FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 24, 2006 |
| | OR |
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number 333-118532
LEINER HEALTH PRODUCTS INC. |
| (Exact name of registrant as specified in its charter) |
DELAWARE | | 95-3431709 |
| (State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification Number) |
901 East 233rd Street, Carson, California | | 90745 |
| (Address of principal executive offices) | | (Zip Code) |
(310) 835-8400 |
| Registrant’s telephone number, including area code |
N/A |
| (Former name or former address, if changed since last report) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer o Accelerated filer o Non-accelerated filer ý
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY |
PROCEEDINGS DURING THE PRECEDING FIVE YEARS: |
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by the court. YES ý* NO o
APPLICABLE ONLY TO CORPORATE ISSUERS |
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.
| Common Stock, $0.01 par value, 1,000 shares outstanding as of June 24, 2006 |
* No reports were required to be filed under Section 12, 13, or 15(d) of the Securities Exchange Act of 1934.
LEINER HEALTH PRODUCTS INC.
Report on Form 10-Q
For the Quarter ended June 24, 2006
Table of Contents
PART I. Financial Information | | |
| | | |
ITEM 1. Financial Statements | | 3 |
| | | |
| | | Condensed Consolidated Balance Sheets At March 25, 2006 and June 24, 2006 (Unaudited) | | 3 |
| | | | | |
| | | Condensed Consolidated Statements of Operations (Unaudited) - For the three months ended June 25, 2005 and June 24, 2006 | | 4 |
| | | | | |
| | | Condensed Consolidated Statements of Cash Flows (Unaudited) - For the three months ended June 25, 2005 and June 24, 2006 | | 5 |
| | | | | |
| | | Notes to Condensed Consolidated Financial Statements (Unaudited) | | 6 |
| | | | | |
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations | | 19 |
| | | |
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk | | 28 |
| | | |
ITEM 4. Controls and Procedures | | 29 |
| | | |
PART II. Other Information | | |
| | | |
ITEM 1. Legal Proceedings. | | 30 |
| | | |
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds. | | 30 |
| | | |
ITEM 3. Defaults Upon Senior Securities. | | 30 |
| | | |
ITEM 4. Submission of Matters to a Vote of Security Holders. | | 30 |
| | | |
ITEM 5. Other Information. | | 30 |
| | | |
ITEM 6. Exhibits. | | 30 |
| | | |
SIGNATURES | | 31 |
PART 1 Financial Information
Item 1 Financial Information
Leiner Health Products Inc.
Condensed Consolidated balance Sheets
(in thousands, except share data)
| | | March 25, 2006 | | June 24, 2006 | |
| | | | | Unaudited | |
ASSETS | | | | | | | |
| Current assets: | | | | | | | |
| Cash and cash equivalents | | $ | 7,731 | | $ | 7,539 | |
| Accounts receivable, net of allowances of $3,545 and $3,019 at March 25, 2006 and June 24, 2006, respectively | | | 73,211 | | | 61,067 | |
| Inventories | | | 165,714 | | | 185,088 | |
| Prepaid expenses and other current assets | | | 16,540 | | | 15,847 | |
| Total current assets | | | 263,196 | | | 269,541 | |
| Property, plant and equipment, net | | | 72,618 | | | 71,146 | |
| Goodwill | | | 58,245 | | | 58,374 | |
| Other noncurrent assets | | | 22,039 | | | 22,903 | |
| Total assets | | $ | 416,098 | | $ | 421,964 | |
| | | | | | | | |
LIABILITIES AND SHAREHOLDER'S DEFICIT | | | | | | | |
| | | | | | | | |
| Current liabilities: | | | | | | | |
| Accounts payable | | $ | 77,648 | | $ | 80,713 | |
| Accrued compensation and benefits | | | 9,994 | | | 8,607 | |
| Customer allowances payable | | | 10,522 | | | 11,477 | |
| Accrued interest | | | 10,436 | | | 6,820 | |
| Other accrued expenses | | | 14,418 | | | 14,674 | |
| Current portion of long-term debt | | | 5,498 | | | 4,754 | |
| Total current liabilities | | | 128,516 | | | 127,045 | |
| Long-term debt | | | 397,119 | | | 401,237 | |
| Other noncurrent liabilities | | | 5,545 | | | 5,612 | |
| Total liabilities | | | 531,180 | | | 533,894 | |
| Commitments and contingencies | | | | | | | |
| Shareholder's deficit: | | | | | | | |
| Common stock, $0.01 par value; 3,000,000 shares authorized, 1,000 issued and outstanding at March 25, 2006 and June 24, 2006 | | | - | | | - | |
| Capital in excess of par value | | | 13,489 | | | 13,500 | |
| Accumulated deficit | | | (130,125 | ) | | (128,138 | ) |
| Accumulated other comprehensive income | | | 1,554 | | | 2,708 | |
| Total shareholder's deficit | | | (115,082 | ) | | (111,930 | ) |
| Total liabilities and shareholder's deficit | | $ | 416,098 | | $ | 421,964 | |
See accompanying notes to condensed consolidated financial statements.
Leiner Health Products Inc.
Condensed Consolidated Statements of Operations
Unaudited
(in thousands)
| | | Three months ended | |
| | | June 25, 2005 | | June 24, 2006 | |
| | | | | | |
| Net sales | | $ | 145,587 | | $ | 163,910 | |
| Cost of sales | | | 123,284 | | | 123,982 | |
| Gross profit | | | 22,303 | | | 39,928 | |
| Marketing, selling and distribution expenses | | | 13,784 | | | 15,194 | |
| General and administrative expenses | | | 7,981 | | | 9,665 | |
| Research and development expenses | | | 1,090 | | | 1,081 | |
| Amortization of other intangibles | | | 10 | | | 282 | |
| Other operating expense (income) | | | 642 | | | (67 | ) |
| Operating income (loss) | | | (1,204 | ) | | 13,773 | |
| Interest expense, net | | | 8,629 | | | 10,045 | |
| Income (loss) before income taxes | | | (9,833 | ) | | 3,728 | |
| Provision for (benefit from) income taxes | | | (5,638 | ) | | 1,741 | |
| Net income (loss) | | $ | (4,195 | ) | $ | 1,987 | |
See accompanying notes to condensed consolidated financial statements.
Leiner Health Products Inc.
Condensed Consolidated Statements of Cash Flows
Unaudited
(in thousands)
| | | | Three months ended | |
| | | | June 25, 2005 | | | June 24, 2006 | |
Operating activities | | | | | | | |
| Net income (loss) | | $ | (4,195 | ) | $ | 1,987 | |
| Adjustments to reconcile net income (loss) to net cash used in operating activities: | | | | | | | |
| Depreciation | | | 3,732 | | | 3,891 | |
| Amortization of other intangibles and other contracts | | | 324 | | | 427 | |
| Amortization of deferred financing charges | | | 448 | | | 485 | |
| Provision for doubtful accounts and allowances | | | 905 | | | 639 | |
| Provision for excess and obsolete inventory | | | 3,227 | | | 5,991 | |
| Deferred income taxes | | | (1,438 | ) | | - | |
| Gain on disposal of assets | | | - | | | (4 | ) |
| Stock option compensation expense | | | 5 | | | 7 | |
| Translation adjustment | | | 521 | | | (1,154 | ) |
| Changes in operating assets and liabilities: | | | | | | | |
| Accounts receivable | | | 18,101 | | | 11,699 | |
| Inventories | | | 1,189 | | | (24,774 | ) |
| Income tax receivable | | | (4,296 | ) | | 1,832 | |
| Accounts payable | | | (15,975 | ) | | 2,965 | |
| Accrued compensation and benefits | | | (1,693 | ) | | (1,437 | ) |
| Customer allowances payable | | | 850 | | | 927 | |
| Accrued interest | | | (3,536 | ) | | (3,618 | ) |
| Other accrued expenses | | | (717 | ) | | (1,606 | ) |
| Other | | | 918 | | | 752 | |
| Net cash used in operating activities | | | (1,630 | ) | | (991 | ) |
Investing activities | | | | | | | |
| Additions to property, plant and equipment | | | (5,406 | ) | | (3,299 | ) |
| Increase in other noncurrent assets | | | (518 | ) | | (497 | ) |
| Net cash used in investing activities | | | (5,924 | ) | | (3,796 | ) |
Financing activities | | | | | | | |
| Net borrowings under bank revolving credit facility | | | - | | | 5,000 | |
| Payments under bank term credit facility | | | (600 | ) | | (600 | ) |
| Proceeds from the exercise of stock options | | | - | | | 4 | |
| Net payments on other long-term debt | | | (1,989 | ) | | (1,027 | ) |
| Net cash provided by (used in) financing activities | | | (2,589 | ) | | 3,377 | |
| Effect of exchange rate changes | | | (687 | ) | | 1,218 | |
| Net decrease in cash and cash equivalents | | | (10,830 | ) | | (192 | ) |
| Cash and cash equivalents at beginning of period | | | 16,951 | | | 7,731 | |
| Cash and cash equivalents at end of period | | $ | 6,121 | | $ | 7,539 | |
See accompanying notes to condensed consolidated financial statements.
Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
1. Basis of Presentation
General
The accompanying unaudited condensed consolidated financial statements of Leiner Health Products Inc. (“Leiner” or the “Company”) consolidate all of the Company’s subsidiaries, including all of its operating subsidiaries, which are Leiner Health Products, L.L.C., Leiner Health Services Corp., and Vita Health Products Inc. (“Vita Health”) and its non-operating subsidiaries, which are VH Vita Holdings Inc., Westcan Pharmaceuticals Ltd., and 6062199 Canada Inc. Such financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Such adjustments consist of adjustments of a normal recurring nature. This report should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto for the year ended March 25, 2006, which are included in the Company’s Annual Report on Form 10-K, on file with the Securities and Exchange Commission (“SEC”) file number 333-118532. Operating results for the three months ended June 24, 2006 are not necessarily indicative of the results that may be expected for the year ending March 31, 2007 or any other future periods.
There have been no material changes in the Company’s critical accounting policies and estimates during the first quarter of fiscal 2007. Accordingly, the disclosures provided in the Company’s Annual Report on Form 10-K for the year ended March 25, 2006, remains current.
2. Fiscal Year
The Company maintains a fifty-two/fifty-three week fiscal year. The Company’s fiscal year end will fall on the last Saturday of March each year. The first three months ended June 25, 2005 and June 24, 2006 were each comprised of 13 weeks.
3. Fair Values of Debt Instruments
Fair values of the Company’s debt instruments have been determined based on borrowing rates currently available to the Company for loans with similar terms or maturity. The table below provides information about the fair value of the Company’s debt obligations under the Credit Facility and Notes (in thousands):
| | | June 24, 2006 | |
| | | Total | | Fair Value | |
| Variable rate ($US) | | $ | 245,800 | | $ | 245,800 | |
| Average interest rate | | | 8.60 | % | | | |
| Fixed rate ($US) | | $ | 150,000 | | $ | 139,500 | |
| Average interest rate | | | 11.00 | % | | | |
The fair value of the Industrial Development Revenue Bond Loan could not be estimated because there is no active market for such debt instruments.
Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
(continued)
4. Comprehensive Income (loss)
The only component of other accumulated comprehensive income (loss) is the cumulative foreign currency translation adjustment recorded in shareholder’s deficit. The comprehensive income (loss) is as follows (in thousands):
| | | Three months ended | |
| | | June 25, 2005 | | June 24, 2006 | |
| Net income (loss) | | $ | (4,195 | ) | $ | 1,987 | |
| Foreign currency translation adjustment | | | (521 | ) | | 1,154 | |
| Comprehensive income (loss) | | $ | (4,716 | ) | $ | 3,141 | |
5. Acquisition
In the second quarter of fiscal 2006, the Company agreed to acquire substantially all of the assets of Pharmaceutical Formulations Inc. (“PFI”), a manufacturer of private label OTC products in the United States, related to its OTC pharmaceutical business (the “Acquisition”), except for assets related to PFI’s Konsyl Pharmaceuticals Inc. subsidiary and other scheduled assets (the “PFI Business”).
The following unaudited pro forma financial information presents the consolidated results of operations as if the Acquisition had occurred at the beginning of fiscal 2006 and does not purport to be indicative of the results that would have occurred had the Acquisition occurred at such date or of results which may occur in the future (in thousands):
| | | Three months ended | |
| | | June 25, 2005 | |
| Net sales | | $ | 158,882 | |
| Operating loss | | | (4,783 | ) |
| Net loss | | | (7,788 | ) |
6. Restructuring charges
In fiscal 2006, the Company eliminated approximately 104 positions from its Carson, Garden Grove and Valencia, California, Fort Mill, South Carolina, and Wilson, North Carolina locations. Severance and other costs related to such reductions totaled $3,836,000 and were paid to the terminated employees, except for the president, on a weekly basis through July 2006. The restructuring charges also include the severance accrued for the president, who resigned effective March 31, 2006. The accrued severance for the president will be paid on a weekly basis through April 2009.
Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
(continued)
The following table summarizes the activities in the Company’s restructuring reserve (in thousands):
| | | Costs for Employess Terminated | |
| Balance at March 25, 2006 | | $ | 2,346 | |
| Cash payments | | | (1,162 | ) |
| Balance at June 24, 2006 | | $ | 1,184 | |
7. Inventories
Inventories consist of the following (in thousands):
| | | March 25, 2006 | | June 24, 2006 | |
| Inventories: | | | | | | | |
| Raw materials, bulk vitamins and packaging materials | | $ | 36,026 | | $ | 38,864 | |
| Work-in-process | | | 57,972 | | | 66,738 | |
| Finished products | | | 71,716 | | | 79,486 | |
| | | $ | 165,714 | | $ | 185,088 | |
8. Debt
Long term debt consists of (in thousands):
| | | March 25, 2006 | | June 24, 2006 | |
| Credit Facility: | | | | | | | |
| Revolving facility | | $ | 5,000 | | $ | 10,000 | |
| Term facility | | | 236,400 | | | 235,800 | |
| Total credit facility | | | 241,400 | | | 245,800 | |
| Senior subordinated notes | | | 150,000 | | | 150,000 | |
| Capital lease obligations | | | 7,117 | | | 6,591 | |
| Industrial development revenue bond loan | | | 4,100 | | | 3,600 | |
| | | | 402,617 | | | 405,991 | |
| Less current portion | | | (5,498 | ) | | (4,754 | ) |
| Total long-term debt | | $ | 397,119 | | $ | 401,237 | |
9. Related Party Transactions
The Company, Leiner Health Products, LLC, a wholly-owned subsidiary, and the Company's ultimate parent company LHP Holding Corp. ("Holdings") have a consulting agreement with North Castle Partners, L.L.C., an affiliate of the North Castle Investors, and certain administrative entities affiliated with the Golden Gate Investors (“GGC Administration”) to provide the Company with certain financial, investment banking, management advisory and other services. As compensation for their services, the Company pays a $1,315,000 management fee in arrears annually plus reasonable out-of-pocket expenses to each of North Castle Partners, L.L.C. and GGC Administration as long as the Company meets a certain performance target. As of June 24, 2006, the Company does not expect to meet its performance target for fiscal 2007 and, therefore, the accrual for management fees has not been recorded in the first quarter of fiscal 2007. Other operating expenses in the accompanying statement of operations for the three months ended June 25, 2005 and June 24, 2006 include management fees, out-of-pocket expenses or related expenses of $672,000 and $9,000, respectively.
Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
(continued)
On June 1, 2006, the Company made a loan to a senior vice president in the amount of $400,000. In accordance with the terms of the loan, the first obligation of $200,000 will be forgiven over three fiscal years subject to the senior vice president’s continued employment with the Company. If the senior vice president does not complete the three year continued employment term, then the senior vice president must repay the entire amount of the first obligation. The Company is amortizing the total amount of the first obligation over the three year term of the employment and as such charged to expense approximately $6,154 in the first quarter of fiscal 2007. The second obligation in the amount of $200,000 will be repaid by the employee starting in the first quarter of fiscal 2008. At June 24, 2006, the aggregate indebtedness under this loan was recorded under the other non-current assets caption in the accompanying condensed consolidated balance sheet. The interest rate on the unpaid principal balance is 8% per annum, subject to certain limitations.
10. Income Taxes
Deferred income taxes are computed using the liability method and reflect the effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.
In assessing the realizability of deferred tax assets, management considers whether it is “more likely than not” that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers taxable income in carryback years, the scheduled reversal of deferred tax liabilities, tax planning strategies, and projected future taxable income in making this assessment.
The Company recorded an income tax provision of $1,741,000 or a 46.7% effective tax rate for the three months ended June 24, 2006, compared to a benefit of $5,638,000 or 57.3 % rate for the three months ended June 25, 2005. The effective tax rate for the three months ended June 24, 2006 is substantially different from the effective rate for the three months ended June 25, 2005 primarily due to the release of a significant portion of the Canadian valuation allowance against its deferred tax assets during the three months ended June 25, 2005. The release of the valuation allowance was based on the Company’s expected current and future profitable Canadian operation.
The effective tax rate was also affected by recently enacted Canadian federal tax rate reductions phased in over a four year period which became law on June 22, 2006 with the passage of Bill C-13. The scheduling of the expected reversal of Canadian deferred tax assets at the lower enacted tax rates is recognized as a first quarter discreet item and thus increased the quarterly tax provision.
11. Employee Benefits
2004 Option Plan
During the third quarter of fiscal 2006, options to purchase 37,500 shares of common stock were granted to certain employees at an exercise price of $2.37. During the first quarter of fiscal 2007, options for 1,769 shares of common stock were exercised at $2.37 per share and options for 1,471 shares of common stock were forfeited.
Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
(continued)
The following table summarizes the information on options outstanding as of June 24, 2006:
Outstanding | | Excercisable |
Exercise price | | Number of Shares | | Average Remaining Contractual Life (years) | | Weighted Average Exercise Price | | Number of Shares | | Weighted Average Exercise Price |
| $ | 2.37 | | 68,232 | | 9.04 | | $ | 2.37 | | 25,452 | | $ | 2.37 |
The fair value of options is estimated at the date of grant using the Black-Scholes option pricing model. The following weighted-average assumptions were used in valuing options issued in the third quarter of fiscal 2006.
| | | | | Three months ended | |
| | | | | June 24, 2006 | |
| Risk free interest rate | | | | | | 4.20 | % |
| Expected term in years | | | | | | 5.00 | |
| Expected volatility | | | | | | 34.69 | % |
| Expected dividend rate | | | | | | 13.00 | % |
| Expected forfeiture rate | | | | | | - | % |
The Company recorded a total expense of $2,888, including the cumulative expense of $1,686 for the options issued in the third quarter of fiscal 2006, as share-based compensation under general and administrative expense in the condensed consolidated statement of operations for the three months ended June 24, 2006. The weighted-average per share, fair value of options granted during fiscal 2005 and fiscal 2006 was $0.41. As of June 24, 2006, there was $28,114 of total unrecorded and unrecognized compensation expense related to nonvested share-based compensation under the 2004 Option Plan. That cost is expected to be recorded and recognized over a weighted average period of 3 years.
Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
(continued)
12. Contingencies
The Company has been named a defendant in seven pending cases alleging adverse reactions associated with the ingestion of Phenylpropanolamine (PPA) containing products that the Company allegedly manufactured and sold. Currently, none of the cases has proceeded to trial, although the Company intends to vigorously defend these allegations if trials ensue. These actions have been tendered to the Company’s insurance carrier. The Company has recorded in its consolidated financial statements a liability for the entire estimated potential liability in the amount of $2,000,000, based on the opinion of outside counsel as to the probable settlement value of the cases based on the Company’s consultations with its primary insurance carrier and broker.
The Company is subject to other legal proceedings and claims that arise in the normal course of business. While the outcome of any of these proceedings and claims cannot be predicted with certainty, management believes that it has provided adequate reserves for these claims and does not believe the outcome of any of these matters will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.
13. Business Segment Information
The Company operates in two business segments. One consists of the Company's U.S. Operations (“Leiner U.S.”) and the other is the Company's Canadian operation (“Vita Health”). The Company's operating segments manufacture a range of vitamins, minerals and nutritional supplements (“VMS”) and OTC pharmaceuticals and distribute their products primarily through FDMC retailers. The accounting policies between the reportable segments are the same as those described in the summary of significant accounting policies. The Company evaluates segment performance based on operating profit, before the effect of non-recurring charges and gains, and inter-segment profit.
Selected financial information for the Company's reportable segments for the three months ended June 25, 2005 and June 24, 2006 is as follows (in thousands):
| | | Leiner U.S. | | Vita Health | | Consolidated Totals | |
Three months ended June 25, 2005: | | | | | | | | | | |
| Net sales to external customers | | $ | 131,937 | | $ | 13,650 | | $ | 145,587 | |
| Intersegment sales | | | 315 | | | - | | | - | |
| Depreciation and amortization, excluding deferred financing charges | | | 3,353 | | | 703 | | | 4,056 | |
| Segment operating income (loss) | | | (2,704 | ) | | 1,500 | | | (1,204 | ) |
| Interest expense, net (1) | | | 8,289 | | | 340 | | | 8,629 | |
| Income tax expense | | | (5,497 | ) | | (141 | ) | | (5,638 | ) |
| Segment assets | | | 345,830 | | | 43,811 | | | 389,641 | |
| Additions to property, plant and equipment | | | 5,301 | | | 105 | | | 5,406 | |
| | | | | | | | | | | |
Three months ended June 24, 2006: | | | | | | | | | | |
| Net sales to external customers | | $ | 152,032 | | $ | 11,878 | | $ | 163,910 | |
| Intersegment sales | | | 474 | | | 588 | | | - | |
| Depreciation and amortization, excluding deferred financing charges | | | 3,917 | | | 401 | | | 4,318 | |
| Segment operating income | | | 13,207 | | | 566 | | | 13,773 | |
| Interest expense (income), net (1) | | | 10,143 | | | (98 | ) | | 10,045 | |
| Income tax expense | | | 1,300 | | | 441 | | | 1,741 | |
| Segment assets | | | 383,088 | | | 38,876 | | | 421,964 | |
| Additions to property, plant and equipment | | | 3,004 | | | 295 | | | 3,299 | |
| (1) | Interest expense, net includes the amortization of deferred financing charges. |
Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
(continued)
The following table sets forth the net sales of the Company’s VMS, OTC pharmaceutical and other product lines for the periods indicated (dollar amounts in thousands):
| | | Three months ended | |
| | | June 25, 2005 | | % | | June 24, 2006 | | % | |
| VMS products | | $ | 84,795 | | | 58 | % | $ | 100,106 | | | 61 | % |
| OTC products | | | 46,695 | | | 32 | % | | 50,159 | | | 31 | % |
| Contract manufacturing services/Other | | | 14,097 | | | 10 | % | | 13,645 | | | 8 | % |
| Total | | $ | 145,587 | | | 100 | % | $ | 163,910 | | | 100 | % |
14. Financial information for subsidiary guarantor and subsidiary non-guarantor
In connection with the issuance of the 11% senior subordinated notes due 2012 (the "Notes"), the Company’s U.S. based subsidiaries, Leiner Health Services, Corp. and Leiner Health Products, LLC, guaranteed the payment of principal, premium and interest on the Notes. Since the Company has no independent assets or operations of its own and owns 100% of the guarantor subsidiaries, the disclosure below is presented consolidating the financial information for the Company and its subsidiary guarantors and subsidiary non-guarantors for the periods indicated.
Leiner Health Products Inc.
Condensed Consolidating Balance Sheets
(in thousands)
| | | March 25, 2006 | |
| | | Company & Guarantor Subsidiaries | | Non-Guarantor Subsidiaries | | Eliminations and Consolidating Entries | | Consolidated | |
ASSETS | | | | | | | | | | | | | |
| Current assets: | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 3,766 | | $ | 3,965 | | $ | - | | $ | 7,731 | |
| Accounts receivable, net of allowances | | | 68,314 | | | 4,897 | | | - | | | 73,211 | |
| Inventories | | | 150,922 | | | 14,792 | | | - | | | 165,714 | |
| Income tax receivable | | | - | | | - | | | - | | | - | |
| Prepaid expenses and other current assets | | | 13,715 | | | 2,825 | | | - | | | 16,540 | |
| Total current assets | | | 236,717 | | | 26,479 | | | - | | | 263,196 | |
| Intercompany receivable | | | 32,875 | | | - | | | (32,875 | ) | | - | |
| Property, plant and equipment, net | | | 64,378 | | | 8,240 | | | - | | | 72,618 | |
| Goodwill | | | 55,019 | | | 3,226 | | | - | | | 58,245 | |
| Other noncurrent assets | | | 22,039 | | | - | | | - | | | 22,039 | |
| Total assets | | $ | 411,028 | | $ | 37,945 | | $ | (32,875 | ) | $ | 416,098 | |
| | | | | | | | | | | | | | |
LIABILITIES AND SHAREHOLDER'S DEFICIT | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| Current liabilities: | | | | | | | | | | | | | |
| Accounts payable | | $ | 75,122 | | $ | 2,526 | | $ | - | | $ | 77,648 | |
| Accrued compensation and benefits | | | 8,749 | | | 1,245 | | | - | | | 9,994 | |
| Customer allowances payable | | | 9,831 | | | 691 | | | - | | | 10,522 | |
| Accrued interest | | | 10,370 | | | 66 | | | - | | | 10,436 | |
| Other accrued expenses | | | 12,323 | | | 2,095 | | | - | | | 14,418 | |
| Current portion of long-term debt | | | 5,487 | | | 11 | | | - | | | 5,498 | |
| Total current liabilities | | | 121,882 | | | 6,634 | | | - | | | 128,516 | |
| Intercompany payable | | | - | | | 32,875 | | | (32,875 | ) | | - | |
| Long-term debt | | | 397,110 | | | 9 | | | - | | | 397,119 | |
| Other noncurrent liabilities | | | 5,545 | | | - | | | - | | | 5,545 | |
| Total liabilities | | | 524,537 | | | 39,518 | | | (32,875 | ) | | 531,180 | |
| Shareholder's deficit: | | | | | | | | | | | | | |
| Common stock | | | - | | | - | | | - | | | - | |
| Capital in excess of par value | | | 13,489 | | | - | | | - | | | 13,489 | |
| Accumulated deficit | | | (126,998 | ) | | (3,127 | ) | | - | | | (130,125 | ) |
| Accumulated other comprehensive income | | | - | | | 1,554 | | | - | | | 1,554 | |
| Total shareholder's deficit | | | (113,509 | ) | | (1,573 | ) | | - | | | (115,082 | ) |
| Total liabilities and shareholder's deficit | | $ | 411,028 | | $ | 37,945 | | $ | (32,875 | ) | $ | 416,098 | |
Leiner Health Products Inc.
Condensed Consolidating Balance Sheets
Unaudited
(in thousands)
| | | June 24, 2006 | |
| | | Parent & Guarantor Subsidiaries | | Non-Guarantor Subsidiaries | | Eliminations and Consolidating Entries | | Consolidated | |
ASSETS | | | | | | | | | | | | | |
| Current assets: | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 3,443 | | $ | 4,096 | | $ | - | | $ | 7,539 | |
| Accounts receivable, net of allowances | | | 56,772 | | | 4,295 | | | - | | | 61,067 | |
| Inventories | | | 169,533 | | | 15,555 | | | - | | | 185,088 | |
| Prepaid expenses and other current assets | | | 12,737 | | | 3,110 | | | - | | | 15,847 | |
| Total current assets | | | 242,485 | | | 27,056 | | | - | | | 269,541 | |
| Intercompany receivable | | | 32,293 | | | - | | | (32,293 | ) | | - | |
| Property, plant and equipment, net | | | 62,681 | | | 8,465 | | | - | | | 71,146 | |
| Goodwill | | | 55,019 | | | 3,355 | | | - | | | 58,374 | |
| Other noncurrent assets | | | 22,903 | | | - | | | - | | | 22,903 | |
| Total assets | | $ | 415,381 | | $ | 38,876 | | $ | (32,293 | ) | $ | 421,964 | |
| | | | | | | | | | | | | | |
LIABILITIES AND SHAREHOLDER'S DEFICIT | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| Current liabilities: | | | | | | | | | | | | | |
| Accounts payable | | $ | 78,470 | | $ | 2,243 | | $ | - | | $ | 80,713 | |
| Accrued compensation and benefits | | | 7,268 | | | 1,339 | | | - | | | 8,607 | |
| Customer allowances payable | | | 10,623 | | | 854 | | | - | | | 11,477 | |
| Accrued interest | | | 6,820 | | | - | | | - | | | 6,820 | |
| Other accrued expenses | | | 12,349 | | | 2,325 | | | - | | | 14,674 | |
| Current portion of long-term debt | | | 4,743 | | | 11 | | | - | | | 4,754 | |
| Total current liabilities | | | 120,273 | | | 6,772 | | | - | | | 127,045 | |
| Intercompany payable | | | - | | | 32,293 | | | (32,293 | ) | | - | |
| Long-term debt | | | 401,230 | | | 7 | | | - | | | 401,237 | |
| Other noncurrent liabilities | | | 5,612 | | | - | | | - | | | 5,612 | |
| Total liabilities | | | 527,115 | | | 39,072 | | | (32,293 | ) | | 533,894 | |
| Shareholder's deficit: | | | | | | | | | | | | | |
| Common stock | | | - | | | - | | | - | | | - | |
| Capital in excess of par value | | | 13,500 | | | - | | | - | | | 13,500 | |
| Accumulated deficit | | | (125,234 | ) | | (2,904 | ) | | - | | | (128,138 | ) |
| Accumulated other comprehensive income | | | - | | | 2,708 | | | - | | | 2,708 | |
| Total shareholder's deficit | | | (111,734 | ) | | (196 | ) | | - | | | (111,930 | ) |
| Total liabilities and shareholder's deficit | | $ | 415,381 | | $ | 38,876 | | $ | (32,293 | ) | $ | 421,964 | |
Leiner Health Products Inc.
Condensed Consolidating Statement of Operations
Unaudited
(in thousands)
| | | Three months ended June 25, 2005 | |
| | | Parent & Gaurantor Subsidiaries | | Non-Guarantor Subsidiaries | | Eliminations and Consolidating Entries | | Consolidated | |
| Net sales | | $ | 132,252 | | $ | 13,650 | | $ | (315 | ) | $ | 145,587 | |
| Cost of sales | | | 113,204 | | | 10,395 | | | (315 | ) | | 123,284 | |
| Gross profit | | | 19,048 | | | 3,255 | | | - | | | 22,303 | |
| Marketing, selling and distribution expenses | | | 12,720 | | | 1,064 | | | - | | | 13,784 | |
| General and administrative expenses | | | 7,267 | | | 714 | | | - | | | 7,981 | |
| Research and development expenses | | | 1,083 | | | 7 | | | - | | | 1,090 | |
| Amortization of other intangibles | | | 10 | | | - | | | - | | | 10 | |
Other operating expense (income) | | | 672 | | | (30 | ) | | - | | | 642 | |
| Operating income (loss) | | | (2,704 | ) | | 1,500 | | | - | | | (1,204 | ) |
| Interest expense, net | | | 8,289 | | | 340 | | | - | | | 8,629 | |
| Income (loss) before income taxes | | | (10,993 | ) | | 1,160 | | | - | | | (9,833 | ) |
| Benefit from income taxes | | | (5,497 | ) | | (141 | ) | | - | | | (5,638 | ) |
| Net income (loss) | | $ | (5,496 | ) | $ | 1,301 | | $ | - | | $ | (4,195 | ) |
Leiner Health Products Inc.
Condensed Consolidating Statement of Operations
Unaudited
(in thousands)
| | | Three months ended June 24, 2006 | |
| | | Parent & Gaurantor Subsidiaries | | Non-Guarantor Subsidiaries | | Eliminations and Consolidating Entries | | Consolidated | |
| Net sales | | $ | 152,506 | | $ | 12,466 | | $ | (1,062 | ) | $ | 163,910 | |
| Cost of sales | | | 115,083 | | | 9,961 | | | (1,062 | ) | | 123,982 | |
| Gross profit | | | 37,423 | | | 2,505 | | | - | | | 39,928 | |
| Marketing, selling and distribution expenses | | | 14,086 | | | 1,108 | | | - | | | 15,194 | |
| General and administrative expenses | | | 8,778 | | | 887 | | | - | | | 9,665 | |
| Research and development expenses | | | 1,063 | | | 18 | | | - | | | 1,081 | |
| Amortization of other intangibles | | | 282 | | | - | | | - | | | 282 | |
| Other operating expense (income) | | | 7 | | | (74 | ) | | - | | | (67 | ) |
| Operating income | | | 13,207 | | | 566 | | | - | | | 13,773 | |
| Interest expense (income), net | | | 10,143 | | | (98 | ) | | - | | | 10,045 | |
| Income before income taxes | | | 3,064 | | | 664 | | | - | | | 3,728 | |
| Provision for income taxes | | | 1,300 | | | 441 | | | - | | | 1,741 | |
| Net income | | $ | 1,764 | | $ | 223 | | $ | - | | $ | 1,987 | |
Leiner Health Products Inc.
Condensed Consolidating Statement of Cash Flows
Unaudited
(in thousands)
| | | Three months ended June 25, 2005 | |
| | | | Parent & Gaurantor Subsidiaries | | | Non-Guarantor Subsidiaries | | | Consolidated | |
Operating activities | | | | | | | | | | |
| Net income (loss) | | $ | (5,496 | ) | $ | 1,301 | | $ | (4,195 | ) |
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | | | | | | | | | | |
| Depreciation | | | 3,029 | | | 703 | | | 3,732 | |
| Amortization of other intangibles and other contracts | | | 324 | | | - | | | 324 | |
| Amortization of deferred financing charges | | | 448 | | | - | | | 448 | |
| Provision for doubtful accounts and allowances | | | 905 | | | - | | | 905 | |
| Provision for excess and obsolete inventory | | | 3,227 | | | - | | | 3,227 | |
| Deferred income taxes | | | - | | | (1,438 | ) | | (1,438 | ) |
| Stock option compensation expense | | | 5 | | | - | | | 5 | |
| Translation adjustment | | | - | | | 521 | | | 521 | |
| Changes in operating assets and liabilities: | | | | | | | | | | |
| Accounts receivable | | | 14,498 | | | 3,603 | | | 18,101 | |
| Inventories | | | (900 | ) | | 2,089 | | | 1,189 | |
| Income tax receivable | | | (5,540 | ) | | 1,244 | | | (4,296 | ) |
| Accounts payable | | | (11,153 | ) | | (4,822 | ) | | (15,975 | ) |
| Accrued compensation and benefits | | | (1,222 | ) | | (471 | ) | | (1,693 | ) |
| Customer allowances payable | | | 966 | | | (116 | ) | | 850 | |
| Accrued interest | | | (3,531 | ) | | (5 | ) | | (3,536 | ) |
| Other accrued expenses | | | (437 | ) | | (280 | ) | | (717 | ) |
| Other | | | 1,027 | | | (109 | ) | | 918 | |
| Net cash provided by (used in) operating activities | | | (3,850 | ) | | 2,220 | | | (1,630 | ) |
Investing activities | | | | | | | | | | |
| Additions to property, plant and equipment | | | (5,301 | ) | | (105 | ) | | (5,406 | ) |
| Decrease in other noncurrent assets | | | (518 | ) | | - | | | (518 | ) |
| Net cash used in investing activities | | | (5,819 | ) | | (105 | ) | | (5,924 | ) |
Financing activities | | | | | | | | | | |
| Payments under bank term credit facility | | | (600 | ) | | - | | | (600 | ) |
| Net payments on other long-term debt | | | (922 | ) | | (1,067 | ) | | (1,989 | ) |
| Net cash used in financing activities | | | (1,522 | ) | | (1,067 | ) | | (2,589 | ) |
| Intercompany | | | 1,029 | | | (1,029 | ) | | - | |
| Effect of exchange rate changes | | | - | | | (687 | ) | | (687 | ) |
| Net decrease in cash and cash equivalents | | | (10,162 | ) | | (668 | ) | | (10,830 | ) |
| Cash and cash equivalents at beginning of period | | | 11,670 | | | 5,281 | | | 16,951 | |
| Cash and cash equivalents at end of period | | $ | 1,508 | | $ | 4,613 | | $ | 6,121 | |
Leiner Health Products Inc.
Condensed Consolidating Statement of Cash Flows
Unaudited
(in thousands)
| | | Three months ended June 24, 2006 | |
| | | Parent & Gaurantor Subsidiaries | | Non-Guarantor Subsidiaries | |
Consolidated | |
Operating activities | | | | | | | | | | |
| Net income | | $ | 1,764 | | $ | 223 | | $ | 1,987 | |
Adjustments to reconcile net income to net cash used in operating activities: | | | | | | | | | | |
| Depreciation | | | 3,490 | | | 401 | | | 3,891 | |
| Amortization of other intangibles and other contracts | | | 427 | | | - | | | 427 | |
| Amortization of deferred financing charges | | | 485 | | | - | | | 485 | |
| Provision for doubtful accounts and allowances | | | 639 | | | - | | | 639 | |
| Provision for excess and obsolete inventory | | | 5,896 | | | 95 | | | 5,991 | |
| Gain on disposal of assets | | | (2 | ) | | (2 | ) | | (4 | ) |
| Stock option compensation expense | | | 7 | | | - | | | 7 | |
| Translation adjustment | | | - | | | (1,154 | ) | | (1,154 | ) |
| Changes in operating assets and liabilities: | | | | | | | | | | |
| Accounts receivable | | | 10,904 | | | 795 | | | 11,699 | |
| Inventories | | | (24,507 | ) | | (267 | ) | | (24,774 | ) |
| Income tax receivable | | | 1,469 | | | 363 | | | 1,832 | |
| Accounts payable | | | 3,348 | | | (383 | ) | | 2,965 | |
| Accrued compensation and benefits | | | (1,482 | ) | | 45 | | | (1,437 | ) |
| Customer allowances payable | | | 792 | | | 135 | | | 927 | |
| Accrued interest | | | (3,550 | ) | | (68 | ) | | (3,618 | ) |
| Other accrued expenses | | | (1,386 | ) | | (220 | ) | | (1,606 | ) |
| Other | | | 922 | | | (170 | ) | | 752 | |
| Net cash used in operating activities | | | (784 | ) | | (207 | ) | | (991 | ) |
Investing activities | | | | | | | | | | |
| Additions to property, plant and equipment | | | (3,004 | ) | | (295 | ) | | (3,299 | ) |
| Decrease in other noncurrent assets | | | (497 | ) | | - | | | (497 | ) |
| Net cash used in investing activities | | | (3,501 | ) | | (295 | ) | | (3,796 | ) |
Financing activities | | | | | | | | | | |
| Net borrowings under bank revolving credit facility | | | 5,000 | | | - | | | 5,000 | |
| Payments under bank term credit facility | | | (600 | ) | | - | | | (600 | ) |
| Proceeds from the exercise of stock options | | | 4 | | | - | | | 4 | |
| Net payments on other long-term debt | | | (1,024 | ) | | (3 | ) | | (1,027 | ) |
| Net cash provided by (used in) financing activities | | | 3,380 | | | (3 | ) | | 3,377 | |
| Intercompany | | | 582 | | | (582 | ) | | - | |
| Effect of exchange rate changes | | | - | | | 1,218 | | | 1,218 | |
| Net increase (decrease) in cash and cash equivalents | | | (323 | ) | | 131 | | | (192 | ) |
| Cash and cash equivalents at beginning of period | | | 3,766 | | | 3,965 | | | 7,731 | |
| Cash and cash equivalents at end of period | | $ | 3,443 | | $ | 4,096 | | $ | 7,539 | |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
As used in the management’s discussion and analysis section of this report, unless the context indicates otherwise, the terms “our company,” “we,” “our,” and “us” refer collectively to Leiner Health Products Inc. and its subsidiaries (the “Company”), including Vita Health Products Inc. of Canada (“Vita”), a wholly owned subsidiary.
Overview
The following discussion explains significant changes in the condensed consolidated financial condition and results of our operations for the three months ended June 24, 2006 (“first quarter of fiscal 2007”), and the significant developments affecting our financial condition since March 25, 2006. The following discussion should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended March 25, 2006, which are included in our Annual Report on Form 10-K, on file with the Securities and Exchange Commission (“SEC”).
Results of Operations
The following table summarizes our historical results of operations as a percentage of net sales for the first quarter ended June 25, 2005 and June 24, 2006.
| | | Percentage of Net Sales Three months ended | |
| | | June 25, 2005 | | June 24, 2006 | |
| Net sales | | | 100.0 | % | | 100.0 | % |
| Cost of sales | | | 84.7 | | | 75.6 | |
| Gross profit | | | 15.3 | | | 24.4 | |
| Selling, general and administrative expenses | | | 15.0 | | | 15.2 | |
| Research and development expenses | | | 0.7 | | | 0.7 | |
| Amortization of other intangibles | | | - | | | 0.2 | |
| Other operating expense | | | 0.4 | | | - | |
| Operating income (loss) | | | (0.8 | ) | | 8.3 | |
| Interest expense, net | | | 5.9 | | | 6.1 | |
| Income (loss) before income taxes | | | (6.7 | ) | | 2.2 | |
| Provision for (benefit from) income taxes | | | (3.9 | ) | | 1.1 | |
| Net income (loss) | | | (2.8 | ) | | 1.1 | |
Net Sales were $163.9 million in the first quarter of fiscal 2007, an increase of $18.3 million, or 12.6%, from $145.6 million in the first quarter of fiscal 2006. The $163.9 million in net sales represents the strongest first quarter in our history. While the first quarters of our fiscal years are typically our lowest sales quarters, the improvements we experienced in the first quarter of fiscal 2007 are strong indicators of our successful navigation of the shifting product landscape. The increase in net sales for the first quarter was primarily due to higher sales of joint care, coenzyme Q10 (CoQ10) and fish oil products and additional revenue due to the PFI acquisition partly offset by lower sales of analgesics and multivitamins products in Canada. We do not expect the current declining trend in our Canadian net sales to continue in the second half of fiscal 2007. Approximately 5% of the growth was due to the PFI acquisition. The prior year’s net sales were also adversely impacted by the establishment of $4.7 million reserve for customer returns of certain branded products.
U.S. net sales were $152.0 million in the first quarter of fiscal 2007, an increase of $20.1 million, or 15.2% from $131.9 million in the first quarter of fiscal 2006. The increase in net sales in the U.S. for the first quarter of fiscal 2007 was primarily due to higher sales of joint care, CoQ10 and fish oil products and additional revenue due to the PFI acquisition. In addition, the prior year’s net sales were adversely impacted by the establishment of $4.7 million reserve for customer returns of certain branded products. Net sales attributable to our Canadian operations were $11.9 million in the first quarter of fiscal 2007, a decrease of $1.8 million, or 13.0%, from $13.7 million in the same period of fiscal 2006. The Canadian year to year decrease for the first quarter of fiscal 2007 was primarily due to the continued impact of the decision by a competitive OTC supplier in Canada to supply retail customers directly on selected items and lower sales of analgesics and multivitamins products to the major customers in Canada.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Regarding our three principal product categories:
| · | VMS product net sales were $100.1 million in the first quarter of fiscal 2007, an increase of $15.3 million, or 18.1%, from $84.8 million in the first quarter of fiscal 2006. The increase in VMS category sales was primarily due to higher sales of joint care, CoQ10 and fish oil products in the U.S. partly offset by lower sales of multivitamins products in Canada. In addition, the prior year’s sales were adversely impacted by the establishment of $4.7 million reserves for customer returns of certain branded products. |
| · | OTC product net sales were $50.2 million in the first quarter of fiscal 2007, an increase of $3.5 million, or 7.4%, from $46.7 million in the first quarter of fiscal 2006. The increase in OTC net sales for the three months ended June 24, 2006 was primarily attributable to additional revenue due to the PFI acquisition and rebound in our Naproxen sales partially offset by lower sales of analgesics products in Canada. |
| · | Contract manufacturing services net sales were $13.6 million in the first quarter of fiscal 2007, a decrease of $0.5 million, or 3.2%, from $14.1 million in the first quarter of fiscal 2006. The decrease in the three month period ended June 24, 2006 was primarily due to a decline in new product sales to one of our key contract manufacturing customers. We expect our contract manufacturing business to grow in fiscal 2007 as we have signed and/or expect to sign a number of major contracts with certain pharmaceutical companies. |
Cost of sales was at $124.0 million, or 75.6%, of net sales, in the first quarter of fiscal 2007, an increase of $0.7 million, or 0.6%, from $123.3 million, or 84.7%, of net sales, in the first quarter of fiscal 2006. The cost of sales as a percentage of net sales decreased in the first quarter of fiscal 2007 compared to the first quarter of fiscal 2006 primarily due to the continued stabilization of joint care margins on lower raw material costs achieved and better fixed cost absorption from higher plant utilization. In addition, the prior year’s cost of sales included the establishment of a reserve to reduce the carrying value of certain branded products.
Gross profit was $39.9 million, or 24.4% of net sales, in the first quarter of fiscal 2007, an increase of $17.6 million, or 79.0%, from $22.3 million, or 15.3% of net sales in the first quarter of fiscal 2006. The increase in gross profit as a percentage of net sales in the first quarter of fiscal 2007 is primarily due to higher sales of CoQ10 and fish oil products, continued stabilization of joint care margins on lower raw material costs, and better fixed cost absorption from higher plant utilization. The prior year’s gross profit included a reserve established for customer returns and a reserve to reduce the carrying value of certain branded products. We expect our gross profit in the fist half of fiscal 2007 to be consistent with the gross profit we achieved in the second half of fiscal 2006.
Selling, general and administrative expenses (“SG&A”) consist of (1) marketing, selling and distribution expenses, which include components such as advertising costs, selling costs, warehousing, shipping and handling and (2) general and administrative expenses, which include components such as administrative functions to support manufacturing activities, salaries, wages and benefit costs, travel and entertainment, professional services and facility costs. SG&A were $24.9 million, or 15.2% of net sales, in the first quarter of fiscal 2007, an increase of $3.1 million, or 14.2%, from $21.8 million, or 14.9% of net sales, in the same period in the prior year. The increase in SG&A was primarily attributable to higher compensation, freight, consultant and broker commissions.
Research and development expenses (“R&D”) of $1.1 million in the first quarter of fiscal 2007 were materially consistent with the R&D expenses in the first quarter of fiscal 2006.
Amortization of other intangibles increased by $0.3 million in the first quarter of fiscal 2007 compared to the first quarter of fiscal 2006 due primarily to intangibles recorded in the fourth quarter of fiscal 2006 related to the PFI acquisition.
Other operating income in the first quarter of fiscal 2007 was $0.1 million compared to other operating expense of $0.6 million in the first quarter of fiscal 2006, a decrease of $0.7 million. The prior year other operating expenses include management fees and related expenses of $0.7 million. We do not expect to meet our performance target for fiscal 2007 and, therefore, the accrual for management fees has not been recorded in the first quarter of fiscal 2007.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
In the first quarter of fiscal 2007, net interest expense of $10.0 million represents an increase of $1.4 million from the first quarter of fiscal 2006 primarily due to an increase in the average interest rate charged on the average outstanding indebtedness and higher level of indebtedness compared to the first quarter of fiscal 2006.
We recorded an income tax provision of $1.7 million, or a 46.7% effective tax rate, in the first quarter of fiscal 2007, compared to a benefit of $5.6 million, or 57.3% effective tax rate, in the first quarter of fiscal 2006. The effective tax rate for the first quarter of fiscal 2007 is substantially different from the effective rate for the first quarter of fiscal 2006 primarily due to the release of a significant portion of the Canadian valuation allowance against its deferred tax assets during the first quarter of fiscal 2006. The release of the valuation allowance was based on our expected current and future profitable Canadian operations.
Primarily as a result of factors discussed above, a net income of $2.0 million was recorded in the first quarter of fiscal 2007 compared to a net loss of $4.2 million in the first quarter of fiscal 2006.
Credit Agreement EBITDA was $18.1 million for the first quarter of fiscal 2007 compared to Credit Agreement EBITDA of $9.2 million for the first quarter of fiscal 2006. Our Credit Agreement EBITDA on a trailing twelve month basis was $83.7 million, which we consider to be more in line with our historical performance prior to the issues we experienced in early fiscal 2006. Details of the definition and calculation of the Credit Agreement EBITDA can be found under “Covenant Restrictions” and “Credit Agreement EBITDA” below.
Concentration of Credit Risk and Significant Customers, Suppliers and Products
Financial instruments, which potentially subject us to concentrations of credit risk, consist principally of trade receivables. We sell our products to a geographically diverse customer base in the food, drug, mass merchant and warehouse club (“FDMC”) retail market. We perform ongoing credit evaluations of our customers and maintain adequate reserves for potential losses.
Our two customers accounted for the following percentage of gross sales in each respective period:
| | | Three months ended | |
| | | June 25, 2005 | | June 24, 2006 | |
| Customer A | | | 45 | % | | 43 | % |
| Customer B | | | 20 | % | | 23 | % |
Our largest customer has two retail divisions that, if viewed as separate entities, would constitute the following percentage of gross sales in each respective period:
| | | Three months ended | |
| | | June 25, 2005 | | June 24, 2006 | |
| Division 1 | | | 26 | % | | 24 | % |
| Division 2 | | | 19 | % | | 19 | % |
Our top ten customers in the aggregate accounted for the following percentage of gross sales in each respective period:
| | | Three months ended | |
| | | June 25, 2005 | | June 24, 2006 | |
| Top ten customers | | | 87 | % | | 86 | % |
At March 25, 2006 and June 24, 2006, we had gross receivables from two U.S. customers representing approximately 43% and 32% and 39% and 34%, respectively of total receivables.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
For the three months ended June 25, 2005 and June 24, 2006, one supplier, excluding purchases by Vita Health, provided approximately 10% of raw materials purchased. No other supplier accounted for more than 10% of our purchases for the three months ended June 24, 2006.
Liquidity and Capital Resources
Our liquidity needs arise primarily from debt service on our substantial indebtedness and from the funding of our capital expenditures, ongoing operating costs and working capital.
As of June 24, 2006, we had outstanding debt of an aggregate amount of $406.0 million, consisting primarily of $235.8 million in principal amount under the term facility (the "Term Facility"), $10.0 million under the revolving facility (the "Revolving Facility"), $150.0 million of 11% senior subordinated notes due 2012 (the "Notes") and an aggregate amount of $10.2 million under our other debt facilities.
Principal and interest payments under the Term Facility and the Revolving Facility, together with principal and interest payments on the Notes, represent significant liquidity requirements for us. We are required to repay the $235.8 million in term loan outstanding as of June 24, 2006 under the Credit Facility by May 27, 2011 with scheduled principal payments of $2.4 million in the remaining periods of fiscal 2007, $1.8 million in fiscal 2008, $2.4 million in fiscal 2009 through fiscal 2011 and $224.4 million in fiscal 2012. All outstanding revolving credit borrowings under the Credit Facility will become due on May 27, 2009. We are also required to repay the $150.0 million of the Notes in fiscal 2013.
In connection with our PFI acquisition and to provide us with additional operating flexibility, on September 23, 2005, we entered into Amendment No. 1 and Acknowledgement (the “Amendment”) with our senior lenders to the Credit Facility. The Amendment, among other things, (a) modified the “applicable margin” rate, (b) modified existing financial and operating covenants that require, among other things, the maintenance of certain financial ratios, (c) added a new financial covenant of Minimum Liquidity provision (as defined) of not less than $20.0 million, and (d) modified the calculation of consolidated credit agreement EBITDA. As a condition to obtaining the consent of the lenders to the foregoing amendments, we paid a fee equal to 0.25% of the aggregate total commitments of our senior lenders, or approximately $0.7 million, and recorded it under other non-current assets in the condensed consolidated balance sheet at March 25, 2006. The Amendment was effective for the quarter ended September 24, 2005 and subsequent quarters through the maturity of the Credit Facility. For additional details see “Covenant Restrictions” and “Credit Agreement EBITDA” below.
Borrowings under the Credit Facility bear interest at a rate per annum, at our option, at a margin above the base rate (the higher of federal funds effective rate plus 0.50% and the prime commercial lending rate of UBS AG) or the LIBOR rate (determined based on interest periods of one, two, three or six months, at our option), as the case may be, plus an “applicable margin.” The amended “applicable margin” is based on our debt rating and leverage ratio. As of June 24, 2006, our weighted average interest rates were 8.60% under the Credit Facility. In addition to specified agent and up-front fees, the Credit Facility requires a commitment fee of up to 0.5% per annum of the average daily unused portion of the Revolving Facility. The Notes bear interest at a rate of 11% per annum.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The Amendment, among other things, requires us to maintain a Minimum Liquidity amount of not less than $20.0 million as of the last day of any fiscal month. At June 24, 2006, we had $31.2 million available under our Revolving Facility. In accordance with our debt agreements, the availability under the Revolving Facility has been reduced by the amount of standby letters of credit issued of approximately $8.8 million as of June 24, 2006. These letters of credit are used as security against our lease obligations, inventory purchasing obligations, and an outstanding note payable. These letters of credit expire annually and need extensions each year to various dates through 2014.
In the event the net revolver availability plus the cash balance falls below the $20.0 million Minimum Liquidity amount, our equity sponsors have committed to contributing to us an additional $6.5 million in equity.
Based upon current levels of operations, anticipated cost-savings and expectations as to future growth, we believe that cash generated from operations, together with amounts available under our Revolving Facility, will be adequate to permit us to meet our debt service obligations, capital expenditure program requirements, ongoing operating costs and working capital needs, although no assurance can be given in this regard. Our future financial and operating performance, ability to service or refinance our debt and ability to comply with the covenants and restrictions contained in the Amendment will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control and will be substantially dependent on the selling prices and demand for our products, raw material costs, and our ability to successfully implement our overall business strategy.
If our future cash flow from operations and other capital resources is insufficient to pay our obligations as they mature or to fund our liquidity needs, we may be forced to reduce or delay our business activities and capital expenditures, sell assets, obtain additional debt or equity capital or restructure or refinance all or a portion of our debt, including the Notes, on or before maturity. We cannot assure you that we would be able to accomplish any of these alternatives on a timely basis or on satisfactory terms, if at all. In addition, the terms of our existing and future indebtedness, including the Notes and Credit Facility, may limit our ability to pursue any of these alternatives.
Covenant Restrictions
The Credit Facility contains various restrictive covenants. It prohibits us from prepaying other indebtedness, including the Notes, and it requires us to satisfy financial condition tests and to maintain specified financial ratios, such as a minimum liquidity, maximum total leverage ratio, minimum interest coverage ratio and limitation on capital expenditures. In addition, the Credit Facility prohibits us from declaring or paying any dividends and from making any payments with respect to the Notes if we fail to perform our obligations under, or fail to meet the conditions of, the Credit Facility or if such payment creates a default under the Credit Facility.
The indenture governing the Notes, among other things: (1) restricts our ability and the ability of our subsidiaries to incur additional indebtedness, issue shares of preferred stock, incur liens, pay dividends or make other specified restricted payments and enter into some transactions with affiliates; (2) imposes specific restrictions on the ability of some of our subsidiaries to pay dividends or make certain payments to us; and (3) places restrictions on our ability and the ability of our subsidiaries to merge or consolidate with any other person or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of our assets. The indenture related to the Notes, the Credit Facility and Amendment also contains various covenants that limit our discretion in operating our businesses.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The financial covenants in the Credit Facility specify, among other things, the following requirements as of the last day of any test period during any period set forth in the table below:
Test Period | | Consolidated Indebtedness to Credit Agreement EDIBTA (1) Leverage Ratio | |
| June 24, 2006 | | | 5.65 to 1.00 | |
| September 23, 2006 | | | 5.65 to 1.00 | |
| December 23, 2006 | | | 5.65 to 1.00 | |
| March 31, 2007 | | | 5.50 to 1.00 | |
| June 30, 2007 | | | 5.50 to 1.00 | |
| September 29, 2007 | | | 5.00 to 1.00 | |
| December 29, 2007 | | | 5.00 to 1.00 | |
| March 29, 2008 | | | 4.50 to 1.00 | |
| June 28, 2008 | | | 4.50 to 1.00 | |
| September 27, 2008 | | | 4.00 to 1.00 | |
| December 27, 2008 | | | 4.00 to 1.00 | |
| March 28, 2009 and thereafter | | | 3.75 to 1.00 | |
| | | Credit Agreement EBITDA (1) to Consolidated Interest Expense Ratio | |
| June 24, 2006 | | | 1.85 to 1.00 | |
| September 23, 2006 | | | 1.85 to 1.00 | |
| December 23, 2006 | | | 1.85 to 1.00 | |
| March 31, 2007 | | | 1.85 to 1.00 | |
| June 30, 2007 | | | 2.00 to 1.00 | |
| September 29, 2007 | | | 2.00 to 1.00 | |
| December 29, 2007 | | | 2.25 to 1.00 | |
| March 29, 2008 | | | 2.25 to 1.00 | |
| June 28, 2008 | | | 2.25 to 1.00 | |
| September 27, 2008 | | | 2.25 to 1.00 | |
| December 27, 2008 | | | 2.50 to 1.00 | |
| March 28, 2009 and thereafter | | | 2.75 to 1.00 | |
Note:
(1) See “Credit Agreement EBITDA” for more information regarding this term.
We were in compliance with all such financial covenants and our Minimum Liquidity provision as of June 24, 2006, was $38.8 million, well above the $20.0 million Minimum Liquidity requirement. Our ability to comply in future periods with the financial covenants in the Amendment will depend on our ongoing financial and operating performance, which, in turn, will be subject to economic conditions and to financial, business and other factors, many of which are beyond our control and will be substantially dependent on the selling prices and demand for our products, raw material costs, and our ability to successfully implement our overall business strategy. If a violation of any of the covenants occurred, we would attempt to obtain a waiver or an amendment from our lenders, although no assurance can be given that we would be successful in this regard. The Credit Facility and the indenture governing the Notes have covenants as well as specified cross-default or cross-acceleration provisions; failure to comply with these covenants in any agreement could result in a violation of such agreement which could, in turn, lead to violations of other agreements pursuant to such cross-default or cross-acceleration provisions.
The Credit Facility is collateralized by substantially all of our assets. Borrowings under the Credit Facility are a key source of our liquidity. Our ability to borrow under the Credit Facility is dependent on, among other things, our compliance with the financial ratio covenants referred to in the preceding paragraphs. Failure to comply with the financial ratio covenants would result in a violation of the Credit Facility and, absent a waiver or amendment from the lenders under such agreement, permit the acceleration of all outstanding borrowings under the Credit Facility.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Credit Agreement EBITDA
The table below sets forth our EBITDA as defined in our Amendment, which we refer to as “Credit Agreement EBITDA.” Credit Agreement EBITDA as presented below is a financial measure that is used in our Amendment. Credit Agreement EBITDA is not a defined term under U.S. generally accepted accounting principles and should not be considered as an alternative to income from operations or net income (loss) as a measure of operating results or cash flows as a measure of liquidity. Credit Agreement EBITDA is calculated by adjusting net income (loss) to exclude interest expense, depreciation and amortization, income tax expense, expenses incurred in connection with the recapitalization, aggregate amount of all other non-cash items (including non-cash compensation charges), proceeds from business interruption insurance, management fees, expenses related to any permitted acquisition (other than the PFI Acquisition), fees and expenses in connection with the exchange of the Notes, expenses incurred to the extent reimbursed by third parties pursuant to indemnification provisions, any non-cash charges outside the normal course of business that result in an accrual of a reserve for cash charges in any future period, expenses incurred or accrued representing joint care customer in-stock investments, inventory reduction impact and other expenses, expenses incurred in connection with any restructuring, expenses incurred in connection with the employment of professionals to assist restructuring, integration of the PFI Business and the Amendment, non-capitalized transition and integration expenses incurred in connection with the PFI Acquisition, any non-cash charges that result from final accounting adjustments associated with the PFI Acquisition, expenses incurred in connection with operating facilities to provide adequate inventory and to ensure continuous supplies to customers of the PFI Business. In addition, Credit Agreement EBITDA also adjusts net income by all non-cash items increasing consolidated net income (other than accrual of revenue or recording of receivables in the ordinary course of the business) and the reversal of any reserve or the payment of any amount that was reserved. The Credit Facility also provides for adjustments to consolidated net income including, among other things, for asset write-downs. The Amendment requires us to comply with a specified debt to Credit Agreement EBITDA leverage ratio and a specified consolidated Credit Agreement EBITDA to interest expense ratio for specified periods. The specific ratios are set out under “Liquidity and Capital Resources” above.
The calculation of Credit Agreement EBITDA is set forth below (in thousands):
| | | Three months ended | |
| | | June 25, 2005 | | June 24, 2006 | |
| Net income (loss) | | $ | (4,195 | ) | $ | 1,987 | |
| Provision for (benefit from) income taxes | | | (5,638 | ) | | 1,741 | |
| Interest expense, net | | | 8,629 | | | 10,045 | |
| Depreciation and amortization | | | 4,055 | | | 4,318 | |
| Asset write-down (1) | | | 5,659 | | | - | |
| Non-cash stock compensation expense | | | 5 | | | 7 | |
| Expenses related to permitted acquisition | | | 22 | | | - | |
| Management fees (2) | | | 672 | | | 9 | |
| Credit Agreement EBITDA (3) | | $ | 9,209 | | $ | 18,107 | |
| (1) | Represents the reserve established for anticipated customer returns and the reduction of the carrying value of inventory related to certain branded products in the first quarter of fiscal 2006. This charge resulted in a reduction to gross profit in the condensed consolidated statement of operations and in operating activities in the condensed consolidated statement of cash flows for the three months ended June 25, 2005. |
| (2) | Management fees are included in other operating expenses in the condensed consolidated statement of operations and in operating activities in the condensed consolidated statement of cash flows. |
| (3) | Credit Agreement EBITDA is calculated in accordance with the definitions contained in our Amendment described under “Credit Agreement EBITDA.” |
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Sources and Uses of Cash
Net cash used in operating activities totaled $1.6 million and $1.0 million in the first quarter of fiscal 2006 and fiscal 2007, respectively. In the first quarter of fiscal 2007, the most significant change in our operating activities was the increase in our inventories by $24.8 million primarily due to support customer requirements of higher fulfillment rates and lower inventory levels by retailers. We do not expect this trend to continue in the second half of fiscal 2007. In addition, our accounts receivable at June 24, 2006, was $61.1 million, or 34 days of net sales outstanding compared to an accounts receivable of $73.2 million, or 38 days of net sales outstanding, at March 25, 2006, a decrease of $12.1 million in the first quarter of fiscal 2007.
Net cash used in investing activities totaled $5.9 million and $3.8 million in the first quarter of fiscal 2006 and fiscal 2007, respectively. The decrease was primarily related to lower capital expenditure in the first quarter of fiscal 2007 compared to the first quarter of fiscal 2006. Capital expenditures were $3.3 million in the first quarter of fiscal 2007, a decrease of $2.1 million, from $5.4 million in the first quarter of fiscal 2006. We expect our capital expenditures to be higher in fiscal 2007 as we continue to increase internal manufacturing and prepare for contract manufacturing and OTC switch opportunities.
Net cash used in financing activities was $2.6 million in the first quarter of fiscal 2006 compared to net cash provided by financing activities of $3.4 million in the first quarter of fiscal 2007. Net cash provided in the first quarter of fiscal 2007 represents primarily the borrowings from our Revolving Facility.
Critical Accounting Policies and Estimates
Revenue Recognition
The following table summarizes the activities in our accruals for contractual allowances, future chargebacks and product returns (in thousands):
| | | Reserve for Contractual Allowances | | Reserve for Future Chargebacks | | Reserve for Product Returns | |
| Balance at March 25, 2006 | | $ | 11,187 | | $ | 1,071 | | $ | 2,865 | |
| Current provision | | | 8,646 | | | 1,576 | | | 309 | |
| Actual returns or credits | | | (8,016 | ) | | (1,708 | ) | | (395 | ) |
| Balance at June 24, 2006 | | $ | 11,817 | | $ | 939 | | $ | 2,779 | |
Actual returns included products sold in prior fiscal periods of $44,000 and $225,000 for the first quarter of fiscal 2006 and 2007, respectively. We do not have the ability to track actual credits for contractual allowances and future chargebacks by fiscal period because a significant time lag exists between the date on which we determine our contractual liability and when we actually pay the liability. In addition, the documentation provided to us by our customers for such deductions are generally insufficient for us to determine the exact date when the liability may have been accrued on our balance sheet.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Forward-looking Statements
This report contains “forward-looking statements” that are subject to risks and uncertainties. These statements often include words such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or similar expressions. These statements are only predictions. In addition to risks and uncertainties noted in this report, there are risks and uncertainties that could cause our actual operating results to differ materially from those anticipated by some of the statements made. Such risks and uncertainties include: (i) slow or negative growth in the vitamin, mineral, supplement or over-the-counter pharmaceutical industry; (ii) adverse publicity regarding the consumption of vitamins, minerals, supplements or over-the-counter pharmaceuticals; (iii) increased competition; (iv) increased costs; (v) increases in the cost of borrowings and/or unavailability of additional debt or equity capital; (vi) changes in general worldwide economic and political conditions in the markets in which we may compete from time to time; (vii) our inability to gain and/or hold market share with our customers; (viii) exposure to and expenses of defending and resolving product liability claims and other litigation; (ix) our ability to successfully implement our business strategy; (x) our inability to manage our operations efficiently; (xi) consumer acceptance of our products; (xii) introduction of new federal, state, local or foreign legislation or regulation or adverse determinations by regulators; (xiii) the mix of our products and the profit margins thereon; and (xiv) the availability and pricing of raw materials. We expressly disclaim any obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
You should carefully consider the risks described above and in “Item 1A. - Risk Factors” in our Annual Report on Form 10-K on file with the SEC. Any of these risks could materially and adversely affect our financial condition, results of operations or cash flows.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
There have been no material changes in our market risk during the first quarter of fiscal 2007. Accordingly, the disclosure provided in the Annual Report on Form 10-K for the year ended March 25, 2006 remains current.
Item 4. Controls and Procedures
The Company’s management, with the participation of the Company’s Chief Executive Officer and Executive Vice President and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of June 24, 2006. Based on that evaluation, the Company’s Chief Executive Officer and Executive Vice President and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 24, 2006. There were no material changes in the Company’s internal control over financial reporting during the first quarter of fiscal 2007 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 1. Legal Proceedings.
There are currently seven pending individual product liability complaints filed against us and/or our customers alleging damages associated with the ingestion of PPA, a substance that previously was an ingredient in some of our diet aid and cold remedy products. These complaints were filed between August 9, 2001 and August 27, 2003 in both state and federal courts in Pennsylvania, New York, Arkansas, Texas, Louisiana, Michigan and Washington. The complaints include allegations such as subarachnoid hemorrhage, aneurysm, intracranial hemorrhage, debilitating neurological injuries and headaches. We previously manufactured products that contained PPA, but removed that ingredient from all of our product formulations promptly after the FDA revised its opinion regarding PPA in November 2000. Two of the seven PPA claims involve products that were neither manufactured nor distributed by us.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Not applicable
Item 3. Defaults Upon Senior Securities.
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable
Item 5. Other Information.
None
Item 6. Exhibits.
| 31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended |
| 31.2 | Certification of Executive Vice Present and Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended |
| 32.1 | Certification of Chief Executive Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2 | Certification of Executive Vice President and Chief Financial Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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.
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| | LEINER HEALTH PRODUCTS INC. |
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| Date: August 8, 2006 | By: | /s/ Kevin McDonnell |
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Kevin McDonnellExecutive Vice President and Chief Financial Officer |
