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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 2004
COMMISSION FILE NUMBER 0-5905
CHATTEM, INC.
A TENNESSEE CORPORATION
IRS EMPLOYER IDENTIFICATION NO. 62-0156300
1715 WEST 38TH STREET
CHATTANOOGA, TENNESSEE 37409
TELEPHONE: 423-821-4571
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
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NONE NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, WITHOUT PAR VALUE
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
ACT).
DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405 OF REGULATION S-K
IS NOT CONTAINED HEREIN AND WILL NOT BE CONTAINED IN THE DEFINITIVE PROXY
STATEMENT INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K.
AS OF MAY 31, 2004, THE AGGREGATE MARKET VALUE OF VOTING SHARES HELD BY
NON-AFFILIATES WAS $346,933,084. FOR PURPOSES OF THIS COMPUTATION, ALL EXECUTIVE
OFFICERS, DIRECTORS AND FIVE PERCENT OR MORE BENEFICIAL OWNERS OF THE COMMON
STOCK OF THE REGISTRANT HAVE BEEN DEEMED TO BE AFFILIATES OF THE REGISTRANT.
SUCH DETERMINATION SHALL NOT BE DEEMED TO BE AN ADMISSION THAT SUCH OFFICERS,
DIRECTORS OR FIVE PERCENT OR MORE OWNERS ARE IN FACT AFFILIATES OF THE
REGISTRANT. AS OF FEBRUARY 7, 2005, 19,835,416 SHARES OF COMMON STOCK WERE
OUTSTANDING.
DOCUMENTS INCORPORATED BY REFERENCE:
PORTIONS OF THE REGISTRANT'S DEFINITIVE PROXY STATEMENT EXPECTED TO BE
DATED MARCH 4, 2005 RELATING TO THE REGISTRANT'S 2005 ANNUAL MEETING OF
SHAREHOLDERS (THE "2005 PROXY STATEMENT") ARE INCORPORATED BY REFERENCE IN PART
III OF THIS FORM 10-K.
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1
PART I
ITEM 1. BUSINESS
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Except as otherwise indicated, all references in this Form 10-K to
"we", "us", "our" or "Chattem" refer to Chattem, Inc. and our subsidiaries. In
addition, in this Form 10-K, our fiscal years ended November 30, 2002, November
30, 2003 and November 30, 2004 are referred to as fiscal 2002, fiscal 2003 and
fiscal 2004, respectively, and our fiscal year ending on November 30, 2005 is
referred to as fiscal 2005. Also in this Form 10-K, all share amounts reflect
the two-for-one split of our common stock on November 29, 2002. Brand names that
are capitalized in this Form 10-K refer to trademarks that we own or license.
GENERAL
We are a leading marketer and manufacturer of a broad portfolio of
branded over-the-counter ("OTC") healthcare products, toiletries and dietary
supplements including such categories as topical analgesics, medicated skin care
products, medicated dandruff shampoos and conditioner, dietary supplements and
other OTC and toiletry products. Our portfolio of products includes
well-recognized brands such as:
o Topical analgesics such as ICY HOT and ASPERCREME;
o Medicated skin care products such as GOLD BOND medicated skin
care powder, cream, lotion, first aid and foot care products;
and PHISODERM medicated acne treatment products and skin
cleansers;
o SELSUN BLUE medicated dandruff shampoos and conditioner;
o Dietary supplements including DEXATRIM, GARLIQUE and NEW PHASE; and
o Other OTC and toiletry products such as PAMPRIN, a menstrual
analgesic; HERPECIN-L, a lip care product; BENZODENT, a dental
analgesic cream; and toiletries such as BULLFROG, a line of
sunblocks; ULTRASWIM, a chlorine-removing shampoo; and SUN-IN, a
hair lightener.
Our products target niche markets that are often outside the core
product areas of larger companies where we believe we can achieve and sustain
significant market penetration through strong advertising and promotion support.
Many of our products are among the U.S. market leaders in their respective
categories. For example, our portfolio of topical analgesic brands and our GOLD
BOND medicated body powders have the leading U.S. market share in these
categories. We support our brands through extensive and cost-effective
advertising and promotion, the expenditures for which represented approximately
29% of our total revenues in fiscal 2004. We sell our products nationally
through mass merchandiser, drug and food channels, principally utilizing our own
sales force.
Our experienced management team has grown our business by developing
product line extensions, increasing market penetration of our existing products
and acquiring brands. In March 2002, we acquired the SELSUN BLUE line of
medicated dandruff shampoos, expanding our brand portfolio into another
attractive niche category. We will continue to seek opportunities to acquire
attractive brands in niche markets such as SELSUN BLUE. We intend to drive
growth through strong marketing and promotional programs, new product
development, acquisitions of new brands, development of strategic marketing
alliances and expansion of our international business.
COMPETITIVE STRENGTHS
We believe that the following key competitive strengths are critical to
our continuing success:
DIVERSE AND BROAD PORTFOLIO OF WELL-RECOGNIZED BRANDED PRODUCTS. We
currently market a diverse and broad portfolio of 23 brands in a variety of
different product categories, including topical analgesics, medicated dandruff
shampoos and conditioner, skin care products, toiletries and dietary
supplements. Our products are marketed under well-recognized brand names, such
as our portfolio of topical analgesic brands ICY HOT, ASPERCREME, FLEXALL,
SPORTSCREME, CAPZASIN and ARTHRITIS HOT, as well as GOLD BOND, SELSUN BLUE,
PHISODERM, DEXATRIM and GARLIQUE. Our presence in diverse product categories
allows us to reduce our exposure to changing consumer demand or weakness in any
single category.
SIGNIFICANT PRESENCE IN NICHE MARKETS. We acquire and develop brands
that compete in niche markets where we believe we can achieve significant market
presence and build brand equity. Our products often face less competitive
pressures, because we focus on niche markets that are frequently outside the
core product areas of larger consumer products and
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pharmaceutical companies. Our focus on niche markets provides us with the
opportunity to develop strong brand equity, identify and respond to consumer
trends in these markets and leverage our strong selling and distribution
capabilities.
HIGH MARGINS AND EFFICIENT OPERATING STRUCTURE. In each of the past
three fiscal years, our gross margins have exceeded 70%. We are able to achieve
these high gross margins as a result of our ability to build and maintain brand
equity, our significant market presence in niche markets and efficiencies in
purchasing, manufacturing and distribution. In addition, we tightly control our
expenses, which strengthens our operating margins. Our high margins and
resulting strong cash flow allow us to weather temporary fluctuations in our
product markets that could otherwise more adversely affect our business.
PROVEN ADVERTISING AND PROMOTION STRATEGY. We aggressively seek to
build brand awareness and usage of our larger brands through extensive and
cost-effective advertising strategies that emphasize the competitive strengths
of our products. We rely principally on television and radio advertising and to
a lesser extent print advertising and promotional programs. We strive to achieve
cost-efficiencies in our advertising by being opportunistic in our purchase of
media and controlling our production costs. We also maintain the flexibility to
allocate purchased media time among our key brands to respond quickly to
changing consumer trends and to support our growing brands. We believe our
well-developed advertising and promotion platform allows us to quickly and
efficiently launch and support newly acquired brands and product line
extensions, as well as increase market penetration of existing brands.
Advertising and promotion expenditures represented approximately 29% of our
total revenues in fiscal 2004. Given the importance of our products' brand
equity, we expect to maintain a significant level of spending on advertising and
promotion.
ESTABLISHED NATIONAL SALES AND DISTRIBUTION NETWORK. We have an
established national sales and distribution network that sells to mass
merchandiser, drug and food retailers such as Wal-Mart Stores, Inc., Walgreen
Co. and The Kroger Co. In fiscal 2004, sales to our top ten customers
constituted approximately 68% of our total sales, which allows us to target our
selling efforts to our key customers and tailor specific programs to meet their
needs. Through targeted sales and by utilizing our established network,
including our approximately 55 person sales force, we believe we can effectively
sell and distribute newly acquired brands and product line extensions while
maintaining tight controls over our selling expenses.
FOCUSED NEW PRODUCT DEVELOPMENT. We strive to increase the value of our
base brands while obtaining an increased market presence through product line
extensions, which is demonstrated by our $3.1 million investment in product
development in fiscal 2004. In fiscal 2003, we completed a new 10,000 square
foot research and development facility and expanded our product development
staff. We rely on internal market research as well as consultants to identify
new product formulations and line extensions that we believe appeal to the needs
of consumers. Recent examples of successful product line extensions include GOLD
BOND ULTIMATE Healing Skin Therapy Lotion and the ICY HOT Medicated Sleeve.
ENHANCED FINANCIAL POSITION. We have strengthened our balance sheet as
a significant portion of our cash flows in fiscal 2004, 2003 and 2002 have been
used to reduce our debt. For example, since the acquisition of SELSUN BLUE in
March 2002, we have paid down approximately $49.5 million in debt as of November
30, 2004. In addition, we completed a debt refinancing transaction in February
2004 that generated a reduction of interest expense of approximately $5.5
million in fiscal 2004. Our total debt outstanding as of November 30, 2004 was
$200.0 million. We also believe that our financial risk profile has been
substantially reduced due to the successful integration of our acquisition of
SELSUN BLUE and strong positive cash flow.
BUSINESS STRATEGY
Our strategy to achieve future growth is to generate new sales through
strong marketing and promotional programs, new product development, acquisitions
of new brands, development of strategic marketing alliances and expansion of our
international business.
BRAND MANAGEMENT AND GROWTH. We will seek to increase market share for
our major brands through focused marketing of our existing products and product
line extensions while maintaining market share for our smaller brands. Our
marketing strategy is to position our products to meet consumer preferences
identified through extensive use of market and consumer research. We intend to
channel advertising and promotion resources to those brands that we feel exhibit
the most potential for growth. We also intend to increase our new product line
extension activities as evidenced by the expansion of our product development
staff and our completed construction of a new research and product development
facility. In addition, we continually evaluate the profit potential of and
markets for our brands and, in instances where our objectives are not realized,
will dispose of these under-performing brands and redeploy the resulting cash
assets. For example, in fiscal 2000, we sold the Ban(R) (a registered trademark
of Kao Corporation) product line of antiperspirants and deodorants in response
to major shifts in the competitive environment in this product category and the
resulting prospect of declining sales.
STRATEGIC ACQUISITIONS AND MARKETING ALLIANCES. We intend to identify
and acquire brands in niche markets where we believe we can achieve a
significant market presence through our established advertising and promotion
platform, sales and
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distribution network and research and development capabilities. We target brands
with sales that are highly responsive to increased advertising support, provide
an opportunity for product line extensions through our research and development
efforts and have the potential to meet our high gross margin goals. We will
continue to seek opportunities to acquire attractive brands in niche markets.
Additionally, we intend to seek alliances that leverage complementary strengths.
EXPANSION OF INTERNATIONAL BUSINESS. In fiscal 2004, our international
revenues were $24.2 million, or approximately 9% of total revenues. We believe
that our acquisition of SELSUN BLUE, which is marketed internationally as
SELSUN, and our hiring of experienced international personnel may allow us to
expand our international presence. We plan to focus our efforts on expanding
SELSUN'S international presence in existing key markets, such as Canada, Mexico,
Brazil, the United Kingdom ("U.K.") and Australia, as well as new markets in
Central Europe and the Middle East. We also intend to continue to leverage
SELSUN's international marketing and distribution network to attempt to launch
certain of our other brands in countries where they are not currently sold.
DEVELOPMENTS DURING FISCAL 2004
Fiscal 2004 was highlighted by the development and marketing of new
product line extensions; the refinancing of our indebtedness; the class action
settlement of all claims relating to DEXATRIM containing phenylpropanolamine
("PPA"); and the continued development of our international business,
principally our SELSUN product line.
In fiscal 2004, we introduced the following product line extensions:
the ICY HOT Medicated Sleeve, DEXATRIM All in One bar, SELSUN BLUE Conditioner,
PAMPRIN All Day, BULLFROG SuperBlock Spray Lotion, PHISODERM Clear Confidence
Self Heating Daily Scrub and Herbal Astringent and GOLD BOND Therapeutic Foot
Cream.
On February 26, 2004, we issued and sold $75.0 million of Floating Rate
Senior Notes due March 1, 2010 (the "Floating Rate Notes") and $125.0 million of
7.0% Senior Subordinated Notes due March 1, 2014 (the "7.0% Subordinated
Notes"), the proceeds of which were used to purchase all of our outstanding
8.875% senior subordinated notes and repay the outstanding debt under our prior
credit facility.
Also, on February 26, 2004, we entered into a new Senior Secured
Revolving Credit Facility (the "Revolving Credit Facility") 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 $50.0 million under the Revolving Credit Facility.
On April 13, 2004, we entered into a class action settlement agreement
with representatives of the plaintiffs' settlement class, which provided for a
national class action settlement of all DEXATRIM PPA claims, both federal and
state. On November 12, 2004, Judge Barbara J. Rothstein of the United States
District Court for the Western District of Washington entered a final order and
judgment certifying the class and granting approval of the DEXATRIM PPA
settlement.
At the end of fiscal 2004, we had completed the transition of SELSUN'S
international manufacturing and marketing operations from its prior owner,
Abbott Laboratories ("Abbott"), to us in approximately 80 foreign countries,
including markets whose combined sales represent approximately 94% of SELSUN
international sales. Abbott will continue to manufacture SELSUN for us for the
European, Middle East and certain Latin American markets for an additional
period ending July 2005 and will also serve as our distributor for SELSUN in
certain other foreign countries.
RECENT DEVELOPMENTS
On December 13, 2004, we entered into a term sheet of settlement with
Interstate Fire & Casualty Company ("Interstate") with regard to Interstate's
lawsuit to rescind its $25.0 million of excess coverage for product liability
claims relating to DEXATRIM products containing PPA. In accordance with the term
sheet of settlement, Interstate will provide coverage of DEXATRIM PPA claims
that are covered by its policy after $78.5 million has been paid toward covered
claims. Once the $78.5 million threshold is met, Interstate will pay 100% of the
next $4.0 million of claims covered by its policy; 75% of the next $8.5 million
of such claims; and 50% of the last $12.5 million of such claims. We are
responsible for any claims not covered by the Interstate policy either because
the alleged injury did not occur before May 31, 2001, or the claim was first
made against us after May 31, 2004. In addition, under the term sheet of
settlement, we and Interstate will dismiss all claims and counterclaims filed
against each other, and we will release all claims against Interstate relating
to the excess coverage product liability insurance.
4
PRODUCTS
We currently market a diverse and broad portfolio of branded OTC
healthcare products, toiletries and dietary supplements in such categories as
topical analgesics, medicated skin care products, medicated dandruff shampoos,
dietary supplements and other OTC and toiletry products. Our branded products by
category consist of:
CATEGORY AND BRANDS PRODUCT DESCRIPTION
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TOPICAL ANALGESICS
ICY HOT Dual action muscular and arthritis pain
reliever
ASPERCREME Odor-free arthritis pain reliever
FLEXALL Aloe-vera based pain reliever
CAPZASIN Deep penetrating, odor-free arthritis pain
reliever
SPORTSCREME Odor-free muscular pain reliever
ARTHRITIS HOT Value-priced arthritis pain reliever
MEDICATED SKIN CARE PRODUCTS
GOLD BOND Medicated powder, cream, lotion, first aid
and foot care products
PHISODERM Medicated acne treatment products and skin
cleansers
MEDICATED DANDRUFF SHAMPOOS
SELSUN BLUE Medicated dandruff shampoos and conditioner
DIETARY SUPPLEMENTS
DEXATRIM Diet pills and bars
GARLIQUE Cholesterol health supplement
MELATONEX Sleep aid
NEW PHASE Menopausal supplement
REJUVEX Menopausal supplement
OMNIGEST EZ Digestive aid
OTHER OTC AND TOILETRY PRODUCTS
INTERNAL ANALGESICS
PAMPRIN Menstrual pain reliever
PREMSYN PMS Premenstrual pain reliever
SEASONAL
BULLFROG Sunscreens and sunblocks
SUN-IN Spray-on hair lightener
ULTRASWIM Chlorine-removing shampoo
ORAL CARE
HERPECIN-L Cold sore lip balm
BENZODENT Denture pain relief cream
OTHER
MUDD Facial deep cleanser
TOPICAL ANALGESICS
Our topical analgesic portfolio experienced significant growth in
fiscal 2004 led by six distinctly positioned brands and the successful ICY HOT
Sleeve introduction. Our flagship brand, ICY HOT, achieved category leadership
behind the continued strength of our ICY HOT Patch business and the incremental
volume generated by the ICY HOT Sleeve. Developed by us with a patent pending,
the ICY HOT Sleeve is designed to provide flexible, joint hugging pain relief to
the knee, elbow, wrist and ankle. The ICY HOT Sleeve received heavy media
support and advertising featuring NBA super-star Shaquille O'Neal.
ASPERCREME provides odor-free pain relief for sufferers of arthritis
and other joint and muscle pain. In the first quarter of fiscal 2005, we will
launch a maximum strength, odor-free patch under our ASPERCREME brand. The
ASPERCREME Back and Body Patch will provide arthritis sufferers an odor-free
alternative in the growing patch segment. CAPZASIN is an arthritis pain reliever
that contains capsaicin, the active ingredient that doctors recommend most for
arthritis sufferers. SPORTSCREME is targeted at serious athletes as well as
"weekend warriors". FLEXALL is marketed toward those who seek an aloe-vera based
pain reliever for
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conditions such as chronic back pain or muscle strain. ARTHRITIS HOT rounds out
the portfolio and is positioned against private label products at a value price.
We support our topical analgesic brands with extensive national
television and radio advertising as well as targeted consumer promotions.
MEDICATED SKIN CARE PRODUCTS
The GOLD BOND brand competes in numerous product categories with
specially formulated products for both adults and babies including body powder,
foot care, first aid and therapeutic hand and body lotions. GOLD BOND has long
been the number one selling brand of medicated body powder domestically, and its
strong brand equity among consumers has allowed us to successfully launch new
line extensions, most recently under the GOLD BOND ULTIMATE line.
In the third quarter of fiscal 2003, we launched GOLD BOND ULTIMATE
Healing Skin Therapy Lotion in a 5.5 oz. tube. In the third quarter of fiscal
2004, we added a 14 oz. pump to the product line, which enjoyed broad acceptance
by retailers given the success of the original 5.5 oz. size. GOLD BOND ULTIMATE
Healing Skin Therapy Lotion helps to heal and nurture extremely dry, cracked and
irritated skin with seven intensive moisturizers plus vitamins A, C & E. The
GOLD BOND ULTIMATE line will expand into the everyday bath powder category with
the introduction of GOLD BOND ULTIMATE Comfort Body Powder during the first
quarter of fiscal 2005. GOLD BOND ULTIMATE Comfort Body Powder is a talc-free
powder that seeks to provide freshness, odor protection and moisture control and
features the signature ULTIMATE fragrance. During the first quarter of fiscal
2004, we also expanded our presence in the foot care category with the
successful launch of GOLD BOND Therapeutic Foot Cream, an intensive moisturizing
treatment that helps heal dry, rough and cracked heels and feet.
The GOLD BOND product line is heavily supported by national television,
print and radio advertising throughout most of the year as well as with proven
consumer promotions such as sampling and coupons to further drive awareness and
trial. We believe GOLD BOND continues to represent a solid opportunity for
growth both through our existing medicated product lines and the introduction of
line extensions under the ULTIMATE line.
PHISODERM is a facial-care brand with an acne and adult line of
cleansers, scrubs and other differentiated products. The brand has a strong
heritage, but competes in the highly competitive adult facial care and teen acne
categories. In an effort to reverse declining sales over the past two years, in
fiscal 2005, the brand will focus its efforts behind an exciting new line of
products introduced as pH2O by PHISODERM. pH2O by PHISODERM is positioned to
leverage the strong brand heritage of PHISODERM with an updated entry into the
adult facial care category. We will support pH2O with national television, print
advertising and consumer promotions targeted to women aged 20 to 49 years old.
MEDICATED DANDRUFF SHAMPOOS
SELSUN BLUE'S domestic net sales have increased more than 50% since we
acquired the brand in March 2002. We attribute the resurgence of this 50 year
old medicated shampoo brand to the development and implementation of an
effective advertising approach, expansion of the brand's appeal to a broader
consumer base, increased media and promotional support and expanded
distribution. In total, virtually all aspects of the brand image have been
enhanced since 2002, including the product, packaging, advertising, media and
retail distribution.
SELSUN BLUE offers four formulations: medicated, with a unique cooling
clean feel; moisturizing, with aloe and moisturizers; 2-in-1, with a patented
conditioning system; and pH balanced for color treated hair. Each formula blends
the active medication (selenium sulfide) with extra hair care properties to
provide alternative formulas for individuals who need a medicated dandruff
shampoo.
We believe that growth opportunities remain for SELSUN BLUE both
domestically and internationally. We support the SELSUN BLUE line with extensive
national television and radio advertising as well as targeted consumer
promotions.
DIETARY SUPPLEMENTS
DEXATRIM, acquired in December 1998, is a leading brand in the diet
pill category. We currently offer two versions of DEXATRIM: DEXATRIM Natural, a
drug-free, all natural, dietary supplement available in green tea, caffeine-free
and extra energy versions, and DEXATRIM Results, a nutrition based weight
control product which contains vitamins, minerals and antioxidants. In 2004, we
introduced the DEXATRIM All in One diet bar, which seeks to combine the benefits
of a diet, energy and nutrition bar in one convenient product. The DEXATRIM All
in One bar is available in five flavors: Chocolate Toffee Crunch, White
Chocolate Raspberry, Lemon Bar Crisp, Chocolate Peanut Butter and Oatmeal
Cinnamon Crisp. In 2005, DEXATRIM will launch DEXATRIM
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Max, a diet pill containing Vitamin B Complex, Ginseng, Chromium and EGCG from
Green Tea. DEXATRIM Max will be introduced to consumers through television
advertising and Sunday newspaper coupons.
We compete in the dietary supplements category with our SUNSOURCE line
of products. We focus the marketing of our SUNSOURCE dietary supplements in two
key areas: cardiovascular and menopausal health. GARLIQUE garlic tablets support
cardiovascular health and are positioned as an odor-free, one-per-day supplement
now available in caplets. NEW PHASE is a menopausal supplement that helps
relieve the common discomforts of menopause, as well as providing support for
strong bones and a healthy heart. In the first quarter of 2005, we will extend
the NEW PHASE franchise with the launch of an extra strength formula that
contains more of the ingredient that helps relieve the common symptoms of
menopause and includes Green Tea for energy. All SUNSOURCE products are
specially formulated to provide consumers with an all-natural, drug-free way to
support their specific health care goals.
OTHER OTC AND TOILETRY PRODUCTS
INTERNAL ANALGESICS
We compete in the menstrual analgesic category with two brands, PAMPRIN
and PREMSYN PMS. PAMPRIN, featuring three distinct formulas, seeks to provide
complete relief of a woman's menstrual symptoms, while PREMSYN PMS has one
formula designed to address specific symptoms of premenstrual syndrome. The
target consumer for our menstrual analgesic business is women aged 18 to 49, and
secondarily teen girls as they first enter the category. For PAMPRIN in 2004, we
initiated a complete brand relaunch, which included streamlining the product
offering, new packaging to improve shelf presence and launching the first new
product line extension in ten years, PAMPRIN All Day. With naproxen sodium as
its active ingredient, PAMPRIN All Day seeks to provide up to 12 hours of relief
from cramps, backache and headache in one caplet. We supported the launch of
PAMPRIN All Day with a network, cable and spot television advertising campaign.
In addition to continued advertising support for PAMPRIN All Day, we will
support PAMPRIN Multi Symptom with television advertising in 2005.
SEASONAL
The majority of sales of our seasonal brands, BULLFROG, SUN-IN and
ULTRASWIM, typically occur during the first two quarters of the fiscal year.
BULLFROG is a line of high quality, high SPF waterproof sunblocks. We launched
SuperBlock Lotion Spray in 2004 to meet consumer demand for a spray lotion. In
2005, we will launch a complete line of childrens' sunblocks - BULLFROG Kids UV
Defender. All three formulas under the Kids UV Defender umbrella will stay true
to BULLFROG'S waterproof and high SPF heritage. The line will feature durable
gel, fast dry spray and spray lotion formulas. This launch will be supported
with print and radio advertising targeted towards mothers of children age 4 to
12. The base BULLFROG business will be supported with local and national radio
as well as through event sponsorships and targeted sampling programs. SUN-IN, a
hair lightener, is available in two varieties of spray-on and a highlighting gel
and is supported by print advertising in teen magazines, an interactive web site
and promotional prepacks. ULTRASWIM is our niche line of swimmers' shampoos and
conditioner. In addition to promotional prepacks, we support this brand through
print advertising targeted at competitive and fitness swimmers to communicate
that ULTRASWIM removes more chlorine from hair than ordinary shampoos.
ORAL CARE
Our oral care brands include HERPECIN-L, a lip care product that treats
cold sores and protects lips from the harmful rays of the sun, and BENZODENT, a
dental analgesic cream for pain related to dentures. We support HERPECIN-L with
national television advertising.
OTHER
Other brands include MUDD, a line of specialty masque products.
INTERNATIONAL BUSINESS
Our international business, which represented approximately 9% of our
total revenues in fiscal 2004, has been concentrated in Canada, an export market
driven from our operations in the U.K. and in international countries in which
SELSUN is sold.
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SELSUN INTERNATIONAL
We plan to focus our efforts on expanding SELSUN'S international
presence in existing key markets, such as Canada, Mexico, Brazil, the U.K. and
Australia, as well as new markets in Central Europe and the Middle East. We also
intend to leverage SELSUN'S international marketing and distribution network to
launch some of our other brands in countries where they are not currently being
sold including Brazil and Mexico. In certain international markets, we sell
SELSUN through a distributor and receive a royalty based on a percentage of
distributor sales. Abbott, from whom we acquired SELSUN in March 2002, will
continue to manufacture SELSUN for us for the European, Middle East and certain
Latin American markets for a period ending July 2005. Abbott will also continue
to serve as our distributor for SELSUN in certain foreign countries under
separate distribution agreements. We have entered into distributor agreements
with third party distributors for SELSUN in various international markets other
than Canada and the U.K. in which we engage national brokers.
EUROPE
Our European business is conducted through Chattem Global Consumer
Products Limited ("Chattem Global"), our newly established Irish subsidiary,
located in Limerick, Ireland, and prior to November 1, 2004 Chattem (U.K.)
Limited ("Chattem (U.K.)"), a wholly-owned subsidiary located in Basingstoke,
Hampshire, England. This unit also services distributors in various other
worldwide locations. Packaging and distribution operations are conducted
principally in Ireland with certain products sourced from our U.S. operations.
Chattem uses a national broker in the U.K., while distributors are used to
market and sell our products on the European continent and elsewhere. Our
products sold in Europe include SELSUN, SUN-IN, MUDD and ULTRASWIM. Cornsilk(R)
is sold by Chattem (U.K.) under a licensing arrangement with the owner of its
registered trademark, Del Laboratories, Inc. SPRAY BLOND Spray-In Hair lightener
is marketed only on the European continent. Certain of our OTC health care
products are sold by Chattem Global to customers in parts of Central Europe and
the Middle East.
CANADA
Chattem Canada, a wholly-owned subsidiary based in Mississauga,
Ontario, Canada, markets and distributes certain of our consumer products
throughout Canada. The manufacturing of these products is principally done in
our facilities in Chattanooga, Tennessee, while some packaging is done in
Mississauga. Chattem Canada utilizes a national broker for its sales efforts.
Brands marketed and sold in Canada include SELSUN, GOLD BOND, PAMPRIN, SUN-IN,
ULTRASWIM, PHISODERM, ASPERCREME, FLEXALL and DEXATRIM.
UNITED STATES EXPORT
Our United States export division services various distributors
primarily located in Europe, the Caribbean and Latin America. We distribute
SELSUN, GOLD BOND, DEXATRIM, PHISODERM and certain of our topical analgesic
products into these markets.
MARKETING, SALES AND DISTRIBUTION
ADVERTISING AND PROMOTION
We aggressively seek to build brand awareness and usage through
extensive and cost effective advertising strategies that emphasize the strengths
of our products. We allocate a significant portion of our revenues to the
advertising and promotion of our products. Expenditures for these purposes were
approximately 29% of total revenues in fiscal 2004.
We will seek to increase market share for our major brands through
focused marketing of our existing products and product line extensions while
maintaining market share for our smaller brands. Our marketing strategy is to
position our products to meet consumer preferences identified through extensive
use of market and consumer research. We intend to channel advertising and
promotion resources to those brands that we feel exhibit the most potential for
growth. We rely principally on television and radio advertising and to a lesser
extent print advertising and promotional programs. We strive to achieve cost
efficiencies in our advertising by being opportunistic in our purchase of media
and controlling our production costs. We also maintain the flexibility to
allocate purchased media time among our key brands to respond quickly to
changing consumer trends and to support our growing brands. We believe our
well-developed advertising and promotion platform allows us quickly and
efficiently to launch and support new brands and product line extensions as well
as increase market penetration of existing brands.
We work directly with retailers to develop promotional calendars and
campaigns for each brand, customizing the promotion to the particular
requirements of the individual retailer. These programs, which include
cooperative advertising, temporary price reductions, in-store displays and
special events, are designed to obtain or enhance distribution at the retail
level
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and to reach the ultimate consumers of the product. We also utilize consumer
promotions such as coupons, samples and trial sizes to increase the trial and
consumption of the products.
CUSTOMERS
Our customers consist of mass merchandisers such as Wal-Mart Stores,
Inc., drug retailers such as Walgreens Co. and food retailers such as The Kroger
Co. In fiscal 2004, our ten largest customers represented approximately 68% of
total revenues, and our 20 largest customers represented approximately 81% of
total revenues, which allows us to target our selling efforts to our key
customers and customize programs to meet their needs. Our fiscal 2004 sales to
Wal-Mart Stores, Inc. accounted for approximately 34% of total revenues. No
other customer accounts for more than 10% of our total revenues. Boots, a U.K.
retailer, accounts for more than 10% of international sales. Consistent with
industry practice, we do not operate under a long-term written supply contract
with any of our customers.
SALES AND DISTRIBUTION
We have an established national sales and distribution sales
organization that sells to mass merchandiser, drug and food retailers. We
utilize our national sales network, consisting primarily of our own sales force,
to sell and distribute newly acquired brands and product line extensions while
maintaining tight controls over our selling expenses. Our experienced sales
force of approximately 55 people serves all direct buying accounts on an
individual basis. Our internal sales force accounts for more than 95% of
domestic sales. For the more fragmented food channel and for the smaller
individual stores, we rely on a national network of regional brokers to provide
retail support. In excess of 90% of our domestic orders are received
electronically through our electronic data interchange, or EDI, system, and
accuracy for our order fulfillment has been consistently high. Our sales
department performs significant analysis helping both our sales people and our
customers to understand sales patterns and create appropriate promotions and
merchandising aids for our products. Although not contractually obligated to do
so, in certain circumstances, we allow our customers to return unsold
merchandise, and for seasonal products, we provide extended payment terms to our
customers.
Internationally, our products are sold by national brokers in Canada
and the U.K. and by distributors in Europe and Latin America. For a transition
period that ended in 2004, Abbott marketed, sold and distributed SELSUN products
for us in certain foreign countries until we satisfied various foreign
regulatory requirements, new distributor arrangements were in place and any
applicable marketing permits were transferred. Abbott will continue to serve as
our distributor for SELSUN in certain foreign countries. We have entered into
distribution agreements with third party distributors for SELSUN in various
international markets except Canada and the U.K.
Most of our products, including those manufactured by third party
manufacturers, are currently shipped from a leased warehouse located in
Chattanooga, Tennessee. We also use a third party logistics service located in
California to warehouse and distribute our products to the west coast area of
the United States. We use outside carriers to transport our products. We do not
generally experience wide variances in the amount of inventory we maintain. At
present, we have no significant backlog of customer orders and are promptly
meeting customer requirements.
MANUFACTURING AND QUALITY CONTROL
We currently manufacture approximately 60% of the sales volume of our
products at our two Chattanooga, Tennessee, facilities. The balance of our
products are manufactured by third party contract manufacturers including our
GOLD BOND medicated powders, foot swabs and first aid wipes, ICY HOT patches and
sleeves, HERPECIN-L, the PHISODERM CLEAR CONFIDENCE Clear Swab and our dietary
supplements, including DEXATRIM and the DEXATRIM All in One bar. Newly acquired
products that are similar to our currently manufactured products generally can
be manufactured by us with the adaptation of existing equipment and facilities
or the addition of new equipment at relatively small cost. We contract with
third party manufacturers to manufacture products that are not compatible with
our existing manufacturing facilities or which can be more cost-effectively
manufactured by others. In many cases, third party manufacturers are not
obligated under contracts that fix the term of their commitment. We believe we
have adequate capacity to meet anticipated demand for our products through our
own manufacturing facilities and third party manufacturers.
We currently are manufacturing all of our North American SELSUN BLUE
products at our Chattanooga, Tennessee, facilities. Abbott will continue to
manufacture SELSUN for us for the European, Middle East and certain Latin
American markets until July 2005. We have entered into third party manufacturing
agreements to source many of the international markets previously supplied by
Abbott.
To monitor the quality of our products, we maintain an internal quality
control system supported by onsite microbiology and analytical laboratories. We
have trained quality control technicians who test our products and processes and
guide the
9
products through the manufacturing cycle. Consultants also are employed from
time to time to test our quality control procedures and the compliance of our
manufacturing operations with the United States Food and Drug Administration
("FDA") regulations. We audit our third party manufacturers to monitor
compliance with applicable current good manufacturing practices ("GMPs") as
defined by FDA regulations.
We purchase raw materials and packaging materials from a number of
third party suppliers primarily on a purchase order basis. Except for pamabrom,
pyrilamine maleate and compap, active ingredients used in our PAMPRIN and
PREMSYN PMS products, we are not limited to a single source of supply for the
ingredients used in the manufacture of our products. Sales of our PAMPRIN and
PREMSYN PMS products represented approximately 4% of our consolidated total
revenues in fiscal 2004. In addition, we have a limited source of supply for
selenium sulfide, the active ingredient in SELSUN BLUE. As a result of the
limited supply and increase in worldwide demand, selenium sulfide prices have
been and are expected to be volatile. We believe that our current sources of
supply and potential alternative sources will be adequate to meet future product
demands.
PRODUCT DEVELOPMENT
We strive to increase the value of our base brands and obtain an
increased market presence through product line extensions. We rely on internal
market research as well as consultants to identify new product formulations and
line extensions that we believe appeal to the needs of consumers. Our growth
strategy includes an increased emphasis on new product development as evidenced
by the expansion of our product development staff and our completion of a new
10,000 square foot research and product development facility in fiscal 2003. We
currently employ approximately 27 persons in our research and development
department and also engage consultants from time to time to provide expertise or
research in a particular product area. Our product development expenditures were
$3.1 million in fiscal 2004.
COMPETITION
We compete in the OTC health care, toiletries and dietary supplements
markets. These markets are highly competitive and are characterized by the
frequent introduction of new products, including the migration of prescription
drugs to the OTC market, often accompanied by major advertising and promotional
support. Our competitors include large OTC pharmaceutical companies such as
Pfizer, Inc. and Johnson & Johnson, consumer products companies such as Procter
& Gamble Co. and dietary supplements companies such as Nature's Bounty, Inc. and
Pharmaton Natural Health Products, many of which have considerably greater
financial and other resources and are not as highly leveraged. Our competitors
may be better positioned to spend more on research and development, employ more
aggressive pricing strategies, utilize greater purchasing power, build stronger
vendor relationships and develop broader distribution channels than us. In
addition, our competitors have often been willing to use aggressive spending on
trade promotions and advertising as a strategy for building market share at the
expense of their competitors including us. The private label or generic category
has also become increasingly more competitive in certain of our product markets.
Our products continue to compete for shelf space among retailers who are
increasingly consolidating.
TRADEMARKS AND PATENTS
Our trademarks are of material importance to our business and among our
most important assets. We own all of our trademarks associated with brands that
we currently market except for PHISODERM, which we license from Valmont, Inc.
under a perpetual royalty free license. In fiscal 2004, substantially all of our
total revenues were from products bearing proprietary or licensed brand names.
Accordingly, our future success may depend in part upon the goodwill associated
with our brand names, particularly GOLD BOND, SELSUN BLUE, ICY HOT, PHISODERM
and ASPERCREME.
Our principal brand names are registered trademarks in the United
States and certain foreign countries. We maintain or have applied for patent and
copyright protection in the United States relating to certain of our existing
and proposed products and processes. We purchase our GOLD BOND Antifungal Foot
Swabs and PHISODERM CLEAR CONFIDENCE Clear Swab, which incorporate a patented
swab delivery system, under a non-exclusive supply agreement with the patent
holder. We also license from third parties other intellectual property that is
used in certain of our products. The sale of these products relies on our
ability to maintain and extend our supply and licensing agreements with these
third parties.
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GOVERNMENT REGULATION
The manufacturing, distribution, processing, formulation, packaging,
labeling and advertising of our products are subject to regulation by federal
agencies, including, but not limited to:
o the FDA;
o the Federal Trade Commission (the "FTC");
o the Drug Enforcement Administration (the "DEA");
o the Consumer Product Safety Commission (the "CPSC");
o the United States Postal Service;
o the Environmental Protection Agency; and
o the Occupational Safety and Health Administration.
These activities are also regulated by various agencies of the states,
localities and foreign countries in which our products are sold. In particular,
the FDA regulates the safety, manufacturing, labeling and distribution of
dietary supplements including vitamins, minerals and herbs, as well as food
additives, OTC and prescription drugs, medical devices and cosmetics. In
addition, the FTC has primary jurisdiction to regulate the advertising of OTC
drugs, dietary supplements, functional toiletries and skin care products.
Under the Federal Food, Drug and Cosmetic Act ("FDC Act") all "new
drugs", including OTC products, are subject to pre-market approval by the FDA
under the new drug application ("NDA") process. The FDC Act defines a "new drug"
as a drug that is not generally recognized among scientifically qualified
experts as safe and effective for use under the conditions stated in its
labeling. A drug might also be new if it has not been used, outside of clinical
investigations, to a material extent or for a material time under conditions
described for a product. A drug that is generally regarded as safe and effective
is not a "new drug" and therefore does not require pre-market approval.
The FDA has adopted an administrative process, the OTC Drug Review, to
determine which active ingredients and indications are safe and effective for
use in OTC products. With the aid of independent expert advisory review panels,
the FDA develops rules, referred to as monographs, that define categories of
safe and effective OTC drugs. The monographs group drug products into
therapeutic classes such as OTC external analgesics. Products that comply with
monograph conditions do not require pre-market approval from the FDA.
The FDA has finalized monographs for certain categories of OTC drugs
such as drug products for the control of dandruff and topical acne drug
products. If a product is marketed beyond the scope of a particular final
monograph and without an approved NDA, such as if the manufacturer makes a label
claim not covered by the monograph, the FDA will consider the product to be
unapproved and misbranded and can take enforcement action against the drug
company and product including, but not limited to, issuing a warning letter or
initiating a product seizure. In order to market a product not covered by a
final monograph, a company must submit an NDA to the FDA.
There are several categories of OTC drugs, such as external analgesics,
for which the FDA has not completed its review. In such cases, the FDA has
established tentative final monographs. These tentative final monographs are
similar to final monographs in that they establish conditions under which OTC
drugs can be marketed for certain uses without FDA pre-marketing approval. The
FDA generally does not take enforcement action against an OTC drug subject to a
tentative final monograph unless there is a safety problem or a substantial
effectiveness question.
All of our OTC drug products are regulated pursuant to the FDA
monograph system. Most of our products are sold according to tentative final
monographs. Therefore, we face the risk that the FDA could take action if there
is a safety or efficacy issue with respect to one of our products or finalize
these monographs with revised conditions as to which our products do not comply.
If any of our products were found not to be in compliance with the final
monograph, we may be forced to reformulate or relabel such products, if
possible, or submit an NDA or an abbreviated NDA to continue to market our
existing formulation. The submission of a marketing application may require the
preparation and submission of clinical tests, which would be time consuming and
expensive. We may not receive FDA approval of any application in a timely manner
or at all. If we were not able to reformulate or relabel our product or obtain
FDA approval of an NDA, we would be required to discontinue selling the affected
product. Changes in monographs could also require us to change our product
formulation or dosage form, revise our labeling, modify our production process
or provide additional scientific data, each of which would involve additional
costs and may be prohibitive.
11
For our OTC drug products that are sold according to final monographs,
we cannot deviate from the conditions described in the final monograph, such as
changes in product formulation or labeling claims, unless we obtain
pre-marketing approval from the FDA. Similarly, we may only market the
prescription form of SELSUN dandruff shampoo (SELSUN Lotion, 2.5%) according to
the conditions and terms described in the FDA-approved NDA. In 2004, we launched
PAMPRIN All Day containing the menstrual pain reliever naproxen sodium. The
Perrigo Company manufactures this product for us under its existing abbreviated
NDA. Failure to comply with the conditions in a final monograph or NDA, where
applicable, could result in an FDA enforcement action.
The FDA regulates the quality of all finished drug products under GMPs.
As part of its regulatory authority, the FDA may periodically conduct audits of
the physical facilities, machinery, processes and procedures that we, or our
suppliers, use to manufacture products. The FDA may perform these audits at any
time without advanced notice. As a result of these audits, the FDA may order us,
or our suppliers, to make certain changes in manufacturing facilities and
processes. We may be required to make additional expenditures to comply with
these orders, or possibly discontinue selling certain products until we, or our
suppliers, comply with these orders. As a result, our business could be
adversely affected.
We have responded to certain questions received from the FDA with
respect to efficacy of pyrilamine maleate, one of the active ingredients used in
certain of the PAMPRIN Menstrual Pain Relief 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.
If pyrilamine maleate is not included in the final monograph, we would be
required to reformulate the products to continue to provide the consumer with
multi-symptom relief benefits. Sales of our PAMPRIN Menstrual Pain Relief and
PREMSYN PMS products represented approximately 4% of our consolidated total
revenues in fiscal 2004. We have been actively monitoring the process and do not
believe that either PAMPRIN Menstrual Pain Relief 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
Menstrual Pain Relief 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.
On September 30, 2004, Merck & Co., Inc. withdrew from the market its
selective COX-2 prescription analgesic Vioxx(R) as a result of cardiovascular
adverse events alleged to have occurred after long-term use (up to 3 years) of
Vioxx in older adults. These data have increased regulatory scrutiny of related
non-steroidal anti-inflammatory drugs (NSAIDs) sold on prescription,
particularly other selective COX-2 drugs. Though less likely, infrequent, or
rare, cardiovascular morbidity might also occur after long-term use of
non-selective NSAIDs, such as naproxen sodium, or ibuprofen. Naproxen sodium
(220mg/caplet) is the active ingredient in PAMPRIN All Day. Naproxen sodium
(220mg) was the subject of an FDA approved Rx-to-OTC switch application
sponsored by Procter & Gamble Co. that allows its over-the-counter sale as an
analgesic. This FDA approval attested to its safety and efficacy when used for
less than 10 days in the relief of minor aches and pains at approved doses of
220mg. Naproxen sodium is now widely used as a simple OTC analgesic for pain
relief. PAMPRIN All Day is indicated for the relief of menstrual cramps,
headache and back pain in women of childbearing age who are otherwise healthy.
Pre-menstrual and menstrual discomfort typically lasts five days and thus is
self-limiting. The FDA will conduct a public FDA Advisory Committee meeting in
mid-February 2005 to discuss safety data related to selective COX-2 NSAIDs sold
on prescription. Because naproxen sodium at prescription doses (550mg bid) was
used as a control group in some company-sponsored clinical trials of selective
COX-2s, it is possible that naproxen sodium might be discussed incidentally to
the primary data analysis and interpretation. In the unlikely event that
naproxen sodium at OTC doses was found to have unacceptable risk in less than 10
days of use, we would be required to reformulate PAMPRIN All Day.
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 conclusively demonstrate 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. Sales of our SPORTSCREME and ASPERCREME products
represented approximately 7% of our consolidated total revenues in fiscal 2004.
Certain of our topical analgesic products are currently marketed under
an FDA tentative final monograph. The FDA has recently 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 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. Thereafter, in April 2004, we launched the ICY HOT Sleeve, a flexible,
non-occlusive fabric patch with menthol levels consistent with the OTC
monograph. If additional research is required either as a preliminary to final
FDA monograph approval and/or as a requirement of future individual product
sale, we may need to invest in a considerable amount of expensive testing and
data analysis. Any preliminary cost may be shared with other patch
manufacturers. Because the submissions made into the FDA docket have been
forwarded from its OTC Division to its Dermatological Division within the Center
for Drug Evaluation and Research ("CDER"), we believe that the monograph is
unlikely to become final and take effect before mid-2006 and perhaps thereafter.
If neither action described above is successful and the final monograph excludes
such products, we will have to file an NDA in order to continue to market the
ICY HOT Patch, ICY HOT Sleeve or similar delivery systems under our other
topical analgesic brands. In such case, we would have to remove the existing
products from the market 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
12
months and would be expensive. It typically takes the FDA at least 12 months to
rule on an NDA once it is submitted. Sales of our ICY HOT patches and ICY HOT
Sleeve products represented approximately 11% of our consolidated total revenues
in fiscal 2004.
The Dietary Supplement Health and Education Act of 1994 ("DSHEA") was
enacted on October 25, 1994. DSHEA amends the FDC Act by defining dietary
supplements, which include vitamins, minerals, amino acids, nutritional
supplements, herbs and botanicals, as a new category of food separate from
conventional food. DSHEA provides a regulatory framework to ensure safe, quality
dietary supplements and to foster the dissemination of accurate information
about such products. Under DSHEA, the FDA is generally prohibited from
regulating dietary supplements as food additives or as drugs unless product
claims, such as claims that a product may diagnose, mitigate, cure or prevent an
illness, disease or malady, permit the FDA to attach drug status to a product.
In such case, the FDA could require pre-market approval to sell the product.
Manufacturers are not required to obtain prior FDA approval before producing or
selling a dietary supplement unless the ingredient is considered "new" or was
not on the market as of October 15, 1994.
DSHEA provides for specific nutritional labeling requirements for
dietary supplements. DSHEA permits substantiated, truthful and non-misleading
statements of nutritional support to be made in labeling such as statements
describing general well-being resulting from consumption of a dietary ingredient
or the role of a nutrient or dietary ingredient in affecting or maintaining a
structure or function of the body. The FDA distinguishes between permitted
structure/function claims for dietary supplements that do not require FDA
pre-approval and disease-related claims that require prior FDA approval. A
dietary supplement label must include a disclaimer that the FDA has not
evaluated a particular structure/function claim.
An article marketed as a dietary supplement and subsequently approved
for use as a drug or biologic may continue to be sold and regulated as a dietary
supplement unless the FDA specifically finds that it is unsafe for use as a
dietary supplement. A substance that has not been marketed as a dietary
supplement prior to its approval as a drug or biologic, or prior to initiation
of substantial clinical investigations for such uses, may be sold as a dietary
supplement pursuant only to an FDA regulation authorizing its use as a dietary
supplement.
The FDA may take enforcement action against a dietary supplement if the
FDA believes the supplement presents a significant or unreasonable risk of
illness or injury under conditions of use suggested in the labeling or under
ordinary conditions of use. Under DSHEA, the FDA bears the burden of proof to
show that a dietary supplement presents a significant or unreasonable risk of
illness or injury. The FDA may also take enforcement action for unlawful
promotion of a dietary supplement.
In the future, manufacturers of dietary supplements may be mandated by
the FDA to comply with post-marketing responsibilities similar to those applied
to OTC drugs. Such regulations may include mandatory adverse event reporting
requirements as part of new GMPs regulations.
The FDA has finalized some of its regulations to implement DSHEA
including those relating to nutritional labeling requirements and nutritional
support claims. The FDA also has under development additional regulations and
guidelines to implement DSHEA. Newly adopted and future regulations may require
expanded or different labeling for our dietary supplements. We cannot determine
what effect these regulations, when fully implemented, will have on our business
in the future. These regulations could require the reformulation or
discontinuance of certain products, additional recordkeeping, warnings,
notification procedures and expanded documentation of the properties of certain
products and scientific substantiation regarding ingredients, product claims and
safety. Failure to comply with applicable FDA requirements can result in
sanctions being imposed on us or the manufacture of our products including, but
not limited to, warning letters, product recalls and seizures, injunctions or
criminal prosecution.
As discussed above, the FDA has promulgated regulations relating to the
manufacturing process for drugs, which are known as current GMPs. We anticipate
that the FDA will promulgate GMPs, which are specific to dietary supplements and
require at least some of the quality control provisions contained in the GMPs
for drugs, which are more rigorous than the GMPs for foods. We source all of our
dietary supplement products from outside suppliers, including DEXATRIM, DEXATRIM
All in One bars, NEW PHASE, GARLIQUE, MELATONIX, REJUVEX and OMNIGEST. As part
of its regulatory authority, the FDA may periodically conduct audits of the
physical facilities, machinery, processes and procedures that we, or our
suppliers, use to manufacture products. The FDA may perform these audits at any
time without advanced notice. As a result of these audits, the FDA may order us,
or our suppliers, to make certain changes in manufacturing facilities and
processes. We may be required to make additional expenditures to comply with
these orders, or possibly discontinue selling certain products until we, or our
suppliers, comply with these orders. As a result, our business could be
adversely affected.
13
In 1994, the Nonprescription Drug Manufacturers Association (now CHPA)
initiated a large scale study in conjunction with the Yale University School of
Medicine to investigate a possible association, if any, of stroke in women aged
18 to 49 using PPA, formerly the active ingredient in certain of our DEXATRIM
products (the "Yale Study"). PPA is also used in other OTC medications, which
were also part of the study. In May 2000, the results of the Yale Study were
filed with the FDA. The investigators concluded that the results of the Yale
Study suggest that PPA increases the risk of hemorrhagic stroke. The FDA
indicated at that time that no immediate action was required and scheduled an
FDA advisory panel to meet in October 2000 to discuss the results of this study.
In October 2000, a Nonprescription Drugs Advisory Committee
commissioned by the FDA to review the safety of PPA, determined that there is an
association between PPA and hemorrhagic stroke and recommended that PPA not be
considered generally recognized as safe for OTC use as a nasal decongestant or
for weight control. In response to a request from the FDA to voluntarily cease
marketing DEXATRIM with PPA, we announced on November 7, 2000 our decision to
immediately cease shipping DEXATRIM with PPA and to accept product returns from
any retailers who decide to discontinue marketing DEXATRIM with PPA. We have
been subject to a number of lawsuits arising from our DEXATRIM with PPA product
most of which are being resolved through the class action settlement of all
DEXATRIM PPA claims described below. See "Legal Proceedings".
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 has 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 lawsuits in addition to those we currently have being filed
against us alleging damages related to the use or purchase of DEXATRIM
containing ephedrine. See "Legal Proceedings".
The FDA regulates some of our products as cosmetics or drug-cosmetics.
There are fewer regulatory requirements for cosmetics than for drugs or dietary
supplements. Cosmetics marketed in the United States must comply with the FDC
Act, the Fair Packaging and Labeling Act and the FDA's implementing regulations.
Cosmetics must also comply with quality and labeling requirements proscribed by
the FDA. In addition, several of our products are subject to product packaging
regulation by the CPSC and the FDA.
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 titanium dioxide on the state's list of
suspected carcinogens. Titanium 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 CHPA, presenting evidence that titanium
dioxide presents "no significant risk" to consumers. Sales of our BULLFROG
Superblock products represented approximately 1% of our consolidated total
revenues in fiscal 2004.
14
ENVIRONMENTAL MATTERS
We continually assess the compliance of our operations with applicable
federal, state and local environmental laws and regulations. Our policy is to
record liabilities for environmental matters when loss amounts are probable and
reasonably determinable. Our manufacturing site utilizes chemicals and other
potentially hazardous materials and generates both hazardous and non-hazardous
waste, the transportation, treatment, storage and disposal of which are
regulated by various governmental agencies. We have engaged environmental
consultants on a regular basis to assist with our compliance efforts. We believe
we are currently in compliance with all applicable environmental permits and are
aware of our responsibilities under applicable environmental laws. Any
expenditures necessitated by changes in law and permitting requirements cannot
be predicted at this time, although such costs are not expected to be material
to our financial position, results of operations or cash flows.
LEGAL PROCEEDINGS
We were named as a defendant in a number of lawsuits alleging that the
plaintiffs were injured as a result of ingestion of products containing PPA,
which was an active ingredient in most of our DEXATRIM products until November
2000. The lawsuits filed in federal court were 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 lawsuits were filed
in state court in a number of different states.
On April 13, 2004, we entered into a class action settlement agreement
with representatives of the plaintiffs' settlement class, which provided for a
national class action settlement of all DEXATRIM PPA claims, both federal and
state. On November 12, 2004, Judge Barbara J. Rothstein of the United States
District Court for the Western District of Washington entered a final order and
judgment certifying the class and granting approval of the DEXATRIM PPA
settlement. After the final judgment was entered, two parties who had objected
to the settlement filed appeals challenging and seeking to set aside the final
judgment. We have reached a preliminary agreement with one of these parties
pursuant to which that party's appeal will be dismissed.
The DEXATRIM PPA settlement includes claims against us involving
alleged injuries by DEXATRIM products containing PPA that were alleged to have
occurred after December 21, 1998, the date we acquired the DEXATRIM brand. In
accordance with the terms of the class action settlement agreement, we
previously published notice of the settlement and details as to the manner in
which claims could be submitted. The deadline for submission of claims was July
7, 2004. A total of 391 claims were submitted prior to the claims deadline. Of
these 391 claims, 173 alleged stroke as an injury and 218 alleged other
non-stroke injuries. These claims will be valued pursuant to the agreed upon
settlement matrix that is designed to evaluate and determine the settlement
value of each claim. A total of 16 claimants elected to opt out of the class
settlement and may continue to pursue claims for damages against us in separate
lawsuits. We have settled two of the opt out claims. In addition, we have
learned that two of the remaining opt out claims have injury dates prior to
December 21, 1998, for which we will seek indemnification from The DELACO
Company ("DELACO"), successor to Thompson Medical Company, Inc., which owned the
DEXATRIM brand prior to December 21, 1998.
In accordance with the terms of the class action settlement agreement,
$60.9 million has been funded into a settlement trust from our first three
layers of insurance coverage, as described below. In addition, on July 14, 2004,
we entered into a settlement agreement with Sidmak Laboratories, Inc.
("Sidmak"), the manufacturer of DEXATRIM products containing PPA, pursuant to
which Sidmak has agreed to contribute $10.0 million into the settlement trust.
To the extent the amount in the settlement trust is insufficient to fully fund
the settlement, we will be required to make additional contributions to the
settlement trust in the future. As described below, we have entered into a
settlement agreement with Interstate with regard to its $25.0 million of
coverage in excess of the insurance funds available in the settlement trust. We
currently expect to use our cash on hand and proceeds of the Interstate policy
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 settlement trust and outside of our available insurance coverage from
Interstate, either pursuant to the terms of the settlement, as a result of the
opt out cases or otherwise, we will have significantly fewer sources of funds
with which to satisfy such liabilities, and we may be unable to do so.
We are also named as a defendant in approximately 206 lawsuits relating
to DEXATRIM containing PPA which involve alleged injuries by DEXATRIM products
containing PPA manufactured and sold prior to our acquisition of DEXATRIM on
December 21, 1998. In these lawsuits, we are being defended on the basis of
indemnification obligations assumed by 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 on December 21, 1998. However, DELACO
is seeking to resolve all DEXATRIM cases with injury dates prior to December 21,
1998 as part of a liquidating Chapter 11 bankruptcy plan. We understand that
DELACO's product liability insurance carriers and other sources are expected to
fund this plan. As part of DELACO's bankruptcy plan, if finally approved, we
expect the bankruptcy court to release us from liability in DEXATRIM cases with
injury dates prior to December 21, 1998, although there can be no assurances in
this regard.
15
If DELACO achieves resolution of the pre-December 21, 1998 cases
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 DELACO's 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.
Our product liability insurance, as described below, would not apply to
claims arising from products manufactured and sold prior to our acquisition of
DEXATRIM. If the DELACO bankruptcy plan does not resolve these cases as we
expect, 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
21, 1998. In the approximately 206 cases that have been filed against us for
products manufactured and sold prior to December 21, 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. Even in these cases, although there can be no assurances, we do not
believe that successor liability would be imposed against us. 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 21, 1998;
we did not cause DELACO's bankruptcy; and many plaintiffs included in cases
filed in states that in some circumstances impose successor liability are
actually residents of other states.
We have reached an agreement with Kemper Indemnity Insurance Company
("Kemper") to settle its lawsuit that sought to rescind our policy for $50.0
million 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 $60.9 million of the $77.0 million of product liability coverage
provided by these insurance policies. The $60.9 million of available coverage
consists of $37.5 million of insurance under the Kemper policy and approximately
$23.4 million under policies with two other insurance companies. As indicated
above, this $60.9 million of coverage has been funded into a settlement trust in
accordance with the terms of the class action settlement agreement.
We have also entered into a term sheet of settlement with Interstate
with regard to Interstate's lawsuit to rescind its $25.0 million of excess
coverage for product liability claims relating to DEXATRIM products containing
PPA. In accordance with the term sheet of settlement agreement, Interstate will
provide coverage of DEXATRIM PPA claims that are covered by its policy after
$78.5 million has been paid toward covered claims. Once the $78.5 million
threshold is met, Interstate will pay 100% of the next $4.0 million of claims
covered by its policy; 75% of the next $8.5 million of such claims; and 50% of
the last $12.5 million of such claims. We are responsible for any claims not
covered by the Interstate policy either because the alleged injury did not occur
before May 31, 2001, or the claim was first made against us after May 31, 2004.
In addition, under the term sheet of settlement, we and Interstate will dismiss
all claims and counterclaims filed against each other, and we will release all
claims against Interstate relating to the excess coverage product liability
insurance.
During the first nine months of fiscal 2004, we incurred settlement,
legal and administrative costs and expenses associated with the DEXATRIM
litigation totaling $4.5 million. Prior to the fourth quarter, we were unable to
reasonably estimate the amount of liability related to the DEXATRIM litigation,
due to the significant assumptions and uncertainty involved in estimating the
value of cases involved. As a result of the final approval of the DEXATRIM PPA
settlement on November 12, 2004 and the term sheet of settlement reached with
Interstate on December 13, 2004, as of November 30, 2004 we were able to
estimate the probable loss related to the DEXATRIM litigation. Based on the
estimated litigation settlement costs relating to our DEXATRIM products, we
recorded a litigation settlement charge of $11.3 million in the fourth quarter
of fiscal 2004 of which $9.5 million is included in accrued liabilities in our
November 30, 2004 Consolidated Balance Sheet. We currently do not expect to
record any additional charges relative to the settlement of the PPA litigation.
As of November 30, 2004, we were named as a defendant in four lawsuits
alleging that the plaintiff was injured as a result of the ingestion of DEXATRIM
containing ephedrine. In addition, three individuals who allege injury caused by
DEXATRIM containing ephedrine filed opt out notices in the PPA class action
settlement. We have reached a preliminary settlement with respect to two of
these pending lawsuits and the three opt out claims. Upon finalization of the
settlement agreements, the two settled lawsuits will be dismissed. Each of these
settlements will be funded by insurance coverage provided by our captive
insurance subsidiary.
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.
16
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. These plaintiffs have not refiled this lawsuit as of February 7, 2005.
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
on February 11, 2004. 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 $75,000. We filed an answer on June 28, 2004 and intend to defend
vigorously the lawsuit.
We have been named as a defendant in a putative class action suit filed
in the Superior Court of the State of California, County of Los Angeles, on
January 13, 2005. The lawsuit seeks injunctive relief, compensatory damages and
attorney fees against us under the California Business and Professions Code,
arising out of alleged deceptive, untrue or misleading advertising and breach of
express warranty in connection with the manufacturing, labeling, advertising,
promotion and sale of certain DEXATRIM Natural products. The lawsuit seeks
certification of a class consisting of all persons who purchased DEXATRIM
Natural in California during the four year period prior to the filing of the
lawsuit and up to the date of any judgment obtained. The plaintiff has
stipulated that the amount in controversy with respect to plaintiff's individual
claim and each member of the proposed class in the action does not exceed
$75,000. We 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, employment law issues 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.
PRODUCT LIABILITY AND INSURANCE
We currently maintain product liability insurance, principally through
third party insurers, that provides coverage for product liability claims
including those asserted in the DEXATRIM PPA litigation. We previously reached
an agreement with Kemper to settle Kemper's lawsuit that sought to rescind our
policy for $50.0 million of excess coverage for product liability claims. After
giving effect to the settlement with Kemper, we have available through our first
three layers of insurance coverage, approximately $60.9 million of the $77.0
million of product liability coverage provided by these policies. These $60.9
million of available funds consist of $37.5 million of insurance under the
Kemper policy and approximately $23.4 million under policies with two other
insurance companies. This $60.9 million of coverage has been funded into a
settlement trust in accordance with the terms of the class action settlement
agreement.
We have also entered into a term sheet of settlement agreement with
Interstate with regard to Interstate's lawsuit to rescind its $25.0 million of
excess coverage for product liability claims relating to DEXATRIM products
containing PPA. In accordance with the term sheet of settlement, Interstate will
provide coverage of DEXATRIM PPA claims that are covered by its policy after
$78.5 million has been paid toward covered claims. Once the $78.5 million
threshold is met, Interstate will pay 100% of the next $4.0 million of claims
covered by its policy; 75% of the next $8.5 million of such claims; and 50% of
the last $12.5 million of such claims. We are responsible for any claims not
covered by the Interstate policy either because the alleged injury did not occur
before May 31, 2001,or the claim was first made against us after
May 31, 2004.
We maintain a significantly lower level of insurance coverage for all
other potential claims relating to our products including DEXATRIM products
containing ephedrine. Our existing product liability insurance coverage for all
of our other products, including DEXATRIM products containing ephedrine,
consists of $10.0 million of coverage through our captive insurance subsidiary,
of which approximately $5.4 million is funded as of February 7, 2005, and a
total of $40.0 million of excess coverage through third party insurers.
All of our insurance policies are subject to certain limitations that
are generally customary for policies of this type, such as deductibles and
exclusions for exemplary and punitive damages. Since plaintiffs in product
liability claims may seek exemplary
17
and punitive damages, if these damages were awarded, some of our insurance
coverage would not cover these amounts, and we may not have sufficient resources
to pay these damages.
The potential concerns relating to ephedrine in DEXATRIM Natural and
DEXATRIM Results have decreased the availability, limited the available coverage
and increased the cost of product liability insurance to us. Any amounts paid by
our insurance to satisfy product liabilities would decrease product liability
insurance coverage available for any other claims. If our liability for product
liability claims is significant, our existing insurance is likely to be
insufficient to cover these claims, and we may not have sufficient resources to
pay the liabilities in excess of our insurance coverage. Furthermore, our
product liability insurance provided by third parties will expire at the end of
each annual policy period, currently in May of each year. We may incur
significant additional costs to obtain insurance coverage upon the expiration of
our current policies and may not be able to obtain coverage in the future in
amounts equal to that which we currently have or in amounts sufficient to
satisfy future claims.
EMPLOYEES
We employ approximately 413 persons on a full-time basis and 9 persons
on a part-time basis in the United States. In addition, we employ approximately
22 persons at our foreign subsidiaries' offices. Our employees are not
represented by any organized labor union, and we consider our labor relations to
be good.
RISK FACTORS
Our business is subject to a number of risks. Some of the risks
associated with our operations are described in the "Competition," "Government
Regulation," "Environmental," and "Manufacturing and Quality Control" portions
of this Form 10-K. In addition to the other information contained in this Form
10-K, the following risk factors should be carefully considered.
WE HAVE INCURRED CHARGES AND FACE UNCERTAINTIES IN THE COST OF THE SETTLEMENT OF
THE NUMEROUS LAWSUITS AGAINST US ALLEGING INJURY FROM THE USE OF DEXATRIM
PRODUCTS.
During the first nine months of fiscal 2004, we incurred settlement,
legal and administrative costs and expenses associated with the DEXATRIM
litigation totaling $4.5 million. Based on the estimated litigation settlement
costs relating to our DEXATRIM products, we recorded a litigation settlement
charge of $11.3 million in the fourth quarter of fiscal 2004. If we are required
to fund significant other liabilities related to the PPA litigation beyond the
settlement trust and outside of our available insurance coverage from
Interstate, either pursuant to the terms of the settlement, as a result of the
opt out cases or otherwise, or if the DELACO bankruptcy does not resolve the
cases with injury dates prior to December 21, 1998 as we expect, we will have
significantly fewer sources of funds with which to satisfy such liabilities, and
we may be unable to do so.
WE MAY FACE ADDITIONAL LAWSUITS ALLEGING INJURY FROM THE USE OF DEXATRIM
PRODUCTS CONTAINING EPHEDRINE, WHICH WE DISCONTINUED MANUFACTURING AND SHIPMENT
IN SEPTEMBER 2002, OR FROM OTHER PRODUCTS THAT WE CURRENTLY PRODUCE OR MAY
PRODUCE IN THE FUTURE.
We are currently named as a defendant in four lawsuits alleging that
the plaintiffs were injured as a result of the ingestion of DEXATRIM containing
ephedrine. In addition, three individuals who allege injury caused by Dexatrim
containing ephedrine filed opt out notices in the PPA class action settlement.
We have reached a preliminary settlement with respect to two of these pending
lawsuits and the three opt out claims. 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.
Our available product liability coverage for the defense of lawsuits
alleging injury from the use of DEXATRIM products containing ephedrine, or from
other products that we currently produce or may produce in the future, consists
of $10.0 million of self-insured coverage through our captive insurance
subsidiary, of which approximately $5.4 million is funded as of February 7,
2005, and a total of $40.0 million of excess coverage through third party
insurers. In the future, if we face significant liabilities relating to the
DEXATRIM products which included ephedrine, our product liability insurance may
be insufficient, and we may not have sufficient resources to satisfy these
liabilities in excess of our insurance coverage.
An inherent risk of our business is exposure to product liability
claims by users of our products. We may also experience significant product
liability exposure related to our other products in the future.
18
OUR PRODUCT LIABILITY INSURANCE COVERAGE MAY BE INSUFFICIENT TO COVER EXISTING
OR FUTURE PRODUCT LIABILITY CLAIMS.
Our business inherently makes us the potential target of product
liability claims. We have product liability insurance, principally through third
party insurers, that provides coverage for product liability claims, including
those asserted in the DEXATRIM PPA litigation. At present, we maintain a
significantly lower level of insurance coverage for all other potential claims
relating to our products including DEXATRIM products containing ephedrine.
We previously reached an agreement with Kemper to settle Kemper's
lawsuit that sought to rescind our policy for $50.0 million 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, subject to certain
limitations, approximately $60.9 million of the $77.0 million of product
liability coverage provided by these policies. The $60.9 million of available
funds consists of $37.5 million of insurance under the Kemper policy and
approximately $23.4 million under policies with two other insurance companies.
This $60.9 million of coverage has been funded into a settlement trust in
accordance with the terms of the class action settlement agreement.
We have also entered into a term sheet of settlement with Interstate
with regard to Interstate's lawsuit to rescind its $25.0 million of excess
coverage for product liability claims relating to DEXATRIM products containing
PPA. In accordance with the term sheet of settlement, Interstate will provide
coverage of DEXATRIM PPA claims that are covered by its policy after $78.5
million has been paid toward covered claims. Once the $78.5 million threshold is
met, Interstate will pay 100% of the next $4.0 million of claims covered by its
policy; 75% of the next $8.5 million of such claims; and 50% of the last $12.5
million of such claims. We are responsible for any claims not covered by the
Interstate policy either because the alleged injury did not occur before May 31,
2001, or the claim was first made against us after May 31, 2004. In
addition, under the term sheet of settlement, we and Interstate will dismiss all
claims and counterclaims filed against each other, and we will release all
claims against Interstate relating to the excess coverage product liability
insurance.
We maintain a significantly lower level of insurance coverage for all
other potential claims relating to our products, including DEXATRIM products
containing ephedrine. Our product liability insurance coverage for all of our
other products, including DEXATRIM products containing ephedrine, consists of
$10.0 million of coverage through our captive insurance subsidiary, of which
approximately $5.4 million is funded as of February 7, 2005, and a total of
$40.0 million of excess coverage through third party insurers.
All of our insurance policies are subject to certain limitations that
are generally customary for policies of this type such as deductibles and
exclusions for exemplary and punitive damages. Since plaintiffs in product
liability claims may seek exemplary and punitive damages, if these damages were
awarded, some of our insurance coverage would not cover these amounts, and we
may not have sufficient resources to pay these damages.
The potential concerns relating to ephedrine in DEXATRIM Natural and
DEXATRIM Results have decreased the availability, limited the available coverage
and increased the cost of product liability insurance to us. Any amounts paid by
our insurance to satisfy product liabilities would decrease product liability
insurance coverage available for any other claims. If our liability for product
liability claims is significant, our existing insurance is likely to be
insufficient to cover these claims, and we may not have sufficient resources to
pay the liabilities in excess of our insurance coverage. Furthermore, our
product liability insurance provided by third parties will expire at the end of
each annual policy period, currently in May of each year. We may incur
significant additional costs to obtain insurance coverage upon the expiration of
our current policies and may not be able to obtain coverage in the future in
amounts equal to that which we currently have or in amounts sufficient to
satisfy future claims.
OUR ACQUISITION STRATEGY IS SUBJECT TO RISK AND MAY NOT BE SUCCESSFUL.
A component of our growth strategy depends on our ability to
successfully execute acquisitions, which involves numerous risks including:
o not accurately identifying suitable products or brands for
acquisition;
o difficulties in integrating the operations, technologies and
manufacturing processes of the acquired products;
o the diversion of management's attention from other business
concerns; and
o incurring substantial additional indebtedness.
19
Any future acquisitions, or potential acquisitions, may result in
substantial costs, disrupt our operations or materially adversely affect our
operating results.
WE FACE SIGNIFICANT COMPETITION IN THE OTC HEALTH CARE, TOILETRIES AND DIETARY
SUPPLEMENTS MARKETS.
The OTC health care, toiletries and dietary supplements markets are
highly competitive and are characterized by the frequent introduction of new
products, including the migration of prescription drugs to the OTC market, often
accompanied by major advertising and promotional support. These introductions
may adversely affect our business especially because we compete in categories in
which product sales are highly influenced by advertising and promotions. Our
competitors include large OTC pharmaceutical companies such as Pfizer, Inc. and
Johnson & Johnson, consumer products companies such as Procter & Gamble Co. and
dietary supplements companies such as Nature's Bounty, Inc. and Pharmaton
Natural Health Products, many of which have considerably greater financial and
other resources than we do and are not as highly leveraged as we are. These
competitors are thus better positioned to spend more on research and
development, employ more aggressive pricing strategies, utilize greater
purchasing power, build stronger vendor relationships and develop broader
distribution channels than us. In addition, our competitors have often been
willing to use aggressive spending on trade promotions and advertising as a
strategy for building market share at the expense of their competitors including
us. The private label or generic category has also become increasingly more
competitive in certain of our product markets. If we are unable to continue to
introduce new and innovative products that are attractive to consumers or are
unable to allocate sufficient resources to effectively advertise and promote our
products so that they achieve wide spread market acceptance, we may not be able
to compete effectively, and our operating results and financial condition may be
adversely affected.
OUR BUSINESS IS REGULATED BY NUMEROUS FEDERAL, STATE AND FOREIGN GOVERNMENTAL
AUTHORITIES, WHICH SUBJECTS US TO ELEVATED COMPLIANCE COSTS AND RISKS OF
NON-COMPLIANCE.
The manufacturing, distribution, processing, formulation, packaging and
advertising of our products are subject to numerous and complicated federal,
state and foreign governmental regulations. Compliance with these regulations is
difficult and expensive. In particular, the FDA regulates the safety,
manufacturing, labeling and distribution of our OTC products, our prescription
strength SELSUN products and our dietary supplements. The FDA also has primary
jurisdiction to regulate any advertising that we might use for the prescription
strength form of SELSUN. In addition, the FTC may regulate the promotion and
advertising of our drug products, particularly OTC versions and dietary
supplements.
All of our OTC drug products are regulated pursuant to the FDA's
monograph system. The monographs, both tentative and final, set out the active
ingredients and labeling indications that are permitted for certain broad
categories of OTC drug products such as topical analgesics. Where the FDA has
finalized a particular monograph, it has concluded that a properly labeled
product formulation is generally recognized as safe and effective and not
misbranded. A tentative final monograph indicates that the FDA has not made a
final determination about products in a category to establish safety and
efficacy for a product and its uses. However unless there is a serious safety or
efficacy issue, the FDA will typically exercise enforcement discretion and
permit companies to sell products conforming to a tentative final monograph
until the final monograph is published. Products that comply with either final
or tentative final monograph standards do not require pre-market approval from
the FDA.
Most of our products are regulated pursuant to tentative final
monographs. We face the risk that the FDA may finalize a monograph and exclude a
formulation including dosage form or a labeling claim that would negatively
affect one or more of our products. If we desire to continue to sell a product
that is outside the scope of a monograph, we would reformulate the product, if
possible, to comply with the final monograph or submit an NDA to have our
existing formulation approved by the FDA. The submission of an NDA could require
the preparation and submission of clinical tests, which may be time consuming
and expensive. We may not receive FDA approval of any application in a timely
manner or at all. If we were not able to conform our product to the conditions
described in a final monograph or submit an NDA and obtain approval in a timely
manner, we would be required to discontinue selling the affected product.
Changes in monographs could also require us to revise our labeling, modify our
production process or provide additional scientific data, each of which would
involve additional costs, which may be prohibitive.
Certain of our topical analgesic products are currently marketed under
an FDA tentative final monograph. The FDA has recently 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 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. Thereafter, in April 2004, we
launched the ICY HOT Sleeve, a flexible, non-occlusive fabric patch with menthol
levels consistent with the OTC monograph. If additional
20
research is required either as a preliminary to final FDA monograph approval
and/or as a requirement of future individual product sale, we may need to invest
in a considerable amount of expensive testing and data analysis. Any preliminary
cost may be shared with other patch manufacturers. Because the submissions made
into the FDA docket have been forwarded from its OTC Division to its
Dermatological Division within CDER, we believe that the monograph is unlikely
to become final and take effect before mid- 2006 and perhaps thereafter. If
neither action described above is successful and the final monograph excludes
such products, we will have to file an NDA in order to continue to market the
ICY HOT Patch, ICY HOT Sleeve or similar delivery systems under our other
topical analgesic brands. In such case, we would have to remove the existing
products 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 an NDA once it is submitted. Sales of our
ICY HOT patches and ICY HOT Sleeve products represented approximately 11% of our
consolidated total revenues in fiscal 2004.
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 Menstrual
Pain Relief 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. If pyrilamine maleate is not
included in the final monograph, we would be required to reformulate the
products to continue to provide the consumer with multi-symptom relief benefits.
Sales of our PAMPRIN Menstrual Pain Relief and PREMSYN PMS products represented
approximately 4% of our consolidated total revenues in fiscal 2004. We have been
actively monitoring the process and do not believe that either PAMPRIN Menstrual
Pain Relief 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 Menstrual Pain Relief 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.
On September 30, 2004, Merck & Co., Inc. withdrew from the market its
selective COX-2 prescription analgesic Vioxx(R) as a result of cardiovascular
adverse events alleged to have occurred after long-term use (up to 3 years) of
Vioxx in older adults. These data have increased regulatory scrutiny of related
non-steroidal anti-inflammatory drugs (NSAIDs) sold on prescription,
particularly other selective COX-2 drugs. Though less likely, infrequent, or
rare, cardiovascular morbidity might also occur after long-term use of
non-selective NSAIDs, such as naproxen sodium, or ibuprofen. Naproxen sodium
(220mg/caplet) is the active ingredient in PAMPRIN All Day. Naproxen sodium
(220mg) was the subject of an FDA approved Rx-to-OTC switch application
sponsored by Procter & Gamble Co. that allows its over-the-counter sale as an
analgesic. This FDA approval attested to its safety and efficacy when used for
less than 10 days in the relief of minor aches and pains at approved doses of
220mg. Naproxen sodium is now widely used as a simple OTC analgesic for pain
relief. PAMPRIN All Day is indicated for the relief of menstrual cramps,
headache and back pain in women of childbearing age who are otherwise healthy.
Pre-menstrual and menstrual discomfort typically lasts five days and thus is
self-limiting. The FDA will conduct a public FDA Advisory Committee meeting in
mid-February 2005 to discuss safety data related to selective COX-2 NSAIDs sold
on prescription. Because naproxen sodium at prescription doses (550mg bid) was
used as a control group in some company-sponsored clinical trials of selective
COX-2s, it is possible that naproxen sodium might be discussed incidentally to
the primary data analysis and interpretation. In the unlikely event that
naproxen sodium at OTC doses was found to have unacceptable risk in less than 10
days of use, we would be required to reformulate PAMPRIN All Day.
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 conclusively demonstrate 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. Sales of our SPORTSCREME and ASPERCREME products
represented approximately 7% of our consolidated total revenues in fiscal 2004.
In accordance with the FDC Act and FDA regulations, our manufacturing
processes and those of our third party manufacturers must also comply with the
FDA's current GMPs. The FDA inspects our facilities and those of our third party
manufacturers periodically to determine if we and our third party manufacturers
are complying with GMPs.
If we or our third party manufacturers fail to comply with federal,
state or foreign regulations, we could be required to:
o suspend manufacturing operations;
o change product formulations;
o suspend the sale of products with non-complying specifications;
o initiate product recalls;
o prepare and submit an NDA or abbreviated NDA; or
o change product labeling, packaging or advertising or take other
corrective action.
Any of these actions could materially and adversely affect our
financial results.
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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 titanium dioxide on the state's list of
suspected carcinogens. Titanium 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 CHPA, presenting evidence that titanium
dioxide presents "no significant risk" to consumers. Sales of our BULLFROG
Superblock products represented approximately 1% of our consolidated total
revenues in fiscal 2004.
OUR SUCCESS DEPENDS ON OUR ABILITY TO ANTICIPATE AND RESPOND IN A TIMELY MANNER
TO CHANGING CONSUMER DEMANDS.
Our success depends on our products' appeal to a broad range of
consumers whose preferences cannot be predicted with certainty and are subject
to change. If our current products do not meet consumer demands, our sales may
decline. In addition, our growth depends upon our ability to develop new
products through product line extensions and product modifications, which
involve numerous risks. We may not be able to accurately identify consumer
preferences and translate our knowledge into customer-accepted products or
successfully integrate these products with our existing product platform or
operations. We may also experience increased expenses incurred in connection
with product development, marketing and advertising that are not subsequently
supported by a sufficient level of sales, which would negatively affect our
margins. Furthermore, product development may divert management's attention from
other business concerns, which could cause sales of our existing products to
suffer. We cannot assure you that newly developed products will contribute
favorably to our operating results.
WE RELY ON A FEW LARGE CUSTOMERS, PARTICULARLY WAL-MART STORES, INC., FOR A
SIGNIFICANT PORTION OF OUR SALES.
In fiscal 2004, Wal-Mart Stores, Inc. represented approximately 34% of
our total revenues, our ten largest customers represented approximately 68% of
our total revenues and our 20 largest customers represented approximately 81% of
our total revenues. Consistent with industry practice, we do not operate under a
long-term written supply contract with Wal-Mart Stores, Inc. or any of our other
customers. Our business would materially suffer if we lost Wal-Mart Stores, Inc.
as a continuing major customer or if our business with Wal-Mart Stores, Inc.
significantly decreases. The loss of sales to any other large customer could
also materially and adversely affect our financial results.
WE MAY BE ADVERSELY AFFECTED BY FLUCTUATIONS IN BUYING DECISIONS OF MASS
MERCHANDISER, DRUG AND FOOD TRADE BUYERS AND THE TREND TOWARD RETAIL TRADE
CONSOLIDATION.
We sell our products to mass merchandiser and food and drug retailers
in the United States. Consequently, our total revenues are affected by
fluctuations in the buying patterns of these customers. These fluctuations may
result from wholesale buying decisions, economic conditions and other factors.
In addition, with the growing trend towards retail consolidation, we are
increasingly dependent upon a few leading retailers, such as Wal-Mart Stores,
Inc., whose bargaining strength continues to grow due to their size. Such
retailers have demanded, and may continue to demand, increased service and order
accommodations as well as price and incremental promotional investment
concessions. As a result, we may face downward pressure on our prices and
increased promotional expenses to meet these demands, which would reduce our
margins. We also may be negatively affected by changes in the policies of our
retail trade customers such as inventory destocking, limitations on access to
shelf space and other conditions.
WE RELY ON THIRD PARTY MANUFACTURERS FOR A PORTION OF OUR PRODUCT PORTFOLIO
INCLUDING PRODUCTS UNDER OUR GOLD BOND, ICY HOT, SELSUN AND DEXATRIM BRANDS.
We use third party manufacturers to make products representing
approximately 40% of our fiscal 2004 sales volume, including our GOLD BOND
medicated powders and foot spray, GOLD BOND antifungal foot swabs and first aid
wipes, the ICY HOT patches and sleeves, PHISODERM CLEAR CONFIDENCE Clear Swab,
HERPECIN-L, and our line of dietary supplements including DEXATRIM and the
DEXATRIM All in One bar and, internationally, our line of SELSUN medicated
dandruff shampoos. In many cases, third party manufacturers are not obligated
under contracts that fix the term of their commitments, and they may discontinue
production upon little or no advance notice. Manufacturers also may experience
problems with product quality or timeliness of product delivery. We rely on
these manufacturers to comply with applicable current GMPs. The loss of a
contract manufacturer
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