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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED AUGUST 31, 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 OCTOBER 9, 2003 19,159,379 SHARES OF THE COMPANY'S COMMON STOCK, WITHOUT
PAR VALUE, WERE OUTSTANDING.
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CHATTEM, INC.
-------------
INDEX
-----
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of
August 31, 2003 and November 30, 2002 ................ 3
Consolidated Statements of Income for
the Three and Nine Months Ended August
31, 2003 and 2002..................................... 5
Consolidated Statements of Cash Flows
for the Nine Months Ended August 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 ........ 25
Item 3. Quantitative and Qualitative Disclosures
About Market Risks.................................... 37
Item 4. Controls and Procedures............................... 37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................... 38
Item 2. Changes in Securities and Use of Proceeds............. 38
Item 3. Defaults Upon Senior Securities....................... 38
Item 4. Submission of Matters to a Vote of Security Holders... 38
Item 5. Other Information..................................... 38
Item 6. Exhibits and Reports on Form 8-K ..................... 38
SIGNATURES ............................................................... 39
2
PART 1. FINANCIAL INFORMATION
-----------------------------
ITEM 1. FINANCIAL STATEMENTS
- -------------------------------
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
(In thousands)
AUGUST 31, NOVEMBER 30,
ASSETS 2003 2002
- ------ -------- --------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents ..................................... $ 21,721 $ 15,924
Accounts receivable, less allowances of $5,155 at
August 31, 2003 and $3,897 at November 30, 2002 ............. 28,540 25,673
Refundable and deferred income taxes .......................... 11,857 9,837
Inventories ................................................... 19,778 18,769
Prepaid expenses and other current assets ..................... 3,148 2,184
-------- --------
Total current assets ........................................ 85,044 72,387
-------- --------
PROPERTY, PLANT AND EQUIPMENT, NET .............................. 28,132 26,658
-------- --------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net ... 245,906 245,787
Debt issuance costs, net ...................................... 5,867 7,126
Other ......................................................... 3,931 3,605
-------- --------
Total other noncurrent assets ............................... 255,704 256,518
-------- --------
TOTAL ASSETS .............................................. $368,880 $355,563
======== ========
The accompanying notes are an integral part of these consolidated financial statements.
3
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
(In thousands)
AUGUST 31, NOVEMBER 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 2003 2002
- ------------------------------------ -------- --------
(Unaudited)
CURRENT LIABILITIES:
Current maturities of long-term debt ......................... $ 8,250 $ 7,250
Accounts payable ............................................. 9,798 12,209
Payable to bank .............................................. 425 452
Accrued liabilities .......................................... 22,777 21,104
-------- --------
Total current liabilities .................................. 41,250 41,015
-------- --------
LONG-TERM DEBT, less current maturities ......................... 206,434 217,458
-------- --------
DEFERRED INCOME TAXES ........................................... 27,388 20,744
-------- --------
OTHER NONCURRENT LIABILITIES .................................... 1,671 1,602
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 15)
SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized 1,000,
none issued ................................................. -- --
Common shares, without par value, authorized 50,000,
issued 19,157 at August 31, 2003 and 19,177 at
November 30, 2002 ........................................... 77,811 79,313
Retained earnings (deficit) .................................. 17,850 (1,097)
-------- --------
95,661 78,216
Unamortized value of restricted common shares issued .......... (2,253) (1,713)
Cumulative other comprehensive income:
Foreign currency translation adjustment ..................... (1,271) (1,759)
-------- --------
Total shareholders' equity ................................. 92,137 74,744
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY ................................................ $368,880 $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 NINE MONTHS
ENDED AUGUST 31, ENDED AUGUST 31,
--------------------------- ---------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
REVENUES:
Net sales .............................................. $ 58,972 $ 63,457 $ 180,366 $ 169,617
Royalties .............................................. 210 947 874 1,873
--------- --------- --------- ---------
Total revenues ....................................... 59,182 64,404 181,240 171,490
--------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales .......................................... 15,995 17,526 51,399 48,673
Advertising and promotion .............................. 17,075 21,307 54,009 55,276
Selling, general and administrative .................... 10,234 9,926 30,445 29,002
--------- --------- --------- ---------
Total costs and expenses ............................. 43,304 48,759 135,853 132,951
--------- --------- --------- ---------
INCOME FROM OPERATIONS ................................... 15,878 15,645 45,387 38,539
--------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense ....................................... (5,057) (5,374) (15,431) (15,518)
Investment and other income, net ....................... 32 79 119 243
--------- --------- --------- ---------
Total other income (expense) ......................... (5,025) (5,295) (15,312) (15,275)
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES AND CHANGE
IN ACCOUNTING PRINCIPLE ................................ 10,853 10,350 30,075 23,264
PROVISION FOR INCOME TAXES ............................... 4,016 3,933 11,128 8,840
--------- --------- --------- ---------
INCOME BEFORE CHANGE IN ACCOUNTING
PRINCIPLE .............................................. 6,837 6,417 18,947 14,424
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE, NET OF INCOME TAX
BENEFIT ................................................ -- -- -- (8,877)
--------- --------- --------- ---------
NET INCOME ............................................... $ 6,837 $ 6,417 $ 18,947 $ 5,547
========= ========= ========= =========
NUMBER OF COMMON SHARES:
Weighted average outstanding-basic ..................... 19,148 18,940 19,178 18,458
========= ========= ========= =========
Weighted average and potential dilutive outstanding .... 19,905 19,870 19,897 19,246
========= ========= ========= =========
NET INCOME PER COMMON SHARE:
Basic:
Income before change in accounting principle ......... $ .36 $ .34 $ .99 $ .78
Change in accounting principle ....................... -- -- -- (.48)
--------- --------- --------- ---------
Total basic ........................................ $ .36 $ .34 $ .99 $ .30
========= ========= ========= =========
Diluted:
Income before change in accounting principle ......... $ .34 $ .32 $ .95 $ .75
Change in accounting principle ....................... -- -- -- (.46)
--------- --------- --------- ---------
Total diluted ...................................... $ .34 $ .32 $ .95 $ .29
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements.
5
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(Unaudited and in thousands, except share and per share amounts)
FOR THE NINE MONTHS ENDED
AUGUST 31,
------------------------
2003 2002
-------- --------
OPERATING ACTIVITIES:
Net income .................................................... $ 18,947 $ 5,547
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ............................. 4,565 3,969
Increase in deferred income taxes ......................... 5,907 4,333
Cumulative effect of change in accounting principle, net .. -- 8,877
Stock option charge ....................................... -- 175
Other, net ................................................ (94) (75)
Changes in operating assets and liabilities, net of product
acquisition:
Accounts receivable ..................................... (2,867) (8,290)
Refundable income taxes ................................. 40 1,031
Inventories ............................................. (1,009) (244)
Prepaid expenses and other current assets ............... (964) (354)
Accounts payable and accrued liabilities ................ (778) 21,037
-------- --------
Net cash provided by operating activities ............ 23,747 36,006
-------- --------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment .................... (3,933) (2,622)
Purchases of patents, trademarks and other product rights ..... (373) (74,996)
Decrease in other assets, net ................................. 108 254
-------- --------
Net cash used in investing activities ................ (4,198) (77,364)
-------- --------
FINANCING ACTIVITIES:
Repayment of long-term debt ................................... (10,000) (8,000)
Proceeds from long-term debt .................................. -- 45,000
Proceeds from exercise of stock options ....................... 1,533 6,146
Repurchase of common shares ................................... (5,351) (1,650)
Change in payable to bank ..................................... (27) 62
Debt issuance costs ........................................... (25) (1,133)
-------- --------
Net cash (used in) provided by financing activities .. (13,870) 40,425
-------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND
CASH EQUIVALENTS .............................................. 118 113
-------- --------
CASH AND CASH EQUIVALENTS:
Increase (decrease) for the period ............................ 5,797 (820)
At beginning of period ........................................ 15,924 35,445
-------- --------
At end of period .............................................. $ 21,721 $ 34,625
======== ========
SCHEDULE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:
Issuance of 69,000 shares of restricted common stock at a value
of $14.50 per share ......................................... $ 1,000 $ --
PAYMENTS FOR:
Interest ...................................................... $ 9,916 $ 9,862
Taxes ......................................................... $ 2,680 $ 536
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 and share amounts are expressed in thousands 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. BASIS OF PRESENTATION
---------------------
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. CASH AND CASH EQUIVALENTS
-------------------------
We consider all short-term deposits and investments with original
maturities of three months or less to be cash equivalents.
3. RECLASSIFICATIONS
-----------------
Certain prior year amounts have been reclassified to conform to the current
period's presentation.
4. RECENT ACCOUNTING PRONOUNCEMENTS
--------------------------------
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting
for Asset Retirement Obligations" ("SFAS 143"). We adopted SFAS 143 on
December 1, 2002. SFAS 143 establishes accounting standards for the
recognition and measurement of an asset retirement obligation and its
associated asset retirement cost. It also provides accounting guidance for
legal obligations associated with the retirement of tangible long-lived
assets. The adoption of SFAS 143 did not have an impact on our financial
position, results of operations or cash flows.
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"). We adopted SFAS 145 on December 1, 2002. SFAS
145 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 SFAS No. 4, "Reporting Gains and Losses
from Extinguishment of Debt". We are also required to reclassify any gain
or loss on extinguishment of debt previously classified as an extraordinary
item in prior periods presented. SFAS 145 also provides accounting
standards for certain lease modifications that have economic effects
similar to sale-leaseback transactions and various other technical
corrections. The adoption of SFAS 145 did not have an impact on our
financial position, results of operations or cash flows.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). We adopted SFAS
146 on January 1, 2003. SFAS 146 supercedes Emerging Issues Task Force
Issue No. 94-3. SFAS 146 requires that the liability for a cost associated
with an exit or disposal activity be recognized when the liability is
incurred, not at the date of an entity's commitment to an exit or disposal
plan. SFAS 146 is to be applied prospectively to exit or disposal
activities initiated after December 31, 2002. The adoption of SFAS 146 did
not have an impact on our financial position, results of operations or cash
flows.
7
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 supercedes
Interpretation No. 34, "Disclosure of Indirect Guarantees of Indebtedness
of Others," and provides guidance on the recognition and disclosures to be
made by a guarantor in its interim and annual financial statements about
its obligations under certain guarantees. The initial recognition and
measurement provisions of FIN 45 are effective for guarantees issued or
modified after December 31, 2002 and are to be applied prospectively. The
disclosure requirements are effective for financial statements for interim
or annual periods ending after December 15, 2002. We had no instruments or
guarantees that required additional or enhanced disclosure under FIN 45 at
August 31, 2003, and no guarantees issued or modified after December 31,
2002 that required recognition and measurement in accordance with the
provisions of FIN 45, except as disclosed in Note 19. The adoption of FIN
45 did not have an impact on our financial position, results of operations
or cash flows.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure" ("SFAS 148"). SFAS 148 amends SFAS
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") to provide
alternative methods of transition for a voluntary change to the
fair-value-based method of accounting for stock-based employee
compensation. SFAS 148 also amends Accounting Principles Board Opinion No.
28, "Interim Financial Reporting" ("APB 28"), 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 transition guidance and annual disclosure provisions of
SFAS 148 are effective for fiscal years ending December 31, 2002. We
implemented the interim disclosure provision in our first fiscal quarter of
2003. The adoption of SFAS 148 did not have an impact on our financial
position, results of operations or cash flows.
In January 2003, the FASB issued Interpretation No. 46, " Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 requires a company to
consolidate a variable interest entity ("VIE"), as defined, when the
company will absorb a majority of the VIE's expected losses, receives a
majority of the VIE's expected residual returns or both. FIN 46 also
requires consolidation of existing, non-controlled affiliates if the VIE is
unable to finance its operations without investor support, or where the
other investors do not have exposure to the significant risks and rewards
of ownership. FIN 46 applies immediately to a VIE created or acquired after
January 31, 2003. For a VIE created before February 1, 2003, FIN 46 applies
in the first fiscal year or interim period beginning after June 15, 2003.
The adoption of FIN 46 did not have an impact on our financial position,
results of operations or cash flows.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149
amends and clarifies accounting for derivative instruments, including
certain derivative instruments embedded in other contracts and for hedging
activities under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." SFAS 149 is generally effective for derivative
instruments, including derivative instruments embedded in certain
contracts, entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The adoption of SFAS 149 did
not have an impact on our financial position, results of operations or cash
flows.
In July 2003, the Emerging Issues Task Force ("EITF") reached a consensus
on Issue No. 03-11, "Reporting Gains and Losses on Derivative Instruments
and Hedging Activities, and Not Held for Trading Purposes" ("EITF 03-11").
EITF 03-11 addresses when gains and losses on derivative contracts not held
for trading purposes should be reported on a net basis. The adoption of
EITF 03-11 did not have an impact on our financial position, results of
operations or cash flows.
5. STOCK-BASED COMPENSATION
------------------------
Our 1998 Non-Statutory Stock Option Plan provides for the issuance of up to
1,400 shares of common stock to key employees, while the 1999 Non-Statutory
Stock Option Plan for Non-Employee Directors allows for the issuance of up
to 200 shares of common stock. The 2000 Non-Statutory Stock Option Plan
provides for the issuance of up to 1,500 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
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.
8
For SFAS 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%, respectively, risk-free interest rates
of 4.47% and 4.14%, respectively, and expected lives of six years.
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 123, our net income and net income per share would have been adjusted
to the pro forma amounts for the three and nine months ended August 31,
2003 and 2002, as indicated below:
For the Three Months For the Nine Months
Ended August 31, Ended August 31,
-------------------- ---------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net income:
As reported...................... $ 6,837 $ 6,417 $ 18,947 $ 5,547
Compensation costs............... 516 491 1,552 1,321
-------- -------- -------- --------
Pro forma........................ $ 6,321 $ 5,926 $ 17,395 $ 4,226
======== ======== ======== ========
Net income per share, basic:
As reported...................... $ .36 $ .34 $ .99 $ .30
Pro forma........................ $ .33 $ .31 $ .91 $ .23
Net income per share, diluted:
As reported...................... $ .34 $ .32 $ .95 $ .29
Pro forma........................ $ .32 $ .30 $ .87 $ .22
6. PATENT, TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS
-----------------------------------------------------
With our adoption of SFAS No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"), on December 1, 2001, we obtained independent appraisals to
determine the fair values of our intangible assets 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. These
charges, which are reported in our Consolidated Statements of Income as a
cumulative effect of change in accounting principle, relate to our
SUNSOURCE product line, which 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 if its products in November
2000. 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 carrying value of trademarks,
which are not subject to amortization under the provisions of SFAS 142, was
$244,763 and $244,390 as of August 31, 2003 and November 30, 2002,
respectively.
The gross carrying amount of intangible assets subject to amortization at
both August 31, 2003 and November 30, 2002, which consist primarily of
non-compete agreements, was $2,400. The related accumulated amortization of
intangible assets at August 31, 2003 and November 30, 2002, was $1,257 and
$1,002, respectively. Amortization of our intangible assets subject to
amortization under the provisions of SFAS 142 was $85 for the three months
ended August 31, 2003 and 2002, respectively, and $255 and $183 for the
nine months ended August 31, 2003 and 2002, respectively. Estimated annual
amortization expense for these assets for the years ended November 30,
2003, 2004, 2005, 2006 and 2007 is $340, $294, $290, $290 and $123,
respectively.
9
7. ADVERTISING EXPENSES
--------------------
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 APB 28) and adjusting that
accrual to the actual expenses incurred at the end of the year.
8. SHIPPING AND HANDLING
---------------------
Shipping and handling costs of $1,602 and $1,365 are included in selling
expenses for the three months ended August 31, 2003 and 2002, respectively,
and $4,647 and $4,521 for the nine months ended August 31, 2003 and 2002,
respectively.
9. CONCENTRATIONS OF CREDIT RISK
-----------------------------
On January 22, 2002, Kmart Corporation ("Kmart"), a customer 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 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 August 31,
2003 and November 30, 2002 our receivables from Kmart were approximately
$940 and $796, respectively. We consider the August 31, 2003 balance
collectible as substantially all of the balance was collected subsequent to
that date.
10. INVENTORIES
-----------
Inventories consisted of the following at August 31, 2003 and November 30,
2002:
2003 2002
----------- -----------
Raw materials and work in process $ 8,218 $ 9,104
Finished goods .......................... 13,287 11,392
Excess of current cost over LIFO
values ................................ (1,727) (1,727)
----------- -----------
Total inventories ................... $ 19,778 $ 18,769
=========== ===========
10
11. ACCRUED LIABILITIES
-------------------
Accrued liabilities consisted of the following at August 31, 2003 and
November 30, 2002:
2003 2002
--------- ---------
Interest..................................... $ 7,601 $ 3,366
Salaries, wages, commissions and pensions.... 2,742 3,739
Product advertising and promotion............ 4,620 7,524
Product acquisitions......................... 501 737
Taxes........................................ 4,292 1,993
Consulting fees.............................. 485 747
Legal fees................................... 205 789
Insurance.................................... 1,092 934
Other ....................................... 1,239 1,275
--------- ---------
Total accrued liabilities ............... $ 22,777 $ 21,104
========= =========
12. LONG-TERM DEBT
--------------
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 covenants,
representations, warranties and other agreements by us that are customary
in credit agreements and security instruments relating to financings of
this type. At August 31, 2003, we owed $10,000 of the term loan of the
Credit Facility and no outstanding balance under its revolving loan
provision.
Although we entered into a preliminary agreement to amend the Credit
Facility on May 23, 2003 to increase the revolving line of credit from
$15,000 to $50,000 and modify certain other terms and conditions, we did
not complete this amendment. On August 22, 2003, the Credit Facility was
amended to revise the restrictions on the amount of capital expenditures
allowed and the dollar amount of our common stock we can purchase, redeem,
acquire or retire.
13. COMPREHENSIVE INCOME
--------------------
Comprehensive income consisted of the following components for the three
and nine months ended August 31, 2003 and 2002, respectively:
For the Three Months For the Nine Months
Ended August 31, Ended August 31,
------------------- -------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net income................. $ 6,837 $ 6,417 $ 18,947 $ 5,547
Other - foreign currency
translation adjustment.... 171 426 488 477
-------- -------- -------- --------
Total................... $ 7,008 $ 6,843 $ 19,435 $ 6,024
======== ======== ======== ========
14. STOCK BUYBACK
-------------
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
shares, before the two-for-one split of our common stock on November 29,
2002, had been reacquired through November 30, 2002 at a cost of $15,225.
In January 2003, our board of directors increased the total authorization
to repurchase our common stock under the buyback
11
program to $10,000. In the first nine months of fiscal 2003, we repurchased
360 shares of our common stock for $5,351. All repurchased shares were
retired and returned to unisssued. At August 31, 2003, $4,649 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% senior
subordinated notes were issued and under the terms of the Credit Facility.
The amendment to the Credit Facility on August 22, 2003 modified the
restrictions to repurchase shares at levels consistent with the current
board authorization (see discussion in Note 12).
15. COMMITMENTS AND CONTINGENCIES
-----------------------------
GENERAL LITIGATION
------------------
As of October 1, 2003, we are named as a defendant in approximately 300
lawsuits involving claims by approximately 630 plaintiffs alleging that the
plaintiffs were injured as a result of ingestion of products containing
phenylpropanolamine ("PPA"), which was an active ingredient in certain of
our DEXATRIM products until November 2000. The lawsuits that are federal
cases have 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.
Approximately 160 of the existing lawsuits involve alleged injuries by
products manufactured and sold prior to our acquisition of DEXATRIM in
December 1998. With respect to these lawsuits, 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.
We are currently defending the balance of approximately 140 lawsuits
involving claims by approximately 410 plaintiffs. Of these 410 plaintiffs,
approximately 170 allege injury as a result of ingestion of DEXATRIM
containing PPA, approximately 180 allege injury as a result of ingestion of
a product other than DEXATRIM, and approximately 60 have not identified a
product.
Of the approximately 170 plaintiffs who allege injury as a result of
ingestion of DEXATRIM containing PPA, 23 plaintiffs are subject to pending
motions to dismiss for failure to comply with discovery and/or motions for
summary judgment applicable to injuries excluded by the federal court's
evidentiary rulings; 23 plaintiffs have alleged in ingestion of DEXATRIM,
but have not alleged the date of ingestion or the type of injury suffered;
and we believe up to 25 plaintiffs may have purchased products sold by
Thompson Medical Company prior to our acquisition of DEXATRIM in December
1998. We believe that there are approximately 100 plaintiffs who have
alleged 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. We believe plaintiffs who make and are able to prove such
allegations are more likely to recover damages from us. Based on discovery
conducted to date, we believe that a limited number of these plaintiffs
present alleged facts and circumstances and potential damages similar to
the Villarreal case discussed below. However, as additional lawsuits are
filed and discovery in the existing lawsuits continues, we expect to know
more about the characteristics of these cases, which will result in changes
in the number of plaintiffs whose alleged injuries are within the
description outlined above and our assessment of the plaintiffs'
allegations.
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 through our
12
product liability insurance coverage and thus had no impact on our
financial position, results of operations or cash flows. The settlement
amount and related expenses did reduce the amount of insurance coverage
available to us for the pending and any subsequently filed cases related to
DEXATRIM containing PPA to $98,500.
During the third quarter of fiscal 2003, the United States District Court
for the Western District of Washington ruled that scientific evidence
supporting the assertion that PPA is an independent risk factor for stroke
is admissible at trial if the PPA was ingested within three days of the
stroke. In cases where the ingestion of PPA occurred more than three days
prior to the stroke, such evidence is inadmissible. The court also ruled
that evidence supporting the assertion that PPA causes non-stroke injuries
such as heart attack, seizures, arrhythmia and psychosis is inadmissible at
trial. Consequently, we believe that federal court DEXATRIM cases involving
ingestion of DEXATRIM with PPA outside the three-day period and cases
alleging non-stroke injuries will be dismissed.
There are no cases involving an alleged ingestion of DEXATRIM with PPA
currently set for trial in 2003. We currently have one case set for trial
in June 2004 and anticipate that additional cases may be set for trial in
the second half of 2004.
We are aggressively defending these lawsuits. 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 of the 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.
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 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. Subject to the outcome of the Kemper lawsuit
discussed below, 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 through policies with four different insurers, 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 one claim 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, and are aggressively defending them. Our 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 $3,600 is currently funded, and a total
of $30,000 of excess coverage through third party insurers.
As previously reported, Kemper Indemnity Insurance Company ("Kemper") has
filed a lawsuit against us in federal court in Chattanooga, Tennessee
seeking to rescind a $50,000 policy of excess insurance coverage for
product liability claims, including those relating to the existence of PPA
in DEXATRIM (the "Kemper Policy"). Coverage under the Kemper Policy is in
excess of $23,500 of product liability insurance coverage that is available
to us from two other insurance companies. In addition, we have $25,000 of
insurance coverage from a fourth insurance company that is in excess of the
Kemper Policy. In the lawsuit, Kemper is seeking to rescind the Kemper
Policy based on allegations that we failed to disclose material information
regarding the Yale Study (a study initiated in 1994 by the Consumer
Healthcare Products Association (formerly the Nonprescription Drug
Manufacturers Association) in conjunction with the Yale University School
of Medicine to investigate a possible association, if any, of stroke in
women aged 18 to 49 using PPA) during the submission process to renew the
Kemper Policy for coverage for the December 21, 1999 to May 31, 2001
13
policy period. In the alternative, Kemper is seeking a declaratory judgment
on certain policy interpretation issues that if granted would bar or limit
coverage for PPA-related claims under the Kemper Policy.
We believe that the claims made by Kemper in its lawsuit are without merit.
We have filed an answer denying that Kemper is entitled to any of the
relief sought and asserting counterclaims against Kemper and affiliated
parties including Berkshire Hathaway Inc. alleging, among other things, a
civil conspiracy to deny coverage, tortious interference with our insurance
contract with Kemper, bad faith, violation of Tennessee's consumer
protection law and fraud.
If the Kemper Policy is rescinded or its coverage limited, then we would
have significantly less insurance coverage with which to satisfy claims
arising in the DEXATRIM with PPA cases, which in turn would substantially
increase the likelihood that we would have to satisfy these claims from our
assets. There can be no assurances that we would have sufficient resources
to satisfy these claims.
Although there are no currently pending lawsuits from our other product
liability insurers, there can be no assurances that one or more of our
insurers will not file and pursue a lawsuit to rescind or limit their
insurance coverage on grounds that are similar to the claims alleged by
Kemper, or other grounds.
We have also been named as a defendant in two lawsuits alleging that the
plaintiffs were injured as a result of the ingestion of DEXATRIM containing
ephedrine. Our available insurance for the defense of these lawsuits, as
described above, is $40,000. We discontinued the manufacturing and shipment
of DEXATRIM containing ephedrine on September 20, 2002.
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
financial position, results of operations or cash flows if disposed of
unfavorably.
REGULATORY
----------
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 1997, the FDA published a proposed rule on the use of dietary
supplements containing ephedrine alkaloids. In June 2002, the United States
Department of Health and Human Services ("HHS") proposed an expanded
scientific evaluation of ephedra which led to the issuance of a report on
February 28, 2003 by the RAND-based Southern California Evidence-Based
Practice Center (the "RAND Report"). The RAND Report concluded that
ephedrine, ephedrine plus caffeine and ephedra-containing dietary
supplements with or without herbs
14
containing caffeine all promote modest amounts of weight loss over the
short term and use of ephedra or ephedrine plus caffeine is associated with
an increased risk of gastrointestinal, psychiatric and autonomic symptoms.
The adverse event reports contained a smaller number of more serious
adverse events. Given the small number of such events, the RAND Report
concluded that further study would be necessary to determine whether
consumption of ephedra or ephedrine may be causally related to these
serious adverse events. In connection with the RAND Report, HHS has sought
public comment on whether additional measures are required concerning the
sale and distribution of dietary supplements containing ephedrine
alkaloids. 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, HHS, which oversees the FDA, and
the FDA have not reached a final decision on the petition.
We discontinued the manufacturing and shipment of DEXATRIM products
containing ephedrine in September 2002. Our DEXATRIM products containing
ephedrine may continue to be sold in isolated cases until our customers'
existing supply of inventory is exhausted or until the products are
returned to us. 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 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 we have received
returns representing substantially all of the DEXATRIM with ephedrine and
that this allowance amount is adequate to cover any returns of DEXATRIM
product containing ephedrine that might yet be received. The unused portion
of this allowance was $235 at August 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. The petition sought a determination that 10%
trolamine salicylate, the active ingredient in SPORTSCREME and ASPERCREME,
was clinically proven to be an effective active ingredient in external
analgesic OTC drug products and should be included in the FDA's yet-to-be
finalized monograph for external analgesics. We have met with the FDA and
submitted a proposed protocol study to evaluate the efficacy of 10%
trolamine salicylate as an active ingredient in OTC external analgesic drug
products. We are working to develop alternate formulations for SPORTSCREME
and ASPERCREME in the event that the FDA does not consider the available
clinical data to conclusively demonstrate the efficacy of trolamine
salicylate when the OTC external analgesic monograph is finalized. If 10%
trolamine salicylate is not included in the final monograph, we would
likely be required to discontinue these products as currently formulated
and remove them from the market after expiration of an anticipated grace
period. If this occurred, we believe we could still market these products
as homeopathic products, and could also reformulate them using ingredients
approved in the FDA monograph.
Certain of our topical analgesic products are currently marketed under a
FDA tentative final monograph. The FDA has recently proposed that the final
monograph exclude external analgesic products in patch, plaster, or
poultice form, unless the FDA receives additional data supporting the
safety and efficacy of these products. We will present to the FDA
information regarding the safety of the patches and arguments to support
their product's inclusion in the final monograph. We are also involved in a
coordinated industry effort to establish with the FDA a protocol of
additional research that will allow the patches to be marketed under the
final monograph even if the final monograph does not explicitly allow them.
This additional research may require a considerable amount of expensive
testing and data analysis by expert consultants. We believe that the
monograph is unlikely to become final and take effect before May 2005. If
neither of our actions described above are successful, and the final
monograph excludes such products, we will have to file a new drug
application ("NDA") in order to continue to market the ICY HOT Patch, or
similar delivery systems, under other of our topical analgesic brands, and
would have to remove the existing product from the market, as of the
effective date of the final monograph, pending FDA review and approval of
the NDA. The preparation of a NDA would likely take us six to 18 months
and would be expensive. It typically takes the FDA at least 12 months to
rule on the NDA once it is submitted.
16. ACQUISITION AND SALE OF BRANDS
------------------------------
On March 28, 2002, we acquired 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, or manufacturers under contract to
15
Abbott, manufactured the product for us domestically until June 2003 and
internationally will manufacture the product for us, except in North
America, until March 2004, 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 ten percent 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 certain 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 the other foreign
markets with significant sales by March 2004.
The following table for the three and nine months ended August 31, 2003
summarizes our estimate of how the results for SELSUN BLUE international,
which are included as royalties on our Consolidated Statements of Income,
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 Nine
Months Ended Months Ended
August 31, August 31,
2003 2003
--------- ---------
NET SALES.............................. $ 1,364 $ 5,469
--------- ---------
COSTS AND EXPENSES:
Cost of sales........................ 529 2,119
Advertising and promotion............ 202 809
Selling, general and administrative.. 423 1,667
--------- ---------
Total costs and expenses........... 1,154 4,595
--------- ---------
INCOME FROM OPERATIONS................. $ 210 $ 874
========= =========
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 Nine
Months Ended
August 31,
2002
---------
Total revenue............................... $ 182,221
Income before change in accounting
principle................................. 14,965
Net income.................................. 6,088
Earnings per share - basic:
Income before change in accounting
principle............................... 0.81
Net income................................ 0.33
Earnings per share- diluted:
Income before change in accounting
principle............................... 0.78
Net income................................ 0.32
16
17. INCOME TAXES
------------
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 and international 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 $109 and $301 for the
three and nine months ended August 31, 2003, respectively.
18. PRODUCT AND GEOGRAPHICAL SEGMENT INFORMATION
--------------------------------------------
Net sales of our domestic product categories within our single healthcare
business segment for the three and nine months ended August 31, 2003 and
2002, respectively, are as follows:
For the Three Months For the Nine Months
Ended August 31, Ended August 31,
----------------------- -----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Topical analgesics $ 14,540 $ 16,224 $ 42,738 $ 46,632
Medicated skin care products 16,926 16,584 44,988 40,526
Dietary supplements 9,664 9,943 30,232 31,861
Medicated dandruff shampoos 6,116 5,429 20,928 9,251
Other OTC products 6,490 9,264 23,711 28,003
--------- --------- --------- ---------
Total $ 53,736 $ 57,444 $ 162,597 $ 156,273
========= ========= ========= =========
19. CONSOLIDATING FINANCIAL STATEMENTS
----------------------------------
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 August 31, 2003
arose in conjunction with Chattem's issuance of the 8.875% senior
subordinated notes on March 24, 1998 and the $60,000 Credit Facility
obtained by Chattem on March 28, 2002. The guarantees' terms match the
terms of the 8.875% senior subordinated notes and the Credit Facility. The
maximum amount of future payments the guarantors would be required to make
under the guarantees as of August 31, 2003 is $214,538.
17
Note 19
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING BALANCE SHEETS
----------------------------
AUGUST 31, 2003
---------------
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------ ------------
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents .................... $ 13,717 $ 491 $ 7,513 $ -- $ 21,721
Accounts receivable, less allowances of
$5,155 ...................................... 24,878 18,118 3,662 (18,118) 28,540
Refundable and deferred income taxes ......... 11,801 -- 56 -- 11,857
Inventories .................................. 14,055 2,330 3,393 -- 19,778
Prepaid expenses and other current assets .... 2,924 -- 224 -- 3,148
------------ ------------ ------------ ------------ ------------
Total current assets ..................... 67,375 20,939 14,848 (18,118) 85,044
------------ ------------ ------------ ------------ ------------
PROPERTY, PLANT AND EQUIPMENT, NET ............. 27,013 775 344 -- 28,132
------------ ------------ ------------ ------------ ------------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased
product rights, net ....................... 1,143 244,763 -- -- 245,906
Debt issuance costs, net ..................... 5,867 -- -- -- 5,867
Investment in subsidiaries ................... 86,790 -- -- (86,790) --
Other ........................................ 3,416 -- 515 -- 3,931
------------ ------------ ------------ ------------ ------------
Total other noncurrent assets ............ 97,216 244,763 515 (86,790) 255,704
------------ ------------ ------------ ------------ ------------
TOTAL ASSETS ............................. $ 191,604 $ 266,477 $ 15,707 $ (104,908) $ 368,880
============ ============ ============ ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Current maturities of long-term debt ......... $ 8,250 $ -- $ -- $ -- $ 8,250
Accounts payable ............................. 8,495 -- 1,303 -- 9,798
Payable to bank .............................. 425 -- -- -- 425
Accrued liabilities .......................... 38,099 1,561 1,235 (18,118) 22,777
------------ ------------ ------------ ------------ ------------
Total current liabilities ................ 55,269 1,561 2,538 (18,118) 41,250
------------ ------------ ------------ ------------ ------------
LONG-TERM DEBT, less current maturities ........ 206,434 -- -- -- 206,434
------------ ------------ ------------ ------------ ------------
DEFERRED INCOME TAXES .......................... 178 27,210 -- -- 27,388
------------ ------------ ------------ ------------ ------------
OTHER NONCURRENT LIABILITIES ................... 1,671 -- -- -- 1,671
------------ ------------ ------------ ------------ ------------
INTERCOMPANY ACCOUNTS .......................... (164,085) 160,671 3,414 -- --
------------ ------------ ------------ ------------ ------------
SHAREHOLDERS' EQUITY:
Preferred shares, without par value,
authorized 1,000, none issued ............. -- -- -- -- --
Common shares, without par value,
authorized 50,000, issued 19,157 .......... 77,811 63,067 7,647 (70,714) 77,811
Retained earnings ............................ 17,850 13,968 2,914 (16,882) 17,850
------------ ------------ ------------ ------------ ------------
Total .................................... 95,661 77,035 10,561 (87,596) 95,661
Unamortized value of restricted common
shares issued ............................. (2,253) -- -- -- (2,253)
Cumulative other comprehensive income:
Foreign currency translation adjustment .. (1,271) -- (806) 806 (1,271)
------------ ------------ ------------ ------------ ------------
Total shareholders' equity ............... 92,137 77,035 9,755 (86,790) 92,137
------------ ------------ ------------ ------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 191,604 $ 266,477 $ 15,707 $ (104,908) $ 368,880
============ ============ ============ ============ ============
18
Note 19
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING BALANCE SHEETS
----------------------------
NOVEMBER 30, 2002
-----------------
(In thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------ ------------
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents ..................... $ 11,505 $ 1,138 $ 3,281 $ -- $ 15,924
Accounts receivable, less allowances of
$3,897 ....................................... 21,585 2,297 4,088 (2,297) 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 6,574 10,431 (2,297) 72,387
------------ ------------ ------------ ------------ ------------
PROPERTY, PLANT AND EQUIPMENT, NET .............. 25,567 775 316 -- 26,658
------------ ------------ ------------ ------------ ------------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased
product rights, net ........................ 1,397 244,390 -- -- 245,787
Debt issuance costs, net ...................... 7,126 -- -- -- 7,126
Investment in subsidiaries .................... 66,783 -- -- (66,783) --
Other ......................................... 3,590 -- 15 -- 3,605
------------ ------------ ------------ ------------ ------------
Total other noncurrent assets ............. 78,896 244,390 15 (66,783) 256,518
------------ ------------ ------------ ------------ ------------
TOTAL ASSETS .............................. $ 162,142 $ 251,739 $ 10,762 $ (69,080) $ 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 ........................... 21,986 326 1,089 (2,297) 21,104
------------ ------------ ------------ ------------ ------------
Total current liabilities ................. 40,645 326 2,341 (2,297) 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 ........................... (171,242) 170,698 544 -- --
------------ ------------ ------------ ------------ ------------
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 63,067 7,647 (70,714) 79,313
Retained earnings (deficit) ................... (1,097) (4,161) 1,501 2,660 (1,097)
------------ ------------ ------------ ------------ ------------
Total ..................................... 78,216 58,906 9,148 (68,054) 78,216
Unamortized value of restricted common
shares issued .............................. (1,713) -- -- -- (1,713)
Cumulative other comprehensive income:
Foreign currency translation adjustment ... (1,759) -- (1,271) 1,271 (1,759)
------------ ------------ ------------ ------------ ------------
Total shareholders' equity ................ 74,744 58,906 7,877 (66,783) 74,744
------------ ------------ ------------ ------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY. $ 162,142 $ 251,739 $ 10,762 $ (69,080) $ 355,563
============ ============ ============ ============ ============
19
Note 19
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF INCOME
----------------------------------
FOR THE NINE MONTHS ENDED AUGUST 31, 2003
-----------------------------------------
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------ ------------
TOTAL REVENUES ................................. $ 135,909 $ 53,512 $ 14,225 $ (22,406) $ 181,240
------------ ------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Cost of sales ................................ 37,413 8,113 5,873 -- 51,399
Advertising and promotion .................... 41,218 8,333 4,458 -- 54,009
Selling, general and administrative........... 28,510 208 1,727 -- 30,445
Equity in subsidiary income .................. (22,542) -- -- 22,542 --
------------ ------------ ------------ ------------ ------------
Total costs and expenses ................. 84,599 16,654 12,058 22,542 135,853
------------ ------------ ------------ ------------ ------------
INCOME FROM OPERATIONS ......................... 51,310 36,858 2,167 (44,948) 45,387
------------ ------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest expense ............................. (15,431) -- -- -- (15,431)
Investment and other income, net ............. 69 3 47 -- 119
Royalties .................................... (20,567) (1,561) (278) 22,406 --
Corporate allocations ........................ 2,951 (2,870) (81) -- --
------------ ------------ ------------ ------------ ------------
Total other income (expense) ............. (32,978) (4,428) (312) 22,406 (15,312)
------------ ------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES ..................... 18,332 32,430 1,855 (22,542) 30,075
(BENEFIT) PROVISION FOR INCOME
TAXES ........................................ (615) 11,301 442 -- 11,128
------------ ------------ ------------ ------------ ------------
NET INCOME ..................................... $ 18,947 $ 21,129 $ 1,413 $ (22,542) $ 18,947
============ ============ ============ ============ ============
20
Note 19
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF INCOME
----------------------------------
FOR THE NINE MONTHS ENDED AUGUST 31, 2002
-----------------------------------------
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------ ------------
TOTAL REVENUES ................................. $ 140,947 $ 26,719 $ 12,022 $ (8,198) $ 171,490
------------ ------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Cost of sales ................................ 38,893 5,193 4,587 -- 48,673
Advertising and promotion .................... 44,881 7,315 3,080 -- 55,276
Selling, general and administrative .......... 27,051 127 1,824 -- 29,002
Equity in subsidiary income .................. (838) -- -- 838 --
------------ ------------ ------------ ------------ ------------
Total costs and expenses ................. 109,987 12,635 9,491 838 132,951
------------ ------------ ------------ ------------ ------------
INCOME FROM OPERATIONS ......................... 30,960 14,084 2,531 (9,036) 38,539
------------ ------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest expense ............................. (15,518) -- -- -- (15,518)
Investment and other income, net ............. 143 66 34 -- 243
Royalties .................................... (6,984) (973) (241) 8,198 --
Insurance premiums ........................... (500) -- 500 -- --
Corporate allocations ........................ 1,862 (1,784) (78) -- --
------------ ------------ ------------ ------------ ------------
Total other income (expense) ............. (20,997) (2,691) 215 8,198 (15,275)
------------ ------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES AND
CHANGE IN ACCOUNTING PRINCIPLE ............... 9,963 11,393 2,746 (838) 23,264
PROVISION FOR INCOME TAXES ..................... 4,416 3,999 425 -- 8,840
------------ ------------ ------------ ------------ ------------
INCOME BEFORE CHANGE IN
ACCOUNTING PRINCIPLE.......................... 5,547 7,394 2,321 (838) 14,424
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE, NET OF
INCOME TAX BENEFIT ........................... -- (8,877) -- -- (8,877)
------------ ------------ ------------ ------------ ------------
NET INCOME (LOSS) .............................. $ 5,547 $ (1,483) $ 2,321 $ (838) $ 5,547
============ ============ ============ ============ ============
21
Note 19
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF CASH FLOWS
--------------------------------------
FOR THE NINE MONTHS ENDED AUGUST 31, 2003
-----------------------------------------
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------ ------------
OPERATING ACTIVITIES:
Net income ................................... $ 18,947 $ 21,129 $ 1,413 $ (22,542) $ 18,947
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization .............. 4,451 -- 114 -- 4,565
Deferred income tax provision .............. 516 5,401 (10) -- 5,907
Other, net ................................. (101) -- 7 -- (94)
Equity in subsidiary income ................ (22,542) -- -- 22,542 --
Changes in operating assets and liabilities:
Accounts receivable ....................... (3,293) (15,821) 426 15,821 (2,867)
Refundable income taxes ................... 40 -- -- -- 40
Inventories ............................... (1,321) 809 (497) -- (1,009)
Prepaid expenses and other current assets . (860) -- (104) -- (964)
Accounts payable and accrued liabilities .. 13,611 1,235 197 (15,821) (778)
------------ ------------ ------------ ------------ ------------
Net cash provided by operating activities . 9,448 12,753 1,546 -- 23,747
------------ ------------ ------------ ------------ ------------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment ... (3,800) -- (133) -- (3,933)
Purchases of patents, trademarks and other
products rights ............................ -- (373) -- -- (373)
Change in other assets, net .................. 143 -- (35) -- 108
------------ ------------ ------------ ------------ ------------
Net cash used in investing activities ... (3,657) (373) (168) -- (4,198)
------------ ------------ ------------ ------------ ------------
FINANCING ACTIVITIES:
Repayment of long-term debt .................. (10,000) -- -- -- (10,000)
Proceeds from exercise of stock options ...... 1,533 -- -- -- 1,533
Repurchase of common shares .................. (5,351) -- -- -- (5,351)
Change in payable to bank .................... (27) -- -- -- (27)
Deferred debt issuance costs ................. (25) -- -- -- (25)
Changes in intercompany accounts ............. 7,291 (10,027) 2,736 -- --
Dividends paid ............................... 3,000 (3,000) -- -- --
------------ ------------ ------------ ------------ ------------
Net cash (used in) provided by financing
activities .............................. (3,579) (13,027) 2,736 -- (13,870)
------------ ------------ ------------ ------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS .................... -- -- 118 -- 118
------------ ------------ ------------ ------------ ------------
CASH AND CASH EQUIVALENTS:
Increase (decrease) for the period ........... 2,212 (647) 4,232 -- 5,797
At beginning of period ....................... 11,505 1,138 3,281 -- 15,924
------------ ------------ ------------ ------------ ------------
At end of period ............................. $ 13,717 $ 491 $ 7,513 $ -- $ 21,721
============ ============ ============ ============ ============
22
Note 19
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF CASH FLOWS
--------------------------------------
FOR THE NINE MONTHS ENDED AUGUST 31, 2002
-----------------------------------------
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------ ------------
OPERATING ACTIVITIES:
Net income (loss) ............................ $ 5,547 $ (1,483) $ 2,321 $ (838) $ 5,547
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Depreciation and amortization .............. 3,873 -- 96 -- 3,969
Deferred income tax provision .............. 9,773 (5,440) -- -- 4,333
Provision for income taxes ................. (3,999) 3,999 -- -- --
Cumulative effect of change in accounting
principle, net ........................... -- 8,877 -- -- 8,877
Stock option charge ........................ 175 -- -- -- 175
Other, net ................................. (75) -- -- -- (75)
Equity in subsidiary income ................ (838) -- -- 838 --
Changes in operating assets and liabilities,
net of product acquisition:
Accounts receivable ..................... (6,720) -- (1,570) -- (8,290)
Refundable income taxes ................. 1,031 -- -- -- 1,031
Inventories ............................. 2,862 (2,368) (738) -- (244)
Prepaid expenses and other current assets (326) -- (28) -- (354)
Accounts payable and accrued liabilities. 21,451 -- (414) -- 21,037
------------ ------------ ------------ ------------ ------------
Net cash provided by (used in) operating
activities .............................. 32,754 3,585 (333) -- 36,006
------------ ------------ ------------ ------------ ------------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment ... (2,600) -- (22) -- (2,622)
Purchases of patents, trademarks and other
products rights ............................ (1,211) (73,785) -- -- (74,996)
Decrease in other assets, net ................ 225 -- 29 -- 254
------------ ------------ ------------ ------------ ------------
Net cash (used in) provided by
investing activities .................... (3,586) (73,785) 7 -- (77,364)
------------ ------------ ------------ ------------ ------------
FINANCING ACTIVITIES:
Repayment of long-term debt .................. (8,000) -- -- -- (8,000)
Proceeds from long-term debt ................. 45,000 -- -- -- 45,000
Proceeds from exercise of stock options ...... 6,146 -- -- -- 6,146
Repurchase of common shares .................. (1,650) -- -- -- (1,650)
Change in payable to bank .................... 62 -- -- -- 62
Debt issuance costs .......................... (1,133) -- -- -- (1,133)
Changes in intercompany accounts ............. (65,680) 65,886 (206) -- --
Dividends paid ............................... 3,000 (3,000) -- -- --
------------ ------------ ------------ ------------ ------------
Net cash (used in) provided by financing
activities .............................. (22,255) 62,886 (206) -- 40,425
------------ ------------ ------------ ------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS ...................... 11 -- 102 -- 113
------------ ------------ ------------ ------------ ------------
CASH AND CASH EQUIVALENTS:
Increase (decrease) for the period ........... 6,924 (7,314) (430) -- (820)
At beginning of period ....................... 20,648 10,003 4,794 -- 35,445
------------ ------------ ------------ ------------ ------------
At end of period ............................. $ 27,572 $ 2,689 $ 4,364 $ -- $ 34,625
============ ============ ============ ============ ============
23
20. EARNINGS PER SHARE
------------------
The following table presents the computation of per share earnings for the
three and nine months ended August 31, 2003 and 2002, respectively:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
AUGUST 31, AUGUST 31,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
NET INCOME:
Income before change in accounting
principle ......................................... $ 6,837 $ 6,417 $ 18,947 $ 14,424
Change in accounting principle ..................... -- -- -- (8,877)
------------ ------------ ------------ ------------
Net income ...................................... $ 6,837 $ 6,417 $ 18,947 $ 5,547
============ ============ ============ ============
NUMBER OF COMMON SHARES:
Weighted average outstanding ....................... 19,148 18,940 19,178 18,458
Issued upon assumed exercise of
outstanding stock options ......................... 647 834 617 700
Effect of issuance of restricted common
shares ............................................ 110 96 102 88
------------ ------------ ------------ ------------
Weighted average and potential
dilutive outstanding .............................. 19,905 19,870 19,897 19,246
============ ============ ============ ============
NET INCOME PER COMMON SHARE:
Basic:
Income before change in accounting
principle ...................................... $ .36 $ .34 $ .99 $ .78
Change in accounting principle .................. -- -- -- (.48)
------------ ------------ ------------ ------------
Total basic .................................. $ .36 $ .34 $ .99 $ .30
============ ============ ============ ============
Diluted:
Income before change in accounting
principle ...................................... $ .34 $ .32 $ .95 $ .75
Change in accounting principle .................. -- -- -- (.46)
------------ ------------ ------------ ------------
Total diluted ................................ $ .34 $ .32 $ .95 $ .29
============ ============ ============ ============
24
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 nine months ended August 31, 2003 and 2002
reflect the two-for-one split of our common stock on November 29, 2002. All
monetary and share amounts are expressed in thousands 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 typically 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 will 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. In the third quarter of
2003, we began shipping GOLD BOND Ultimate Healing Skin Therapy Lotion and ICY
HOT Back Patch. Line extensions, product introductions and acquisitions require
a significant amount of introductory advertising and promotional support. For a
period of time, these products do not generate a commensurate amount of sales or
earnings. As a result, we may experience a short-term impact on our
profitability due to acquisitions and line extensions.
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 secured credit facility
(the "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.
25
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, except in North America,
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 until we
assume manufacturing or enter into third party agreements. Abbott Laboratories
is also marketing, selling and distributing SELSUN BLUE products for us in
certain 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 pays us an
initial 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.
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 SELSUN BLUE'S
total net sales. We are focusing our efforts on expanding SELSUN BLUE'S
international presence in existing key markets, such as Canada, Mexico, Brazil,
the United Kingdom ("U.K.") and Australia. As we initially focus on 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. The timing of such launches
will be dependent on the local distributors' resources as well as any regulatory
requirements.
In connection with our acquisition of SELSUN BLUE on March 28, 2002, we obtained
a $60,000 Credit Facility from a syndicate of commercial banks led by Bank of
America, N.A., as agent. The Credit Facility included 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. As of August
31, 2003, we owed $10,000 under the Credit Facility.
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 approximately $200.
These acquisitions, together with the PHISODERM trademark rights previously
acquired in 1994 for the United States, Canada and Puerto Rico, provide us with
the capability to expand our PHISODERM business in numerous markets
internationally.
Although we entered into a preliminary agreement to amend the Credit Facility on
May 23, 2003 to increase the revolving line of credit from $15,000 to $50,000
and modify certain other terms and conditions, we did not complete this
amendment. On August 22, 2003, the Credit Facility was amended to revise the
restrictions on the amount of capital expenditures allowed and the dollar amount
of our common stock we can purchase, redeem, acquire or retire.
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, we are not limited to a single source of supply for the ingredients
used in the manufacture of our products. PAMPRIN AND PREMSYN PMS products net
sales in fiscal 2002 represented 5.5% of our consolidated total revenues in that
year. We believe that our current sources of supply and potential alternative
sources will be adequate to meet future product demands.
During the nine months ended August 31, 2003, we repurchased and returned to
unissued 360 shares of our common stock for $5,351 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 $4,649 at August 31, 2003.
26
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 net 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. 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.
The income before change in accounting principle margin (income before change in
accounting principle/total revenues) increased in 2003 over 2002 from 10.0% and
8.4% to 11.6 % and 10.5 % for the three and nine months ended August 31, 2003,
respectively. The EBITDA margin (EBITDA/total revenues) increased from 25.9% and
24.3% of total revenues in the 2002 periods to 28.8% and 26.9 % in the three and
nine months ended August 31, 2003, respectively. A reconciliation of EBITDA to
income before change in accounting principle is presented in the following
table:
For the Three Months Ended August 31, For the Nine Months Ended August 31,
--------------------------------------------- --------------------------------------------
Dollar Percentage Dollar Percentage
Increase Increase Increase Increase
2003 2002 (Decrease) (Decrease) 2003 2002 (Decrease) (Decrease)
-------- -------- -------- -------- -------- -------- -------- --------
Income before change in
accounting principle .... $ 6,837 $ 6,417 $ 420 6.5% $ 18,947 $ 14,424 $ 4,523 31.4%
Add:
Provision for income
taxes ................... 4,016 3,933 83 2.1% 11,128 8,840 2,288 25.9%
Interest expense, net ..... 5,025 5,295 (270) (5.1%) 15,312 15,275 37 .2%
Depreciation and
amortization less amounts
included in interest .... 1,153 1,046 107 10.2% 3,305 3,075 230 7.5%
-------- -------- -------- -------- -------- --------
EBITDA ...................... $ 17,031 $ 16,691 $ 340 2.0% $ 48,692 $ 41,614 $ 7,078 17.0%
======== ======== ======== ======== ======== ========
Given the perceived safety concerns and the regulatory uncertainties relating to
ephedrine, we developed alternative formulations for DEXATRIM Natural and
DEXATRIM Results to exclude ephedrine. 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 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 August 31, 2003 was $235.
As previously reported, Kemper Indemnity Insurance Company ("Kemper") has filed
a lawsuit against us in federal court in Chattanooga, Tennessee seeking to
rescind a $50,000 policy of excess insurance coverage for product liability
claims, including those relating to the existence of phenylpropanolamine ("PPA")
in DEXATRIM (the "Kemper Policy"). Coverage under the Kemper Policy is in excess
of $23,500 of product liability insurance coverage that is available to us from
two other insurance companies. In addition, we have $25,000 of insurance
coverage from a fourth insurance company that is in excess of the Kemper Policy.
In the lawsuit, Kemper is seeking to rescind the Kemper Policy based on
allegations that we failed to disclose material information regarding the Yale
Study (a study initiated in 1994 by the Consumer Healthcare Products Association
(formerly the Nonprescription Drug Manufacturers Association) in conjunction
with the Yale University School of Medicine to investigate a possible
association, if any, of stroke in women aged 18 to 49 using PPA) during the
submission process to renew the Kemper Policy for coverage for the December 21,
1999 to May 31, 2001 policy period. In the alternative, Kemper is seeking a
declaratory judgment on certain policy interpretation issues that if granted
would bar or limit coverage for PPA-related claims under the Kemper Policy.
We believe that the claims made by Kemper in its lawsuit are without merit. We
have filed an answer denying that Kemper is entitled to any of the relief sought
and asserting counterclaims against Kemper and affiliated parties including
Berkshire Hathaway Inc. alleging, among other things, a civil conspiracy to deny
coverage, tortious interference with our insurance contract with Kemper, bad
faith, violation of Tennessee's consumer protection law and fraud.
27
If the Kemper Policy is rescinded or its coverage limited, then we would have
significantly less insurance coverage with which to satisfy claims arising in
the DEXATRIM with PPA cases, which in turn would substantially increase the
likelihood that we would have to satisfy these claims from our assets. There can
be no assurances that we would have sufficient resources to satisfy these
claims.
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 NINE MONTHS
ENDED AUGUST 31, ENDED AUGUST 31,
----------------------- -----------------------
2003 2002 2003 2002
-------- -------- -------- --------
TOTAL REVENUES ...................... 100.0% 100.0% 100.0% 100.0%
-------- -------- -------- --------
COSTS AND EXPENSES:
Cost of sales ..................... 27.0 27.2 28.4 28.4
Advertising and promotion ......... 28.9 33.1 29.8 32.2
Selling, general and administrative 17.3 15.4 16.8 16.9
-------- -------- -------- --------
Total costs and expenses ........ 73.2 75.7 75.0 77.5
-------- -------- -------- --------
INCOME FROM OPERATIONS .............. 26.8 24.3 25.0 22.5
-------- -------- -------- --------
OTHER INCOME (EXPENSE):
Interest expense .................. (8.5) (8.3) (8.5) (9.0)
Investment and other income, net .. .1 .1 .1 .1
-------- -------- -------- --------
Total other income (expense) ... (8.4) (8.2) (8.4) (8.9)
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES AND
CHANGE IN ACCOUNTING PRINCIPLE .... 18.4 16.1 16.6 13.6
PROVISION FOR INCOME TAXES .......... 6.8 6.1 6.1 5.2
-------- -------- -------- --------
INCOME BEFORE CHANGE IN
ACCOUNTING PRINCIPLE .............. 11.6% 10.0% 10.5% 8.4%
======== ======== ======== ========
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 August 31, 2003 financial statements:
Allowance For Doubtful Accounts
-------------------------------
As of August 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 allowance may be impacted by the
deterioration in the financial condition of a large customer or weakness in the
economic environment resulting in a higher level of customer bankruptcy filings
or delinquencies. There have been no material changes in our estimate during the
quarter ended August 31, 2003.
28
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.
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 an allowance 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. There have been no material changes in this allowance during
the quarter ended August 31, 2003.
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, display activity 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.
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 AUGUST 31, 2003 AND 2002
- ---------------------------------------------------------
To facilitate discussion of our operating results for the three months ended
August 31, 2003 and 2002, respectively, we have included the following income
statement data table:
For the Three Months Ended August 31,
-----------------------------------------------------------
Dollar Percentage
Increase Increase
2003 2002 (Decrease) (Decrease)
-------- -------- -------- --------
Total revenues ........................ $ 59,182 $ 64,404 $ (5,222) (8.1%)
Domestic sales ........................ 53,736 57,444 (3,708) (6.5%)
International sales ................... 5,446 6,960 (1,514) (21.8%)
Cost of sales ......................... 15,995 17,526 (1,531) (8.7%)
Advertising and promotion ............. 17,075 21,307 (4,232) (19.9%)
Selling, general and administrative ... 10,234 9,926 308 3.1%
Interest expense ...................... 5,057 5,374 (317) (5.9%)
Investment and other income, net ...... 32 79 (47) (59.5%)
Net income ............................ 6,837 6,417 420 6.5%
For the third quarter of fiscal 2003, total revenues, comprised of domestic and
international sales, decreased $5,222 or 8.1% compared to the same quarter in
fiscal 2002.
29
DOMESTIC SALES
- --------------
Domestic sales for the third quarter of fiscal 2003 decreased $3,708 or 6.5% as
compared to the same quarter in fiscal 2002. 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 August 31,
-----------------------------------------------------------
Dollar Percentage
Increase Increase
2003 2002 (Decrease) (Decrease)
-------- -------- -------- --------
Topical analgesics .................... $ 14,540 $ 16,224 $ (1,684) (10.4%)
Medicated skin care products .......... 16,926 16,584 342 2.1%
Dietary supplements ................... 9,664 9,943 (279) (2.8%)
Medicated dandruff shampoos ........... 6,116 5,429 687 12.7%
Other OTC products .................... 6,490 9,264 (2,774) (29.9%)
-------- -------- --------
Total ............................... $ 53,736 $ 57,444 $ (3,708) (6.5%)
======== ======== ========
Increases in the domestic sales of medicated dandruff shampoos and medicated
skin care products were more than offset by decreases in other product
categories. Domestic net sales of SELSUN BLUE medicated dandruff shampoo were up
12.7% in the third quarter of fiscal 2003 as compared to the same period in
fiscal 2002. Net sales growth in the medicated skin care products category was
led by a 18.3% increase in the GOLD BOND franchise. GOLD BOND sales growth came
primarily in the lotion and foot care lines as well as from product
introductions in the first quarter related to GOLD BOND Antifungal Foot Swabs,
GOLD BOND First Aid Quick Spray and GOLD BOND First Aid Wipes. This was
partially offset by a 31.7% decrease in PHISODERM net sales compared to a
year-ago period when the brand was relaunched and the PHISODERM Clear Confidence
Acne Body Wash, PHISODERM Clear Confidence Acne Facial Mask and PHISODERM Clear
Confidence Acne Clear Swab products were initially shipped to retailers.
Sales declines were recorded for our topical analgesic portfolio (ICY HOT,
FLEXALL, ASPERCREME, SPORTSCREME, CAPZASIN, and ARTHRITIS HOT) as the entire
category declined and competition from outside the category increased. Net sales
for the dietary supplement category declined primarily due to a 18.1% drop in
DEXATRIM sales from the comparable period last year. The decline in net sales of
DEXATRIM was partially offset by increased sales of GARLIQUE and NEW PHASE. The
decrease in net sales of other OTC products was due primarily to PAMPRIN and
PREMSYN PMS, which suffered sales declines due to intense competition.
INTERNATIONAL SALES
- -------------------
For the third quarter of fiscal 2003, international sales, including royalties
from the sales of SELSUN BLUE, decreased $1,514 or 21.8% as compared to the
third quarter of fiscal 2002. Our Canadian subsidiary experienced a 9.4 % sales
decrease largely as a result of soft GOLD BOND sales in Canada. Sales at our
U.K. subsidiary decreased 46.4% primarily due to weak economic conditions in the
U.K. and decreased sales to distributors in Central Europe. Other international
sales increased 19.8% almost entirely as a result of the acquisition of SELSUN
BLUE in the second quarter of fiscal 2002.
With the exception of NEW PHASE, sales variances for domestic and international
operations were principally the result of unit sales volumes. NEW PHASE sales
increased partially due to a unit sales price increase.
COST OF SALES
- -------------
Cost of sales as a percentage of total revenues was 27.0% for the third quarter
of fiscal 2003 as compared to 27.2% for the same quarter in fiscal 2002. The
reduction is primarily the result of reductions in cost of production associated
with moving the domestic production of SELSUN BLUE to our facility in
Chattanooga.
30
ADVERTISING AND PROMOTION
- -------------------------
Advertising and promotion expenses decreased $4,232 or 19.9% as compared to the
same quarter of fiscal 2002 and were 28.9% of total revenues for the three
months ended August 31, 2003 compared to 33.1% for the comparable period of
fiscal 2002. Increases in advertising and promotion expenditures in the current
period were recorded for ICY HOT, FLEXALL, the recently introduced GOLD BOND
products and NEW PHASE. Decreases in advertising and promotion expenditures were
recognized for the balance of the topical analgesic brands, PHISODERM, DEXATRIM,
MUDD, PAMPRIN, BULLFROG, HERPECIN and the other GOLD BOND products.
SELLING, GENERAL AND ADMINISTRATIVE
- -----------------------------------
Selling, general and administrative expenses increased $308 or 3.1% as compared
to the same quarter of fiscal 2002. Selling, general and administrative expenses
were 17.3% and 15.4% of total revenues for the third quarter of 2003 and 2002,
respectively. The increase in selling, general and administrative expenses was
largely a result of international severance costs and legal expense related to
the Kemper litigation.
INTEREST EXPENSE
- ----------------
Interest expense decreased $317 or 5.9% as compared to the same quarter of
fiscal 2002. The decrease was largely the result of lower outstanding balances
under our Credit Facility borrowed to partially fund the acquisition of the
SELSUN BLUE product line in March 2002. Until our indebtedness is reduced
substantially, interest expense will continue to represent a significant
percentage of our total revenues.
INVESTMENT AND OTHER INCOME
- ---------------------------
Investment and other income decreased $47 or 59.5% as compared to the same
quarter of fiscal 2002 primarily due to a decline in interest income. The use of
cash and cash equivalents to make principal payments on the Credit Facility and
lower interest rates on short-term investments contributed to the decrease in
interest income.
NET INCOME
- ----------
Net income increased $420 or 6.5% as compared to the same quarter of fiscal
2002. This increase primarily resulted from lower costs and expenses as a
percentage of revenues partially offset by decreased revenues.
COMPARISON OF NINE MONTHS ENDED AUGUST 31, 2003 AND 2002
- --------------------------------------------------------
To facilitate discussion of our operating results for the nine months ended
August 31, 2003 and 2002, respectively, we have included the following income
statement data table:
For the Nine Months Ended August 31,
--------------------------------------------------------
Dollar Percentage
Increase Increase
2003 2002 (Decrease) (Decrease)
-------- -------- -------- --------
Total revenues .................................. $181,240 $171,490 $ 9,750 5.7%
Domestic sales .................................. 162,597 156,273 6,324 4.0%
International sales ............................. 18,643 15,217 3,426 22.5%
Cost of sales ................................... 51,399 48,673 2,726 5.6%
Advertising and promotion ....................... 54,009 55,276 (1,267) (2.3%)
Selling, general and administrative ............. 30,445 29,002 1,443 5.0%
Interest expense ................................ 15,431 15,518 (87) (0.6%)
Investment and other income, net ................ 119 243 (124) (51.0%)
Income before change in accounting principle .... 18,947 14,424 4,523 31.4%
Net income ...................................... 18,947 5,547 13,400 241.6%
31
For the nine months ended August 31, 2003, total revenues, comprised of domestic
and international sales, increased $9,750 or 5.7% compared to the same period in
fiscal 2002.
DOMESTIC SALES
- --------------
Domestic sales for the nine months ended August 31, 2003 increased $6,324 or
4.0% as compared to the same period in fiscal 2002. A comparison of domestic
sales for the categories of products included in our portfolio of OTC healthcare
products is as follows:
For the Nine Months Ended August 31,
--------------------------------------------------------
Dollar Percentage
Increase Increase
2003 2002 (Decrease) (Decrease)
-------- -------- -------- --------
Topical analgesics .................... $ 42,738 $ 46,632 $ (3,894) (8.4%)
Medicated skin care products .......... 44,988 40,526 4,462 11.0%
Dietary supplements ................... 30,232 31,861 (1,629) (5.1%)
Medicated dandruff shampoos ........... 20,928 9,251 11,677 126.2%
Other OTC products .................... 23,711 28,003 (4,292) (15.3%)
-------- -------- --------
Total ............................... $162,597 $156,273 $ 6,324 4.0%
======== ======== ========
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 126.2% domestic net sales increase in the first nine months of fiscal
2003 as compared to the same period of fiscal 2002. If sales under Abbott
Laboratories for the first quarter and the period March 1, 2002 to March 28,
2002 had been included, the sales increase would have been 20.7% compared to the
same period in fiscal 2002. The sales increase for the medicated skin care
category was due in part to a 16.3% increase in net sales of the GOLD BOND
product line in the current nine 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. PHISODERM net sales decreased 3.1%
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 in the current period. The sales decrease in the dietary
supplement category was due to a decrease in DEXATRIM sales. DEXATRIM sales
declined as a result of negative publicity surrounding the diet pill category
and the introduction of a product line extension, DEXATRIM Results, in the
comparable period last year. This was offset by strong sales of GARLIQUE whose
net sales rose 22.5% in the year-to-year comparison. Sales of the other
SUNSOURCE brands declined in the year-to-year comparison with the exception of
NEW PHASE, which registered a 148.3% sales gain. The sales decrease in the other
OTC products category was due primarily to the results of PAMPRIN and PREMSYN
PMS, which suffered sales declines due to intense competition.
INTERNATIONAL SALES
- -------------------
For the nine months ended August 31, 2003, international sales, including
royalties from the sales of SELSUN BLUE, increased $3,426 or 22.5% as compared
to the same period in fiscal 2002. Our Canadian subsidiary produced a 24.6%
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. Our U.K. subsidiary showed a 13.7% sales increase primarily due to
our acquisition of SELSUN BLUE and sales of our OTC products in Eastern Europe
and elsewhere. Other international sales increased 38.3% almost entirely as a
result of the acquisition of SELSUN BLUE in the second quarter of fiscal 2002.
With the exception of NEW PHASE, sales variances for domestic and international
operations were principally the result of unit sales volumes. NEW PHASE sales
increased partially due to a unit sales price increase.
32
COST OF SALES
- -------------
Cost of sales as a percentage of total revenues was 28.4% for the nine months
ended August 31, 2003 and 2002, respectively. A $750 charge for the estimated
cost of returns of DEXATRIM containing ephedrine was included in cost of sales
for the nine months ended August 31, 2003.
ADVERTISING AND PROMOTION
- -------------------------
Advertising and promotion expenses decreased $1,267 or 2.3% as compared to the
same nine month period of fiscal 2002 and were 29.8% of total revenues compared
to 32.2% for the comparable period of fiscal 2002. Increases in advertising and
promotion expenditures in the first nine months of 2003 were recorded for SELSUN
BLUE, ICY HOT, FLEXALL, the recently introduced GOLD BOND products, BULLFROG,
and NEW PHASE. Decreases in advertising and promotion expenditures were
recognized for the balance of the topical analgesic brands, PHISODERM, DEXATRIM,
MUDD, PAMPRIN, the other GOLD BOND products and GARLIQUE.
SELLING, GENERAL AND ADMINISTRATIVE
- -----------------------------------
Selling, general and administrative expenses increased $1,443 or 5.0% as
compared to the same period of fiscal 2002. Selling, general and administrative
expenses were 16.8% and 16.9% of total revenues for the nine months ended August
31, 2003 and 2002, respectively. The increase was largely a result of increased
compensation costs of $668 related to a restricted stock grant, as well as,
international severance costs, legal fees related to the Kemper litigation,
increased selling expenses due to increased sales and increases in
administrative costs.
INTEREST EXPENSE
- ----------------
Interest expense decreased $87 or 0.6% as compared to the same period in fiscal
2002. The decrease was the result of lower outstanding principal balances on our
Credit Facility as compared to the same period in 2002. Until our indebtedness
is reduced substantially, interest expense will continue to represent a
significant percentage of our total revenues.
INVESTMENT AND OTHER INCOME
- ---------------------------
Investment and other income decreased $124 or 51.0% as compared to the same
period of fiscal 2002 primarily due to a decline in interest income. The use of
cash and cash equivalents to make principal payments on the Credit Facility and
lower interest rates on short-term investments contributed to the decrease in
interest income.
INCOME BEFORE CHANGE IN ACCOUNTING PRINCIPLE
- --------------------------------------------
Income before change in accounting principle increased $4,523 or 31.4% as
compared to the same period of fiscal 2002. This increase primarily resulted
from increased revenues and lower costs and expenses as a percentage of
revenues.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
- ---------------------------------------------------
In the first quarter of fiscal 2002, we adopted the provisions of SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"), which requires us to
perform certain fair value based tests of the carrying value of our indefinite
lived intangible assets annually 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
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.
33
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, servicing long-term debt, acquisitions, working capital, repurchases
of our common stock, payment of income taxes and capital expenditures.
Cash of $23,747 and $36,006 was provided by operations for the nine months ended
August 31, 2003 and 2002, respectively. The decrease in cash flows from
operations over the prior year period was primarily the result of a decrease in
accounts payable and accrued liabilities, partially offset by an increase in net
income.
Investing activities used cash of $4,198 and $77,364 in the nine months ended
August 31, 2003 and 2002, respectively. The decrease in usage of cash in the
current period was primarily due to the absence of a significant product line
acquisition, such as the purchase of SELSUN BLUE in the comparable period of
last year.
Financing activities used cash of $13,870 in the first nine months of fiscal
2003, but provided cash of $40,425 in the same period of the prior year. The
decrease in cash provided in the current period was largely the result of the
absence of additional borrowings required to partially finance a significant
acquisition, such as SELSUN BLUE, which was acquired in the comparable period of
last year, an increase in cost of repurchases of our common shares and a
decrease in proceeds from the exercise of our stock options.
Total debt outstanding was $214,684 at August 31, 2003 compared to $224,708 at
November 30, 2002. We have repaid $10,000 of long-term debt during the nine
months ended August 31, 2003.
As of October 1, 2003 we are named as a defendant in approximately 300 lawsuits
involving claims by approximately 630 plaintiffs alleging that the plaintiffs
were injured as a result of ingestion of products containing PPA, which until
November 2000 was the active ingredient in certain of our DEXATRIM products. See
Note 15 of Notes to Consolidated Financial Statements for a discussion of these
lawsuits.
As of August 31, 2003, the remaining amount authorized by our board of directors
under our stock buyback program was $4,649; 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 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 nine months ended August
31, 2003 and 2002, these subsidiaries accounted for 8% and 7% of total revenues,
respectively, and 3% of total assets 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 was sold in approximately 90 foreign countries and had $20,100 of
international sales in 2001, our international business operations have expanded
significantly, which will increase our exposure to fluctuations in foreign
exchange rates. During the first nine months of fiscal 2003, a portion of these
foreign sales was reflected as royalties, which have been paid to us in U.S.
dollars, and Abbott Laboratories has continued to supply the international
product and bill us in U.S. dollars.
34
Historically, gains or losses from foreign currency transactions have not had a
material impact on our operating results. Gains (losses) of $52 and ($5) for the
three months ended and $227 and ($58) for the nine months ended August 31, 2003
and 2002, respectively, resulted from foreign currency transactions and are
included in selling, general and administration expenses in the Consolidated
Statements of Income.
RECENT ACCOUNTING PRONOUNCEMENTS
- --------------------------------
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS 143"). We adopted SFAS 143 on December 1, 2002.
SFAS 143 establishes accounting standards for the recognition and measurement of
an asset retirement obligation and its associated asset retirement cost. It also
provides accounting guidance for legal obligations associated with the
retirement of tangible long-lived assets. The adoption of SFAS 143 did not have
an impact on our financial position, results of operations or cash flows.
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"). We adopted SFAS 145 on December 1, 2002. SFAS 145 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 SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt". We
are also required to reclassify any gain or loss on extinguishment of debt
previously classified as an extraordinary item in prior periods presented. SFAS
145 also provides accounting standards for certain lease modifications that have
economic effects similar to sale-leaseback transactions and various other
technical corrections. The adoption of SFAS 145 did not have an impact on our
financial position, results of operations or cash flows.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). We adopted SFAS 146 on January
1, 2003. SFAS 146 supercedes Emerging Issues Task Force Issue No. 94-3. SFAS 146
requires that the liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred, not at the date of an
entity's commitment to an exit or disposal plan. SFAS 146 is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
The adoption of SFAS 146 did not have an impact on our financial position,
results of operations or cash flows.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 supercedes Interpretation No. 34,
"Disclosure of Indirect Guarantees of Indebtedness of Others," and provides
guidance on the recognition and disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees. The initial recognition and measurement provisions of FIN 45 are
effective for guarantees issued or modified after December 31, 2002, and are to
be applied prospectively. The disclosure requirements are effective for
financial statements for interim or annual periods ending after December 15,
2002. We had no instruments or guarantees that required additional or enhanced
disclosure under FIN 45 at August 31, 2003, and no guarantees issued or modified
after December 31, 2002 that required recognition and measurement in accordance
with the provisions of FIN 45, except as disclosed in Note 19 of Notes to the
Consolidated Financial Statements. The adoption of FIN 45 did not have an impact
on our financial position, results of operations or cash flows.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS 148"). SFAS 148 amends SFAS No.
123, "Accounting for Stock-Based Compensation" to provide alternative methods of
transition for a voluntary change to the fair-value-based method of accounting
for stock-based employee compensation. SFAS 148 also amends 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 transition guidance and annual disclosure provisions of SFAS 148
are effective for fiscal years ending December 31, 2002. We implemented the
interim disclosure provision in our first fiscal quarter of 2003. The adoption
of SFAS 148 did not have an impact on our financial position, results of
operations or cash flows.
In January 2003, the FASB issued Interpretation No. 46, " Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 requires a company to consolidate
a variable interest entity ("VIE"), as defined, when the company will
35
absorb a majority of the VIE's expected losses, receives a majority of the VIE's
expected residual returns, or both. FIN 46 also requires consolidation of
existing, non-controlled affiliates if the VIE is unable to finance its
operations without investor support, or where the other investors do not have
exposure to the significant risks and rewards of ownership. FIN 46 applies
immediately to a VIE created or acquired after January 31, 2003. For a VIE
created before February 1, 2003, FIN 46 applies in the first fiscal year or
interim period beginning after June 15, 2003. The adoption of FIN 46 did not
have an impact on our financial position, results of operations or cash flows.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities under SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
149 is generally effective for derivative instruments, including derivative
instruments embedded in certain contracts, entered into or modified after June
30, 2003, and for hedging relationships designated after June 30, 2003. The
adoption of SFAS 149 did not have an impact on our financial position, results
of operations or cash flows.
In July 2003, the Emerging Issues Task Force ("EITF") reached a consensus on
Issue No. 03-11, "Reporting Gains and Losses on Derivative Instruments and
Hedging Activities, and Not Held for Trading Purposes" ("EITF 03-11"). EITF
03-11 addresses when gains and losses on derivative contracts not held for
trading purposes should be reported on a net basis. The adoption of EITF 03-11
did not have an impact on our financial position, results of operations 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 availability of our $50 million
excess product liability coverage to be determined in the Kemper rescission and
declaratory judgment lawsuit; the lack of availability, limits of coverage and
expense related to product liability insurance including the outcome of the
rescission and declaration judgment action filed by Kemper; 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 prior 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 insurance coverage; the
possible effect of the negative public perception resulting from product
liability claims on sales of DEXATRIM products without PPA or ephedrine; the
impact of brand acquisitions and divestitures; the impact of gains or losses
resulting from product acquisitions or 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.
36
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.
Our exposure to interest rate risks currently consists of our 8.875% senior
subordinated notes and our Credit Facility. The aggregate balance outstanding
under the 8.875% senior subordinated notes as of August 31, 2003 was $204,684.
Should interest rates increase or decrease, the estimated fair value of these
notes would decrease or increase, respectively. Loans under our 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 August 31, 2003, the variable rate on the term loan under our Credit
Facility was 3.36%. The balance outstanding under our term loan was $10,000 as
of August 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 third quarter of
fiscal 2003 would be approximately $16, net of income tax benefit. As of August
31, 2003, no revolving credit loans or letters of credit were outstanding under
our 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 Consolidated Statements of Income. During
2003, pursuant to our supply agreement with Abbott Laboratories, we are billed
in U.S. dollars for purchases of SELSUN BLUE for foreign markets. In many cases
in the future, we will be billed in the respective foreign currency. The
potential loss resulting from a hypothetical 10.0% adverse change in the quoted
foreign currency exchange rate amounts to approximately $920 at August 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)-15(e) and 15(d)-15(e)) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act") as of August 31, 2003 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 Disclosure Controls & Procedures. Since the Evaluation
Date, there have not been any significant changes in our disclosure controls &
procedures or in other factors that could significantly affect such controls.
37
PART II. OTHER INFORMATION
--------------------------
ITEM 1. LEGAL PROCEEDINGS
- --------------------------
See Note 15 of Notes to Consolidated Financial Statements included in
Part 1, Item 1 of this Report.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
- --------------------------------------------------
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- ----------------------------------------
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
None.
ITEM 5. OTHER INFORMATION
- --------------------------
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ----------------------------------------
(a) Exhibits:
First Amendment to Credit Agreement, dated as of August 22, 2003,
by and among Chattem, Inc., its domestic Subsidiaries, identified
Lenders, and Bank of America, N.A., as Agent (Exhibit 10).
Certification required by Rule 13a-14(a) under the Securities
Exchange Act of 1934 (Exhibit 31).
Certification required by Rule 13a-14(b) under the Securities
Exchange Act of 1934 and 18 U.S.C. Section 1350 (Exhibit 32).
(b) The following Form 8-K reports were filed with the Securities and
Exchange Commission during the three months ended August 31, 2003:
Form 8-K, filed August 13, 2003, regarding information relating to
a lawsuit filed against the Company by Kemper Indemnity Insurance
Company and announcing revised financial estimates for the third
quarter of fiscal 2003.
Form 8-K, filed July 23, 2003, regarding information relating to
our DEXATRIM with PPA litigation.
Form 8-K, filed June 19, 2003, containing a copy of our press
release announcing our financial results for the second quarter
ended May 31, 2003.
38
CHATTEM, INC.
-------------
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CHATTEM, INC.
(Registrant)
Dated: October 9, 2003 \s\ A. Alexander Taylor II
-------------------- -------------------------------------------
A. Alexander Taylor II
President and Director
(Chief Operating Officer)
Dated: October 9, 2003 \s\ Richard D. Moss
-------------------- -------------------------------------------
Richard D. Moss
Vice President and Chief Financial Officer
(Principal Financial Officer)
39
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
EXHIBIT INDEX
-------------
Exhibit Number Description of Exhibit
-------------- ----------------------
10 First Amendment to Credit Agreement, dated as of August
22, 2003, by and among Chattem, Inc., its domestic
Subsidiaries, identified Lenders, and Bank of America,
N.A., as Agent.
31 Certification required by Rule 13a-14(a) under the
Securities Exchange Act of 1934.
32 Certification required by Rule 13a-14(b) under the
Securities Exchange Act of 1934 and 18 U.S.C. Section
1350.
40