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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 26, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-19725
PERRIGO COMPANY
(Exact name of registrant as specified in its charter)
Michigan 38-2799573
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
515 Eastern Avenue 49010
Allegan, Michigan (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (269) 673-8451
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock (without par value)
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [X] NO [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sale price of the common stock on December
26, 2003 as reported on The NASDAQ Stock Market(R), was approximately
$811,784,797. Shares of common stock held by each executive officer and director
and by each person who owns 5% or more of the outstanding common stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.
As of July 26, 2004 the registrant had outstanding 70,945,126 shares of common
stock.
Documents incorporated by reference: Portions of the Registrant's Proxy
Statement for its Annual Meeting on October 29, 2004 are incorporated by
reference into Part III.
PART I.
Item 1. Business. (Dollar and share amounts in thousands, except per share
amounts)
GENERAL
Perrigo Company (the Company), established in 1887, is the largest manufacturer
of store brand over-the-counter (OTC) pharmaceutical and nutritional products in
the United States. Store brand products are sold under a retailer's own label
and compete with nationally advertised brand name products. The Company
attributes its leadership position in the store brand market to its commitment
to product quality, customer service, retailer marketing support and its
comprehensive product assortment and low cost production.
The Company's principal executive offices are located at 515 Eastern Avenue,
Allegan, Michigan 49010, its telephone number is (269) 673-8451 and its fax
number is (269) 673-7535. The Company's website address is www.perrigo.com,
where the Company makes available free of charge the Company's reports on Forms
10-K, 10-Q and 8-K, as well as any amendments to these reports, as soon as
reasonably practicable after they are electronically filed with or furnished to
the Securities and Exchange Commission.
The Company operates primarily through two wholly owned domestic subsidiaries,
L. Perrigo Company and Perrigo Company of South Carolina, Inc., and four wholly
owned foreign subsidiaries, Perrigo de Mexico S.A. de C.V., Quimica y Farmacia,
S.A. de C.V. (Quifa), Wrafton Laboratories Limited (Wrafton), and Perrigo UK
Limited, formerly Peter Black Pharmaceuticals Ltd. (Peter Black). As used
herein, "the Company" means Perrigo Company, its subsidiaries and all
predecessors of Perrigo Company and its subsidiaries.
The Company's customers are major national and regional retail drug, supermarket
and mass merchandise chains such as Wal-Mart, CVS, Walgreens, Albertson's,
Kroger, Safeway, and Dollar General and major wholesalers such as McKesson and
Supervalu.
The Company currently manufactures and markets certain products under brand
names, such as Good Sense(R) and Dr. Rosenblatt. The Company also manufactures
products under contract for marketers of national brand products.
The Company has realigned its segment reporting with the acquisition of Peter
Black. The Company has four reportable segments: Consumer Healthcare,
Pharmaceuticals, UK Operations and Mexico Operations. Consumer Healthcare
includes the U.S. operations supporting the sale of OTC pharmaceutical and
nutritional products. This reportable segment markets a broad line of products
that are comparable in quality and effectiveness to national brand products.
These products include analgesics, cough and cold remedies, gastrointestinal and
feminine hygiene products; as well as vitamins, nutritional supplements and
nutritional drinks. The cost to the retailer of a store brand product is
significantly lower than that of a comparable nationally advertised brand name
product. The retailer therefore can price a store brand product below the
competing national brand product while still realizing a greater profit margin.
Generally, the retailers' dollar profit per unit of store brand product sold is
greater than the dollar profit per unit of the comparable national brand
product. The consumer benefits by receiving a quality product at a price below a
comparable national brand product. This reportable segment includes
approximately 90% of the Company's revenues. Pharmaceuticals include the
development and eventual sale of prescription drug products. UK Operations
support the sale of OTC pharmaceutical and nutritional products in the United
Kingdom and includes the newly acquired Peter Black. UK Operations is a supplier
of store brand products to major grocery and pharmacy retailers and a contract
manufacturer of OTC pharmaceutical and nutritional products. Mexico Operations
support the sale of OTC and
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prescription drug products to retail, wholesale and governmental customers in
Mexico. See Notes A and J of the consolidated financial statements for
additional segment and geographic information.
SIGNIFICANT DEVELOPMENTS DURING FISCAL 2004
Consumer Healthcare -- Drug Application Approvals and New Product Introductions
In fiscal 2004, the Company received approval from the United States Food and
Drug Administration (FDA) for seven drug applications. The applications were for
the following products: famotidine 10 mg chewable tablet, two for loratadine
tablets 10 mg, ibuprofen chewable tablets 50 mg and 100 mg,
ibuprofen-pseudoephedrine oral suspension, naproxen-pseudoephedrine caplets and
miconazole nitrate cream.
The Company launched several new products, most notably loratadine syrup,
loratadine quick-dissolve tablets and children's ibuprofen-pseudoephedrine oral
suspension, comparable to the national brands Claritin(R), Alavert(R) and
Children's Motrin(R) Cold. In addition, the Company launched Dr. Rosenblatt's
Starch Blocker and experienced continued strong sales of loratadine and
pseudoephedrine sulfate 10 mg/240 mg tablets, newly launched in late fiscal
2003, comparable to Claritin-D(R) 24 Hour Extended Release tablets. The revenues
generated in fiscal 2004 from new products were approximately $70,000.
Pharmaceuticals -- Growth Strategy
In fiscal 2003, the Company announced its intent to enter the market for generic
prescription drug products as a focus for future growth complementing its strong
position in the OTC pharmaceutical market. In fiscal 2004, the Company invested
$4,000, primarily in increased research and development costs, for the
development of generic pharmaceutical products. The Company currently has
several products in development and three Abbreviated New Drug Applications
(ANDA) that have been filed with the FDA. The Company does not expect the
revenues for generic pharmaceutical products to be material in fiscal 2005.
The Company has reviewed potential acquisition opportunities as a means of
accelerating its entry into this market. The Company purchased an option to
acquire a controlling interest in Lannett Company, Inc., a manufacturer of
generic pharmaceutical products. However, upon further review, the Company
determined that this acquisition would not be in the best long-term interests of
its shareholders and the option has since expired. The Company continues to seek
acquisition opportunities that will further its development of this market and
increase shareholder value.
The Company is building its organizational structure to support its generic
pharmaceutical products business. During fiscal 2004, several key positions have
been filled, including vice presidents for scientific affairs and sales.
Additionally, the Company appointed directors for various functions, including
pharmaceutical operations, pharmaceutical business development and
pharmaceutical contract management.
Acquisition
In December 2003, the Company acquired Peter Black for $12,061 in cash, plus
contingent consideration that is not expected to be material. Peter Black,
located in the United Kingdom, is the largest manufacturer of store brand
vitamin and nutritional supplement products for grocery stores, pharmacies and
contract customers in the United Kingdom. Peter Black is included in the UK
Operations segment. The assets and liabilities, which are not considered
significant to the
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Company, were added to the Company's consolidated balance sheet beginning
December 27, 2003. No goodwill was recorded as a result of the acquisition.
Results of operations were included beginning in the third quarter of fiscal
2004.
Quarterly Cash Dividend
The Company paid quarterly dividends of $9,136, or $0.13 per share, during
fiscal 2004. The declaration and payment of dividends and the amount paid, if
any, is subject to the discretion of the Board of Directors and will depend on
the earnings, financial condition and capital and surplus requirements of the
Company and other factors the Board of Directors may consider relevant.
In the second quarter of fiscal 2004, the Board of Directors increased the
dividend from $0.025 per share to $0.035 per share, an increase of 40%, and
continued the higher dividend rate throughout the remainder of fiscal 2004.
Tax Examination
In January 2004, the Company was notified by the Internal Revenue Service that
it had concluded the routine Federal tax examination of tax years 1998, 1999 and
2000. As a result, the Company recorded a one-time income tax benefit of $13,100
in the second quarter of fiscal 2004, reducing its income tax accrual associated
with these audits. The Company believes it has appropriately accrued for
probable Federal income tax exposures subsequent to 2000.
FTC Investigation
The United States Federal Trade Commission (FTC) is investigating a 1998
agreement between Alpharma, Inc. and the Company related to a children's
ibuprofen suspension product. The agreement is no longer in effect. The Company
is currently negotiating with the FTC to close this investigation. Because of
the likelihood that the Company will enter into a settlement agreement with the
FTC, the Company has recorded a $4,750 charge in the fourth quarter of fiscal
2004 which is expected to resolve all claims by the FTC and state governments.
The Company continues to cooperate with the FTC to finalize the settlement
agreement; however, the inquiry could result in the Company being involved in
further proceedings with the FTC, state attorneys general or private litigants.
BUSINESS STRATEGY
The Company attributes its sustained leadership position in the store brand
market to its implementation of several focused business strategies that reflect
the Company's commitment to its customers and employees. The strategy is
outlined below.
Product Quality and Product Assortment
The Company is committed to consistently providing a high quality product to the
customer. Substantially all products are developed using ingredients and
formulas comparable to those of national brand products. Packaging is designed
to make the product visually appealing to the consumer. The Company offers a
comprehensive product assortment in order to fill customers' needs while
minimizing their product sourcing costs. High quality standards are maintained
throughout all phases of production, testing, warehousing and distribution by
adhering to "Current Good Manufacturing Practices" (cGMP) promulgated by the
FDA.
The Company is dedicated to being the first manufacturer to develop and market
key new store brand products. As a result, the Company has a research and
development staff that management
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believes is one of the most experienced in the industry at developing products
comparable to national brand products. This staff also responds to changes in
existing national brand products by reformulating existing Company products. In
the OTC pharmaceutical market, certain new products are the result of changes in
product status from "prescription only" (Rx) to OTC (non-prescription). These
"Rx switch" products require approval by the FDA through either its ANDA process
or its New Drug Application (NDA) process. To accelerate the approval process,
the Company relies on both internal development and strategic product
development agreements with outside sources.
Customer Service and Marketing Support
The Company seeks to establish customer loyalty by providing superior customer
service and marketing support. This includes providing (1) a comprehensive
assortment of high quality, value priced products, (2) timely processing,
shipment and delivery of orders, (3) assistance in managing customer inventories
and (4) support in managing and building the customer's store brand business.
The Company provides marketing support that is directed at developing customized
marketing programs for the customers' store brand products. The primary
objective of this store brand management approach is to enable customers to
increase sales of their own brand name products by communicating store brand
quality and value to the consumer. The Company's marketing personnel assist in
the development and introduction of new store brand products and promotion of
customers' ongoing store brand products by performing consumer research,
providing market information and establishing individualized promotions and
marketing programs.
Low Cost Supplier
The Company continually strives to improve its manufacturing capabilities and
technology to provide the manufacturing flexibility necessary to meet its
customers' changing needs and to achieve a low cost supplier position. Education
of the work force and a team approach enhances employees' skills to generate and
implement programs to increase the Company's productivity, improve quality and
better serve customers. Continuous improvement programs are utilized to improve
efficiency by eliminating waste from all phases of Company operations.
The Company strives to develop partnerships with its suppliers to ensure
reliable and competitively priced raw materials and packaging supplies.
Initiatives to control supply costs include volume purchases, global sourcing,
inventory and supply management, and quality and delivery measurements.
PRODUCTS
The Company currently markets approximately 1,200 store brand products to
approximately 300 customers. The Company includes as separate products multiple
sizes, flavors and product forms of certain products. The Company has a leading
market share in certain of its products in the store brand market.
Net sales related to new products were approximately $70,000 for fiscal 2004,
$45,000 for fiscal 2003 and $35,000 for fiscal 2002. A product is considered new
if it was added to the Company's product lines in the two most recent fiscal
years that net sales are recorded.
The following table illustrates net sales for the Company's two product lines
from fiscal 2000 through fiscal 2004. Excluded from this table is the Company's
personal care business, which was sold in August 1999.
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Net Sales(1) by Product Line
Fiscal Year
---------------------------------------------------------------
2004 2003 2002 2001 2000
---------------------------------------------------------------
OTC Pharmaceuticals $737,299 $688,480 $683,451 $624,495 $597,996
Nutritional 160,905 145,620 151,612 138,590 137,790
-------- -------- -------- -------- --------
$898,204 $834,100 $835,063 $763,085 $735,786
======== ======== ======== ======== ========
(1) Net sales were increased by broker commissions that were reclassified to
selling and administration expenses. The amounts reclassified for 2004,
2003, 2002, 2001 and 2000 were $8,121, $8,113, $8,741, $9,597 and $9,202,
respectively. See Note A.
Listed below are major consumer healthcare product categories under which the
Company markets products for store brand labels, the annual retail market size
for food, drug and mass merchandise retailers in the United States, excluding
Wal-Mart, according to Information Resources Inc., and the names of certain
national brands against which the Company's products compete.
Retail
Market Size
Product Categories (Billions) Comparable National Brands
- ------------------ ---------- --------------------------
Cough/Cold/Allergy/Sinus $3.5 Advil(R)Cold & Sinus, Afrin(R), Alavert(R), Aleve(R) Cold &
Sinus, Benadryl(R), Claritin(R), Dimetapp(R), NyQuil(R),
PediaCare(R), Robitussin(R), Sudafed(R), Tavist(R), Triaminic(R),
Tylenol(R)
Analgesics $2.2 Advil(R), Aleve(R), Bayer(R), Excedrin(R), Motrin(R), Tylenol(R)
Gastrointestinal $1.9 Alka-Seltzer(R), Citrucel(R), Correctol(R), Ex-Lax(R), Fibercon(R),
Imodium A-D(R), Maalox(R), Metamucil(R), Mylanta(R), Pepcid(R)AC,
Pepto Bismol(R), Phillips(R), Senokot(R), Tagamet HB(R), Tums(R),
Zantac(R) 75
Vitamins/Nutritional $2.9 Centrum(R), Flintstones(R), One-A-Day(R)/Caltrate(R),
Supplements/Diet Aids Osteo Bi-Flex(R), Ensure(R)
RESEARCH AND DEVELOPMENT
Research and development is a key component of the Company's business strategy.
The Company focuses on developing store brand products comparable in
formulation, quality and effectiveness to existing national brand products. As
part of the product development process, the Company considers the possibility
of any potential patent infringement and develops alternative formulations or
processes so as not to infringe any valid patent.
The Company has FDA approval to manufacture and distribute products such as
children's ibuprofen-pseudoephedrine oral suspension, loperamide hydrochloride
and tioconazole ointment, which are products comparable to the national brands
Children's Motrin(R) Cold, Imodium A-D(R) and 1-Day(TM), respectively.
The Company has the rights to distribute, through use of strategic alliance
agreements, products such as ibuprofen & pseudoephedrine tablets, acid reducer
tablets and loratadine and
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pseudoephedrine sulfate extended release tablets, products that are comparable
to the national brands Advil(R) Cold & Sinus, Pepcid(R) AC and Claritin(R) D-24,
respectively.
The Company estimates that products for which marketing exclusivity is expiring
through the year 2007 represent a substantial potential market. The Company
actively pursues all avenues to offer store brand products comparable to certain
of these products; however, there can be no assurance that it will be successful
in obtaining the right to distribute additional products in the future.
The Company spent $27,721, $23,315 and $25,689 for research and development
during fiscal 2004, 2003 and 2002, respectively. The Company anticipates that
research and development expenditures will be higher than the fiscal 2004 level
in the foreseeable future, primarily due to its entry into the generic
pharmaceutical market.
SALES AND MARKETING
The Company employs its own sales force to service larger customers and uses
industry brokers for some retailers. Field sales employees, with support from
marketing and customer service, are assigned to specific customers in order to
understand and work most effectively with the customer. They assist in
developing in-store marketing programs and optimizing communication of
customers' needs to the rest of the Company. Industry brokers provide a
distribution channel for some products, primarily those marketed under the Good
Sense(R) label.
In contrast to national brand manufacturers who incur considerable advertising
and marketing expenditures that are directly targeted to the end consumer, the
Company's primary marketing efforts are channeled through its customers, the
retailers and wholesalers, and reach the consumer through in-store marketing
programs. These programs are intended to increase visibility of store brand
products and to invite comparisons to national brand products in order to
communicate store brand value to the consumer. Merchandising vehicles such as
floor displays, bonus sizes, coupons, rebates, store signs and promotional packs
are incorporated into customers' programs. Because the retailer profit margin
for store brand products is generally higher than for national brand products,
retailers and wholesalers often commit funds for additional promotions. The
Company's marketing efforts are also directed at new product introductions and
conversions and providing market research data. Market analysis and research is
used to monitor trends for products and categories and develop category
management recommendations.
Wal-Mart accounted for 28% of net sales for fiscal 2004, 27% for fiscal 2003 and
25% for fiscal 2002. Should Wal-Mart's current relationship with the Company
change adversely, the resulting loss of business would have a material adverse
impact on the Company's consolidated operating results and financial position.
Such a change is not anticipated in the foreseeable future. No other customer
individually accounted for more than 10% of net sales.
MANUFACTURING AND DISTRIBUTION
The Company has manufacturing facilities located in the United States, the
United Kingdom and Mexico at June 26, 2004. The Company supplements its
production capabilities with the purchase of product from outside sources and
will continue to do so in the future. During fiscal 2004, the average capacity
utilization was 60% for OTC pharmaceuticals and 65% for nutritional facilities.
The capacity of these facilities may be fully utilized at certain times due to
the seasonal nature of the consumer healthcare business. The Company may elect
to utilize available capacity by contract manufacturing for national brand
companies.
The Company's manufacturing operations are designed to allow low cost production
of a wide variety of products of different quantities, sizes and packaging while
maintaining a high level of customer service and quality. Flexible production
line changeover capabilities and fast cycle times
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allow the Company to respond quickly to changes in manufacturing schedules.
The Company has logistics facilities located in the United States, the United
Kingdom and Mexico. Both contract freight and common carriers are used to
deliver products.
COMPETITION
The market for store brand OTC pharmaceutical and nutritional products is highly
competitive. Competition is based primarily on price, quality and assortment of
products, customer service, marketing support and availability of new products.
The Company believes it competes favorably in all of these areas.
The Company is the largest manufacturer of store brand OTC pharmaceutical
products in the United States. The Company's direct competition in store brand
products consists primarily of independent, privately owned companies and is
highly fragmented in terms of both geographic market coverage and product
categories. Additionally, competition is growing from generic prescription drug
manufacturers in the Rx to OTC switch products market. The Company competes in
the nutritional area with a number of public and private companies, some of
which have broader product lines and larger sales volumes.
The Company's products also compete with nationally advertised brand name
products. Most of the national brand companies have resources substantially
greater than those of the Company. National brand companies could in the future
seek to compete more directly in the store brand market by manufacturing store
brand products or by lowering prices of national brand products. The Company
believes that the manufacturing methods and business approach used by national
brand companies are not easily adapted to the requirements of the store brand
market. These requirements include the ability to produce many different package
designs and product sizes. In addition, the marketing focus of national brand
companies is directed towards the consumer rather than toward the retailer.
MATERIALS SOURCING
Raw materials and packaging supplies are generally available from multiple
suppliers. Certain components and finished goods are purchased rather than
manufactured because of temporary production limitations, FDA restrictions or
economic and other factors. In the past, supplies of certain raw materials, bulk
tablets and components were limited, or were available from one or only a few
suppliers. Historically, the Company has been able to react to situations that
require alternate sourcing. Should alternate sourcing be required, the nature of
the FDA restrictions placed on products approved through the ANDA or NDA process
could substantially lengthen the approval process for an alternate source and
adversely affect financial results. The Company has good, cooperative working
relationships with substantially all of its suppliers and has historically been
able to capitalize on economies of scale in the purchase of materials and
supplies due to its volume of purchases.
In December 2002, a supplier of tablet/caplet gelatin coating processing
confirmed its intention to discontinue selling its services to the Company as of
March 31, 2003. Sales related to these products have decreased $12,000 in fiscal
2004 compared to fiscal 2003. No further reduction in future sales is expected.
The Company has arranged alternative coating sources to service customer
requirements. In May 2004, the Company's former supplier filed a patent
infringement suit against the Company relating to its replacement products. The
Company does not expect the outcome of this suit to have a material adverse
effect on its operations or financial results.
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TRADEMARKS AND PATENTS
The Company owns certain trademarks and patents; however, its business as a
whole is not materially dependent upon its ownership of any one trademark or
patent, or group of trademarks or patents.
SEASONALITY
The Company's sales of OTC pharmaceutical and nutritional products are subject
to the seasonal demands for the cough/cold/flu and allergy products in the
second and third quarters. The second quarter of fiscal 2004 saw higher sales
for these products reflecting the earlier than usual peak of the cough/cold/flu
season in the U.S. market. However, sales for the entire season were relatively
unchanged from the prior year. Historically, the Company's sales of
cough/cold/flu products have varied from year to year based in large part on the
severity and length of the cough/cold/flu season. While the Company believes
that the severity and length of the cough/cold/flu season will continue to
impact its sales of cough/cold/flu products, there can be no assurance that the
Company's future sales of those products will necessarily follow historical
patterns.
PRODUCT LIABILITY
Over the last ten years the aggregate amount paid in settlement of liability
claims has not been material, and the Company is unaware of any suits that would
exceed its insurance limits. The Company believes that, currently, its product
liability coverage is adequate to cover anticipated lawsuits.
In November 2000, at the request of the FDA, the Company voluntarily withdrew
from the U.S. market its products containing Phenylpropanolamine (PPA), an
ingredient used in the manufacture of certain OTC cough/cold and diet products.
Numerous individual PPA-related lawsuits have been filed alleging that the
plaintiffs suffered injury, generally some type of stroke, from ingesting the
Company's PPA-containing products. At this time, the outcome of these suits is
not determinable. See "Item 3. Legal Proceedings" and "Additional Item.
Cautionary Note Regarding Forward-Looking Statements - Exposure to Product
Liability Claims."
ENVIRONMENTAL
The Company is subject to various federal, state and local environmental laws
and regulations. The Company believes that the costs for complying with such
laws and regulations will not be material to the business of the Company. The
Company does not have any material remediation liabilities outstanding.
GOVERNMENT REGULATION
The manufacturing, processing, formulation, packaging, labeling, testing,
storing, distributing, advertising and sale of the Company's products are
subject to regulation by one or more United States agencies, including the FDA,
the FTC, the Drug Enforcement Administration (DEA) and the Consumer Product
Safety Commission (CPSC), as well as by foreign agencies. Various agencies of
the states and localities in which the Company's products are sold also regulate
these activities. In addition, the Company manufactures and markets certain of
its products in accordance with the guidelines designated by voluntary standard
setting organizations, such as the United States Pharmacopoeia Convention, Inc.
(USP) and NSF International (NSF). The Company believes that its policies,
operations and products comply in all material respects with existing
regulations.
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Food and Drug Administration
The FDA has jurisdiction over the Company's (1) marketing of ANDA, NDA, and OTC
monograph drug products and (2) marketing of dietary supplements, which are
regulated as foods. The FDA's jurisdiction extends to the manufacturing,
testing, labeling, packaging, and distribution of these products.
OTC Pharmaceuticals. The majority of the Company's OTC pharmaceuticals are
regulated under the OTC Monograph System and subject to certain FDA regulations.
Under the OTC Monograph System, selected OTC drugs are generally recognized as
safe and effective and do not require the submission and approval of an NDA or
ANDA prior to marketing. The FDA OTC Monograph System includes well-known
ingredients and specifies requirements for permitted indications, required
warnings and precautions, allowable combinations of ingredients and dosage
levels. Drug products marketed under the OTC Monograph System must conform to
specific quality and labeling requirements; however, these products generally
can be developed with fewer regulatory hurdles than those products that require
the filing of an NDA or ANDA. It is, in general, less costly to develop and
bring to market a product produced under the OTC Monograph System. From time to
time, adequate information may become available to the FDA regarding certain
drug products that will allow the reclassification of those products as
generally recognized as safe and effective and not misbranded and, therefore, no
longer requiring the approval of an NDA or ANDA prior to marketing. For this
reason, there may be increased competition and lower profitability related to a
particular product should it be reclassified to the OTC Monograph System. In
addition, regulations may change from time to time, requiring formulation,
packaging or labeling changes for certain products.
The Company also markets products that have switched from prescription to OTC
status. These Rx to OTC switch products require approval by the FDA through its
NDA or ANDA process before they can be commercialized. Based on current FDA
regulations, all chemistry, manufacturing and control issues, bioequivalence and
labeling related to these products are addressed by the information included in
the NDA or ANDA. The ANDA process generally requires less time and expense for
FDA approval compared to the NDA process. For approval of an ANDA, the Company
must demonstrate that the product is essentially the same as a product that has
previously been approved by the FDA and is on the market and that the Company's
manufacturing process and other requirements meet FDA standards. This approval
process may require that bioequivalence and/or efficacy studies be performed
using a small number of subjects in a controlled clinical environment. Approval
time is generally about eighteen months to four years from the date of
submission of the application. Changes to a product marketed under an ANDA or
NDA are governed by specific FDA regulations and guidelines that define when
proposed changes, if approved by the FDA, can be implemented.
Under the Drug Price Competition and Patent Term Restoration Act of 1984 (the
Hatch-Waxman Amendments to the Federal Food, Drug and Cosmetic Act) a company
can obtain a three-year period of marketing exclusivity for an Rx to OTC switch
product if the Company does a clinical study that is essential to FDA approval.
This exclusivity would prevent other companies from obtaining approval of
applications for the switch product. Unless the Company establishes
relationships with the companies having exclusive marketing rights, or the
Company conducts its own clinical trials, the Company's ability to market Rx to
OTC switch products and offer its customers products comparable to the national
brand products would be delayed until the expiration of the three-year
exclusivity granted to the company initiating the switch. There can be no
assurance that, in the event that the Company applies for FDA approvals, the
Company will obtain the approvals to market Rx to OTC switch products or,
alternatively, that the Company will be able to obtain these products from other
manufacturers.
Under the FDA Modernization Act of 1997, a manufacturer may obtain an additional
six months
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(which, under certain circumstances, may be extended to one year) of exclusivity
if the innovator conducts pediatric studies on the product. This exclusivity
will, in certain instances, delay sales by the Company of certain products.
If the Company is first to file its ANDA and meets certain requirements, the
Company may be entitled to a 180-day exclusivity for that product. When a
company submits an ANDA, the company is required to include a patent
certification to certain patents that cover the innovator product. If the ANDA
applicant challenges the validity of the innovator's patent or certifies that
its product does not infringe the patent, the product innovator may sue for
infringement. The legal action would not result in material damages but could
result in the Company being prevented from introducing the product if it is not
successful in the legal action. The Company would, however, incur the cost of
defending the legal action, and that action would have the effect of triggering
a statutorily mandated delay in FDA approval of the ANDA for a period of up to
30 months.
If the Company is not first to file its ANDA, the FDA may grant 180-day
exclusivity to another company, thereby effectively delaying the launch of the
Company's product. In addition, if exclusivity is granted to the Company, there
can be no assurance that the beginning of the exclusivity period will coincide
with the ability of the Company to market the product. The Company may forfeit
its exclusivity as the result of events that are outside of the Company's
control.
All facilities where NDA, ANDA, and OTC drugs are manufactured, tested, packed,
warehoused or distributed must comply with FDA cGMPs. All of the Company's NDA,
ANDA, and OTC drug products are manufactured, tested, packaged, stored and
distributed according to cGMP regulations. The FDA performs periodic audits to
ensure that the Company's facilities remain in compliance with all appropriate
regulations. The failure of a facility to be in compliance may lead to a breach
of representations made to private label customers or to regulatory action
against the products made in that facility, including seizure, injunction or
recall.
The Company is also subject to the requirements of the Comprehensive
Methamphetamine Control Act of 1996, a law designed to allow the DEA to monitor
transactions involving chemicals that may be used illegally in the production of
methamphetamine. The Comprehensive Methamphetamine Control Act of 1996
establishes certain registration and recordkeeping requirements for
manufacturers of OTC cold, allergy, asthma and diet medicines that contain
ephedrine, pseudoephedrine or PPA. While certain of the Company's OTC drug
products contain pseudoephedrine, the Company's U.S. products contain neither
ephedrine, a chemical compound that is distinct from pseudoephedrine, nor PPA.
Pseudoephedrine is a common ingredient in decongestant products manufactured by
the Company and other pharmaceutical companies. The Company believes that its
products are in compliance with all applicable DEA requirements.
Dietary Supplements. The Dietary Supplement Health and Education Act of 1994
(DSHEA) was enacted on October 25, 1994 and amended the Federal Food, Drug, and
Cosmetic Act to, among other things: (1) define dietary supplements and dietary
ingredients, (2) require ingredient and nutrition labeling, (3) permit
"structure/function" statements for dietary supplements and (4) permit the
display of certain published literature where supplements are sold. Although
dietary supplements are regulated as foods, the FDA is prohibited from
regulating the dietary ingredients in supplements as food additives. In
addition, the FDA is generally prohibited from regulating dietary supplements as
drugs unless the supplements bear drug or disease claims.
DSHEA provides for specific nutritional labeling requirements for dietary
supplements that are slightly different than those for conventional foods. All
supplements must bear a "Supplement Facts" box, which must list all of the
supplement's dietary ingredients using nomenclature as specified in FDA
regulations. DSHEA also permits dietary supplements to bear statements (1)
claiming a benefit related to a classical nutrient deficiency disease, provided
the prevalence of the
-10-
disease in the United States is disclosed, (2) describing the role of a nutrient
or dietary ingredient intended to affect the structure or function in humans,
(3) characterizing the documented mechanism by which a nutrient or dietary
ingredient acts to maintain such structure or function and (4) describing
general well-being from consumption of a nutrient or dietary ingredient.
On January 6, 2000, the FDA published a Final Rule clarifying the types of
statements permissible in dietary supplement labeling. The statements cannot
state expressly or implicitly that a dietary supplement has any effect on a
"disease," which the FDA defines in the Final Rule. However, dietary supplements
may bear certain statements from several OTC drug monographs (e.g., relief of
occasional sleeplessness).
Another type of claim that may be permitted by the FDA in dietary supplement
labeling is a "health claim," which characterizes the role of a nutrient to a
disease or health-related condition. There are three types of health claims: (1)
health claims authorized by FDA regulations based on significant scientific
agreement among experts qualified by scientific training and experience to
evaluate such claims (2) health claims based on an authoritative statement of a
scientific body of the United States Government or National Academy of Sciences
and not objected to by the FDA and (3) "qualified health claims," which are a
result of litigation and which may be made with a lower level of substantiation,
provided that the FDA does not object to the claims.
Structure/function claims, health claims, and qualified health claims give
industry more latitude in marketing dietary supplements and provide information
to consumers about the use and benefits of dietary supplements.
The FDA has proposed regulations for cGMP requirements for dietary supplements.
Although the Company cannot predict the specific content of the final cGMPs or
the timing of issuance, it believes the changes will have minimal impact on its
business. Until the final dietary supplement cGMPs are in place, the Company is
following the FDA food cGMPs for its supplement products. In addition, as
explained below, the Company also follows the NSF Good Manufacturing Practices
Dietary Supplement Program.
The Company cannot determine what effect the FDA future regulations will have on
its business. Future regulations could, among other things, require expanded
documentation of the properties of certain products or scientific substantiation
regarding ingredients, product claims or safety. In addition, the Company cannot
predict whether new legislation regulating the Company's activities will be
enacted or what effect any legislation would have on the Company's business.
Consumer Product Safety Commission
The CPSC has authority, under the Poison Prevention Packaging Act, to designate
those products, including vitamin products and OTC pharmaceuticals, that require
child resistant closures to help reduce the incidence of accidental poisonings.
The CPSC has adopted regulations requiring numerous OTC pharmaceuticals and
iron-containing dietary supplements to have these closures and has adopted rules
regarding the testing of these closures by both children and adults. The
Company, working with its packaging suppliers, believes that it is in compliance
with all CPSC requirements.
Federal Trade Commission
The FTC exercises primary jurisdiction over the advertising and other
promotional practices of marketers of dietary supplements and OTC
pharmaceuticals and often works with the FDA regarding these practices. The FTC
considers whether a product's claims are substantiated, truthful and not
misleading.
-11-
The FTC is investigating a 1998 agreement between Alpharma, Inc. and the Company
related to a children's ibuprofen suspension product. The agreement is no longer
in effect. The Company is currently negotiating with the FTC to close this
investigation. Because of the likelihood that the Company will enter into a
settlement agreement with the FTC, the Company has recorded a $4,750 charge in
the fourth quarter of fiscal 2004 which is expected to resolve all claims by the
FTC and state governments. The Company continues to cooperate with the FTC to
finalize the settlement agreement; however, the inquiry could result in the
Company being involved in further proceedings with the FTC, state attorneys
general or private litigants.
State Regulation
All states regulate foods and drugs under laws that generally parallel federal
statutes. The Company is also subject to other state consumer health and safety
regulations, such as California Proposition 65 and Oklahoma House Bill 2176,
that could have a potential impact on the Company's business if the Company is
ever found not to be in compliance. The Company is not engaged in any material
state governmental enforcement or other regulatory actions and is not aware of
material non-compliance with state regulations.
United States Pharmacopoeial Convention
The USP is a non-governmental, voluntary standard-setting organization. Its drug
monographs and standards are incorporated by reference into the Federal Food,
Drug, and Cosmetic Act as the standards that must be met for the listed drugs,
unless compliance with those standards is specifically disclaimed. USP standards
exist for most OTC pharmaceuticals. The FDA typically requires USP compliance as
part of cGMP compliance.
NSF International
NSF is an independent, not-for-profit, non-governmental organization providing
risk management services in public health and safety. Its services include
standards development, product certification, safety audits, management systems
registration and education programs. NSF is accredited by the American National
Standards Institute, the Occupational Safety and Health Administration and the
Standard Council of Canada. These accreditations attest to the competency of
services provided by NSF and compliance with established national and
international standards for third-party certification.
The NSF Good Manufacturing Practices Dietary Supplement Program enables
manufacturers to become independently registered by NSF as conforming to
guidelines that provide a system of processes, procedures and documentation to
assure the product produced has the strength, composition, quality and purity
represented on the product label. The Company's nutritional facility has earned
NSF registration.
Foreign Regulation
The Company manufactures, packages and distributes OTC pharmaceuticals and
nutritional products in the United Kingdom and provides contract manufacturing
and packaging services for major pharmaceutical and healthcare companies in the
United Kingdom. The manufacturing, processing, formulation, packaging, testing,
labeling, advertising and sale of these products are subject to regulation by
one or more United Kingdom agencies, including the Medicines and Healthcare
Products Regulatory Agency, the Department of Health, the Department of the
Environment, Her Majesty's Customs and Excise, the Department of Trade and
Industry, the Health and Safety Executive and the Department of Transport.
-12-
The Company manufactures, packages and distributes Rx pharmaceutical, OTC
pharmaceutical and nutritional products in Mexico. The manufacturing,
processing, formulation, packaging, labeling, testing, advertising and sale of
these products are subject to regulation by one or more Mexican agencies,
including the Health Ministry, the Commercial and Industrial Secretariat, the
Federal Work's Secretariat, the Environmental Natural Resources and Fishing
Secretariat, the Federal Environmental Protection Ministry and the Treasury and
Public Credit Secretariat and its Customs Government department.
The Company exports OTC pharmaceutical and nutritional products to foreign
countries. Government regulations for exporting these products are covered by
the United States FDA, and where appropriate, DEA law, as well as each
individual country's requirement for importation of such products. Each country
requires approval of these products through a registration process by that
country's regulatory agencies. These registrations govern the process, formula,
packaging, testing, labeling, advertising and sale of the Company's products and
regulate what is required and what may be represented to the public on labeling
and promotional material. Approval for the sale of the Company's products by
foreign regulatory agencies may be subject to delays.
EMPLOYEES
As of June 26, 2004, the Company had 2,710 full-time and temporary employees in
the United States. The Company has not been a party to a collective bargaining
agreement in the United States. The Company had 679 employees in the United
Kingdom, none of whom are covered by a collective bargaining agreement. The
Company had 502 employees in Mexico, of whom 282 are covered by a collective
bargaining agreement. Management considers its relations with its employees to
be good.
Item 2. Properties.
As of June 26, 2004, the Company owned or leased the following primary
facilities, classified by segment: No. of Approx. Square Footage Location
Facilities Owned Leased
No. of Approx. Square Footage
Location Facilities Owned Leased
-------- ---------- ----- ------
Consumer Healthcare Michigan 13 2,000,000 -
South Carolina 3 200,000 160,000
UK Operations Braunton, United Kingdom 1 230,000 -
Swadlincote, United Kingdom 1 - 110,000
Mexico Operations Ramos Arizpe, Mexico 2 110,000 30,000
All of the facilities above provide manufacturing, logistics and offices to
support the respective business segment. The Company leases other minor
properties for logistics and offices in the United States and Mexico. The
Company considers all of its properties to be well-maintained and suitable for
the intended purpose of the facility.
Item 3. Legal Proceedings. (Dollar amounts in thousands)
The Company is not a party to any litigation, other than routine litigation
incidental to its business except for the litigation described below. The
Company believes that none of the routine litigation, individually or in the
aggregate, will be material to the business of the Company.
-13-
The FTC is investigating a 1998 agreement between Alpharma, Inc. and the Company
related to a children's ibuprofen suspension product. The agreement is no longer
in effect. The Company is currently negotiating with the FTC to close this
investigation. Because of the likelihood that the Company will enter into a
settlement agreement with the FTC, the Company has recorded a $4,750 charge in
the fourth quarter of fiscal 2004 which is expected to resolve all claims by the
FTC and state governments. The Company continues to cooperate with the FTC to
finalize the settlement agreement; however, the inquiry could result in the
Company being involved in further proceedings with the FTC, state attorneys
general or private litigants.
The Company is currently defending numerous individual lawsuits pending in
various state and federal courts involving PPA, an ingredient used in the
manufacture of certain OTC cough/cold and diet products. The Company
discontinued using PPA in the United States in November 2000 at the request of
the FDA. These cases allege that the plaintiff suffered injury, generally some
type of stroke, from ingesting PPA-containing products. Many of these suits also
name other manufacturers or retailers of PPA-containing products. These personal
injury suits seek an unspecified amount of compensatory, exemplary and statutory
damages. The Company maintains product liability insurance coverage for the
claims asserted in these lawsuits. The Company believes that it has meritorious
defenses to these lawsuits and intends to vigorously defend them. At this time,
the Company cannot determine whether it will be named in additional PPA-related
suits, the outcome of existing suits or the effect that PPA-related suits may
have on its financial condition or operating results.
In August 1999, the Company filed a civil antitrust lawsuit in the United States
District Court for the Western District of Michigan against a group of vitamin
raw material suppliers alleging the defendants conspired to fix the prices of
vitamin raw materials sold to the Company. The relief sought included money
damages and a permanent injunction enjoining defendants from future violation of
antitrust laws. The Company has entered into settlement agreements with all of
the defendants. The Company received settlement payments of $3,128 and $27,891
in fiscal 2003 and 2002, respectively. The payments were net of attorney fees
and expenses that were withheld prior to the disbursement of the funds to the
Company. The Company will not receive any additional income related to this
lawsuit.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to the vote of security holders during the fourth
quarter of fiscal 2004.
Additional Item. Executive Officers of the Registrant.
The executive officers of the Company and their ages and positions as of July
26, 2004 were:
Name Age Position
---- --- --------
F. Folsom Bell 62 Executive Vice President, Business Development
David T. Gibbons 60 Chairman of the Board, President and Chief Executive Officer
John T. Hendrickson 41 Executive Vice President and General Manager, Perrigo Consumer
Healthcare
Todd W. Kingma 44 Vice President and General Counsel
Mark P. Olesnavage 51 Executive Vice President and General Manager, Perrigo
Pharmaceuticals
Douglas R. Schrank 56 Executive Vice President and Chief Financial Officer
Mr. Bell was named Executive Vice President, Business Development, in September
2000. From
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January 2000 until that time, Mr. Bell acted as a consultant to the Company. Mr.
Bell was a member of the Board of Directors from January 1981 through February
1986, when he voluntarily resigned. Mr. Bell was re-elected in June 1988 and
voluntarily resigned in January 2003. He was the Chairman, President and Chief
Executive Officer of Thermo-Serv, Inc. from July 1989 to September 1999.
Mr. Gibbons was elected Chairman of the Board in August 2003. He was elected
President and Chief Executive Officer in May 2000 and a director of the Company
in June 2000. Previously, Mr. Gibbons served as President of Rubbermaid Europe
from 1997 to 1999 and President of Rubbermaid Home Products from 1995 to 1997.
Prior to joining Rubbermaid, he served in various management, sales and
marketing capacities with 3M Company from 1968 to 1995.
Mr. Hendrickson was named Executive Vice President and General Manager, Perrigo
Consumer Healthcare in August 2003. He served as Executive Vice President of
Operations from October 1999 to August 2003, Vice President of Operations from
October 1997 to October 1999 and Vice President of Customer Service from October
1996 to October 1997. Previously, he had been Director of Engineering of the
Company since 1993 and served in various positions in process engineering from
1989 to 1992. Prior to 1989, Mr. Hendrickson was in research management for five
years at Procter & Gamble Company. He is a member of the Board of Directors of
the Consumer Healthcare Products Association.
Mr. Kingma was named Vice President and General Counsel in August 2003. He was
at Pharmacia, now Pfizer, Inc., from 1991 to 2003 in a variety of legal
assignments, most recently as Vice President and Associate General Counsel.
Before joining Pharmacia, he was an attorney with Dykema Gossett.
Mr. Olesnavage was named Executive Vice President and General Manager, Perrigo
Pharmaceuticals in August 2003. He served as Executive Vice President Sales,
Marketing and Scientific Affairs from August 2000 to August 2003 and President
of Customer Business Development from June 1995 to August 2000. He served as
President of the OTC pharmaceutical operations from February 1994 to June 1995.
He served as Vice President of Pharmaceutical Business Development from July
1992 to January 1993 and Vice President-Marketing from June 1987 to July 1992.
Previously he had been Director of Marketing of the Company since 1981. He is a
member of the Board of Directors of the Generic Pharmaceutical Industry
Association.
Mr. Schrank was named Executive Vice President and Chief Financial Officer in
January 2000. Mr. Schrank was President of M. A. Hanna Company's Hanna Color
subsidiary from 1998 to 1999, Senior Vice President of the Plastics Division
from 1995 to 1998 and Vice President and Chief Financial Officer from 1993 to
1995. From 1977 to 1993, Mr. Schrank served in senior level financial,
administrative and sales positions at Sealy Corporation, Eyelab, Inc. and The
Pillsbury Company.
-15-
PART II.
(Dollar and share amounts in thousands, except per share amounts)
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters.
The Company's common stock was first quoted and began trading on The Nasdaq
Stock Market(R) on December 17, 1991 under the symbol PRGO.
Set forth below are the high and low prices for the Company's common stock as
reported on The Nasdaq Stock Market(R) for the last eight quarters:
Fiscal 2004: High Low
- ----------- ---- ---
First Quarter $16.74 $12.65
Second Quarter $16.25 $12.32
Third Quarter $20.45 $15.61
Fourth Quarter $24.96 $17.87
Fiscal 2003: High Low
- ----------- ---- ---
First Quarter $13.02 $ 9.25
Second Quarter $13.50 $10.32
Third Quarter $13.31 $10.53
Fourth Quarter $16.49 $11.67
The number of record holders of the Company's common stock as of July 26, 2004
was 1,437.
In January 2003, the Board of Directors adopted a policy of paying regular
quarterly dividends. The Company paid quarterly dividends of $9,136 and $3,484,
or $0.13 and $0.05 per share, during fiscal 2004 and 2003, respectively. The
declaration and payment of dividends and the amount paid, if any, is subject to
the discretion of the Board of Directors and will depend on the earnings,
financial condition and capital and surplus requirements of the Company and
other factors the Board of Directors may consider relevant. The Company did not
repurchase any shares in the fourth quarter of fiscal 2004.
Item 6. Selected Financial Data.
The following selected consolidated financial data should be read in conjunction
with the consolidated financial statements and the notes to these statements
included in Item 8 of this report. The consolidated statement of income data set
forth below with respect to the fiscal years ended June 26, 2004, June 28, 2003
and June 29, 2002 and the consolidated balance sheet data at June 26, 2004 and
June 28, 2003 are derived from, and are qualified by reference to, the audited
consolidated financial statements included in Item 8 of this report and should
be read in conjunction with those financial statements and notes thereto. The
consolidated statement of income data for the Company set forth below with
respect to the fiscal years ended June 30, 2001 and July 1, 2000 and the
consolidated balance sheet data for the Company at June 29, 2002, June 30, 2001
and July 1, 2000 are derived from audited consolidated financial statements of
the Company not included in this report. The statement of income data reflects
one month of personal care operations for fiscal 2000. All periods presented
have been adjusted for the expensing of stock options. Certain amounts have been
reclassified to conform to the current year presentation.
-16-
Fiscal Year
--------------------------------------------------------------
2004(1) 2003 (1) 2002(1) 2001 2000(2)
------- -------- ------- ---- -------
Statement of Income Data
Net sales (3) $898,204 $834,100 $835,063 $763,085 $753,486
Cost of sales 630,240 596,076 608,622 563,194 591,846
PPA product discontinuation - - - 17,600 -
--------- --------- --------- --------- --------
Gross profit 267,964 238,024 226,441 182,291 161,640
--------- --------- --------- --------- --------
Operating expenses
Distribution 15,154 15,563 16,327 15,148 16,002
Research and development 27,721 23,315 25,689 23,434 22,114
Selling and administration (3) 122,193 117,096 112,723 106,064 93,448
--------- --------- --------- --------- --------
Subtotal 165,068 155,974 154,739 144,646 131,564
--------- --------- --------- --------- --------
Restructuring - - 7,136 2,175 1,048
Goodwill impairment - - 11,524 - -
Unusual litigation - (3,128) (27,891) (995) (4,154)
--------- --------- --------- --------- --------
Total 165,068 152,846 145,508 145,826 128,458
--------- --------- --------- --------- --------
Operating income 102,896 85,178 80,933 36,465 33,182
Interest and other, net (3,087) (1,080) (1,355) (3,748) 4,994
--------- --------- --------- --------- --------
Income before income taxes 105,983 86,258 82,288 40,213 28,188
Income tax expense 25,416 32,210 37,498 15,799 11,363
--------- --------- --------- --------- --------
Net income $ 80,567 $ 54,048 $ 44,790 $ 24,414 $ 16,825
========= ========= ========= ========= ========
Earnings per share
Basic $ 1.15 $ 0.77 $ 0.61 $ 0.33 $ 0.23
Diluted $ 1.11 $ 0.76 $ 0.60 $ 0.33 $ 0.23
Weighted average shares outstanding
Basic 70,206 69,746 73,164 73,646 73,370
Diluted 72,289 71,158 74,606 74,087 73,536
Dividends declared per share $ 0.13 $ 0.05 - - -
June 26, June 28, June 29, June 30, July 1,
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Balance Sheet Data
Cash and investment securities $171,700 $ 93,827 $ 76,824 $ 11,016 $ 7,055
Working capital, excluding cash and
investment securities 114,043 118,828 109,993 133,135 147,963
Property, plant and equipment, net 227,641 218,778 211,044 212,087 193,580
Goodwill 35,919 35,919 35,919 47,195 18,199
Total assets 759,094 643,970 601,375 582,536 493,838
Shareholders' equity 536,232 448,424 418,162 387,367 353,468
- ----------------
(1) See Item 7 for a discussion of results of operations.
(2) Includes a charge of $15,000 for higher than normal obsolescence expenses,
a charge of $7,000 for fixed production costs and settlement proceeds
related to a civil antitrust lawsuit of $4,154.
(3) Net sales were increased by broker commissions that were reclassified to
selling and administration expenses. The amounts reclassified for 2004,
2003, 2002, 2001 and 2000 were $8,121, $8,113, $8,741, $9,597 and $9,202,
respectively. See Note A.
-17-
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
GENERAL
Segments
The Company has realigned its segment reporting with the acquisition of Peter
Black. The Company has four reportable segments: Consumer Healthcare,
Pharmaceuticals, UK Operations and Mexico Operations. Consumer Healthcare
includes the U.S. operations supporting the sale of OTC pharmaceutical and
nutritional products. Pharmaceuticals include the development and eventual sale
of prescription drug products. UK Operations support the sale of OTC
pharmaceutical and nutritional products in the United Kingdom and includes the
newly acquired Peter Black. UK Operations is a supplier of store brand products
to major grocery and pharmacy retailers and a contract manufacturer of OTC
pharmaceutical and nutritional products. Mexico Operations support the sale of
OTC and prescription drug products for retail, wholesale and governmental
customers in Mexico. See Notes A and J of the consolidated financial statements
for additional segment and geographic information.
Products and Customers
The major categories in which the Company markets its products are analgesic,
cough/cold, gastrointestinal and vitamin products. According to Information
Resources, Inc., the annual retail market for food, drug and mass merchandise
retailers in the United States, excluding Wal-Mart, for OTC pharmaceutical and
nutritional products is more than $10 billion. The store brand industry commands
more than 20% of the retail market. The Company estimates its share of the store
brand industry to be more than 50%.
The Company's customers are major national and regional retail drug, supermarket
and mass merchandise chains such as Wal-Mart, CVS, Walgreens, Albertson's,
Kroger, Safeway and Dollar General and major wholesalers such as McKesson and
Supervalu.
Consumer Healthcare -- Drug Application Approvals and New Product Introductions
In fiscal 2004, the Company received approval from the FDA for seven drug
applications. The applications were for the following products: famotidine 10 mg
chewable tablet, two for loratadine tablets 10 mg, ibuprofen chewable tablets 50
mg and 100 mg, ibuprofen-pseudoephedrine oral suspension,
naproxen-pseudoephedrine caplets and miconazole nitrate cream.
The Company launched several new products, most notably loratadine syrup,
loratadine quick-dissolve tablets and children's ibuprofen-pseudoephedrine oral
suspension, comparable to the national brands Claritin(R), Alavert(R) and
Children's Motrin(R) Cold. In addition, the Company launched Dr. Rosenblatt's
Starch Blocker and experienced continued strong sales of loratadine and
pseudoephedrine sulfate 10 mg/240 mg tablets, newly launched in late fiscal
2003, comparable to Claritin-D(R) 24 Hour Extended Release tablets. The revenues
generated in fiscal 2004 from new products were approximately $70,000.
Pharmaceuticals -- Growth Strategy
In fiscal 2003, the Company announced its intent to enter the market for generic
prescription drug products as a focus for future growth complementing its strong
position in the OTC pharmaceutical market. In fiscal 2004, the Company invested
$4,000, primarily in increased research and development costs, for the
development of generic pharmaceutical products. The Company
-18-
currently has several products in development and three ANDAs that have been
filed with the FDA. The Company does not expect the revenues for generic
pharmaceutical products to be material in fiscal 2005.
The Company has reviewed potential acquisition opportunities as a means of
accelerating its entry into this market. The Company purchased an option to
acquire a controlling interest in Lannett Company, Inc., a manufacturer of
generic pharmaceutical products. However, upon further review, the Company
determined that this acquisition would not be in the best long-term interests of
its shareholders and the option has since expired. The Company continues to seek
acquisition opportunities that will further its development of this market and
increase shareholder value.
The Company is building its organizational structure to support its generic
pharmaceutical products business. During fiscal 2004, several key positions have
been filled, including vice presidents for scientific affairs and sales.
Additionally, the Company appointed directors for various functions, including
pharmaceutical operations, pharmaceutical business development and
pharmaceutical contract management.
Seasonality
The Company's sales of OTC pharmaceutical and nutritional products are subject
to the seasonal demands for cough/cold/flu and allergy products in the second
and third quarters. The second quarter of fiscal 2004 saw higher sales for these
products reflecting the earlier than usual peak of the cough/cold/flu season in
the U.S. market. However, sales for the entire season were relatively unchanged
from the prior year. Historically, the Company's sales of cough/cold/flu
products have varied from year to year based in large part on the severity and
length of the cough/cold/flu season. While the Company believes that the
severity and length of the cough/cold/flu season will continue to impact its
sales of cough/cold/flu products, there can be no assurance that the Company's
future sales of those products will necessarily follow historical patterns.
Acquisitions
In December 2003, the Company acquired Peter Black for $12,061 in cash, plus
contingent consideration that is not expected to be material. Peter Black,
located in the United Kingdom, is the largest manufacturer of store brand
vitamin and nutritional supplement products for grocery stores, pharmacies and
contract customers in the United Kingdom. The assets and liabilities, which are
not considered significant to the Company, were added to the Company's
consolidated balance sheet beginning December 27, 2003. No goodwill was recorded
as a result of the acquisition. Results of operations are included beginning in
the third quarter of fiscal 2004.
Subsequent to year-end, the Company entered into a purchase agreement for $5,000
to acquire certain assets from a manufacturer of foot care products. The
transaction is expected to close in the first quarter of fiscal 2005.
Quarterly Cash Dividend
The Company paid quarterly dividends of $9,136, or $0.13 per share, during
fiscal 2004. The declaration and payment of dividends and the amount paid, if
any, is subject to the discretion of the Board of Directors and will depend on
the earnings, financial condition and capital and surplus requirements of the
Company and other factors the Board of Directors may consider relevant.
In the second quarter of fiscal 2004, the Board of Directors increased the
dividend from $0.025 per share to $0.035 per share, an increase of 40%, and
continued the higher dividend rate throughout the remainder of fiscal 2004.
-19-
Tax Examination
In January 2004, the Company was notified by the Internal Revenue Service that
it had concluded the routine Federal tax examination of tax years 1998, 1999 and
2000. As a result, the Company recorded a one-time income tax benefit of $13,100
in the second quarter of fiscal 2004, reducing its income tax accrual associated
with these audits. The Company believes it has appropriately accrued for
probable Federal income tax exposures subsequent to 2000.
Broker Commissions
The Company uses industry brokers as a method of servicing certain of its
customers. While, historically, the broker commissions have been reported as a
reduction in net sales, management believes these expenses are more
appropriately classified as sales and administration expense. Consequently,
broker commissions were reclassified from net sales to sales and administration
expense for all periods presented. Broker commissions reclassified for fiscal
years 2004, 2003 and 2002 were $8,121, $8,113 and $8,741, respectively. This
reclassification affects only Consumer Healthcare.
FTC Investigation
The FTC is investigating a 1998 agreement between Alpharma, Inc. and the Company
related to a children's ibuprofen suspension product. The agreement is no longer
in effect. The Company is currently negotiating with the FTC to close this
investigation. Because of the likelihood that the Company will enter into a
settlement agreement with the FTC, the Company has recorded a $4,750 charge in
the fourth quarter of fiscal 2004 which is expected to resolve all claims by the
FTC and state governments. The Company continues to cooperate with the FTC to
finalize the settlement agreement; however, the inquiry could result in the
Company being involved in further proceedings with the FTC, state attorneys
general or private litigants.
RESULTS OF OPERATIONS
The following table sets forth, for fiscal 2004, 2003 and 2002, certain items
from the Company's consolidated statements of income expressed as a percent to
net sales:
Fiscal Year
------------------------------------------
2004 2003 2002
------- ------ --------
Net sales 100.0% 100.0% 100.0%
Cost of sales 70.2 71.5 72.9
------- ------ -------
Gross profit 29.8 28.5 27.1
------- ------ -------
Operating expenses
Distribution 1.7 1.9 2.0
Research and development 3.1 2.8 3.1
Selling and administration 13.6 13.9 13.4
------- ------ -------
Subtotal 18.4 18.6 18.5
------- ------ -------
Restructuring - - 0.9
Goodwill impairment - - 1.4
Unusual litigation - (0.4) (3.4)
------- ------ -------
Total 18.4 18.2 17.4
------- ------ -------
Operating income 11.4 10.3 9.7
Interest and other, net (0.3) (0.1) (0.2)
------- ------ -------
Income before income taxes 11.7 10.4 9.9
Income tax expense 2.8 3.9 4.5
------- ------ -------
Net income 8.9% 6.5% 5.4%
======= ====== =======
-20-
CONSUMER HEALTHCARE
Year-to-Date
---------------------------------------
2004 2003 2002
-------- -------- --------
Net sales $800,619 $757,035 $770,187
Gross profit $251,570 $220,173 $208,348
Gross profit % 31.4% 29.1% 27.1%
Operating expenses $144,003 $139,268 $113,488
Operating expenses % 18.0% 18.4% 14.7%
Operating income $107,567 $ 80,905 $ 94,860
Operating income % 13.4% 10.7% 12.3%
Net Sales
Fiscal 2004 net sales increased 6% or $43,584 compared to fiscal 2003. Net sales
increased approximately $59,000 due to sales of significant new products
containing loratadine and a starch blocker as well as higher unit sales of
analgesic products. The increase was offset by lower unit sales of existing
vitamin products, antacid products and products related to tablet/caplet gelatin
coating processing.
In December 2002, a supplier of tablet/caplet gelatin coating processing
confirmed its intention to discontinue selling its services to the Company as of
March 31, 2003. Sales related to these products have decreased $12,000 in fiscal
2004 compared to fiscal 2003. No further reduction in future sales is expected.
The Company has arranged alternative coating sources to service customer
requirements. In May 2004, the Company's former supplier filed a patent
infringement suit against the Company relating to its replacement products. The
Company does not expect the outcome of this suit to have a material adverse
effect on its operations or financial results.
Fiscal 2003 net sales decreased 2% or $13,152 compared to fiscal 2002. Net sales
decreased $31,000 primarily due to lower unit sales of analgesic, antacid,
laxative, vitamin and contract manufactured products, partially offset by sales
from the launch of loratadine and pseudoephedrine sulfate extended release
tablets. In product categories where sales declined, the decline was a result of
discontinuing lower margin products at certain customers and exiting sales of
low volume products. The overall volume shortfall was partially offset by a
favorable mix of products sold and improved net realized pricing.
Gross Profit
Fiscal 2004 gross profit increased 14% or $31,397 compared to fiscal 2003,
primarily due to increased sales volume from new products, more efficient
operations and lower inventory obsolescence expenses. The increase in gross
profit percent was primarily due to improved operating efficiencies resulting
from the Company's decision to increase production and inventory levels in the
fourth quarter of fiscal 2004 in anticipation of the fiscal 2005 cough/cold/flu
season. Approximately one-quarter of the gross profit percent increase was due
to lower inventory obsolescence expenses.
Fiscal 2003 gross profit increased 6% or $11,825 compared to fiscal 2002.
Approximately two-thirds of the gross profit percentage increase was due to
improved operating efficiencies. The remaining gross profit percentage increase
was primarily due to a favorable mix of products sold and improved net realized
pricing.
-21-
Operating Expenses
Fiscal 2004 operating expenses increased 3% or $4,735 compared to fiscal 2003.
Selling and administration expenses increased by $1,650, primarily due to higher
costs related to wages, benefits, insurance and the FTC settlement agreement
partially offset by a reduction in bad debt expense and the settlement of a
large customer's 2002 bankruptcy. Operating expenses were favorably impacted by
unusual litigation income of $3,128 in the first quarter of fiscal year 2003.
Fiscal 2003 operating expenses increased 23% or $25,780 compared to fiscal 2002.
Research and development decreased $2,587 due to the timing of projects. Selling
and administration increased $6,554 primarily due to insurance costs and
employee benefit expenses, partially offset by lower bad debt expense. Fiscal
2002 operating expenses were favorably impacted by $27,891 of unusual litigation
income. The lawsuit that gave rise to this income has been settled with all
defendants and no additional income will be received. Fiscal 2002 operating
expenses were unfavorably impacted by bad debt expense related to the bankruptcy
of a large customer and a restructuring charge related to the sale of the
logistics facility.
PHARMACEUTICALS
Fiscal 2004 operating expenses were $4,961. Approximately 75% of the expenses
were related to costs for the development of prescription drug products and the
remaining expenses were related to administration.
UK OPERATIONS
Year-to-Date
-----------------------------------------
2004 2003 2002
-------- -------- --------
Net sales $72,740 $46,537 $34,900
Gross profit $ 8,698 $ 6,854 $ 6,614
Gross profit % 12.0% 14.7% 19.0%
Operating expenses $ 8,643 $ 4,608 $ 3,728
Operating expenses % 11.9% 9.9% 10.7%
Operating income $ 55 $ 2,246 $ 2,886
Operating income % 0.1% 4.8% 8.3%
Net Sales
Fiscal 2004 net sales increased 56% or $26,203 compared to fiscal 2003. The
increase was primarily due to sales of nutritional products of approximately
$16,000 related to the acquisition of Peter Black. Two-thirds of the remaining
increase was due to exchange rate fluctuations. The balance of the increase was
due to higher sales volumes of OTC and contract products.
Fiscal 2003 net sales increased 33% or $11,637 during fiscal 2002. Approximately
two-thirds of the increase in sales was due to higher volume at Wrafton. The
remaining increase was due to exchange rate fluctuations.
Gross Profit
Fiscal 2004 gross profit increased by 27% or $1,844 compared to fiscal 2003
primarily due to the acquisition of Peter Black and exchange rate fluctuations.
The gross profit percent decreased primarily because the mix of products sold
included more sales of nutrition products which contribute lower gross margins
than OTC products.
-22-
Fiscal 2003 gross profit increased by 4% or $240 compared to fiscal 2002. Gross
profit percent decreased primarily because the mix of products sold included
more sales of contract products which contribute lower gross margins than OTC
products.
Operating Expenses
Fiscal 2004 operating expenses increased by 88% or $4,035 compared to fiscal
2003 primarily due to the acquisition and integration of Peter Black and
exchange rate fluctuations. Approximately one-quarter of the increase was due to
exchange rate fluctuations.
Fiscal 2003 operating expenses increased 24% or $880 compared to fiscal 2002
primarily due to exchange rate fluctuations.
MEXICO OPERATIONS
Year-to-Date
----------------------------------------
2004 2003 2002
-------- -------- --------
Net sales $24,845 $30,528 $ 29,976
Gross profit $ 7,696 $10,997 $ 11,479
Gross profit % 31.0% 36.0% 38.3%
Operating expenses $ 7,461 $ 8,970 $ 28,292
Operating expenses % 30.0% 29.4% 94.4%
Operating income (loss) $ 235 $ 2,027 $(16,813)
Operating income (loss) % 0.9% 6.6% (56.1)%
Net Sales
Fiscal 2004 net sales decreased 19% or $5,683 compared to fiscal 2003, primarily
due to lower volume of government contract sales and distributor sales partially
offset by store brand sales. Approximately 30% of the decrease was due to
exchange rate fluctuations.
Fiscal 2003 net sales increased 2% or $552 compared to fiscal 2002.
Gross Profit
Fiscal 2004 gross profit decreased 30% or $3,301 compared to fiscal 2003. The
decrease in gross profit was primarily related to lower volume of products sold.
Approximately 20% of the decrease was related to exchange rate fluctuations.
Fiscal 2003 gross profit decreased 4% or $482 compared to fiscal 2002 due
primarily to changes implemented as a result of the restructuring plan.
Operating Expenses
Fiscal 2004 operating expenses decreased 17% or $1,509 compared to fiscal 2003,
primarily due to lower selling expenses as a result of a change from direct
selling to the use of independent distributors partially offset by an increase
in bad debt expense related to a large retail distributor.
Fiscal 2003 operating expenses decreased 68% or $19,322 compared to fiscal 2002.
Fiscal 2002 was unfavorably impacted by the restructuring at Quifa that resulted
in a goodwill impairment charge
-23-
of $11,524 and restructuring charges of $5,090. The additional decline in
operating expenses was primarily due to reduced expenses from the changes
implemented at Quifa as a result of the restructuring plan.
INTEREST AND OTHER (CONSOLIDATED)
Fiscal 2004 interest income was $1,018 compared to interest expense of $861 for
fiscal 2003. Interest income in 2004 compared to 2003 increased due to higher
levels of invested cash in fiscal 2004. Other income was $2,069 for fiscal 2004
compared to $1,941 for fiscal 2003.
Fiscal 2003 interest expense was $861 compared to $934 for fiscal 2002. Other
income was $1,941 for fiscal 2003 compared to $2,289 for fiscal 2002.
INCOME TAXES (CONSOLIDATED)
The effective tax rate was 24.0%, 37.3% and 45.6% for fiscal 2004, 2003 and
2002, respectively.
In January 2004, the Company was notified by the Internal Revenue Service that
it had concluded the routine Federal tax examination of tax years 1998, 1999 and
2000. As a result, the Company recorded a one-time income tax benefit of $13,100
in the second quarter of fiscal 2004, reducing its income tax accrual associated
with these audits. The Company believes it has appropriately accrued for
probable Federal income tax exposures subsequent to 2000.
The high effective tax rate for fiscal 2002 was primarily due to nondeductible
expenses related to goodwill impairment and restructuring costs at Quifa.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash and investment securities increased $77,873 to $171,700 at June 26, 2004
from $93,827 at June 28, 2003. Working capital, including cash and investment
securities, increased $73,088 to $285,743 at June 26, 2004 from $212,655 at June
28, 2003. The Company's priorities for use of cash and investment securities
include support of seasonal working capital demands, investment in capital
assets, opportunistic repurchase of common stock and acquisition of generic
prescription drug companies to accelerate entry into the market or complementary
businesses that could leverage retailer relationships, offer a product niche
opportunity or support geographic expansion.
Net cash provided by operating activities increased $38,293 or 48% to $118,527
for fiscal 2004 compared to $80,234 for fiscal 2003, primarily due to an
increase in net income, which includes a tax benefit of $13,100 as discussed
above. Net cash used for investing activities increased $19,878 or 60% to
$53,154 for fiscal 2004 compared to $33,276 for fiscal 2003. In December 2003,
the Company acquired Peter Black for $12,061 in cash.
Capital expenditures for facilities and equipment for fiscal 2004 of $28,294
were for normal equipment replacement and productivity enhancements. Capital
expenditures for fiscal 2005 are expected to be $25,000 to $30,000.
Net cash from financing activities increased $31,308 to $1,480 for fiscal 2004
compared to $29,828 net cash for financing activities for fiscal 2003. The
increase was primarily due to a reduction in common stock repurchases of $30,916
and an increase in proceeds from employee stock option exercises of $3,852. The
increase was partially offset by higher dividend payments of $5,652 in fiscal
2004.
-24-
In fiscal 2004, the Company continued its common stock repurchase program.
Purchases are made on the open market, subject to market conditions, and are
funded by cash from operations. The total remaining expenditure approved by the
Board of Directors for the repurchase of additional shares is $20,000. The
remaining repurchase program was announced on October 29, 2003 and will expire
on April 28, 2005. The share repurchase program announced on August 20, 2002
expired during the third quarter of fiscal 2004. The common stock repurchased
was retired upon purchase. During fiscal 2004, the Company repurchased 200
shares of its common stock for $2,766. For fiscal years 2003 and 2002, the
Company repurchased 3,296 and 2,533 shares of common stock for $33,682 and
$31,923, respectively.
In January 2003, the Board of Directors adopted a policy of paying regular
quarterly dividends. The Company paid quarterly dividends of $9,136 and $3,484,
or $0.13 and $0.05 per share, during fiscal 2004 and 2003, respectively. The
declaration and payment of dividends and the amount paid, if any, is subject to
the discretion of the Board of Directors and will depend on the earnings,
financial condition and capital and surplus requirements of the Company and
other factors the Board of Directors may consider relevant.
Dividends paid for the years ended June 26, 2004 and June 28, 2003 are as
follows:
Dividend
Declaration Date Record Date Payable Declared
- ---------------- ----------- ------- --------
Fiscal 2004
April 30, 2004 May 28, 2004 June 22, 2004 $0.035
January 30, 2004 February 27, 2004 March 23, 2004 $0.035
October 28, 2003 November 28, 2003 December 23, 2003 $0.035
August 7, 2003 August 29, 2003 September 23, 2003 $0.025
Fiscal 2003
May 9, 2003 May 30, 2003 June 24, 2003 $0.025
January 23, 2003 February 28, 2003 March 21, 2003 $0.025
The Company had no long-term debt at June 26, 2004 and June 28, 2003. Cash, cash
equivalents, investment securities and cash flows from operations are expected
to be sufficient to finance the known and/or foreseeable liquidity and capital
needs of the Company.
Effective September 23, 1999, the Company entered into a revolving credit
agreement with a group of banks that provided an unsecured revolving credit
facility. The Company terminated its credit facility in December 2003.
-25-
CONTRACTUAL OBLIGATIONS
The Company's enforceable and legally binding obligations as of June 26, 2004
are set forth in the following table. Some of the amounts included in this table
are based on management's estimates and assumptions about these obligations,
including the duration, the possibility of renewal, anticipated actions by third
parties and other factors. Because these estimates and assumptions are
necessarily subjective, the enforceable and legally binding obligations actually
paid in future periods may vary from the amounts reflected in the table. The
Company has no long-term debt.
2006 - 2008 -
2005 2007 2009 Thereafter Total
---- ---- ---- ---------- -----
Operating leases (a) $ 4,660 $5,781 $2,067 $ 256 $ 12,764
Purchase obligations (b) 89,677 70 - - 89,747
Purchase agreement (c) 5,000 - - - 5,000
Other long-term liabilities reflected
on the consolidated balance sheet
Deferred compensation and benefits (d) - - - 4,683 4,683
Other (e) 151 151 151 785 1,238
-------- ------ ------ ------ ---------
Total $ 99,488 $6,002 $2,218 $5,724 $ 113,432
======== ====== ====== ====== =========
(a) Used in normal course of business principally for warehouse facilities
and computer equipment.
(b) Consists of commitments for both materials and services.
(c) Purchase agreement to acquire certain assets from a manufacturer of
foot care products.
(d) Includes amounts associated with non-qualified plans related to
deferred compensation and executive retention. These amounts are
assumed payable after five years, although certain circumstances, such
as termination, would require earlier payment.
(e) Consists of a foreign grant for capital expenditures which is amortized
over the life of the corresponding purchased assets.
CRITICAL ACCOUNTING POLICIES
Determination of certain amounts in the Company's financial statements requires
the use of estimates. These estimates are based upon the Company's historical
experiences combined with management's understanding of current facts and
circumstances. Although the estimates are considered reasonable, actual results
could differ from the estimates. The accounting policies, discussed below, are
considered by management to require the most judgment and are critical in the
preparation of the financial statements. These policies are reviewed by the
Audit Committee. Other accounting policies are included in Note A of the
consolidated financial statements.
Allowance for Doubtful Accounts - The Company maintains an allowance for
customer accounts that reduces receivables to amounts that are expected to be
collected. In estimating the allowance, management considers factors such as
current overall economic conditions, industry-specific economic conditions,
historical and anticipated customer performance, historical experience with
write-offs and the level of past-due amounts. Changes in these conditions may
result in additional allowances. The allowance for doubtful accounts was $8,296
at June 26, 2004 and $10,242 at June 28, 2003.
Inventory - The Company maintains an allowance for estimated obsolete or
unmarketable inventory based on the difference between the cost of the inventory
and its estimated market value. In estimating the allowance, management
considers factors such as excess or slow moving inventories, product expiration
dating, products on quality hold, current and future customer demand and market
conditions. Changes in these conditions may result in additional allowances. The
allowance for inventory was $22,888 at June 26, 2004 and $21,717 at June 28,
2003.
-26-
Goodwill - Goodwill is tested for impairment annually or more frequently if
changes in circumstances or the occurrence of events suggest impairment exists.
The test for impairment requires the Company to make several estimates about
fair value, most of which are based on projected future cash flows. The
estimates associated with the goodwill impairment tests are considered critical
due to the judgments required in determining fair value amounts, including
projected future cash flows. Changes in these estimates may result in the
recognition of an impairment loss. The required annual testing is performed in
the second quarter of the fiscal year and resulted in no impairment charge for
fiscal 2004.
Product Liability and Workers' Compensation - The Company maintains accruals to
provide for claims incurred that are related to product liability and workers'
compensation. In estimating these accruals, management considers actuarial
valuations of exposure based on loss experience. These actuarial valuations
include significant estimates and assumptions, which include, but are not
limited to, loss development, interest rates, product sales, litigation costs,
accident severity and payroll expenses. Changes in these estimates and
assumptions may result in additional accruals. The accrual for product liability
claims was $3,876 at June 26, 2004 and $3,229 at June 28, 2003. The accrual for
workers' compensation claims was $2,458 at June 26, 2004 and $3,632 at June 28,
2003.
Item 7A. Quantitative And Qualitative Disclosures About Market Risk.
The Company is exposed to market risks, which include changes in interest rates
and changes in the foreign currency exchange rate as measured against the U.S.
dollar.
The Company is exposed to interest rate changes primarily as a result of
interest income earned on its investment of cash on hand and, if the Company
borrows funds to finance its operations, interest expense. The Company had
invested cash and investment securities of $171,700 at June 26, 2004. Management
believes that a fluctuation in interest rates in the near future will not have a
material impact on the Company's consolidated financial statements.
The Company has international operations in the United Kingdom and Mexico.
These operations transact business in the local currency, thereby creating
exposures to changes in exchange rates. The Company does not currently have
hedging or similar foreign currency contracts. However, the Company may obtain a
contractual currency exchange rate in contemplation of a significant
transaction, such as a foreign acquisition. Significant currency fluctuations
could adversely impact foreign revenues; however, the Company cannot predict
future changes in foreign currency exposure.
Additional Item. Cautionary Note Regarding Forward-Looking Statements.
Certain statements in Management's Discussion and Analysis of Results of
Operations and Financial Condition and other portions of this report are
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended, and are subject to the safe harbor created
thereby. These statements relate to future events or the Company's future
financial performance and involve known and unknown risks, uncertainties and
other factors that may cause the actual results, levels of activity, performance
or achievements of the Company or its industry to be materially different from
those expressed or implied by any forward-looking statements. In some cases,
forward-looking statements can be identified by terminology such as "may,"
"will," "could," "would," "should," "expect," "plan," "anticipate," "intend,"
"believe," "estimate," "predict," "potential" or other comparable terminology.
Although the Company believes that the expectations reflected in these
forward-looking statements are reasonable, it can give no assurance that such
expectations will prove to be correct. Unless otherwise required by applicable
securities laws, the Company disclaims any intention or obligation to update or
revise any forward-looking
-27-
statements, whether as a result of new information, future events or otherwise.
Fluctuation in Quarterly Results
The Company's quarterly operating results depend on a variety of factors
including, but not limited to, the severity, length and timing of the
cough/cold/flu season, the timing of new product introductions by the Company
and its competitors, the magnitude and timing of research and development
investments, changes in the levels of inventories maintained by the Company's
customers and the timing of retailer promotional programs. Accordingly, the
Company may be subject to significant and unanticipated quarter-to-quarter
fluctuations.
Potential Volatility of Stock Price
The market price of the Company's common stock has been, and could be, subject
to wide fluctuations in response to, among other things, quarterly fluctuations
in operating results, adverse circumstances affecting the introduction or market
acceptance of new products, failure to meet published estimates of or changes in
earnings estimates by securities analysts, announcements of new products or
enhancements by competitors, receipt of regulatory approvals by competitors,
sales of common stock by existing holders, loss of key personnel, market
conditions in the industry, shortages of key product inventory components and
general economic conditions.
Manufacturing Facilities
The vast majority of the Company's domestic OTC products are manufactured in
Allegan, Michigan. In addition, all of the Company's domestic nutritional
products are produced at one manufacturing facility in Greenville, South
Carolina. Revenues from sales of products manufactured in these facilities
comprise approximately 90% of the Company's total revenues. A significant
disruption at any of these facilities could impair the Company's ability to
produce and ship products on a timely basis, which could have a material adverse
effect on the Company's business, financial position and operating results.
Regulatory Environment
Several United States and foreign agencies regulate the manufacturing,
processing, formulation, packaging, labeling, testing, storing, distribution,
advertising and sale of the Company's products. Various state and local agencies
also regulate these activities. In addition, the Company manufactures and
markets certain of its products in accordance with the guidelines established by
voluntary standard organizations. Should the Company fail to adequately conform
to these regulations and guidelines, there may be a significant impact on the
operating results of the Company. In particular, packaging or labeling changes
mandated by the FDA can have a material impact on the results of operations of
the Company. Required changes could be related to safety or effectiveness
issues. With specific regard to safety, there have been instances within the
Company's product categories in which evidence of product tampering has occurred
resulting in a costly product recall. The Company believes that it has a good
relationship with the FDA, which it intends to maintain. If these relationships
should deteriorate, however, the Company's ability to bring new and current
products to market could be impeded. See "Item 1. Business - Government
Regulation."
Pseudoephedrine - Retail Sales Limits
Certain states are enacting legislation in reaction to nationwide concerns over
the control of chemicals that may be used illegally in the production of
methamphetamine. This legislation may result in the removal of certain products
containing pseudoephedrine from the retail shelf to a more
-28-
controlled position of sale behind the pharmacy counter of a retailer.
Additionally, such legislation may require special product packaging, enhanced
recordkeeping and limits on the amount of product a consumer may purchase.
Products containing pseudoephedrine generated approximately one-fifth of the
Company's fiscal 2004 revenues. The Company expects these products to contribute
similarly to total revenues in the future. The Company cannot predict whether
further legislation will be passed or, if it is passed, its impact on future
revenues of these products.
Store Brand Product Growth
The future growth of domestic store brand products will be influenced by general
economic conditions, which can influence consumers to switch to store brand
products, consumer perception and acceptance of the quality of the products
available, the development of new products, the market exclusivity periods
awarded on prescription to OTC switch products and the Company's ability to grow
its store brand market share. The Company does not advertise like the national
brand companies and thus is dependent on retailer promotional spending to drive
sales volume and increase market share. Growth opportunities for the products in
which the Company currently has a significant store brand market share (cough
and cold remedies and analgesics) will be driven by the ability to offer new
products to existing domestic customers. Branded pharmaceutical companies may
use state and federal regulatory and legislative means to limit the use of brand
equivalent products. Should store brand growth be limited by any of these
factors, there could be a significant impact on the operating results of the
Company.
Competitive Issues
The market for store brand OTC pharmaceutical and nutritional products is highly
competitive. Store brand competition is based primarily on price, quality and
assortment of products, customer service, marketing support and availability of
new products. National brand companies and/or generic Rx companies could choose
to compete more directly by manufacturing store brand products or by lowering
the prices of national brand products. Due to the high degree of price
competition, the Company has not always been able to fully pass on cost
increases to its customers. The inability to pass on future cost increases, the
impact of direct store brand competitors and the impact of national brand
companies lowering prices of their products or directly operating in the store
brand market could have a material adverse impact on financial results. In
addition, since the Company sells its nutritional products through retail drug,
supermarket and mass merchandise chains, it may experience increased competition
in its nutritional products business through alternative channels such as health
food stores, direct mail and direct sales as more consumers obtain products
through these channels. Retailer reverse auctions have added a new dimension to
competition as some retailers have instituted this process to obtain competitive
price quotes over the world wide web. The Company has evaluated, and will
continue to evaluate, the products and product categories in which it does
business. Future product line extensions, or deletions, could have a material
impact on the Company's financial position or results of operations.
Generic Equivalent Products
Various risks and uncertainties are attendant to the Company's decision to
expand into the manufacture and sale of generic prescription drugs. If the
Company is unsuccessful in establishing and growing that business, it could
negatively affect the Company's stock price, financial position and operating
results. Even if the Company's generic business is ultimately successful, the
costs of entering into and establishing that business may exceed the profits
derived from it for some period of time.
Many of the factors applicable to the Company's store brand OTC pharmaceutical
and nutritional businesses discussed in this Annual Report similarly are
applicable to the generic prescription drug
-29-
business. For example, the highly competitive nature of the market, the heavily
regulated environment, intellectual property issues (e.g., patent and licensing
issues, potential infringement claims and confidentiality concerns),
availability of raw materials and market acceptance of products are all factors
affecting that business. In addition, federal or state legislative proposals,
reimbursement policies of third-parties (such as insurance companies, health
maintenance organizations, managed care organizations, Medicaid and Medicare),
cost containment measures and health care reform, as well as other factors that
the Company may not be able to adequately identify due to its inexperience with
generic equivalents, could affect the marketing, pricing and demand for generic
prescription drugs.
Customer Issues
The Company's largest customer, Wal-Mart, currently comprises approximately 28%
of total net sales. Should Wal-Mart's current relationship with the Company
change adversely, the resulting loss of business could have a material adverse
impact on the Company's financial position and results of operations.
The impact of retailer consolidation could have an adverse impact on future
sales growth. Should a large customer encounter financial difficulties, the
exposure on uncollectible receivables and unusable inventory could have a
material adverse impact on the Company's financial position or results of
operations.
Research and Development
The Company's investment in research and development is expected to be above
historical levels due to the Company's planned expansion into the manufacture
and sale of generic prescription drugs as well as the high cost of developing
and becoming a qualified manufacturer of new products that are switching from
prescription to OTC status. The ability to attract scientists proficient in
emerging delivery forms and/or contracting with a third party innovator in order
to generate new products of this type is a critical element of the Company's
long term plans. Should the Company fail to attract qualified employees or enter
into reasonable agreements with third party innovators, long term sales growth
and profit would be adversely impacted.
Patent and Trade Dress Issues
The Company's ability to bring new products to market is limited by certain
patent and trade dress factors including, but not limited to, the existence of
patents protecting brand products for the Consumer Healthcare and
Pharmaceuticals segments and the regulatory exclusivity periods awarded on
products that have switched from prescription to OTC status. The cost and time
to develop these prescription and switch candidate products is significantly
greater than the rest of the new products that the Company seeks to introduce.
Moreover, the Company's packaging of certain products could be subject to trade
dress and design patent legal actions regarding infringement. Although the
Company designs its products and packaging to avoid infringing upon any valid
proprietary rights of national brand marketers, there can be no assurance that
the Company will not be subject to such legal actions in the future.
Effect of Research and Publicity on Nutritional Product Business
The Company believes that growth in the nutritional products business is based
largely on national media attention regarding scientific research suggesting
potential health benefits from regular consumption of certain vitamin and other
nutritional products. There can be no assurance of future favorable scientific
results and media attention, or the absence of unfavorable or inconsistent
findings. In the event of future unfavorable scientific results or media
attention, the Company's sales
-30-
of nutritional products could be materially adversely impacted.
Dependence on Personnel
The Company's future success will depend in large part upon its ability to
attract and retain highly skilled research and development scientists,
management information specialists, operations, sales, marketing and managerial
personnel. The Company does not have employment contracts with any key personnel
other than David T. Gibbons, its Chairman of the Board, President and Chief
Executive Officer. Should the Company not be able to attract or retain key
qualified employees, future operating results may be adversely impacted.
Availability of Raw Materials and Supplies
In the past, supplies of certain raw materials, bulk tablets and finished goods
purchased by the Company were limited, or were available from one or only a few
suppliers, and it is possible that this will occur in the future. Should this
situation occur, it can result in increased prices, rationing and shortages. In
response to these problems the Company tries to identify alternative materials
or suppliers for such raw materials, bulk tablets and finished goods. The nature
of FDA restrictions placed on products approved through the ANDA or NDA process
could substantially lengthen the approval process for an alternate material
source. Certain material shortages and approval of alternate sources could
adversely affect financial results.
In December 2002, a supplier of tablet/caplet gelatin coating processing
confirmed its intention to discontinue selling its services to the Company as of
March 31, 2003. Sales related to these products have decreased $12,000 in fiscal
2004 compared to fiscal 2003. No further reduction in future sales is expected.
The Company has arranged alternative coating sources to service customer
requirements. In May 2004, the Company's former supplier filed a patent
infringement suit against the Company relating to its replacement products. The
Company does not expect the outcome of this suit to have a material adverse
effect on its operations or financial results.
Legal Exposure
From time to time, the Company and/or its subsidiaries become involved in
lawsuits arising from various commercial matters, including, but not limited to,
competitive issues, contract issues, intellectual property matters, workers'
compensation, product liability and regulatory issues such as Proposition 65 in
California. See "Item 3. Legal Proceedings" for a discussion of litigation.
Litigation tends to be unpredictable and costly. No assurance can be made that
litigation will not have a material adverse effect on the Company's financial
position or results of operations in the future.
Insurance Costs
The Company maintains insurance, including property, general and product
liability, and directors' and officers' liability, to protect itself against
potential loss exposures. To the extent that losses occur, there could be an
adverse effect on the Company's financial results depending on the nature of the
loss and the level of insurance coverage maintained by the Company. The Company
cannot predict whether deductible or retention amounts will increase or whether
coverages will be reduced in the future. From time to time, the Company may
reevaluate and change the types and levels of insurance coverage that it
purchases.
Exposure to Product Liability Claims
The Company, like other retailers, distributors and manufacturers of products
that are ingested, is exposed to product liability claims in the event that,
among other things, the use of its products
-31-
results in injury. There is no assurance that product liability insurance will
continue to be available to the Company at an economically reasonable cost or
that the Company's insurance will be adequate to cover liability that the
Company incurs in connection with product liability claims. See "Item 3. Legal
Proceedings".
Capital Requirements and Liquidity
The Company maintains a broad product line to function as a primary supplier for
its customers. Capital investments are driven by growth, technological
advancements, cost improvement and the need for manufacturing flexibility.
Estimation of future capital expenditures could vary materially due to the
uncertainty of these factors. If the Company fails to stay current with the
latest manufacturing and packaging technology, it may be unable to competitively
support the launch of new product introductions.
The Company anticipates that cash, cash equivalents, investment securities, and
cash flows from operations will substantially fund working capital and capital
expenditures. The Company has historically evaluated acquisition opportunities
and anticipates that acquisition opportunities will continue to be identified
and evaluated in the future. The historical growth of sales and profits has been
significantly influenced by acquisitions. There is no assurance that future
sales and profits will, or will not, be impacted by acquisition activities. The
Company's current capital structure, results of operations and cash flow needs
could be materially impacted by acquisitions.
International Operations
The Company sources certain key raw materials from foreign suppliers and is
increasing its sales outside the United States. The Company's primary markets
outside the United States are Mexico, Canada and the United Kingdom. The Company
may have difficulty in international markets due, for example, to greater
regulatory barriers, the necessity of adapting to new regulatory systems and
problems related to markets with different cultural bases and political systems.
Sales to customers outside the United States and foreign raw material purchases
expose the Company to a number of risks including unexpected changes in
regulatory requirements and tariffs, possible difficulties in enforcing
agreements, longer payment cycles, exchange rate fluctuations, difficulties
obtaining export or import licenses, the imposition of withholding or other
taxes, economic or political instability, embargoes, exchange controls or the
adoption of other restrictions on foreign trade. Should any of these risks
occur, they may have a material adverse impact on the operating results of the
Company.
Financial Statement Estimates, Judgments and Assumptions
The consolidated and condensed financial statements included in the periodic
reports that the Company files with the Securities and Exchange Commission are
prepared in conformity with U.S. generally accepted accounting principles
(GAAP). The preparation of financial statements in accordance with GAAP involves
making estimates, judgments and assumptions that affect reported amounts of
assets, liabilities, revenues, expenses and income. Estimates, judgments and
assumptions are inherently subject to change in the future, and any such changes
could result in corresponding changes to the amounts of assets, liabilities,
revenues, expenses and income. Any such changes could have a material adverse
effect on the Company's financial position and operating results and could
negatively affect the market price of the Company's common stock.
Tax Rate Implication
Income tax rate changes by governments and changes in the tax jurisdictions in
which the Company operates could influence the effective tax rates for future
years. Entry into new tax jurisdictions,
-32-
whether domestic or international, increases the likelihood of fluctuation.
Interest Rate Implication
The Company incurs interest expense at its foreign subsidiaries due to its use
of credit facilities in the United Kingdom and Mexico that employ variable
interest rates. The interest rates are established at the time of borrowing
based upon the prime rate or the LIBOR rate, plus a factor, or at a rate based
on an interest rate agreed upon between the Company and its Agent at the time
the loan is made. Interest income is related to investing cash on hand in
various short-term investments whereby the interest rate is determined on the
day the investment is made. Accordingly, interest income and expense is subject
to fluctuation due to the variability of interest rates.
-33-
Item 8. Financial Statements and Supplementary Data.
PAGE
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm............................................... 35
Consolidated Statements of Income for Fiscal 2004, 2003 and 2002...................................... 36
Consolidated Balance Sheets as of June 26, 2004 and June 28, 2003..................................... 37
Consolidated Statements of Shareholders' Equity for Fiscal 2004, 2003 and 2002........................ 38
Consolidated Statements of Cash Flows for Fiscal 2004, 2003 and 2002.................................. 39
Notes to Consolidated Financial Statements............................................................ 40 - 53
-34-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and Board of Directors
Perrigo Company
Allegan, Michigan
We have audited the accompanying consolidated balance sheets of Perrigo Company
and subsidiaries as of June 26, 2004 and June 28, 2003 and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended June 26, 2004. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on the consolidated financial statements
based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Perrigo Company and
subsidiaries as of June 26, 2004 and June 28, 2003 and the results of their
operations and their cash flows for each of the three years in the period ended
June 26, 2004 in conformity with U.S. generally accepted accounting principles.
By: /s/ BDO Seidman, LLP
---------------------
BDO Seidman, LLP
Grand Rapids, Michigan
July 23, 2004
-35-
PERRIGO COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
Fiscal Year
-----------------------------------
2004 2003 2002
--------- --------- ---------
Net sales $ 898,204 $ 834,100 $ 835,063
Cost of sales 630,240 596,076 608,622
--------- --------- ---------
Gross profit 267,964 238,024 226,441
--------- --------- ---------
Operating expenses
Distribution 15,154 15,563 16,327
Research and development 27,721 23,315 25,689
Selling and administration 122,193 117,096 112,723
--------- --------- ---------
Subtotal 165,068 155,974 154,739
--------- --------- ---------
Restructuring - - 7,136
Goodwill impairment - - 11,524
Unusual litigation - (3,128) (27,891)
--------- --------- ---------
Total 165,068 152,846 145,508
--------- --------- ---------
Operating income 102,896 85,178 80,933
Interest and other, net (3,087) (1,080) (1,355)
--------- --------- ---------
Income before income taxes 105,983 86,258 82,288
Income tax expense 25,416 32,210 37,498
--------- --------- ---------
Net income $ 80,567 $ 54,048 $ 44,790
========= ========= =========
Earnings per share
Basic $ 1.15 $ 0.77 $ 0.61
Diluted $ 1.11 $ 0.76 $ 0.60
Weighted average shares outstanding:
Basic 70,206 69,746 73,164
Diluted 72,289 71,158 74,606
Dividends declared per share $ 0.13 $ 0.05 $ -
See accompanying notes to consolidated financial statements.
-36-
PERRIGO COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands)
June 26, June 28,
2004 2003
--------- ---------
Assets
Current assets
Cash and cash equivalents $ 161,252 $ 93,827
Investment securities 10,448 -
Accounts receivable 86,040 87,018
Inventories 174,253 160,326
Current deferred income taxes 29,877 32,643
Prepaid expenses and other current assets 11,359 5,383
--------- ---------
Total current assets 473,229 379,197
Property and equipment
Land 14,359 13,962
Building 196,029 188,509
Machinery and equipment 251,797 226,644
--------- ---------
462,185 429,115
Less accumulated depreciation 234,544 210,337
--------- ---------
227,641 218,778
Goodwill 35,919 35,919
Non-current deferred income taxes 8,137 3,968
Other non-current assets 14,168 6,108
--------- ---------
$ 759,094 $ 643,970
========= =========
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable $ 88,858 $ 72,186
Notes payable 9,528 8,980
Payroll and related taxes 41,387 40,535
Accrued expenses 43,689 36,590
Accrued income taxes - 5,568
Current deferred income taxes 4,024 2,683
--------- ---------
Total current liabilities 187,486 166,542
Non-current deferred income taxes 29,606 25,484
Other non-current liabilities 5,770 3,520
Shareholders' equity
Preferred stock, without par value, 10,000 shares authorized - -
Common stock, without par value, 200,000 shares authorized 104,160 88,990
Unearned compensation (514) (111)
Accumulated other comprehensive income 2,892 1,282
Retained earnings 429,694 358,263
--------- ---------
Total shareholders' equity 536,232 448,424
--------- ---------
$ 759,094 $ 643,970
========= =========
Supplemental Disclosures of Balance Sheet Information
Allowance for doubtful accounts $ 8,296 $ 10,242
Allowance for inventory $ 22,888 $ 21,717
Working capital $ 285,743 $ 212,655
Preferred stock, shares issued - -
Common stock, shares issued 70,882 70,034
See accompanying notes to consolidated financial statements.
-37-
PERRIGO COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
Common Stock Accumulated
Issued Other
-------------------- Unearned Comprehensive Comprehensive Retained
Shares Amount Compensation Income Income Earnings
------- --------- ------------ ------------- ------------- ---------
Balance at June 30, 2001 74,072 $ 124,495 $ (465) $ 428 $ 262,909
Net income - - - - $ 44,790 44,790
Foreign currency translation adjustments - - - (55) (55) -
Issuance of common stock under:
Stock options 970 10,192 - - - -
Restricted stock plan 41 711 (711) - - -
Compensation for stock options - 6,066 - - - -
Earned compensation for restricted stock - - 568 - - -
Tax effect from stock transactions - 1,157 - - - -
Purchases and retirements of common stock (2,533) (31,923) - - - -
------- --------- ---------- ---------- ----------- ---------
Balance at June 29, 2002 72,550 110,698 (608) 373 44,735 307,699
===========
Net income - - - - 54,048 54,048
Foreign currency translation adjustments - - - 909 909 -
Issuance of common stock under:
Stock options 769 7,100 - - - -
Restricted stock plan 11 131 (131) - - -
Compensation for stock options - 5,224 - - - -
Cash dividends, $0.05 per share - - - - - (3,484)
Earned compensation for restricted stock - - 628 - - -
Tax effect from stock transactions - (481) - - - -
Purchases and retirements of common stock (3,296) (33,682) - - - -
------- --------- ---------- ---------- ----------- ---------
Balance at June 28, 2003 70,034 88,990 (111) 1,282 54,957 358,263
===========
Net income - - - - 80,567 80,567
Foreign currency translation adjustments - - - 1,610 1,610 -
Issuance of common stock under:
Stock options 988 10,248 - - - -
Restricted stock plan 60 835 (835) - - -
Compensation for stock options - 5,128 - - - -
Cash dividends, $0.13 per share - - - - - (9,136)
Earned compensation for restricted stock - - 432 - - -
Tax effect from stock transactions - 1,725 - - - -
Purchases and retirements of common stock (200) (2,766) - - - -
------- --------- ---------- ---------- ----------- ---------
Balance at June 26, 2004 70,882 $ 104,160 $ (514) $ 2,892 $ 82,177 $ 429,694
======= ========= ========== ========== =========== =========
See accompanying notes to consolidated financial statements.
-38-
PERRIGO COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Fiscal Year
-----------------------------------
2004 2003 2002
--------- --------- ---------
Cash Flows From Operating Activities
Net income $ 80,567 $ 54,048 $ 44,790
Adjustments to derive cash flows
Depreciation and amortization 28,452 26,126 25,613
Compensation - stock options 5,128 5,224 6,066
Deferred income taxes 3,366 (6,847) 1,711
Goodwill impairment - - 11,524
Restructuring - - 7,136
Changes in operating assets and liabilities,
net of a business acquisition and a restructuring
Accounts receivable 4,075 (4,427) 14,301
Inventories (6,168) (4,656) 5,512
Accounts payable 10,891 (2,329) (9,955)
Payrolls and related taxes 1,072 9,185 5,218
Accrued expenses 6,050 3,869 4,878
Accrued income taxes (5,552) (2,516) (12,492)
Other (9,354) 2,557 123
--------- --------- ---------
Net cash from operating activities 118,527 80,234 104,425
--------- --------- ---------
Cash Flows For Investing Activities
Additions to property and equipment (28,294) (32,296) (27,528)
Proceeds from sale of assets held for sale - - 14,161
Acquisition of a business, net of cash (12,061) - -
Investment in equity subsidiaries (2,000) - -
Purchase of securities (17,099) - -
Proceeds from sales of securities 6,300 - -
Other - (980) (398)
--------- --------- ---------
Net cash for investing activities (53,154) (33,276) (13,765)
--------- --------- ---------
Cash From (For) Financing Activities
Borrowings (repayments) of short-term debt, net 702 640 (4,506)
Tax benefit (expense) of stock transactions 1,725 (481) 1,157
Issuance of common stock 11,083 7,231 10,192
Repurchase of common stock (2,766) (33,682) (31,923)
Cash dividends (9,136) (3,484) -
Other (128) (52) 234
--------- --------- ---------
Net cash from (for) financing activities 1,480 (29,828) (24,846)
--------- --------- ---------
Net increase in cash and cash equivalents 66,853 17,130 65,814
Cash and cash equivalents, at beginning of period 93,827 76,824 11,016
Effect of exchange rate changes on cash 572 (127) (6)
--------- --------- ---------
Cash and cash equivalents, at end of period $ 161,252 $ 93,827 $ 76,824
========= ========= =========
Supplemental Disclosures of Cash Flow Information Cash paid during the year
for:
Interest $ 591 $ 1,257 $ 1,542
Income taxes $ 31,079 $ 43,417 $ 47,103
See accompanying notes to consolidated financial statements.
-39-
PERRIGO COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
The Company is the largest manufacturer of store brand over-the-counter (OTC)
pharmaceutical and nutritional products in the United States. Additionally, the
Company manufactures OTC pharmaceutical and nutritional products in the United
Kingdom and OTC pharmaceutical and prescription drug products in Mexico.
The Company's principal customers are major national and regional retail
supermarket, drug store and mass merchandise chains and major wholesalers
located within the United States. One customer accounted for 28% of net sales
during fiscal 2004, 27% in fiscal 2003 and 25% in fiscal 2002. None of the
Company's other customers individually account for more than 10% of its net
sales. International net sales, primarily in the United Kingdom and Mexico , for
fiscal 2004, 2003, and 2002 were $109,605, $88,440 and $79,788, respectively.
The Company operates primarily through two wholly owned domestic subsidiaries,
L. Perrigo Company and Perrigo Company of South Carolina, Inc., and four wholly
owned foreign subsidiaries, Perrigo de Mexico S.A. de C.V., Quimica y Farmacia,
S.A. de C.V. (Quifa), Wrafton Laboratories Limited (Wrafton), and Perrigo UK
Limited, formerly Peter Black Pharmaceuticals Ltd. (Peter Black). As used
herein, "the Company" means Perrigo Company, its subsidiaries and all
predecessors of Perrigo Company and its subsidiaries.
The Company has manufacturing facilities in the United States, the United
Kingdom and Mexico. As of June 26, 2004 and June 28, 2003, the net book value of
property and equipment located outside the United States was $42,608 and
$27,685, respectively.
The Company has realigned its segment reporting with the acquisition of Peter
Black. The Company has four reportable segments: Consumer Healthcare,
Pharmaceuticals, UK Operations and Mexico Operations. Consumer Healthcare
includes the U.S. operations supporting the sale of OTC pharmaceutical and
nutritional products. Pharmaceuticals include the development and eventual sale
of prescription drug products. UK Operations support the sale of OTC
pharmaceutical and nutritional products in the United Kingdom and includes the
newly acquired Peter Black. UK Operations is a supplier of store brand products
to major grocery and pharmacy retailers and a contract manufacturer of OTC
pharmaceutical and nutritional products. Mexico Operations support the sale of
OTC and prescription drug products for retail, wholesale and governmental
customers in Mexico. See Note J for additional segment and geographic
information.
Basis of Presentation
The Company's fiscal year is a fifty-two or fifty-three week period, which ends
the Saturday on or about June 30. The last three fiscal years were comprised of
52 weeks ended June 26, 2004, June 28, 2003 and June 29, 2002.
In December 2003, the Company acquired Peter Black for $12,061 in cash, plus
contingent consideration that is not expected to be material. Peter Black,
located in the United Kingdom, is the largest manufacturer of store brand
vitamin and nutritional supplement products for grocery
-40-
stores, pharmacies and contract customers in the United Kingdom. The assets and
liabilities, which are not considered significant to the Company, were added to
the Company's consolidated balance sheet beginning December 27, 2003. No
goodwill was recorded as a result of the acquisition. Results of operations are
included beginning in the third quarter of fiscal 2004.
Subsequent to year-end, the Company entered into a purchase agreement for $5,000
to acquire certain assets from a manufacturer of foot care products. The
transaction is expected to close in the first quarter of fiscal 2005.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
all majority owned subsidiaries. The Company consolidates results of operations
and financial position of the UK and Mexico operations on a twelve-month period
ending in May. All material intercompany transactions and balances have been
eliminated in consolidation. The Company owns a minority interest in a Canadian
company and a Chinese company. These investments are accounted for using the
equity method and are recorded in other noncurrent assets.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions,
which affect the reported earnings, financial position and various disclosures.
Although the estimates are considered reasonable, actual results could differ
from the estimates.
International
The Company translates its foreign operations' assets and liabilities
denominated in foreign currencies into U.S. dollars at current rates of exchange
as of the balance sheet date, and income and expense items at the average
exchange rate for the reporting period. Translation adjustments resulting from
exchange rate fluctuations are recorded in the cumulative translation account, a
component of accumulated other comprehensive income. Accumulated comprehensive
income is comprised entirely of foreign currency translation adjustments.
Consolidated translation adjustments resulting from exchange rate fluctuations
on transactions denominated in currencies other than the functional currency are
not material.
Revenues
Revenues from product sales are recognized when the goods are shipped to the
customer. When title and risk pass to the customer is dependent on the
customer's shipping terms. If the customer has shipping terms of Free on Board
(FOB) shipping point, title and risk pass to the customer as soon as the freight
carrier leaves the Company's shipping location. If the customer has shipping
terms of FOB destination, title and risk pass to the customer upon receipt of
the order at the customer's location. Approximately 35% of the Company's
revenues relate to customers that have shipping terms of FOB destination. A
provision is recorded to exclude shipments estimated to be in-transit to these
customers at the end of the reporting period. A provision is also recorded as
revenues are recognized for estimated losses on credit sales due to customer
claims for discounts, price discrepancies, returned goods and other items.
Shipping and handling costs billed to customers are included in net sales.
Conversely, shipping and handling expenses incurred by the Company are included
in cost of sales.
-41-
Broker Commissions
The Company uses industry brokers as a method of servicing certain of its
customers. While, historically, the broker commissions have been reported as a
reduction in net sales, management believes these expenses are more
appropriately classified as sales and administration expense. Consequently,
broker commissions were reclassified from net sales to sales and administration
expense for all periods presented. Broker commissions reclassified for fiscal
years 2004, 2003 and 2002 were $8,121, $8,113 and $8,741, respectively. This
reclassification affects only Consumer Healthcare.
Financial Instruments
The carrying amount of the Company's financial instruments, consisting of cash
and cash equivalents, investment securities, accounts receivable, accounts
payable and notes payable, approximates their fair value.
Generally, the Company does not enter into derivative contracts either to hedge
existing risks or for speculative purposes. However, the Company has entered
into foreign currency forward contracts to essentially fix the exchange rate
related to funding international acquisitions as it did in fiscal 2004 to
acquire Peter Black. The Company was not a party to any other derivative
contracts during the years presented.
Cash and Cash Equivalents
Cash and cash equivalents consist primarily of demand deposits and other
short-term investments with maturities of three months or less at the date of
purchase.
Investment Securities
The Company has investments in debt securities that are classified as
available-for-sale. The securities are carried at estimated fair value of
$10,448 at June 26, 2004 which approximates amortized cost. The securities
consist of corporate bonds that mature as follows: $4,607 mature within one year
and $5,841 mature between one and four years. Realized gains and losses on
investment securities are determined using the specific identification method.
Amortization of premiums and discounts are included in interest income.
Accounts Receivable
The Company maintains an allowance for customer accounts that reduces
receivables to amounts that are expected to be collected. In estimating the
allowance, management considers factors such as current overall economic
conditions, industry-specific economic conditions, historical and anticipated
customer performance, historical experience with write-offs and the level of
past-due amounts. Changes in these conditions may result in additional
allowances. The allowance for doubtful accounts was $8,296 at June 26, 2004 and
$10,242 at June 28, 2003.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using
the first-in first-out (FIFO) method.
The Company maintains an allowance for estimated obsolete or unmarketable
inventory based on the difference between the cost of the inventory and its
estimated market value. In estimating the
-42-
allowance, management considers factors such as excess or slow moving
inventories, product expiration dating, current and future customer demand and
market conditions. Changes in these conditions may result in additional
allowances. The allowance for inventory was $22,888 at June 26, 2004 and $21,717
at June 28, 2003.
Long-Lived Assets
Property and equipment are recorded at cost and are depreciated primarily using
the straight-line method for financial reporting and accelerated methods for tax
reporting. Cost includes an amount of interest associated with significant
capital projects. Useful lives for financial reporting range from 5-10 years for
machinery and equipment, and 10-40 years for buildings. Maintenance and repair
costs are charged to earnings, while expenditures that increase asset lives are
capitalized.
Other than goodwill, the Company periodically reviews long-lived assets that
have finite lives and that are not held for sale for impairment by comparing the
carrying value of the assets to their estimated future undiscounted cash flows.
Goodwill is reviewed annually for impairment by comparing the carrying value of
each reporting unit to the present value of its expected future cash flows. For
fiscal 2004 and 2003, the required annual testing resulted in no impairment
charge.
The Company's intangible assets, excluding goodwill, are immaterial.
Share-Based Awards
Share-based compensation awards are recognized at fair value. All periods
presented have been adjusted to reflect compensation costs that would have been
recognized had the recognition provisions of SFAS 123, as amended by SFAS 148,
been applied to all awards granted after July 1, 1995.
Income Taxes
Deferred income tax assets and liabilities are recorded based upon the
difference between financial reporting and tax reporting bases of assets and
liabilities using the enacted tax rates.
Provision has not been made for U.S. or additional foreign taxes on
undistributed earnings of foreign subsidiaries because those earnings are
considered permanently reinvested in the operations of those subsidiaries.
New Accounting Standards
In December 2003, the Medicare Prescription Drug, Improvement and Modernization
Act of 2003 (Act) was signed into law. The Act entitles employers who provide
certain prescription drug benefits for retirees to receive a federal subsidy
beginning in calendar 2006, thereby creating the potential for significant
benefit cost savings. FASB Staff Position (FSP) 106-2 requires companies to
record the amount expected to be received under the Act as an actuarial gain, to
the extent the related post-retirement medical plan's (plan) total unrecognized
actuarial gains or losses exceed certain thresholds, to be amortized into income
over time. FSP 106-2 is effective beginning the first quarter of fiscal 2005.
The Company is a sponsor of a plan that provides prescription drug benefits. The
Company is currently evaluating any effects the Act may have on the plan and our
financial statements. Accordingly, any measures of the accumulated
post-retirement benefit obligation or net periodic post-retirement benefit cost
in the financial statements or accompanying notes do not reflect the effects of
the Act on the plan.
-43-
Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 46(R),
"Consolidation of Variable Interest Entities", issued in December 2003, requires
that if a business enterprise has a controlling financial interest in a variable
interest entity, and is considered the primary beneficiary, the assets,
liabilities and results of the activities of the variable interest entity shall
be included in the consolidated financial statements of the business enterprise.
(FIN) 46(R) is effective for the Company in the fourth quarter of fiscal 2004.
Based on the Company's evaluation of the requirements of (FIN) 46(R), no
variable interest entities that are subject to consolidation were identified
and, as such, the adoption of (FIN) 46(R) for fiscal year 2004 had no impact on
the Company's consolidated financial position or results of operations.
NOTE B - EARNINGS PER SHARE
A reconciliation of the numerators and denominators used in the basic and
diluted earnings per share (EPS) calculation follows:
Fiscal Year
---------------------------
2004 2003 2002
------- ------- -------
Numerator:
Net income used for both basic and diluted EPS $80,567 $54,048 $44,790
======= ======= =======
Denominator:
Weighted average shares outstanding for basic EPS 70,206 69,746 73,164
Dilutive effect of share-based awards 2,083 1,412 1,442
------- ------- -------
Weighted average shares outstanding for diluted EPS 72,289 71,158 74,606
======= ======= =======
Share-based awards outstanding that are antidilutive were 1,819 for fiscal 2004,
3,204 for fiscal 2003 and 2,341 for fiscal 2002. These share-based awards were
excluded from the diluted EPS calculation.
NOTE C - INVENTORIES
Inventories are summarized as follows:
June 26, 2004 June 28, 2003
------------- -------------
Finished goods $ 71,875 $ 59,547
Work in process 58,784 58,628
Raw materials 43,594 42,151
-------- --------
$174,253 $160,326
======== ========
The Company maintains an allowance for estimated obsolete or unmarketable
inventory based on the difference between the cost of inventory and its
estimated market value. The inventory balances stated above are net of an
inventory allowance of $22,888 at June 26, 2004 and $21,717 at June 28, 2003.
-44-
NOTE D - CREDIT ARRANGEMENTS
Effective September 23, 1999, the Company entered into a revolving credit
agreement with a group of banks which provided an unsecured revolving credit
facility. The Company terminated its credit facility in December 2003.
At June 26, 2004 and June 28, 2003, Wrafton had short-term, unsecured debt with
a bank in the United Kingdom of $4,008 and $3,177, respectively, which was
supported by a Company guarantee. Interest rates are established at the time of
borrowing based on LIBOR plus 1%.
At June 26, 2004 and June 28, 2003, Quifa had short-term, unsecured debt with
two banks in Mexico of $5,520 and $5,803, respectively, which was supported by a
Company guarantee. Interest rates are established at the time of borrowing based
on a rate agreed upon between the banks and Quifa.
Short-term debt is included in Notes Payable.
NOTE E - SHAREHOLDERS' EQUITY
In April 1996, the Company's Board of Directors adopted a Preferred Share
Purchase Rights Plan and declared a dividend distribution to be made to
shareholders of record on April 22, 1996 of one Preferred Share Purchase Right
for each outstanding share of the Company's common stock. The Rights contain
provisions that are intended to protect the Company's stockholders in the event
of an unsolicited and unfair attempt to acquire the Company. The Company is
entitled to redeem the Rights at $.01 per Right at any time before a 20%
position has been acquired. The Rights will expire on April 10, 2006, unless
previously redeemed or exercised.
Prior to October 28, 2003, the Company had stock option plans for employees and
directors that were approved by shareholders. Additionally, the Company had
restricted stock plans and agreements as described below that were not approved
by shareholders.
The Company had a restricted stock plan for directors that granted $10 worth of
restricted shares to each director on the date of the Annual Board Meeting. The
number of shares issued was based on the fair market value of the shares on the
date of the Annual Board Meeting. No additional shares will be granted under
this plan and the remaining shares available for grant have been transferred to
the plan that became effective October 28, 2003.
In August 2001, the Company granted 25 shares of restricted stock valued at $440
to David T. Gibbons pursuant to restricted stock agreements. Additionally, Mr.
Gibbons was granted 96 shares valued at $503 under the terms of his employment
agreement in May 2000. The restricted shares granted in August 2001 and May 2000
vested on August 14, 2003 and June 30, 2003, respectively.
In August 2001, the Company granted 12 shares of restricted stock valued at $211
to Douglas R. Schrank pursuant to a restricted stock agreement. The restricted
shares vested on August 14, 2003.
Effective October 28, 2003, the Company's shareholders approved the 2003
Long-Term Incentive Plan. All share-based compensation for employees, directors
and others will be granted under this plan. The purpose of the plan is to
attract and retain individuals of exceptional managerial talent and encourage
these individuals to acquire a vested interest in the Company's success and
prosperity. The awards that are granted under this program primarily include
non-qualified stock
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options, incentive stock options and restricted shares. All other share-based
compensation plans were terminated and any remaining shares available for grant
were transferred to this plan.
Generally, awards granted under the preceding plans vest and may be exercised
and/or sold from one to ten years after the date of grant based on a vesting
schedule.
Proceeds from the exercise of stock options and income tax benefits attributable
to stock options exercised are credited to common stock. Stock option
compensation expense was $5,128 for fiscal 2004, $5,224 for fiscal 2003 and
$6,066 for fiscal 2002.
The Company accounts for restricted shares as unearned compensation, which is
ratably charged to expense over the vesting period. In fiscal 2004, the Company
granted 60 shares of restricted stock valued at $835 pursuant to the 2003
Long-term Incentive Plan. Compensation expense for restricted shares was $432
for fiscal 2004, $628 for fiscal 2003 and $568 for fiscal 2002. The unearned
compensation included in shareholders' equity was $514 at June 26, 2004 and $111
at June 28, 2003. A holder of restricted shares has all rights of a shareholder
except that the shares are restricted as to sale or transfer for the vesting
period and the shares are forfeited upon termination in certain circumstances.
Prior to the second quarter of fiscal 2003, the Company accounted for stock
option compensation under the recognition and measurement provisions of
Accounting Principles Board (APB) Opinion 25, "Accounting for Stock Issued to
Employees", and related interpretations. No stock option compensation cost was
reflected in results reported prior to the second quarter of fiscal 2003, as all
options granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of grant. Beginning in the
second quarter of fiscal 2003, the Company adopted the fair value recognition
provisions of SFAS 123, "Accounting for Stock-Based Compensation", as amended by
SFAS 148, "Accounting for Stock-Based Compensation - Transition and Disclosure",
for stock option compensation. All prior periods presented were adjusted in last
year's annual report to reflect the compensation cost that would have been
recognized had the recognition provisions of SFAS 123, as amended by SFAS 148,
been applied to all awards granted after July 1, 1995. Compensation costs are
included in selling and administration operating expenses.
A summary of activity for the Company's stock option plans is presented below:
Fiscal Year
-----------------------------------------------------------------
2004 2003 2002
--------------------- ------------------ -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Shares outstanding
at beginning of year 6,249 $ 10.46 6,530 $ 10.72 6,385 $ 10.07
Granted 1,053 14.01 978 10.22 1,237 15.13
Exercised (988) 10.17 (769) 9.17 (970) 10.18
Terminated (264) 20.15 (490) 15.52 (122) 19.06
Shares outstanding at end of year 6,050 10.70 6,249 10.46 6,530 10.72
Options exercisable at end of year 2,787 9.55 2,653 10.66 2,599 11.75
Shares available for grant
at end of year 4,249 2,538 3,026
Price per share of options outstanding $5.25 to $21.55 $5.25 to $29.38 $5.25 to $29.38
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The weighted average fair value per share at the date of grant for options
granted during fiscal 2004, 2003 and 2002 was $5.56, $4.11 and $6.49,
respectively. The fair value was estimated using the Black-Scholes option
pricing model, assuming forfeitures are accounted for as they occur, with the
following weighted average assumptions:
Fiscal Year
------------------------
2004 2003 2002
------ ------ ----
Dividend yield 0.008% 0.006% -
Volatility, as a percent 34.4% 37.3% 37.7%
Risk-free interest rate 3.6% 3.6% 4.7%
Expected life in years after vest date 3.0 3.0 3.0
The following table summarizes information concerning options outstanding and
exercisable under the plans at June 26, 2004:
Weighted Number
Number Average Weighted
Range of Outstanding Remaining Weighted Exercisable Average
Exercise At June 26, Contractual Average At June 26, Exercise
Prices 2004 Term (Years) Exercise Price 2004 Price
------ ----------- ------------ -------------- ----------- ---------
$ 5.25 - 7.95 1,678 5.77 $ 6.16 1,119 $ 6.03
$ 8.06 - 11.81 1,737 6.25 $ 9.65 769 $ 9.44
$11.83 - 13.90 1,623 6.92 $ 13.49 508 $ 12.94
$14.12 - 21.55 1,012 7.17 $ 15.57 391 $ 15.49
--------- --------
6,050 2,787
========= ========
In January 2003, the Board of Directors adopted a policy of paying regular
quarterly dividends. The Company paid quarterly dividends of $9,136 and $3,484,
or $0.13 and $0.05 per share, during fiscal 2004 and 2003, respectively. The
declaration and payment of dividends and the amount paid, if any, is subject to
the discretion of the Board of Directors and will depend on the earnings,
financial condition, capital and surplus requirements of the Company and other
factors the Board of Directors may consider relevant.
In fiscal 2004, the Company continued its common stock repurchase program.
Purchases are made on the open market, subject to market conditions, and are
funded by cash from operations. The total remaining expenditure approved by the
Board of Directors for the repurchase of additional shares is $20,000. The
remaining repurchase program was announced on October 29, 2003 and will expire
on April 28, 2005. The share repurchase program announced on August 20, 2002
expired during the third quarter of fiscal 2004. The common stock repurchased
was retired upon purchase. The Company did not repurchase any shares in the
fourth quarter of fiscal 2004.
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NOTE F - RETIREMENT PLANS
The Company has a qualified profit-sharing and investment plan under section
401(k) of the Internal Revenue Code, which covers substantially all domestic
employees. Contributions to the plan are at the discretion of the Board of
Directors. Additionally, the Company matches a portion of employees'
contributions. The Company's contributions to the plan were $8,420, $6,834 and
$6,342 in fiscal 2004, 2003 and 2002, respectively.
The Company has postretirement plans that provide medical benefits for retirees
and their eligible dependents. Employees become eligible for these benefits if
they meet certain minimum age and service requirements. The Company reserves the
right to modify or terminate these plans. The plans are not funded. The unfunded
accumulated postretirement benefit obligation was $5,122 at June 26, 2004 and
$4,837 at June 28, 2003. The benefits expensed were $285, $658 and $586 in
fiscal 2004, 2003 and 2002, respectively.
The Company has non-qualified plans relating to deferred compensation and
executive retention that allow certain employees and directors to defer
compensation subject to specific requirements. Although the plans are not
formally funded, the Company owns insurance policies with a cash surrender value
of $5,402 that are intended as a long-term funding source for these plans. The
assets are not a committed funding source and may, under certain circumstances,
be subject to claims from creditors. The deferred compensation liability was
$4,683 at June 26, 2004 and $2,754 at June 28, 2003.
NOTE G - INCOME TAXES
The provision for income taxes consists of the following:
Fiscal Year
--------------------------------
2004 2003 2002
-------- -------- --------
Current:
Federal $ 20,176 $ 39,060 $ 32,687
State 2,473 2,153 2,019
Foreign (1,293) (120) 555
-------- -------- --------
Total 21,356 41,093 35,261
-------- -------- --------
Deferred:
Federal 2,703 (9,302) 1,876
State 183 (434) 131
Foreign 1,174 853 230
-------- -------- --------
Total 4,060 (8,883) 2,237
-------- -------- --------
Total $ 25,416 $ 32,210 $ 37,498
======== ======== ========
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A reconciliation of the provision based on the Federal statutory income tax rate
to the Company's effective income tax rate is as follows:
Fiscal Year
----------------------
2004 2003 2002
---- ---- ----
Provision at Federal statutory rate 35.0% 35.0% 35.0%
State income taxes, net of Federal benefit 2.5 2.0 2.6
Foreign tax rate differences 0.1 (0.5) (0.2)
Expenses not deductible for tax purposes (0.1) 1.2 9.3
Tax examination adjustment (12.4) - -
Other (1.1) (0.4) (1.1)
---- ---- ----
Effective income tax rate 24.0% 37.3% 45.6%
==== ==== ====
Provision has not been made for U.S. or additional foreign taxes on
undistributed earnings of foreign subsidiaries because those earnings are
considered permanently reinvested in the operations of those subsidiaries. It is
not practicable to estimate the amount of tax that might be payable on the
eventual remittance of such earnings.
In January 2004, the Company was notified by the Internal Revenue Service that
it had concluded the routine Federal tax examination of tax years 1998, 1999 and
2000. As a result, the Company recorded a one-time income tax benefit of $13,100
in the second quarter of fiscal 2004, reducing its income tax accrual associated
with these audits. The Company believes it has appropriately accrued for
probable Federal income tax exposures subsequent to 2000.
Deferred income taxes arise from temporary differences between financial
reporting and tax reporting basis of assets and liabilities, and operating loss
and tax credit carry forwards for tax purposes. The components of the net
deferred income tax asset (liability) are as follows:
June 26, 2004 June 28, 2003
------------- -------------
Deferred income tax asset (liability):
Property and equipment $ (25,209) $ (22,416)
Inventory basis differences 9,941 12,519
Accrued liabilities 12,474 11,270
Allowance for doubtful accounts 2,436 4,335
Accrued postretirement benefit 1,895 1,790
Accrued healthcare expense 1,792 1,711
Prepaid healthcare expense (2,220) (2,220)
Research & Development credit 2,124 -
State operating loss carry forwards 60,774 54,618
Capital loss carry forward 1,284 1,543
Other, net 233 1,455
---------- ---------
Subtotal 65,524 64,605
Valuation allowance for carry forwards (61,140) (56,161)
---------- ---------
Net deferred income tax asset (liability) $ 4,384 $ 8,444
========== =========
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The above amounts are classified in the consolidated balance sheet as follows:
June 26, 2004 June 28, 2003
------------- -------------
Assets $ 38,014 $ 36,611
Liabilities (33,630) (28,167)
----------- ---------
Net deferred income tax asset (liability) $ 4,384 $ 8,444
=========== =========
At June 26, 2004, the Company had state net operating loss carry forwards of
$60,774 and a capital loss carry forward of $1,284. At June 26, 2004, a
valuation allowance of $59,856 had been provided for the state net operating
loss and a $1,284 valuation allowance had been provided for the capital loss as
utilization of such carry forwards within the applicable statutory periods is
uncertain. The state net operating loss carry forward expires through 2024,
while the capital loss carry forward expires through 2007. Both expiring state
net operating loss carry forwards and expiring capital loss carry forwards and
the required valuation allowances are adjusted annually. After application of
the valuation allowances described above, the Company anticipates no limitations
will apply with respect to utilization of the net deferred income tax assets
described above.
NOTE H - COMMITMENTS AND CONTINGENCIES
The Company leases certain assets, principally warehouse facilities and computer
equipment, under agreements that expire at various dates through March 2009.
Certain leases contain provisions for renewal and purchase options and require
the Company to pay various related expenses. Future non-cancelable minimum
operating lease commitments are as follows: 2005--$4,660; 2006--$3,604;
2007--$2,177, 2008--$1,581 and 2009 and thereafter -- $742. Rent expense under
all leases was $6,766, $7,779 and $8,823 for fiscal 2004, 2003 and 2002,
respectively.
The Company is not a party to any litigation, other than routine litigation
incidental to its business except for the litigation described below. The
Company believes that none of the routine litigation, individually or in the
aggregate, will be material to the business of the Company.
The United States Federal Trade Commission (FTC) is investigating a 1998
agreement between Alpharma, Inc. and the Company related to a children's
ibuprofen suspension product. The agreement is no longer in effect. The Company
is currently negotiating with the FTC to close this investigation. Because of
the likelihood that the Company will enter into a settlement agreement with the
FTC, the Company has recorded a $4,750 charge in the fourth quarter of fiscal
2004 which is expected to resolve all claims by the FTC and state governments.
The Company continues to cooperate with the FTC to finalize the settlement
agreement; however, the inquiry could result in the Company being involved in
further proceedings with the FTC, state attorneys general or private litigants.
The Company is currently defending numerous individual lawsuits pending in
various state and federal courts involving phenylpropanolamine (PPA), an
ingredient used in the manufacture of certain OTC cough/cold and diet products.
The Company discontinued using PPA in the United States in November 2000 at the
request of the United States Food and Drug Administration (FDA). These cases
allege that the plaintiff suffered injury, generally some type of stroke, from
ingesting PPA-containing products. Many of these suits also name other
manufacturers or retailers of PPA-containing products. These personal injury
suits seek an unspecified amount of compensatory, exemplary and statutory
damages. The Company maintains product liability insurance coverage for the
claims asserted in these lawsuits. The Company believes that it has meritorious
defenses to these lawsuits and intends to vigorously defend them. At this time,
the Company cannot determine
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whether it will be named in additional PPA-related suits, the outcome of
existing suits or the effect that PPA-related suits may have on its financial
condition or operating results.
In August 1999, the Company filed a civil antitrust lawsuit in the United States
District Court for the Western District of Michigan against a group of vitamin
raw material suppliers alleging the defendants conspired to fix the prices of
vitamin raw materials sold to the Company. The relief sought included money
damages and a permanent injunction enjoining defendants from future violation of
antitrust laws. The Company has entered into final settlement agreements with
all of the defendants. The Company received settlement payments of $3,128 and
$27,891 in fiscal 2003 and 2002, respectively. The payments were net of attorney
fees and expenses that were withheld prior to the disbursement of the funds to
the Company. No additional income will be received.
The Company has pending certain other legal actions and claims incurred in the
normal course of business. The Company believes that these actions are without
merit or are covered by insurance and is actively pursuing the defense thereof.
The Company believes the resolution of all of these matters will not have a
material adverse effect on its financial condition and results of operations as
reported in the accompanying consolidated financial statements. However,
depending on the amount and timing of an unfavorable resolution of these
lawsuits, it is possible that the Company's future results of operations or cash
flow could be materially impacted in a particular period.
NOTE I - QUARTERLY FINANCIAL DATA (UNAUDITED)
First Second Third Fourth
Fiscal 2004 Quarter Quarter(1) Quarter Quarter(4)
----------- -------- ---------- -------- ----------
Net sales (3) $211,839 $247,377 $232,863 $206,125
Gross profit 60,020 76,179 68,755 63,010
Net income 16,508 38,235 17,739 8,085
Basic earnings per share 0.24 0.55 0.25 0.11
Diluted earnings per share 0.23 0.53 0.24 0.11
Weighted average shares outstanding
Basic 70,040 69,967 70,296 70,671
Diluted 71,809 71,500 72,598 73,277
First Second Third Fourth
Fiscal 2003 Quarter(2) Quarter Quarter Quarter
----------- ---------- ------- ------- -------
Net Sales(3) $215,427 $229,918 $204,352 $184,403
Gross profit 63,891 66,693 60,442 46,998
Net income 18,778 16,814 14,132 4,324
Basic earnings per share 0.27 0.24 0.20 0.06
Diluted earnings per share 0.26 0.24 0.20 0.06
Weighted average shares outstanding
Basic 70,719 69,273 69,337 69,614
Diluted 71,745 70,394 70,601 71,439
(1) Includes $13,100 income related to tax examination. See Note G.
(2) Includes pre-tax income of $3,128 related to settlement proceeds of an
antitrust lawsuit. See Note H.
(3) Net sales were increased by broker commissions that were reclassified to
selling and administration expenses. The amounts reclassified for 2004
were $8,121 (Q1 $2,034, Q2 $2,283, Q3 $2,123 and Q4 $1,681) and 2003 were
$8,113 (Q1 $2,212, Q2 $2,397, Q3 $1,736 and Q4 $1,768). See Note A
(4) Includes pre-tax charge of $4,750 related to the FTC investigation.
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NOTE J - SEGMENT INFORMATION
The Company has realigned its segment reporting with the acquisition of Peter
Black. The Company has four reportable segments: Consumer Healthcare,
Pharmaceuticals, UK Operations and Mexico Operations. Consumer Healthcare
includes the U.S. operations supporting the sale of OTC pharmaceutical and
nutritional products. Pharmaceuticals include the development and eventual sale
of prescription drug products. UK Operations support the sale of OTC
pharmaceutical and nutritional products in the United Kingdom and includes the
newly acquired Peter Black. UK Operations is a supplier of store brand products
to major grocery and pharmacy retailers and a contract manufacturer of OTC
pharmaceutical and nutritional products. Mexico Operations support the sale of
OTC and prescription drug products for retail, wholesale and governmental
customers in Mexico. The accounting policies of each segment are the same as
those described in the summary of significant accounting policies set forth in
Note A.
Consumer Pharma- UK Mexico
Healthcare ceuticals Operations Operations Total
---------- --------- ---------- ---------- -----
Fiscal 2004
Net sales(1) $800,619 - $ 72,740 $ 24,845 $898,204
Operating income (loss)(1) $107,567 $ (4,961) $ 55 $ 235 $102,896
Operating income % 13.4% - 0.1% 0.9% 11.4%
Total assets $646,052 - $ 90,936 $ 22,106 $759,094
Capital expenditures $ 18,154 - $ 6,408 $ 3,732 $ 28,294
Property, plant, equip, net $185,033 - $ 32,677 $ 9,931 $227,641
Depreciation/amortization $ 23,993 135 $ 3,679 $ 645 $ 28,452
Fiscal 2003
Net Sales(1) $757,035 - $ 46,537 $ 30,528 $834,100
Operating income(1) $ 80,905 - $ 2,246 $ 2,027 $ 85,178
Operating income % 10.7% - 4.8% 6.6% 10.2%
Total assets $527,422 - $ 57,871 $ 19,851 $643,970
Capital expenditures $ 27,523 - $ 2,730 $ 2,043 $ 32,296
Property, plant, equip, net $191,093 - $ 20,176 $ 7,509 $218,778
Depreciation/amortization $ 23,533 - $ 1,988 $ 605 $ 26,126
Fiscal 2002
Net Sales(1) $770,187 - $ 34,900 $ 29,976 $835,063
Operating income (loss)(1) $ 94,860 - $ 2,886 $(16,813) $ 80,933
Operating income (loss) % 12.3% - 8.3% (56.1)% 9.7%
Total assets $519,880 - $ 57,825 $ 16,082 $601,375
Capital expenditures $ 19,329 - $ 5,294 $ 2,905 $ 27,528
Property, plant, equip, net $186,961 - $ 17,644 $ 6,439 $211,044
Depreciation/amortization $ 23,392 - $ 1,521 $ 700 $ 25,613
Asset impairment &
restructuring $ 2,046 - - $ 16,614 $ 18,660
(1) Net sales were increased by broker commissions and reclassified to selling
and administration expenses. The amounts reclassified to Consumer
Healthcare for 2004, 2003 and 2002 were $8,121, $8,113 and $8,741,
respectively. See Note A.
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NOTE K - ACQUISITION
In December 2003, the Company acquired Peter Black for $12,061 in cash, plus
contingent consideration that is not expected to be material. Peter Black,
located in the United Kingdom, is the largest manufacturer of store brand
vitamin and nutritional supplement products for grocery stores, pharmacies and
contract customers in the United Kingdom selling to supermarket, drug and mass
merchandise retailers under their store brand labels. The assets and
liabilities, which are not considered significant to the Company, were added to
the Company's consolidated balance sheet beginning December 27, 2003. No
goodwill was recorded as a result of the acquisition. Results of operations are
included beginning in the third quarter of fiscal 2004.
Subsequent to year-end, the Company entered into a purchase agreement for $5,000
to acquire certain assets from a manufacturer of foot care products. The
transaction is expected to close in the first quarter of fiscal 2005.
NOTE L - RESTRUCTURING AND GOODWILL IMPAIRMENT CHARGES
Update of 2002 Restructuring -- In the fourth quarter of fiscal 2002, the
Company approved a restructuring plan related to Quifa. The implementation of
the plan began in June 2002 and was completed in its entirety in the first
quarter of fiscal 2004. The Company discontinued certain customers and products
because of inadequate profitability and misalignment with strategic goals. In
fiscal 2002, equipment related to the discontinued customers and products was
written down to its fair market value resulting in an impairment charge of
$2,590. The Company accrued employee termination benefits of $2,000 and other
restructuring costs of $500 that were included in the restructuring line in the
consolidated statement of income for fiscal 2002. No additional charges related
to this restructuring plan have been recorded since fiscal 2002. Through June
26, 2004, the Company terminated 220 employees, performing certain production
and administrative tasks, as a result of the restructuring plan. In fiscal 2004
and 2003, $230 and $2,270 was paid related to the termination benefits and other
restructuring costs.
Due to the changes necessary at Quifa, its goodwill was re-tested for impairment
in the fourth quarter of fiscal 2002. The fair value of the reporting unit was
estimated using the present value of expected future cash flows. The testing
procedure resulted in a goodwill impairment charge of $11,524 in fiscal 2002.
The goodwill impairment charge is recorded as a separate line item in the fiscal
2002 consolidated statement of income.
For fiscal 2002, the Company incurred restructuring charges of $2,046 related to
the declining net realizable value of its LaVergne, Tennessee logistics
facility. The effect of suspending depreciation on this facility was
approximately $400 in fiscal 2002. The Company sold this facility in the second
quarter of fiscal 2002. The effect of selling this facility is included in the
Consumer Healthcare segment.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
Item 9A. Controls and Procedures
As of June 26, 2004, the Company's management, including its Chief Executive
Officer and its Chief Financial Officer, have reviewed and evaluated the
effectiveness of the Company's disclosure controls and procedures pursuant to
Rule 13a-15(b) of the Securities Exchange Act of
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1934. Based on that review and evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that the Company's disclosure controls and
procedures are adequate and effective in ensuring that all material information
relating to the Company and its consolidated subsidiaries required to be
included in the Company's periodic Securities and Exchange Commission (SEC)
filings would be made known to them by others within those entities in a timely
manner and that no changes are required at this time.
In connection with the evaluation by the Company's management, including its
Chief Executive Officer and Chief Financial Officer, of the Company's internal
control over financial reporting pursuant to Rule 13a-15(d) of the Securities
Exchange Act of 1934, no changes during the quarter ended June 26, 2004 were
identified that have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting.
PART III.
Item 10. Directors and Executive Officers of the Registrant.
(a) Directors of the Company.
This information is incorporated by reference to the Company's Proxy
Statement for the 2004 Annual Meeting under the heading "Election of
Directors".
(b) Executive Officers of the Company.
See Part I, Additional Item of this Form 10-K.
(c) Audit Committee Financial Expert.
This information is incorporated by reference to the Company's Proxy
Statement for the 2004 Annual Meeting under the heading "Board of
Directors and Committees".
(d) Identification and Composition of the Audit Committee.
This information is incorporated by reference to the Company's Proxy
Statement for the 2004 Annual Meeting under the heading "Board of
Directors and Its Committees".
(e) Compliance with Section 16(a) of the Exchange Act.
This information is incorporated by reference to the Company's Proxy
Statement for the 2004 Annual Meeting under the heading "Section 16(a)
Beneficial Ownership Reporting Compliance".
(f) Code of Ethics
This information is incorporated by reference to the Company's Proxy
Statement for the 2004 Annual Meeting under the heading "Corporate
Governance".
Item 11. Executive Compensation.
This information is incorporated by reference to the Company's Proxy Statement
for the 2004 Annual Meeting under the headings "Executive Compensation" and
"Director Compensation".
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
This information is incorporated by reference to the Company's Proxy Statement
for the 2004 Annual Meeting under the heading "Ownership of Perrigo Common
Stock". Information concerning equity compensation plans is incorporated by
reference to the Company's Proxy Statement for the
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2004 Annual Meeting under the heading "Equity Compensation Plan Information".
Item 13. Certain Relationships and Related Transactions.
None.
Item 14. Principal Accountant Fees and Services.
This information is incorporated by reference to the Company's Proxy Statement
for the 2004 Annual Meeting under the heading "Independent Accountants".
PART IV.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following documents are filed or incorporated by reference as part of
this Form 10-K:
1. All financial statements. See Index to Consolidated Financial Statements.
2. Financial Schedules
Report of Independent Registered Public Accounting Firm on Financial
Statement Schedule.
Schedule II - Valuation and Qualifying Accounts. Schedules other than the
one listed are omitted because the required information is included in the
footnotes, immaterial or not applicable.
3. Exhibits:
3(a) Amended and Restated Articles of Incorporation of Registrant,
incorporated by reference from Amendment No. 2 to Registration
Statement No. 33-43834 filed by the Registrant on September 23,
1993.
3(b) Restated Bylaws of Registrant, dated April 10, 1996, as amended,
incorporated by reference from the Registrant's Form 10-K filed on
September 6, 2000.
4(a) Shareholders' Rights Plan, incorporated by reference from the
Registrant's Form 8-K filed on April 10, 1996. (SEC File No.
00-19725).
10(a)* Registrant's 2003 Long-Term Incentive Plan effective October 29,
2003, as amended, incorporated by reference from the Registrant's
Proxy Statement for its 2003 Annual Meeting of Shareholders filed
on September 26, 2003.
10(b)* Registrant's Employee Stock Option Plan, as amended, incorporated
by reference from the Registrant's Form 10-K filed on September
18, 2002.
10(c)* Registrant's 1989 Non-Qualified Stock Option Plan for Directors, as
amended, incorporated by reference from Exhibit B of the
Registrant's 1997 Proxy Statement as amended at the Annual Meeting
of Shareholders on October 31, 2000.
10(d)* Registrant's Restricted Stock Plan for Directors, dated November
6, 1997, incorporated by reference from Registrant's 1998 Form
10-K filed on October 6, 1998.
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10(e)* Employment Agreement, Restricted Stock Agreement, Contingent
Restricted Stock Agreement, and Noncompetition and Nondisclosure
Agreement, dated April 19, 2000, between Registrant and David T.
Gibbons, incorporated by reference from the Registrant's Form 10-Q
filed on April 26, 2000.
10(f)* Registrant's Executive Retention Plan, dated January 1, 2002,
incorporated by reference from the Registrant's Form 10-Q filed on
October 30, 2002.
10(g)* Registrant's Nonqualified Deferred Compensation Plan, dated
December 31, 2001, as amended, incorporated by reference from the
Registrant's Form 10-Q filed on January 24, 2002.
10(h)* Registrant's Restricted Stock Plan for Directors II, dated August
14, 2001, incorporated by reference from the Registrant's Form
10-Q filed on October 23, 2001.
10(i)* Registrant's Management Incentive Bonus Plan, effective June 29,
2004, incorporated by reference from the Registrant's Form 10-Q
filed on October 23, 2003.
21 Subsidiaries of the Registrant.
23 Consent of BDO Seidman, LLP.
24 Power of Attorney (see signature page).
31 Rule 13a-14(a) Certifications.
32 Section 1350 Certifications.
* Denotes management contract or compensatory plan or arrangement.
(b) Exhibit and reports on Form 8-K.
On April 23, 2004, the Company furnished under Item 12 its April 23, 2004
press release containing its third quarter earnings information.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON FINANCIAL STATEMENT SCHEDULE
Shareholders and Board of Directors
Perrigo Company
Allegan, Michigan
The audits referred to in our report dated July 23, 2004, relating to the
consolidated financial statements of Perrigo Company and Subsidiaries, which is
contained in Item 8 of this Form 10-K for the year ended June 26, 2004, included
the audit of Schedule II - Valuation and Qualifying Accounts. This financial
statement schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statement schedule
based upon our audits.
In our opinion, such financial statement schedule presents fairly, in all
material respects, the information set forth therein.
By: /s/ BDO Seidman, LLP
--------------------
BDO Seidman, LLP
Grand Rapids, Michigan
July 23, 2004
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SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
PERRIGO COMPANY
(in thousands)
Balance Net Balance
at Beginning Bad Debt at End
Description of Period Expenses Deductions(1) of Period
----------- --------- -------- ------------- ---------
Year Ended June 29, 2002:
Allowances deducted from
asset accounts:
Allowance for uncollectible accounts $ 6,798 $ 2,013 $ 346 $ 8,465
Year Ended June 28, 2003:
Allowances deducted from
asset accounts:
Allowance for uncollectible accounts $ 8,465 $ 2,476 $ 699 $10,242
Year Ended June 26, 2004:
Allowances deducted from
asset accounts:
Allowance for uncollectible accounts $10,242 $(1,228) $ 718 $ 8,296
(1) Uncollectible accounts charged off, net of recoveries.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K for
the fiscal ended June 26, 2004 to be signed on its behalf by the undersigned,
thereunto duly authorized in the City of Allegan, State of Michigan on the 10th
of August 2004.
PERRIGO COMPANY
By: /s/ David T. Gibbons
------------------------------------------
David T. Gibbons
Chairman of the Board, President and Chief
Executive Officer
POWER OF ATTORNEY
Each person whose signature appears below hereby appoints David T. Gibbons and
Douglas R. Schrank and each of them severally, acting alone and without the
other, his true and lawful attorney-in-fact with authority to execute in the
name of each such person, and to file with the Securities and Exchange
Commission, together with any exhibits thereto and other documents therewith,
any and all amendments to this Annual Report on Form 10-K for the fiscal year
ended June 26, 2004 necessary or advisable to enable Perrigo Company to comply
with the Securities Exchange Act of 1934, any rules, regulations and
requirements of the Securities and Exchange Commission in respect thereof, which
amendments may make such other changes in the report as the aforesaid
attorney-in-fact executing the same deems appropriate.
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Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual
Report on Form 10-K for the fiscal year ended June 26, 2004 has been signed by
the following persons in the capacities indicated on the 10th of August 2004.
Signature Title
--------- -----
/s/ David T. Gibbons Chairman of the Board, President, and Chief
- ---------------------------------------- Executive Officer
David T. Gibbons (Principal Executive Officer)
/s/ Douglas R. Schrank Executive Vice President and Chief Financial Officer
- ---------------------------------------- (Principal Accounting and Financial Officer)
Douglas R. Schrank
/s/ Laurie Brlas Director
- ----------------------------------------
Laurie Brlas
/s/ Gary M. Cohen Director
- ----------------------------------------
Gary M. Cohen
/s/ Peter R. Formanek Director
- ----------------------------------------
Peter R. Formanek
/s/ Larry D. Fredricks Director
- ----------------------------------------
Larry D. Fredricks
/s/ Judith A. Hemberger Director
- ----------------------------------------
Judith A. Hemberger
/s/ Michael J. Jandernoa Director
- ----------------------------------------
Michael J. Jandernoa
/s/ Gary K. Kunkle, Jr. Director
- ----------------------------------------
Gary K. Kunkle, Jr.
/s/ Herman Morris, Jr. Director
- ----------------------------------------
Herman Morris, Jr.
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EXHIBIT INDEX
Exhibit Document
- ------- --------
21 Subsidiaries of the Registrant
23 Consent of BDO Seidman, LLP
31 Rule 13a-14(a) Certifications.
32 Section 1350 Certifications.
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