agencies,
including the Health Ministry, the Commercial and Industrial Secretariat, the
Federal Work's Secretariat, the Environmental Natural Resources and Fishing
Secretariat, the Federal Environmental Protection Ministry and the Treasury and
Public Credit Secretariat and its Customs Government department.
The Company exports OTC pharmaceutical and nutritional products to foreign
countries. Government regulations for exporting these products are covered by
the United States FDA, and where appropriate, DEA law, as well as each
individual country's requirement for importation of such products. Each country
requires approval of these products through a registration process by that
country's regulatory agencies. These registrations govern the process, formula,
packaging, testing, labeling, advertising and sale of the Company's products and
regulate what is required and what may be represented to the public on labeling
and promotional material. Approval for the sale of the Company's products by
foreign regulatory agencies may be subject to delays.
EMPLOYEES
As of June 26, 2004, the Company had 2,710 full-time and temporary employees in
the United States. The Company has not been a party to a collective bargaining
agreement in the United States. The Company had 679 employees in the United
Kingdom, none of whom are covered by a collective bargaining agreement. The
Company had 502 employees in Mexico, of whom 282 are covered by a collective
bargaining agreement. Management considers its relations with its employees to
be good.
Item 2. Properties.
As of June 26, 2004, the Company owned or leased the following primary
facilities, classified by segment: No. of Approx. Square Footage Location
Facilities Owned Leased
No. of Approx. Square Footage
Location Facilities Owned Leased
-------- ---------- ----- ------
Consumer Healthcare Michigan 13 2,000,000 -
South Carolina 3 200,000 160,000
UK Operations Braunton, United Kingdom 1 230,000 -
Swadlincote, United Kingdom 1 - 110,000
Mexico Operations Ramos Arizpe, Mexico 2 110,000 30,000
All of the facilities above provide manufacturing, logistics and offices to
support the respective business segment. The Company leases other minor
properties for logistics and offices in the United States and Mexico. The
Company considers all of its properties to be well-maintained and suitable for
the intended purpose of the facility.
Item 3. Legal Proceedings. (Dollar amounts in thousands)
The Company is not a party to any litigation, other than routine litigation
incidental to its business except for the litigation described below. The
Company believes that none of the routine litigation, individually or in the
aggregate, will be material to the business of the Company.
-13-
The FTC is investigating a 1998 agreement between Alpharma, Inc. and the Company
related to a children's ibuprofen suspension product. The agreement is no longer
in effect. The Company is currently negotiating with the FTC to close this
investigation. Because of the likelihood that the Company will enter into a
settlement agreement with the FTC, the Company has recorded a $4,750 charge in
the fourth quarter of fiscal 2004 which is expected to resolve all claims by the
FTC and state governments. The Company continues to cooperate with the FTC to
finalize the settlement agreement; however, the inquiry could result in the
Company being involved in further proceedings with the FTC, state attorneys
general or private litigants.
The Company is currently defending numerous individual lawsuits pending in
various state and federal courts involving PPA, an ingredient used in the
manufacture of certain OTC cough/cold and diet products. The Company
discontinued using PPA in the United States in November 2000 at the request of
the FDA. These cases allege that the plaintiff suffered injury, generally some
type of stroke, from ingesting PPA-containing products. Many of these suits also
name other manufacturers or retailers of PPA-containing products. These personal
injury suits seek an unspecified amount of compensatory, exemplary and statutory
damages. The Company maintains product liability insurance coverage for the
claims asserted in these lawsuits. The Company believes that it has meritorious
defenses to these lawsuits and intends to vigorously defend them. At this time,
the Company cannot determine whether it will be named in additional PPA-related
suits, the outcome of existing suits or the effect that PPA-related suits may
have on its financial condition or operating results.
In August 1999, the Company filed a civil antitrust lawsuit in the United States
District Court for the Western District of Michigan against a group of vitamin
raw material suppliers alleging the defendants conspired to fix the prices of
vitamin raw materials sold to the Company. The relief sought included money
damages and a permanent injunction enjoining defendants from future violation of
antitrust laws. The Company has entered into settlement agreements with all of
the defendants. The Company received settlement payments of $3,128 and $27,891
in fiscal 2003 and 2002, respectively. The payments were net of attorney fees
and expenses that were withheld prior to the disbursement of the funds to the
Company. The Company will not receive any additional income related to this
lawsuit.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to the vote of security holders during the fourth
quarter of fiscal 2004.
Additional Item. Executive Officers of the Registrant.
The executive officers of the Company and their ages and positions as of July
26, 2004 were:
Name Age Position
---- --- --------
F. Folsom Bell 62 Executive Vice President, Business Development
David T. Gibbons 60 Chairman of the Board, President and Chief Executive Officer
John T. Hendrickson 41 Executive Vice President and General Manager, Perrigo Consumer
Healthcare
Todd W. Kingma 44 Vice President and General Counsel
Mark P. Olesnavage 51 Executive Vice President and General Manager, Perrigo
Pharmaceuticals
Douglas R. Schrank 56 Executive Vice President and Chief Financial Officer
Mr. Bell was named Executive Vice President, Business Development, in September
2000. From
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January 2000 until that time, Mr. Bell acted as a consultant to the Company. Mr.
Bell was a member of the Board of Directors from January 1981 through February
1986, when he voluntarily resigned. Mr. Bell was re-elected in June 1988 and
voluntarily resigned in January 2003. He was the Chairman, President and Chief
Executive Officer of Thermo-Serv, Inc. from July 1989 to September 1999.
Mr. Gibbons was elected Chairman of the Board in August 2003. He was elected
President and Chief Executive Officer in May 2000 and a director of the Company
in June 2000. Previously, Mr. Gibbons served as President of Rubbermaid Europe
from 1997 to 1999 and President of Rubbermaid Home Products from 1995 to 1997.
Prior to joining Rubbermaid, he served in various management, sales and
marketing capacities with 3M Company from 1968 to 1995.
Mr. Hendrickson was named Executive Vice President and General Manager, Perrigo
Consumer Healthcare in August 2003. He served as Executive Vice President of
Operations from October 1999 to August 2003, Vice President of Operations from
October 1997 to October 1999 and Vice President of Customer Service from October
1996 to October 1997. Previously, he had been Director of Engineering of the
Company since 1993 and served in various positions in process engineering from
1989 to 1992. Prior to 1989, Mr. Hendrickson was in research management for five
years at Procter & Gamble Company. He is a member of the Board of Directors of
the Consumer Healthcare Products Association.
Mr. Kingma was named Vice President and General Counsel in August 2003. He was
at Pharmacia, now Pfizer, Inc., from 1991 to 2003 in a variety of legal
assignments, most recently as Vice President and Associate General Counsel.
Before joining Pharmacia, he was an attorney with Dykema Gossett.
Mr. Olesnavage was named Executive Vice President and General Manager, Perrigo
Pharmaceuticals in August 2003. He served as Executive Vice President Sales,
Marketing and Scientific Affairs from August 2000 to August 2003 and President
of Customer Business Development from June 1995 to August 2000. He served as
President of the OTC pharmaceutical operations from February 1994 to June 1995.
He served as Vice President of Pharmaceutical Business Development from July
1992 to January 1993 and Vice President-Marketing from June 1987 to July 1992.
Previously he had been Director of Marketing of the Company since 1981. He is a
member of the Board of Directors of the Generic Pharmaceutical Industry
Association.
Mr. Schrank was named Executive Vice President and Chief Financial Officer in
January 2000. Mr. Schrank was President of M. A. Hanna Company's Hanna Color
subsidiary from 1998 to 1999, Senior Vice President of the Plastics Division
from 1995 to 1998 and Vice President and Chief Financial Officer from 1993 to
1995. From 1977 to 1993, Mr. Schrank served in senior level financial,
administrative and sales positions at Sealy Corporation, Eyelab, Inc. and The
Pillsbury Company.
-15-
PART II.
(Dollar and share amounts in thousands, except per share amounts)
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters.
The Company's common stock was first quoted and began trading on The Nasdaq
Stock Market(R) on December 17, 1991 under the symbol PRGO.
Set forth below are the high and low prices for the Company's common stock as
reported on The Nasdaq Stock Market(R) for the last eight quarters:
Fiscal 2004: High Low
- ----------- ---- ---
First Quarter $16.74 $12.65
Second Quarter $16.25 $12.32
Third Quarter $20.45 $15.61
Fourth Quarter $24.96 $17.87
Fiscal 2003: High Low
- ----------- ---- ---
First Quarter $13.02 $ 9.25
Second Quarter $13.50 $10.32
Third Quarter $13.31 $10.53
Fourth Quarter $16.49 $11.67
The number of record holders of the Company's common stock as of July 26, 2004
was 1,437.
In January 2003, the Board of Directors adopted a policy of paying regular
quarterly dividends. The Company paid quarterly dividends of $9,136 and $3,484,
or $0.13 and $0.05 per share, during fiscal 2004 and 2003, respectively. The
declaration and payment of dividends and the amount paid, if any, is subject to
the discretion of the Board of Directors and will depend on the earnings,
financial condition and capital and surplus requirements of the Company and
other factors the Board of Directors may consider relevant. The Company did not
repurchase any shares in the fourth quarter of fiscal 2004.
Item 6. Selected Financial Data.
The following selected consolidated financial data should be read in conjunction
with the consolidated financial statements and the notes to these statements
included in Item 8 of this report. The consolidated statement of income data set
forth below with respect to the fiscal years ended June 26, 2004, June 28, 2003
and June 29, 2002 and the consolidated balance sheet data at June 26, 2004 and
June 28, 2003 are derived from, and are qualified by reference to, the audited
consolidated financial statements included in Item 8 of this report and should
be read in conjunction with those financial statements and notes thereto. The
consolidated statement of income data for the Company set forth below with
respect to the fiscal years ended June 30, 2001 and July 1, 2000 and the
consolidated balance sheet data for the Company at June 29, 2002, June 30, 2001
and July 1, 2000 are derived from audited consolidated financial statements of
the Company not included in this report. The statement of income data reflects
one month of personal care operations for fiscal 2000. All periods presented
have been adjusted for the expensing of stock options. Certain amounts have been
reclassified to conform to the current year presentation.
-16-
Fiscal Year
--------------------------------------------------------------
2004(1) 2003 (1) 2002(1) 2001 2000(2)
------- -------- ------- ---- -------
Statement of Income Data
Net sales (3) $898,204 $834,100 $835,063 $763,085 $753,486
Cost of sales 630,240 596,076 608,622 563,194 591,846
PPA product discontinuation - - - 17,600 -
--------- --------- --------- --------- --------
Gross profit 267,964 238,024 226,441 182,291 161,640
--------- --------- --------- --------- --------
Operating expenses
Distribution 15,154 15,563 16,327 15,148 16,002
Research and development 27,721 23,315 25,689 23,434 22,114
Selling and administration (3) 122,193 117,096 112,723 106,064 93,448
--------- --------- --------- --------- --------
Subtotal 165,068 155,974 154,739 144,646 131,564
--------- --------- --------- --------- --------
Restructuring - - 7,136 2,175 1,048
Goodwill impairment - - 11,524 - -
Unusual litigation - (3,128) (27,891) (995) (4,154)
--------- --------- --------- --------- --------
Total 165,068 152,846 145,508 145,826 128,458
--------- --------- --------- --------- --------
Operating income 102,896 85,178 80,933 36,465 33,182
Interest and other, net (3,087) (1,080) (1,355) (3,748) 4,994
--------- --------- --------- --------- --------
Income before income taxes 105,983 86,258 82,288 40,213 28,188
Income tax expense 25,416 32,210 37,498 15,799 11,363
--------- --------- --------- --------- --------
Net income $ 80,567 $ 54,048 $ 44,790 $ 24,414 $ 16,825
========= ========= ========= ========= ========
Earnings per share
Basic $ 1.15 $ 0.77 $ 0.61 $ 0.33 $ 0.23
Diluted $ 1.11 $ 0.76 $ 0.60 $ 0.33 $ 0.23
Weighted average shares outstanding
Basic 70,206 69,746 73,164 73,646 73,370
Diluted 72,289 71,158 74,606 74,087 73,536
Dividends declared per share $ 0.13 $ 0.05 - - -
June 26, June 28, June 29, June 30, July 1,
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Balance Sheet Data
Cash and investment securities $171,700 $ 93,827 $ 76,824 $ 11,016 $ 7,055
Working capital, excluding cash and
investment securities 114,043 118,828 109,993 133,135 147,963
Property, plant and equipment, net 227,641 218,778 211,044 212,087 193,580
Goodwill 35,919 35,919 35,919 47,195 18,199
Total assets 759,094 643,970 601,375 582,536 493,838
Shareholders' equity 536,232 448,424 418,162 387,367 353,468
- ----------------
(1) See Item 7 for a discussion of results of operations.
(2) Includes a charge of $15,000 for higher than normal obsolescence expenses,
a charge of $7,000 for fixed production costs and settlement proceeds
related to a civil antitrust lawsuit of $4,154.
(3) Net sales were increased by broker commissions that were reclassified to
selling and administration expenses. The amounts reclassified for 2004,
2003, 2002, 2001 and 2000 were $8,121, $8,113, $8,741, $9,597 and $9,202,
respectively. See Note A.
-17-
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
GENERAL
Segments
The Company has realigned its segment reporting with the acquisition of Peter
Black. The Company has four reportable segments: Consumer Healthcare,
Pharmaceuticals, UK Operations and Mexico Operations. Consumer Healthcare
includes the U.S. operations supporting the sale of OTC pharmaceutical and
nutritional products. Pharmaceuticals include the development and eventual sale
of prescription drug products. UK Operations support the sale of OTC
pharmaceutical and nutritional products in the United Kingdom and includes the
newly acquired Peter Black. UK Operations is a supplier of store brand products
to major grocery and pharmacy retailers and a contract manufacturer of OTC
pharmaceutical and nutritional products. Mexico Operations support the sale of
OTC and prescription drug products for retail, wholesale and governmental
customers in Mexico. See Notes A and J of the consolidated financial statements
for additional segment and geographic information.
Products and Customers
The major categories in which the Company markets its products are analgesic,
cough/cold, gastrointestinal and vitamin products. According to Information
Resources, Inc., the annual retail market for food, drug and mass merchandise
retailers in the United States, excluding Wal-Mart, for OTC pharmaceutical and
nutritional products is more than $10 billion. The store brand industry commands
more than 20% of the retail market. The Company estimates its share of the store
brand industry to be more than 50%.
The Company's customers are major national and regional retail drug, supermarket
and mass merchandise chains such as Wal-Mart, CVS, Walgreens, Albertson's,
Kroger, Safeway and Dollar General and major wholesalers such as McKesson and
Supervalu.
Consumer Healthcare -- Drug Application Approvals and New Product Introductions
In fiscal 2004, the Company received approval from the FDA for seven drug
applications. The applications were for the following products: famotidine 10 mg
chewable tablet, two for loratadine tablets 10 mg, ibuprofen chewable tablets 50
mg and 100 mg, ibuprofen-pseudoephedrine oral suspension,
naproxen-pseudoephedrine caplets and miconazole nitrate cream.
The Company launched several new products, most notably loratadine syrup,
loratadine quick-dissolve tablets and children's ibuprofen-pseudoephedrine oral
suspension, comparable to the national brands Claritin(R), Alavert(R) and
Children's Motrin(R) Cold. In addition, the Company launched Dr. Rosenblatt's
Starch Blocker and experienced continued strong sales of loratadine and
pseudoephedrine sulfate 10 mg/240 mg tablets, newly launched in late fiscal
2003, comparable to Claritin-D(R) 24 Hour Extended Release tablets. The revenues
generated in fiscal 2004 from new products were approximately $70,000.
Pharmaceuticals -- Growth Strategy
In fiscal 2003, the Company announced its intent to enter the market for generic
prescription drug products as a focus for future growth complementing its strong
position in the OTC pharmaceutical market. In fiscal 2004, the Company invested
$4,000, primarily in increased research and development costs, for the
development of generic pharmaceutical products. The Company
-18-
currently has several products in development and three ANDAs that have been
filed with the FDA. The Company does not expect the revenues for generic
pharmaceutical products to be material in fiscal 2005.
The Company has reviewed potential acquisition opportunities as a means of
accelerating its entry into this market. The Company purchased an option to
acquire a controlling interest in Lannett Company, Inc., a manufacturer of
generic pharmaceutical products. However, upon further review, the Company
determined that this acquisition would not be in the best long-term interests of
its shareholders and the option has since expired. The Company continues to seek
acquisition opportunities that will further its development of this market and
increase shareholder value.
The Company is building its organizational structure to support its generic
pharmaceutical products business. During fiscal 2004, several key positions have
been filled, including vice presidents for scientific affairs and sales.
Additionally, the Company appointed directors for various functions, including
pharmaceutical operations, pharmaceutical business development and
pharmaceutical contract management.
Seasonality
The Company's sales of OTC pharmaceutical and nutritional products are subject
to the seasonal demands for cough/cold/flu and allergy products in the second
and third quarters. The second quarter of fiscal 2004 saw higher sales for these
products reflecting the earlier than usual peak of the cough/cold/flu season in
the U.S. market. However, sales for the entire season were relatively unchanged
from the prior year. Historically, the Company's sales of cough/cold/flu
products have varied from year to year based in large part on the severity and
length of the cough/cold/flu season. While the Company believes that the
severity and length of the cough/cold/flu season will continue to impact its
sales of cough/cold/flu products, there can be no assurance that the Company's
future sales of those products will necessarily follow historical patterns.
Acquisitions
In December 2003, the Company acquired Peter Black for $12,061 in cash, plus
contingent consideration that is not expected to be material. Peter Black,
located in the United Kingdom, is the largest manufacturer of store brand
vitamin and nutritional supplement products for grocery stores, pharmacies and
contract customers in the United Kingdom. The assets and liabilities, which are
not considered significant to the Company, were added to the Company's
consolidated balance sheet beginning December 27, 2003. No goodwill was recorded
as a result of the acquisition. Results of operations are included beginning in
the third quarter of fiscal 2004.
Subsequent to year-end, the Company entered into a purchase agreement for $5,000
to acquire certain assets from a manufacturer of foot care products. The
transaction is expected to close in the first quarter of fiscal 2005.
Quarterly Cash Dividend
The Company paid quarterly dividends of $9,136, or $0.13 per share, during
fiscal 2004. The declaration and payment of dividends and the amount paid, if
any, is subject to the discretion of the Board of Directors and will depend on
the earnings, financial condition and capital and surplus requirements of the
Company and other factors the Board of Directors may consider relevant.
In the second quarter of fiscal 2004, the Board of Directors increased the
dividend from $0.025 per share to $0.035 per share, an increase of 40%, and
continued the higher dividend rate throughout the remainder of fiscal 2004.
-19-
Tax Examination
In January 2004, the Company was notified by the Internal Revenue Service that
it had concluded the routine Federal tax examination of tax years 1998, 1999 and
2000. As a result, the Company recorded a one-time income tax benefit of $13,100
in the second quarter of fiscal 2004, reducing its income tax accrual associated
with these audits. The Company believes it has appropriately accrued for
probable Federal income tax exposures subsequent to 2000.
Broker Commissions
The Company uses industry brokers as a method of servicing certain of its
customers. While, historically, the broker commissions have been reported as a
reduction in net sales, management believes these expenses are more
appropriately classified as sales and administration expense. Consequently,
broker commissions were reclassified from net sales to sales and administration
expense for all periods presented. Broker commissions reclassified for fiscal
years 2004, 2003 and 2002 were $8,121, $8,113 and $8,741, respectively. This
reclassification affects only Consumer Healthcare.
FTC Investigation
The FTC is investigating a 1998 agreement between Alpharma, Inc. and the Company
related to a children's ibuprofen suspension product. The agreement is no longer
in effect. The Company is currently negotiating with the FTC to close this
investigation. Because of the likelihood that the Company will enter into a
settlement agreement with the FTC, the Company has recorded a $4,750 charge in
the fourth quarter of fiscal 2004 which is expected to resolve all claims by the
FTC and state governments. The Company continues to cooperate with the FTC to
finalize the settlement agreement; however, the inquiry could result in the
Company being involved in further proceedings with the FTC, state attorneys
general or private litigants.
RESULTS OF OPERATIONS
The following table sets forth, for fiscal 2004, 2003 and 2002, certain items
from the Company's consolidated statements of income expressed as a percent to
net sales:
Fiscal Year
------------------------------------------
2004 2003 2002
------- ------ --------
Net sales 100.0% 100.0% 100.0%
Cost of sales 70.2 71.5 72.9
------- ------ -------
Gross profit 29.8 28.5 27.1
------- ------ -------
Operating expenses
Distribution 1.7 1.9 2.0
Research and development 3.1 2.8 3.1
Selling and administration 13.6 13.9 13.4
------- ------ -------
Subtotal 18.4 18.6 18.5
------- ------ -------
Restructuring - - 0.9
Goodwill impairment - - 1.4
Unusual litigation - (0.4) (3.4)
------- ------ -------
Total 18.4 18.2 17.4
------- ------ -------
Operating income 11.4 10.3 9.7
Interest and other, net (0.3) (0.1) (0.2)
------- ------ -------
Income before income taxes 11.7 10.4 9.9
Income tax expense 2.8 3.9 4.5
------- ------ -------
Net income 8.9% 6.5% 5.4%
======= ====== =======
-20-
CONSUMER HEALTHCARE
Year-to-Date
---------------------------------------
2004 2003 2002
-------- -------- --------
Net sales $800,619 $757,035 $770,187
Gross profit $251,570 $220,173 $208,348
Gross profit % 31.4% 29.1% 27.1%
Operating expenses $144,003 $139,268 $113,488
Operating expenses % 18.0% 18.4% 14.7%
Operating income $107,567 $ 80,905 $ 94,860
Operating income % 13.4% 10.7% 12.3%
Net Sales
Fiscal 2004 net sales increased 6% or $43,584 compared to fiscal 2003. Net sales
increased approximately $59,000 due to sales of significant new products
containing loratadine and a starch blocker as well as higher unit sales of
analgesic products. The increase was offset by lower unit sales of existing
vitamin products, antacid products and products related to tablet/caplet gelatin
coating processing.
In December 2002, a supplier of tablet/caplet gelatin coating processing
confirmed its intention to discontinue selling its services to the Company as of
March 31, 2003. Sales related to these products have decreased $12,000 in fiscal
2004 compared to fiscal 2003. No further reduction in future sales is expected.
The Company has arranged alternative coating sources to service customer
requirements. In May 2004, the Company's former supplier filed a patent
infringement suit against the Company relating to its replacement products. The
Company does not expect the outcome of this suit to have a material adverse
effect on its operations or financial results.
Fiscal 2003 net sales decreased 2% or $13,152 compared to fiscal 2002. Net sales
decreased $31,000 primarily due to lower unit sales of analgesic, antacid,
laxative, vitamin and contract manufactured products, partially offset by sales
from the launch of loratadine and pseudoephedrine sulfate extended release
tablets. In product categories where sales declined, the decline was a result of
discontinuing lower margin products at certain customers and exiting sales of
low volume products. The overall volume shortfall was partially offset by a
favorable mix of products sold and improved net realized pricing.
Gross Profit
Fiscal 2004 gross profit increased 14% or $31,397 compared to fiscal 2003,
primarily due to increased sales volume from new products, more efficient
operations and lower inventory obsolescence expenses. The increase in gross
profit percent was primarily due to improved operating efficiencies resulting
from the Company's decision to increase production and inventory levels in the
fourth quarter of fiscal 2004 in anticipation of the fiscal 2005 cough/cold/flu
season. Approximately one-quarter of the gross profit percent increase was due
to lower inventory obsolescence expenses.
Fiscal 2003 gross profit increased 6% or $11,825 compared to fiscal 2002.
Approximately two-thirds of the gross profit percentage increase was due to
improved operating efficiencies. The remaining gross profit percentage increase
was primarily due to a favorable mix of products sold and improved net realized
pricing.
-21-
Operating Expenses
Fiscal 2004 operating expenses increased 3% or $4,735 compared to fiscal 2003.
Selling and administration expenses increased by $1,650, primarily due to higher
costs related to wages, benefits, insurance and the FTC settlement agreement
partially offset by a reduction in bad debt expense and the settlement of a
large customer's 2002 bankruptcy. Operating expenses were favorably impacted by
unusual litigation income of $3,128 in the first quarter of fiscal year 2003.
Fiscal 2003 operating expenses increased 23% or $25,780 compared to fiscal 2002.
Research and development decreased $2,587 due to the timing of projects. Selling
and administration increased $6,554 primarily due to insurance costs and
employee benefit expenses, partially offset by lower bad debt expense. Fiscal
2002 operating expenses were favorably impacted by $27,891 of unusual litigation
income. The lawsuit that gave rise to this income has been settled with all
defendants and no additional income will be received. Fiscal 2002 operating
expenses were unfavorably impacted by bad debt expense related to the bankruptcy
of a large customer and a restructuring charge related to the sale of the
logistics facility.
PHARMACEUTICALS
Fiscal 2004 operating expenses were $4,961. Approximately 75% of the expenses
were related to costs for the development of prescription drug products and the
remaining expenses were related to administration.
UK OPERATIONS
Year-to-Date
-----------------------------------------
2004 2003 2002
-------- -------- --------
Net sales $72,740 $46,537 $34,900
Gross profit $ 8,698 $ 6,854 $ 6,614
Gross profit % 12.0% 14.7% 19.0%
Operating expenses $ 8,643 $ 4,608 $ 3,728
Operating expenses % 11.9% 9.9% 10.7%
Operating income $ 55 $ 2,246 $ 2,886
Operating income % 0.1% 4.8% 8.3%
Net Sales
Fiscal 2004 net sales increased 56% or $26,203 compared to fiscal 2003. The
increase was primarily due to sales of nutritional products of approximately
$16,000 related to the acquisition of Peter Black. Two-thirds of the remaining
increase was due to exchange rate fluctuations. The balance of the increase was
due to higher sales volumes of OTC and contract products.
Fiscal 2003 net sales increased 33% or $11,637 during fiscal 2002. Approximately
two-thirds of the increase in sales was due to higher volume at Wrafton. The
remaining increase was due to exchange rate fluctuations.
Gross Profit
Fiscal 2004 gross profit increased by 27% or $1,844 compared to fiscal 2003
primarily due to the acquisition of Peter Black and exchange rate fluctuations.
The gross profit percent decreased primarily because the mix of products sold
included more sales of nutrition products which contribute lower gross margins
than OTC products.
-22-
Fiscal 2003 gross profit increased by 4% or $240 compared to fiscal 2002. Gross
profit percent decreased primarily because the mix of products sold included
more sales of contract products which contribute lower gross margins than OTC
products.
Operating Expenses
Fiscal 2004 operating expenses increased by 88% or $4,035 compared to fiscal
2003 primarily due to the acquisition and integration of Peter Black and
exchange rate fluctuations. Approximately one-quarter of the increase was due to
exchange rate fluctuations.
Fiscal 2003 operating expenses increased 24% or $880 compared to fiscal 2002
primarily due to exchange rate fluctuations.
MEXICO OPERATIONS
Year-to-Date
----------------------------------------
2004 2003 2002
-------- -------- --------
Net sales $24,845 $30,528 $ 29,976
Gross profit $ 7,696 $10,997 $ 11,479
Gross profit % 31.0% 36.0% 38.3%
Operating expenses $ 7,461 $ 8,970 $ 28,292
Operating expenses % 30.0% 29.4% 94.4%
Operating income (loss) $ 235 $ 2,027 $(16,813)
Operating income (loss) % 0.9% 6.6% (56.1)%
Net Sales
Fiscal 2004 net sales decreased 19% or $5,683 compared to fiscal 2003, primarily
due to lower volume of government contract sales and distributor sales partially
offset by store brand sales. Approximately 30% of the decrease was due to
exchange rate fluctuations.
Fiscal 2003 net sales increased 2% or $552 compared to fiscal 2002.
Gross Profit
Fiscal 2004 gross profit decreased 30% or $3,301 compared to fiscal 2003. The
decrease in gross profit was primarily related to lower volume of products sold.
Approximately 20% of the decrease was related to exchange rate fluctuations.
Fiscal 2003 gross profit decreased 4% or $482 compared to fiscal 2002 due
primarily to changes implemented as a result of the restructuring plan.
Operating Expenses
Fiscal 2004 operating expenses decreased 17% or $1,509 compared to fiscal 2003,
primarily due to lower selling expenses as a result of a change from direct
selling to the use of independent distributors partially offset by an increase
in bad debt expense related to a large retail distributor.
Fiscal 2003 operating expenses decreased 68% or $19,322 compared to fiscal 2002.
Fiscal 2002 was unfavorably impacted by the restructuring at Quifa that resulted
in a goodwill impairment charge
-23-
of $11,524 and restructuring charges of $5,090. The additional decline in
operating expenses was primarily due to reduced expenses from the changes
implemented at Quifa as a result of the restructuring plan.
INTEREST AND OTHER (CONSOLIDATED)
Fiscal 2004 interest income was $1,018 compared to interest expense of $861 for
fiscal 2003. Interest income in 2004 compared to 2003 increased due to higher
levels of invested cash in fiscal 2004. Other income was $2,069 for fiscal 2004
compared to $1,941 for fiscal 2003.
Fiscal 2003 interest expense was $861 compared to $934 for fiscal 2002. Other
income was $1,941 for fiscal 2003 compared to $2,289 for fiscal 2002.
INCOME TAXES (CONSOLIDATED)
The effective tax rate was 24.0%, 37.3% and 45.6% for fiscal 2004, 2003 and
2002, respectively.
In January 2004, the Company was notified by the Internal Revenue Service that
it had concluded the routine Federal tax examination of tax years 1998, 1999 and
2000. As a result, the Company recorded a one-time income tax benefit of $13,100
in the second quarter of fiscal 2004, reducing its income tax accrual associated
with these audits. The Company believes it has appropriately accrued for
probable Federal income tax exposures subsequent to 2000.
The high effective tax rate for fiscal 2002 was primarily due to nondeductible
expenses related to goodwill impairment and restructuring costs at Quifa.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash and investment securities increased $77,873 to $171,700 at June 26, 2004
from $93,827 at June 28, 2003. Working capital, including cash and investment
securities, increased $73,088 to $285,743 at June 26, 2004 from $212,655 at June
28, 2003. The Company's priorities for use of cash and investment securities
include support of seasonal working capital demands, investment in capital
assets, opportunistic repurchase of common stock and acquisition of generic
prescription drug companies to accelerate entry into the market or complementary
businesses that could leverage retailer relationships, offer a product niche
opportunity or support geographic expansion.
Net cash provided by operating activities increased $38,293 or 48% to $118,527
for fiscal 2004 compared to $80,234 for fiscal 2003, primarily due to an
increase in net income, which includes a tax benefit of $13,100 as discussed
above. Net cash used for investing activities increased $19,878 or 60% to
$53,154 for fiscal 2004 compared to $33,276 for fiscal 2003. In December 2003,
the Company acquired Peter Black for $12,061 in cash.
Capital expenditures for facilities and equipment for fiscal 2004 of $28,294
were for normal equipment replacement and productivity enhancements. Capital
expenditures for fiscal 2005 are expected to be $25,000 to $30,000.
Net cash from financing activities increased $31,308 to $1,480 for fiscal 2004
compared to $29,828 net cash for financing activities for fiscal 2003. The
increase was primarily due to a reduction in common stock repurchases of $30,916
and an increase in proceeds from employee stock option exercises of $3,852. The
increase was partially offset by higher dividend payments of $5,652 in fiscal
2004.
-24-
In fiscal 2004, the Company continued its common stock repurchase program.
Purchases are made on the open market, subject to market conditions, and are
funded by cash from operations. The total remaining expenditure approved by the
Board of Directors for the repurchase of additional shares is $20,000. The
remaining repurchase program was announced on October 29, 2003 and will expire
on April 28, 2005. The share repurchase program announced on August 20, 2002
expired during the third quarter of fiscal 2004. The common stock repurchased
was retired upon purchase. During fiscal 2004, the Company repurchased 200
shares of its common stock for $2,766. For fiscal years 2003 and 2002, the
Company repurchased 3,296 and 2,533 shares of common stock for $33,682 and
$31,923, respectively.
In January 2003, the Board of Directors adopted a policy of paying regular
quarterly dividends. The Company paid quarterly dividends of $9,136 and $3,484,
or $0.13 and $0.05 per share, during fiscal 2004 and 2003, respectively. The
declaration and payment of dividends and the amount paid, if any, is subject to
the discretion of the Board of Directors and will depend on the earnings,
financial condition and capital and surplus requirements of the Company and
other factors the Board of Directors may consider relevant.
Dividends paid for the years ended June 26, 2004 and June 28, 2003 are as
follows:
Dividend
Declaration Date Record Date Payable Declared
- ---------------- ----------- ------- --------
Fiscal 2004
April 30, 2004 May 28, 2004 June 22, 2004 $0.035
January 30, 2004 February 27, 2004 March 23, 2004 $0.035
October 28, 2003 November 28, 2003 December 23, 2003 $0.035
August 7, 2003 August 29, 2003 September 23, 2003 $0.025
Fiscal 2003
May 9, 2003 May 30, 2003 June 24, 2003 $0.025
January 23, 2003 February 28, 2003 March 21, 2003 $0.025
The Company had no long-term debt at June 26, 2004 and June 28, 2003. Cash, cash
equivalents, investment securities and cash flows from operations are expected
to be sufficient to finance the known and/or foreseeable liquidity and capital
needs of the Company.
Effective September 23, 1999, the Company entered into a revolving credit
agreement with a group of banks that provided an unsecured revolving credit
facility. The Company terminated its credit facility in December 2003.
-25-
CONTRACTUAL OBLIGATIONS
The Company's enforceable and legally binding obligations as of June 26, 2004
are set forth in the following table. Some of the amounts included in this table
are based on management's estimates and assumptions about these obligations,
including the duration, the possibility of renewal, anticipated actions by third
parties and other factors. Because these estimates and assumptions are
necessarily subjective, the enforceable and legally binding obligations actually
paid in future periods may vary from the amounts reflected in the table. The
Company has no long-term debt.
2006 - 2008 -
2005 2007 2009 Thereafter Total
---- ---- ---- ---------- -----
Operating leases (a) $ 4,660 $5,781 $2,067 $ 256 $ 12,764
Purchase obligations (b) 89,677 70 - - 89,747
Purchase agreement (c) 5,000 - - - 5,000
Other long-term liabilities reflected
on the consolidated balance sheet
Deferred compensation and benefits (d) - - - 4,683 4,683
Other (e) 151 151 151 785 1,238
-------- ------ ------ ------ ---------
Total $ 99,488 $6,002 $2,218 $5,724 $ 113,432
======== ====== ====== ====== =========
(a) Used in normal course of business principally for warehouse facilities
and computer equipment.
(b) Consists of commitments for both materials and services.
(c) Purchase agreement to acquire certain assets from a manufacturer of
foot care products.
(d) Includes amounts associated with non-qualified plans related to
deferred compensation and executive retention. These amounts are
assumed payable after five years, although certain circumstances, such
as termination, would require earlier payment.
(e) Consists of a foreign grant for capital expenditures which is amortized
over the life of the corresponding purchased assets.
CRITICAL ACCOUNTING POLICIES
Determination of certain amounts in the Company's financial statements requires
the use of estimates. These estimates are based upon the Company's historical
experiences combined with management's understanding of current facts and
circumstances. Although the estimates are considered reasonable, actual results
could differ from the estimates. The accounting policies, discussed below, are
considered by management to require the most judgment and are critical in the
preparation of the financial statements. These policies are reviewed by the
Audit Committee. Other accounting policies are included in Note A of the
consolidated financial statements.
Allowance for Doubtful Accounts - The Company maintains an allowance for
customer accounts that reduces receivables to amounts that are expected to be
collected. In estimating the allowance, management considers factors such as
current overall economic conditions, industry-specific economic conditions,
historical and anticipated customer performance, historical experience with
write-offs and the level of past-due amounts. Changes in these conditions may
result in additional allowances. The allowance for doubtful accounts was $8,296
at June 26, 2004 and $10,242 at June 28, 2003.
Inventory - The Company maintains an allowance for estimated obsolete or
unmarketable inventory based on the difference between the cost of the inventory
and its estimated market value. In estimating the allowance, management
considers factors such as excess or slow moving inventories, product expiration
dating, products on quality hold, current and future customer demand and market
conditions. Changes in these conditions may result in additional allowances. The
allowance for inventory was $22,888 at June 26, 2004 and $21,717 at June 28,
2003.
-26-
Goodwill - Goodwill is tested for impairment annually or more frequently if
changes in circumstances or the occurrence of events suggest impairment exists.
The test for impairment requires the Company to make several estimates about
fair value, most of which are based on projected future cash flows. The
estimates associated with the goodwill impairment tests are considered critical
due to the judgments required in determining fair value amounts, including
projected future cash flows. Changes in these estimates may result in the
recognition of an impairment loss. The required annual testing is performed in
the second quarter of the fiscal year and resulted in no impairment charge for
fiscal 2004.
Product Liability and Workers' Compensation - The Company maintains accruals to
provide for claims incurred that are related to product liability and workers'
compensation. In estimating these accruals, management considers actuarial
valuations of exposure based on loss experience. These actuarial valuations
include significant estimates and assumptions, which include, but are not
limited to, loss development, interest rates, product sales, litigation costs,
accident severity and payroll expenses. Changes in these estimates and
assumptions may result in additional accruals. The accrual for product liability
claims was $3,876 at June 26, 2004 and $3,229 at June 28, 2003. The accrual for
workers' compensation claims was $2,458 at June 26, 2004 and $3,632 at June 28,
2003.
Item 7A. Quantitative And Qualitative Disclosures About Market Risk.
The Company is exposed to market risks, which include changes in interest rates
and changes in the foreign currency exchange rate as measured against the U.S.
dollar.
The Company is exposed to interest rate changes primarily as a result of
interest income earned on its investment of cash on hand and, if the Company
borrows funds to finance its operations, interest expense. The Company had
invested cash and investment securities of $171,700 at June 26, 2004. Management
believes that a fluctuation in interest rates in the near future will not have a
material impact on the Company's consolidated financial statements.
The Company has international operations in the United Kingdom and Mexico.
These operations transact business in the local currency, thereby creating
exposures to changes in exchange rates. The Company does not currently have
hedging or similar foreign currency contracts. However, the Company may obtain a
contractual currency exchange rate in contemplation of a significant
transaction, such as a foreign acquisition. Significant currency fluctuations
could adversely impact foreign revenues; however, the Company cannot predict
future changes in foreign currency exposure.
Additional Item. Cautionary Note Regarding Forward-Looking Statements.
Certain statements in Management's Discussion and Analysis of Results of
Operations and Financial Condition and other portions of this report are
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended, and are subject to the safe harbor created
thereby. These statements relate to future events or the Company's future
financial performance and involve known and unknown risks, uncertainties and
other factors that may cause the actual results, levels of activity, performance
or achievements of the Company or its industry to be materially different from
those expressed or implied by any forward-looking statements. In some cases,
forward-looking statements can be identified by terminology such as "may,"
"will," "could," "would," "should," "expect," "plan," "anticipate," "intend,"
"believe," "estimate," "predict," "potential" or other comparable terminology.
Although the Company believes that the expectations reflected in these
forward-looking statements are reasonable, it can give no assurance that such
expectations will prove to be correct. Unless otherwise required by applicable
securities laws, the Company disclaims any intention or obligation to update or
revise any forward-looking
-27-
statements, whether as a result of new information, future events or otherwise.
Fluctuation in Quarterly Results
The Company's quarterly operating results depend on a variety of factors
including, but not limited to, the severity, length and timing of the
cough/cold/flu season, the timing of new product introductions by the Company
and its competitors, the magnitude and timing of research and development
investments, changes in the levels of inventories maintained by the Company's
customers and the timing of retailer promotional programs. Accordingly, the
Company may be subject to significant and unanticipated quarter-to-quarter
fluctuations.
Potential Volatility of Stock Price
The market price of the Company's common stock has been, and could be, subject
to wide fluctuations in response to, among other things, quarterly fluctuations
in operating results, adverse circumstances affecting the introduction or market
acceptance of new products, failure to meet published estimates of or changes in
earnings estimates by securities analysts, announcements of new products or
enhancements by competitors, receipt of regulatory approvals by competitors,
sales of common stock by existing holders, loss of key personnel, market
conditions in the industry, shortages of key product inventory components and
general economic conditions.
Manufacturing Facilities
The vast majority of the Company's domestic OTC products are manufactured in
Allegan, Michigan. In addition, all of the Company's domestic nutritional
products are produced at one manufacturing facility in Greenville, South
Carolina. Revenues from sales of products manufactured in these facilities
comprise approximately 90% of the Company's total revenues. A significant
disruption at any of these facilities could impair the Company's ability to
produce and ship products on a timely basis, which could have a material adverse
effect on the Company's business, financial position and operating results.
Regulatory Environment
Several United States and foreign agencies regulate the manufacturing,
processing, formulation, packaging, labeling, testing, storing, distribution,
advertising and sale of the Company's products. Various state and local agencies
also regulate these activities. In addition, the Company manufactures and
markets certain of its products in accordance with the guidelines established by
voluntary standard organizations. Should the Company fail to adequately conform
to these regulations and guidelines, there may be a significant impact on the
operating results of the Company. In particular, packaging or labeling changes
mandated by the FDA can have a material impact on the results of operations of
the Company. Required changes could be related to safety or effectiveness
issues. With specific regard to safety, there have been instances within the
Company's product categories in which evidence of product tampering has occurred
resulting in a costly product recall. The Company believes that it has a good
relationship with the FDA, which it intends to maintain. If these relationships
should deteriorate, however, the Company's ability to bring new and current
products to market could be impeded. See "Item 1. Business - Government
Regulation."
Pseudoephedrine - Retail Sales Limits
Certain states are enacting legislation in reaction to nationwide concerns over
the control of chemicals that may be used illegally in the production of
methamphetamine. This legislation may result in the removal of certain products
containing pseudoephedrine from the retail shelf to a more
-28-
controlled position of sale behind the pharmacy counter of a retailer.
Additionally, such legislation may require special product packaging, enhanced
recordkeeping and limits on the amount of product a consumer may purchase.
Products containing pseudoephedrine generated approximately one-fifth of the
Company's fiscal 2004 revenues. The Company expects these products to contribute
similarly to total revenues in the future. The Company cannot predict whether
further legislation will be passed or, if it is passed, its impact on future
revenues of these products.
Store Brand Product Growth
The future growth of domestic store brand products will be influenced by general
economic conditions, which can influence consumers to switch to store brand
products, consumer perception and acceptance of the quality of the products
available, the development of new products, the market exclusivity periods
awarded on prescription to OTC switch products and the Company's ability to grow
its store brand market share. The Company does not advertise like the national
brand companies and thus is dependent on retailer promotional spending to drive
sales volume and increase market share. Growth opportunities for the products in
which the Company currently has a significant store brand market share (cough
and cold remedies and analgesics) will be driven by the ability to offer new
products to existing domestic customers. Branded pharmaceutical companies may
use state and federal regulatory and legislative means to limit the use of brand
equivalent products. Should store brand growth be limited by any of these
factors, there could be a significant impact on the operating results of the
Company.
Competitive Issues
The market for store brand OTC pharmaceutical and nutritional products is highly
competitive. Store brand competition is based primarily on price, quality and
assortment of products, customer service, marketing support and availability of
new products. National brand companies and/or generic Rx companies could choose
to compete more directly by manufacturing store brand products or by lowering
the prices of national brand products. Due to the high degree of price
competition, the Company has not always been able to fully pass on cost
increases to its customers. The inability to pass on future cost increases, the
impact of direct store brand competitors and the impact of national brand
companies lowering prices of their products or directly operating in the store
brand market could have a material adverse impact on financial results. In
addition, since the Company sells its nutritional products through retail drug,
supermarket and mass merchandise chains, it may experience increased competition
in its nutritional products business through alternative channels such as health
food stores, direct mail and direct sales as more consumers obtain products
through these channels. Retailer reverse auctions have added a new dimension to
competition as some retailers have instituted this process to obtain competitive
price quotes over the world wide web. The Company has evaluated, and will
continue to evaluate, the products and product categories in which it does
business. Future product line extensions, or deletions, could have a material
impact on the Company's financial position or results of operations.
Generic Equivalent Products
Various risks and uncertainties are attendant to the Company's decision to
expand into the manufacture and sale of generic prescription drugs. If the
Company is unsuccessful in establishing and growing that business, it could
negatively affect the Company's stock price, financial position and operating
results. Even if the Company's generic business is ultimately successful, the
costs of entering into and establishing that business may exceed the profits
derived from it for some period of time.
Many of the factors applicable to the Company's store brand OTC pharmaceutical
and nutritional businesses discussed in this Annual Report similarly are
applicable to the generic prescription drug
-29-
business. For example, the highly competitive nature of the market, the heavily
regulated environment, intellectual property issues (e.g., patent and licensing
issues, potential infringement claims and confidentiality concerns),
availability of raw materials and market acceptance of products are all factors
affecting that business. In addition, federal or state legislative proposals,
reimbursement policies of third-parties (such as insurance companies, health
maintenance organizations, managed care organizations, Medicaid and Medicare),
cost containment measures and health care reform, as well as other factors that
the Company may not be able to adequately identify due to its inexperience with
generic equivalents, could affect the marketing, pricing and demand for generic
prescription drugs.
Customer Issues
The Company's largest customer, Wal-Mart, currently comprises approximately 28%
of total net sales. Should Wal-Mart's current relationship with the Company
change adversely, the resulting loss of business could have a material adverse
impact on the Company's financial position and results of operations.
The impact of retailer consolidation could have an adverse impact on future
sales growth. Should a large customer encounter financial difficulties, the
exposure on uncollectible receivables and unusable inventory could have a
material adverse impact on the Company's financial position or results of
operations.
Research and Development
The Company's investment in research and development is expected to be above
historical levels due to the Company's planned expansion into the manufacture
and sale of generic prescription drugs as well as the high cost of developing
and becoming a qualified manufacturer of new products that are switching from
prescription to OTC status. The ability to attract scientists proficient in
emerging delivery forms and/or contracting with a third party innovator in order
to generate new products of this type is a critical element of the Company's
long term plans. Should the Company fail to attract qualified employees or enter
into reasonable agreements with third party innovators, long term sales growth
and profit would be adversely impacted.
Patent and Trade Dress Issues
The Company's ability to bring new products to market is limited by certain
patent and trade dress factors including, but not limited to, the existence of
patents protecting brand products for the Consumer Healthcare and
Pharmaceuticals segments and the regulatory exclusivity periods awarded on
products that have switched from prescription to OTC status. The cost and time
to develop these prescription and switch candidate products is significantly
greater than the rest of the new products that the Company seeks to introduce.
Moreover, the Company's packaging of certain products could be subject to trade
dress and design patent legal actions regarding infringement. Although the
Company designs its products and packaging to avoid infringing upon any valid
proprietary rights of national brand marketers, there can be no assurance that
the Company will not be subject to such legal actions in the future.
Effect of Research and Publicity on Nutritional Product Business
The Company believes that growth in the nutritional products business is based
largely on national media attention regarding scientific research suggesting
potential health benefits from regular consumption of certain vitamin and other
nutritional products. There can be no assurance of future favorable scientific
results and media attention, or the absence of unfavorable or inconsistent
findings. In the event of future unfavorable scientific results or media
attention, the Company's sales
-30-
of nutritional products could be materially adversely impacted.
Dependence on Personnel
The Company's future success will depend in large part upon its ability to
attract and retain highly skilled research and development scientists,
management information specialists, operations, sales, marketing and managerial
personnel. The Company does not have employment contracts with any key personnel
other than David T. Gibbons, its Chairman of the Board, President and Chief
Executive Officer. Should the Company not be able to attract or retain key
qualified employees, future operating results may be adversely impacted.
Availability of Raw Materials and Supplies
In the past, supplies of certain raw materials, bulk tablets and finished goods
purchased by the Company were limited, or were available from one or only a few
suppliers, and it is possible that this will occur in the future. Should this
situation occur, it can result in increased prices, rationing and shortages. In
response to these problems the Company tries to identify alternative materials
or suppliers for such raw materials, bulk tablets and finished goods. The nature
of FDA restrictions placed on products approved through the ANDA or NDA process
could substantially lengthen the approval process for an alternate material
source. Certain material shortages and approval of alternate sources could
adversely affect financial results.
In December 2002, a supplier of tablet/caplet gelatin coating processing
confirmed its intention to discontinue selling its services to the Company as of
March 31, 2003. Sales related to these products have decreased $12,000 in fiscal
2004 compared to fiscal 2003. No further reduction in future sales is expected.
The Company has arranged alternative coating sources to service customer
requirements. In May 2004, the Company's former supplier filed a patent
infringement suit against the Company relating to its replacement products. The
Company does not expect the outcome of this suit to have a material adverse
effect on its operations or financial results.
Legal Exposure
From time to time, the Company and/or its subsidiaries become involved in
lawsuits arising from various commercia