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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MAY 31, 2004
COMMISSION FILE NUMBER 0-5905
CHATTEM, INC.
A TENNESSEE CORPORATION
I.R.S. EMPLOYER IDENTIFICATION NO. 62-0156300
1715 WEST 38TH STREET
CHATTANOOGA, TENNESSEE 37409
TELEPHONE: 423-821-4571
Registrant 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, and has been
subject to such filing requirements for the past 90 days.
The registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange
Act).
As of June 30, 2004, 19,715,078 shares of the Company's common stock, without
par value, were outstanding.
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CHATTEM, INC.
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of May 31, 2004 and
November 30, 2003 3
Condensed Consolidated Statements of Income for the Three and Six
Months Ended May 31, 2004 and May 31, 2003 5
Condensed Consolidated Statements of Cash Flows for the Six Months
Ended May 31, 2004 and May 31, 2003 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 25
Item 3. Quantitative and Qualitative Disclosures About Market Risks 38
Item 4. Controls and Procedures 38
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 39
Item 2. Changes in Securities and Use of Proceeds 39
Item 3. Defaults Upon Senior Securities 39
Item 4. Submission of Matters to a Vote of Security Holders 39
Item 5. Other Information 39
Item 6. Exhibits and Reports on Form 8-K 40
SIGNATURES 41
2
PART 1. FINANCIAL INFORMATION
-----------------------------
ITEM 1. FINANCIAL STATEMENTS
- ----------------------------
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
(In thousands)
MAY 31, NOVEMBER 30,
ASSETS 2004 2003
---------- ----------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 10,890 $ 26,931
Accounts receivable, less allowances of $4,034 at
May 31, 2004 and $3,594 at November 30, 2003 39,057 25,478
Inventories 18,839 17,559
Refundable income taxes 6,569 4,431
Deferred income taxes 1,152 3,441
Prepaid expenses and other current assets 1,095 3,376
---------- ----------
Total current assets 77,602 81,216
---------- ----------
PROPERTY, PLANT AND EQUIPMENT, NET 28,288 28,722
---------- ----------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net 245,717 245,847
Debt issuance costs, net 5,532 5,504
Other 4,059 2,096
---------- ----------
Total other noncurrent assets 255,308 253,447
---------- ----------
TOTAL ASSETS $ 361,198 $ 363,385
========== ==========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
(In thousands)
MAY 31, NOVEMBER 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 2004 2003
---------- ----------
(Unaudited)
CURRENT LIABILITIES:
Current maturities of long-term debt $ -- $ 7,750
Accounts payable and other 9,805 10,924
Accrued liabilities 14,995 15,979
---------- ----------
Total current liabilities 24,800 34,653
---------- ----------
LONG-TERM DEBT, less current maturities 200,000 204,676
---------- ----------
DEFERRED INCOME TAXES 29,725 26,796
---------- ----------
OTHER NONCURRENT LIABILITIES 1,746 1,689
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 18)
SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized 1,000,
none issued -- --
Common shares, without par value, authorized 50,000,
issued 19,557 at May 31, 2004 and 19,161 at
November 30, 2003 81,410 77,815
Retained earnings 28,809 22,274
---------- ----------
110,219 100,089
Unamortized value of restricted common shares issued (2,951) (2,058)
Cumulative other comprehensive income:
Foreign currency translation adjustment (701) (820)
Minimum pension liability adjustment, net of income taxes (1,640) (1,640)
---------- ----------
Total shareholders' equity 104,927 95,571
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $ 361,198 $ 363,385
========== ==========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
(Unaudited and in thousands, except per share amounts)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED MAY 31, ENDED MAY 31,
-------------------------- --------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
REVENUES:
Net sales $ 69,886 $ 63,269 $ 130,813 $ 121,394
Royalties 206 364 516 664
---------- ---------- ---------- ----------
Total revenues 70,092 63,633 131,329 122,058
---------- ---------- ---------- ----------
COSTS AND EXPENSES:
Cost of sales 20,556 17,713 37,508 35,404
Advertising and promotion 19,080 18,529 37,612 36,934
Selling, general and administrative 10,671 10,397 21,306 20,211
Settlement and administrative costs of PPA litigation 3,463 -- 3,657 --
---------- ---------- ---------- ----------
Total costs and expenses 53,770 46,639 100,083 92,549
---------- ---------- ---------- ----------
INCOME FROM OPERATIONS 16,322 16,994 31,246 29,509
---------- ---------- ---------- ----------
OTHER INCOME (EXPENSE):
Interest expense (3,639) (5,227) (8,394) (10,374)
Investment and other income, net 115 53 160 87
Loss on early extinguishment of debt (1,649) -- (12,958) --
---------- ---------- ---------- ----------
Total other income (expense) (5,173) (5,174) (21,192) (10,287)
---------- ---------- ---------- ----------
INCOME BEFORE INCOME TAXES 11,149 11,820 10,054 19,222
PROVISION FOR INCOME TAXES 3,902 4,299 3,519 7,112
---------- ---------- ---------- ----------
NET INCOME $ 7,247 $ 7,521 $ 6,535 $ 12,110
========== ========== ========== ==========
NUMBER OF COMMON SHARES:
Weighted average outstanding-basic 19,286 19,052 19,193 19,177
========== ========== ========== ==========
Weighted average and potential dilutive outstanding 20,176 19,751 20,038 19,966
========== ========== ========== ==========
NET INCOME PER COMMON SHARE:
Basic $ .38 $ .39 $ .34 $ .63
========== ========== ========== ==========
Diluted $ .36 $ .38 $ .33 $ .61
========== ========== ========== ==========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------
(Unaudited and in thousands, except per share amounts)
FOR THE SIX MONTHS ENDED
--------------------------
MAY 31, MAY 31,
2004 2003
---------- ----------
OPERATING ACTIVITIES:
Net income $ 6,535 $ 12,110
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 3,072 3,021
Deferred income taxes 5,218 3,774
Tax benefit realized from stock option exercises 2,504 199
Loss on early extinguishment of debt 12,958 --
Other, net 49 (116)
Changes in operating assets and liabilities:
Accounts receivable (13,579) (6,524)
Inventories (1,280) (1,648)
Refundable income taxes (2,138) 242
Prepaid expenses and other current assets 2,295 1,236
Accounts payable and accrued liabilities (2,103) 82
---------- ----------
Net cash provided by operating activities 13,531 12,376
---------- ----------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (1,240) (2,566)
Purchases of patents, trademarks and other product rights (19) (308)
(Increase) decrease in other assets, net (701) 289
---------- ----------
Net cash used in investing activities (1,960) (2,585)
---------- ----------
FINANCING ACTIVITIES:
Repayment of long-term debt (212,288) (8,250)
Proceeds from long-term debt 200,000 --
Proceeds from borrowings under revolving credit facility 25,000 --
Repayments of revolving credit facility (25,000) --
Proceeds from exercise of stock options 2,880 275
Repurchase of common shares (3,234) (3,900)
Increase in debt issuance costs (5,718) (25)
Retirement of debt issuance costs (7,861) --
Premium on interest rate cap agreement (1,375) --
---------- ----------
Net cash used in financing activities (27,596) (11,900)
---------- ----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH
EQUIVALENTS (16) 146
---------- ----------
CASH AND CASH EQUIVALENTS:
Decrease for the period (16,041) (1,963)
At beginning of period 26,931 15,924
---------- ----------
At end of period $ 10,890 $ 13,961
========== ==========
SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Issuance of 70 and 69 shares of restricted common stock at a value of $19.98 and
$14.50 per share for the six months ended May 31, 2004 and 2003, respectively $ 1,399 $ 1,000
PAYMENTS FOR:
Interest $ 7,807 $ 9,656
Taxes $ 196 $ 2,599
The accompanying notes are an integral part of these condensed
consolidated financial statements.
6
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
(UNAUDITED)
All monetary and share amounts are expressed in thousands.
1. BASIS OF PRESENTATION
---------------------
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial information and the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by
accounting principles generally accepted in the United States for complete
financial statements. These condensed consolidated financial statements
should be read in conjunction with the audited consolidated financial
statements and related notes thereto included in our Annual Report on Form
10-K for the year ended November 30, 2003. The accompanying unaudited
condensed consolidated financial statements, in the opinion of management,
include all adjustments necessary for a fair presentation. All such
adjustments are of a normal recurring nature.
2. CASH AND CASH EQUIVALENTS
-------------------------
We consider all short-term deposits and investments with original
maturities of three months or less to be cash equivalents.
3. RECLASSIFICATIONS
-----------------
Certain amounts have been reclassified to conform to the current
period's presentation.
4. RECENT ACCOUNTING PRONOUNCEMENTS
--------------------------------
In April 2002, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 145,
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" ("SFAS 145"). We adopted SFAS
145 on December 1, 2002. SFAS 145 requires us to classify gains and losses
on extinguishments of debt as income or loss from continuing operations
rather than as extraordinary items as previously required under SFAS No. 4,
"Reporting Gains and Losses from Extinguishment of Debt". We are also
required to reclassify any gain or loss on extinguishment of debt
previously classified as an extraordinary item in prior periods presented.
SFAS 145 also provides accounting standards for certain lease modifications
that have economic effects similar to sale-leaseback transactions and
various other technical corrections. The application of SFAS 145 resulted
in recording a loss on early extinguishment of debt of $12,958 in the first
and second quarters of fiscal 2004, which was classified in the condensed
consolidated financial statements in accordance with the provisions of SFAS
145.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). We adopted SFAS
146 on January 1, 2003. SFAS 146 supercedes Emerging Issues Task Force
("EITF") Issue No. 94-3. SFAS 146 requires that the liability for a cost
associated with an exit or disposal activity be recognized when the
liability is incurred, not at the date of an entity's commitment to an exit
or disposal plan. SFAS 146 is to be applied prospectively to exit or
disposal activities initiated after December 31, 2002. The application of
SFAS 146 resulted in recording $40 of accrued liabilities related to the
restructuring of the United Kingdom ("U.K.") operations. We expect to
record additional charges related to the restructuring of the U.K.
operations in the third and fourth quarters of fiscal 2004.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("FIN 46"). FIN 46 requires a company to
consolidate a variable interest entity ("VIE"), as defined, when the
company will absorb a majority of the VIE's expected losses, receives a
majority of the VIE's expected residual returns or both. FIN 46 also
requires consolidation of existing, non-controlled affiliates if the VIE is
unable to finance its operations without investor support, or where the
other investors do not have exposure to the significant risks and rewards
of ownership. FIN 46 applies immediately to a VIE created or acquired after
January 31, 2003. For a VIE created before February 1, 2003, FIN 46 applies
in the first fiscal year or interim period beginning after March 15, 2004,
our third fiscal quarter beginning June 1, 2004. Application of FIN 46 is
also required in financial statements that have interests in structures
that are commonly referred to as special-purpose entities for periods
ending after December 15, 2003. The adoption of FIN 46 did not have an
impact on our financial position, results of operations or cash flows.
7
In December 2003, the FASB issued SFAS No. 132 (revised 2003),
"Employers' Disclosure about Pensions and Other Postretirement Benefits"
("SFAS 132"). The revision of SFAS 132 provides for additional disclosures
including the description of the types of plan assets, investment strategy,
measurement date(s), plan obligations, cash flows and components of net
periodic benefit cost recognized in interim periods. The revisions of SFAS
132 are effective for financial statements with fiscal years ending after
December 15, 2003 and interim periods beginning after December 15, 2003.
The adoption of the revised SFAS 132 did not have an impact on our
financial position, results of operations or cash flows.
5. STOCK-BASED COMPENSATION
------------------------
Our 1998 Non-Statutory Stock Option Plan provides for the issuance of
up to 1,400 shares of common stock to key employees, while the 1999
Non-Statutory Stock Option Plan for Non-Employee Directors allows for the
issuance of up to 200 shares of common stock. Our 2000 Non-Statutory Stock
Option Plan provides for the issuance of up to 1,500 shares of common
stock. Our 2003 Stock Incentive Plan provides for the issuance of up to
1,500 shares of common stock. Options granted under the plans vest ratably
over four years and are exercisable for a period of up to ten years from
the date of grant.
For SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123") purposes, as amended by SFAS No. 148, "Accounting for Stock Based
Compensation-Transition and Disclosure", the fair value of each option
grant has been estimated as of the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions for
grants in 2004 and 2003: expected dividend yield of 0%, expected volatility
of 60% and 64%, respectively, risk-free interest rates of 4.65% and 3.95%,
respectively, and expected lives of approximately five and six years,
respectively.
Had compensation expense for stock option grants been determined based
on the fair value at the grant dates consistent with the method prescribed
by SFAS 123, our net income and net income per share would have been
adjusted to the pro forma amounts for the three and six months ended May
31, 2004 and 2003, respectively, as indicated below:
For the Three Months Ended For the Six Months Ended
May 31, May 31,
------------------------- -------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net income:
As reported $ 7,247 $ 7,521 $ 6,535 $ 12,110
Fair value method compensation cost, net 1,110 472 1,999 1,033
---------- ---------- ---------- ----------
Pro forma $ 6,137 $ 7,049 $ 4,536 $ 11,077
========== ========== ========== ==========
Net income per share, basic:
As reported $ .38 $ .39 $ .34 $ .63
Pro forma $ .32 $ .37 $ .24 $ .58
Net income per share, diluted:
As reported $ .36 $ .38 $ .33 $ .61
Pro forma $ .30 $ .36 $ .23 $ .55
8
6. EARNINGS PER SHARE
------------------
The following table presents the computation of per share earnings for
the three and six months ended May 31, 2004 and 2003, respectively:
For the Three Months Ended For the Six Months Ended
May 31, May 31,
------------------------- -------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
NET INCOME $ 7,247 $ 7,521 $ 6,535 $ 12,110
========== ========== ========== ==========
NUMBER OF COMMON SHARES:
Weighted average outstanding 19,286 19,052 19,193 19,177
Issued upon assumed exercise of
outstanding stock options 814 612 783 694
Effect of issuance of restricted
common shares 76 87 62 95
---------- ---------- ---------- ----------
Weighted average and potential
dilutive outstanding (1) 20,176 19,751 20,038 19,966
========== ========== ========== ==========
NET INCOME PER COMMON SHARE:
Basic $ .38 $ .39 $ .34 $ .63
========== ========== ========== ==========
Diluted $ .36 $ .38 $ .33 $ .61
========== ========== ========== ==========
(1) Because their effects are anti-dilutive, excludes shares issuable
under stock option plans and restricted stock issuance whose grant
price was greater than the average market price of common shares
outstanding as follows: 199 and 1,042 shares for the three months ended
May 31, 2004 and 2003, respectively, and 100 and 96 shares for the six
months ended May 31, 2004 and 2003, respectively.
7. ADVERTISING EXPENSES
--------------------
We incur significant expenditures on television, radio and print
advertising to support our nationally branded over-the-counter ("OTC")
health care products and toiletries. Customers purchase products from us
with the understanding that the brands will be supported by our extensive
media advertising. This advertising supports the retailers' sales effort
and maintains the important brand franchise with the consuming public.
Accordingly, we consider our advertising program to be clearly implicit in
our sales arrangements with our customers. Therefore, we believe it is
appropriate to allocate a percentage of the necessary supporting
advertising expenses to each dollar of sales by charging a percentage of
sales on an interim basis based upon anticipated annual sales and
advertising expenditures (in accordance with Accounting Principles Board
Opinion No. 28, "Interim Financial Reporting") and adjusting that accrual
to the actual expenses incurred at the end of the year.
8. SHIPPING AND HANDLING
---------------------
Shipping and handling costs of $1,999 and $1,588 are included in
selling expenses for the three months ended May 31, 2004 and 2003,
respectively, and $3,434 and $3,045 for the six months ended May 31, 2004
and 2003, respectively.
9. PATENTS, TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS
------------------------------------------------------
The carrying value of trademarks, which are not subject to
amortization under the provisions of SFAS No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"), was $244,809 and $244,790 as of May 31,
2004 and November 30, 2003, respectively. The gross carrying amount of
intangible assets subject to amortization at both May 31, 2004 and November
30, 2003, which consist primarily of non-compete agreements, was $2,400.
The related accumulated amortization of intangible assets at May 31, 2004
and November 30, 2003 was $1,492 and $1,343, respectively. Amortization of
our intangible assets subject to amortization under the provisions of SFAS
142 for the three months ended May 31, 2004 and 2003 was $73 and $85,
respectively, and for the six months ended May 31, 2004 and 2003 was $149
and $170, respectively. Estimated annual amortization expense for these
assets for the years ended November 30, 2005, 2006, 2007, 2008 and 2009 is
$290, $290, $123, $40 and $20, respectively.
9
10. INVENTORIES
-----------
Inventories consisted of the following as of May 31, 2004 and November
30, 2003:
2004 2003
---------- ----------
Raw materials and work in process $ 8,091 $ 9,740
Finished goods 12,436 9,507
Excess of current cost over LIFO values (1,688) (1,688)
---------- ----------
Total inventories $ 18,839 $ 17,559
========== ==========
11. ACCRUED LIABILITIES
-------------------
Accrued liabilities consisted of the following as of May 31, 2004 and
November 30, 2003:
2004 2003
---------- ----------
Interest $ 3,219 $ 3,115
Salaries, wages and commissions 3,133 3,604
Product advertising and promotion 5,806 5,348
Insurance 480 1,151
Pension 956 1,040
Other 1,401 1,721
---------- ----------
Total accrued liabilities $ 14,995 $ 15,979
========== ==========
12. LONG-TERM DEBT
--------------
Long-term debt consisted of the following as of May 31, 2004 and
November 30, 2003:
2004 2003
---------- ----------
Revolving Credit Facility due 2009 at a
variable rate of 4.75% as of
May 31, 2004 $ -- $ --
Term loan payable to banks at variable
rates of 3.42% and 3.39% as of
February 26, 2004 (termination date) and
November 30, 2003, respectively -- 7,750
8.875% Senior Subordinated Notes, plus
unamortized premium of $138
for 2003 -- 204,676
Floating Rate Senior Notes due 2010
at a variable rate of 4.12% as of
May 31, 2004 75,000 --
7.0% Senior Subordinated Notes due 2014 125,000 --
---------- ----------
Total long-term debt 200,000 212,426
Less: current maturities -- 7,750
---------- ----------
Total long-term debt, net of current maturities $ 200,000 $ 204,676
========== ==========
On February 26, 2004, we entered into a new Senior Secured Revolving
Credit Facility that matures February 26, 2009 (the "Revolving Credit
Facility") with Bank of America, N.A. that provided an initial borrowing
capacity of $25,000 and an additional $25,000, subject to successful
syndication. On March 9, 2004, we entered into a new commitment agreement
with a syndicate of commercial banks led by Bank of America, N.A., as
agent, that enables us to borrow up to a total of $50,000 under the
Revolving Credit Facility. Borrowings under our Revolving Credit Facility
bear interest at LIBOR plus applicable percentages of 1.75% to 2.50% or a
base rate (the higher of the federal funds rate plus 0.5% or the prime
rate) plus applicable percentages of 0.25% to 1.0%. The applicable
percentages are calculated based on our leverage ratio. As of May 31, 2004,
no amounts have been borrowed under the Revolving Credit Facility, and the
variable rate was 4.75%. Borrowings under our Revolving Credit Facility are
secured by substantially all of our assets, except real property, and
shares of capital stock of our domestic subsidiaries held by us and by the
assets of the guarantors (our domestic subsidiaries). The Revolving Credit
Facility contains covenants, representations, warranties and other
agreements by us that are customary in credit
10
agreements and security instruments relating to financings of this type.
The significant financial covenants include fixed charge coverage ratio,
leverage ratio, senior secured leverage ratio, net worth and brand value
calculations. On June 30, 2004, we had no borrowings outstanding under our
Revolving Credit Facility.
On March 28, 2002, we obtained a $60,000 senior secured credit
facility from a syndicate of commercial banks led by Bank of America, N.A.,
as agent (the "Credit Facility"). The Credit Facility included a $15,000
revolving credit line and a $45,000 term loan. The remaining balance of the
term loan under the Credit Facility was repaid as part of the refinancing
transactions discussed herein, and the revolving credit line under the
Credit Facility was terminated on February 26, 2004.
On February 10, 2004, we commenced a cash tender offer and consent
solicitation for the $204,538 outstanding principal amount of our 8.875%
Senior Subordinated Notes due 2008 (the "8.875% Subordinated Notes"). The
consent solicitation expired on February 24, 2004, and a total of
approximately $174,530, or approximately 85.3% of the 8.875% Subordinated
Notes, were tendered and accepted for payment on February 26, 2004. The
remaining principal outstanding, call premium, accrued interest and
interest to call date amounting to $32,227 was placed in escrow with the
indenture trustee to fund the purchase of additional 8.875% Subordinated
Notes tendered prior to March 9, 2004, the expiration date of the tender
offer, and the redemption of the remaining 8.875% Subordinated Notes not
tendered. The redemption of the remaining 8.875% Subordinated Notes not
tendered in such offer were called in accordance with their terms on April
1, 2004 at a redemption price of 102.9583% of their aggregate principal
amount. On April 1, 2004, the remaining amount held in escrow was released
for payment and all outstanding 8.875% Subordinated Notes were redeemed.
The completion of our refinancing of the Credit Facility and purchase
of approximately $174,530 of our 8.875% Subordinated Notes that were
tendered on February 26, 2004 resulted in a loss on early extinguishment of
debt of $11,309 and a tax benefit of $3,958. In the second quarter of
fiscal 2004, we recorded a loss on early extinguishment of debt of $1,649
and a related tax benefit of $577 related to the redemption of the
remaining $30,008 of our 8.875% Subordinated Notes.
Also on February 26, 2004, we issued and sold $75,000 of Floating Rate
Senior Notes due March 1, 2010 (the "Floating Rate Notes") and $125,000 of
7.0% Senior Subordinated Notes due March 1, 2014 (the "7.0% Subordinated
Notes"), the proceeds of which were used to purchase our 8.875%
Subordinated Notes and refinance the Credit Facility as discussed above.
The Floating Rate Notes bear interest at a three-month LIBOR plus
3.00% per year (4.12% as of May 31, 2004). Interest payments are due
quarterly in arrears commencing on June 1, 2004. On March 8, 2004, we
entered into an interest rate cap agreement effective June 1, 2004 with
decreasing notional principal amounts and cap rates ranging from 4.0% to
5.0% over the life of the agreement. We paid a $1,375 premium to enter into
the interest rate cap agreement, which will be amortized over the life of
the agreement. The current portion of the premium on the interest rate cap
agreement of $14 is included in prepaid expenses and other current assets,
and the long-term portion of $1,361 is included in other noncurrent assets.
The amortized value of the premium on the interest rate cap will be
compared to its fair value quarterly. If the fair value is lower than the
carrying value of the premium on the interest rate cap, a charge will be
recorded to other comprehensive income. The interest rate cap agreement
terminates on March 1, 2010. Our domestic subsidiaries are guarantors of
the Floating Rate Notes. The guarantees of the Floating Rate Notes are
unsecured senior obligations of the guarantors and rank equally with all of
the current and future unsecured senior debt of the guarantors. The
guarantees of the Floating Rate Notes effectively rank junior to any
secured debt of the guarantors, including the guarantors' guarantee of our
indebtedness under the Revolving Credit Facility. At any time after March
1, 2005, we may redeem any of the Floating Rate Notes upon not less than 30
nor more than 60 days' notice at redemption prices (expressed in
percentages of principal amount), plus accrued and unpaid interest, if any,
and liquidated damages, if any, to the applicable redemption rate, if
redeemed during the twelve-month periods beginning March 1, 2005 at 102.0%,
March 1, 2006 at 101.0% and March 1, 2007 and thereafter at 100.0%. At any
time prior to March 1, 2005, we may redeem up to 35.0% of the aggregate
principal amount of the Floating Rate Notes (including any additional
Floating Rate Notes) at a redemption price of 100.0% of the principal
amount thereof, plus a premium equal to the interest rate per annum on the
Floating Rate Notes applicable on the date on which notice of the
redemption is given, together with accrued and unpaid interest and
liquidated damages, if any, with the net cash proceeds of one or more
qualified equity offerings; provided, that (i) at least 65.0% of the
aggregate principal amount of Floating Rate Notes remains outstanding
immediately after the occurrence of each redemption (excluding Floating
Rate Notes held by us and our subsidiaries); and (ii) the redemption must
occur within 90 days of the date of the closing of such qualified equity
offering.
Interest payments on the 7.0% Subordinated Notes are due semi-annually
in arrears on March 1 and September 1, commencing on September 1, 2004. Our
domestic subsidiaries are guarantors of the 7.0% Subordinated Notes. The
guarantees of the 7.0% Subordinated Notes are unsecured senior subordinated
obligations of the guarantors. At any time after March 1, 2009, we may
redeem any of the 7.0% Subordinated Notes upon not less than 30 nor more
than 60 days' notice at redemption prices (expressed in percentages of
principal amount), plus accrued and unpaid interest, if any, and
liquidation
11
damages, if any, to the applicable redemption rate, if redeemed during the
twelve-month periods beginning March 1, 2009 at 103.500%, March 1, 2010 at
102.333%, March 1, 2011 at 101.167% and March 1, 2012 and thereafter at
100.000%. At any time prior to March 1, 2007, we may redeem up to 35.0% of
the aggregate principal amount of the 7.0% Subordinated Notes (including
any additional 7.0% Subordinated Notes) at a redemption price of 107.0% of
the principal amount thereof, plus accrued and unpaid interest and
liquidated damages, if any, thereon to the applicable redemption rate, with
the net cash proceeds of one or more qualified equity offerings; provided,
that (i) at least 65.0% of the aggregate principal amount of the 7.0%
Subordinated Notes remains outstanding immediately after the occurrence of
such redemption (excluding 7.0% Subordinated Notes held by us and our
subsidiaries); and (ii) the redemption must occur within 90 days of the
date of the closing of such qualified equity offering.
The indentures governing the Floating Rate Notes and 7.0% Subordinated
Notes, among other things, limit our ability and the ability of our
restricted subsidiaries to: (i) borrow money or sell preferred stock, (ii)
create liens, (iii) pay dividends on or redeem or repurchase stock, (iv)
make certain types of investments, (v) sell stock in our restricted
subsidiaries, (vi) restrict dividends or other payments from restricted
subsidiaries, (vii) enter into transactions with affiliates, (viii) issue
guarantees of debt and (ix) sell assets or merge with other companies. In
addition, if we experience specific kinds of changes in control, we must
offer to purchase the Floating Rate Notes and 7.0% Subordinated Notes at
101.0% of their principal amount plus accrued and unpaid interest.
The future maturities of long-term debt outstanding as of May 31, 2004
are as follows:
2005 $ --
2006 --
2007 --
2008 --
2009 --
Thereafter 200,000
--------
$200,000
========
13. COMPREHENSIVE INCOME
--------------------
Comprehensive income consisted of the following components for the
three and six months ended May 31, 2004 and 2003, respectively:
For the Three Months Ended For the Six Months Ended
May 31, May 31,
-------------------------- -------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net income $ 7,247 $ 7,521 $ 6,535 $ 12,110
Other - foreign currency
translation adjustment (151) (47) 119 317
---------- ---------- ---------- ----------
Total $ 7,096 $ 7,474 $ 6,654 $ 12,427
========== ========== ========== ==========
14. STOCK BUYBACK
-------------
In January 2004, our board of directors increased the total
authorization to repurchase our common stock under our stock buyback
program to $20,000. During the six months ended May 31, 2004, we
repurchased 129 shares for $3,234. All repurchased shares were retired and
returned to unissued. We are limited in our ability to repurchase shares
due to restrictions under the terms of our Revolving Credit Facility and
the indenture pursuant to which Floating Rate Notes and 7.0% Subordinated
Notes were issued.
15. RETIREMENT PLANS AND POSTRETIREMENT HEALTH CARE BENEFITS
--------------------------------------------------------
RETIREMENT PLANS
We have a noncontributory defined benefit pension plan ("the Plan"),
which covers substantially all employees. The Plan provides benefits based
upon years of service and the employee's compensation. Our contributions
are based on computations by independent actuaries. Plan assets at May 31,
2004 and November 30, 2003 were invested primarily in United States
government and agency securities and corporate debt and equity securities.
In October 2000, our board of directors adopted an amendment to the Plan
that freezes benefits of the Plan and prohibits new entrants to the Plan
effective December 31, 2000.
12
Net periodic pension cost for the three and six months ended May 31,
2004 and 2003 comprised the following components:
For the Three Months Ended For the Six Months Ended
May 31, May 31,
---------------------- ----------------------
2004 2003 2004 2003
-------- -------- -------- --------
Service cost $ -- $ -- $ -- $ --
Interest cost on projected benefit
obligation 155 152 310 304
Actual return on plan assets (178) (157) (356) (314)
Net amortization and deferral 28 (36) 56 (72)
-------- -------- -------- --------
Net pension cost (benefit) $ 5 $ (41) $ 10 $ (82)
======== ======== ======== ========
No employer contributions were made for the six months ended May 31,
2004 and May 31, 2003, and no employer contributions are required to be
made in fiscal 2004.
POSTRETIREMENT HEALTH CARE BENEFITS
We maintain certain postretirement health care benefits for eligible
employees. Employees become eligible for these benefits if they meet
certain age and service requirements. We pay a portion of the cost of
medical benefits for certain retired employees over the age of 65.
Effective January 1, 1993, our contribution is a service-based percentage
of the full premium. We pay these benefits as claims are incurred. Employer
contributions expected for fiscal 2004 are approximately $70.
Net periodic postretirement health care benefits cost for the three
and six months ended May 31, 2004 and May 31, 2003, included the following
components:
For the Three Months Ended For the Six Months Ended
May 31, May 31,
---------------------- ----------------------
2004 2003 2004 2003
-------- -------- -------- --------
Service cost $ 16 $ 14 $ 32 $ 28
Interest cost on accumulated
postretirement benefit obligation 20 20 40 40
Amortization of prior service cost 4 4 8 8
Amortization of net gain (8) (7) (16) (14)
-------- -------- -------- --------
Net periodic postretirement benefits cost $ 32 $ 31 $ 64 $ 62
======== ======== ======== ========
16. INCOME TAXES
------------
We account for income taxes using the asset and liability approach as
prescribed by SFAS No. 109, "Accounting for Income Taxes". This approach
requires recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been included in the
consolidated financial statements or tax returns. Using the enacted tax
rates in effect for the year in which the differences are expected to
reverse, deferred tax assets and liabilities are determined based on the
differences between the financial reporting and the tax basis of an asset
or liability. We record income tax expense in our consolidated financial
statements based on an estimated annual effective income tax rate. Our tax
rate for the three and six months ended May 31, 2004 was 35%, respectively,
as compared to 36% in the corresponding quarter of fiscal 2003 and 37% for
the six months ended May 31, 2003. The lower rate in fiscal 2004 reflects
the implementation of a number of foreign and state tax planning
initiatives.
13
17. PRODUCT SEGMENT INFORMATION
---------------------------
Net sales of our domestic product categories within our single
healthcare business segment for the three and six months ended May 31, 2004
and 2003 are as follows:
For the Three Months Ended For the Six Months Ended
May 31, May 31,
--------------------- ---------------------
2004 2003 2004 2003
-------- -------- -------- --------
Topical analgesics $ 18,134 $ 14,626 $ 33,846 $ 28,198
Medicated skin care products 17,330 14,912 30,663 28,062
Dietary supplements 10,369 10,963 18,880 20,568
Medicated dandruff shampoos and conditioner 7,406 6,641 16,627 14,812
Other OTC and toiletry products 10,445 9,039 19,275 17,221
-------- -------- -------- --------
Total $ 63,684 $ 56,181 $119,291 $108,861
======== ======== ======== ========
18. COMMITMENTS AND CONTINGENCIES
-----------------------------
GENERAL LITIGATION
As of June 30, 2004, we were named as a defendant in approximately 345
lawsuits involving claims by approximately 680 plaintiffs alleging that the
plaintiffs were injured as a result of ingestion of products containing
phenylpropanolamine ("PPA"), which was an active ingredient in most of our
DEXATRIM products until November 2000. Most of the lawsuits seek an
unspecified amount of compensatory and exemplary damages or punitive
damages. The lawsuits that are federal cases have now been transferred to
the United States District Court for the Western District of Washington
before United States District Judge Barbara Jacobs Rothstein (In Re
Phenylpropanolamine ("PPA") Products Liability Litigation, MDL No. 1407).
The remaining cases are state court cases that have been filed in a number
of different states.
We believe that approximately 203 or approximately 59% of the existing
lawsuits in which we are named as a defendant represent cases involving
alleged injuries by products manufactured and sold prior to our acquisition
of DEXATRIM in December 1998. We have been defended in these lawsuits on
the basis of indemnification obligations assumed by The DELACO Company,
Inc. ("DELACO"), successor to Thompson Medical Company, Inc., which owned
DEXATRIM prior to December 1998. DELACO maintains product liability
insurance coverage for products manufactured and sold prior to December
1998 with annual limits of coverage and has an excess liability policy but
otherwise has only nominal assets. We understand that DELACO's insurance
carriers are disputing their responsibility for such coverage and are
engaged in settlement discussions with DELACO. On February 12, 2004, DELACO
filed a Chapter 11 bankruptcy petition in the United States Bankruptcy
Court for the Southern District of New York. Accordingly, it is uncertain
whether DELACO will be able to indemnify us for claims arising from
products manufactured and sold prior to our acquisition of DEXATRIM in
December 1998 and even if it is able to do so, it is unlikely that DELACO
will be able to indemnify us beyond its insurance coverage. In addition, we
cannot assure you that the insurance maintained by DELACO will be
sufficient to cover these claims or that ultimately we will not be held
liable for these claims. Our product liability insurance, as described
below, would not apply to claims arising from products manufactured and
sold prior to our acquisition of DEXATRIM. In addition to indemnification
from DELACO, we will also seek to defend ourselves in these lawsuits on the
basis that we did not manufacture and sell products containing PPA prior to
December 1998.
In the approximately 203 cases that have been filed against us for
products manufactured and sold prior to December 1998, approximately half
of the plaintiffs are in cases filed in states that we believe do not under
current law impose liability upon a successor. The remaining plaintiffs are
in cases filed in states that may in some circumstances permit liability
against a successor. However, although there can be no assurances, we do
not believe that successor liability would be imposed against us in these
cases. The reasons for our belief, among others, are that we did not
purchase all of DELACO's assets and DELACO continued to operate its
remaining business after December 1998; we did not cause DELACO's
bankruptcy; many plaintiffs included in cases filed in states that in some
circumstances impose successor liability are actually residents of other
states; and we believe that a remedy will be available to plaintiffs who
file claims in the DELACO bankruptcy.
As of June 30, 2004, in the approximately 142 lawsuits we are
defending, approximately 173 plaintiffs specifically allege ingestion of
DEXATRIM. The remaining plaintiffs either do not specifically allege
ingestion of DEXATRIM or have sued multiple manufacturers or sellers of
products containing PPA without identifying the products they ingested.
On December 19, 2003, we entered into a memorandum of understanding
with the Plaintiffs' Steering Committee ("PSC") in IN RE
PHENYLPROPANOLAMINE ("PPA") PRODUCTS LIABILITY LITIGATION, MDL 1407,
pending before the United States
14
District Court for the Western District of Washington (the "Memorandum of
Understanding"). The Memorandum of Understanding memorialized certain
settlement terms concerning lawsuits relating to DEXATRIM products
containing PPA.
On April 13, 2004, we entered into a class action settlement agreement
with representatives of the plaintiffs' settlement class. The court granted
preliminary approval of the class action settlement on April 23, 2004. The
class action settlement agreement is generally consistent with the terms of
and supercedes the Memorandum of Understanding and provides for a national
class action settlement of all DEXATRIM PPA claims. The class action
settlement is subject to final approval by the court at a fairness hearing
currently scheduled for August 26, 2004.
In accordance with the terms of the DEXATRIM class action settlement
agreement, $60,885 has been funded into an initial settlement trust from
our first three layers of insurance coverage, as described below. We have
published notice of the final settlement and details as to the manner in
which claims can be submitted. The deadline for submission of all claims is
July 7, 2004. If the final settlement is approved by the court, claims
submitted in the class settlement would be valued pursuant to an agreed
upon settlement matrix that is designed to evaluate and determine the
settlement value of each claim. To the extent the amount in the initial
settlement trust is ultimately insufficient to fully fund the settlement,
we will be required to make additional contributions to the settlement
trust in the future.
Based upon the Memorandum of Understanding and the settlement matrix,
Judge Rothstein entered a stay of discovery in all federal court DEXATRIM
PPA cases which allowed us to negotiate the class action settlement
agreement and file our class action settlement. Approximately 70% of our
cases are included in the multi-district litigation, or MDL. We expect most
of our cases pending in state courts will join in the settlement discussed
above.
On December 19, 2003, DELACO also entered into a Memorandum of
Understanding with the PSC. We understand that DELACO intends to implement
its contemplated settlement with the PSC through a liquidating Chapter 11
bankruptcy plan. If DELACO pursues the settlement through its bankruptcy
plan, we expect that the administrative process for DELACO's settlement
will be similar to the process in our class action. We have filed a claim
in DELACO's bankruptcy case in order to preserve our claims for
indemnification against DELACO. As part of this Chapter 11 plan, we expect
that after resolution of creditors' claims, DELACO will seek to liquidate
and distribute all of its assets and will dissolve as a company.
We cannot assure you that the terms of the class action settlement
agreement will be approved by the court. If the settlement is not approved,
we will continue to defend individual cases in a number of different state
and federal jurisdictions. If the final settlement is approved, we believe
that the settlement will include a substantial majority of the claims by
users of DEXATRIM products containing PPA, but that some claims may elect
to "opt out" of any class settlement and will continue to pursue claims for
damages against us in separate lawsuits. We cannot estimate at this time
how many claims may opt out or whether such claims will result in
significant additional liability for us. To the extent the number or
settlement value of opt out claims exceeds certain levels as specified in
the class action settlement agreement, we reserve the right to terminate
the settlement.
In the second quarter of fiscal 2004, we took a $3,463 charge relating
to settlement and administrative costs associated with the DEXATRIM PPA
litigation. Although we believe that an additional liability existed as of
May 31, 2004 related to our PPA litigation, because the final terms of the
settlement are still uncertain and have not been approved, we are not able
to estimate reasonably the amount of such liability at May 31, 2004 and
have made no provision for this liability in our condensed consolidated
financial statements.
As indicated above, $60,885 from our first three layers of our product
liability insurance coverage available for the PPA litigation has been
funded into an initial settlement trust. To the extent the amount in the
initial settlement trust is insufficient to fully fund the settlement, we
will be required to make additional contributions to the settlement trust
in the future. We currently expect to use certain of our cash on hand to
fund any required additional contributions to the settlement trust. If we
are required to fund significant other liabilities related to the PPA
litigation beyond the initial settlement trust, either pursuant to the
terms of the settlement, as a result of litigation or otherwise, we will
have significantly fewer sources of funds with which to satisfy such
liabilities, and we may be unable to do so. Moreover, if the settlement is
not approved, we may not have sufficient funds to satisfy all claims
against us.
We have reached an agreement with Kemper Indemnity Insurance Company
("Kemper") to settle Kemper's lawsuit that sought to rescind our policy for
$50,000 of excess coverage for product liability claims. After giving
effect to the settlement with Kemper, we have available for the claims
against us related to the PPA litigation, through our first three layers of
insurance coverage, approximately $60,885 of the $77,000 of product
liability coverage provided by these insurance policies. The $60,885 of
available coverage consists of $37,500 of insurance under the Kemper policy
and approximately $23,385 under policies with two other insurance
companies. As indicated above, this $60,885 of coverage has been funded
into an initial settlement trust in accordance with the terms of the class
action settlement agreement.
15
We continue to aggressively defend an action brought by Interstate
Fire & Casualty Company ("Interstate") to rescind its $25,000 of excess
coverage for product liability and pursue our available remedies at law
against Interstate. We cannot assure you that we will be successful in
retaining such excess coverage. The Interstate policy is in excess of the
product liability insurance available from Kemper and the two other
insurance companies referred to above. In the event the $60,885 of
insurance funds available in the initial settlement trust are exhausted
under the PPA settlement or otherwise, coverage under the Interstate policy
would not be available until we have paid $12,615 toward the settlement of
PPA claims to reach the $73,500 coverage point for the Interstate policy.
We maintain a significantly lower level of insurance coverage for all
other potential claims relating to our products including DEXATRIM products
containing ephedrine. As of June 1, 2004, our product liability insurance
coverage for all of our other products, including DEXATRIM products
containing ephedrine, consists of $10,000 of self-insured coverage through
our captive insurance subsidiary, of which approximately $4,250 is
currently funded, and a total of $40,000 of excess coverage through third
party insurers.
We have been named as a defendant in one lawsuit alleging that the
plaintiff was injured as a result of the ingestion of DEXATRIM containing
ephedrine. We have been named in an additional lawsuit alleging that the
plaintiff was injured as a result of the ingestion of DEXATRIM Natural, but
the allegations do not indicate whether the DEXATRIM Natural contained
ephedrine. We intend to vigorously defend both of these lawsuits.
We previously were named in a class action filed in the United States
District Court for the Southern District of New York seeking certification
of a class consisting of New York residents who have purchased DEXATRIM
Results or DEXATRIM Natural since January 2000. The class action lawsuit
sought compensatory and punitive damages arising out of allegedly false
advertising in connection with the sale of DEXATRIM Results and DEXATRIM
Natural products. None of the plaintiffs in this action alleged personal
injury as a result of the ingestion of a DEXATRIM product. On March 29,
2004, a stipulation was submitted to the court dismissing the case on
jurisdictional grounds. Pursuant to the stipulation, the plaintiffs may
re-file the class action in New York state court.
On December 30, 2003, the United States Food and Drug Administration
("FDA") issued a consumer alert on the safety of dietary supplements
containing ephedrine alkaloids and on February 6, 2004 published a final
rule with respect to these products. The final rule prohibits the sale of
dietary supplements containing ephedrine alkaloids because such supplements
present an unreasonable risk of illness or injury. The final rule became
effective on April 11, 2004. Although we discontinued the manufacturing and
shipment of DEXATRIM containing ephedrine in September 2002, the FDA's
final rule may result in additional lawsuits being filed against us
alleging damages related to the use or purchase of DEXATRIM containing
ephedrine.
We have been named as a defendant in a putative class action suit
filed in the Superior Court of the State of California for the County of
Los Angeles. The lawsuit seeks certification of classes consisting of
residents of the United States, or residents of the State of California,
who have purchased our BULLFROG sun care products during the past four
years. The lawsuit seeks injunctive relief and compensatory damages under
the California Business and Professions Code against us arising out of
alleged deceptive, untrue or misleading advertising, and breach of
warranty, in connection with the manufacturing, labeling, advertising,
promotion and sale of BULLFROG products. The plaintiff has stipulated that
the amount in controversy with respect to plaintiffs' individual claim and
each member of the proposed class does not exceed $75. We filed an answer
on June 28, 2004 and intend to defend vigorously the lawsuit.
Other claims, suits and complaints arise in the ordinary course of our
business involving such matters as patents and trademarks, product
liability, environmental matters and other alleged injuries or damage. The
outcome of such litigation cannot be predicted, but, in the opinion of
management, based in part upon assessments from counsel, all such other
pending matters are without merit or are of such kind or involve such other
amounts as would not have a material adverse effect on our financial
position, results of operations or cash flows if disposed of unfavorably.
REGULATORY
The FDA, the Drug Enforcement Administration and a number of state and
local governments have enacted or proposed restrictions or prohibitions on
the sale of products that contain ephedrine. Ephedrine can refer to the
herbal substance derived from the plant ephedra or the plant heart leaf,
which, until September 2002, was used in the manufacturing of some forms of
DEXATRIM Natural and DEXATRIM Results, or synthetic ephedrine, an FDA
regulated ingredient used in some OTC drug products, which has not been
used in our products. These restrictions include the prohibition of OTC
sales, required warnings or labeling statements, record keeping and
reporting requirements, the prohibition of sales to minors, per transaction
limits on the quantity of product that may be purchased and limitations on
advertising and promotion.
16
In 1997, the FDA published a proposed rule on the use of dietary
supplements containing ephedrine alkaloids. In June 2002, the United States
Department of Health and Human Services ("HHS") proposed an expanded
scientific evaluation of ephedra which led to the issuance of a report by
the RAND-based Southern California Evidence-Based Practice Center (the
"RAND Report"). The RAND Report concluded that ephedrine, ephedrine plus
caffeine and ephedra-containing dietary supplements with or without herbs
containing caffeine all promote modest amounts of weight loss over the
short term and use of ephedra or ephedrine plus caffeine is associated with
an increased risk of gastrointestinal, psychiatric and autonomic symptoms.
The adverse event reports contained a smaller number of more serious
adverse events. Given the small number of such events, the RAND Report
concluded that further study would be necessary to determine whether
consumption of ephedra or ephedrine may be causally related to these
serious adverse events. In connection with the RAND Report, HHS sought
public comment on whether additional measures are required concerning the
sale and distribution of dietary supplements containing ephedrine
alkaloids.
On December 30, 2003, the FDA issued a consumer alert on the safety of
dietary supplements containing ephedrine alkaloids and on February 6, 2004
published a final rule with respect to these products. The final rule
prohibits the sale of dietary supplements containing ephedrine alkaloids
because such supplements present an unreasonable risk of illness or injury.
The final rule became effective on April 11, 2004. Although we discontinued
the manufacturing and shipment of DEXATRIM containing ephedrine in
September 2002, the FDA's final rule may result in additional lawsuits
being filed against us alleging damages related to the use or purchase of
DEXATRIM containing ephedrine.
We were notified in October 2000 that the FDA denied a citizen
petition submitted by Thompson Medical Company, Inc., the previous owner of
SPORTSCREME and ASPERCREME. The petition sought a determination that 10%
trolamine salicylate, the active ingredient in SPORTSCREME and ASPERCREME,
was clinically proven to be an effective active ingredient in external
analgesic OTC drug products and should be included in the FDA's yet-to-be
finalized monograph for external analgesics. We have met with the FDA and
submitted a proposed protocol study to evaluate the efficacy of 10%
trolamine salicylate as an active ingredient in OTC external analgesic drug
products. We are working to develop alternate formulations for SPORTSCREME
and ASPERCREME in the event that the FDA does not consider the available
clinical data to demonstrate conclusively the efficacy of trolamine
salicylate when the OTC external analgesic monograph is finalized. If 10%
trolamine salicylate is not included in the final monograph, we would
likely be required to discontinue these products as currently formulated
and remove them from the market after expiration of an anticipated grace
period. If this occurred, we believe we could still market these products
as homeopathic products and could also reformulate them using ingredients
included in the FDA monograph.
Certain of our topical analgesic products are currently marketed under
an FDA tentative final monograph. The FDA has proposed that the final
monograph exclude external analgesic products in patch, plaster, or
poultice form, unless the FDA receives additional data supporting the
safety and efficacy of these products. On October 14, 2003, we submitted to
the FDA information regarding the safety of our ICY HOT patches and
arguments to support our product's inclusion in the final monograph. We
have also participated in an industry effort coordinated by the Consumer
Healthcare Products Association ("CHPA") to establish with the FDA a
protocol of additional research that will allow the patches to be marketed
under the final monograph even if the final monograph does not explicitly
allow them. The CHPA submission to FDA was made on October 15, 2003. This
additional research may require a considerable amount of expensive testing
and data analysis by expert consultants. Some of this cost may be shared
with other patch manufacturers. We believe that the monograph is unlikely
to become final and take effect before November 2005. If neither action
described above is successful and the final monograph excludes such
products, we will have to file a new drug application ("NDA") in order to
continue to market the ICY HOT Patch or similar delivery systems under our
other topical analgesic brands. In such case, we would have to remove the
existing product from the market as of one year from the effective date of
the final monograph, pending FDA review and approval of an NDA. The
preparation of an NDA would likely take us six to 18 months and would be
expensive. It typically takes the FDA at least 12 months to rule on the NDA
once it is submitted.
We have responded to certain questions with respect to efficacy
received from the FDA in connection with clinical studies for pyrilamine
maleate, one of the active ingredients used in certain of the PAMPRIN and
PREMSYN PMS products. While we addressed all of the FDA questions in
detail, the final monograph for menstrual drug products, which has not yet
been issued, will determine if the FDA considers pyrilamine maleate safe
and effective for menstrual relief products. We have been actively
monitoring the process and do not believe that either PAMPRIN or PREMSYN
PMS will be materially adversely affected by the FDA review. We believe
that any adverse finding by the FDA would likewise affect our principal
competitors in the menstrual product category. We are also aware of the
FDA's concern about the potential toxicity due to concomitant use of OTC
and prescription drugs that contain the ingredient acetaminophen, an
ingredient also found in PAMPRIN and PREMSYN PMS. We are participating in
an industry-wide effort to reassure the FDA that the current recommended
dosing regimen is safe and effective and that proper labeling and public
education by both OTC and prescription drug companies are the best policies
to abate the FDA's concern. There can be no assurance as to what action, if
any, the FDA may take with respect to acetaminophen.
17
Our business is also regulated by the California Safe Drinking Water
and Toxic Enforcement Act of 1986, known as Proposition 65. Proposition 65
prohibits businesses from exposing consumers to chemicals that the state
has determined cause cancer or reproduction toxicity without first giving
fair and reasonable warning unless the level of exposure to the carcinogen
or reproductive toxicant falls below prescribed levels. From time to time,
one or more ingredients in our products could become subject to an inquiry
under Proposition 65. If an ingredient is on the state's list as a
carcinogen, it is possible that a claim could be brought, in which case we
would be required to demonstrate that exposure is below a "no significant
risk" level for consumers. Any such claims may cause us to incur
significant expense, and we may face monetary penalties or injunctive
relief, or both, or be required to reformulate our product to acceptable
levels. The State of California under Proposition 65 is also considering
the inclusion of titantium dioxide on the state's list of suspected
carcinogens. Titantium dioxide has a long history of widespread use as an
excipient in prescription and OTC pharmaceuticals, cosmetics, dietary
supplements and skin care products and is an active ingredient in our
BULLFROG Superblock products. We have participated in an industry-wide
submission to the State of California, facilitated through the CHPA,
presenting evidence that titantium dioxide presents "no significant risk"
to consumers.
19. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
--------------------------------------------
The condensed consolidating financial statements, for the dates or
periods indicated, of Chattem, Inc. ("Chattem"), Signal Investment &
Management Co. ("Signal"), SunDex, LLC ("SunDex") and Chattem (Canada)
Holdings, Inc. ("Canada"), the guarantors of the long-term debt of Chattem,
and the non-guarantor direct and indirect wholly-owned subsidiaries of
Chattem are presented below. Signal is 89% owned by Chattem and 11% owned
by Canada. SunDex and Canada are wholly-owned subsidiaries of Chattem. The
guarantees of Signal, SunDex and Canada are full and unconditional and
joint and several. The guarantees of Signal, SunDex and Canada as of May
31, 2004 arose in conjunction with Chattem's issuance of the Revolving
Credit Facility, the Floating Rate Notes and the 7.0% Subordinated Notes
(See Note 12). The maximum amount of future payments the guarantors would
be required to make under the guarantees as of May 31, 2004 is $200,000.
18
Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
MAY 31, 2004
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------ ------------
ASSETS
- ------
CURRENT ASSETS:
Cash and cash equivalents $ 318 $ 2,574 $ 7,998 $ -- $ 10,890
Accounts receivable, less allowances of
$4,034 34,369 13,370 4,688 (13,370) 39,057
Interest receivable -- 619 -- (619) --
Inventories 13,854 2,291 2,694 -- 18,839
Refundable income taxes 6,533 -- 36 -- 6,569
Deferred income taxes 1,152 -- -- -- 1,152
Prepaid expenses and other current assets 1,098 -- 163 (166) 1,095
------------ ------------ ------------ ------------ ------------
Total current assets 57,324 18,854 15,579 (14,155) 77,602
------------ ------------ ------------ ------------ ------------
PROPERTY, PLANT AND EQUIPMENT, NET 27,182 775 331 -- 28,288
------------ ------------ ------------ ------------ ------------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased
product rights, net 908 307,099 -- (62,290) 245,717
Debt issuance costs, net 5,532 -- -- -- 5,532
Investment in subsidiaries 251,534 33,000 66,024 (350,558) --
Note receivable -- 33,000 -- (33,000) --
Other 3,559 -- 500 -- 4,059
------------ ------------ ------------ ------------ ------------
Total other noncurrent assets 261,533 373,099 66,524 (445,848) 255,308
------------ ------------ ------------ ------------ ------------
TOTAL ASSETS $ 346,039 $ 392,728 $ 82,434 $ (460,003) $ 361,198
============ ============ ============ ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable and other $ 8,552 $ -- $ 1,253 $ -- $ 9,805
Accrued liabilities 25,398 1,795 1,957 (14,155) 14,995
------------ ------------ ------------ ------------ ------------
Total current liabilities 33,950 1,795 3,210 (14,155) 24,800
------------ ------------ ------------ ------------ ------------
LONG-TERM DEBT 200,000 -- 33,000 (33,000) 200,000
------------ ------------ ------------ ------------ ------------
DEFERRED INCOME TAXES 452 29,319 (46) -- 29,725
------------ ------------ ------------ ------------ ------------
OTHER NONCURRENT LIABILITIES 1,746 -- -- -- 1,746
------------ ------------ ------------ ------------ ------------
INTERCOMPANY ACCOUNTS 4,964 (7,309) 2,345 -- --
------------ ------------ ------------ ------------ ------------
SHAREHOLDERS' EQUITY:
Preferred shares, without par value,
authorized 1,000, none issued -- -- -- -- --
Common shares, without par value,
authorized 50,000, issued 19,557 81,410 -- -- -- 81,410
Share capital of subsidiaries -- 330,586 38,647 (369,233) --
Retained earnings 28,809 38,337 5,496 (43,833) 28,809
------------ ------------ ------------ ------------ ------------
Total 110,219 368,923 44,143 (413,066) 110,219
------------ ------------ ------------ ------------ ------------
Unamortized value of restricted common
shares issued (2,951) -- -- -- (2,951)
Cumulative other comprehensive income:
Foreign currency translation adjustment (701) -- (218) 218 (701)
Minimum pension liability adjustment,
net of income taxes (1,640) -- -- -- (1,640)
------------ ------------ ------------ ------------ ------------
Total shareholders' equity 104,927 368,923 43,925 (412,848) 104,927
------------ ------------ ------------ ------------ ------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 346,039 $ 392,728 $ 82,434 $ (460,003) $ 361,198
============ ============ ============ ============ ============
19
Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
NOVEMBER 30, 2003
(In thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------ ------------
ASSETS
- ------
CURRENT ASSETS:
Cash and cash equivalents $ 18,702 $ 1,964 $ 6,265 $ -- $ 26,931
Accounts receivable, less allowances of
$3,594 21,729 7,089 3,749 (7,089) 25,478
Inventories 12,670 2,040 2,849 -- 17,559
Refundable income taxes 4,414 -- 17 -- 4,431
Deferred income taxes 3,441 -- -- -- 3,441
Prepaid expenses and other current assets 4,401 -- 142 (1,167) 3,376
------------ ------------ ------------ ------------ ------------
Total current assets 65,357 11,093 13,022 (8,256) 81,216
------------ ------------ ------------ ------------ ------------
PROPERTY, PLANT AND EQUIPMENT, NET 27,595 775 352 -- 28,722
------------ ------------ ------------ ------------ ------------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased
product rights, net 1,057 307,080 -- (62,290) 245,847
Debt issuance costs, net 5,504 -- -- -- 5,504
Investment in subsidiaries 235,928 -- -- (235,928) --
Other 1,596 -- 500 -- 2,096
------------ ------------ ------------ ------------ ------------
Total other noncurrent assets 244,085 307,080 500 (298,218) 253,447
------------ ------------ ------------ ------------ ------------
TOTAL ASSETS $ 337,037 $ 318,948 $ 13,874 $ (306,474) $ 363,385
============ ============ ============ ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Current maturities of long-term debt $ 7,750 $ -- $ -- $ -- $ 7,750
Accounts payable and other 9,804 -- 1,120 -- 10,924
Accrued liabilities 21,417 628 2,190 (8,256) 15,979
------------ ------------ ------------ ------------ ------------
Total current liabilities 38,971 628 3,310 (8,256) 34,653
------------ ------------ ------------ ------------ ------------
LONG-TERM DEBT, less current maturities 204,676 -- -- -- 204,676
------------ ------------ ------------ ------------ ------------
DEFERRED INCOME TAXES 56 26,788 (48) -- 26,796
------------ ------------ ------------ ------------ ------------
OTHER NONCURRENT LIABILITIES 1,689 -- -- -- 1,689
------------ ------------ ------------ ------------ ------------
INTERCOMPANY ACCOUNTS (3,926) 3,469 457 -- --
------------ ------------ ------------ ------------ ------------
SHAREHOLDERS' EQUITY:
Preferred shares, without par value,
authorized 1,000, none issued -- -- -- -- --
Common shares, without par value,
authorized 50,000, issued 19,161 77,815 -- -- -- 77,815
Share capital of subsidiaries -- 263,704 6,504 (270,208) --
Retained earnings 22,274 24,359 3,998 (28,357) 22,274
------------ ------------ ------------ ------------ ------------
Total 100,089 288,063 10,502 (298,565) 100,089
------------ ------------ ------------ ------------ ------------
Unamortized value of restricted common
shares issued (2,058) -- -- -- (2,058)
Cumulative other comprehensive income:
Foreign currency translation adjustment (820) -- (347) 347 (820)
Minimum pension liability adjustment,
net of income taxes (1,640) -- -- -- (1,640)
------------ ------------ ------------ ------------ ------------
Total shareholders' equity 95,571 288,063 10,155 (298,218) 95,571
------------ ------------ ------------ ------------ ------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 337,037 $ 318,948 $ 13,874 $ (306,474) $ 363,385
============ ============ ============ ============ ============
20
Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
FOR THE SIX MONTHS ENDED MAY 31, 2004
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------ ------------
TOTAL REVENUES $ 104,264 $ 38,417 $ 8,942 $ (20,294) $ 131,329
------------ ------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Cost of sales 29,428 5,698 3,574 (1,192) 37,508
Advertising and promotion 28,903 6,427 2,282 -- 37,612
Selling, general and administrative 20,234 216 856 -- 21,306
Settlement and administrative costs of
PPA litigation 3,657 -- -- -- 3,657
Equity in subsidiary income (15,476) -- -- 15,476 --
------------ ------------ ------------ ------------ ------------
Total costs and expenses 66,746 12,341 6,712 14,284 100,083
------------ ------------ ------------ ------------ ------------
INCOME FROM OPERATIONS 37,518 26,076 2,230 (34,578) 31,246
------------ ------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest expense (8,394) -- (1,238) 1,238 (8,394)
Investment and other income, net 94 1,240 689 (1,863) 160
Loss on early extinguishment of debt (12,958) -- -- -- (12,958)
Royalties (15,988) (3,114) -- 19,102 --
Corporate allocations 1,791 (1,731) (60) -- --
------------ ------------ ------------ ------------ ------------
Total other income (expense) (35,455) (3,605) (609) 18,477 (21,192)
------------ ------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 2,063 22,471 1,621 (16,101) 10,054
------------ ------------ ------------ ------------ ------------
(BENEFIT FROM) PROVISION FOR INCOME TAXES (4,472) 7,865 126 -- 3,519
------------ ------------ ------------ ------------ ------------
NET INCOME $ 6,535 $ 14,606 $ 1,495 $ (16,101) $ 6,535
============ ============ ============ ============ ============
21
Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED MAY 31, 2003
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------ ------------
TOTAL REVENUES $ 90,971 $ 26,973 $ 10,505 $ (6,391) $ 122,058
------------ ------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Cost of sales 25,934 5,889 4,231 (650) 35,404
Advertising and promotion 28,824 4,816 3,294 -- 36,934
Selling, general and administrative 18,938 144 1,129 -- 20,211
Equity in subsidiary income (10,424) -- -- 10,424 --
------------ ------------ ------------ ------------ ------------
Total costs and expenses 63,272 10,849 8,654 9,774 92,549
------------ ------------ ------------ ------------ ------------
INCOME FROM OPERATIONS 27,699 16,124 1,851 (16,165) 29,509
------------ ------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest expense (10,374) -- -- -- (10,374)
Investment and other income, net 69 2 16 -- 87
Royalties (4,463) (1,069) (209) 5,741 --
Corporate allocations 1,974 (1,918) (56) -- --
------------ ------------ ------------ ------------ ------------
Total other income (expense) (12,794) (2,985) (249) 5,741 (10,287)
------------ ------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 14,905 13,139 1,602 (10,424) 19,222
PROVISION FOR INCOME TAXES 2,795 4,030 287 -- 7,112
------------ ------------ ------------ ------------ ------------
NET INCOME $ 12,110 $ 9,109 $ 1,315 $ (10,424) $ 12,110
============ ============ ============ ============ ============
22
Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MAY 31, 2004
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------ ------------
OPERATING ACTIVITIES:
Net income $ 6,535 $ 14,606 $ 1,495 $ (16,101) $ 6,535
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 3,028 -- 44 -- 3,072
Deferred income taxes 2,687 2,529 2 -- 5,218
Tax benefit realized from stock option
exercises 2,504 -- -- -- 2,504
Loss on early extinguishment of debt 12,958 -- -- -- 12,958
Other, net 33 -- 16 -- 49
Equity in subsidiary income (16,101) -- -- 16,101 --
Changes in operating assets and
liabilities:
Accounts receivable (12,640) (6,280) (939) 6,280 (13,579)
Interest receivable -- (619) -- 619 --
Inventories (1,183) (251) 154 -- (1,280)
Refundable income taxes (2,119) -- (19) -- (2,138)
Prepaid expenses and other current assets 3,317 -- (22) (1,000) 2,295
Accounts payable and accrued liabilities 2,729 1,167 (100) (5,899) (2,103)
------------ ------------ ------------ ------------ ------------
Net cash provided by operating activities 1,748 11,152 631 -- 13,531
------------ ------------ ------------ ------------ ------------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (1,232) -- (8) -- (1,240)
Purchases of patents, trademarks and other
product rights -- (19) -- -- (19)
Increase in note receivable -- (33,000) -- 33,000 --
(Increase) decrease in other assets, net (818) -- 117 -- (701)
------------ ------------ ------------ ------------ ------------
Net cash (used in) provided by
investing activities (2,050) (33,019) 109 33,000 (1,960)
------------ ------------ ------------ ------------ ------------
FINANCING ACTIVITIES:
Repayment of long-term debt (212,288) -- -- -- (212,288)
Proceeds from long-term debt 200,000 -- -- -- 200,000
Proceeds from borrowings under revolving 25,000 -- -- -- 25,000
credit facility
Payments of revolving credit facility (25,000) -- -- -- (25,000)
Proceeds from exercise of stock options 2,880 -- -- -- 2,880
Repurchase of common shares (3,234) -- -- -- (3,234)
Increase in debt issuance costs (5,718) -- -- -- (5,718)
Retirement of debt issuance costs (7,861) -- -- -- (7,861)
Premium on interest rate cap agreement (1,375) -- -- -- (1,375)
Intercompany debt proceeds, net -- -- 33,000 (33,000) --
Changes in intercompany accounts 9,514 23,102 (32,616) -- --
Dividends paid -- (625) 625 -- --
------------ ------------ ------------ ------------ ------------
Net cash (used in) provided by
financing activities (18,082) 22,477 1,009 (33,000) (27,596)
------------ ------------ ------------ ------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH
AND CASH EQUIVALENTS -- -- (16) -- (16)
------------ ------------ ------------ ------------ ------------
CASH AND CASH EQUIVALENTS:
(Decrease) increase for the period (18,384) 610 1,733 -- (16,041)
At beginning of period 18,702 1,964 6,265 -- 26,931
------------ ------------ ------------ ------------ ------------
At end of period $ 318 $ 2,574 $ 7,998 $ -- $ 10,890
============ ============ ============ ============ ============
23
Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MAY 31, 2003
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------ ------------
OPERATING ACTIVITIES:
Net income $ 12,110 $ 9,109 $ 1,315 $ (10,424) $ 12,110
Adjustments to reconcile net income to
net cash (used in) provided by
operating activities:
Depreciation and amortization 2,947 -- 74 -- 3,021
Deferred income taxes 177 3,597 -- -- 3,774
Tax benefit realized from stock
option exercises 199 -- -- -- 199
Other, net (119) -- 3 -- (116)
Equity in subsidiary income (10,424) -- -- 10,424 --
Changes in operating assets and
liabilities:
Accounts receivable (6,427) -- (97) -- (6,524)
Inventories (1,778) 337 (207) -- (1,648)
Refundable income taxes 242 -- -- -- 242
Prepaid expenses and other current
assets 1,031 -- 205 -- 1,236
Accounts payable and accrued
liabilities (43) -- 125 -- 82
------------ ------------ ------------ ------------ ------------
Net cash (used in) provided by
operating activities (2,085) 13,043 1,418 -- 12,376
------------ ------------ ------------ ------------ ------------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (2,446) -- (120) -- (2,566)
Purchase of patents, trademarks and other
product rights (8) (300) -- -- (308)
Decrease (increase) in other assets, net 599 -- (310) -- 289
------------ ------------ ------------ ------------ ------------
Net cash used in investing activities (1,855) (300) (430) -- (2,585)
------------ ------------ ------------ ------------ ------------
FINANCING ACTIVITIES:
Repayment