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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MAY 31, 2003
COMMISSION FILE NUMBER 0-5905
CHATTEM, INC.
- --------------------------------------------------------------------------------
A TENNESSEE CORPORATION
I.R.S. EMPLOYER IDENTIFICATION NO. 62-0156300
1715 WEST 38TH STREET
CHATTANOOGA, TENNESSEE 37409
TELEPHONE: 423-821-4571
REGISTRANT HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS, AND HAS BEEN
SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.
THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12b-2 OF THE EXCHANGE
ACT).
AS OF JULY 11, 2003 19,230,414 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
May 31, 2003 and November 30, 2002 ...................... 3
Consolidated Statements of Income
for the Three and Six Months Ended
May 31, 2003 and 2002.................................... 5
Consolidated Statements of Cash
Flows for the Six Months Ended
May 31, 2003 and 2002.................................... 6
Notes to Consolidated Financial Statements .............. 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ..................... 23
Item 3. Quantitative and Qualitative Disclosures About
Market Risks............................................. 33
Item 4. Controls and Procedures.................................. 34
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................ 35
Item 4. Submission of Matters to a Vote of Security Holders...... 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)
MAY 31, NOVEMBER 30,
ASSETS 2003 2002
- ------ ------------ ------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents ................................. $ 13,961 $ 15,924
Accounts receivable, less allowance for doubtful accounts
of $1,241 at May 31, 2003 and $962 at November 30, 2002.. 32,197 25,673
Refundable and deferred income taxes ...................... 10,705 9,837
Inventories ............................................... 20,417 18,769
Prepaid expenses and other current assets ................. 1,257 2,184
------------ ------------
Total current assets ................................... 78,537 72,387
------------ ------------
PROPERTY, PLANT AND EQUIPMENT, NET .......................... 27,631 26,658
------------ ------------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net 245,925 245,787
Debt issuance costs, net .................................. 6,266 7,126
Other ..................................................... 3,247 3,605
------------ ------------
Total other noncurrent assets .......................... 255,438 256,518
------------ ------------
TOTAL ASSETS ......................................... $ 361,606 $ 355,563
============ ============
The accompanying notes are an integral part
of these consolidated financial statements.
3
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
---------------------------
(In thousands)
MAY 31, NOVEMBER 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 2003 2002
- ------------------------------------ ------------ ------------
(Unaudited)
CURRENT LIABILITIES:
Current maturities of long-term debt ...................... $ 8,000 $ 7,250
Accounts payable .......................................... 10,120 12,209
Payable to bank ........................................... -- 452
Accrued liabilities ....................................... 24,168 21,104
------------ ------------
Total current liabilities .............................. 42,288 41,015
------------ ------------
LONG-TERM DEBT, less current maturities ..................... 208,442 217,458
------------ ------------
DEFERRED INCOME TAXES ....................................... 25,190 20,744
------------ ------------
OTHER NONCURRENT LIABILITIES ................................ 1,647 1,602
------------ ------------
COMMITMENTS AND CONTINGENCIES (Note 10)
SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized 1,000,
none issued ............................................ -- --
Common shares, without par value, authorized 50,000,
issued 19,026 at May 31, 2003 and 19,177 at
November 30, 2002 ...................................... 76,917 79,313
Retained earnings (deficit) ............................... 11,013 (1,097)
------------ ------------
87,930 78,216
Unamortized value of restricted common shares issued....... (2,449) (1,713)
Cumulative other comprehensive income:
Foreign currency translation adjustment ................ (1,442) (1,759)
------------ ------------
Total shareholders' equity ............................. 84,039 74,744
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .......... $ 361,606 $ 355,563
============ ============
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 SIX MONTHS
ENDED MAY 31, ENDED MAY 31,
------------------------------ ------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
REVENUES:
Net sales ......................................... $ 63,269 $ 57,746 $ 121,394 $ 106,160
Royalties ......................................... 364 926 664 926
------------ ------------ ------------ ------------
Total revenues ................................. 63,633 58,672 122,058 107,086
------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Cost of sales ..................................... 17,713 16,686 35,404 31,147
Advertising and promotion ......................... 18,529 18,095 36,934 33,969
Selling, general and administrative ............... 10,397 9,539 20,211 19,076
------------ ------------ ------------ ------------
Total costs and expenses ....................... 46,639 44,320 92,549 84,192
------------ ------------ ------------ ------------
INCOME FROM OPERATIONS .............................. 16,994 14,352 29,509 22,894
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest expense .................................. (5,227) (5,303) (10,374) (10,144)
Investment and other income, net .................. 53 58 87 164
------------ ------------ ------------ ------------
Total other income (expense) ................... (5,174) (5,245) (10,287) (9,980)
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES AND CHANGE
IN ACCOUNTING PRINCIPLE ........................... 11,820 9,107 19,222 12,914
PROVISION FOR INCOME TAXES .......................... 4,299 3,472 7,112 4,907
------------ ------------ ------------ ------------
INCOME BEFORE CHANGE IN ACCOUNTING PRINCIPLE ........ 7,521 5,635 12,110 8,007
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE,
NET OF INCOME TAX BENEFIT ......................... -- -- -- (8,877)
------------ ------------ ------------ ------------
NET INCOME (LOSS) ................................... $ 7,521 $ 5,635 $ 12,110 $ (870)
============ ============ ============ ============
NUMBER OF COMMON SHARES:
Weighted average outstanding-basic ................ 19,052 18,498 19,177 18,216
============ ============ ============ ============
Weighted average and potential dilutive outstanding 19,751 19,329 19,966 18,919
============ ============ ============ ============
NET INCOME (LOSS) PER COMMON SHARE:
Basic:
Income before change in accounting principle ... $ .39 $ .30 $ .63 $ .44
Change in accounting principle ................. -- -- -- (.49)
------------ ------------ ------------ ------------
Total basic ................................. $ .39 $ .30 $ .63 $ (.05)
============ ============ ============ ============
Diluted:
Income before change in accounting principle ... $ .38 $ .29 $ .61 $ .42
Change in accounting principle ................. -- -- -- (.47)
------------ ------------ ------------ ------------
Total diluted ............................... $ .38 $ .29 $ .61 $ (.05)
============ ============ ============ ============
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 SIX MONTHS ENDED
MAY 31,
------------------------------
2003 2002
------------ ------------
OPERATING ACTIVITIES:
Net income (loss) ............................................. $ 12,110 $ (870)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation and amortization ............................. 3,021 2,601
Cumulative effect of change in accounting principle, net .. -- 8,877
Stock option charge ....................................... -- 175
Increase in deferred income taxes ......................... 3,774 2,003
Other, net ................................................ (116) 4
Changes in operating assets and liabilities:
Accounts receivable ..................................... (6,524) (9,905)
Refundable income taxes ................................. 40 1,031
Inventories ............................................. (1,648) (870)
Prepaid expenses and other current assets ............... 927 164
Accounts payable and accrued liabilities ................ 935 13,424
------------ ------------
Net cash provided by operating activities ............ 12,519 16,634
------------ ------------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment .................... (2,566) (2,048)
Purchase of trademarks and other product rights .............. (308) (74,847)
Change in other assets, net ................................... 598 34
------------ ------------
Net cash used in investing activities ................ (2,276) (76,861)
------------ ------------
FINANCING ACTIVITIES:
Repayment of long-term debt ................................... (8,250) (6,500)
Proceeds from long-term debt .................................. -- 45,000
Proceeds from exercise of stock options ....................... 275 5,918
Repurchase of common shares ................................... (3,900) (630)
Change in payable to bank ..................................... (452) (151)
Deferred debt issuance costs .................................. (25) (1,099)
------------ ------------
Net cash provided by (used in) financing activities .. (12,352) 42,538
------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS .... 146 23
------------ ------------
CASH AND CASH EQUIVALENTS:
Decrease for the period ....................................... (1,963) (17,666)
At beginning of period ........................................ 15,924 35,445
------------ ------------
At end of period .............................................. $ 13,961 $ 17,779
============ ============
SCHEDULE OF NON-CASH FINANCING ACTIVITIES:
Issuance of 69,000 shares of restricted common stock at a value
of $14.50 per share ........................................... $ 1,000 $ --
PAYMENTS FOR:
Interest ...................................................... $ 9,656 $ 9,117
Taxes ......................................................... $ 2,599 $ 532
The accompanying notes are an integral part
of these consolidated financial statements.
6
CHATTEM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
(UNAUDITED)
All monetary amounts are expressed in thousands of dollars unless contrarily
evident. Unless otherwise indicated the number of shares of our common stock and
related per share computations included in these financial statements and notes
thereto have been adjusted to reflect the two-for-one split of our common stock
on November 29, 2002.
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 our Annual
Report on Form 10-K for the year ended November 30, 2002. 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 recurring nature.
2. In June 2001 the Financial Accounting Standards Board ("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 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. Accordingly, we discontinued the amortization of
the cost of these intangible assets which consist solely of trademarks. The
carrying value of these trademarks was $244,690 as of May 31, 2003. Also in
connection with the adoption of SFAS 142, we 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 $.46 per diluted share. The write-down was primarily related to our
SUNSOURCE product line which has experienced a decline in sales volume
since its initial purchase in 1997 and to a lesser degree our DEXATRIM
product line, which discontinued the marketing of one of its products in
November 2000. This adjustment is shown as a cumulative effect of change in
accounting principle in the consolidated statement of income for the six
months ended May 31, 2002. After reviewing all pertinent information
relating to the revaluation of these intangible assets and performing the
annual impairment test as prescribed by SFAS 142 as of November 30, 2002,
we determined that a revaluation thereof was not required. The gross
carrying amount and accumulated amortization of our intangible assets
subject to amortization, which consist primarily of non-compete agreements,
were $2,400 and $1,172, respectively, at May 31, 2003. For the three and
six months ended May 31, 2003 and 2002, respectively, amortization of our
intangible assets subject to amortization was $44 and $97 and $85 and $170,
respectively.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" ("SFAS 145"). SFAS 145, which was adopted by us effective
December 1, 2002, requires us to classify gains and losses on
extinguishments of debt as income or loss from continuing operations rather
than as extraordinary items as previously required under FASB Statement No.
4. We are also required to reclassify any gain or loss on extinguishment of
debt previously classified as an extraordinary item in prior periods
presented. Our results of operations, financial position and cash flows,
therefore, will not be affected.
On December 31, 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" ("SFAS 148"). SFAS
148, which was adopted by us on December 1, 2002, amends SFAS 123,
"Accounting for Stock-Based Compensation" and Accounting Principles Board
Opinion No. 28, "Interim Financial Reporting", to require disclosure in the
summary of significant accounting policies of the effects of an entity's
accounting policy with respect to stock-based employee compensation on
reported net income and earnings per share in annual and interim financial
statements. The adoption of this pronouncement did not have an impact on
our results of operations, financial position or cash flows.
7
Our 1998 Non-Statutory Stock Option Plan provides for issuance of up to
1,400,000 shares of common stock to key employees, while the 1999
Non-Statutory Stock Option Plan for Non-Employee Directors allows issuance
of up to 200,000 shares of common stock. The 2000 Non-Statutory Stock
Option Plan provides for the issuance of up to 1,500,000 shares of common
stock. The 2003 Stock Incentive Plan, which was adopted by our board of
directors on January 21, 2003 and was approved by our shareholders at the
April 16, 2003 annual shareholders' meeting, provides for the issuance of
up to 1,500,000 shares of common stock. Options vest ratably over four
years and are exercisable for a period of up to ten years from the date of
grant.
For SFAS No. 123 purposes, as amended by SFAS 148, the fair value of each
option grant has been estimated as of the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 2003 and 2002: expected dividend yield of 0%,
expected volatility of 64% and 65%, risk-free interest rates of 3.95% and
5.34% and expected lives of six years. (See "Recent Accounting
Pronouncements" for a description of the provisions of SFAS 148.)
Had compensation expense for stock option grants been determined based on
the fair value at the grant dates consistent with the method prescribed by
SFAS No. 123, our net income (loss) and net income (loss) per share would
have been adjusted to the pro forma amounts for the three and six months
ended May 31, 2003 and 2002, respectively, as indicated below:
For the Three Months For the Six Months
Ended May 31, Ended May 31,
------------------------- -------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income (loss):
As reported ....................... $ 7,521 $ 5,635 $ 12,110 $ (870)
Compensation costs ................ 472 376 1,033 823
---------- ---------- ---------- ----------
Pro forma ......................... $ 7,049 $ 5,259 $ 11,077 $ (1,693)
========== ========== ========== ==========
Net income (loss) per share, basic:
As reported ....................... $ .39 $ .30 $ .63 $ (.05)
Pro forma ......................... $ .37 $ .28 $ .58 $ (.09)
Net income (loss) per share, diluted:
As reported ....................... $ .38 $ .29 $ .61 $ (.05)
Pro forma ......................... $ .36 $ .27 $ .55 $ (.09)
3. We incur significant expenditures on television, radio and print
advertising to support our nationally branded over-the-counter ("OTC")
health care products. Customers purchase products from us with the
understanding that the brands will be supported by our extensive media
advertising. This advertising supports the retailers' sales effort and
maintains the important brand franchise with the consuming public.
Accordingly, we consider our advertising program to be clearly implicit in
our sales arrangements with our customers. Therefore, we believe it is
appropriate to allocate a percentage of the necessary supporting
advertising expenses to each dollar of sales by charging a percentage of
sales on an interim basis based upon anticipated annual sales and
advertising expenditures (in accordance with Accounting Principles Board
Opinion No. 28) and adjusting that accrual to the actual expenses incurred
at the end of the year.
8
4. Shipping and handling costs of $1,588 and $1,639 are included in selling
expenses for the three months ended May 31, 2003 and 2002, respectively,
and $3,045 and $3,156 for the six months ended May 31, 2003 and 2002,
respectively.
5. Inventories consisted of the following at May 31, 2003 and November 30,
2002:
2003 2002
-------- --------
Raw materials and work in process ............. $ 9,248 $ 9,104
Finished goods ................................ 12,896 11,392
Excess of current cost over LIFO values........ (1,727) (1,727)
-------- --------
Total inventories ......................... $ 20,417 $ 18,769
======== ========
6. Accrued liabilities consisted of the following at May 31, 2003 and November
30, 2002:
2003 2002
-------- --------
Interest ...................................... $ 3,203 $ 3,366
Salaries, wages and commissions................ 2,438 3,739
Product advertising and promotion ............. 11,279 7,524
Product acquisitions .......................... 716 737
Taxes ......................................... 3,255 1,993
Consulting fees ............................... 667 747
Legal fees .................................... 823 789
Insurance ..................................... 1,164 934
Other ......................................... 623 1,275
-------- --------
Total accrued liabilities ................. $ 24,168 $ 21,104
======== ========
7. Comprehensive income (loss) consisted of the following components for the
three and six months ended May 31, 2003 and 2002, respectively:
For the Three Months For the Six Months
Ended May 31, Ended May 31,
-------------------- --------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net income (loss) ....... $ 7,521 $ 5,635 $ 12,110 $ (870)
Other - foreign currency
translation adjustment (47) 245 317 51
-------- -------- -------- --------
Total ................ $ 7,474 $ 5,880 $ 12,427 $ (819)
======== ======== ======== ========
8. In fiscal 1999 and 2000 our board of directors authorized repurchases of
our common stock not to exceed $20,000. Under these authorizations
1,142,200 shares, before the two-for-one split of our common stock on
November 29, 2002, had been reaquired through November 30, 2002 at a cost
of $15,225. In January 2003, our board of directors increased to $10,000
the total authorization to repurchase our common stock under the buyback
program. In the first six months of fiscal 2003, we repurchased 272,800
shares of our common stock for $3,900. All repurchased shares were retired
and returned to unisssued. At May 31, 2003, $6,100 of our current
authorization was available for future repurchases. We, however, are
limited in our ability to repurchase shares due to restrictions under the
terms of the indenture with respect to which our 8.875% Notes were issued
and under the terms of our current credit facility (see discussion in Note
14).
9. On January 22, 2002, Kmart Corporation ("Kmart"), a customer of ours
representing approximately 5% of fiscal 2001 consolidated revenues, filed a
petition under Chapter 11 of the United States Bankruptcy Code. This
bankruptcy filing did not impact our results of operations and financial
9
position for fiscal 2001 as substantially all accounts receivable due from
Kmart as of November 30, 2001 were subsequently collected. At the time of
the filing Kmart owed us approximately $1,200. In the first quarter of
fiscal 2002 we established an allowance for doubtful accounts of $1,000 to
cover our estimated bad debt related to Kmart. In the second quarter of
fiscal 2002 we sold our receivable from Kmart to a financial institution
for $367. We continue to sell to Kmart at decreased volume levels and as of
May 31, 2003 our receivables from Kmart were approximately $1,118.
10. We were named as a defendant in a lawsuit brought by the Center for
Environment Health ("CEH") contending that we 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. Violations of either Proposition 65 or the California
Business and Professions Code render a defendant liable for civil penalties
of up to $2.5 per day per violation.
We were also named as a defendant in a lawsuit filed on December 29, 1999,
JOHNSON et al. v. BRISTOL-MYERS SQUIBB CO., et al ("Johnson"). 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 we 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 and
the California Civil Code. 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 was made on
April 23, 2003. In the settlement, we paid an amount that was within the
expected range that had been previously accrued by us. The settlement
amount was not material to our results of operations.
As of July 1, 2003, we have been named as a defendant in approximately 320
lawsuits involving claims by approximately 1,500 plaintiffs alleging that
the plaintiffs were injured as a result of ingestion of products containing
phenylpropanolamine ("PPA"), which was an active ingredient in most of our
DEXATRIM products until November 2000. We anticipate that additional
lawsuits will be filed with similar or other allegations related to our
DEXATRIM products containing PPA. Because of the number of lawsuits filed,
the early stage of discovery in many of these cases, the non-specific
factual allegations against a broad group of defendants in most cases, the
unspecified amount of damages in most of the cases, and the unresolved
evidentiary hearings and other legal matters presently pending before the
various state and federal courts, it is impractical to state with certainty
at this time the amount being sought in these cases. The lawsuits that are
federal cases have now been transferred to the United States District Court
for the Western District of Washington (In re Phenylpropanolamine (PPA)
Products Liability Litigation, MDL No. 1407). The remaining cases are state
court cases which have been filed in a number of different states.
As a result of a recent evidentiary hearing in the federal cases, we expect
that lawsuits involving claims for injuries other than ischemic or
hemorrhagic stroke will be excluded from the federal PPA litigation. Also,
plaintiffs in the federal cases were required under a recent court order to
identify by June 30, 2003 the specific PPA containing product they have
taken. We anticipate that these two developments could significantly reduce
the number of lawsuits and plaintiffs who are parties to those lawsuits
pending against us.
There are no cases involving an alleged ingestion of DEXATRIM with PPA
currently set for trial in 2003, however, it is anticipated that
significant evidentiary and other hearings will be held during the course
of the year in the federal cases.
10
Slightly more than half of the existing suits represent cases involving
alleged injuries by products manufactured and sold prior to our acquisition
of DEXATRIM in December 1998. We are being defended and are indemnified
from liability by The DELACO Company, Inc. ("DELACO"), successor to
Thompson Medical Company, Inc. which owned DEXATRIM prior to December 1998.
We understand that DELACO maintains product liability insurance coverage
for products manufactured and sold prior to December 1998 with annual
limits of coverage and has an excess liability policy, but otherwise has
only nominal assets. Accordingly, it is unlikely that DELACO will be able
to indemnify us beyond its insurance coverage, although we believe we
should not be held legally responsible for products we did not manufacture
and sell. In addition, there can be no assurance that the insurance
maintained by DELACO will be sufficient to cover claims related to products
manufactured or sold prior to our acquisition of DEXATRIM. Our product
liability insurance, as described more fully below, would not apply to
claims arising from products manufactured and sold prior to our acquisition
of DEXATRIM.
Of the approximately 150 lawsuits, involving approximately 1,285 plaintiffs
that we are defending, approximately 185 plaintiffs allege injury as a
result of ingestion of DEXATRIM containing PPA, approximately 770
plaintiffs allege injury as a result of ingestion of a product other than
DEXATRIM, and approximately 330 plaintiffs have not identified a product.
We currently believe that there are approximately 88 identified plaintiffs
who allege that they suffered a stroke within three days of ingesting
DEXATRIM products containing PPA that were sold after our acquisition of
DEXATRIM in December 1998. Of these 88 plaintiffs we believe based on
discovery conducted to date that a smaller number of plaintiffs present
claims that are as significant as the Villarreal case discussed below. As
additional lawsuits are filed and discovery in the existing lawsuits
continues, we expect to know more about the characteristics of the cases,
which will result in a fluctuation in the number of cases ascribed to the
categories described above.
On May 7, 2003, we announced that a settlement had been reached in the case
of Jennifer Villarreal, et al. v. Chattem, Inc., et al., which was
scheduled for trial in May 2003 in the District Court of Brazoria County,
Texas. In this case, the plaintiff suffered a hemorrhagic stroke after
allegedly ingesting DEXATRIM containing PPA. Pursuant to the terms of the
settlement, we paid a settlement amount of $3,000 plus $500 for certain
fees and expenses and were fully released from further liability in the
case. The settlement was funded by our product liability insurance coverage
and thus will have no impact on our financial position, results of
operations or cash flows. The settlement amount and related expenses have
reduced the amount of insurance coverage available to us for the pending
and any subsequently filed cases related to DEXATRIM containing PPA to
approximately $98,500.
We have also been named as a defendant in a lawsuit alleging that the
plaintiff was injured as a result of the ingestion of DEXATRIM containing
ephedrine. Our available insurance for the defense of this lawsuit, as
described below, is $40,000. We discontinued the manufacturing and shipment
of DEXATRIM containing ephedrine on September 20, 2002.
We are aggressively defending these lawsuits. At this stage of the
proceedings, we cannot express a range of likely outcomes or fully evaluate
the risks that these lawsuits pose and, consequently, have not established
reserves for the DEXATRIM litigation. It is also too early to estimate the
number of lawsuits related to DEXATRIM with PPA or DEXATRIM with ephedrine
that will be filed or whether our available insurance will be sufficient to
cover these claims. If these lawsuits result in liabilities greater than
our insurance coverage, we may not have sufficient resources to satisfy
these obligations
We currently maintain product liability insurance, that provides coverage
for product liability claims, including those asserted in the lawsuits
currently pending and anticipated to be filed against us relating to the
existence of PPA in DEXATRIM. We have $98,500 of remaining product
liability insurance coverage available to us for injuries related to
DEXATRIM containing PPA occurring after our acquisition of DEXATRIM in
December 1998 and prior to May 31, 2001, if the claims are made before May
31, 2004. Injuries occurring before December 1998 or after May 31, 2001, or
claims made after May 31, 2004, would not be covered by these insurance
policies. We currently have two claims in which there are multiple PPA
manufacturers as defendants that relate to injuries occurring after May 31,
2001. We believe we have meritorious defenses to these claims. Our
11
insurance policies are subject to certain other limitations that are
generally customary for policies of this type.
We maintain a significantly lower level of insurance coverage for all other
potential claims relating to our products, including DEXATRIM products
containing ephedrine. Our product liability insurance coverage for all of
our other products, including DEXATRIM products containing ephedrine,
consists of $10,000 of self-insured coverage through our captive insurance
subsidiary, of which approximately $3,500 is currently funded, and a total
of $30,000 of excess coverage through third party insurers.
Effective on or about May 1, 2003, we and other retail and manufacturing
defendants reached a settlement without admission of liability or violation
of law in a lawsuit brought in the Superior Court of the State of
California, County of San Francisco, by Citizens for Responsible Business,
Inc. alleging our failure to comply with newly-added provisions of the
Federal Food, Drug and Cosmetic Act with respect to the labeling of
products purporting to contain "ginseng" in violation of the California
Business and Professional Code. The settlement amount was not material to
our results of operations. Under the terms of the settlement, the
plaintiffs provided a general release to us and all of our suppliers,
distributors and retailers with respect to all of our products, while we
are prohibited from shipping after July 1, 2003 products containing
"Siberian Ginseng" that do not comply with the new labeling requirements
Other claims, suits and complaints arise in the ordinary course of our
business involving such matters as patents and trademarks, product
liability, environmental matters and other alleged injuries or damage. The
outcome of such litigation cannot be predicted, but, in the opinion of
management, based in part upon the opinion of counsel, all such other
pending matters are without merit or are of such kind or involve such other
amounts as would not have a material adverse effect on our consolidated
operating results or financial position if disposed of unfavorably.
The Federal Food and Drug Administration ("FDA"), the Drug Enforcement
Administration and a number of state and local governments have enacted or
proposed restrictions or prohibitions on the sale of products that contain
ephedrine. Ephedrine can refer to the herbal substance derived from the
plant ephedra or the plant heart leaf, which, until September 2002, was
used in the manufacturing of some forms of DEXATRIM Natural and DEXATRIM
Results, or synthetic ephedrine, a FDA regulated ingredient used in some
OTC drug products, which has not been used in our products. These
restrictions include the prohibition of OTC sales, required warnings or
labeling statements, record keeping and reporting requirements, the
prohibition of sales to minors, per transaction limits on the quantity of
product that may be purchased and limitations on advertising and promotion.
The enactment of further restrictions or prohibitions on sales, the
perceived safety concerns related to ephedrine and the possibility of
further regulatory action could result in an increase in the number of
ephedrine related lawsuits filed, including ones in which we are named as a
defendant. 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. In response to this request, a
report issued on February 28, 2003 by the RAND-based Southern California
Evidence-Based Practice Center for the U.S. Department of Health and Human
Services Agency for Healthcare Research and Quality (the "RAND Report")
concluded that ephedrine, ephedrine plus caffeine and ephedra-containing
dietary supplements with or without herbs containing caffeine all promote
modest amounts of weight loss over the short term and use of ephedra or
ephedrine plus caffeine is associated with an increased risk of
gastrointestinal, psychiatric and autonomic symptoms. The adverse event
reports contained a smaller number of more serious adverse events. Given
the small number of such events, the RAND Report concluded that further
study would be necessary to determine whether consumption of ephedra or
ephedrine may be causally related to these serious adverse events. In
September 2001, the Public Citizen Health Research Group petitioned the FDA
to ban the production and sale of dietary supplements containing ephedrine
alkaloids. To date, the Department of Health and Human Services, which
oversees the FDA, and the FDA have not reached a final decision on the
petition.
We have developed alternative formulations for DEXATRIM Natural and
DEXATRIM Results which exclude ephedrine and discontinued the manufacturing
and shipment of DEXATRIM products containing ephedrine in September 2002.
Our DEXATRIM products containing ephedrine may continue to be sold in the
trade until our customers' existing supply of inventory is exhausted or
until the products are returned to us. Negative publicity relating to the
12
possible harmful effects of ephedrine and the possibility of further
regulatory action to restrict or prohibit the sale of products containing
ephedrine could result in a return of products from retailers or our
decision to accept product returns of DEXATRIM with ephedrine, for which we
provided a $750 allowance in the first quarter of fiscal 2003. At this time
we believe that this allowance amount is adequate to cover any returns of
DEXATRIM product containing ephedrine that might be received. The unused
portion of this allowance was $678 at May 31, 2003.
We were notified in October 2000 that the FDA denied a citizen petition
submitted by Thompson Medical Company, Inc., the previous owner of
SPORTSCREME and ASPERCREME, seeking a determination that 10% trolamine
salicylate, the active ingredient in SPORTSCREME and ASPERCREME, was
clinically proven to be an effective active ingredient in external
analgesic OTC drug products, and thus should be included in the FDA's
yet-to-be finalized monograph for external analgesics. We have met with the
FDA and submitted a proposed protocol study to evaluate the efficacy of 10%
trolamine salicylate as an active ingredient in OTC external analgesic drug
products. Based on comments received from the FDA at the meeting, we may
revise and resubmit the protocol. After we receive final comments from the
FDA, we expect 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 us to provide clinical data, which would be expensive. We are
working to develop alternate formulations for SPORTSCREME and ASPERCREME in
the event that the FDA does not consider the available clinical data to
conclusively demonstrate the efficacy of trolamine salicylate when the OTC
external analgesic monograph is finalized. If 10% trolamine salicylate is
not included in the final monograph, we would likely be required to
discontinue these products as currently formulated and remove them from the
market after expiration of an anticipated grace period. If this occurred,
we believe we could still market these products as homeopathic products,
and could also reformulate them using ingredients approved in the FDA
monograph.
11. Certain prior year amounts have been reclassified to conform to the current
period's presentation.
12. We consider all short-term deposits and investments with original
maturities of three months or less to be cash equivalents.
13. On March 28, 2002, we completed the acquisition of SELSUN BLUE, a line of
medicated dandruff shampoos, from Abbott Laboratories ("Abbott") for
$75,000, plus inventories of $1,380 and assumed liabilities of $1,178. This
acquisition includes worldwide rights (except India) to manufacture, sell
and market SELSUN BLUE plus related intellectual property and certain
manufacturing equipment. Abbott manufactured the product for us until June
2003 domestically, and will continue to manufacture the product for us
until March 2004 internationally, or such earlier date as we enter into our
own agreements with contract manufacturers. All of our SELSUN BLUE domestic
product lines are presently being manufactured at our Chattanooga
facilities. We generally pay Abbott a fee of 10% over standard
manufacturing costs until we assume manufacturing or enter into third party
agreements. Abbott is also marketing, selling and distributing 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
initially pays us 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 our assumption of sales and marketing responsibility in such
countries. Abbott pays all costs and expenses related to the manufacture,
marketing and sales of SELSUN BLUE in these countries. As we assume
responsibility for the sales and marketing effort in a country, the royalty
arrangement with respect to such country terminates and we record these
international sales directly, as well as the costs and expenses associated
with these sales. We have completed the transition for certain key markets
and expect to complete the transition for all other relevant foreign
countries by March 2004.
13
The following table summarizes our estimate of how the results for SELSUN
BLUE international, that are included as royalties on our consolidated
statements of income, for the three and six months ended May 31, 2003 would
have been presented had the transition period been finalized on the date of
acquisition:
SELECTED SELSUN BLUE INTERNATIONAL DATA (Unaudited)
For the Three For the Six
Months Ended Months Ended
May 31, 2003 May 31, 2003
---------- ----------
NET SALES ................................. $ 2,074 $ 4,105
---------- ----------
COSTS AND EXPENSES:
Cost of sales ........................... 803 1,590
Advertising and promotion ............... 307 607
Selling, general and administrative...... 600 1,244
---------- ----------
Total costs and expenses .............. 1,710 3,441
---------- ----------
INCOME FROM OPERATIONS .................... $ 364 $ 664
========== ==========
The following unaudited consolidated pro forma information assumes the
acquisition of SELSUN BLUE had occurred at the beginning of the period
presented:
PRO FORMA CONSOLIDATED RESULTS OF OPERATIONS (Unaudited)
For the Six Months
Ended May 31, 2002
------------------
Total revenue .......................... $ 117,817
Income before change in
accounting principle.................. 8,548
Net loss ............................... (329)
Earnings per share-basic:
Income before change in
accounting principle.................. 0.47
Net loss ............................. (0.02)
Earnings per share-diluted:
Income before change in
accounting principle.................. 0.45
Net loss ............................. (0.02)
14. Also on March 28, 2002, we obtained a $60,000 senior secured credit
facility from a syndicate of commercial banks led by Bank of America, N.A.,
as agent (the "Credit Facility"). The Credit Facility includes a $15,000
revolving credit facility and a $45,000 term loan. The Credit Facility
together with our available cash was used to finance the acquisition of
SELSUN Blue and was used to provide working capital for general corporate
purposes. The $45,000 term loan and any outstanding loans under the
revolving credit facility mature on March 28, 2007. The Credit Facility is
secured by the stock of our domestic subsidiaries and all of our present
and future assets, excluding real property. The Credit Facility contains
14
covenants, representations, warranties and other agreements by us that are
customary in credit agreements and security instruments relating to
financings of this type. At May 31, 2003, we owed $11,750 under the Credit
Facility.
On May 23, 2003, we entered into a preliminary agreement to amend the
Credit Facility to increase the revolving line of credit from $15,000 to
$50,000, eliminate the term loan feature of the facility and modify certain
other terms and conditions. The existing term loan balance at May 31, 2003
was $11,750, which amount would initially be outstanding under the
contemplated $50,000 revolving credit facility, leaving an initial amount
available for borrowing of $38,250. We believe that the amended Credit
Facility, together with our strong cash flow from operations, would allow
us greater flexibility to fund potential acquisitions and repurchase our
common shares and senior subordinated notes, and also reduce our interest
expense on an annual basis. If completed, we anticipate deferred financing
fees of approximately $100, net of income taxes, will be written off as a
result of the amendment. We are also evaluating alternate financing
structures from our bank group that may provide additional flexibility.
15. We record income tax expense in our financial statements based on an
estimated annual effective income tax rate. During the second quarter of
fiscal 2003 we revised our estimated income tax rate based on the
implementation of state tax planning strategies. This revision resulted in
a decrease in the annual effective income tax rate to 37% from 38% or a
reduction in income tax expense of $192 during the second quarter of fiscal
2003.
16. Net sales of our domestic product categories within our single healthcare
business segment for the three and six months ended May 31, 2003 and 2002,
respectively, are as follows:
For the Three Months For the Six Months
Ended May 31 Ended May 31
------------------- -------------------
2003 2002 2003 2002
-------- -------- -------- --------
Topical analgesics ........... $ 14,626 $ 15,886 $ 28,198 $ 30,408
Medicated skin care products.. 14,912 12,404 28,062 23,942
Dietary supplements .......... 10,963 11,682 20,568 21,918
Medicated dandruff shampoos... 6,641 3,810 14,812 3,822
Other OTC products ........... 9,039 9,666 17,221 18,739
-------- -------- -------- --------
Total ...................... $ 56,181 $ 53,448 $108,861 $ 98,829
======== ======== ======== ========
17. The condensed consolidating financial statements, for the dates or periods
indicated, of Chattem, Inc. ("Chattem"), Signal Investment & Management Co.
("Signal") and SunDex, LLC ("SunDex"), the guarantors of the long-term debt
of Chattem, and the non-guarantor wholly-owned subsidiaries 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. The guarantee of Signal and SunDex as of May 31, 2003
arose in conjunction with Chattem's issuance of the 8.875% Senior
Subordinated Notes on March 24, 1998 (the "8.875% Notes") and the $60,000
senior secured credit facility (the "Credit Facility") obtained by Chattem
on March 28, 2002. The guarantees' terms match the terms of the 8.875%
Notes and the Credit Facility. The maximum amount of future payments the
guarantors would be required to make under the guarantees as of May 31,
2003 is $216,288.
15
Note 17
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEETS
MAY 31, 2003
----------------------------
(Unaudited and in thousands)
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- --------- ---------
ASSETS
- ------
CURRENT ASSETS:
Cash and cash equivalents ............... $ 6,203 $ 403 $ 92 $ 7,263 $ -- $ 13,961
Accounts receivable, less allowance
for doubtful accounts of $1,241 ....... 27,810 -- -- 4,387 -- 32,197
Refundable and deferred income taxes .... 10,655 -- -- 50 -- 10,705
Inventories ............................. 14,388 -- 2,802 3,227 -- 20,417
Prepaid expenses and other current
assets ................................ 1,029 -- -- 228 -- 1,257
--------- --------- --------- --------- --------- ---------
Total current assets .................. 60,085 403 2,894 15,155 -- 78,537
--------- --------- --------- --------- --------- ---------
PROPERTY, PLANT AND EQUIPMENT, NET......... 26,492 -- 775 364 -- 27,631
--------- --------- --------- --------- --------- ---------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased
product rights, net ................... 1,235 182,400 62,290 -- -- 245,925
Debt issuance costs, net ................ 6,266 -- -- -- -- 6,266
Investment in subsidiaries .............. 70,714 -- -- -- (70,714) --
Other ................................... 3,229 -- -- 18 -- 3,247
--------- --------- --------- --------- --------- ---------
Total other noncurrent assets ......... 81,444 182,400 62,290 18 (70,714) 255,438
--------- --------- --------- --------- --------- ---------
TOTAL ASSETS ....................... $ 168,021 $ 182,803 $ 65,959 $ 15,537 $ (70,714) $ 361,606
========= ========= ========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Current maturities of long-term debt .... $ 8,000 $ -- $ -- $ -- $ -- $ 8,000
Accounts payable ........................ 9,033 -- -- 1,087 -- 10,120
Accrued liabilities ..................... 23,182 -- -- 986 -- 24,168
--------- --------- --------- --------- --------- ---------
Total current liabilities ............. 40,215 -- -- 2,073 -- 42,288
--------- --------- --------- --------- --------- ---------
LONG-TERM DEBT, less current maturities ... 208,442 -- -- -- -- 208,442
--------- --------- --------- --------- --------- ---------
DEFERRED INCOME TAXES ..................... (216) 25,406 -- -- -- 25,190
--------- --------- --------- --------- --------- ---------
OTHER NONCURRENT LIABILITIES .............. 1,647 -- -- -- -- 1,647
--------- --------- --------- --------- --------- ---------
INTERCOMPANY ACCOUNTS ..................... (163,305) 164,557 (5,223) 3,971 -- --
--------- --------- --------- --------- --------- ---------
SHAREHOLDERS' EQUITY:
Preferred shares, without par value,
authorized 1,000, none issued ......... -- -- -- -- -- --
Common shares, without par value,
authorized 50,000, issued 19,026 ...... 76,917 2 63,065 7,647 70,714 76,917
Retained earnings (deficit) ............. 7,241 (7,162) 8,117 2,817 -- 11,013
--------- --------- --------- --------- --------- ---------
Total ................................. 84,158 (7,160) 71,182 10,464 70,714 87,930
Unamortized value of restricted common
shares issued ......................... (2,449) -- -- -- -- (2,449)
Cumulative other comprehensive income:
Foreign currency translation adjustment (471) -- -- (971) -- (1,442)
--------- --------- --------- --------- --------- ---------
Total shareholders' equity (deficit)... 81,238 (7,160) 71,182 9,493 70,714 84,039
--------- --------- --------- --------- --------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY................ $ 168,021 $ 182,803 $ 65,959 $ 15,537 $ 70,714 $ 361,606
========= ========= ========= ========= ========= =========
16
Note 17
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEETS
NOVEMBER 30, 2002
----------------------------
(In thousands)
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- --------- ---------
ASSETS
- ------
CURRENT ASSETS:
Cash and cash equivalents ............... $ 11,505 $ 1,133 $ 5 $ 3,281 $ -- $ 15,924
Accounts receivable, less allowance for
doubtful accounts of $962 ............. 21,585 -- -- 4,088 -- 25,673
Refundable and deferred income taxes .... 9,791 -- -- 46 -- 9,837
Inventories ............................. 12,734 -- 3,139 2,896 -- 18,769
Prepaid expenses and other current assets 2,064 -- -- 120 -- 2,184
--------- --------- --------- --------- --------- ---------
Total current assets .................. 57,679 1,133 3,144 10,431 -- 72,387
--------- --------- --------- --------- --------- ---------
PROPERTY, PLANT AND EQUIPMENT, NET ........ 25,567 -- 775 316 -- 26,658
--------- --------- --------- --------- --------- ---------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased
product rights, net ................... 1,397 182,100 62,290 -- -- 245,787
Debt issuance costs, net ................ 7,126 -- -- -- -- 7,126
Investment in subsidiaries .............. 70,714 -- -- -- (70,714) --
Other ................................... 3,590 -- -- 15 -- 3,605
--------- --------- --------- --------- --------- ---------
Total other noncurrent assets ......... 82,827 182,100 62,290 15 (70,714) 256,518
--------- --------- --------- --------- --------- ---------
TOTAL ASSETS ....................... $ 166,073 $ 183,233 $ 66,209 $ 10,762 $ (70,714) $ 355,563
========= ========= ========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Current maturities of long-term debt .... $ 7,250 $ -- $ -- $ -- $ -- $ 7,250
Accounts payable ........................ 10,957 -- -- 1,252 -- 12,209
Payable to bank ......................... 452 -- -- -- -- 452
Accrued liabilities ..................... 20,015 -- -- 1,089 -- 21,104
--------- --------- --------- --------- --------- ---------
Total current liabilities ............. 38,674 -- -- 2,341 -- 41,015
--------- --------- --------- --------- --------- ---------
LONG-TERM DEBT, less current maturities ... 217,458 -- -- -- -- 217,458
--------- --------- --------- --------- --------- ---------
DEFERRED INCOME TAXES ..................... (1,065) 21,809 -- -- -- 20,744
--------- --------- --------- --------- --------- ---------
OTHER NONCURRENT LIABILITIES .............. 1,602 -- -- -- -- 1,602
--------- --------- --------- --------- --------- ---------
INTERCOMPANY ACCOUNTS ..................... (169,271) 170,530 (1,803) 544 -- --
--------- --------- --------- --------- --------- ---------
SHAREHOLDERS' EQUITY:
Preferred shares, without par value,
authorized 1,000, none issued ......... -- -- -- -- --
Common shares, without par value,
authorized 50,000, issued 19,177 ...... 79,313 2 63,065 7,647 70,714 79,313
Retained earnings (deficit) ............. 1,563 (9,108) 4,947 1,501 -- (1,097)
--------- --------- --------- --------- --------- ---------
Total ................................. 80,876 (9,106) 68,012 9,148 70,714 78,216
Unamortized value of restricted common
shares issued ......................... (1,713) -- -- -- -- (1,713)
Cumulative other comprehensive income:
Foreign currency translation adjustment (488) -- -- (1,271) -- (1,759)
--------- --------- --------- --------- --------- ---------
Total shareholders' equity (deficit)... 78,675 (9,106) 68,012 7,877 70,714 74,744
--------- --------- --------- --------- --------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY ............... $ 166,073 $ 183,233 $ 66,209 $ 10,762 $ 70,714 $ 355,563
========= ========= ========= ========= ========= =========
17
Note 17
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF INCOME
FOR THE SIX MONTHS ENDED MAY 31, 2003
-------------------------------------
(Unaudited and in thousands)
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- --------- ---------
TOTAL REVENUES ............................ $ 91,463 $ -- $ 20,090 $ 10,505 $ -- $ 122,058
--------- --------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales ........................... 25,284 -- 5,889 4,231 -- 35,404
Advertising and promotion ............... 27,572 -- 6,068 3,294 -- 36,934
Selling, general and administrative...... 18,938 30 114 1,129 -- 20,211
--------- --------- --------- --------- --------- ---------
Total costs and expenses .............. 71,794 30 12,071 8,654 -- 92,549
--------- --------- --------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS ............. 19,669 (30) 8,019 1,851 -- 29,509
--------- --------- --------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense ........................ (10,374) -- -- -- -- (10,374)
Investment and other income, net ........ 69 2 -- 16 -- 87
Royalties ............................... (4,744) 6,022 (1,069) (209) -- --
Corporate allocations ................... 1,974 -- (1,918) (56) -- --
--------- --------- --------- --------- --------- ---------
Total other income (expense) .......... (13,075) 6,024 (2,987) (249) -- (10,287)
--------- --------- --------- --------- --------- ---------
INCOME BEFORE INCOME TAXES ................ 6,594 5,994 5,032 1,602 -- 19,222
PROVISION FOR INCOME TAXES ................ 2,915 2,048 1,862 287 -- 7,112
--------- --------- --------- --------- --------- ---------
NET INCOME ................................ $ 3,679 $ 3,946 $ 3,170 $ 1,315 $ -- $ 12,110
========= ========= ========= ========= ========= =========
18
Note 17
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF INCOME
FOR THE SIX MONTHS ENDED MAY 31, 2002
-------------------------------------
(Unaudited and in thousands)
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- --------- ---------
TOTAL REVENUES ............................ $ 91,585 $ -- $ 8,998 $ 6,503 $ -- $ 107,086
--------- --------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales ........................... 26,307 -- 2,336 2,504 -- 31,147
Advertising and promotion ............... 31,327 -- 795 1,847 -- 33,969
Selling, general and administrative ..... 17,943 5 -- 1,128 -- 19,076
--------- --------- --------- --------- --------- ---------
Total costs and expenses .............. 75,577 5 3,131 5,479 -- 84,192
--------- --------- --------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS ............. 16,008 (5) 5,867 1,024 -- 22,894
--------- --------- --------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense ........................ (10,144) -- -- -- -- (10,144)
Investment and other income, net ........ 70 66 -- 28 -- 164
Royalties ............................... (5,123) 5,713 (458) (132) -- --
Corporate allocations ................... 870 -- (820) (50) -- --
--------- --------- --------- --------- --------- ---------
Total other income (expense) .......... (14,327) 5,779 (1,278) (154) -- (9,980)
--------- --------- --------- --------- --------- ---------
INCOME BEFORE INCOME TAXES AND CHANGE IN
ACCOUNTING PRINCIPLE .................... 1,681 5,774 4,589 870 -- 12,914
PROVISION FOR INCOME TAXES ................ 915 1,963 1,744 285 -- 4,907
--------- --------- --------- --------- --------- ---------
INCOME BEFORE CHANGE IN
ACCOUNTING PRINCIPLE..................... 766 3,811 2,845 585 -- 8,007
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE, NET OF INCOME TAX BENEFIT..... -- (8,877) -- -- -- (8,877)
--------- --------- --------- --------- --------- ---------
NET INCOME (LOSS) ......................... $ 766 $ (5,066) $ 2,845 $ 585 $ -- $ (870)
========= ========= ========= ========= ========= =========
19
Note 17
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MAY 31, 2003
-------------------------------------
(Unaudited and in thousands)
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- --------- ---------
OPERATING ACTIVITIES:
Net income ........................................ $ 3,679 $ 3,946 $ 3,170 $ 1,315 $ -- $ 12,110
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Depreciation and amortization ................... 2,947 -- -- 74 -- 3,021
Deferred income tax provision ................... 177 3,597 -- -- -- 3,774
Provision for income taxes ...................... (3,910) 2,048 1,862 -- -- --
Other, net ...................................... (119) -- -- 3 -- (116)
Changes in operating assets and liabilities:
Accounts receivable .......................... (6,427) -- -- (97) -- (6,524)
Refundable income taxes ...................... 40 -- -- -- -- 40
Inventories .................................. (1,778) -- 337 (207) -- (1,648)
Prepaid expenses and other current assets .... 1,031 -- -- (104) -- 927
Accounts payable and accrued liabilities ..... 810 -- -- 125 -- 935
--------- --------- --------- --------- --------- ---------
Net cash provided by (used in) operating
activities ............................... (3,550) 9,591 5,369 1,109 -- 12,519
--------- --------- --------- --------- --------- ---------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment ........ (2,446) -- -- (120) -- (2,566)
Purchase of trademarks and other products rights.. (8) (300) -- -- -- (308)
Change in other assets, net ....................... 599 -- -- (1) -- 598
--------- --------- --------- --------- --------- ---------
Net cash used in investing activities ...... (1,855) (300) -- (121) -- (2,276)
--------- --------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Repayment of long-term debt ....................... (8,250) -- -- -- -- (8,250)
Proceeds from exercise of stock options ........... 275 -- -- -- -- 275
Repurchase of common shares ....................... (3,900) -- -- -- -- (3,900)
Change in payable to bank ......................... (452) -- -- -- -- (452)
Deferred debt issuance costs ...................... (25) -- -- -- -- (25)
Changes in intercompany accounts .................. 10,434 (8,021) (5,282) 2,869 -- --
Dividends paid .................................... 2,000 (2,000) -- -- -- --
--------- --------- --------- --------- --------- ---------
Net cash provided by (used in) financing
activities ............................... 82 (10,021) (5,282) 2,869 -- (12,352)
--------- --------- --------- --------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS ........................... 21 -- -- 125 -- 146
--------- --------- --------- --------- --------- ---------
CASH AND CASH EQUIVALENTS:
Increase (decrease) for the period ................ (5,302) (730) 87 3,982 -- (1,963)
At beginning of period ............................ 11,505 1,133 5 3,281 -- 15,924
--------- --------- --------- --------- --------- ---------
At end of period .................................. $ 6,203 $ 403 $ 92 $ 7,263 $ -- $ 13,961
========= ========= ========= ========= ========= =========
20
Note 17
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MAY 31, 2002
-------------------------------------
(Unaudited and in thousands)
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- --------- ---------
OPERATING ACTIVITIES:
Net income (loss) ............................. $ 766 $ (5,066) $ 2,845 $ 585 $ -- $ (870)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Depreciation and amortization ............... 2,540 -- -- 61 -- 2,601
Deferred income tax provision ............... 2,003 -- -- -- -- 2,003
Provision for income taxes .................. (3,707) 1,963 1,744 -- -- --
Cumulative effect of change in accounting
principle, net ............................ -- 8,877 -- -- -- 8,877
Stock option charge ......................... 175 -- -- -- -- 175
Other, net .................................. 4 -- -- -- -- 4
Changes in operating assets and liabilities:
Accounts receivable ....................... (9,314) -- -- (591) -- (9,905)
Refundable income taxes ................... 1,031 -- -- -- -- 1,031
Inventories ............................... 42 -- -- (912) -- (870)
Prepaid expenses and other current assets . 128 -- -- 36 -- 164
Accounts payable and accrued liabilities .. 13,878 -- -- (454) -- 13,424
--------- --------- --------- --------- --------- ---------
Net cash provided by (used in) operating
activities ............................ 7,546 5,774 4,589 (1,275) -- 16,634
--------- --------- --------- --------- --------- ---------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment .... (2,029) -- -- (19) -- (2,048)
Purchase of trademarks and other product rights (1,187) (73,660) -- -- -- (74,847)
Change in other assets, net ................... 25 -- -- 9 -- 34
--------- --------- --------- --------- --------- ---------
Net cash used in investing activities ... (3,191) (73,660) -- (10) -- (76,861)
--------- --------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Repayment of long-term debt ................... (6,500) -- -- -- -- (6,500)
Proceeds from long-term debt .................. 45,000 -- -- -- -- 45,000
Proceeds from exercise of stock options ....... 5,918 -- -- -- -- 5,918
Repurchase of common shares ................... (630) -- -- -- -- (630)
Change in payable to bank ..................... (151) -- -- -- -- (151)
Increase in debt issuance costs ............... (1,099) -- -- -- -- (1,099)
Changes in intercompany accounts .............. (54,488) 59,893 (4,589) (816) -- --
Dividends paid ................................ 2,000 (2,000) -- -- -- --
--------- --------- --------- --------- --------- ---------
Net cash provided by (used in)
financing activities .................. (9,950) 57,893 (4,589) (816) -- 42,538
--------- --------- --------- --------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS
45 -- -- (22) -- 23
--------- --------- --------- --------- --------- ---------
CASH AND CASH EQUIVALENTS:
Decrease for the period ....................... (5,550) (9,993) -- (2,123) -- (17,666)
At beginning of period ........................ 20,648 10,003 -- 4,794 -- 35,445
--------- --------- --------- --------- --------- ---------
At end of period .............................. $ 15,098 $ 10 $ -- $ 2,671 $ -- $ 17,779
========= ========= ========= ========= ========= =========
21
18. The following table presents the computation of per share earnings for the
three and six months ended May 31, 2003 and 2002, respectively.
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
MAY 31, MAY 31,
------------------------- -------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
NET INCOME (LOSS):
Income before change in accounting principle ................ $ 7,521 $ 5,635 $ 12,110 $ 8,007
Change in accounting principle .............................. -- -- -- (8,877)
---------- ---------- ---------- ----------
Net income (loss) ........................................ $ 7,521 $ 5,635 $ 12,110 $ (870)
========== ========== ========== ==========
NUMBER OF COMMON SHARES:
Weighted average outstanding ................................ 19,052 18,498 19,177 18,216
Issued upon assumed exercise of outstanding stock options ... 612 741 694 623
Effect of issuance of restricted common shares .............. 87 90 95 80
---------- ---------- ---------- ----------
Weighted average and potential dilutive outstanding ......... 19,751 19,329 19,966 18,919
========== ========== ========== ==========
NET INCOME (LOSS) PER COMMON SHARE:
Basic:
Income before change in accounting principle ............. $ .39 $ .30 $ .63 $ .44
Change in accounting principle ........................... -- -- -- (.49)
---------- ---------- ---------- ----------
Total basic .......................................... $ .39 $ .30 $ .63 $ (.05)
========== ========== ========== ==========
Diluted:
Income before change in accounting principle ............. $ .38 $ .29 $ .61 $ .42
Change in accounting principle ........................... -- -- -- (.47)
---------- ---------- ---------- ----------
Total diluted ........................................ $ .38 $ .29 $ .61 $ (.05)
========== ========== ========== ==========
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the audited consolidated financial
statements and related notes thereto included in our 2002 Annual Report on Form
10-K filed with the Securities and Exchange Commission. All of the applicable
amounts herein for the three and six months ended May 31, 2003 and 2002,
respectively, reflect the two-for-one split of our common stock on November 29,
2002. All monetary amounts are expressed in thousands of dollars unless
contrarily evident. This discussion and analysis contains forward-looking
statements that involve risks, uncertainties and assumptions. The actual results
may differ materially from those anticipated in these forward-looking statements
as a result of a number of factors, including, but not limited to, those
described in our filings with the Securities and Exchange Commission.
GENERAL
- -------
We are a leading marketer and manufacturer of a broad portfolio of branded
over-the-counter ("OTC") healthcare products, toiletries and dietary
supplements, including such categories as topical analgesics, medicated skin
care products, dietary supplements, medicated dandruff shampoos and other OTC
products. Our portfolio of products includes well-recognized brands, such as:
o ICY HOT, ASPERCREME and FLEXALL topical analgesics;
o Medicated skin care products such as GOLD BOND medicated skin care
powder, cream, lotion, first aid, swab and spray products; and
PHISODERM medicated acne treatment products and skin cleansers;
o Dietary supplements including DEXATRIM and the SUNSOURCE line;
o SELSUN BLUE medicated dandruff shampoos; and
o Other OTC products such as PAMPRIN and PREMSYN PMS, menstrual
analgesics; HERPECIN-L, a lip care product; and BENZODENT, a dental
analgesic cream.
Our products target niche markets that are often outside the core product areas
of larger companies where we believe we can achieve and sustain significant
market penetration through strong advertising and promotion support. Many of our
products are among the U.S. market leaders in their respective categories. For
example, our portfolio of topical analgesic brands and our GOLD BOND medicated
body powders have the leading U.S. market share in these categories. We sell our
products nationally through mass merchandiser, drug and food channels,
principally utilizing our own sales force.
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 SELSUN BLUE from Abbott Laboratories for $75,000 plus
inventories of $1,380 and assumed liabilities of $1,178. We financed the
acquisition with a $45,000 term loan under our senior credit facility and
$31,380 of cash. We acquired worldwide rights (except in India) to manufacture,
sell and market SELSUN BLUE plus related intellectual property and certain
manufacturing equipment.
Abbott Laboratories, or manufacturers under contract to Abbott Laboratories,
manufactured the product for us domestically until June 2003, and
internationally will manufacture the product for us until March 2004, or such
earlier date as we enter into our own agreements with contract manufacturers.
All of our domestic SELSUN BLUE product lines are presently being manufactured
at our Chattanooga facilities. We generally pay Abbott Laboratories ten percent
over standard manufacturing costs. Abbott Laboratories is also marketing,
selling and distributing 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 initially pays us 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 our assumption of sales and marketing
responsibility in such countries. Abbott Laboratories pays all costs and
expenses related to the manufacture, marketing and sales of SELSUN BLUE in these
countries. As we assume responsibility for the sales and marketing effort in a
country, the royalty arrangement with respect to such country terminates and we
record these international sales directly, as well as the costs and expenses
associated with these sales. We have completed the transition for certain key
markets and expect to complete the transition for all other relevant foreign
countries by March 2004.
23
In fiscal 2002, our international revenues were $21,042, or 9.4% of total
revenues. In 2001, SELSUN BLUE was sold in approximately 90 countries, with
aggregate international sales of $20,100, or approximately 50% of its total net
sales. We are focusing our efforts on expanding SELSUN BLUE'S international
presence in the existing key markets, such as Canada, Mexico, Brazil and
Australia. As we initially focus on the existing key markets, we are
discontinuing the sale of SELSUN BLUE in certain smaller markets and will thus
experience what we believe will be a short term decrease in international sales
of SELSUN BLUE. 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.
In connection with our acquisition of SELSUN BLUE on March 28, 2002, we obtained
a $60,000 senior secured credit facility from a syndicate of commercial banks
led by Bank of America, N.A., as agent. The senior credit facility included a
$15,000 revolving credit facility and a $45,000 term loan. The senior credit
facility together with our available cash was used to finance the acquisition of
SELSUN BLUE. As of May 31, 2003, we owed $11,750 under this credit facility.
On May 23, 2003 we entered into a preliminary agreement to amend our senior
credit facility to increase the revolving line of credit from $15,000 to
$50,000, eliminate the term loan feature of the facility and modify certain
other terms and conditions. The existing term loan balance at May 31, 2003 of
$11,750 would initially be outstanding under the contemplated $50,000 revolving
credit facility, leaving $38,250 available for borrowing. If completed, we
anticipate deferred financing fees of approximately $100, net of income taxes,
will be written off as a result of this amendment. We believe that the amended
senior credit facility, together with our strong cash flow from operations,
would allow us greater flexibility to fund potential acquisitions and repurchase
our common shares and senior subordinated notes, and also reduce our interest
expense on an annual basis. We are also evaluating alternate financing
structures from our bank group that may provide additional flexibility.
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 and on September 20, 2002 we discontinued
the manufacturing and shipment of DEXATRIM Natural and DEXATRIM Results
containing ephedrine. Negative publicity relating to the possible harmful
effects of ephedrine and the possibility of further regulatory action to
restrict or prohibit the sale of products containing ephedrine has resulted in
returns of these products from retailers for which we provided a $750 allowance
in the first quarter of fiscal 2003. At this time we still believe the $750
allowance recorded in the first quarter is adequate to cover any returns of
DEXATRIM product containing ephedrine that might be received. The unused portion
of this allowance at May 31, 2003 was $678.
We purchase raw materials and packaging materials from a number of third party
suppliers, primarily on a purchase order basis. Except for pamabrom and
pyrilamine maleate, active ingredients used in our PAMPRIN and PREMSYN PMS
products, whose combined net sales in fiscal 2002 represented 5.9% of our
consolidated total revenues in that year, we are not limited to a single source
of supply for the ingredients used in the manufacture of our products. We
believe that our current sources of supply and potential alternative sources
will be adequate to meet future product demands.
In March 2003, we acquired the FISODERM, FISOHEX and FISOAC product line in
Brazil and nearly all of the worldwide trademarks for PHISODERM, PHISOHEX and
other related trademarks from GlaxoSmithKline for an immaterial amount. This
purchase excludes trademarks in Taiwan, Australia, Papua/New Guinea and New
Zealand. In 2002, sales of the Brazilian product line were less than $200. These
acquisitions, together with the PHISODERM trademark rights previously acquired
in 1994 for the United States, Canada and Puerto Rico, provide us with worldwide
capability to expand our PHISODERM business.
During the six months ended May 31, 2003, we repurchased, and returned to
unissued, 272,800 shares of our common stock for $3,900 in accordance with our
previously announced stock buyback program. In January 2003 our board of
directors increased the total authorization to repurchase stock under our stock
buyback program to $10,000. The remaining availability under the board
authorization is $6,100 at May 31, 2003.
EBITDA, earnings before interest, taxes, depreciation and amortization, is a key
non-GAAP financial measure used by us to measure operating performance but may
not be comparable to a similarly titled measure reported by other companies. The
most directly comparable GAAP financial measure is income before change in
accounting principle. EBITDA is used to supplement operating income as an
indicator of operating performance and not as an alternative to measures defined
and required by accounting principles generally accepted in the United States.
24
We consider EBITDA an important indicator of our operational strength and
performance including our ability to pay interest, service debt and fund capital
expenditures. EBITDA is also one measure used in the calculation of certain
ratios to determine our compliance with the terms of our existing credit
facility.
For the three and six months ended May 31, 2003, income before change in
accounting principle increased $1,886 and $4,103 or 33.5% and 51.2% to $7,521
and $12,110 from $5,635 and $8,007 for the three and six months ended May 31,
2002, respectively. EBITDA for the three and six months ended May 31, 2003 was
$18,012 and $ 31,661 as compared to $15,386 and $ 24,923 for the three and six
months ended May 31, 2002, an increase of $2,626 and $6,738, respectively. The
income before change in accounting principle margin (income before change in
accounting principle/total revenues) increased in 2003 over 2002 from 9.6% and
7.5% to 11.8% and 9.9% for the three and six months ended May 31, 2003,
respectively. The EBITDA margin (EBITDA/total revenues) increased from 26.2% and
23.3% of total revenues, in the 2002 period to 28.3% and 25.9% in the three and
six months ended May 31, 2003. A reconciliation of EBITDA to income before
change in accounting principle is presented in the following table:
For the Three Months For the Six Months
Ended May 31, Ended May 31,
------------------- -------------------
2003 2002 2003 2002
-------- -------- -------- --------
Income before change in accounting
principle......................... $ 7,521 $ 5,635 $ 12,110 $ 8,007
Add:
Provision for income taxes ....... 4,299 3,472 7,112 4,907
Interest expense, net ............ 5,174 5,245 10,287 9,980
Depreciation and amortization less
amounts included in interest ... 1,018 1,034 2,152 2,029
-------- -------- -------- --------
EBITDA ............................. $ 18,012 $ 15,386 $ 31,661 $ 24,923
======== ======== ======== ========
We will continue to seek sales increases through a combination of acquisitions
and internal growth while seeking to maintain high operating income levels. As
previously high-growth brands mature, sales increases will become even more
dependent on acquisitions and development of successful line extensions. During
the first quarter of fiscal 2003, we introduced GOLD BOND Antifungal Foot Swabs,
GOLD BOND First Aid Quick Spray and GOLD BOND First Aid Wipes. 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 and/or earnings. As a
result, we may experience a short-term impact on our profitability due to
acquisitions and line extensions.
25
RESULTS OF OPERATIONS
- ---------------------
The following table sets forth, for income before change in accounting principle
and for the periods indicated, certain items from our consolidated statements of
income expressed as a percentage of total revenues:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED MAY 31, ENDED MAY 31,
----------------- -----------------
2003 2002 2003 2002
------ ------ ------ ------
TOTAL REVENUES ...................... 100.0% 100.0% 100.0% 100.0%
------ ------ ------ ------
COSTS AND EXPENSES:
Cost of sales ..................... 27.9 28.4 29.0 29.1
Advertising and promotion ......... 29.1 30.8 30.3 31.7
Selling, general and administrative 16.3 16.3 16.5 17.8
------ ------ ------ ------
Total costs and expenses ........ 73.3 75.5 75.8 78.6
------ ------ ------ ------
INCOME FROM OPERATIONS .............. 26.7 24.5 24.2 21.4
------ ------ ------ ------
OTHER INCOME (EXPENSE):
Interest expense .................. (8.2) (9.1) (8.5) (9.5)
Investment and other income, net... .1 .1 .1 .2
------ ------ ------ ------
Total other income (expense)..... (8.1) (9.0) (8.4) (9.3)
------ ------ ------ ------
INCOME BEFORE INCOME TAXES .......... 18.6 15.5 15.8 12.1
PROVISION FOR INCOME TAXES .......... 6.8 5.9 5.9 4.6
------ ------ ------ ------
INCOME BEFORE CHANGE IN
ACCOUNTING PRINCIPLE............... 11.8% 9.6% 9.9% 7.5%
====== ====== ====== ======
CRITICAL ACCOUNTING POLICIES
- ----------------------------
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States requires management to use estimates.
Several different estimates or methods can be used by management that might
yield different results. The following are the significant estimates used by
management in the preparation of the May 31, 2003 financial statements:
Allowance For Doubtful Accounts
-------------------------------
As of May 31, 2003, an estimate was made of the collectibility of the
outstanding accounts receivable balances. This estimate requires the utilization
of outside credit services, knowledge about the customer and the customer's
industry, new developments in the customer's industry and operating results of
the customer, as well as general economic conditions and historical trends. When
all these facts are compiled a judgment as to the collectibility of the
individual account is made. As noted above, many factors can impact this
estimate. The adequacy of the estimated reserve may be impacted by the
deterioration of a large customer or weakness in the economic environment
resulting in a higher level of customer bankruptcy filings. There have been no
material changes in our estimate during the quarter ended May 31, 2003.
Product Return Allowances
-------------------------
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 return products for a variety of
reasons. Examples include products damaged in transit, discontinuance of a
particular size or form of product and shipping errors. As sales are recorded we
accrue an estimated amount for product returns based upon our historical
experience and any known specific events that affect the accrual. We charge the
allowance account resulting from this accrual with any authorized product
returns upon receipt of the product or deduction from remittance by the
customer.
26
During the second quarter of 2003 we revised downward our estimate of returns
related to our SUNSOURCE line of products. This resulted in a reduction in the
allowance of approximately $110 during the second quarter of 2003. The estimate
was revised downward due to the stronger than expected performance of certain
items in the SUNSOURCE line. Previously we had expected some loss in
distribution and had increased our estimate of returns to provide for this loss
in distribution. The stronger than expected performance in the second quarter
has reduced the potential amount of product to be returned.
In accordance with industry practice, we allow our customers to return unsold
sun care products at the end of the sun care season. We record the sales at the
time the products are shipped and title transfers. At the time of shipment we
also record a reduction in sales and a reserve on our balance sheet for
anticipated returns based upon an estimated return level. The level of returns
may fluctuate from our estimates due to several factors including weather
conditions, customer inventory levels and competitive conditions. Each
percentage point change in our return rate would impact our net sales by
approximately $100.
Promotional Accrual
-------------------
We routinely enter into agreements with our customers to participate in
promotional programs. These programs generally take the form of coupons,
temporary price reductions, scan downs and participations in advertising
vehicles produced by the customer. The ultimate cost of these programs is often
variable based on the number of units actually sold. Estimated unit sales of a
product under a promotional program are used to estimate the total cost of the
program. Actual results can differ from the original estimate. We also consider
customer delays in requesting promotional program payments when evaluating the
required accrual. Many customers audit programs significantly after the date of
performance to determine the actual amount due and make a claim for
reimbursement at that time. As a result, changes in the unit sales trends under
promotional programs as well as the timing of payments could result in changes
in the accrual.
Income taxes
------------
We record tax expense in our financial statements based on an estimated annual
effective tax rate. During the second quarter of fiscal 2003 we revised our
estimated annual effective tax rate based on the implementation of state tax
planning strategies. This revision resulted in a decrease in the annual
effective tax rate to 37% from 38%, or a reduction in tax expense of $192 during
the second quarter of fiscal 2003.
For a summary of our significant accounting policies, see Note 2 of Notes to
Consolidated Financial Statements included in our Annual Report on Form 10-K for
the year ended November 30, 2002.
COMPARISON OF THREE MONTHS ENDED MAY 31, 2003 AND 2002
- ------------------------------------------------------
Our total revenues for the three months ended May 31, 2003, comprised of net
sales and royalties from the international sales of SELSUN BLUE, increased
$4,961, or 8.5%, to $63,633 from $58,672 for the same period last year. Domestic
sales increased $2,733, or 5.1%, to $56,181 from $53,448 for last year's
comparable period. International revenues, including the royalties described
above, increased $2,228, or 42.6%, from $5,224 in the fiscal 2002 period to
$7,452 in the current period.
A comparison of domestic sales for the categories of products included in our
portfolio of OTC healthcare products is as follows:
For the Three Months
Ended May 31
--------------------
2003 2002
-------- --------
Topical analgesics .................. $ 14,626 $ 15,886
Medicated skin care products......... 14,912 12,404
Dietary supplements ................. 10,963 11,682
Medicated dandruff shampoos ......... 6,641 3,810
Other OTC products .................. 9,039 9,666
-------- --------
Total ............................. $ 56,181 $ 53,448
======== ========
27
For domestic consumer products in the 2003 period, sales increases were
recognized for our medicated dandruff shampoo and medicated skin care
categories. SELSUN BLUE medicated dandruff shampoo (acquired in March, 2002)
achieved a 57% domestic net sales increase in the second quarter of fiscal 2003
as compared to the same period of fiscal 2002. Had sales under Abbott
Laboratories for the period March 1, 2002 to March 28, 2002 been included in the
fiscal 2002 amount, the sales increase would have been 1.5% compared to the same
period in 2002. The sales increase for the medicated skin care category was due
in part to net sales of the GOLD BOND product line which increased 11% in the
current fiscal quarter over the same period last year, led by the introduction
of GOLD BOND Antifungal Foot Swabs, GOLD BOND First Aid Quick Spray and GOLD
BOND First Aid Wipes. In addition PHISODERM net sales increased 24% over the
corresponding year-ago period largely as a result of the introduction in fiscal
2002 of PHISODERM Clear Confidence Acne Body Wash, PHISODERM Clear Confidence
Acne Facial Masque and PHISODERM Clear Confidence Acne Clear Swab. Sales
declines were recorded for our topical analgesic portfolio (ICY HOT, FLEXALL,
ASPERCREME, SPORTSCREME, CAPZASIN and ARTHRITIS HOT). The sales decline for our
topical analgesics reflects the strong sales in this category in the prior year
period as a result of the introduction of the ICY HOT Patch and increased
competition within the topical analgesic category. The sales decrease in the
dietary supplements category was due to a decrease in sales of DEXATRIM which
was hurt by negative publicity surrounding the diet pill category, and the
introduction of DEXATRIM Results in the comparable period last year. This was
offset by strong sales of GARLIQUE whose net sales rose 18% in the year-to-year
comparison. The sales decrease in the other OTC products category was due to the
results of PAMPRIN and PREMSYN PMS which continued to suffer sales declines due
to competitive reasons.
For international operations, the Canadian business produced a 42.8 % sales
increase, largely as a result of the acquisition of SELSUN BLUE in March 2002
and the continuing growth of SUN-IN and PHISODERM sales in Canada. The U.K.
operations showed a 61.4 % sales increase, primarily due to our acquisition of
SELSUN BLUE and sales of our OTC drug brands in Eastern Europe and elsewhere.
Other international sales increased 13.6 %, almost entirely as a result of the
acquisition of SELSUN BLUE in the second quarter of fiscal 2002. For both the
domestic and international operations, sales variances were principally the
result of change in the volume of unit sales of the particular brand with the
exception of NEW PHASE, for which a sales increase was partially due to a unit
sales price increase.
Cost of sales as a percentage of total revenues was 27.9% for the second
quarter of fiscal 2003 as compared to 28.4% for the same period in fiscal 2002.
The reduction in cost of sales as a percentage of total revenues is the result
of our moving the domestic production of SELSUN BLUE to our facility in
Chattanooga which has decreased our cost of production.
Advertising and promotion expenses increased $434, or 2.4%, to $18,529 in
the current period as compared to $18,095 in the same period last year, and were
29.1% of total revenues for the three months ended May 31, 2003 compared to
30.8% for the comparable period of fiscal 2002. Increases in advertising and
promotion expenditures in the current period were recorded for SELSUN BLUE, the
recently introduced GOLD BOND products, PHISODERM, and NEW PHASE of the
SUNSOURCE product line. Decreases of advertising and promotion expenditures were
recognized for most of the topical analgesic brands, DEXATRIM, MUDD, PAMPRIN,
the other GOLD BOND products and GARLIQUE.
Selling, general and administrative expenses increased $858, or 9.0%, to
$10,397 in the second quarter of fiscal 2003 as compared to $9,539 in the same
quarter of fiscal 2002 and were 16.3% of total revenues for both periods. The
increase in selling, general and administrative expenses was largely a result of
increased compensation costs of $668 related to a restricted stock grant,
increased selling expenses due to increased sales and increases in
administrative costs.
Interest expense decreased $76, or 1.4%, to $5,227 for the three months
ended May 31, 2003 as compared to $5,303 in the same period last year. The
decrease was largely the result of lower outstanding balances due to principal
payments on the $45,000 credit facility borrowed to partially fund the
28
acquisition of the SELSUN BLUE product line in March 2002, partially offset by
the write off of $145 of deferred financing costs resulting from prepayments on
the term loan facility. Until our indebtedness is reduced substantially,
interest expense will continue to represent a significant percentage of our
total revenues.
Investment and other income decreased $5, or 8.6%, to $53 in the current
period as compared to $58 in the same period of fiscal 2002. This decrease was
primarily due to a decline in interest income as a result of our use of $31,380
cash and cash equivalents to partially finance our acquisition of the SELSUN
BLUE product line in March 2002 as well as lower interest rates on short-term
investments.
Net income increased $1,886, or 33.5%, to $7,521 for the second quarter of
fiscal 2003 as compared to $5,635 in same quarter of fiscal 2002. This increase
primarily resulted from increased revenues and lower costs and expenses as a
percentage of revenues.
COMPARISON OF SIX MONTHS ENDED MAY 31, 2003 AND 2002
Our total revenues for the six months ended May 31, 2003, comprised of net
sales and royalties from the international sales of SELSUN BLUE, increased
$14,972, or 14.0%, to $122,058 from $107,086 for the same period last year.
Domestic sales increased $10,032, or 10.2 %, to $108,861 from $98,829 for last
year's comparable period. International revenues, including the royalties
described above, increased $4,940, or 59.8%, from $8,257 in the fiscal 2002
period to $13,197 in the current period.
A comparison of domestic sales for the categories of products included in
our portfolio of OTC healthcare products is as follows:
For the Six Months
Ended May 31
---------------------
2003 2002
-------- --------
Topical analgesics ...................... $ 28,198 $ 30,408
Medicated skin care products............. 28,062 23,942
Dietary supplements ..................... 20,568 21,918
Medicated dandruff shampoos ............. 14,812 3,822
Other OTC products ...................... 17,221 18,739
-------- --------
Total ................................. $108,861 $ 98,829
======== ========
For domestic consumer products in the 2003 period, sales increases were
recognized for our medicated dandruff shampoo and medicated skin care
categories. SELSUN BLUE medicated dandruff shampoo (acquired in March 2002)
achieved a 275 % domestic net sales increase in the first six months of fiscal
2003 as compared to the same period of fiscal 2002. Had sales under Abbott
Laboratories for the first quarter and the period March 1, 2002 to March 28,
2002 been included the sales increase would have been 8.1% compared to the same
period in fiscal 2002. The sales increase for the medicated skin care category
was due in part to net sales of the GOLD BOND product line which increased 11%
in the current six month period over the same period last year, led by the
introduction of GOLD BOND Antifungal Foot Swabs, GOLD BOND First Aid Quick Spray
and GOLD BOND First Aid Wipes. In addition, PHISODERM net sales increased 19%
over the corresponding year-ago period largely as a result of the introduction
in fiscal 2002 of PHISODERM Clear Confidence Acne Body Wash, PHISODERM Clear
Confidence Acne Facial Masque and PHISODERM Clear Confidence Acne Clear Swab.
29
Sales declines were recorded for our topical analgesic portfolio (ICY HOT,
FLEXALL, ASPERCREME, SPORTSCREME, CAPZASIN and ARTHRITIS HOT). The sales decline
for our topical analgesics reflects the strong sales in this category in the
prior year period as a result of the introduction of the ICY HOT Patch and
increased competition within the topical analgesic category. The sales decrease
in the dietary supplement category was due to a decrease in sales of DEXATRIM
which was hurt by negative publicity surrounding the diet pill category, and the
introduction of DEXATRIM Results in the comparable period last year. This was
offset by strong sales of GARLIQUE whose net sales rose 23% in the year-to-year
comparison. Sales of the other SUNSOURCE brands declined in the year to year
comparison. The sales decrease in the other OTC products category was due
primarily to the results of PAMPRIN and PREMSYN PMS which continued to suffer
sales declines because of strong competition.
For international operations, the Canadian business produced a 47.6 % sales
increase, largely as a result of the acquisition of SELSUN BLUE in March 2002
and the continuing growth of GOLD BOND Medicated Lotion and PHISODERM sales in
Canada. The U.K. operations showed a 73.8% sales increase, primarily due to our
acquisition of SELSUN BLUE and sales of our OTC drug brands in Eastern Europe
and elsewhere. Other international sales increased 53.6 %, almost entirely as a
result of the acquisition of SELSUN BLUE in the second quarter of fiscal 2002.
For both the domestic and international operations, sales variances were
principally the result of change in the volume of unit sales of the particular
brand with the exception of NEW PHASE, for which a sales increase was partially
due to an increase in the unit sales price.
Cost of sales as a percentage of total revenues was 29.0% for the six
months ended May 31, 2003 as compared to 29.1% for the same period in fiscal
2002. The small reduction in cost of sales as a percentage of total revenues is
the result of our moving the domestic production of SELSUN BLUE to our facility
in Chattanooga which has decreased our cost of production. Inventory
obsolescence charges of $1,016, including $750 for the estimated cost of returns
of DEXATRIM containing ephedrine, were included in cost of sales for the six
months ended May 31, 2003.
Advertising and promotion expenses increased $2,965, or 8.7%, to $36,934 in
the six months ended May 31, 2003 as compared to $33,969 in the same period last
year, and were 30.3% of total revenues for the six months ended May 31, 2003
compared to 31.7% for the comparable period of fiscal 2002. Increases in
advertising and promotion expenditures in the first six months of 2003 were
recorded for SELSUN BLUE, the recently introduced GOLD BOND products, PHISODERM,
and NEW PHASE of the SUNSOURCE product line. Decreases of advertising and
promotion expenditures were recognized for most of the topical analgesic brands,
DEXATRIM, MUDD, PAMPRIN, the other GOLD BOND products and GARLIQUE.
Selling, general and administrative expenses increased $1,135, or 5.9%, to
$20,211 in the first six months of 2003 as compared to $19,076 in the same
period of fiscal 2002 and were 16.5% and 17.8% of total revenues, respectively.
The increase in selling, general and administrative expenses was largely a
result of increased compensation costs of $668 related to a restricted stock
grant, increased selling expenses due to increased sales and increases in
administrative costs. The decrease in the percentage of these expenses to total
revenues was due to cost savings programs and the increase in total revenues in
the comparison of the two fiscal periods.
Interest expense increased $230, or 2.3%, to $10,374 for the six months
ended May 31, 2003 as compared to $10,144 in the same period last year. The
increase was largely the result of the write off of $145 of deferred financing
costs resulting from prepayments on the term loan facility. Until our
indebtedness is reduced substantially, interest expense will continue to
represent a significant percentage of our total revenues.
Investment and other income decreased $77, or 47.0%, to $87 in the current
period as compared to $164 in the same period of fiscal 2002. This decrease was
primarily due to a decline in interest income as a result of our use of $31,380
cash and cash equivalents to partially finance our acquisition of the SELSUN
BLUE product line in March 2002 as well as lower interest rates on short-term
investments.
Income before change in accounting principle increased $4,103, or 51.2%, to
$12,110 for the six months ended May 31, 2003 as compared to $8,007 in same
period of fiscal 2002. This increase primarily resulted from increased revenues
and lower costs and expenses as a percentage of revenues.
30
In the first quarter of fiscal 2002, we adopted the provisions of SFAS No.
142, "Goodwill and Other Intangible Assets", which requires us to perform
annually certain fair value based tests of the carrying value of our indefinite
lived intangible assets and to discontinue amortization of our indefinite lived
intangible assets. Upon adoption of SFAS 142, we obtained independent appraisals
to determine the fair value of these assets as of December 1, 2001, and recorded
a write-down of $8,877, net of income tax benefit of $5,440, as a cumulative
effect of change in accounting principle and discontinued the amortization of
our indefinite lived intangible assets. The write-down was primarily related to
our SUNSOURCE product line, which has experienced a decline in sales volume
since its initial purchase in 1997 and to a lesser degree our DEXATRIM product
line, which discontinued the marketing of one of its products in November 2000.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
We have historically financed our operations with a combination of internally
generated funds and borrowings. Our principal uses of cash are for operating
expenses, long-term debt servicing, acquisitions, working capital, repurchases
of our common stock, payment of income taxes and capital expenditures.
Cash of $12,519 and $16,634 was provided by operations for the six months ended
May 31, 2003 and 2002, respectively. The decrease in cash flows from operations
over the prior year period was primarily the result of an increase in
inventories and a much smaller increase in accounts payable and accrued
liabilities, partially offset by an increase in net income from operations.
Investing activities used cash of $2,276 and $76,861 in the six months ended May
31, 2003 and 2002, respectively. The decrease in usage of cash in the current
period as compared to the same period of the prior year was primarily due to the
absence in the current period of the acquisition of a significant product line
such as the purchase of SELSUN BLUE in the comparable period of last year.
Financing activities used cash of $12,352 in the first six months of fiscal 2003
but provided cash of $42,538 in the same period of the prior year. The decrease
in cash provided in the current period as compared to the same period of the
prior year was largely the result of the absence in the current period of
additional borrowings that would be required to partially finance a significant
acquisition such as SELSUN BLUE which was acquired in the same period of last
year.
The following table presents working capital data at May 31, 2003 and November
30, 2002 or for the respective twelve months then ended:
Item 2003 2002
------------ ------- -------
Working capital (current assets less current liabilities) ... $36,249 $31,372
Current ratio (current assets divided by current liabilities) 1.86 1.76
Quick ratio (cash and cash equivalents and accounts
receivable divided by current liabilities) ................ 1.09 1.01
Average accounts receivable turnover ........................ 7.56 9.49
Average inventory turnover .................................. 3.78 3.80
Working capital as a percentage of total assets ............. 10.02% 8.82%
The increase in the current and quick ratios at May 31, 2003 as compared to
November 30, 2002 was primarily the result of an increase in accounts receivable
due to extended dating of invoices associated with the sale of our seasonal
products of SUN-IN, BULLFROG and ULTRASWIM offset in part by a decrease in cash
and cash equivalents due to repayments on our term loan and repurchases of our
common shares.
Total long-term debt outstanding was $208,442 at May 31, 2003 compared to
$217,458 at November 30, 2002. We have repaid $8,250 of long term debt during
the six months ended May 31, 2003.
Days sales outstanding in accounts receivable were 46.7 at May 31, 2003 as
compared to 47.2 at May 31, 2002. Our domestic days sales outstanding were 44.2
and 44.6 at May 31, 2003 and 2002, respectively.
31
As of July 1, 2003 we have been named as a defendant in approximately 320
lawsuits involving claims by approximately 1,500 plaintiffs alleging that the
plaintiffs were injured as a result of ingestion of products containing
phenylpropanolamine ("PPA"), which until November 2000 was the active ingredient
in certain of our DEXATRIM products. See Note 10 of Notes to Consolidated
Financial Statements for a discussion of these lawsuits.
As of May 31, 2003, the remaining amount authorized by our board of directors
under our stock buyback program was $6,100; however, we are limited in our
ability to repurchase shares due to restrictions under the terms of the
indenture with respect to which our senior subordinated notes were issued and
under the terms of our current credit facility. Also, on December 21, 1998, we
filed a shelf registration statement with the Securities and Exchange Commission
for $250,000 of debt and equity securities of which $75,000 was utilized in the
sale of the 8.875% notes in May 1999.
We believe that cash provided by operating activities, our cash and cash
equivalents balance and funds available under the revolver portion 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. It is likely that any acquisitions that we make
in the future will require us to obtain additional financing.
FOREIGN OPERATIONS
- ------------------
Historically, our primary foreign operations have been conducted through our
Canadian and United Kingdom subsidiaries. The currencies of these subsidiaries
are Canadian dollars and British pounds, respectively. Fluctuations in 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 six months ended May 31,
2003 and 2002, these subsidiaries accounted for 9% and 6% of total revenues,
respectively, and 3% of total asset for both periods, 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 payments between us
and our two foreign subsidiaries. Following our acquisition of SELSUN BLUE,
which is sold in approximately 90 foreign countries and had $20,100 of
international sales in 2001, our international business operations has expanded
significantly, which will increase our exposure to fluctuations in foreign
exchange rates. During the first six months of fiscal 2003, a large portion of
these foreign sales was reflected as royalties, which have been paid to us in
U.S. dollars. Historically, gains or losses from foreign currency transactions
have not had a material impact on our operating results. Gains (losses) of $175
and ($53) for the six months ended May 31, 2003 and 2002, respectively, resulted
from foreign currency transactions.
RECENT ACCOUNTING PRONOUNCEMENTS
- --------------------------------
In June 2001 the Financial Accounting Standards Board ("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 us on December 1, 2001, required 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.
Accordingly, we discontinued the amortization of the cost of these intangible
assets which consist solely of trademarks. The carrying value of these
trademarks was $244,680 as of May 31, 2003. Also in connection with the adoption
of SFAS 142, we 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 $.46 per diluted share. The write-down was primarily
related to our SUNSOURCE product line which has experienced a decline in sales
volume since its initial purchase in 1997 and to a lesser degree our DEXATRIM
product line, which discontinued the marketing of one of its products in
November 2000. This adjustment is shown as a cumulative effect of change in
accounting principle in the consolidated statement of income for the six months
ended May 31, 2002. After reviewing all pertinent information relating to the
revaluation of these intangible assets and performing the annual impairment test
as prescribed by SFAS 142 as of November 30, 2002 we determined that a
revaluation thereof was not required. The gross carrying amount and accumulated
32
amortization of our intangible assets subject to amortization, which consist
primarily of non-compete agreements were $2,400 and $1,172, respectively at May
31, 2003. For the three and six months ended May 31, 2003 and 2002 amortization
of our intangible assets subject to amortization was $44 and $97 and $85 and
$170, respectively.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections"
("SFAS 145"). SFAS 145, which was adopted by us effective December 1, 2002,
required us to classify gains and losses on extinguishments of debt as income or
loss from continuing operations rather than as extraordinary items as previously
required under FASB Statement No. 4. We are also required to reclassify any gain
or loss on extinguishment of debt previously classified as an extraordinary item
in prior periods presented. Our results of operations, financial position and
cash flows, therefore, will not be affected.
On December 31, 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS 148"). SFAS 148, which was
adopted by us on December 1, 2002, amends SFAS 123, "Accounting for Stock-Based
Compensation" and Accounting Principles Board Opinion No. 28, "Interim Financial
Reporting", to require disclosure in the summary of significant accounting
policies of the effects of an entity's accounting policy with respect to
stock-based employee compensation on reported net income and earnings per share
in annual and interim financial statements. The adoption of this pronouncement
did not have an impact on our results of operations, financial position or cash
flows.
FORWARD LOOKING STATEMENTS
- --------------------------
We 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. We rely 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. 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. We undertake
no obligation to update publicly any forward-looking statements whether as a
result of new information, future events or otherwise. The risks, uncertainties
and assumptions of the forward-looking statements include, but are not limited
to existing and possible additional 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 reduction of available insurance
coverage as proceeds are used to fund any product liability settlements or
awards; the possibility of other product liability claims including claims
relating to the existence of ephedrine in DEXATRIM products; our ability to fund
liabilities from product liability claims greater than our insurance coverage or
outside the scope of our insurance coverage; the impact of brand acquisitions
and divestitures; 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; our ability to sell and market SELSUN BLUE
internationally where we have only limited experience and infrastructure;
constraints resulting from our financial condition, including the degree to
which we are leveraged, debt service requirements and restrictions under
indentures and loan agreements; government regulations; risks of loss of
material customers; public perception regarding our products; dependence on
third party manufacturers; environmental matters; and other risks described in
our Securities and Exchange Commission filings.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
We are exposed to market risks from changes in interest rates and foreign
currency exchange rates, which may adversely affect our results of operations
and financial condition. We seek to minimize the risks from these interest rates
and foreign currency exchange rate fluctuations through our regular operating
and financing activities.
33
Our exposure to interest rate risks currently consists of our 8.875% Senior
Notes and our senior credit facility. The aggregate balance outstanding under
the 8.875% Senior Notes as of May 31, 2003 was $204,692. Should interest rates
increase or decrease, the estimated fair value of these notes would decrease or
increase, respectively. Loans under our senior credit facility bear interest at
a rate equal to the higher of LIBOR or the federal funds rate plus .05% plus
percentages ranging from .75% to 1.5% depending on our leverage. As of May 31,
2003, the variable rate on the term loan under our senior credit facility was
3.54%. The balance outstanding under our term loan was $11,750 as of May 31,
2003. The impact of a one-point rate change on the outstanding balance of our
term loan on our results of operations for the second quarter of fiscal 2003
would be approximately $19, net of tax. As of May 31, 2003, no revolving credit
loans or letters of credit were outstanding under our senior credit facility.
We are subject to risk from changes in the foreign exchange rates relating to
our Canadian and United Kingdom subsidiaries. Assets and liabilities of these
subsidiaries are translated to United States dollars at year-end exchange rates.
Income and expense items are translated at average rates of exchange prevailing
during the year. Translation adjustments are accumulated as a separate component
of shareholders' equity. Gains and losses which result from foreign currency
transactions are included in the accompanying consolidated statements of income.
The potential loss resulting from a hypothetical 10.0% adverse change in the
quoted foreign currency exchange rate amounts to approximately $957 at May 31,
2003.
This market risk discussion contains forward-looking statements. Actual results
may differ materially from this discussion based upon general market conditions
and changes in financial markets.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Our Chief
Executive Officer and Chief Financial Officer have evaluated the effectiveness
of our disclosure controls and procedures (as such terms are defined in Rules
13(a)-14(c) and 15(d)-14(c) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act") (as of the date within 90 days prior to the filing
date of this Form 10-Q (the "Evaluation Date")). Based on such evaluation, such
officers have concluded that, as of the Evaluation Date, our disclosure controls
and procedures are effective in alerting them on a timely basis to material
information relating to us (including our consolidated subsidiaries) required to
be included in our periodic filings under the Exchange Act.
(b) Changes in Internal Controls. Since the Evaluation Date, there
have not been any significant changes in our internal controls or in other
factors that could significantly affect such controls.
34
PART II. OTHER INFORMATION
--------------------------
ITEM 1. LEGAL PROCEEDINGS
See Note 10 of Notes to Consolidated Financial Statements (unaudited)
included in Part 1, Item 1 of this Form 10-Q.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of shareholders was held on April 16, 2003 in
Chattanooga, Tennessee. At the meeting, the following persons were elected as
directors to serve for a three year term: Robert E. Bosworth (12,663,494 votes
for and 5,424,316 votes withheld) and Richard E. Cheney (17,115,920 votes for
and 971,890 votes withheld), The following directors' terms of office continued
after the annual meeting: A. Alexander Taylor II, Samuel E. Allen, Philip H.
Sanford, Bill W. Stacy and Zan Guerry.
The shareholders also approved our 2003 Stock Incentive Plan with
11,732,201 votes for the plan, 2,368,836 voting against and 3,986,733
abstentions.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Restricted Stock Agreement dated May 29, 2003 between Chattem,
Inc. and Zan Guerry (Exhibit 10.1).
First Amendment to the Second Amended and Restated Master
Trademark License Agreement between Signal Investment &
Management Co. and Chattem, Inc., effective May 31, 2003 (Exhibit
10.2).
First Amendment to Master Trademark License Agreement between
Signal Investment & Management Co. and SunDex, LLC, effective May
31, 2003 (Exhibit 10.3).
Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
(Exhibit 99).
(b) The following Form 8-K report was filed with the Securities and
Exchange Commission during the three months ended May 31, 2003:
Report on Form 8-K dated May 7, 2003 to report settlement of the
previously disclosed case, Jennifer Villarreal et al. vs.
Chattem, Inc. et al.
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: July 14, 2003 /s/ A. Alexander Taylor II
------------- ---------------------------
A. Alexander Taylor II
President and Director
(Chief Operating Officer)
Dated: July 14, 2003 /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.
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: July 14, 2003 /s/ Zan Guerry
------------- ------------------------
Zan Guerry, Chairman and
Chief Executive Officer
37
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 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.
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: July 14, 2003 /s/ Richard D. Moss
------------- ------------------------
Richard D. Moss,
Vice President and
Chief Financial Officer
38
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
EXHIBIT INDEX
-------------
Exhibit Number Description of Exhibit
- -------------- ----------------------
10.1 Restricted Stock Agreement dated May 29, 2003 between Chattem,
Inc. and Zan Guerry.
10.2 First Amendment to the Second Amended and Restated Master
Trademark License Agreement between Signal Investment &
Management Co. and Chattem, Inc., effective May 31, 2003.
10.3 First Amendment to Master Trademark License Agreement between
Signal Investment & Management Co. and SunDex, LLC. effective
May 31, 2003.
99 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
39