CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
-----------------------------------------------
(Unaudited)
Nine Months Ended Three Months Ended
----------------------------- --------------------------
October 2, September 27, October 2, September 27
2004 2003 2004 2003
----------------------------- --------------------------
REVENUES
Gross sales $ 56,415,000 $ 53,664,000 $ 18,927,000 $ 19,017,000
Less: Sales discounts and allowances 1,981,000 1,258,000 739,000 404,000
NET SALES 54,434,000 52,406,000 18,188,000 18,613,000
------------ ------------ ------------ -------------
COST AND EXPENSES
Cost of goods sold 46,476,000 43,322,000 15,257,000 14,834,000
Selling, general and administrative 12,051,000 8,752,000 4,367,000 3,463,000
Research and development 221,000 235,000 72,000 88,000
------------ ------------ ------------ -------------
58,748,000 52,309,000 19,696,000 18,385,000
------------ ------------ ------------ -------------
INCOME( LOSS) FROM OPERATIONS (4,314,000) 97,000 (1,508,000) 228,000
------------ ------------ ------------ -------------
OTHER INCOME (EXPENSE)
Interest expense (2,591,000) (2,551,000) (1,019,000) (844,000)
Other 40,000 258,000 (46,000) (35,000)
------------ ------------ ------------ -------------
(2,551,000) (2,293,000) (1,065,000) (879,000)
------------ ------------ ------------ -------------
LOSS BEFORE INCOME TAX BENEFIT (6,865,000) (2,196,000) (2,573,000) (651,000)
INCOME TAX BENEFIT 2,375,000 901,000 872,000 271,000
------------ ------------ ------------ -------------
$ (4,490,000) $ (1,295,000) $ (1,701,000) $ (380,000)
============ ============ ============ ============
NET LOSS
LOSS PER SHARE - BASIC AND DILUTED $ (0.05) $ (0.02) $ (0.02) $ (0.00)
============ ============ ============ ============
BASIC AND DILUTED AVERAGE COMMON SHARES
OUTSTANDING 85,892,000 85,342,000 85,966,000 85,346,000
============ ============ ============ ============
The accompanying notes are an integral part of these condensed consolidated financial statements
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------
(Unaudited)
Nine Months Ended
-------------------------------------
October 2, September 27,
2004 2003
-------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (4,490,000) $ (1,295,000)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization 1,526,000 2,050,000
Amortization of bond discount and deferred financing costs 385,000 207,000
Amortization of deferred gain on sale/leaseback (35,000) (39,000)
Changes in operating assets and liabilities:
(Increase) in accounts receivable (1,180,000) (223,000)
Decrease in inventories 1,371,000 1,379,000
Decrease (increase) in prepaid expenses and other assets 818,000 (585,000)
Increase in due to ICC Industries Inc. 1,682,000 1,680,000
Increase (decrease) in accounts payable and accrued expenses 1,139,000 (16,000)
--------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,216,000 3,158,000
--------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of Konsyl Pharmaceuticals, Inc., net of cash acquired of $493,000 - (5,775,000)
Purchase of property, plant and equipment (1,296,000) (1,317,000)
--------------- --------------
NET CASH USED IN INVESTING ACTIVITIES (1,296,000) (7,092,000)
--------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase in due to ICC Industries Inc. 1,515,000 1,832,000
Proceeds from equipment financing 1,039,000 1,216,000
(Repayments) of capital lease obligations (1,828,000) (1,873,000)
Borrowings of long-term debt 577,000 3,700,000
(Repayments) of long-term debt (1,549,000) (385,000)
Proceeds from stock option exercise 32,000 -
Issuance of common stock under rights offering - 6,000
--------------- --------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (214,000) 4,496,000
NET (DECREASE) IN CASH (294,000) 562,000
CASH, BEGINNING OF PERIOD 363,000 (476,000)
--------------- --------------
CASH, END OF PERIOD $ 69,000 86,000
=============== ==============
Non cash investing and financing transactions:
Interest Paid $ 2,597,000 $ 2,566,000
=============== ==============
Income Taxes Paid $ 13,000 $ 32,000
=============== ==============
(Continued)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Nine Months Ended
-----------------------------------------
October 2, September 27,
2004 2003
------------------- ------------------
Allocation of debt proceeds to conversion feature (Note 6) $ 921,000 $ -
=============== ==============
Note issued to former Konsyl shareholder in connection with Konsyl acquisition $ - $ 2,500,000
=============== ==============
Warrants issued in connection with Konsyl acquisition $ - $ 244,000
=============== ==============
The accompanying notes are an integral part of these condensed consolidated financial statements
PHARMACEUTICAL FORMULATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
| |
Note 1 |
Basis of Presentation |
| |
|
The accompanying unaudited interim financial statements of
Pharmaceutical Formulations, Inc. (the “Company”, “we” or
“us”) have been prepared in accordance with accounting principles
generally accepted in the United States of America and rules and regulations of
the Securities and Exchange Commission for interim financial information.
Accordingly, they do not include all of the information and footnote disclosures
required by accounting principles generally accepted in the United States of
America for complete financial statements. |
| |
|
In the opinion of the Company, the accompanying unaudited
condensed consolidated financial statements contain all adjustments (consisting
of normal recurring entries) necessary to present fairly the Company’s
financial position as of October 2, 2004 and its results of operations for the
nine and three month periods ended October 2, 2004 and September 27, 2003 and
cash flows for the nine months ended October 2, 2004 and September 27,
2003. |
| |
|
The accounting policies followed by the Company are set forth in
Note 3 of the Company’s consolidated financial statements as contained in
the Form 10-K for the year ended January 3, 2004 filed with the Securities and
Exchange Commission. These financial statements should be read in conjunction
with the financial statements and notes thereto included in the Company’s
Form 10-K for the year ended January 3, 2004. |
| |
|
The Company experiences seasonal fluctuations in its OTC business
due to the timing of the cough/cold and allergy seasons. The fourth quarter is
typically the strongest quarter in terms of sales. |
| |
|
The results of operations for the nine months and three months
ended October 2, 2004 are not necessarily indicative of the results to be
expected for the fiscal year ending January 1, 2005 or any other interim
period. |
| |
|
The accompanying condensed consolidated financial statements
include the accounts of Pharmaceutical Formulations, Inc. (PFI) and its wholly
owned subsidiaries. All significant inter-company accounts and transactions have
been eliminated. The Company acquired Konsyl Pharmaceuticals, Inc. on May 15,
2003. The results of operations of Konsyl have been included in the
Company’s results of operations beginning May 16, 2003 |
| |
|
During December 2002, the Company changed its fiscal year-end from
the 52-53 week period that ends on the Saturday closest to June 30 to the 52-53
week period that ends on the Saturday closest to December 31. The current
fiscal year is the 52 weeks ending January 1, 2005. |
| |
|
The Company is majority owned by ICC Industries, Inc. (see Note
5). |
| |
|
Certain reclassifications have been made to the prior period
financial statements to conform to the current period presentation. |
| |
|
As permitted by SFAS No. 123, “Accounting for Stock- Based
Compensation”, the Company accounts for stock-based compensation
arrangements with employees in accordance with provisions of Accounting
Principles Board (“APB”) Opinion No. 25, “Accounting for Stock
Issued to Employees”. Compensation expense for stock options issued to
employees is based on the difference on the date of grant between the fair value
of the Company’s stock and the exercise price of the option. No stock-based
employee compensation cost is reflected in net loss for the periods presented,
as all options granted under those plans had an exercise price equal to the
market value of the underlying common stock at the date of grant. |
| |
|
Had compensation cost for the Company’s option plans been
determined using the fair value method at the grant dates, the effect on the
Company’s net loss and loss per share for the nine-month and three-month
periods ended October 2, 2004 and September 27, 2003 would have been as
follows: |
Nine Months Ended Three Months Ended
--------------------------------- -----------------------------
October 2, Sept.27 October 2, Sept.27
2004 2003 2004 2003
-------------- ----------------- -------------- -------------
Net loss as reported $(4,490,000) $(1,295,000) $(1,701,000) $ (380,000)
Deduct: Total stock-based
employee compensation
determined under fair value
method for all awards, net of
related tax effects (57,000) (102,000) (13,000) (34,000)
-------------- ----------------- -------------- -------------
Proforma net loss $(4,547,000) $(1,397,000) $(1,714,000) $ (414,000)
Basic and diluted loss per share
As reported $ (0.05) $ (0.02) $ (0.02) $ (0.00)
Proforma $ (0.05) $ (0.02) $ (0.02) $ (0.00)
The weighted average assumptions used for the periods presented are as follows:
Nine Months Ended Three Months Ended
--------------------------------- -----------------------------
October 2, Sept.27 October 2, Sept.27
2004 2003 2004 2003
-------------- ----------------- -------------- -------------
Risk-free interest rate 3.44% 2.4% 3.44% 2.4%
Expected dividend yield - - - -
Expected lives 5 years 5 years 5 years 5 years
Expected volatility 140% 125% 140% 125%
| |
|
Collective Bargaining Agreement
Substantially all of the Company’s non-management employees
are covered by a collective bargaining agreement, between PFI and Local 522
affiliated with the International Brotherhood of Teamsters of New Jersey, that
was set to expire on October 31, 2004. The union representing the majority of
the Company’s manufacturing and operational workers entered into a
memorandum of understanding with the Company on October 21, 2004, which was
approved by a vote of the union members on October 23, 2004. The memorandum of
understanding extends the term of the current agreement, with certain
amendments, for three years. The changes include increases in wages and medical
payments (10.2% over three years) and changes in policy regarding attendance,
classifications and titles, job performance, job bids, bereavement and Company
shutdown. A formal agreement reflecting these revised terms is in process. |
| |
Note 2 |
Financial Results and Liquidity |
| |
|
As of October 2, 2004, the Company has negative working capital of
$4,832,000, an accumulated deficit of $82,259,000 and a stockholders’
deficit of $22,250,000. In addition, the Company had net losses of $4,490,000
for the nine months ended October 2, 2004 and $1,701,000 for the three months
ended October 2, 2004. In view of these matters, realization of a major portion
of the Company’s assets is dependent upon the Company’s ability to
meet its financing requirements and the success of its future operations. The
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or amounts of
liabilities. Management plans are outlined below. |
| |
|
We continue to address customer relationship issues and are
continuing the process of rebuilding our sales base through the initiatives
detailed below. Note, however, that the FDA Warning Letter discussed in Note 3
may impact our ability to carryout the initiatives, objectives and actions noted
below and otherwise affect our business, results of operations or financial
condition. As part of these initiatives, we have undertaken the following: |
| |
|
• |
Continuing to expand our custom manufacturing for some major
pharmaceutical companies. |
| |
|
• |
Eliminating several unprofitable product lines consisting mainly
of items purchased from third parties and repackaged end products for smaller
customers. |
| |
|
• |
Evaluating product line and customer profitability. |
| |
|
• |
Increasing our business supplying other manufacturers with bulk
tablets and capsules, taking advantage of higher volumes and better
margins. |
| |
|
• |
Exploring opportunities to expand our product line through joint
venture marketing agreements. |
| |
|
• |
Launching the HealthPharm™ brand of OTC medicines as an
Extreme Value Brand for Dollar Store programs. |
| |
|
• |
Exploring exclusive branding opportunities. |
| |
|
• |
Exploring opportunities to expand our international sales. |
| |
|
• |
Increasing prices where possible. |
| |
|
These objectives, along with sustaining market share and
increasing sales, are projected to be driven by the following: |
| |
|
• |
Re-establishing strong relationships within our distribution
network. |
| |
|
• |
Controlling and reducing, where appropriate, fixed and variable
expenses. |
| |
|
• |
Improving manufacturing efficiencies. |
| |
|
• |
Shortening delivery time. |
| |
|
• |
Improving on-time delivery. |
| |
|
• |
Filing ANDAs for new products as they come to the OTC Market. |
| |
|
• |
Obtaining marketing rights for products produced by other generic
pharmaceutical manufacturers. |
| |
|
We believe that cash flow from operations, our revolving credit
facility and equipment and term loan financing, plus continued financial support
from ICC, our parent company, will be sufficient to fund our currently
anticipated operations, working capital, capital spending and debt service
through September 30, 2005. While no assurance can be given that cash flow will
be sufficient to fund operations, ICC has committed to provide us with the
necessary financing to continue our operations through March 31, 2005. ICC has
supported us in the past by providing loans, replacing loans from our
asset-based lenders and providing us with working capital. Based upon prior
history, management believes ICC will continue to support PFI after March 31,
2005 but that ICC has not made any legal commitment to do so. Additionally, ICC
has guaranteed our debt with our major lender (see Note 6). |
| |
|
|
In March 2002, action was brought against PFI in the United States
District Court for the Southern District of New York seeking $20 million in
damages and $40 million in punitive damages related to the sales of allegedly
defective product. The Company believes the lawsuit is without merit and is
vigorously defending against it. |
| |
|
(b) |
Case relating to Max Tesler |
| |
|
|
In May 1998, the Company brought an action in Middlesex County
Superior Court, NJ against one of its former outside corporate counsels seeking
damages for conflict of interest, breaches of fiduciary duty and loyalty,
negligence and malpractice during its representation of the Company. The action
has been sent to binding arbitration, which is expected to commence in the
winter or spring of 2005. |
| |
|
(c) |
Apotex Corporation and Torpharm vs. PFI |
| |
|
|
In July 2000, an action was instituted in the Circuit Court of
Cook County, Illinois against the Company by Apotex Corporation
(“Apotex”) and Torpharm, Inc. seeking an unspecified amount in damages
and specific performance in the nature of purchasing a certain product from
Apotex. The complaint alleges that the Company would purchase a certain product
exclusively from Apotex. The counts specified in the complaint include breach of
contract, negligent misrepresentation, breach of implied covenant of good faith
and fair dealing, breach of implied covenant to use best efforts, specific
performance, breach of fiduciary duty, reformation and a Uniform Commercial Code
action for the price of 3 million tablets. Management believes the lawsuit is
without merit and is vigorously defending against it. |
| |
|
|
The Company is a party to various other legal proceedings arising
in the normal conduct of business. Management believes that the final outcome of
all current legal matters will not have a material adverse effect upon the
Company’s financial position or results of operations. |
| |
|
The prior owner of our Edison, New Jersey manufacturing facility, Revco,
conducted a soil and groundwater cleanup of such facility, under the New Jersey
Industrial Site Recovery Act (ISRA), as administered by the New Jersey
Department of Environmental Protection (NJDEP). NJDEP determined that the soil
remediation was complete and approved the groundwater remediation plan, subject
to certain conditions. Revco began operating a groundwater remediation treatment
system in 1995. Although CVS (as the successor to Revco) is primarily
responsible for the entire cost of the cleanup, we guaranteed the cleanup. In
addition, we agreed to indemnify the owner of the facility under the terms of
the 1989 sale leaseback. If CVS defaults in its obligations to pay the cost of
the clean-up, and such costs exceed the amount of the bond posted by Revco, we
may be required to make payment for any cleanup. The likelihood of CVS being
unable to satisfy any claims which may be made against it in connection with the
facility, however, are remote in our opinion. Accordingly, we believe that we
will not have to bear any costs associated with remediation of the facility and
we will not need to make any material capital expenditures for environmental
control facilities. |
| |
|
Our facilities are subject to periodic inspection by the Food and
Drug Administration for, among other things, conformance to current Good
Manufacturing Practices, or cGMP. Following an inspection, the FDA typically
provides its observations, if any, in the form of a Form 483 (Notice of
Inspectional Observations). In January 2004, the FDA initiated an inspection of
our Edison, New Jersey manufacturing facility. Following the inspection, the FDA
issued to us a Form 483 notice concerning our compliance with cGMP, including
observations related to training, personnel and control systems. Although we
responded to the Form 483 to address and correct the deficiencies, the FDA
further issued a warning letter dated May 5, 2004 (received by us on May 11,
2004) relating to these observations. On June 3, 2004, the Company responded to
the FDA with a plan of the corrective actions that the Company has taken or
proposes to take. In that response, the Company committed to further developing
and implementing, in a timely manner, the principles and strategies of
systems-based quality management for improved cGMP compliance, operational
performance and efficiencies. On July 19, 2004, the FDA acknowledged the
Company’s response and requested additional detail and clarification of
certain items. On August 17, 2004 the Company responded to the FDA and provided
the information requested. On September 16, 2004 the FDA requested additional
information which the Company provided in its response dated October 15, 2004.
The Company continues to reiterate to the FDA its commitment to bringing its
operations in full compliance with FDA regulations. |
| |
|
There can be no assurance, however, that our actions in response
to the Form 483 and warning letter will be deemed adequate by the FDA or that
additional actions will not be required by us. In addition, we remain subject to
periodic FDA inspections and there can be no assurances that we will not be
required to undertake additional actions to comply with the Federal Food, Drug
and Cosmetic Act and any other applicable regulatory requirements. Any failure
by us to comply with applicable regulatory requirements could have a material
adverse effect on our ability to continue to manufacture and distribute our
products. The FDA has many enforcement tools including recalls, seizures,
injunctions, civil fines and/or criminal prosecutions. During the pendancy of
any FDA action it is also possible that the FDA will not approve any NDAs or
ANDAs that we may submit for products to be manufactured at this facility. At
this time, the FDA has not taken any action other than to issue the Form 483 and
warning letter. Any additional actions that the FDA may take could have a
material adverse effect on our business, results of operations or financial
condition. While there can be no assurance that an adverse determination of any
of the matters identified in the FDA’s warning letter could not have a
material adverse impact on our business in any future period, management does
not believe, based on the information currently known to it, that the warning
letter, or the actions that need to be taken in response to such letter, will
materially adversely affect our operations. |
| |
|
On September 29, 2004 the FDA approved the Company’s
supplemental new drug application for a new ANDA of orange ibuprofen. |
| |
|
Inventories consist of the following: |
October 2, 2004 January 3, 2004
--------------- -----------------
Raw materials $ 5,117,000 $ 5,676,000
Work in progress 1,267,000 1,233,000
Finished goods 6,297,000 7,143,000
-------------- ----------------
$ 12,681,000 $ 14,052,000
============== ================
| |
Note 5 |
Related Party Transactions |
| |
|
As of October 2, 2004, ICC owned a total of 74,488,835 shares of
our common stock, representing approximately 86.6% of the total number of shares
outstanding on that date. The following additional transactions with ICC and its
subsidiaries are reflected in the consolidated financial statements as of
October 2, 2004 and September 27, 2003 or for the nine and three months ended
October 2, 2004 and September 27, 2003: |
Nine Months Ended Three Months Ended
-------------------------------------- --------------------------------
Oct. 2, 2004 Sept. 27,2003 Oct. 2, 2004 Sept. 27, 2003
---------------- -------------------- --------------- ----------------
Inventory purchases $ 4,578,000 $5,175,000 $ 1,460,000 $1,930,000
Interest charges 920,000 769,000 336,000 255,000
As of
--------------------------------
Oct. 2, 2004 Jan. 3, 2004
--------------- -----------------
Accounts payable $10,358,000 $ 11,761,000
Note payable 23,154,000 21,729,000
| |
|
The Company has a revolving credit facility with The CIT
Group/Business Credit, Inc., which is secured by accounts receivable and
inventory, which expires on December 31, 2006. The credit agreement with CIT
includes certain financial covenants including a requirement to maintain minimum
tangible net worth, net worth for Konsyl, and minimum net income on a rolling
three-month basis. |
| |
|
On August 20, 2004 the Company obtained a waiver of certain covenants and the
Company and CIT agreed to an amendment to the credit agreement, while
reaffirming ICC’s guarantee of this debt. The amendment to the agreement
set, effective April 26, 2004, new financial covenants beginning July 31, 2004
for minimum tangible net worth and minimum fixed charge coverage ratio, each
calculated on a rolling three-month basis and additional financial covenants for
maximum accounts payable (other than to CIT or ICC) and minimum borrowing
availability as of each month end beginning July 31, 2004. The parties further
amended the agreement to include an EBITDA covenant as of September 20,
2004. |
| |
|
The Company has a requirement to maintain a lockbox with CIT. |
| |
|
On September 27, 2003 the Company modified its term loan and
security agreement with ICC. The modification consisted of a reduction in the
interest rate from prime + 1% to prime. The loan principal under this agreement
was $21,289,000 as of September 27, 2003. On March 31, 2004 the Company further
modified its term loan and security agreement with ICC. The loan principal under
this modification was increased to $21,989,000. Principal payments were due
commencing in July 2004 at $275,000 per month and in increasing amounts
thereafter with a final payment of $18,139,000 in July 2005. Interest was
payable monthly on outstanding principal in arrears commencing on July 31, 2004
at the prime rate (4.25% at July 3, 2004). The Company did not make the
principal or interest payments that were due commencing in July 2004. On August
20, 2004 the Company and ICC further modified the term loan and security
agreement, effective June 30, 2004. The loan principal under this modification
was increased to $22,389,000 to reflect $400,000 of advances made by ICC during
the three-month period ended July 3, 2004. Under the modified loan agreement,
principal payments were due commencing in September 2004 at $300,000 per month
and in increasing amounts thereafter with a final payment of $18,339,000 in
September 2005. |
| |
|
The Company did not make the principal payments due in September 2004. On
October 2, 2004 the Company further modified its term loan and security
agreement with ICC. The loan principal under this modification was increased to
$22,804,000 to reflect $415,000 of advances made by ICC during the three-month
period ended October 2, 2004. Principal payments are now due commencing on
December 2004 at $300,000 per month and in increasing amounts thereafter with a
final payment of $18,754,000 in December 2005. The loan, as amended, is secured
by a secondary security interest in all of our assets. Additionally, the
agreement with ICC contains certain negative covenants including a cross-default
provision. |
| |
|
Convertible Subordinated Debt |
| |
|
In June 2004, holders of $1,105,000 in principal amount of our 8%
and 8.25% convertible subordinated debentures agreed to extend the payment terms
on those bonds, which were due to mature on June 15, 2004, to June 15, 2005, at
the current interest rate of 8% or 8.25%, depending on which bonds are held. In
exchange for the bondholders’ signed agreements to extend the maturity date
on the bonds, they received a one-time up-front fee of $10 per $1,000 of bond
principal held by them. The fee of approximately $11,000 is included in deferred
financing costs and is being amortized over the life of the debt. In addition,
the bondholders obtained the right to convert the bonds into our common stock at
a reduced price of $.30 per share from $.34 per share. |
| |
|
In accordance with EITF 00-27, “Application of EITF Issue 98-5 to Certain
Convertible Instruments,” the Company measured the intrinsic value of the
beneficial conversion feature at $921,000 based on the market price of the stock
of $0.55 and recorded this as a debt discount and a related increase in paid in
capital. This debt discount is being amortized over the extended due date of the
bonds using the straight line method (which approximates the effective interest
method since the amortization period is one year). During the nine and three
months ended October 2, 2004, the Company recognized additional interest expense
related to the amortization of this conversion feature of $269,000 and $230,000,
respectively. |
| |
|
Additionally in June 2004, the Company repaid the remainder of the outstanding
debentures for $400,000, on their due date of June 15, 2004. ICC advanced to the
Company the funds in order to repay these debentures. Such advances were
included in the ICC note discussed above, as modified effective June 30,
2004. |
| |
|
At October 2, 2004, the Company had an aggregate of $828,000 outstanding
principal amount of convertible subordinated debentures due June 15, 2005
(originally due June, 2002) (the “8% Debentures”) with interest
payable semi-annually. At October 2, 2004, the Company had an aggregate of
$277,000 outstanding principal amount of convertible subordinated debentures due
June 15, 2005 (originally due June, 2002) (the “8¼ % Debentures”)
with interest payable annually. The holders of both debentures may convert them
at any time into shares of common stock at a conversion price of $.30 per share.
The obligations under the debentures may be paid at any time. |
| |
|
The above debentures, net of the debt discount resulting from the
beneficial conversion feature, are included on the Company’s condensed
consolidated balance sheet in current portion of long-term debt. |
| |
Note 7 |
Major Customers and Products and Export Sales |
| |
|
Sales to customers which represented more than 10% of consolidated
gross sales in the nine and three months ended October 2, 2004 and September 27,
2003, as a percentage of gross sales, were as follows: |
Nine Months Ended Three Months Ended
---------------------------- ----------------------------
Oct. 2, Sept. 27 Oct. 2, Sept. 27
Customer 2004 2003 2004 2003
----------- ------------- ----------- ---------- ------------
Dollar General 11% 10% 10% 10%
Target 12% 11% 14% 12%
Costco 7% 9% 6% 6%
| |
|
As of October 2, 2004 and January 3, 2004, the three customers
mentioned above collectively represented 36.1% and 37.2% of net accounts
receivable, respectively. |
| |
|
Sales of ibuprofen represented 27.3% of net sales for the nine
months ended October 2, 2004 and 29.7% of net sales for the nine months ended
September 27, 2003. Sales of ibuprofen represented 28.6% of net sales for the
quarter ended October 2, 2004 and 29.8% of net sales for the quarter ended
September 27, 2003. |
| |
|
Sales to customers outside the United States were $1,300,000 and
$1,430,000 for the nine months ended October 2, 2004 and September 27, 2003 and
$$468,000 and $600,000 for the three months ended October 2, 2004 and the three
months ended September 27, 2003. |
| |
Note 8 |
Dilutive Securities |
| |
As of October 2, 2004 and September 27, 2003, the Company had options and
warrants and convertible debentures outstanding that were not considered in
diluted loss per share because the effect would be antidilutive as the Company
has losses in all periods presented.
The following summarizes the options and warrants outstanding as of the dates
indicated:
|
October 2, September 27,
2004 2003
------------- -------------
Options 2,839,500 3,106,750
Warrants 1,310,000 1,310,000
--------- ---------
Total 4,149,500 4,416,750
========= =========
| |
As of October 2, 2004 and September 27, 2003, the conversion of the Company's
convertible debentures would have resulted in the issuance of 3,683,000 and
4,513,000 shares, respectively.
|
| |
The Pharmaceutical Formulations, Inc. 2004 Stock Option Plan (the "2004 Plan")
was adopted by the Board on May 20, 2004 and approved by the stockholders on
June 16, 2004.
The purpose of the 2004 Plan is to advance the interests of the Company and its
stockholders by strengthening the ability of the Company and its subsidiaries to
attract and retain persons of ability as key employees, directors and
consultants and to motivate such employees, directors and consultants, upon
whose judgment, initiative and efforts the financial success and growth of the
Company largely depend, to exercise their best efforts on behalf of the Company.
The 2004 Plan replaced, effective as of the date of such stockholder approval,
the 1994 Stock Option Plan (the "1994 Plan") as to future grants;
options previously granted under the 1994 Plan will continue for the life of
such options. The 1994 Plan authorized the grant of up to 7,500,000 shares of
common stock, of which options on 3,136,750 shares were issued and outstanding
as of June 16, 2004. Of that amount, 2,739,500 options were outstanding
as of October 2, 2004.
The aggregate number of shares of common stock which may be the subject of
options under the 2004 Plan is 5,000,000. As of October 2, 2004 100,000 shares
have been granted under the 2004 Plan. During the three months ended October 2,
2004, options for 30,000 shares were exercised under option agreements,
resulting in proceeds to the Company of $3,900. The maximum number of shares of
common stock which may be the subject of options granted to any person during
any calendar year cannot exceed 300,000.
|
| |
ITEM 2 |
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
RESULTS OF OPERATIONS
| |
The Company acquired Konsyl Pharmaceuticals, Inc. on May 15, 2003. Results of
operations of Konsyl are included in the Company's results beginning May 16,
2003. References to "PFI" mean the operations of the Company excluding the
Konsyl operations.
|
| |
The Company's gross sales for the nine months ended October 2, 2004 were
$56,415,000 as compared to $53,664,000 in the comparable period in the prior
year, an increase of $2,751,000 or 5.1%. This increase in gross sales is due to
the inclusion of Konsyl's gross sales for a full nine-month period offset
by a decrease in gross sales at PFI. Konsyl's gross sales were $8,007,000 in the
current nine-month period as compared to $4,016,000 in the comparable prior year
period of four and one-half months. Gross sales for PFI for the nine months
ended October 2, 2004 were $48,408,000 as compared to $49,648,000 in the
comparable period in the prior year, a decrease of $1,240,000 or 2.5%.
|
| |
PFI's decrease in gross sales for the nine months ended October 2, 2004 was
primarily due to increased price competition in the Private Label Over the
Counter market and a decrease in production for certain contract manufacturing
customers. Konsyl's sales increase is due to the fact that operations for 2003
only covered four and one-half months, commencing May 16, 2003.
|
| |
The Company's gross sales for the three months ended October 2, 2004 were
$18,927,000 as compared to $19,017,000 in the comparable period in the prior
year, a decrease of $90,000 or .5%. Gross sales of Konsyl were $2,527,000 in the
current three-month period as compared to $2,677,000 in the comparable prior
period. Gross sales for PFI for the three months ended October 2, 2004 were
$16,400,000 as compared to $16,340,000 in the comparable period in the prior
year, an increase of $60,000, or .4%.
|
| |
The Company's net sales for the nine months ended October 2, 2004 were
$54,434,000 as compared to $52,406,000 in the comparable period in the prior
fiscal year, an increase of $2,028,000 or 3.9%. This increase in net sales is
due to the inclusion of Konsyl's net sales for the full nine months in 2004
versus four and one-half months in 2003, offset by a decrease in net sales at
PFI. Konsyl's net sales were $7,606,000 in the current nine-month period as
compared to $3,869,000 in the prior period of four and one-half months. Net
sales for PFI for the nine months ended October 2, 2004 were $46,828,000 as
compared to $48,537,000 in the comparable period in the prior year, a decrease
of $1,709,000 or 3.5%.
|
| |
The Company's net sales for the three months ended October 2, 2004 were
$18,188,000 as compared to $18,613,000 in the comparable period in the prior
fiscal year, a decrease of $425,000 or 2.3%. Net sales of Konsyl were $2,328,000
in the current three-month period as compared to $2,583,000 in the prior period.
Net sales for PFI for the three months ended October 2, 2004 were $15,860,000 as
compared to $16,030,000 in the comparable period in the prior year, a decrease
of $170,000, or 1.1%.
|
| |
The Company's sales discounts and allowances as a percentage of gross sales for
the nine months ended October 2, 2004 was 3.5% as compared to 2.3% in the prior
period. Konsyl's sales discounts and allowances as a percentage of gross sales
was 5.0% in the current nine-month period as compared to 3.7% in the prior
period. PFI's sales discounts and allowances as a percentage of gross sales for
the nine months ended October 2, 2004 was 3.3% as compared to 2.2% in the prior
period.
|
| |
The Company's sales discounts and allowances as a percentage of gross sales in
the three months ended October 2, 2004 was 3.9% as compared to 2.1% in the
comparable period in the prior year. Konsyl's sales discounts and allowances as
a percentage of gross sales was 7.9% in the three months ended October 2, 2004
as compared to 3.5% in the prior period. Konsyl's increase is due to higher
sales allowances and charge backs from Konsyl's retail customers. PFI's sales
discounts and allowances as a percentage of gross sales for the three months
ended October 2, 2004 was 3.3% as compared to 1.9% in the prior period. PFI's
increases in sales allowances for both the nine and three months periods were
primarily due to volume-related rebate programs and additional chargebacks from
our private label customers.
|
| |
The Company's cost of sales as a percentage of net sales was 85.4% for the nine
months ended October 2, 2004 as compared to 82.7% in the prior year period.
Konsyl's cost of sales as a percentage of net sales was 49.8% for the current
nine-month period as compared to 56.0% in the prior period. PFI's cost of sales
as a percentage of net sales was 91.2% for the current nine-month period as
compared to 84.8% in the prior period.
|
| |
The Company's cost of sales as a percentage of net sales was 83.9% for the three
months ended October 2, 2004 as compared to 79.7% in the prior year period.
Konsyl's cost of sales as a percentage of net sales was 45.2% for the current
three-month period as compared to 52.9% in the prior period. Konsyl's higher
cost of sales percentage in the prior period was primarily due to
acquisition-related inventory adjustments. PFI's cost of sales as a percentage
of net sales for the current three-month period increased to 89.6% from 84.0% in
the prior period due to a decrease in sales as a result of increased competition
in the Private Label Over the Counter market, decreased production for certain
contract manufacturing, increased sales returns and allowances due to higher
retailer rebate programs and charge backs from our private label customers and a
shift in product mix in both the Private Label and Contract Manufacturing
businesses to lower margin products.
|
| |
Selling, General and Administrative |
| |
The Company's selling, general and administrative expenses were $12,051,000 or
22.1% of net sales for the nine months ended October 2, 2004 as compared to
$8,752,000 or 16.7% of net sales in the prior year period, an increase of
$3,299,000 or 37.7%. This increase is primarily due to Konsyl's operating
results being included as of May 16, 2003. Konsyl's selling, general and
administrative expenses were $3,140,000 or 41.3% of net sales for the nine
months ended October 2, 2004 as compared to $1,249,000 or 32.3% of net sales in
the prior period, an increase of $1,891,000. PFI's selling, general and
administrative expenses were $8,911,000 or 19.0% of net sales for the nine
months ended October 2, 2004 as compared to $7,503,000 or 15.5% of net sales in
the prior period.
|
| |
The Company's selling, general and administrative expenses were $4,367,000 or
24.0% of net sales for the three months ended October 2, 2004 as compared to
$3,463,000 or 18.6% of net sales in the prior year period, an increase of
$904,000 or 26.1%. Konsyl's selling, general and administrative expenses were
$1,110,000 or 47.7% of net sales for the three months ended October 2, 2004 as
compared to $801,000 or 31.0% of net sales in the prior period. This increase
was due to Konsyl's operating results being included as of May 16, 2003 and
higher advertising and promotional expenses for new and existing products. PFI's
selling, general and administrative expenses were $3,257,000 or 20.5% of net
sales for the three months ended October 2, 2004 as compared to $2,662,000 or
16.6% of net sales in the prior period. This increase in selling, general and
administrative expenses for the nine and three months period was primarily due
to higher distribution expenses, professional fees, rent (see Interest Expense
below), insurance expenses and personnel expenses.
|
| |
Interest expense was $2,591,000 for the nine months ended October 2, 2004 as
compared to $2,551,000 for the prior year period. Interest expense was
$1,019,000 for the three months ended October 2, 2004 as compared to $844,000
for the prior year period. The increase in interest expense in the nine month
period was primarily attributable to expiration of the capital lease on the
Company's building in Edison, New Jersey and its replacement with an operating
lease. The increase was partially offset by the beneficial conversion of the
debentures that resulted in additional interest expense $268,000. The interest
expense increase for the three months ended October 2, 2004 was primarily the
result of the beneficial conversion mentioned above. This conversion added
$230,000 to interest expense for the third quarter.
|
| |
We file a consolidated tax return with ICC our majority shareholder. In
accordance with a tax sharing agreement between the two companies, we will be
reimbursed for the federal tax savings generated from ICC's use of our losses.
In addition, the agreement provides for an allocation of the group's tax
liability, based upon the ratio that each member's contribution of taxable
income bears to the consolidated taxable income of the group. In connection with
this tax sharing agreement, we recorded a federal tax benefit of $2,375,000 for
the nine months ended October 2, 2004 and a federal tax benefit of $901,000 for
the nine months ended September 27, 2003. The tax benefit was $872,000 for the
three months ended October 2, 2004 as compared to $271,000 for the comparable
prior year period. The estimated effective tax rate is lower than previously
projected due to the lack of deductibility of the interest associated with the
beneficial conversion of debentures.
|
| |
The Company reported a net loss of $4,490,000 or $.05 per share for the nine
months ended October 2, 2004 as compared to a net loss of $1,295,000 or $.02 per
share in the prior year period. The Company reported a net loss of $1,701,000 or
$.02 per share for the three months ended October 2, 2004 as compared to a net
loss of $380,000 or $.00 per share in the prior year period.
|
Critical Accounting Estimates
| |
Our critical estimates are discussed in our Form 10-K for the year ended January
3, 2004. The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions in certain circumstances that affect amounts reported
in the accompanying financial statements and related notes. In preparing these
financial statements, our management has made its best estimates and judgments
of certain amounts included in the financial statements, giving due
consideration to materiality. We believe that the critical accounting policies
discussed in our Form 10-K affect our more significant estimates used in the
preparation of financial statements. Management has discussed the development
and selection of the critical accounting estimates with the audit committee of
our Board of Directors, and the audit committee has reviewed our disclosures in
the 10-K relating to these estimates. There have been no changes during the
quarter in our identification of critical accounting policies and estimates.
|
| |
As of October 2, 2004, our commitments are as follows: |
Operating
Lease Capital Lease Long-Term
Fiscal year: Obligations Obligations1 Debt2 Total
-------------------------------------------------------------------------------
2004 $ 577,000 $ 435,000 $ 1,003,000 $ 2,015,000
2005 2,135,000 1,912,000 25,185,000 29,232,000
2006 1,964,000 983,000 13,295,000 16,242,000
2007 1,964,000 653,000 750,000 3,367,000
2008 1,856,000 472,000 - 2,328,000
Thereafter 17,493,000 280,000 - 17,773,000
-------------------------------------------------------------------------------
Total Payments $25,989,000 $ 4,735,000 $40,233,000 $70,957,000
===============================================================================
| |
1 Amounts include principal payments of $4,297,000 and interest payments of $438,000.
2 Includes note payable amounts due to ICC of $23,154,000.
|
LIQUIDITY AND CAPITAL RESOURCES
| |
Cash decreased by $294,000 during the nine months ended October 2, 2004.
|
| |
Total
cash provided by operating activities was $1,216,000 for the nine months ended
October 2, 2004. This was primarily attributable to non-cash charges of
$1,876,000 for depreciation and amortization, an increase in amounts due to ICC
of $1,682,000, an increase in accounts payable and accrued expenses of
$1,139,000, a decrease in prepaid expenses and other assets of $818,000 and a
decrease in inventories of $1,371,000, offset by a net loss of $4,490,000 and an
increase in accounts receivable of $1,180,000.
|
| |
Net cash used in investing activities for the nine months ended October 2, 2004
was $1,296,000, attributable to expenditures for capital equipment.
|
| |
Net cash used in financing activities for the nine months ended October 2, 2004
was $214,000, primarily attributable to repayments of capital lease obligations
of $1,828,000 and long term debt of $1,549,000 partially offset by cash advances
from ICC of $1,515,000, proceeds of $1,039,000 received under new equipment
financing agreements, proceeds from stock option exercise of $32,000 and
additional borrowings of $577,000.
|
| |
We intend to spend up to an estimated $2,000,000 for capital improvements during
the fiscal year ending January 1, 2005 to increase manufacturing capacity and
reduce manufacturing costs. We anticipate that these capital expenditures will
be funded through equipment lease financing and working capital. While we have
in the past had no difficulty in obtaining such financing, there can be no
assurance that we will obtain the financing in the future.
|
| |
As of October 2, 2004, the Company has negative working capital of $4,832,000,
an accumulated deficit of $82,259,000 and a stockholders' deficit of
$22,250,000. In addition, the Company had net losses of $4,490,000 for the nine
months ended October 2, 2004 and $1,701,000 for the three months ended October
2, 2004. In view of these matters, realization of a major portion of the
Company's assets is dependent upon the Company's ability to meet its financing
requirements and the success of its future operations.
|
| |
We continue to address customer relationship issues and are continuing the
process of rebuilding our sales base and to pursue our plan to increase revenues
and improve operational efficiencies to restore profitability. To carry out
these plans, we have set forth certain initiatives, objectives and actions
detailed in Note 3 to the Notes to the Condensed Consolidated Financial
Statements. Note, however, that the FDA Warning Letter discussed in Note 3 in
the Notes to Condensed Consolidated Financial Statements may impact our ability
to carryout these initiatives, objectives and actions and otherwise affect our
business, results of operations or financial condition.
|
| |
We believe that cash flow from operations, our revolving credit facility and
equipment and term loan financing, plus continued financial support from ICC our
parent company, will be sufficient to fund our currently anticipated operations,
working capital, capital spending and debt service through September 30, 2005.
While no assurance can be given that cash flow will be sufficient to fund
operations, ICC has committed to provide us with the necessary financing to
continue our operations through March 31, 2005. ICC has supported us in the past
by providing loans, replacing loans from our asset-based lenders and providing
us with working capital. Based upon prior history, management believes ICC will
continue to support PFI after March 31, 2005 but that ICC has not made any legal
commitment to do so. Additionally, ICC has guaranteed our debt with our major
lender.
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| |
ITEM 3 |
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK |
| |
PFI would be adversely affected by an increase in interest rates. Each 1%
change in the prime rate will change the Company's annual interest expenditures
by approximately $435,000, based on current levels of borrowing and related base
interest rates.
|
| |
ITEM 4 |
CONTROLS AND PROCEDURES |
| |
We have carried out an evaluation under the supervision of our management,
including the Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based on that evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that, as of October 2, 2004, except as
otherwise noted below, our disclosure controls and procedures were effective to
ensure that information required to be disclosed by us in the reports filed or
submitted under the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified in the
rules and forms of the SEC, and include controls and procedures designed to
ensure that information required to be disclosed by us in such reports is
assembled and reported to our management, including the Chief Executive Officer
and Chief Financial Officer, as appropriate to allow timely decisions regarding
required disclosures.
|
| |
Our independent auditors, Grant Thornton LLP, have advised management and the
audit committee of our board of directors of two matters that they considered to
be material weaknesses in our internal controls, as that term is defined under
standards established by the Public Company Accounting Oversight Board: (i) the
lack of adequate preparation of account reconciliations and analysis necessary
to accurately prepare financial statements and (ii) the lack of sufficient
qualified personnel in our accounting department.
|
| |
We considered these matters in connection with the quarter-end closing process
and the preparation of the consolidated financial statements for the quarter
ended October 2, 2004 included in this Form 10-Q and believe that the concerns
identified by our auditors have not impaired or prevented our ability to report
accurately our financial condition and results of operation for the periods
covered by this report. Management is actively working to assess and correct the
conditions reported by our auditors and we plan to implement certain
enhancements to our disclosure controls and our internal control over financial
reporting in 2004 which we believe should address the issues identified by Grant
Thornton. Our efforts to-date have included reinforcing existing policies and
procedures, undertaking timely accounting reconciliations, and hiring additional
qualified personnel in the accounting department.
|
PART II OTHER INFORMATION
| |
See Note 3 to Notes to Condensed Consolidated Financial Statements.
|
| |
ITEM 2 |
CHANGES IN SECURITIES AND USE OF PROCEEDS |
| |
ITEM 3 |
DEFAULTS UPON SENIOR SECURITIES |
| |
ITEM 4 |
SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
|
| |
See Note 3 to Notes to Condensed Consolidated Financial Statements regarding the
recent FDA warning letter.
|
| |
On September 20, 2004, the Company and The CIT Group/Business Credit, Inc.
amended their revolving credit agreement to include an EBITDA covenant. On
October 2, 2004 the Company further modified its term loan and security
agreement with ICC. The loan principal under this modification was increased to
$22,804,000 to reflect $415,000 of advances made by ICC during the three-month
period ended October 2, 2004 and the principal payments schedule was modified.
See Note 6 to Notes to Condensed Consolidated Financial Statements.
|
| |
When used in the Form 10-Q and in future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases and in oral
statements made with the approval of an authorized executive officer, the words
or phrases "will likely result," "are expected to," "will continue," "is
anticipated", "estimate," "project," "expect," "believe," "hope," or similar
expressions are intended to identify "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such statements
are subject to certain risks and uncertainties that could cause actual results
to differ materially from historical earnings and those presently anticipated or
projected. The Company wishes to caution readers not to place undue reliance on
such forward-looking statements, which speak only as of the date
made.
|
| |
ITEM 6 |
EXHIBITS AND REPORTS ON FORM 8-K |
| |
10.1 |
Agreement between The CIT Group/Business Credit, Inc., Pharmaceutical
Formulations, Inc. and Konsyl Pharmaceuticals, Inc. dated September 20, 2004
amending certain terms of the First Amended and Restated Financing Agreement
between The CIT Group/Business Credit, Inc. successor by merger to The CIT
Group/Credit Finance, Inc. and assignee of Fidelcor Business Credit Corporation
(as Lender) and Pharmaceutical Formulations, Inc. (successor by merger to
Private Formulations, Inc. f/k/a PharmaControl Corp.) and Konsyl
Pharmaceuticals, Inc., jointly and severally (collectively as Borrower) dated as
of May 15, 2003
|
| |
10.2 |
Term Loan and Security Agreement dated as of October 2, 2004 between ICC and the
Registrant
|
| |
31 |
Certifications of the Chief Executive Officer and Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|
| |
32 |
Certification of the Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|
| |
The Registrant filed or furnished the following report on Form 8-K during the
third quarter of the fiscal year ending January 1, 2005:
|
| |
Date of Report |
Item Number (Summary) |
| |
August 23, 2004 |
2.02 (regarding results of operations and financial condition for
the second fiscal quarter) |
| |
May 15, 2003 |
Item 7 of old Form 8-K (Amendment No. 1 to 8-K as originally filed
on May 30, 2003 relating to the acquisition of Konsyl Pharmaceuticals Inc., to
include certain financial statements, filed on October 4, 2004) |
| |
September 15, 2004 |
5.03 (regarding amendments to Bylaws )
8.01 (regarding adoption of code of ethics and corporate governance guidelines)
9.01 (exhibits)
|
| |
October 23, 2004 |
1.01 (entry into a material definitive agreement with union)
9.01 (exhibit)
|
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
PHARMACEUTICAL FORMULATIONS, INC.
(REGISTRANT)
|
Date: November 16, 2004
|
By: /s/ James Ingram
James Ingram
Chairman and Chief Executive Officer
(Principal Executive Officer)
|
|
Date: November 16, 2004
|
By: /s/ A. Ernest Toth, Jr.
A. Ernest Toth, Jr.
Chief Financial Officer
(Principal Accounting Officer)
|
EXHIBIT INDEX
| 10.1 |
Agreement between The CIT Group/Business Credit, Inc., Pharmaceutical
Formulations, Inc. and Konsyl Pharmaceuticals, Inc. dated September 20, 2004
amending certain terms of the First Amended and Restated Financing Agreement
between The CIT Group/Business Credit, Inc. successor by merger to The CIT
Group/Credit Finance, Inc. and assignee of Fidelcor Business Credit Corporation
(as Lender) and Pharmaceutical Formulations, Inc. (successor by merger to
Private Formulations, Inc. f/k/a PharmaControl Corp.) and Konsyl
Pharmaceuticals, Inc., jointly and severally (collectively as Borrower) dated as
of May 15, 2003
|
| 10.2 |
Term Loan and Security Agreement dated as of October 2, 2004 between ICC and the
Registrant
|
| 31 |
Certifications of the Chief Executive Officer and Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|
| 32 |
Certification of the Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|