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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED AUGUST 31, 2002
COMMISSION FILE NUMBER 0-5905
CHATTEM, INC.
A TENNESSEE CORPORATION
I.R.S. EMPLOYER IDENTIFICATION NO. 62-0156300
1715 WEST 38TH STREET
CHATTANOOGA, TENNESSEE 37409
TELEPHONE: 423-821-4571
REGISTRANT HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS, AND HAS BEEN
SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.
AS OF OCTOBER 14, 2002, 9,516,620 SHARES OF THE COMPANY'S COMMON STOCK, WITHOUT
PAR VALUE, WERE OUTSTANDING.
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CHATTEM, INC.
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INDEX
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PAGE
NO.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of August 31, 2002 and
November 30, 2001 .................................................. 3
Consolidated Statements of Income for the Three and Nine
Months Ended August 31, 2002 and 2001 .............................. 5
Consolidated Statements of Cash Flows for the Nine Months Ended
August 31, 2002 and 2001 ........................................... 6
Notes to Consolidated Financial Statements ........................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ............................................ 23
Item 4. Controls and Procedures........................................ 34
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds...................... 35
Item 3. Legal Proceedings.............................................. 35
Item 6. Exhibits and Reports on Form 8-K .............................. 35
SIGNATURES ............................................................... 36
2
PART 1. FINANCIAL INFORMATION
-----------------------------
ITEM 1. FINANCIAL STATEMENTS
- ----------------------------
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
(In thousands)
AUGUST 31, NOVEMBER 30,
ASSETS 2002 2001
- ------ -------- --------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents ...................................... $ 34,625 $ 35,445
Accounts receivable, less allowance for doubtful accounts
of $838 at August 31, 2002 and $500 at
November 30, 2001 ............................................. 29,150 20,860
Refundable and deferred income taxes ........................... 8,654 4,646
Inventories .................................................... 14,504 14,260
Prepaid expenses and other current assets ...................... 3,021 2,667
-------- --------
Total current assets ......................................... 89,954 77,878
-------- --------
PROPERTY, PLANT AND EQUIPMENT, NET ............................... 26,626 26,275
-------- --------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net .... 245,868 185,373
Debt issuance costs, net ....................................... 7,881 7,665
Other .......................................................... 2,123 2,482
-------- --------
Total other noncurrent assets ................................ 255,872 195,520
-------- --------
TOTAL ASSETS ............................................... $372,452 $299,673
======== ========
The accompanying notes are an integral part of these consolidated financial statements.
3
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
(In thousands)
AUGUST 31, NOVEMBER 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 2002 2001
- ------------------------------------ --------- ---------
(Unaudited)
CURRENT LIABILITIES:
Current maturities of long-term debt ............................. $ 7,000 $ --
Accounts payable ................................................. 12,903 9,010
Payable to bank .................................................. 213 151
Accrued liabilities .............................................. 32,282 15,138
--------- ---------
Total current liabilities ...................................... 52,398 24,299
--------- ---------
LONG-TERM DEBT, less current maturities ............................ 234,716 204,740
--------- ---------
DEFERRED INCOME TAXES .............................................. 16,952 16,251
--------- ---------
OTHER NONCURRENT LIABILITIES ....................................... 1,622 1,765
--------- ---------
COMMITMENTS AND CONTINGENCIES (Note 11)
SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized 1,000,
none issued .................................................... -- --
Common shares, without par value, authorized 50,000,
issued 9,453 at August 31, 2002 and 8,973 at
November 30, 2001 .............................................. 1,968 1,868
Paid-in surplus .................................................. 73,795 65,960
Accumulated deficit .............................................. (5,573) (11,120)
--------- ---------
70,190 56,708
Unamortized value of restricted common shares issued ............. (672) (859)
Cumulative other comprehensive income:
Foreign currency translation adjustment ........................ (1,754) (2,231)
Minimum pension liability adjustment, net of income taxes ...... (1,000) (1,000)
--------- ---------
Total shareholders' equity .................................... 66,764 52,618
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY ................................................... $ 372,452 $ 299,673
========= =========
The accompanying notes are an integral part of these consolidated financial statements.
4
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
(Unaudited and in thousands, except per share amounts)
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED AUGUST 31, ENDED AUGUST 31,
--------------------------- ---------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
REVENUES:
Net sales (Note 2) ......................................... $ 63,457 $ 45,208 $ 169,617 $ 139,975
Royalties (Note 14) ........................................ 947 -- 1,873 --
--------- --------- --------- ---------
Total revenues ........................................... 64,404 45,208 171,490 139,975
--------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales .............................................. 17,526 12,663 48,673 40,553
Advertising and promotion (Note 2) ......................... 21,307 14,337 55,276 48,442
Selling, general and administrative (Note 2) ............... 9,926 9,106 29,002 24,991
--------- --------- --------- ---------
Total costs and expenses ................................. 48,759 36,106 132,951 113,986
--------- --------- --------- ---------
INCOME FROM OPERATIONS ....................................... 15,645 9,102 38,539 25,989
--------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense ........................................... (5,374) (4,959) (15,518) (17,024)
Investment and other income, net ........................... 79 289 243 1,910
--------- --------- --------- ---------
Total other income (expense) ............................. (5,295) (4,670) (15,275) (15,114)
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES,
EXTRAORDINARY GAIN (LOSS) AND CHANGE
IN ACCOUNTING PRINCIPLE .................................... 10,350 4,432 23,264 10,875
PROVISION FOR INCOME TAXES ................................... 3,933 1,684 8,840 4,132
--------- --------- --------- ---------
INCOME BEFORE EXTRAORDINARY GAIN (LOSS)
AND CHANGE IN ACCOUNTING PRINCIPLE ......................... 6,417 2,748 14,424 6,743
EXTRAORDINARY GAIN (LOSS) ON EARLY
EXTINGUISHMENT OF DEBT, NET OF INCOME
TAXES ...................................................... -- (603) -- 6,948
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE, NET OF INCOME TAX
BENEFIT (Note 3) ........................................... -- -- (8,877) --
--------- --------- --------- ---------
NET INCOME ................................................... $ 6,417 $ 2,145 $ 5 ,547 $ 13,691
========= ========= ========= =========
NUMBER OF COMMON SHARES:
Weighted average outstanding-basic ......................... 9,470 8,876 9,229 8,871
========= ========= ========= =========
Weighted average and potential dilutive outstanding ........ 9,935 9,031 9,623 8,917
========= ========= ========= =========
NET INCOME PER COMMON SHARE:
Basic:
Income before extraordinary gain (loss) and change in
accounting principle ................................... $ .68 $ .31 $ 1.56 $ .76
Extraordinary gain (loss) ................................ -- (.07) -- .78
Change in accounting principle ........................... -- -- (.96) --
--------- --------- --------- ---------
Total basic ............................................ $ .68 $ .24 $ .60 $ 1.54
========= ========= ========= =========
Diluted:
Income before extraordinary gain (loss) and change in
accounting principle ................................... $ .65 $ .30 $ 1.50 $ .76
Extraordinary gain (loss) ................................ -- (.06) -- .78
Change in accounting principle ........................... -- -- (.92) --
--------- --------- --------- ---------
Total diluted .......................................... $ .65 $ .24 $ .58 $ 1.54
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements.
5
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(Unaudited and in thousands, except share and per share amounts)
FOR THE NINE MONTHS ENDED
AUGUST 31,
---------------------------
2002 2001
--------- ---------
OPERATING ACTIVITIES:
Net income ............................................................. $ 5,547 $ 13,691
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ...................................... 3,969 7,627
Increase in deferred income taxes .................................. 4,333 --
Gain on product divestiture ........................................ -- (79)
Extraordinary gain on early extinguishment of debt, net ............ -- (6,948)
Cumulative effect of change in accounting principle, net ........... 8,877 --
Stock option charge ................................................ 175 394
Other, net ......................................................... (75) (59)
Changes in operating assets and liabilities, net of product
acquisition:
Accounts receivable .............................................. (8,290) 16,215
Refundable income taxes .......................................... 1,031 600
Inventories ...................................................... (244) 2,077
Prepaid expenses and other current assets ........................ (354) (2,309)
Accounts payable and accrued liabilities ......................... 21,037 (16,331)
--------- ---------
Net cash provided by operating activities ..................... 36,006 14,878
--------- ---------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment ............................. (2,622) (1,512)
Additions to trademarks and other product rights ....................... (74,996) (277)
Proceeds from product divestiture ...................................... -- 1,179
Decrease in other assets, net .......................................... 254 374
--------- ---------
Net cash used in investing activities ......................... (77,364) (236)
--------- ---------
FINANCING ACTIVITIES:
Repayment of long-term debt ............................................ (8,000) (84,453)
Payment of consent fees and other costs related to repayment of
long-term debt ....................................................... -- (3,293)
Proceeds from long-term debt ........................................... 45,000 --
Proceeds from exercise of stock options ................................ 6,146 95
Repurchase of common shares ............................................ (1,650) --
Change in payable to bank .............................................. 62 (1,529)
Debt issuance costs .................................................... (1,133) --
--------- ---------
Net cash provided by (used in) financing activities ............ 40,425 (89,180)
--------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND
CASH EQUIVALENTS ....................................................... 113 (31)
--------- ---------
CASH AND CASH EQUIVALENTS:
Decrease for the period ................................................ (820) (74,569)
At beginning of period ................................................. 35,445 102,534
--------- ---------
At end of period ....................................................... $ 34,625 $ 27,965
========= =========
SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Issuance of 100,000 shares of restricted common stock at an average
value of $9.93 each ................................................. $ -- $ 993
PAYMENTS FOR:
Interest ............................................................... $ 9,862 $ 14,331
Taxes .................................................................. $ 536 $ 266
The accompanying notes are an integral part of these consolidated financial statements.
6
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
(UNAUDITED)
Note: All monetary amounts are expressed in thousands of dollars unless
contrarily evident.
1. The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. These consolidated financial
statements should be read in conjunction with the audited consolidated
financial statements and related notes thereto included in the Company's
Annual Report on Form 10-K for the year ended November 30, 2001. The
accompanying unaudited consolidated financial statements, in the opinion
of management, include all adjustments necessary for a fair presentation.
All such adjustments are of a normal and recurring nature.
2. The Emerging Issues Task Force ("EITF") of the Financial Accounting
Standards Board ("FASB") finalized EITF Issue No. 00-14, "Accounting for
Certain Sales Incentives" ("EITF 00-14") and EITF Issue No. 00-25, "Vendor
Income Statement Characterization of Consideration Paid to a Reseller of
the Vendor's Products" ("EITF 00-25") in November 2000 and July 2001,
respectively. (See "Recently Issued Accounting Pronouncements" on page 33
of this Form 10-Q report for a discussion of the provisions of these two
statements). The Company adopted the requirements of these two
pronouncements effective December 1, 2001. The following table presents
the effect of the requirements of these two pronouncements on the
components, as indicated, of the consolidated statements of income for the
three and nine months ended August 31, 2002 and 2001, respectively:
Advertising Selling,
and General and
Net Promotion Administrative
Sales Expense Expense
-------- -------- --------
For the Three Months Ended
August 31, 2002:
Previous reporting basis ..... $ 66,277 $ 23,884 $ 10,169
Impact of adopting EITF's
00-14 and 00-25 ........... 2,820 2,577 243
-------- -------- --------
Current reporting basis ...... $ 63,457 $ 21,307 $ 9,926
======== ======== ========
For the Three Months Ended
August 31, 2001:
Previous reporting basis ..... $ 49,641 $ 18,528 $ 9,348
Impact of adopting EITF's
00-14 and 00-25 ............ 4,433 4,191 242
-------- -------- --------
Current reporting basis ...... $ 45,208 $ 14,337 $ 9,106
======== ======== ========
For the Nine Months Ended
August 31, 2002:
Previous reporting basis ..... $180,630 $ 65,625 $ 29,666
Impact of adopting EITF's
00-14 and 00-25 ............ 11,013 10,349 664
-------- -------- --------
Current reporting basis ...... $169,617 $ 55,276 $ 29,002
======== ======== ========
7
For the Nine Months Ended
August 31, 2001:
Previous reporting basis...... $153,603 $ 61,391 $ 25,670
Impact of adopting EITF's
00-14 and 00-25............. 13,628 12,949 679
-------- -------- --------
Current reporting basis....... $139,975 $ 48,442 $ 24,991
======== ======== ========
Appropriate adjustments have likewise been made in the consolidating
statements of income for the nine months ended August 31, 2002 and 2001,
respectively. (See Note 17 of Notes to Consolidated Financial Statements).
The Company's income before extraordinary gain (loss) and change in
accounting principle and net income for the three and nine months ended
August 31, 2002 and 2001, respectively, and its financial position at
August 31, 2002 and 2001, respectively, were not affected by the adoption
of the provisions of these two pronouncements.
3. In June 2001 the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). The
provisions of SFAS 142, which were adopted by the Company on December 1,
2001, require the Company to discontinue the amortization of the cost of
intangible assets with indefinite lives and also requires certain fair
value based tests of the carrying value of indefinite lived intangible
assets. Income before extraordinary gain (loss) and net income for the
three and nine months ended August 31, 2001, respectively, adjusted to
exclude amortization expense recognized in those periods which was related
to intangible assets that are no longer being amortized, are as follows:
For the Three Months Ended For the Nine Months Ended
August 31, 2001 August 31, 2001
-------------------------- --------------------------
Income Before Income Before
Extraordinary Extraordinary
Gain(Loss) Net Income Gain(Loss) Net Income
------- ------- ------- -------
As reported ....................... $ 2,748 $ 2,145 $ 6,743 $13,691
Amortization, net of
tax ............................. 864 864 2,591 2,591
------- ------- ------- -------
Adjusted .......................... $ 3,612 $ 3,009 $ 9,334 $16,282
======= ======= ======= =======
Per common share, as adjusted:
Basic ........................... $ .41 $ .34 $ 1.05 $ 1.84
======= ======= ======= =======
Diluted ......................... $ .40 $ .33 $ 1.05 $ 1.83
======= ======= ======= =======
Also in connection with the adoption of SFAS 142, the Company obtained
independent appraisals to determine the fair values of these intangible
assets at December 1, 2001 and compared their fair values with their
carrying values to determine the write-down of $8,877, net of income tax
benefit of $5,440, or $.92 per diluted share. The write-down was primarily
related to the Company's SUNSOURCE product line, which experienced a
decline in sales volume as compared to sales levels at its initial
purchase in 1997. This adjustment is shown as a cumulative effect of
change in accounting principle in the consolidated statement of income for
the nine months ended August 31, 2002.
4. The Company incurs significant expenditures on television, radio and print
advertising to support its nationally branded over-the-counter ("OTC")
health care products. Customers purchase products from the Company with
the understanding that the brands will be supported by the Company's
extensive media advertising. This advertising supports the retailers'
sales effort and maintains the important brand franchise with the
consuming public. Accordingly, the Company considers its advertising
program to be clearly
8
implicit in its sales arrangements with its customers. Therefore, the
Company believes it is appropriate to allocate a percentage of the
necessary supporting advertising expenses to each dollar of sales by
charging a percentage of sales on an interim basis based upon anticipated
annual sales and advertising expenditures (in accordance with Accounting
Principles Board Opinion No. 28) and adjusting that accrual to the actual
expenses incurred at the end of the year.
5. Inventories consisted of the following at August 31, 2002 and November 30,
2001:
2002 2001
-------- --------
Raw materials and work in process .... $ 7,081 $ 8,108
Finished goods ....................... 9,462 8,191
Excess of current cost over LIFO
values ............................. (2,039) (2,039)
-------- --------
Total inventories ................ $ 14,504 $ 14,260
======== ========
6. Accrued liabilities consisted of the following at August 31, 2002 and
November 30, 2001:
2002 2001
------- -------
Income and other taxes ................... $ 5,505 $ 290
Interest ................................. 7,756 3,070
Salaries, wages and commissions .......... 2,959 3,462
Product advertising and promotion ........ 12,540 3,654
Product acquisitions and divestitures .... 737 2,205
Other .................................... 2,785 2,457
------- -------
Total accrued liabilities ............ $32,282 $15,138
======= =======
7. Comprehensive income consisted of the following components for the three
and nine months ended August 31, 2002 and 2001, respectively:
For the Three Months For the Nine Months
Ended August 31, Ended August 31,
------------------------ ------------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net income ................... $ 6,417 $ 2,145 $ 5,547 $ 13,691
Other - foreign currency
translation adjustment .... 426 (20) 477 (61)
-------- -------- -------- --------
Total ..................... $ 6,843 $ 2,125 $ 6,024 $ 13,630
======== ======== ======== ========
8. In fiscal 1999 and 2000 the Company's board of directors authorized
repurchases of the Company's common stock not to exceed an aggregate total
of $20,000. Under these authorizations, 1,142,200 shares at a cost of
$15,224 have been reacquired through August 31, 2002, leaving $4,776
available for future repurchases. The Company, however, is limited in its
ability to repurchase shares due to restrictions under the terms of the
indenture with respect to which its senior subordinated notes were issued
and under the terms of the Credit Facility. (See Note 15 of Notes to
Consolidated Financial Statements for a description of this facility). The
repurchased shares were retired and returned to unissued. In the first
nine months of fiscal 2002, 79,200 shares were repurchased at a cost of
$1,650.
9. On January 17, 2001 the Company completed a consent solicitation and
tender offer pursuant to which it retired $70,462 principal amount of its
8.875% senior subordinated notes due 2008 and $7,397 principal amount of
its 12.75% senior subordinated notes due 2004. The consideration paid for
the consent solicitation and tender offer was $64,937, which was provided
by the proceeds of the Ban(R) sale. An extraordinary gain on the early
extinguishment of debt of $7,551, net of income taxes, was recognized in
the first six months of fiscal 2001. On June 15, 2001 the Company retired
all of the remaining outstanding principal balance of $21,748 of the
12.75% notes, at which time an extraordinary loss on the early
9
extinguishment of debt of $603, net of income tax benefit, was recorded in
connection with this retirement. This loss primarily consisted of the
premium paid on the retirement of the notes and the write-off of related
unamortized deferred issuance and initial discount costs.
10. On January 22, 2002 Kmart Corporation ("Kmart"), a customer of the Company
representing approximately 5% of fiscal 2001 consolidated revenues, filed
a petition under Chapter 11 of the United States Bankruptcy Code. At the
time of the filing Kmart owed the Company approximately $1,200. This
bankruptcy filing did not impact the Company's results of operations and
financial position for fiscal 2001. In the first quarter of fiscal 2002
the Company established a reserve of $1,000 to cover its estimated bad
debt related to Kmart. In the second quarter of fiscal 2002 the Company
sold its receivable from Kmart to a financial institution for $367. The
Company continues to sell to Kmart at decreased volume levels and as of
August 31, 2002 the Company's receivables from Kmart were approximately
$1,056.
11. COMMITMENTS AND CONTINGENCIES
-----------------------------
GENERAL LITIGATION
The Company was named as a defendant in a lawsuit brought by the Center
for Environment Health ("CEH") contending that the Company violated the
California Safe Drinking Water and Toxic Enforcement Act of 1998
(Proposition 65) by selling to California consumers without a warning
topical skin care products containing zinc oxide which in turn contains
lead. The lawsuit contended that the purported failure to comply with
Proposition 65 requirements also constituted a violation of the California
Business & Professions Code Section 1700 et seq. Violations of either
Proposition 65 or Business and Professions Code 1700 et seq. render a
defendant liable for civil penalties of up to $2.5 per day per violation.
The Company was also named as a defendant in a lawsuit filed in San
Francisco Superior Court on December 29, 1999, JOHNSON et al. v.
BRISTOL-MYERS SQUIBB CO., et al., Case No. 308872. This was a putative
class action brought by two named plaintiffs on behalf of the general
public in California, against the same entities that are defendants in the
CEH lawsuit. As with the CEH lawsuit, the Johnson lawsuit alleged that the
Company violated Proposition 65 by selling to California consumers without
a warning topical skin care products containing zinc oxide which in turn
contains lead. The lawsuit did not assert claims directly under
Proposition 65, but asserted that the alleged failure to comply with
Proposition 65 gave rise to claims under California's Business and
Professions Code Section 17200 et seq., 17500 et seq., and the Civil Code
Section 1750 et seq. The lawsuit sought injunctive and equitable relief,
restitution, the disgorgement of allegedly wrongfully obtained revenues
and damages.
The plaintiffs in the two separate actions filed a consolidated amended
complaint that included a claim based upon the allegation that zinc oxide
allegedly also contains cadmium. During the third quarter of fiscal 2002 a
settlement was finalized among the parties for these two cases pending
final court approval. Final court approval of the settlement is expected
during the Company's fourth quarter of fiscal 2002. In the settlement, the
Company paid a settlement amount that was within the expected range that
had been previously accrued by the Company. The settlement amount was not
material to the Company's results of operations.
The Company has been named as a defendant in approximately 160 lawsuits
involving claims by approximately 765 plaintiffs alleging that the
plaintiffs were injured as a result of ingestion of products containing
phenylpropanolamine ("PPA"), which was an active ingredient in most of the
Company's DEXATRIM products until November 2000. The Company anticipates
that additional lawsuits will be filed in which similar or other
allegations related to the Company's DEXATRIM products containing PPA.
Most of the lawsuits seek an unspecified amount of compensatory and
exemplary damages or punitive damages. At this stage of the proceedings,
it is not possible for the Company to determine the outcome of these
matters or the effect of their resolution on the Company's financial
position or operating results. The earliest scheduled trial date in these
cases is set for January 2003, and it is anticipated that other cases will
be set for trial beginning later in 2003.
10
There can be no assurance that Company will be successful in the defense
of these lawsuits or that these lawsuits will not have a material adverse
effect on the Company's results of operations or its financial position.
Approximately half of the existing suits represent cases involving alleged
injuries by products manufactured and sold prior to the Company's
acquisition of DEXATRIM in December 1998. The Company is being defended
and is indemnified from liability by The DELACO Company, Inc., successor
to Thompson Medical Company, Inc., ("Thompson Medical") which owned
DEXATRIM prior to December 1998. The Company understands that The DELACO
Company, Inc. maintains product liability insurance coverage for products
manufactured and sold prior to December 1998 with annual limits of
coverage and has an excess liability policy, but otherwise has only
nominal assets. Accordingly, it is unlikely that The DELACO Company, Inc.
will be able to indemnify the Company beyond its insurance coverage. In
addition, there can be no assurance that the insurance maintained by The
DELACO Company, Inc. will be sufficient to cover claims related to
products manufactured or sold prior to the Company's acquisition of
DEXATRIM or that ultimately the Company will not be held liable for these
claims. Although the Company maintains product liability insurance
coverage for claims asserted in the balance of the lawsuits, such coverage
may be insufficient to satisfy these claims. Moreover, the Company's
product liability insurance coverage would not apply to claims arising
from products manufactured and sold prior to the Company's acquisition of
DEXATRIM. If the Company is forced to assume PPA-related liabilities
arising prior to the Company's acquisition of DEXATRIM or if PPA-related
lawsuits resulted in liabilities greater than amounts available under or
exceed the scope of the Company's insurance coverage, the Company may not
have sufficient resources to satisfy these obligations.
Other claims, suits and complaints arise in the ordinary course of the
Company's business involving such matters as patents and trademarks,
product liability, environmental matters and other alleged injuries or
damage. The outcome of such litigation cannot be predicted, but, in the
opinion of management, based in part upon the opinion of counsel, all such
pending matters are without merit or are of such kind or involve such
amounts as would not have a material adverse effect on the consolidated
operating results or financial position of the Company if disposed of
unfavorably.
REGULATORY
In 1994 the Nonprescription Drug Manufacturers Association (now the
Consumer Healthcare Products Association) ("CHPA") initiated a large-scale
study in conjunction with the Yale University School of Medicine to
investigate a possible association, if any, of stroke in women aged 18 to
49 using PPA which, until November 2000, was the active ingredient in
certain of the DEXATRIM products (the "Yale Study"). PPA is also used in
other OTC medications, which were also part of the Yale Study. In May
2000, the results of the Yale Study were filed with the Food and Drug
Administration ("FDA"). The investigators concluded that the results of
the Yale Study suggest that PPA increases the risks of hemorrhagic stroke.
The FDA indicated at that time that no immediate action was required and
scheduled a FDA advisory panel to meet in October 2000 to discuss the
results of the study.
In October 2000, a Nonprescription Drugs Advisory Committee ("NDAC"),
commissioned by the FDA to review the safety of PPA, determined that there
is an association between PPA and hemorrhagic stroke and recommended that
PPA not be considered generally recognized as safe for OTC use as a nasal
decongestant or for weight control. In response to a request from the FDA
to cease voluntarily marketing DEXATRIM with PPA, the Company announced on
November 7, 2000 its decision to cease immediately shipping DEXATRIM with
PPA and to accept product returns from any retailers who decide to
discontinue marketing DEXATRIM with PPA.
The Food and Drug Administration, the Drug Enforcement Administration and
a number of state and local governments have enacted or proposed
restrictions or prohibitions on the sale of products that
11
contain ephedrine. Ephedrine can refer to the herbal substance derived
from the plant ephedra or the plant heart leaf, which has been used in
some forms of DEXATRIM, or synthetic ephedrine, a FDA regulated ingredient
used in some OTC drug products, which is not used in our products. These
restrictions include the prohibition of OTC sales, required warnings or
labeling statements, record keeping and reporting requirements, the
prohibition of sales to minors, per transaction limits on the quantity of
product that may be purchased and limitations on advertising and
promotion. These restrictions could adversely affect the sale of DEXATRIM
Natural and DEXATRIM Results, which have had SKU's containing naturally
occurring sources of ephedrine. Failure to comply with these restrictions
could also lead to regulatory enforcement action, including the seizure of
violative products, product recalls, civil or criminal fines or other
penalties. The enactment of these restrictions or prohibitions on sales,
the perceived safety concerns related to ephedrine and the possibility of
further regulatory action, increases the likelihood that claims relating
to the existence of naturally-occurring sources of ephedrine in DEXATRIM
Natural and DEXATRIM Results will be filed against the Company. Although
the Company is not currently defending any lawsuits alleging product
liability claims relating to the existence of naturally-occurring sources
of ephedrine in DEXATRIM, we understand that lawsuits have been filed
against other manufacturers of appetite supppresssants containing
ephedrine. In late 2000 the FDA requested the National Institutes of
Health to commission a review of the safety and efficacy of ephedrine in
herbal products used to control weight. This review will be based on all
adverse events, records and scientific data available to the reviewers. It
is expected that the report will be issued in early Fall of 2002. In
September 2001 The Public Citizen Health Research Group petitioned the FDA
to ban the production and sale of dietary supplements containing ephedrine
alkaloids. As of August 31, 2002 the FDA's parent entity, the Department
of Health and Human Services, has decided to defer making a decision on
the petition until it has further scientific information on the safety of
ephedrine alkaloids. If the FDA concludes that ephedrine should not be
used in dietary supplements, the Company will be required to reformulate
the product. The Company has developed alternative formulations for
DEXATRIM Natural and DEXATRIM Results to exclude ephedrine and since the
end of the third quarter of fiscal 2002 has discontinued the sale of
DEXATRIM products containing ephedrine.
The Company was notified in October 2000 that the FDA denied a citizen
petition submitted by Thompson Medical, the previous owner of SPORTSCREME
and ASPERCREME, seeking a determination that 10% trolamine salicylate was
clinically proven to be an effective active ingredient in external
analgesic OTC drug products, and thus should be included in the FDA's
yet-to-be finalized monograph for external analgesics. The Company has met
with the FDA and submitted a proposed protocol study to evaluate the
efficacy of 10% trolamine salicylate as an active ingredient in OTC
external analgesic drug products. Based on comments received from the FDA
at the meeting, the Company may revise and resubmit the protocol. After
final comments from the FDA, the Company expects that it will take one or
two years to produce the clinical data for FDA review. The FDA could
finalize the OTC external analgesic monograph before the protocol and
clinical data results are finalized, which would place 10% trolamine
salicylate in non-monograph status, thus requiring the submission of a new
drug application to market and sell OTC products with 10% trolamine
salicylate. This submission would likely require the Company to provide
clinical data, which would be expensive. The Company is working to develop
alternate formulations for SPORTSCREME and ASPERCREME in the event that
the FDA does not consider the available clinical data to conclusively
demonstrate the efficacy of trolamine salicylate when the OTC external
analgesic monograph is finalized. If 10% trolamine salicylate is not
included in the final monograph, the Company would likely be required to
discontinue these products and remove them from the market after
expiration of an anticipated grace period or review the option of
marketing these products as homeopathic products.
12. Certain prior year amounts have been reclassified to conform to the
current period's presentation.
13. The Company considers all short-term deposits and investments with
original maturities of three months or less to be cash equivalents.
12
14. On March 28, 2002 the Company completed the acquisition of SELSUN BLUE, a
leading medicated dandruff shampoo, from Abbott Laboratories ("Abbott")
for $75,000, plus inventories of $1,380 and assumed liabilities of $1,173.
This acquisition includes worldwide rights (except India) to manufacture,
sell and market SELSUN BLUE plus related intellectual property and certain
manufacturing equipment. The purchase price of $77,553 was allocated
$1,518 to inventory, $1,000 to property, plant and equipment, $73,785 to
the trademark which was assigned an indefinite life and $1,250 to other
purchased product rights which were assigned useful lives of 5 years. This
is a preliminary allocation which will be revised upon completion of
appraisals of the assets. Abbott will continue to manufacture the product
for the Company until June 2003 domestically, or such earlier date as the
Company moves production to its Chattanooga, Tennessee facilities, and
until March 2004 internationally, or such earlier date as the Company
enters into its own agreements with contract manufacturers. The Company
will generally pay Abbott a fee of ten percent over standard manufacturing
costs until the Company assumes manufacturing or enters into third party
agreements, except as discussed below. The Company will also rely on
Abbott to market, sell and distribute SELSUN BLUE products in most foreign
countries until the Company satisfies various foreign regulatory
requirements, new distributors are in place and any applicable marketing
permits are transferred. During the marketing transition period, Abbott
will initially pay the Company a royalty equal to 28% of international
sales of SELSUN BLUE in these countries with the royalty reduced to 14% of
international sales in certain countries if foreign regulatory
requirements are satisfied prior to the Company's assumption of sales and
marketing responsibility in such countries. Abbott will pay all costs and
expenses related to the manufacture, marketing and sales of SELSUN BLUE in
these countries. As the Company assumes responsibility for the sales and
marketing effort in a country, the royalty arrangement with respect to
such country will terminate and the Company will record these
international sales directly, as well as the costs and expenses associated
with these sales. The following table summarizes the Company's estimate of
how the results for SELSUN BLUE international for the three and nine
months ended August 31, 2002 would have been presented had the transition
period been finalized on the date of acquisition:
ESTIMATED SELECTED SELSUN BLUE INTERNATIONAL DATA (Unaudited)
For the Three For the Nine
Months ended Months ended
August 31, August 31,
2002 2002
------ ------
NET SALES ................................ $4,450 $7,701
------ ------
COSTS AND EXPENSES:
Cost of sales .......................... 1,724 2,983
Advertising and promotion .............. 658 1,139
Selling, general and administrative .... 1,121 1,706
------ ------
Total costs and expenses ............. 3,503 5,828
------ ------
INCOME FROM OPERATIONS ................... $ 947 $1,873
====== ======
13
The following unaudited consolidated pro forma information assumes the
acquisition of SELSUN BLUE had occurred at the beginning of the periods
presented:
PRO FORMA CONSOLIDATED RESULTS OF OPERATIONS (Unaudited)
For the Three Months For the Nine Months
Ended August 31, Ended August 31,
--------------- ------------------------------
2001 2002 2001
----------- ----------- -----------
Total revenue .................... $ 54,819 $ 182,221 $ 169,293
Income before extraordinary
gain (loss) and change in
accounting principle ........... 3,906 14,740 10,636
Net income ....................... 3,303 5,863 17,584
Earnings per share - basic:
Income before extraordinary
gain (loss) and change in
accounting principle .......... .44 1.60 1.20
Net income ..................... .37 .64 1.98
Earnings per share - diluted:
Income before extraordinary
gain (loss) and change in
accounting principle .......... .43 1.53 1.19
Net income ..................... .37 .61 1.97
The pro forma consolidated results of operations include adjustments to
give effect to interest expense on debt to finance the acquisition,
depreciation expense on adjusted property, plant and equipment values,
amortization of certain intangible assets, increased manufacturing costs
of 10% over standard historical costs and decrease in interest income on
cash used in the acquisition, together with related income tax effects.
The pro forma information is for comparative purposes only and does not
purport to be indicative of the results that would have occurred had the
acquisition and borrowings occurred at the beginning of the periods
presented, or indicative of the results that may occur in the future.
15. On March 28, 2002 the Company obtained a $60,000 senior secured credit
facility from a syndicate of commercial banks led by Bank of America,
N.A., as agent (the "Credit Facility"). The Credit Facility includes a
$15,000 revolving credit line and a $45,000 term loan. The Credit Facility
together with the Company's available cash was used to finance the
acquisition of SELSUN BLUE and was used to provide working capital and for
general corporate purposes. The $45,000 term loan, which requires
principal payments to be made quarterly, and any outstanding loans under
the revolving credit line mature on March 28, 2007. The Credit Facility is
secured by the stock of the Company's domestic subsidiaries and all
present and future assets of the Company, excluding real property. The
Credit Facility contains covenants, representations, warranties and other
agreements by the Company that are customary in credit agreements and
security instruments relating to financings of this type.
16. On June 17, 2002 the Company announced that it was commencing a public
offering of 1,800,000 shares of its common stock through an underwriting
group led by Banc of America Securities LLC. On June 28, 2002 the Company
announced the postponment of the public offering, due to adverse market
conditions. On September 12, 2002 the Company announced that it was
considering the recommencement of the public offering. On September 24,
2002, however, the Company announced that it had postponed indefinitely
any plans for the recommencement of the public offering, again due to
unfavorable market conditions. Selling, general and administrative
expenses for the third quarter of 2002 include $500 of expenses related to
the indefinitely postponed public offering.
14
17. The condensed consolidating financial statements, for the dates or periods
indicated, of Chattem, Inc. ("Chattem"), Signal Investment & Management
Co. ("Signal") and SunDex, Inc. ("SunDex"), the guarantors of the
long-term debt of Chattem, and the non-guarantor wholly-owned subsidiary
companies of Chattem are presented below. Signal and SunDex are
wholly-owned subsidiaries of Chattem; the guarantee of Signal and SunDex
is full and unconditional and joint and several.
15
Note 17
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING BALANCE SHEETS
----------------------------
AUGUST 31, 2002
---------------
(Unaudited and in thousands)
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- --------- ---------
ASSETS
- ------
CURRENT ASSETS:
Cash and cash equivalents ..................... $ 27,572 $ 458 $ 2,231 $ 4,364 $ -- $ 34,625
Accounts receivable, less allowance for
doubtful accounts of $838 ................... 24,162 -- -- 4,988 -- 29,150
Refundable and deferred income taxes .......... 8,553 -- -- 101 -- 8,654
Inventories ................................... 9,392 -- 2,368 2,744 -- 14,504
Prepaid expenses and other current assets ..... 2,828 -- -- 193 -- 3,021
--------- --------- --------- --------- --------- ---------
Total current assets ........................ 72,507 458 4,599 12,390 -- 89,954
--------- --------- --------- --------- --------- ---------
PROPERTY, PLANT AND EQUIPMENT,
NET ......................................... 25,504 -- 775 347 -- 26,626
--------- --------- --------- --------- --------- ---------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased
product rights, net ......................... 1,483 182,095 62,290 -- -- 245,868
Debt issuance costs, net ...................... 7,881 -- -- -- -- 7,881
Investment in subsidiaries .................... 71,725 -- -- -- (71,725) --
Other ......................................... 2,106 -- -- 17 -- 2,123
--------- --------- --------- --------- --------- ---------
Total other noncurrent assets ............... 83,195 182,095 62,290 17 (71,725) 255,872
--------- --------- --------- --------- --------- ---------
TOTAL ASSETS .............................. $ 181,206 $ 182,553 $ 67,664 $ 12,754 $ (71,725) $ 372,452
========= ========= ========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS'
- -----------------------------
EQUITY
------
CURRENT LIABILITIES:
Current maturities of long-term debt .......... $ 7,000 $ -- $ -- $ -- $ -- $ 7,000
Accounts payable .............................. 12,116 -- -- 787 -- 12,903
Payable to bank ............................... 213 -- -- -- -- 213
Accrued liabilities ........................... 31,668 -- -- 614 -- 32,282
--------- --------- --------- --------- --------- ---------
Total current liabilities ................... 50,997 -- -- 1,401 -- 52,398
--------- --------- --------- --------- --------- ---------
LONG-TERM DEBT, less current maturities ......... 234,716 -- -- -- -- 234,716
--------- --------- --------- --------- --------- ---------
DEFERRED INCOME TAXES ........................... 7,542 9,410 -- -- -- 16,952
--------- --------- --------- --------- --------- ---------
OTHER NONCURRENT LIABILITIES .................... 1,622 -- -- -- -- 1,622
--------- --------- --------- --------- --------- ---------
INTERCOMPANY ACCOUNTS ........................... (185,642) 182,865 2,654 123 -- --
--------- --------- --------- --------- --------- ---------
SHAREHOLDERS' EQUITY:
Preferred shares, without par value,
authorized 1,000, none issued ............... -- -- -- -- -- --
Common shares, without par value,
authorized 50,000, issued 9,453 ............. 1,968 2 63,065 8,658 71,725 1,968
Paid-in surplus ............................... 73,795 -- -- -- -- 73,795
Retained earnings (deficit) ................... (1,621) (9,724) 1,945 3,827 -- (5,573)
--------- --------- --------- --------- --------- ---------
Total ....................................... 74,142 (9,722) 65,010 12,485 71,725 70,190
Unamortized value of restricted common
shares issued ............................... (672) -- -- -- -- (672)
Cumulative other comprehensive income:
Foreign currency translation adjustment ...... (499) -- -- (1,255) -- (1,754)
Minimum pension liability adjustment, net .... (1,000) -- -- -- -- (1,000)
--------- --------- --------- --------- --------- ---------
Total shareholders' equity (deficit) ........ 71,971 (9,722) 65,010 11,230 71,725 66,764
--------- --------- --------- --------- --------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY .................. $ 181,206 $ 182,553 $ 67,664 $ 12,754 $ 71,725 $ 372,452
========= ========= ========= ========= ========= =========
16
Note 17
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING BALANCE SHEETS
----------------------------
NOVEMBER 30, 2001
-----------------
(Unaudited and in thousands)
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- ---------
ASSETS
- ------
CURRENT ASSETS:
Cash and cash equivalents ..................... $ 20,648 $ 10,003 $ 4,794 $ -- $ 35,445
Accounts receivable, less allowance for
doubtful accounts of $500 ................... 17,690 -- 3,170 -- 20,860
Refundable and deferred income taxes .......... 4,545 -- 101 -- 4,646
Inventories ................................... 12,409 -- 1,851 -- 14,260
Prepaid expenses and other current assets ..... 2,517 -- 150 -- 2,667
--------- --------- --------- --------- ---------
Total current assets ........................ 57,809 10,003 10,066 -- 77,878
--------- --------- --------- --------- ---------
PROPERTY, PLANT AND EQUIPMENT,
NET ........................................... 25,879 -- 396 -- 26,275
--------- --------- --------- --------- ---------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased
product rights, net ......................... 3,987 181,386 -- -- 185,373
Debt issuance costs, net ...................... 7,665 -- -- -- 7,665
Investment in subsidiaries .................... 8,280 -- -- (8,280) --
Other ......................................... 2,436 -- 46 -- 2,482
--------- --------- --------- --------- ---------
Total other noncurrent assets ............... 22,368 181,386 46 (8,280) 195,520
--------- --------- --------- --------- ---------
TOTAL ASSETS .............................. $ 106,056 $ 191,389 $ 10,508 $ (8,280) $ 299,673
========= ========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS'
- -----------------------------
EQUITY
------
CURRENT LIABILITIES:
Accounts payable .............................. $ 8,523 $ -- $ 487 $ -- $ 9,010
Payable to bank ............................... 151 -- -- -- 151
Accrued liabilities ........................... 13,851 -- 1,287 -- 15,138
--------- --------- --------- --------- ---------
Total current liabilities ................... 22,525 -- 1,774 -- 24,299
--------- --------- --------- --------- ---------
LONG-TERM DEBT .................................. 204,740 -- -- -- 204,740
--------- --------- --------- --------- ---------
DEFERRED INCOME TAXES ........................... 1,401 14,850 -- -- 16,251
--------- --------- --------- --------- ---------
OTHER NONCURRENT LIABILITIES .................... 1,765 -- -- -- 1,765
--------- --------- --------- --------- ---------
INTERCOMPANY ACCOUNTS ........................... (178,860) 179,833 (973) -- --
--------- --------- --------- --------- ---------
SHAREHOLDERS' EQUITY:
Preferred shares, without par value,
authorized 1,000, none issued ............... -- -- -- -- --
Common shares, without par value,
authorized 50,000, issued 8,973 ............. 1,868 2 8,278 8,280 1,868
Paid-in surplus ............................... 65,960 -- -- -- 65,960
Retained earnings (deficit) ................... (10,994) (3,296) 3,170 -- (11,120)
--------- --------- --------- --------- ---------
Total ....................................... 56,834 (3,294) 11,448 8,280 56,708
Unamortized value of restricted common
shares issued ............................... (859) -- -- -- (859)
Cumulative other comprehensive income:
Foreign currency translation adjustment ...... (490) -- (1,741) -- (2,231)
Minimum pension liability adjustment, net .... (1,000) -- -- -- (1,000)
--------- --------- --------- --------- ---------
Total shareholders' equity (deficit) ........ 54,485 (3,294) 9,707 8,280 52,618
--------- --------- --------- --------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY .................. $ 106,056 $ 191,389 $ 10,508 $ 8,280 $ 299,673
========= ========= ========= ========= =========
17
Note 17
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF INCOME
----------------------------------
FOR THE NINE MONTHS ENDED AUGUST 31, 2002
-----------------------------------------
(Unaudited and in thousands)
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- --------- ---------
TOTAL REVENUES ........................... $ 141,966 $ -- $ 17,502 $ 12,022 $ -- $ 171,490
--------- --------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales .......................... 38,893 -- 5,193 4,587 -- 48,673
Advertising and promotion .............. 45,900 -- 6,296 3,080 -- 55,276
Selling, general and administrative .... 27,051 8 119 1,824 -- 29,002
--------- --------- --------- --------- --------- ---------
Total costs and expenses ............. 111,844 8 11,608 9,491 -- 132,951
--------- --------- --------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS ............ 30,122 (8) 5,894 2,531 -- 38,539
--------- --------- --------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense ....................... (15,518) -- -- -- -- (15,518)
Investment and other income, net ....... 143 66 -- 34 -- 243
Royalties .............................. (6,984) 8,198 (973) (241) -- --
Insurance premiums ..................... (500) -- -- 500 -- --
Corporate allocations .................. 1,862 -- (1,784) (78) -- --
--------- --------- --------- --------- --------- ---------
Total other income (expense) ........ (20,997) 8,264 (2,757) 215 -- (15,275)
--------- --------- --------- --------- --------- ---------
INCOME BEFORE INCOME TAXES AND
CHANGE IN ACCOUNTING PRINCIPLE .......... 9,125 8,256 3,137 2,746 -- 23,264
PROVISION FOR INCOME TAXES ............... 4,416 2,807 1,192 425 -- 8,840
--------- --------- --------- --------- --------- ---------
INCOME BEFORE CHANGE IN
ACCOUNTING PRINCIPLE ................... 4,709 5,449 1,945 2,321 -- 14,424
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE, NET OF
INCOME TAX BENEFIT ..................... -- (8,877) -- -- -- (8,877)
--------- --------- --------- --------- --------- ---------
NET INCOME (LOSS) ........................ $ 4, 709 $ (3,428) $ 1,945 $ 2,321 $ -- $ 5,547
========= ========= ========= ========= ========= =========
18
Note 17
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF INCOME
----------------------------------
FOR THE NINE MONTHS ENDED AUGUST 31, 2001
-----------------------------------------
(Unaudited and in thousands)
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- ---------
NET SALES ................................ $ 130,485 $ -- $ 9,490 $ -- $ 139,975
--------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales .......................... 36,849 -- 3,704 -- 40,553
Advertising and promotion .............. 41,688 4,179 2,575 -- 48,442
Selling, general and administrative .... 23,427 15 1,549 -- 24,991
--------- --------- --------- --------- ---------
Total costs and expenses ............. 101,964 4,194 7,828 -- 113,986
--------- --------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS ........... 28,521 (4,194) 1,662 -- 25,989
--------- --------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense ....................... (17,024) -- -- -- (17,024)
Investment and other income, net ....... 337 1,537 36 -- 1,910
Royalties .............................. (6,895) 7,083 (188) -- --
Insurance premiums ..................... (40) -- 40 -- --
Corporate allocations .................. 23 -- (23) -- --
--------- --------- --------- --------- ---------
Total other income (expense) ........ (23,599) 8,620 (135) -- (15,114)
--------- --------- --------- --------- ---------
INCOME BEFORE INCOME TAXES AND
EXTRAORDINARY GAIN ..................... 4,922 4,426 1,527 -- 10,875
PROVISION FOR INCOME TAXES ............... 2,292 1,505 335 -- 4,132
--------- --------- --------- --------- ---------
INCOME BEFORE EXTRAORDINARY
GAIN ................................... 2,630 2,921 1,192 -- 6,743
EXTRAORDINARY GAIN ON EARLY
EXTINGUISHMENT OF DEBT, NET OF
INCOME TAXES ........................... 6,948 -- -- -- 6,948
--------- --------- --------- --------- ---------
NET INCOME ............................... $ 9,578 $ 2,921 $ 1,192 $ -- $ 13,691
========= ========= ========= ========= =========
19
Note 17
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF CASH FLOWS
--------------------------------------
FOR THE NINE MONTHS ENDED AUGUST 31, 2002
-----------------------------------------
(Unaudited and in thousands)
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
-------- -------- -------- -------- ------ --------
OPERATING ACTIVITIES:
Net income (loss) ..................................... $ 4,709 $ (3,428) $ 1,945 $ 2,321 $ -- $ 5,547
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization ....................... 3,873 -- -- 96 -- 3,969
Deferred income tax provision ....................... 9,773 (5,440) -- -- -- 4,333
Provision for income taxes .......................... (3,999) 2,807 1,192 -- -- --
Cumulative effect of change in accounting
principle, net .................................... -- 8,877 -- -- -- 8,877
Stock option charge ................................. 175 -- -- -- -- 175
Other, net .......................................... (75) -- -- -- -- (75)
Changes in operating assets and liabilities, net
of product acquisition:
Accounts receivable ............................... (6,720) -- -- (1,570) -- (8,290)
Refundable income taxes ........................... 1,031 -- -- -- -- 1,031
Inventories ....................................... 2,862 -- (2,368) (738) -- (244)
Prepaid expenses and other current assets ......... (326) -- -- (28) -- (354)
Accounts payable and accrued liabilities .......... 21,451 -- -- (414) -- 21,037
-------- -------- -------- -------- ------ --------
Net cash provided by (used in) operating
activities .................................... 32,754 2,816 769 (333) -- 36,006
-------- -------- -------- -------- ------ --------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment ............ (2,600) -- -- (22) -- (2,622)
Purchase of trademarks and other product rights ....... (1,211) (73,785) -- -- -- (74,996)
Decrease in other assets, net ......................... 225 -- -- 29 -- 254
-------- -------- -------- -------- ------ --------
Net cash provided by (used in)
investing activities ......................... (3,586) (73,785) -- 7 -- (77,364)
-------- -------- -------- -------- ------ --------
FINANCING ACTIVITIES:
Repayment of long-term debt ........................... (8,000) -- -- -- -- (8,000)
Proceeds from long-term debt .......................... 45,000 -- -- -- -- 45,000
Proceeds from exercise of stock options ............... 6,146 -- -- -- -- 6,146
Repurchase of common shares ........................... (1,650) -- -- -- -- (1,650)
Change in payable to bank ............................. 62 -- -- -- -- 62
Debt issuance costs ................................... (1,133) -- -- -- -- (1,133)
Changes in intercompany accounts ...................... (65,680) 64,424 1,462 (206) -- --
Dividends paid ........................................ 3,000 (3,000) -- -- -- --
-------- -------- -------- -------- ------ --------
Net cash provided by (used in) financing
activities ................................... (22,255) 61,424 1,462 (206) -- 40,425
-------- -------- -------- -------- ------ --------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS ............................. 11 -- -- 102 -- 113
-------- -------- -------- -------- ------ --------
CASH AND CASH EQUIVALENTS:
Increase (decrease) for the period .................... 6,924 (9,545) 2,231 (430) -- (820)
At beginning of period ................................ 20,648 10,003 -- 4,794 -- 35,445
-------- -------- -------- -------- ------ --------
At end of period ...................................... $ 27,572 $ 458 $ 2,231 $ 4,364 $ -- $ 34,625
======== ======== ======== ======== ====== ========
20
Note 17
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF CASH FLOWS
--------------------------------------
FOR THE NINE MONTHS ENDED AUGUST 31, 2001
-----------------------------------------
(Unaudited and in thousands)
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- ---------
OPERATING ACTIVITIES:
Net income ............................................ $ 9,578 $ 2,921 $ 1,192 $ -- $ 13,691
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ....................... 3,398 4,179 50 -- 7,627
Gain on product divestiture ......................... -- (79) -- -- (79)
Provision for income taxes .......................... (1,505) 1,505 -- -- --
Extraordinary gain on early extinguishment of
debt, net ......................................... (6,948) -- -- -- (6,948)
Stock option charge ................................. 394 -- -- -- 394
Other, net .......................................... (59) -- -- -- (59)
Changes in operating assets and liabilities, net
of product divestitures:
Accounts receivable ............................... 14,703 1,154 358 -- 16,215
Refundable income taxes ........................... 600 -- -- -- 600
Inventories ....................................... 1,760 -- 317 -- 2,077
Prepaid expenses and other current assets ......... (2,261) -- (48) -- (2,309)
Accounts payable and accrued liabilities .......... (15,986) -- (345) -- (16,331)
--------- --------- --------- --------- ---------
Net cash provided by operating activities ....... 3,674 9,680 1,524 -- 14,878
--------- --------- --------- --------- ---------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment ............ (1,496) -- (16) -- (1,512)
Additions to trademarks and other product rights ...... -- (277) -- -- (277)
Proceeds from product divestiture ..................... 1,179 -- -- -- 1,179
Decrease in other assets, net ......................... 374 -- -- -- 374
--------- --------- --------- --------- ---------
Net cash provided by (used in)
investing activities .......................... 57 (277) (16) -- (236)
--------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Repayment of long- term debt .......................... (84,453) -- -- -- (84,453)
Payment of consent fees related to repayment of
long-term debt ...................................... (3,293) -- -- -- (3,293)
Proceeds from exercise of stock options ............... 95 -- -- -- 95
Change in payable to bank ............................. (1,529) -- -- -- (1,529)
Changes in intercompany accounts ...................... 92,351 (93,077) 726 -- --
Dividends paid ........................................ 3,000 (3,000) -- -- --
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing
activities ................................... 6,171 (96,077) 726 -- (89,180)
--------- --------- --------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS ............................. (32) -- 1 -- (31)
--------- --------- --------- --------- ---------
CASH AND CASH EQUIVALENTS:
Increase (decrease) for the period .................... 9,870 (86,674) 2,235 -- (74,569)
At beginning of period ................................ 5,515 95,747 1,272 -- 102,534
--------- --------- --------- --------- ---------
At end of period ...................................... $ 15,385 $ 9,073 $ 3,507 $ -- $ 27,965
========= ========= ========= ========= =========
21
18. The following table presents the computation of earnings per share of the
Company for the three and nine months ended August 31, 2002 and 2001,
respectively:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED AUGUST 31, ENDED AUGUST 31,
-------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
NET INCOME:
Income before extraordinary gain (loss) and
change in accounting principle .................. $ 6,417 $ 2,748 $ 14,424 $ 6,743
Extraordinary gain (loss) ......................... -- (603) -- 6,948
Change in accounting principle .................... -- -- (8,877) --
-------- -------- -------- --------
Net income ................................. $ 6,417 $ 2,145 $ 5,547 $ 13,691
======== ======== ======== ========
NUMBER OF COMMON SHARES:
Weighted average outstanding ...................... 9,470 8,876 9,229 8,871
Issued upon assumed exercise of outstanding
stock options ................................... 417 142 350 40
Effect of issuance of restricted common stock ..... 48 13 44 6
-------- -------- -------- --------
Weighted average and potential dilutive
outstanding ............................... 9,935 9,031 9,623 8,917
======== ======== ======== ========
NET INCOME PER COMMON SHARE:
Basic:
Income before extraordinary gain (loss) and
change in accounting principle ............... $ .68 $ .31 $ 1.56 $ .76
Extraordinary gain (loss) ...................... -- (.07) -- .78
Change in accounting principle ................. -- -- (.96) --
-------- -------- -------- --------
Total basic ................................ $ .68 $ .24 $ .60 $ 1.54
======== ======== ======== ========
Diluted:
Income before extraordinary gain (loss) and
change in accounting principle ............... $ .65 $ .30 $ 1.50 $ .76
Extraordinary gain (loss) ...................... -- (.06) -- .78
Change in accounting principle ................. -- -- (.92) --
-------- -------- -------- --------
Total diluted .............................. $ .65 $ .24 $ .58 $ 1.54
======== ======== ======== ========
19. In April 2002 the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical
Corrections" ("SFAS 145"). SFAS 145, which will be adopted by the Company
effective December 1, 2002, will require the Company to classify gains and
losses on extinguishments of debt as income or loss from continuing
operations rather than as extraordinary items as previously required under
FASB Statement No. 4. The Company will also be required to reclassify any
gain or loss on extinguishment of debt previously classified as an
extraordinary item in prior periods presented. The results of operations
and financial position of the Company, therefore, will not be affected.
Ban(R) is a registered trademark of Kao Corporation.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------ ----------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
General
- -------
We are a leading marketer and manufacturer of a broad portfolio of branded
over-the-counter healthcare products, toiletries and dietary supplements,
including such categories as topical analgesics, skin care products, appetite
suppressants and medicated dandruff shampoos. Our portfolio of products includes
well-recognized brands, such as ICY HOT, ASPERCREME and FLEXALL topical
analgesics; GOLD BOND medicated skin care powder, cream, lotion and spray
products; PHISODERM medicated acne treatment products and skin cleansers;
DEXATRIM appetite suppressants; and SELSUN BLUE medicated dandruff shampoos. Our
products target niche markets that are often outside the core product areas of
large companies where we believe we can achieve and sustain significant market
penetration through strong advertising and promotion support. Many of our
products are among the U.S. market leaders in their respective categories. For
example, our portfolio of topical analgesic brands and our GOLD BOND medicated
body powders have the leading U.S. market share in these categories.
We have grown by actively acquiring new brands and expanding our existing
brands. Our strategy to achieve future growth is to acquire new brands, generate
profitable internal growth and expand our international business.
On March 28, 2002, we acquired the SELSUN BLUE line of medicated dandruff
shampoos from Abbott Laboratories for $75.0 million in cash, plus $1.4 million
for inventories and assumed liabilities of $1.2 million, which we financed with
a $45.0 million term loan under our senior credit facility and $31.4 million of
cash. We acquired the worldwide rights (except in India) to manufacture, sell
and market SELSUN BLUE plus related intellectual property and manufacturing
equipment. In 2001, SELSUN BLUE recorded $40.7 million in sales and product
contribution of $13.5 million.
Abbott Laboratories, or manufacturers under contract to Abbott Laboratories,
will initially manufacture SELSUN BLUE for us domestically until June 2003, or
such earlier date as we move production to our Chattanooga, Tennessee
facilities, which we expect to do by the second quarter of 2003. Abbott
Laboratories, or manufacturers under contract to Abbott Laboratories, will
manufacture SELSUN BLUE for us internationally until March 2004 or such earlier
date as we enter our own agreements with foreign contract manufacturers. We will
generally pay Abbott Laboratories 10% over standard manufacturing costs until we
assume manufacturing or enter into our own third party agreements, except as
discussed below. We will also rely on Abbott Laboratories to market, sell and
distribute SELSUN BLUE products for us in most foreign countries until we
satisfy various foreign regulatory requirements, new distributors are in place
and any applicable marketing permits are transferred. During the transition
period, Abbott Laboratories will initially pay us a royalty equal to 28% of
international net sales in these countries with the royalty reduced to 14% of
international sales in certain countries if foreign regulatory requirements are
satisfied prior to the assumption of sales and marketing responsibility in such
countries. Abbott Laboratories will pay all costs and expenses related to the
manufacture, marketing and sales of SELSUN BLUE in these foreign countries. As
we take over responsibility for the sales and marketing effort in a country, the
royalty arrangement with respect to such country will terminate and we will
record these international sales directly, as well as the costs and expenses
associated with these sales. We expect to complete the transition for most key
markets by the end of 2002 and for all other relevant foreign countries by March
2004. Total revenues for the three and nine months ended August 31, 2001
reflected our net sales, and total revenues for the three and nine months ended
August 31, 2002 reflected both our net sales and royalty income from
international sales of SELSUN BLUE.
In fiscal 2001 our international sales were $13.9 million, or 7.7% of net sales.
In 2001 SELSUN BLUE was sold in approximately 90 countries, with aggregate
international sales of $20.1 million, or approximately 50% of its total net
sales. Our plan is to expand SELSUN BLUE's international presence both in
existing and new markets. We also intend to leverage SELSUN BLUE's
international marketing and distribution network to launch other brands in
countries where they are not currently being sold.
23
Other key brand acquisitions include our acquisition of DEXATRIM, a line of
appetite suppressants, ASPERCREME, CAPZASIN, SPORTSCREME and ARTHRITIS HOT,
topical analgesics, in December 1998, and GOLD BOND, the leading medicated body
powder in the United States, in 1996.
Product line extensions are a key element of our effort to generate profitable
internal growth. In fiscal 1999 we introduced MUDD Self-Heating Skin Cleanser.
In fiscal 2000 we introduced PHISODERM 4-Way Daily Acne Cleanser and PHISODERM
Blemish Patch. During fiscal 2001 we introduced DEXATRIM Natural Ephedrine Free,
ICY HOT Patch, BULLFROG Fast Blast and BULLFROG Sensitive Skin as line
extensions. During the first quarter of fiscal 2002 we introduced DEXATRIM
Results, GOLD BOND Foot Spray, PHISODERM Acne Body Wash and PHISODERM Acne
Facial Masque, and we recently began shipping PHISODERM Clear Swab.
Line extensions, product introductions and acquisitions require a significant
amount of introductory advertising and promotional support. For a period of time
these products do not generate a commensurate amount of sales or earnings. As a
result, we may experience a short-term impact on our profitability.
We continually evaluate the profit potential of and markets for our brands and,
in instances where our objectives are not realized, will dispose of these
underperforming brands and redeploy the assets. For example, in September 2000
we sold the Ban product line of antiperspirants and deodorants for $160.0
million plus inventories and the assumption of certain liabilities, in response
to major shifts in the competitive environment in this product category and the
resulting prospect of declining sales. We used $52.2 million of the net proceeds
from the sale of Ban to repay all of the outstanding indebtedness under our
prior senior credit facility. In fiscal 2001 we sold Norwich aspirin for $1.1
million. In fiscal 1998 we sold the Cornsilk oil control makeup brand for $10.7
million, plus inventories and the assumption of certain liabilities. We recorded
a loss on product divestitures in fiscal 2000 of $4.2 million related to the
sale of Ban and $0.8 million in connection with the sale of Norwich aspirin.
In November 2000 we voluntarily withdrew our DEXATRIM products containing
phenylpropanolamine, or PPA, from the market. As a result of the withdrawal, we
recorded $8.4 million of charges, including a reserve of $5.6 million for
estimated product returns and a write-down of $2.8 million for inventories. In
fiscal 2000, sales of DEXATRIM containing PPA constituted approximately $18.0
million of the total DEXATRIM brand sales of $29.0 million. Despite the absence
of sales of DEXATRIM containing PPA in fiscal 2001, total DEXATRIM sales in
fiscal 2001 were $27.6 million, as a result of the growth of DEXATRIM Natural
sales from $10.9 million in fiscal 2000 to $27.5 million in fiscal 2001.
We currently offer two versions of DEXATRIM: DEXATRIM Natural and DEXATRIM
Results. Given the perceived safety concerns and the regulatory uncertainties
relating to ephedrine, we have developed alternative formulations for DEXATRIM
Natural and DEXATRIM Results to exclude ephedrine. We discontinued marketing of
DEXATRIM products containing ephedrine as of the end of September 2002, without
any material charges and/or reserves against sales.
On January 12, 2002 Kmart Corporation, a customer of ours representing
approximately 5% of our fiscal 2001 consolidated net sales, filed a petition
under Chapter 11 of the United States Bankruptcy Code. At the time of filing
Kmart Corporation owed us approximately $1.2 million. In the first quarter of
2002 we increased our allowance for doubtful accounts by $1.0 million for this
potential loss. This bankruptcy filing did not impact the results of operations
and financial position for fiscal 2001. In the second quarter of 2002 we sold
the outstanding amounts of accounts receivable related to Kmart Corporation to
Bank of America, N.A. for $0.4 million. We continue to sell to Kmart Corporation
at decreased volume levels and as of August 31, 2002 our receivables from Kmart
Corporation were approximately $1.1 million.
The Emerging Issues Task Force, or EITF, of the Financial Accounting Standards
Board, or FASB, finalized EITF Issue No. 00-14, "Accounting for Certain Sales
Incentives" and EITF Issue No. 00-25, "Vendor Income Statement Characterization
of Consideration Paid to a Reseller of the Vendor's Products" in November 2000
and July 2001, respectively. EITF Issue No. 00-14 requires us to classify the
reduction in or refund of the selling price of a product resulting from any cash
sales incentives as a reduction of revenue. We adopted EITF Issue No. 00-14
beginning in the first quarter of fiscal 2002. In prior periods, we recognized
all sales incentives as an advertising and promotion expense. This pronouncement
has the effect of reducing net sales
24
and advertising and promotion expense in comparison to prior years. Under the
provisions of EITF Issue No. 00-25, we are required to reclassify certain
marketing and selling expenses, previously classified under advertising and
promotion expenses and selling expenses, respectively, as reductions of net
sales. We adopted EITF Issue No. 00-25 beginning in the first quarter of fiscal
2002. Income statement information for the three and nine months ended August
31, 2001 has been restated to reflect the effect these pronouncements would have
had if adopted for those periods. The amounts of these advertising, promotion
and selling expenses for the three and nine months ended August 31, 2001 were
$2.8 million and $11.0 million, respectively.
RESULTS OF OPERATIONS
- ---------------------
The following table sets forth, for income before extraordinary gain (loss) and
change in accounting principle and for the periods indicated, certain items from
our consolidated statements of income expressed as a percentage of total
revenues (consisting of net sales plus, for periods in fiscal 2002, royalties
from international sales of SELSUN BLUE):
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED AUGUST 31, ENDED AUGUST 31,
---------------------- ----------------------
2002(1) 2001(1) 2002(1) 2001(1)
----- ----- ----- -----
TOTAL REVENUES ........................... 100.0% 100.0% 100.0% 100.0%
----- ----- ----- -----
COSTS AND EXPENSES:
Cost of sales .......................... 27.2 28.0 28.4 29.0
Advertising and promotion .............. 33.1 31.7 32.2 34.6
Selling, general and administrative .... 15.4 20.1 16.9 17.8
----- ----- ----- -----
Total costs and expenses ............. 75.7 79.8 77.5 81.4
----- ----- ----- -----
INCOME FROM OPERATIONS ................... 24.3 20.2 22.5 18.6
----- ----- ----- -----
OTHER INCOME (EXPENSE):
Interest expense ....................... (8.3) (11.0) (9.1) (12.2)
Investment and other income, net ....... .1 .6 .2 1.4
----- ----- ----- -----
Total other income (expense) ........ (8.2) (10.4) (8.9) (10.8)
----- ----- ----- -----
INCOME BEFORE INCOME TAXES ............... 16.1 9.8 13.6 7.8
PROVISION FOR INCOME TAXES ............... 6.1 3.7 5.2 3.0
----- ----- ----- -----
INCOME BEFORE EXTRAORDINARY
GAIN (LOSS) AND CHANGE IN
ACCOUNTING PRINCIPLE ................... 10.0% 6.1% 8.4% 4.8%
===== ===== ===== =====
(1) Amounts for the three and nine months ended August 31, 2002 reflect the
effect of the adoption of EITF Issue Nos. 00-14 and 00-25 and amounts for
the three and nine months ended August 31, 2001 have been restated to
reflect the effects these pronouncements would have had if adopted during
those periods.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
The selection and application of accounting principles and methods impact our
financial results. Our most critical accounting policies are described below.
IMPAIRMENT TESTING OF INTANGIBLE ASSETS
- ---------------------------------------
In June 2001, the FASB issued Statement of Financial Accounting Standards, or
SFAS, No. 142,"Goodwill and Other Intangible Assets". The provisions of SFAS No.
142, which were adopted by us on December 1, 2001, require us to discontinue the
amortization of the cost of intangible assets with indefinite lives and to
perform certain fair value based tests of the carrying value of indefinite lived
intangible assets. SFAS No.142
25
requires this testing to be performed at least annually. These impairment tests
are impacted by judgments as to future cash flows and brand performance. For a
further discussion of SFAS No.142, see Note 3 of Notes to Consolidated Financial
Statements.
PRODUCT RETURN RESERVES
- -----------------------
Revenue is recognized when our products are shipped to our customers. It is our
policy across all classes of customers that all sales are final. As is common in
the consumer products industry, customers occasionally return products for a
variety of reasons. Examples include product damaged in transit, discontinuance
of a particular size or form of product and shipping errors. We record an
estimate of products to be returned by customers as a reserve against sales. We
generally base this reserve on our historical return experience and sales
volume. Significant judgment is required when estimating the reserves for
product returns.
For a summary of our significant accounting policies, see Note 2 of Notes to
Consolidated Financial Statements filed as an exhibit to our Form 10-K report
for the year ended November 30, 2001.
26
COMPARISON OF THREE MONTHS ENDED AUGUST 31, 2002 AND 2001
- ---------------------------------------------------------
Our total revenues, comprised of net sales and royalty income from the
international sales of SELSUN BLUE, in the third quarter of fiscal 2002
increased $19.2 million, or 42.5%, to $64.4 million from $45.2 million in the
third quarter of fiscal 2001. Domestic sales increased $15.8 million, or 37.9%,
to $57.4 million from $41.6 million. International sales, including royalties
received from the SELSUN BLUE international sales, increased $3.4 million, or
95.1%, to $7.0 million, from $3.6 million in the third quarter of fiscal 2001.
For purposes of this comparison, the prior year amounts have been restated to
reflect the impact of EITF Issue Nos. 00-14 and 00-25.
For our domestic products, third quarter fiscal 2002 sales increases were
recognized for the topical analgesic product group, which includes ICY HOT,
ASPERCREME, FLEXALL, SPORTSCREME, CAPZASIN and ARTHRITIS HOT. The PHISODERM,
DEXATRIM, GOLD BOND, BULLFROG, SUN-IN, ULTRASWIM AND HERPECIN-L brands also
recognized sales increases. SUNSOURCE recognized a sales increase led by
GARLIQUE. Sales declines were recorded for the PAMPRIN and PREMSYN PMS brands.
Sales of our other products remained largely unchanged relative to the year-ago
period.
The increased sales for our topical analgesic product group were led by sales
increases of 34.7% for ICY HOT, 32.0% for ARTHRITIS HOT and 9.3% for ASPERCREME.
ICY HOT sales benefited from the introduction of the ICY HOT Patch, which began
shipping in the second quarter of fiscal 2001. The increase in sales of DEXATRIM
and PHISODERM was primarily the result of the introduction of line extensions in
the first quarter of fiscal 2002, specifically DEXATRIM Results, PHISODERM Acne
Body Wash, PHISODERM Acne Facial Masque and the PHISODERM Clear Swab, which
began shipping during June 2002. DEXATRIM, PHISODERM and GOLD BOND sales
benefited from additional advertising and promotion support. The decline in
PAMPRIN and PREMSYN PMS sales was primarily due to reduced advertising and
promotion expenditures and intense competition in the menstrual products
category. Sales variances were largely the result of changes in volume of unit
sales of the particular brands.
For our international products in the three months ended August 31, 2002, we
realized sales increases of $1.5 million, or 73.3%, $0.6 million, or 42.7%, and
$0.4 million, or 289.8%, for the United Kingdom, Canada and United States export
operations, respectively. The increase in sales of the United Kingdom operation
was largely associated with increased sales of the ICY HOT, ARTHRITIS HOT and
ASPERCREME product lines. The increase in Canadian sales was primarily due to
increased unit sales of PHISODERM, SUN-IN and SELSUN BLUE. The increase in sales
of the United States export business was primarily related to the SELSUN BLUE
product line.
Cost of sales as a percentage of total revenues decreased to 27.2% from 28.0% in
the fiscal 2001 period. This decrease was primarily the result of a favorable
change in product mix to higher gross margin product lines in the current
period.
Our advertising and promotion expenses increased $7.0 million, or 48.6%, for the
three months ended August 31, 2002 and were 33.1% of total revenue compared to
31.7% in the corresponding fiscal 2001 period. The increase as a percentage of
sales was primarily due to the difference in the dollar amount of promotion
costs reclassified out of advertising and promotion expense between 2002 and
2001, partially offset by the discontinuation of the amortization of intangible
assets with indefinite lives and the inclusion of royalty income in the 2002
period. The increases in advertising and promotions expenditures related
primarily to DEXATRIM, PHISODERM and GOLD BOND offset by declines in advertising
and promotion expenses for PAMPRIN, the topical analgesics and certain SUNSOURCE
products.
Domestic net sales of SELSUN BLUE are included in consolidated net sales since
our acquisition of SELSUN BLUE on March 28, 2002. International results for
SELSUN BLUE since March 28, 2002 have been reflected as royalty income.
The increase of $0.8 million, or 9.0%, in selling, general and administrative
expenses for the three months ended August 31, 2002 was largely associated with
increased field sales expenses as a result of increased sales, increased product
liability insurance expense and the write-off of costs related to the Company's
indefinitely postponed public equity offering. Our selling, general and
administrative expenses were 15.4% of total
27
revenues in the current period as compared to 20.1% in the same period last
year. We anticipate that we will experience additional increases in insurance
costs, despite reduced amounts and scope of coverage, as a result of product
liability claims relating to DEXATRIM with PPA and the concern that other claims
relating to DEXATRIM could be filed.
On June 17, 2002 the Company announced that it was commencing a public offering
of 1,800,000 shares of its common stock through an underwriting group led by
Banc of America Securities LLC. On June 28, 2002 the Company announced the
postponment of the public offering, due to adverse market conditions. On
September 12, 2002 the Company announced that it was considering the
recommencement of the public offering. On September 24, 2002, however, the
Company announced that it had postponed indefinitely any plans for the
recommencement of the public offering, again due to unfavorable market
conditions. Selling, general and administrative expenses for the third quarter
of 2002 included $0.5 million of expenses related to the indefinitely postponed
public offering.
Interest expense increased $0.4 million, or 8.4%, reflecting additional interest
expense incurred related to borrowings under the new credit facility associated
with the acquisition of SELSUN BLUE. Until our indebtedness is reduced
substantially, interest expense will continue to represent a significant
percentage of our net sales.
Investment and other income for the three months ended August 31, 2002 decreased
$0.2 million, or 72.7%, due to the use of $31.4 million of cash to purchase
SELSUN BLUE on March 28, 2002.
Income before extraordinary gain and change in accounting principle increased
$3.7 million in the third quarter of fiscal 2002 as compared to the same period
last year. This increase was largely the result of an increase in total
revenues.
EBITDA (earnings before interest, taxes, depreciation and amortization) is a key
standard used by us to measure operating performance, but may not be comparable
to similarly titled measures reported by other companies. EBITDA is used to
supplement operating income as an indicator of operating performance and not as
an alternative to measures defined and required by generally accepted accounting
principles. EBITDA increased 47.1% to $16.7 million in the third quarter of
fiscal 2002 as compared to $11.3 million in the third quarter of fiscal 2001.
EBITDA margin increased from 22.9% of total revenues in the third quarter of
fiscal 2001 to 24.8% of total revenues in the third quarter of fiscal 2002.
COMPARISON OF THE NINE MONTHS ENDED AUGUST 31, 2002 AND 2001
- ------------------------------------------------------------
Our total revenues, comprised of net sales and royalty income from the
international sales of SELSUN BLUE, in the nine months ended August 31, 2002
increased $31.5 million, or 22.5%, to $171.5 million from $140.0 million in the
first nine months of 2001. Domestic sales increased $26.5 million, or 20.4%, to
$156.3 million from $129.8 million. International sales, including royalties
received from the SELSUN BLUE international sales, increased $5.0 million, or
49.8%, from $10.2 million in the first nine months of fiscal 2001 to $15.2
million in the first nine months of fiscal 2002. For purposes of this
comparison, the prior year amounts have been restated to reflect the impact of
EITF Issue Nos. 00-14 and 00-25.
For our domestic products, for the nine months ended August 31, 2002, sales
increases were recognized for the topical analgesic product group, which
includes ICY HOT, ASPERCREME, FLEXALL, SPORTSCREME, CAPZASIN and ARTHRITIS HOT.
The GOLD BOND, DEXATRIM, GARLIQUE and PHISODERM brands also recognized sales
increases. Sales declines were recorded for our PAMPRIN, PREMSYN PMS, FLEXALL
and MUDD brands. Sales of our other products remained largely unchanged.
The increased sales for our topical analgesic product group were led by sales
increases of 57.9% for ICY HOT, 17.3% for ARTHRITIS HOT, 9.1% for ASPERCREME and
8.3% for CAPZASIN. ICY HOT sales benefited from the introduction of the ICY HOT
Patch, which shipped beginning in the second quarter of fiscal 2001. The
increase in sales of DEXATRIM and PHISODERM was primarily the result of the
introduction of line extensions in the first and second quarter of fiscal 2002,
specifically DEXATRIM Results, PHISODERM Acne Body Wash and PHISODERM Acne
Facial Masque. The PHISODERM Clear Swab was introduced in June of 2002.
PHISODERM, DEXATRIM, GOLD BOND, and GARLIQUE sales benefited from additional
advertising and promotion support. The decline in
28
PAMPRIN and PREMSYN PMS sales was primarily due to reduced advertising and
promotion expenditures and intense competition in the menstrual products
category. Sales variances were largely the result of changes in volume of unit
sales of the particular brands.
For our international products in the nine months ended August 31, 2002, we
realized sales increases of $2.1 million, or 44.5%, $0.4 million, or 8.5%, and
$0.7 million, or 97.3%, for the United Kingdom, Canada and United States export
operations, respectively. The increase in sales of the United Kingdom operation
was largely associated with increased sales of the ICY HOT, ARTHRITIS HOT and
ASPERCREME product lines. The increase in Canadian sales was primarily due to
increased sales of the GOLD BOND, PHISODERM and SELSUN BLUE product lines. The
increase in sales of the United States export business was primarily related to
the ICY HOT and SELSUN BLUE product lines.
Cost of sales as a percentage of total revenues decreased to 28.4% from 29.0% in
the fiscal 2002 period due to a favorable change in the mix of products sold.
Our advertising and promotion expenses increased $6.8 million, or 14.1%, for the
nine months ended August 31, 2002 and were 32.2% of total revenues compared to
34.6% in the corresponding fiscal 2001 period. The decrease as a percentage of
sales was primarily due to the discontinuation of amortization of intangible
assets with indefinite lives partially offset by an increase in advertising and
promotional spending and the inclusion of royalty income in the 2002 period.
Increases in these expenditures related primarily to DEXATRIM, GOLD BOND,
HERPECIN-L and GARLIQUE offset by declines in advertising and promotion expenses
for the PAMPRIN, PREMSYN PMS, topical analgesics, ULTRASWIM, BULLFROG and
certain SUNSOURCE products.
Domestic net sales of SELSUN BLUE are included in consolidated net sales since
our acquisition of SELSUN BLUE on March 28, 2002. International results for
SELSUN BLUE since March 28, 2002 have been recorded as royalty income.
The increase of $4.0 million, or 16.0%, in selling, general and administrative
expenses in the first nine months of fiscal 2002 was largely associated with
increased freight costs and field sales expenses as a result of increased sales,
increased product liability insurance expense, the addition of $1.0 million to
the bad debts provision related to the Kmart bankruptcy and the write-off of
costs related to the Company's postponed public offering of equity. Our selling,
general and administrative expenses were 16.9% of total revenues in the current
period as compared to 17.8% in the same period last year. We may continue to
experience additional increases in insurance costs, despite reduced amounts and
scope of coverage, as a result of product liability claims relating to DEXATRIM
with PPA and the concern that other claims relating to DEXATRIM could be filed.
On June 17, 2002 the Company announced that it was commencing a public offering
of 1,800,000 shares of its common stock through an underwriting group led by
Banc of America Securities LLC. On June 28, 2002 the Company announced the
postponment of the public offering, due to adverse market conditions. On
September 12, 2002 the Company announced that it was considering the
recommencement of the public offering. On September 24, 2002, however, the
Company announced that it had postponed indefinitely any plans for the
recommencement of the public offering, again due to unfavorable market
conditions. Selling, general and administrative expenses for the third quarter
of 2002 included $0.5 million of expenses related to the indefinitely postponed
public offering.
Interest expense decreased $1.5 million, or 8.8%, reflecting primarily the
retirement in fiscal 2001 of $99.6 million principal amount of our notes, offset
in part by additional interest expense related to borrowings under the new
senior credit facility associated with the acquisition of SELSUN BLUE.
Investment and other income for the nine months ended August 31, 2002 decreased
$1.7 million, or 87.3%, largely as a result of a reduction in interest income
due to the use of a major portion of the funds received from the sale of Ban in
September 2000 to retire $99.6 million principal amount of our senior
subordinated notes in fiscal 2001 and the use of $31.4 million of cash to
purchase SELSUN BLUE on March 28, 2002.
29
Income before extraordinary gain and change in accounting principle increased
$7.7 million in the first nine months of fiscal 2002 as compared to the same
period last year. This increase was largely the result of an increase in total
revenues.
A cumulative effect of change in accounting principle of $8.9 million, net of
income tax benefit, was recorded in the nine months ended August 31, 2002. This
charge, resulting from the write-off of a portion of the carrying value of
indefinite lived intangible assets as required by SFAS No.142, primarily related
to our SUNSOURCE product line which has experienced a decline in sales volume as
compared to sales levels at the time of its initial purchase in 1997.
An extraordinary net gain from the early extinguishment of debt of $6.9 million,
net of income taxes, was realized in the first nine months of fiscal 2001. This
net gain resulted from the retirement of a portion of our senior subordinated
notes in January and June 2001, respectively.
EBITDA for the nine months ended August 31, 2002 increased 27.4% to $41.6
million from $32.7 million for the nine months ended August 31, 2001. EBITDA
margin increased to 22.8% from 21.3% of total revenues for the nine months ended
August 31, 2002 as compared to the nine months ended August 31, 2001.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
We have historically financed our operations and acquisitions with a combination
of internally generated funds and borrowings. Our principal uses of cash are
working capital, servicing and repayments of long-term debt, acquisitions,
repurchases of our common stock and capital expenditures.
Net cash provided by operations was $36.0 million and $14.9 million for the nine
months ended August 31, 2002 and 2001, respectively. The increase was primarily
the result of increases in income before extraordinary gain on the early
extinguishment of debt and change in accounting principle, deferred income taxes
and accrued liabilities partially offset by increases in all current assets,
except cash and cash equivalents and refundable income taxes.
Net cash used in investing activities was $77.4 million and $0.2 million for the
nine months ended August 31, 2002 and 2001, respectively. The increase in the
use of cash for the nine months ended August 31, 2002 was primarily due to the
acquisition of SELSUN BLUE in the second quarter of fiscal 2002.
Cash provided by financing activities was $40.4 million for the nine months
ended August 31, 2002 as compared to net cash used in financing activities of
$89.2 million in the nine months ended August 31, 2001. The funds provided in
the fiscal 2002 period were primarily from borrowings for the acquisition of
SELSUN BLUE and proceeds from the exercise of stock options, while the funds
used in the fiscal 2001 period were principally for retirement of $29.1 million
of the 12.75% notes and $70.5 million of the 8.875% notes.
The following table presents certain working capital data, in thousands of
dollars, and ratios at August 31, 2002 and at November 30, 2001 or for the years
then ended:
August 31, November 30,
Item 2002 2001
------------ ---------- ----------
Working capital (current assets less current liabilities) ........... $ 37,556 $ 53,579
Current ratio (current assets divided by current liabilities) ....... 1.72 3.20
Quick ratio (cash and cash equivalents and accounts
receivable divided by current liabilities) ........................ 1.22 2.32
Average accounts receivable turnover ................................ 8.40 6.44
Average inventory turnover .......................................... 4.41 3.58
Working capital as a percentage of total assets ..................... 10.08% 17.88%
30
Decreases in the current ratio, quick ratio and working capital at August 31,
2002 as compared to November 30, 2001 were primarily the result of an increase
in the current portion of long-term debt from the acquisition of SELSUN BLUE on
March 28, 2002 and an increase in accounts payable and accrued liabilities
partially offset by an increase in all current assets, except cash and cash
equivalents and refundable income taxes.
Days' sales outstanding in accounts receivable were 39 at the end of the third
quarter of fiscal 2002, as compared to 44 at the end of the third quarter of
fiscal 2001. This decrease is due to improved accounts receivable collections.
Days' sales outstanding were down slightly from the fiscal 2001 year-end level
of 42, reflecting better than anticipated collections of seasonal receivables,
which have longer payment terms.
On January 17, 2001 we completed the consent solicitation and tender offer
pursuant to which we retired $70.5 million principal amount of our 8.875% notes
and $7.4 million principal amount of our 12.75% notes. The consideration paid
for the consent solicitation and tender offer was $64.9 million, which was
provided by the proceeds of our divestiture of the Ban product line in fiscal
2000. An extraordinary gain on the early extinguishment of debt of $7.6 million,
net of income taxes, was recognized in the first six months of fiscal 2001. On
June 15, 2001 we retired all of the remaining outstanding principal balance of
$21.7 million of our 12.75% notes and accrued interest thereon. In connection
with the retirement of our 12.75% notes, we recognized a loss on the early
extinguishment of debt of $0.6 million, net of income tax benefit, in the third
quarter of fiscal 2001. This loss primarily consisted of the premium paid on the
retirement of the notes and the write-off of related unamortized deferred
issuance and initial discount costs.
Our total long-term debt outstanding at November 30, 2001 was $204.7 million. On
March 28, 2002, we obtained a $60.0 million senior secured credit facility from
a syndicate of commercial banks led by Bank of America, N.A. The credit facility
includes a $15.0 million revolving credit line and $45.0 million of term loans.
Borrowings of $45.0 million under the term loans of our credit facility together
with cash of $31.4 million were used to finance the acquisition of SELSUN BLUE.
We prepaid $6.5 million of principal on the term loans during the second quarter
of 2002 and made a regularly scheduled principal payment of $1.5 million during
the third quarter of 2002. For a description of our senior credit facility, see
note 15 of our unaudited consolidated financial statements. The weighted average
interest rate under our senior credit facility term loans on August 31, 2002 was
4.81%. As of August 31, 2002, there was $37.0 million outstanding under our
senior credit facility. As of August 31, 2002, $15.0 million was available for
borrowing under the revolving credit portion of our senior credit facility.
In fiscal 1999, our board of directors authorized repurchases of our common
stock of up to $10.0 million in the aggregate. In April 2000, our board of
directors authorized repurchases of up to an additional $10.0 million of our
common stock. Under these authorizations, 172,500 shares at a cost of $3.9
million were repurchased in fiscal 1999, 876,500 shares at a cost of $9.5
million were repurchased in fiscal 2000 and 14,000 shares at a cost of $0.2
million were repurchased in fiscal 2001. In the nine months ended August 31,
2002 we repurchased, and returned to unissued, 79,200 shares for $1.7 million.
As of August 31, 2002, the remaining amount authorized by our board of directors
under our stock buyback plan was $4.8 million; however, we are limited in our
ability to repurchase shares due to restrictions under the terms of the
indenture for our 8.875% notes and our senior credit facility.
We believe that cash provided by operating activities, our cash and cash
equivalents balance and funds available under the revolver of our senior credit
facility will be sufficient to fund our capital expenditures, debt service and
working capital requirements for the foreseeable future as our business is
currently conducted. Any acquisitions that we make in the future may require us
to obtain additional financing.
31
CONTRACTUAL OBLIGATIONS
- -----------------------
The following data summarizes our contractual obligations, in thousands of
dollars, as of August 31, 2002. We had no commercial obligations at that date.
Payments due by period
------------------------------------------------------------------------
Within 1 Years Years After
Total year 2-3 4-5 5 years
-------- -------- -------- -------- --------
Contractual Obligations:
Long-term debt (1) ...................... $241,538 $ 7,000 $ 17,500 $ 12,500 $204,538
Operating leases ........................ 2,338 291 403 368 1,276
-------- -------- -------- -------- --------
Total contractual cash obligations .... $243,876 $ 7,291 $ 17,903 $ 12,868 $205,814
======== ======== ======== ======== ========
(1) Long-term debt consists of borrowings under our senior credit facility and our 8.875% notes.
FOREIGN OPERATIONS
- ------------------
Historically, our primary foreign operations have been conducted through our
Canadian and United Kingdom subsidiaries. The functional currencies of these
subsidiaries are Canadian dollars and British pounds, respectively. Fluctuations
in foreign exchange rates can impact operating results, including total revenues
and expenses, when translations of the subsidiary financial statements are made
in accordance with SFAS No.52, "Foreign Currency Translation". For the years
ended November 30, 2001 and 2000 these subsidiaries accounted for 7.1% and 6.6%
of total revenues, respectively, and 3.5% and 2.0% of total assets,
respectively. For the nine months ended August 31, 2002 and 2001 these
subsidiaries accounted for 7.0% and 6.8% of total revenues, respectively, and
3.3% and 3.2% of total assets, respectively. It has not been our practice to
hedge our assets and liabilities in Canada and the United Kingdom or our
intercompany transactions due to the inherent risks associated with foreign
currency hedging transactions and the timing of payment between us and our two
foreign subsidiaries. Following our acquisition of SELSUN BLUE, which is sold in
approximately 90 foreign countries, and had $20.1 million of international sales
in 2001, our international operations will expand significantly, which will
increase our exposure to fluctuations in foreign exchange rates. Historically,
gains or losses from foreign currency transactions have not had a material
impact on our operating results, although with our acquisition of SELSUN BLUE we
expect this impact to increase. Losses, in thousands of dollars, of $7 and $20
for the years ended November 30, 2001 and 2000, respectively, and a gain of $58
and a loss of $2 for the nine months ended August 31, 2002 and 2001,
respectively, resulted from foreign currency transactions. See "Foreign Currency
Translation " of Note 2 of Notes to Consolidated Financial Statements filed as
an exhibit to our Form 10-K report for the year ended November 30, 2001.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
- -----------------------------------------
In September 2000, the EITF of the FASB reached a final consensus on EITF Issue
No. 00-10,"Accounting for Shipping and Handling Fees and Costs ". EITF Issue No.
00-10 was effective beginning in the fourth quarter of fiscal 2001 and addressed
the income statement classification of amounts charged to customers for shipping
and handling, as well as costs incurred related to shipping and handling. The
EITF concluded that amounts billed to a customer in a sales transaction related
to shipping and handling should be classified as revenue. The EITF also
concluded that if costs incurred related to shipping and handling are
significant and not included in cost of sales, an entity should disclose both
the amount of such costs and the line item on the income statement that includes
them. Costs incurred related to shipping and handling included in revenues were
required to be reclassified to cost of sales. We currently classify shipping and
handling costs as a selling expense. The amount of shipping and handling costs
included in selling expense was $1.4 million and $1.3 million for the three
months ended August 31, 2002 and 2001, respectively, and $4.5 million and $4.1
million for the first nine months of fiscal 2002 and 2001, respectively. The
adoption of this pronouncement in fiscal 2001 did not have an impact on our
results of operations or financial position.
32
In November 2000, the EITF finalized EITF Issue No. 00-14,"Accounting for
Certain Sales Incentives". EITF Issue No. 00-14 addresses the recognition,
measurement and income statement classification for sales incentives offered to
customers. Sales incentives include discounts, coupons, rebates,
"buy-one-get-one-free" promotions and generally any other offers that entitle a
customer to receive a reduction in the price of a product or service by
submitting a claim for a refund or rebate. Under EITF Issue No. 00-14 the
reduction in or refund of the selling price of the product or service resulting
from any cash sales incentives should be classified as a reduction of revenue.
In prior periods, we recognized all sales incentives as an advertising and
promotion expense. Although this pronouncement has not had any impact on our
operating income or financial position, the presentation prescribed has the
effect of reducing net sales and advertising and promotion expense in comparison
to prior years. We adopted EITF Issue No. 00-14 beginning in the first quarter
of fiscal 2002. See Note 2 of our audited and unaudited financial statements for
the impact of the adoption of this pronouncement.
In June 2001, the FASB issued SFAS No.142, "Goodwill and Other Intangible
Assets". The provisions of SFAS No. 142, which were adopted by us on December 1,
2001, require us to discontinue the amortization of the cost of intangible
assets with indefinite lives resulting from acquired brands for accounting
purposes and to perform certain fair value based tests of the carrying value of
indefinite lived intangible assets. Accordingly, we discontinued the
amortization of the cost of these intangible assets. The discontinuation of this
amortization favorably affected net income in the third quarter of fiscal 2002
by $.9 million, net of income tax benefit, or $.09 per diluted share, and
favorably impacted the nine months ended August 31, 2002 by $2.6 million, or
$.27 per diluted share. Also in connection with the adoption of SFAS No.142, we
obtained independent appraisals to determine the fair value of the intangible
assets at December 1, 2001 and compared their fair values with the carrying
values to determine the write-down of $8.9 million, net of income tax benefit of
$5.4 million, or $.92 per diluted share. The write-down was primarily related to
our SUNSOURCE product line which has experienced a decline in sales volume from
the sales level at its initial purchase in 1997. This adjustment is shown as a
cumulative effect of change in accounting principle in the consolidated
statement of income for the nine months ended August 31, 2002.
In July 2001, the EITF finalized EITF Issue No. 00-25, "Vendor Income Statement
Characterization of Consideration Paid to a Reseller of the Vendor's Products".
Under the provisions of EITF Issue No. 00-25 we are required to reclassify
certain marketing and selling expenses as reductions of net sales. Our operating
income and financial position, therefore, will not be affected. We adopted EITF
Issue No. 00-25 beginning in the first quarter of fiscal 2002. See Note 2 of our
notes to our audited and unaudited financial statements for the impact of the
adoption of this pronouncement.
In April 2002 the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 62, Amendment of FASB Statement No. 13, and Technical Corrections",
or SFAS 145. SFAS 145, which will be adopted by the Company effective December
1, 2002, will require the Company to classify gains and losses on
extinguishments of debt as income or loss from continuing operations rather than
as extraordinary items as previously required under FASB Statement No. 4. The
Company will also be required to reclassify any gain or loss on extinguishment
of debt previously classified as an extraordinary item in prior periods
presented. The results of operations, financial position and cash flows of the
Company, therefore, will not be affected.
FORWARD LOOKING STATEMENTS
- --------------------------
The Company may from time to time make written and oral forward-looking
statements. Written forward-looking statements may appear in documents filed
with the Securities and Exchange Commission, in press releases and in reports to
shareholders. The Private Securities Litigation Reform Act of 1995 contains a
safe harbor for forward-looking statements. The Company relies on this safe
harbor in making such disclosures. The forward-looking statements are based on
management's current beliefs and assumptions about expectations, estimates,
strategies and projections for the Company. These statements are not guarantees
of future performance and involve risks, uncertainties and assumptions that are
difficult to predict. Therefore, actual outcomes and results may differ
materially from what is expressed or forecasted in such forward-looking
statements. The Company undertakes no obligation to update publicly any
forward-looking statements whether as a result of new information,
33
future events or otherwise. The risks, uncertainties and assumptions of the
forward-looking statements include, but are not limited to, existing and
possible future product liability claims relating to the prior existence of PPA
in DEXATRIM; the possible effect of the negative public perception resulting
from product liability claims on sales of DEXATRIM products without PPA; the
lack of availability, limits of coverage and expense related to product
liability insurance; the possibility of other product liability claims,
including claims relating to the existence of ephedrine in DEXATRIM products;
the impact of brand acquisitions and divestitures; the impact of gains or losses
resulting from product acquisitions or divestitures; extraordinary gains or
losses resulting from financings or debt repayments; product demand and market
acceptance risks; product development risks, such as delays or difficulties in
developing, producing and marketing new products or line extensions; the impact
of competitive products, pricing and advertising; the Company's ability to
integrate SELSUN BLUE into its own operations; the Company's ability to sell and
market SELSUN BLUE internationally where its has only limited experience and
infrastructure; constraints resulting from the financial condition of the
Company, including the degree to which the Company is leveraged; debt service
requirements and restrictions under indentures and loan agreements; government
regulations; risks of loss of material customers; public perception regarding
the Company's products; dependence on third party manufacturers; environmental
matters; and other risks described in the Company's Securities and Exchange
Commission filings.
ITEM 4. CONTROLS AND PROCEDURES
- -------------------------------
(a) Evaluation of Disclosure Controls and Procedures. The Company's Chief
Executive Officer and Chief Financial Officer have evaluated the
effectiveness of the Company's disclosure controls and procedures (as such
term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act")) as of a date within
90 days prior to the filing date of this quarterly report (the "Evaluation
Date"). Based on such evaluation, such officers have concluded that, as of
the Evaluation Date, the Company's disclosure controls and procedures are
effective in alerting them on a timely basis to material information
relating to the Company (including its consolidated subsidiaries) required
to be included in the Company's periodic filing under the Exchange Act.
(b) Changes in Internal Controls. Since the Evaluation Date, there have not
been any significant changes in the Company's internal controls or in
other factors that could significantly affect such controls.
34
PART II. OTHER INFORMATION
--------------------------
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
- --------------------------------------------------
During the third quarter of fiscal 2002, the Company granted a total
of 28,000 options to acquire shares of the Company's common stock to three
newly-hired officers or employees of the Company. Because of the limited number
of shares available under the Company's option plans for which registration
statements have been filed pursuant to Form S-8, the shares to be acquired
pursuant to the options have not been registered under the Securities Act in
reliance upon exemptions from such registration requirements. The terms of each
of the option grants are identical to option grants under the Company's option
plans that are the subject of registration statements filed under the Securities
Act. The Company intends to register the shares subject to the options in a
subsequently filed registration statement under the Securities Act of 1933.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
See Note 11 of Notes to Consolidated Financial Statements included
to Part 1, Item 1 of this Report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ----------------------------------------
(a) Exhibits:
NONE
(b) The following Form 8-K reports and amendments to a previously filed
Form 8-K report were filed with the Securities and Exchange
Commission during the three months ended August 31, 2002:
Form 8-K, filed June 18, 2002, relating to the re-audit by Ernst &
Young LLP, independent public accountants, of the Company's
financial statements for fiscal 2001.
The following amendments to Form 8-K, filed April 10, 2002, relating
to the acquisition of SELSUN BLUE and the related financing
arrangements:
Form 8-K/A, Amendment No. 1, filed June 10, 2002.
Form 8-K/A, Amendment No. 2, filed June 17, 2002.
Form 8-K/A, Amendment No. 3, filed July 3, 2002.
Form 8-K, filed September 17, 2002, related to the sale of shares of
the Company's common stock by three affiliates of the Company.
35
CHATTEM, INC.
-------------
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CHATTEM, INC.
(Registrant)
Dated: October 15, 2002 \s\ A. Alexander Taylor II
---------------- --------------------------
A. Alexander Taylor II
President and Director
(Chief Operating Officer)
Dated: October 15, 2002 \s\ Richard D. Moss
---------------- ---------------------------------
Richard D. Moss
Vice President and Chief Financial Officer
(Principal Financial Officer)
36
CERTIFICATIONS
I, Zan Guerry, Chairman and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Chattem, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusion about the
effectiveness of this disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: October 15, 2002
----------------
/s/ Zan Guerry
------------------------------------
Zan Guerry, Chairman and
Chief Executive Officer
CERTIFICATIONS
I, Richard D. Moss, Vice President and Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Chattem, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusion about the
effectiveness of this disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: October 15, 2002
----------------
/s/ Richard D. Moss
------------------------------------
Richard D. Moss, Vice President and
Chief Financial Officer