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 February 28, 2006
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
Insert by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) for 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 þ NO
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 þ Accelerated filer Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES NO þ
As of April 7, 2006, 19,421,096 shares of the Company’s common stock, without par value, were outstanding.
CHATTEM, INC.
INDEX
| | PAGE NO. |
| PART I. FINANCIAL INFORMATION | |
| | |
Item 1. Financial Statements | |
| | |
Condensed Consolidated Balance Sheets as of February 28, 2006 and November 30, 2005 | 3 |
| | |
| Condensed Consolidated Statements of Income for the Three Months Ended February 28, 2006 and February 28, 2005 | 5 |
| | |
Condensed Consolidated Statements of Cash Flows for the Three Months Ended February 28, 2006 and February 28, 2005 | 6 |
| | |
| Notes to Condensed Consolidated Financial Statements | 7 |
| | |
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations | 28 |
| | |
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 1A. Risk Factors | 38 |
| | |
Item 2. Unregistered Sales of Equity 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 | 39 |
| | |
SIGNATURES | 40 |
| | |
| | |
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS | | FEBRUARY 28, 2006 | | NOVEMBER 30, 2005 | |
| | | (Unaudited) | | | |
| | | | | | |
| CURRENT ASSETS: | | | | | |
| Cash and cash equivalents | | $ | 8,125 | | $ | 47,327 | |
| Accounts receivable, less allowances of $3,083 at February 28, 2006 and $2,338 at November 30, 2005 | | | 51,944 | | | 33,672 | |
| Other receivables | | | 9,103 | | | 9,600 | |
| Inventories | | | 25,427 | | | 23,631 | |
| Refundable income taxes | | | — | | | 1,207 | |
| Deferred income taxes | | | 2,478 | | | 2,478 | |
| Prepaid expenses and other current assets | | | 4,461 | | | 5,106 | |
| Total current assets | | | 101,538 | | | 123,021 | |
| | | | | | | | |
| PROPERTY, PLANT AND EQUIPMENT, NET | | | 30,126 | | | 29,884 | |
| | | | | | | | |
| OTHER NONCURRENT ASSETS: | | | | | | | |
| Patents, trademarks and other purchased product rights, net | | | 206,327 | | | 206,387 | |
| Debt issuance costs, net | | | 2,867 | | | 4,297 | |
| Other | | | 5,525 | | | 4,704 | |
| Total other noncurrent assets | | | 214,719 | | | 215,388 | |
| | | | | | | | |
| TOTAL ASSETS | | $ | 346,383 | | $ | 368,293 | |
| | | | | | | | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
LIABILITIES AND SHAREHOLDERS’ EQUITY | | FEBRUARY 28, 2006 | | NOVEMBER 30, 2005 | |
| | | (Unaudited) | | | |
| | | | | | |
| CURRENT LIABILITIES: | | | | | |
| Current maturities of long-term debt | | $ | | | $ | 37,000 | |
| Accounts payable and other | | | 11,931 | | | 17,238 | |
| Accrued liabilities | | | 23,485 | | | 16,327 | |
| Total current liabilities | | | 35,416 | | | 70,565 | |
| | | | | | | | |
| LONG-TERM DEBT, less current maturities | | | 150,500 | | | 145,500 | |
| | | | | | | | |
| DEFERRED INCOME TAXES | | | 27,872 | | | 27,736 | |
| | | | | | | | |
| OTHER NONCURRENT LIABILITIES | | | 1,890 | | | 1,865 | |
| | | | | | | | |
| COMMITMENTS AND CONTINGENCIES (Note 18) | | | | | | | |
| | | | | | | | |
| SHAREHOLDERS’ EQUITY: | | | | | | | |
| Preferred shares, without par value, authorized 1,000, none issued | | | | | | | |
| Common shares, without par value, authorized 50,000, issued and outstanding 19,421 at February 28, 2006 and 19,668 at November 30, 2005 | | | 56,590 | | | 63,876 | |
| Retained earnings | | | 75,626 | | | 60,853 | |
| | | | 132,216 | | | 124,729 | |
Unamortized value of restricted common shares issued Cumulative other comprehensive income, net of tax: | | | (1,522 | ) | | (1,818 | ) |
| Interest rate cap adjustment | | | (30 | ) | | (83 | ) |
| Foreign currency translation adjustment | | | 41 | | | (201 | ) |
| Total shareholders’ equity | | | 130,705 | | | 122,627 | |
| | | | | | | | |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | | $ | 346,383 | | $ | 368,293 | |
| | | | | | | | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited and in thousands, except per share amounts)
| | | FOR THE THREE MONTHS ENDED | |
| | | FEBRUARY 28, | | FEBRUARY 28, | |
| | | 2006 | | 2005 | |
| | | | | | |
| TOTAL REVENUES: | | | | | |
| Net sales | | $ | 83,977 | | $ | 71,480 | |
| Royalties | | | 47 | | | 51 | |
| Total revenues | | | 84,024 | | | 71,531 | |
| | | | | | | | |
| COSTS AND EXPENSES: | | | | | | | |
| Cost of sales | | | 26,020 | | | 20,260 | |
| Advertising and promotion | | | 27,187 | | | 20,351 | |
| Selling, general and administrative | | | 11,591 | | | 11,884 | |
| Litigation settlement | | | (8,613 | ) | | 2,755 | |
| Total costs and expenses | | | 56,185 | | | 55,250 | |
| | | | | | | | |
| INCOME FROM OPERATIONS | | | 27,839 | | | 16,281 | |
| | | | | | | | |
| OTHER INCOME (EXPENSE): | | | | | | | |
| Interest expense | | | (2,844 | ) | | (3,495 | ) |
| Investment and other income, net | | | 194 | | | 147 | |
| Loss on early extinguishment of debt | | | (2,805 | ) | | | |
| Total other income (expense) | | | (5,455 | ) | | (3,348 | ) |
| | | | | | | | |
| INCOME BEFORE INCOME TAXES | | | 22,384 | | | 12,933 | |
| | | | | | | | |
| PROVISION FOR INCOME TAXES | | | 7,611 | | | 4,268 | |
| | | | | | | | |
| NET INCOME | | $ | 14,773 | | $ | 8,665 | |
| | | | | | | | |
NUMBER OF COMMON SHARES: Weighted average outstanding - basic | | | 19,553 | | | 19,648 | |
| Weighted average and potential dilutive outstanding | | | 19,577 | | | 20,489 | |
| | | | | | | | |
| NET INCOME PER COMMON SHARE: | | | | | | | |
| Basic | | $ | .76 | | $ | .44 | |
| Diluted | | $ | .75 | | $ | .42 | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands, except per share amount)
| | | FOR THE THREE MONTHS ENDED | |
| | | FEBRUARY 28, 2006 | | FEBRUARY 28, 2005 | |
| OPERATING ACTIVITIES: | | | | | |
| Net income | | $ | 14,773 | | $ | 8,665 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | |
| Depreciation and amortization | | | 1,425 | | | 1,624 | |
| Deferred income taxes | | | 239 | | | 1,778 | |
Excess tax benefit from stock-based compensation | | | (309 | ) | | 186 | |
| Stock-based compensation | | | 852 | | | | |
| Loss on early extinguishment of debt | | | 2,805 | | | | |
| Other, net | | | 66 | | | 361 | |
| Changes in operating assets and liabilities: | | | | | | | |
| Accounts receivable and other | | | (17,775 | ) | | (8,712 | ) |
| Inventories | | | (1,644 | ) | | (286 | ) |
| Refundable income taxes | | | 1,516 | | | 2,172 | |
| Prepaid expenses and other current assets | | | 652 | | | 382 | |
| Accounts payable and accrued liabilities | | | 3,126 | | | 1,778 | |
| Net cash provided by operating activities | | | 5,726 | | | 7,948 | |
| | | | | | | | |
| INVESTING ACTIVITIES: | | | | | | | |
| Purchases of property, plant and equipment | | | (1,276 | ) | | (599 | ) |
| Decrease (increase) in other assets, net | | | (611 | ) | | 667 | |
| Net cash (used in) provided by investing activities | | | (1,887 | ) | | 68 | |
| | | | | | | | |
| FINANCING ACTIVITIES: | | | | | | | |
| Repayment of long-term debt | | | (75,000 | ) | | | |
| Proceeds from borrowings under revolving credit facility | | | 43,000 | | | | |
| Repayment of policy loans | | | | | | (1,031 | ) |
| Proceeds from exercise of stock options | | | 311 | | | 187 | |
| Repurchase of common shares | | | (10,130 | ) | | (3,514 | ) |
| Increase in debt issuance costs | | | (15 | ) | | | |
| Retirement of debt issuance costs | | | (1,501 | ) | | | |
| Excess tax benefit from stock-based compensation | | | 309 | | | | |
| Net cash used in financing activities | | | (43,026 | ) | | (4,358 | ) |
| | | | | | | | |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS | | | (15 | ) | | (312 | ) |
| | | | | | | | |
| CASH AND CASH EQUIVALENTS: | | | | | | | |
| (Decrease) increase for the period | | | (39,202 | ) | | 3,346 | |
| At beginning of period | | | 47,327 | | | 40,193 | |
| At end of period | | $ | 8,125 | | $ | 43,539 | |
| | | | | | | | |
| SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: | | | | | | | |
| Issuance of 50 shares of restricted common stock at a value of $35.37 per share in 2005 | | $ | | | $ | 1,768 | |
| | | | | | | | |
| PAYMENTS FOR: | | | | | | | |
| Interest | | $ | 1,793 | | $ | 1,003 | |
| Taxes | | $ | 1,045 | | $ | 85 | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
CHATTEM, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
All monetary and share amounts (other than per share amounts) in these Notes are expressed in thousands.
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, 2005. 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.
Certain prior year amounts have been reclassified to conform to the current period’s presentation.
| 4. | RECENT ACCOUNTING PRONOUNCEMENTS |
In December 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN 46R”), which supersedes Interpretation No. 46, “Consolidation of Variable Interest Entities” issued in January 2003. FIN 46R 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 46R 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 46R applies immediately to a VIE created or acquired after January 31, 2003. For a VIE created before February 1, 2003, FIN 46R applies in the first fiscal year or interim period beginning after March 15, 2004, our third fiscal quarter beginning June 1, 2004. Application of FIN 46R is also required in financial statements that have interests in structures that are commonly referred to as special-purpose entities for periods ending after December 15, 2003. The adoption of FIN 46R did not have a material impact on our financial position, results of operations or cash flows.
In November 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 151, “Inventory Costs” (“SFAS 151”). SFAS 151 amends the guidance in Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing”, to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage) should be recognized as current-period charges and requires the allocation of fixed production overheads to inventory based on normal capacity of the production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS 151 on December 1, 2005 did not have an impact on our financial position, results of operations or cash flows.
In November 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” in Determining Whether to Report Discontinued Operations” (“EITF 03-13”). Under the consensus, the approach for assessing whether cash flows of the component have been eliminated from the ongoing operations of the entity focuses on whether continuing cash flows are direct or indirect cash flows. Cash flows of the component would not be eliminated if the continuing cash flows to the entity are considered direct cash flows. The consensus should be applied to a component of an enterprise that is either disposed of or classified as held for sale in fiscal periods beginning after December 15, 2004. The adoption of EITF 03-13 on December 1, 2005 did not have an impact on our financial position, results of operations or cash flows.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”. SFAS 123R supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and amends SFAS No. 95, “Statement of Cash Flows”. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions and requires all share-based payments to employees, including grants of employee stock options, to be recognized as additional compensation expense in the financial statements based on the calculated fair value of the awards. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation costs to be reported as a financing cash flow. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. We adopted this statement effective for our fiscal year beginning December 1, 2005. We have described the impact of adopting SFAS 123R in our condensed consolidated financial statements in Note 5, Stock-Based Compensation.
In December 2004, the FASB issued SFAS 153, “Exchanges of Nonmonetary Assets” (“SFAS 153”). SFAS 153 amends the guidance in APB Opinion No. 29, “Accounting for Nonmonetary Transactions” to eliminate certain exceptions to the principle that exchanges of nonmonetary assets be measured based on the fair value of the assets exchanged. SFAS 153 eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. This statement is effective for nonmonetary asset exchanges in fiscal years beginning after June 15, 2005. The adoption of SFAS 153 on December 1, 2005 did not have an impact on our financial position, results of operations or cash flows.
The American Jobs Creation Act of 2004 (the “AJCA”) was enacted on October 22, 2004. The AJCA repeals an export incentive, creates a new deduction for qualified domestic manufacturing activities and includes a special one-time deduction of 85% of certain foreign earnings repatriated to the U.S.
In December 2004, the FASB issued FASB Staff Position No. 109-1, “Application of FASB Statement No. 109 (SFAS 109), Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (FSP 109-1). FSP 109-1 clarifies that the manufacturer’s deduction provided for under the American Jobs Creation Act of 2004 (AJCA) should be accounted for as a special deduction in accordance with SFAS 109 and not as a tax rate reduction. In accordance with FSP 109-1, we treat the deduction for qualified domestic manufacturing activities, which became effective beginning December 1, 2005, as a reduction of the income tax provision in future years when realized.
The FASB also issued FASB Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 (FSP 109-2). The AJCA introduces a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. FSP 109-2 provides accounting and disclosure guidance for the repatriation provision. We have described the impact of FSP 109-2 in our condensed consolidated financial statements in Note 16, Income Taxes.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” or (“SFAS No. 154”). SFAS No. 154 replaces APB No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements” and establishes retrospective application as the required method for reporting a change in accounting principle. The reporting of a correction of an error by restating previously issued financial statements is also addressed. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 is not expected to have an impact on our financial position, results of operations or cash flows.
In October 2005, the FASB issued FASB Staff Position (“FSP”) 123R-2, “Practical Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123(R) (“FSP 123R-2”)”. FSP 123R-2 provides companies with a “practical accommodation” when determining the grant date of an award that is subject to the accounting provisions in SFAS 123R. Specifically, assuming a company meets all of the other criteria in the definition of grant date in SFAS 123R, a mutual understanding (between the company and the recipient) of the key terms and conditions of an award is presumed to exist at the date the award is approved (in accordance with the company’s normal corporate governance policy) if (1) the award is unilateral grant meaning that the recipient does not have the ability to negotiate the key terms and conditions of the award, and (2) the key terms and conditions of the award are expected to be communicated to the recipient within a relatively short period of time (as defined in the FSP 123R-2) after the grant was approved. This FSP was effective upon initial adoption of SFAS 123-R on December 1, 2005.
In November 2005, the FASB issued FSP 123R-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” (“FSP 123R-3”). FSP 123R-3 provides a practical exception when a company transitions to the accounting requirements in SFAS 123R. SFAS 123R requires a company to calculate the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to adopting SFAS 123R (“APIC Pool”), assuming the company
had been following the recognition provisions prescribed by SFAS 123. The FASB learned that several companies do not have the necessary historical information to calculate the APIC pool as envisioned by SFAS 123R and accordingly, the FASB decided to allow a practical exception as documented in FSP 123R-3. This FSP was effective on its issuance date.
We currently provide stock-based compensation under five stock incentive plans that have been approved by our shareholders. 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 and 2005 Stock Incentive Plans both provide for the issuance of up to 1,500 shares of common stock. Stock options granted under all of these plans generally vest over four years from the date of grant as specified in the plans or by the compensation committee of our board of directors and are exercisable for a period of up to ten years from the date of grant.
Effective December 1, 2005, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), using the modified prospective method. SFAS 123R requires the recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements and is measured based on the grant date fair value of the award. SFAS 123R also requires the stock option compensation expense to be recognized over the period during which an employee is required to provide service in exchange for the award (the vesting period). Prior to our adopting SFAS 123R, we accounted for our stock-based compensation plans under Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Under APB 25, generally no compensation expense is recorded when the terms of the award are fixed and the exercise price of the employee stock option equals or exceeds the fair value of the underlying stock on the date of grant. We adopted the disclosure-only provision of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”).
In the first quarter of fiscal 2006, we recorded compensation expense related to stock options that reduced income from operations by $852, provision for income taxes by $290, net income by $562 and basic and diluted net income per share by $.03. The stock option compensation expense was included partly in advertising and promotion expenses and partly in selling, general and administrative expenses in the accompanying condensed consolidated statement of income. We capitalized $152 of stock option compensation cost as a component of the carrying cost of inventory on-hand as of February 28, 2006.
The weighted average fair value of stock options at the date of grant during the three months ended February 28, 2006 and 2005 was $13.03 and $8.53, respectively. For options granted subsequent to our adoption date of SFAS 123R on December 1, 2005, the fair value of each stock option grant was estimated on the date of grant using a Flex Lattice Model. For options granted prior to our adoption date of SFAS 123R, during the three-months ended February 28, 2005, we used the Black-Scholes option pricing model. We used the following assumptions to determine the fair value of stock option grants during the three months ended February 28, 2006 and 2005:
| | | | Three Months Ended February 28 | |
| | | | 2006 | | 2005 | |
| | Expected life | | | 4.6 years | | | 5.0 years | |
| | Volatility | | | 48 | % | | 57 | % |
| | Risk-free interest rate | | | 4.55 | % | | 4.38 | % |
| | Dividend yield | | | 0 | % | | 0 | % |
| | Forfeitures | | | 0.9 | % | | 0 | % |
The expected life of stock options represents the period of time that the stock options granted are expected to be outstanding based on historical exercise trends. The expected volatility is based on the historical price volatility of our common stock. The risk-free interest rate represents the U.S. Treasury bill rate for the expected life of the related stock options. The dividend yield represents our anticipated cash dividend over the expected life of the stock options. Subsequent to the adoption of SFAS 123R and in connection with using the Flex Lattice Model to determine the fair value of stock option grants, the forfeiture rate was determined by analyzing post vesting stock option activity for three separate groups (non-employee directors, officers and other employees). Prior to the adoption of SFAS 123R, forfeitures were not an input assumption for our fair value calculations of stock options under the Black-Scholes pricing model.
A summary of stock option activity for the three-months ended February 28, 2006 is presented below:
| | | | | Shares Under Option | | | Weighted Average Exercise Price | | | Weighed Average Remaining Contractual Life | | | Aggregate Intrinsic Value | |
| | Outstanding at December 1, 2005 | | | 1,753 | | $ | 23.94 | | | | | | | |
| | Granted | | | 412 | | | 38.05 | | | | | | | |
| | Exercised | | | (30 | ) | | 11.64 | | | | | | | |
| | Cancelled | | | (72 | ) | | 30.20 | | | | | | | |
| | | | | | | | | | | | | | | |
| | Outstanding at February 28, 2006 | | | 2,063 | | $ | 26.73 | | | 6.6 years | | $ | 24,144 | |
| | | | | | | | | | | | | | | |
| | Exercisable at February 28, 2006 | | | 937 | | $ | 25.99 | | | 6.2 years | | $ | 12,486 | |
The total fair value of stock options that vested during the three months ended February 28, 2006 and 2005 was $1,004 and $1,907, respectively. The total intrinsic value of stock options exercised during the three months ended February 28, 2006 and 2005 was $860 and $517, respectively.
As of February 28, 2006, we had $11,771 of unrecognized compensation cost related to stock options that will be recorded over a weighted average period of approximately 3 years.
We are also authorized to grant restricted shares of common stock to employees under our stock incentive plans that have been approved by shareholders. The restricted shares under these plans meet the definition of “nonvested shares” in SFAS 123R. The restricted shares generally vest over a four year service period commencing upon the date of grant. The total fair market value of restricted shares on the date of grant is amortized to expense on a straight line basis over the four-year vesting period. The amortization expense related to restricted shares during the three months ended February 28, 2006 and 2005 was $190 and $319, respectively.
Restricted share activity under the plans is summarized as follows:
| | | | Number of Shares | | Weighted Average Grant Date Fair Value | |
| | Nonvested at December 1, 2005 | | | 75 | | $ | 24.27 | |
| | Granted | | | | | | | |
| | Vested | | | (9 | ) | | 21.13 | |
| | Forfeited | | | (3 | ) | | 35.37 | |
| | Nonvested at February 28, 2006 | | | 63 | | | 24.28 | |
Prior to December 1, 2005, we accounted for stock-based compensation plans under APB 25. We adopted the disclosure-only provision of SFAS 123. 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 months ended February 28, 2005 as indicated below:
| | | | 2005 | |
| | Net income: | | | |
| | As reported | | $ | 8,665 | |
| | Recognized stock-based compensation costs, net | | | | |
| | Fair value method compensation costs, net | | | (1,278 | ) |
| | Pro forma | | $ | 7,387 | |
| | Net income per share, basic: | | | | |
| | As reported | | $ | .44 | |
| | Pro forma | | $ | .38 | |
| | Net income per share, diluted: | | | | |
| | As reported | | $ | .42 | |
| | Pro forma | | $ | .36 | |
The following table presents the computation of per share earnings for the three months ended February 28, 2006 and February 28, 2005, respectively:
| | | 2006 | | 2005 | |
| | | | | | |
| NET INCOME | | $ | 14,773 | | $ | 8,665 | |
| | | | | | | | |
| NUMBER OF COMMON SHARES: | | | | | | | |
| Weighted average outstanding | | | 19,553 | | | 19,648 | |
| Issued upon assumed exercise of outstanding stock options | | | | | | 762 | |
| Effect of issuance of restricted common shares | | | 24 | | | 79 | |
| Weighted average and potential dilutive outstanding (1) | | | 19,577 | | | 20,489 | |
| | | | | | | | |
| NET INCOME PER COMMON SHARE: | | | | | | | |
| Basic | | $ | .76 | | $ | .44 | |
| Diluted | | $ | .75 | | $ | .42 | |
(1) Because their effects are anti-dilutive, excludes shares issuable under stock option plans and restricted stock issuance whose grant price was greater than the average market price of common shares outstanding as follows: 571 and 0 shares for the three months ended February 28, 2006 and 2005, respectively.
We incur significant expenditures on television, radio and print advertising to support our nationally branded over-the-counter (“OTC”) health care products and toiletries. Customers purchase products from us with the understanding that the brands will be supported by our extensive media advertising. This advertising supports the retailers’ sales effort and maintains the important brand franchise with the consuming public. Accordingly, we consider our advertising program to be
clearly implicit in our sales arrangements with our customers. Therefore, we believe it is appropriate to allocate a percentage of the necessary supporting advertising expenses to each dollar of sales by charging a percentage of sales on an interim basis based upon anticipated annual sales and advertising expenditures (in accordance with Accounting Principles Board Opinion No. 28, “Interim Financial Reporting”) and adjusting that accrual to the actual expenses incurred at the end of the year.
Shipping and handling costs of $2,264 and $1,857 are included in selling expenses for the three months ended February 28, 2006 and 2005, respectively.
| 9. | PATENT, TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS |
The carrying value of trademarks, which are not subject to amortization under the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), was $205,983 as of February 28, 2006 and November 30, 2005, respectively. The gross carrying amount of intangible assets subject to amortization at February 28, 2006 and November 30, 2005, which consist primarily of non-compete agreements, was $2,139, respectively. The related accumulated amortization of intangible assets at February 28, 2006 and November 30, 2005 was $1,795 and $1,735, respectively. Amortization of our intangible assets subject to amortization under the provisions of SFAS 142 for the three months ended February 28, 2006 and 2005 was $60 and $73, respectively. Estimated annual amortization expense for these assets for the years ended November 30, 2007, 2008, 2009, 2010 and 2011 is $106, $40, $20, $0 and $0, respectively.
On February 28, 2005, we entered into an agreement to sell the trademark and product rights of our Selsun business in certain countries in Africa and Asia. As a result of the sale, $3,143 of indefinite-lived assets and $108 of intangible assets subject to amortization were retired, which resulted in an insignificant loss.
Inventories consisted of the following as of February 28, 2006 and November 30, 2005:
| | | | 2006 | | 2005 | |
| | | | | | | |
| | Raw materials and work in process | | $ | 12,358 | | $ | 12,388 | |
| | Finished goods | | | 13,069 | | | 11,243 | |
| | Total inventories | | $ | 25,427 | | $ | 23,631 | |
Accrued liabilities consisted of the following as of February 28, 2006 and November 30, 2005:
| | | | 2006 | | 2005 | |
| | | | | | | |
| | Interest | | $ | 4,089 | | $ | 3,201 | |
| | Salaries, wages and commissions | | | 2,778 | | | 5,991 | |
| | Product advertising and promotion | | | 9,095 | | | 2,589 | |
| | Litigation settlement and legal fees | | | 1,617 | | | 2,212 | |
| | Income taxes payable | | | 3,773 | | | | |
| | Other | | | 2,133 | | | 2,334 | |
| | Total accrued liabilities | | $ | 23,485 | | $ | 16,327 | |
Long-term debt consisted of the following as of February 28, 2006 and November 30, 2005:
| | | | 2006 | | 2005 | |
| | Revolving Credit Facility due 2010 at a variable rate of 5.93% and 7.00% as of February 28, 2006 and November 30, 2005, respectively | | $ | 43,000 | | $ | | |
| | Floating Rate Senior Notes due 2010 at a variable rate of 7.41% and 6.87% as of December 30, 2005 (date redeemed) and November 30, 2005, respectively | | | | | | 75,000 | |
| | 7.0% Senior Subordinated Notes due 2014 | | | 107,500 | | | 107,500 | |
| | Total long-term debt | | | 150,500 | | | 182,500 | |
| | Less: current maturities | | | | | | 37,000 | |
| | Total long-term debt, net of current maturities | | $ | 150,500 | | $ | 145,500 | |
On February 26, 2004, we entered into a new Senior Secured Revolving Credit Facility that matures February 26, 2009 (the “Revolving Credit Facility”) with Bank of America, N.A. that provided an initial borrowing capacity of $25,000 and an additional $25,000, subject to successful syndication. On March 9, 2004, we entered into a new commitment agreement with a syndicate of commercial banks led by Bank of America, N.A., as agent, that enabled us to borrow up to a total of $50,000 under the Revolving Credit Facility. On November 29, 2005, we entered into an amendment to our Revolving Credit Facility (the “Amended Revolving Credit Facility”) that, among other things, increased our borrowing capacity under the facility from $50,000 to $100,000, increased our flexibility to repurchase shares of our stock, improved our borrowing rate under the facility and extended the maturity date to November 15, 2010. Borrowings under our Amended Revolving Credit Facility bear interest at LIBOR plus applicable percentages of 1.0% to 2.0% or a base rate (the higher of the federal funds rate plus 0.5% or the prime rate) plus applicable percentages of 0.0% to 0.5%. The applicable percentages are calculated based on our leverage ratio. As of February 28, 2006 and November 30, 2005, $43,000 and $0, respectively have been borrowed under the Amended Revolving Credit Facility, and the variable rate was 5.93% and 7.0%, respectively. Borrowings under our Amended Revolving Credit Facility are secured by substantially all of our assets, except real property, and shares of capital stock of our domestic subsidiaries held by us and by the assets of the guarantors (our domestic subsidiaries). The Amended Revolving 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. The significant financial covenants include fixed charge coverage ratio, leverage ratio, senior secured leverage ratio, net worth and brand value calculations. On April 7, 2006, we had $38,000 of borrowings outstanding under our Amended Revolving Credit Facility.
On February 26, 2004, we issued and sold $75,000 of Floating Rate Senior Notes due March 1, 2010 (the “Floating Rate Senior Notes”) and $125,000 of the 7.0% Subordinated Notes, the proceeds of which were used to purchase $204,538 of our 8.875% Senior Subordinated Notes due 2008 on February 26, 2004 and April 1, 2004 and refinance our then existing credit facility.
On March 8, 2004, we entered into an interest rate cap agreement effective June 1, 2004 with decreasing annual notional principal amounts of $15,000 beginning March 1, 2006 and cap rates ranging from 4.0% to 5.0% over the life of the agreement. We paid a $1,375 premium to enter into the interest rate cap agreement, which will be amortized over the life of the agreement. The current portion of the premium on the interest rate cap agreement of $213 is included in prepaid expenses and other current assets, and the long-term portion of $942 is included in other noncurrent assets. During the first quarter of fiscal 2006, the amortized value of the premium on the interest rate cap was compared to the fair value of the interest rate cap and the change in the market value of the premium of $98, net of tax, was recorded to other comprehensive income. Also as of November 30, 2005, a portion of the interest rate cap was deemed to be an ineffective cash flow hedge due to the reduction of variable rate debt upon the subsequent redemption of the Floating Rate Senior Notes, resulting in a loss of $60, net of tax, reflected in the income statement as interest expense. The balance of the cash flow hedge was deemed to be effective as of November 30, 2005. As of February 28, 2006, a portion of the interest rate cap continued to be deemed an ineffective cash flow hedge due to the reduction of variable rate debt due to the redemption of the Floating Rate Senior Notes, resulting in a gain of $24, net of tax, reflected in the income statement. The balance of the cash flow hedge was deemed to be effective as of February 28, 2006. The fair value of the interest rate cap agreement is valued by a third party. The interest rate cap agreement terminates on March 1, 2010. Our domestic subsidiaries were
guarantors of the Floating Rate Senior Notes. The guarantees of the Floating Rate Senior Notes were unsecured senior obligations of the guarantors and ranked equally with all of the current and future unsecured senior debt of the guarantors. The guarantees of the Floating Rate Senior Notes effectively ranked junior to any secured debt of the guarantors, including the guarantors’ guarantee of our indebtedness under the Amended Revolving Credit Facility.
Interest payments on the 7.0% Subordinated Notes are due semi-annually in arrears on March 1 and September 1, commencing on September 1, 2004. Our domestic subsidiaries are guarantors of the 7.0% Subordinated Notes. The guarantees of the 7.0% Subordinated Notes are unsecured senior subordinated obligations of the guarantors. At any time after March 1, 2009, we may redeem any of the 7.0% Subordinated Notes upon not less than 30 nor more than 60 days’ notice at redemption prices (expressed in percentages of principal amount), plus accrued and unpaid interest, if any, and liquidation damages, if any, to the applicable redemption rate, if redeemed during the twelve-month periods beginning March 1, 2009 at 103.500%, March 1, 2010 at 102.333%, March 1, 2011 at 101.167% and March 1, 2012 and thereafter at 100.000%. At any time prior to March 1, 2007, we may redeem up to 35% of the aggregate principal amount of the 7.0% Subordinated Notes (including any additional 7.0% Subordinated Notes) at a redemption price of 107.0% of the principal amount thereof, plus accrued and unpaid interest and liquidated damages, if any, thereon to the applicable redemption rate, with the net cash proceeds of one or more qualified equity offerings; provided, that (i) at least 65.0% of the aggregate principal amount of the 7.0% Subordinated Notes remains outstanding immediately after the occurrence of such redemption (excluding the 7.0% Subordinated Notes held by us and our subsidiaries); and (ii) the redemption must occur within 90 days of the date of the closing of such qualified equity offering.
The indenture governing the 7.0% Subordinated Notes, among other things, limits our ability and the ability of our restricted subsidiaries to: (i) borrow money or sell preferred stock, (ii) create liens, (iii) pay dividends on or redeem or repurchase stock, (iv) make certain types of investments, (v) sell stock in our restricted subsidiaries, (vi) restrict dividends or other payments from restricted subsidiaries, (vii) enter into transactions with affiliates, (viii) issue guarantees of debt and (ix) sell assets or merge with other companies. In addition, if we experience specific kinds of changes in control, we must offer to purchase the 7.0% Subordinated Notes at 101.0% of their principal amount plus accrued and unpaid interest.
During the second quarter of fiscal 2005, we repurchased $17,500 of our 7.0% Subordinated Notes in the open market at an average premium of 1.6% over the principal amount of the notes. The repurchases resulted in a loss on early extinguishment of debt, including related expenses of $744. The outstanding balance of the remaining 7.0% Subordinated Notes was reduced to $107,500.
On November 30, 2005, we called our $75,000 of Floating Rate Senior Notes for full redemption on December 30, 2005. On December 30, 2005, we fully redeemed our $75,000 of Floating Rate Senior Notes at a price of 102% of par plus accrued interest to December 30, 2005. We utilized borrowings of $38,000 under our Amended Revolving Credit Facility and $38,948 of our cash on hand to fund the redemption of the Floating Rate Senior Notes. As a result of the redemption, we paid a 2% premium over par or $1,500, retired associated debt issuance costs of $1,303 and incurred other related call fees, which resulted in a loss on early extinguishment of debt of $2,805 during the first quarter of fiscal 2006. As of April 7, 2006, our borrowing capacity under the Amended Revolving Credit Facility was $62,000.
The future maturities of long-term debt outstanding as of February 28, 2006 are as follows:
| 2008 | | | |
| 2009 | | | |
| 2010 | | 43,000 | |
| 2011 | | | | |
| Thereafter | | | 107,500 | |
| | | $ | 150,500 | |
Comprehensive income consisted of the following components for the three months ended February 28, 2006 and 2005, respectively:
| | | | 2006 | | 2005 | |
| | | | | | | |
| | Net income | | $ | 14,773 | | $ | 8,665 | |
| | Other - interest rate cap adjustment | | | 53 | | | (31 | ) |
| | Other - foreign currency translation adjustment | | | 242 | | | 6 | |
| | Total | | $ | 15,068 | | $ | 8,640 | |
In the first quarter of fiscal 2006, we repurchased 275 shares for $10,130. All repurchased shares were retired and returned to unissued. We, however, are limited in our ability to repurchase shares due to restrictions under the terms of our Amended Revolving Credit Facility and the indenture pursuant to which the 7.0% Subordinated Notes were issued. Subsequent to February 28, 2006 to the date of this filing, we have not repurchased any shares.
| 15. | RETIREMENT PLANS AND POSTRETIREMENT HEALTH CARE BENEFITS |
RETIREMENT PLANS
We have a noncontributory defined benefit pension plan (“the Plan”), which covers substantially all employees as of December 31, 2000. The Plan provides benefits based upon years of service and the employee's compensation. Our contributions are based on computations by independent actuaries. Plan assets at February 28, 2006 and November 30, 2005 were invested primarily in United States government and agency securities and corporate debt and equity securities. In October 2000, our board of directors adopted an amendment to the Plan that freezes benefits of the Plan and prohibits new entrants to the Plan effective December 31, 2000.
Net periodic pension cost for the three months ended February 28, 2006 and 2005 comprised the following components:
| | | | 2006 | | 2005 | |
| | Service cost | | $ | -- | | $ | -- | |
| | Interest cost on projected benefit obligation | | | 156 | | | 152 | |
| | Actual return on plan assets | | | (226 | ) | | (212 | ) |
| | Net amortization and deferral | | | 0 | | | 5 | |
| | Net pension cost (benefit) | | $ | (70 | ) | $ | (55 | ) |
No employer contributions were made for the three months ended February 28, 2006 and 2005, and no employer contributions are expected to be made in fiscal 2006.
POSTRETIREMENT HEALTH CARE BENEFITS
We maintain certain postretirement health care benefits for eligible employees. Employees become eligible for these benefits if they meet certain age and service requirements. We pay a portion of the cost of medical benefits for certain retired employees over the age of 65. Effective January 1, 1993, our contribution is a service-based percentage of the full premium. We pay these benefits as claims are incurred. Employer contributions expected for fiscal 2006 are approximately $73.
Net periodic postretirement health care benefits cost for the three months ended February 28, 2006 and 2005, included the following components:
| | | | 2006 | | 2005 | |
| | Service cost | | $ | 20 | | $ | 18 | |
| | Interest cost on accumulated postretirement benefit obligation | | | 22 | | | 21 | |
| | Amortization of prior service cost | | | 4 | | | 4 | |
| | Amortization of net gain | | | (4 | ) | | (4 | ) |
| | Net periodic postretirement benefits cost | | $ | 42 | | $ | 39 | |
We account for income taxes using the asset and liability approach as prescribed by SFAS No. 109, “Accounting for Income Taxes”. This approach requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Using the enacted tax rates in effect for the year in which the differences are expected to reverse, deferred tax assets and liabilities are determined based on the differences between the financial reporting and the tax basis of an asset or liability. We record income tax expense in our consolidated financial statements based on an estimated annual effective income tax rate. Our tax rate for the three months ended February 28, 2006 was 34%, as compared to 33% in the three months ended February 28, 2005.
Undistributed earnings of Chattem Canada amounted to approximately $98 for the three months ended February 28, 2006. These earnings are considered to be reinvested indefinitely and, accordingly, no provision for U.S. federal and state income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, we would be subject to U.S. income taxes (subject to an adjustment for foreign tax credits).
During fiscal 2005, pursuant to the provisions of the American Jobs Creation Act of 2004 (the “Act”), we adopted a domestic reinvestment plan for purposes of facilitating the repatriation of dividends from our Canadian affiliates. Upon distribution of fiscal 2004 and 2005 earnings, we were subject to U.S. income taxes of $213. The majority of the cash distribution was treated as an extraordinary dividend and qualified for the 85 percent dividend received deduction allowed under the Act.
| 17. | PRODUCT SEGMENT INFORMATION |
Net sales of our domestic product categories within our single healthcare business segment for the three months ended February 28, 2006 and 2005 are as follows:
| | | | | |
| | | | 2006 | | 2005 | |
| | Topical pain care products | | $ | 32,441 | | $ | 21,407 | |
| | Medicated skin care products | | | 16,892 | | | 17,624 | |
| | Dietary supplements | | | 8,853 | | | 8,660 | |
| | Medicated dandruff shampoos and conditioner | | | 11,816 | | | 9,800 | |
| | Other OTC and toiletry products | | | 8,441 | | | 8,078 | |
| | Total | | $ | 78,443 | | $ | 65,569 | |
| 18. | COMMITMENTS AND CONTINGENCIES |
GENERAL LITIGATION
We were named as a defendant in a number of lawsuits alleging that the plaintiffs were injured as a result of ingestion of products containing phenylpropanolamine (“PPA”), which was an active ingredient in most of our Dexatrim products until November 2000. The lawsuits filed in federal court were transferred to the United States District Court for the Western
District of Washington before United States District Judge Barbara Jacobs Rothstein (In Re Phenylpropanolamine (“PPA”) Products Liability Litigation, MDL No. 1407). The remaining lawsuits were filed in state court in a number of different states.
On April 13, 2004, we entered into a class action settlement agreement with representatives of the plaintiffs’ settlement class, which provided for a national class action settlement of all Dexatrim PPA claims. On November 12, 2004, Judge Barbara J. Rothstein of the United States District Court for the Western District of Washington entered a final order and judgment certifying the class and granting approval of the Dexatrim PPA settlement. After the final judgment was entered, two parties who had objected to the settlement filed appeals challenging and seeking to set aside the final judgment. Both of these appeals have now been dismissed.
The Dexatrim PPA settlement includes claims against us involving alleged injuries by Dexatrim products containing PPA in which the alleged injury occurred after December 21, 1998, the date we acquired the Dexatrim brand. In accordance with the terms of the class action settlement agreement, we previously published notice of the settlement and details as to the manner in which claims could be submitted. The deadline for submission of claims was July 7, 2004. A total of 391 claims were certified by the court as timely submitted. Of these 391 claims, 173 alleged stroke as an injury and 218 alleged other non-stroke injuries. Of the 391 total claims, only 371 claimants actually had alleged injuries that occurred after December 21, 1998 and continued to pursue their claims in the settlement. The remaining claimants have either withdrawn their claims or cannot be located. A total of 14 claimants with alleged injuries that occurred after December 21, 1998 elected to opt out of the class settlement. Subsequently, we have settled nine of the opt out claims. The five remaining opt out claimants may pursue claims for damages against us in separate lawsuits. As of April 7, 2006, three of the five remaining opt out claimants have filed lawsuits against us that we are continuing to defend.
We previously reached an agreement with Kemper Indemnity Insurance Company ("Kemper") to settle its lawsuit that sought to rescind our policy for $50,000 of excess coverage for product liability claims. After giving effect to the settlement with Kemper, we have available for the claims against us related to the PPA litigation, through our first three layers of insurance coverage, approximately $60,885 of the $77,000 of product liability coverage provided by these insurance policies. The $60,885 of available coverage consists of $37,500 of insurance under the Kemper policy and approximately $23,385 under policies with two other insurance companies. In accordance with the terms of the class action settlement agreement, this $60,885 of coverage has been funded into a settlement trust. In addition, on July 14, 2004, we entered into a settlement agreement with Sidmak Laboratories, Inc. (“Sidmak”), the manufacturer of Dexatrim products containing PPA, pursuant to which Sidmak has contributed $10,000 into the settlement trust. We have also entered into a settlement agreement with Interstate Fire & Casualty Company (“Interstate”) with regard to its $25,000 of coverage in excess of the insurance funds available in the settlement trust.
During the fourth quarter of fiscal 2005, we resolved substantially all of the claims submitted in the Dexatrim PPA settlement and now estimate that the total cost of the Dexatrim settlement will be approximately $56,000. As indicated above, a total of $70,885 was previously funded into a settlement trust by our insurers and Sidmak for the purpose of paying claims in the settlement. Any funds remaining in the settlement trust after all claims and expenses of the trust have been paid will be distributed as approved by the court in accordance with the class action settlement agreement and our settlement agreements with each of Kemper and Sidmak. Payment of claims through the settlement trust is now substantially complete and we currently expect that we could recover up to approximately $8,500 from the settlement trust after all claims and expenses of the settlement trust have been paid. If realized, this potential recovery is estimated to occur during mid 2006. We currently do not expect to record any additional charges relative to the settlement of the PPA litigation, except for legal expenses that will be recorded in the period incurred. During the first quarter of fiscal 2006, we incurred and recorded $137 of legal expenses related to the Dexatrim litigation.
We have also been named as a defendant in approximately 206 lawsuits relating to Dexatrim containing PPA which involve alleged injuries by Dexatrim products containing PPA manufactured and sold prior to our acquisition of Dexatrim on December 21, 1998. In these lawsuits, we have been defended on the basis of indemnification obligations assumed by The DELACO Company (“DELACO”), successor by merger to the Thompson Medical Company, Inc., which owned the brand prior to December 21, 1998. On February 12, 2004, DELACO filed a Chapter 11 bankruptcy petition in the United States Bankruptcy Court for the Southern District of New York. We filed a claim in DELACO’s bankruptcy case in order to preserve our claims for indemnification against DELACO.
In order to resolve DELACO’s indemnity obligations to us, we entered into a settlement agreement with DELACO dated June 30, 2005 (“the DELACO Agreement”). The DELACO Agreement was approved by the DELACO bankruptcy court on July 28, 2005. Pursuant to the DELACO Agreement, we agreed to assume responsibility for all claims against DELACO and its predecessor, Thompson Medical Company, Inc., or us relating to Dexatrim products involving an injury date after
December 21, 1998, and hold the DELACO bankruptcy estate harmless from any such claims. In exchange, a settlement trust to be established under DELACO’s bankruptcy plan agreed to pay us $8,750 and assume responsibility for all claims related to Dexatrim products alleging injury dates on or before December 21, 1998. On February 17, 2006, the DELACO bankruptcy court entered an order confirming the DELACO bankruptcy plan which incorporated the terms of the DELACO Agreement. In accordance with the DELACO bankruptcy plan, the settlement trust established under the plan paid us $8,750 on March 17, 2006. In addition, this order will allow us to dismiss all cases against us with injury dates prior to December 21, 1998, and channel these cases to the DELACO settlement trust whether brought by an injured party or a co-defendant to a Dexatrim products liability case. We expect all claims with injury dates prior to December 21, 1998 to be channeled to the DELACO settlement trust.
The confirmation of the DELACO bankruptcy plan effectively released us from liability for all PPA products liability cases with injury dates prior to December 21, 1998. The payment to us by the DELACO settlement trust of $8,750 and the channeling of cases to the DELACO settlement trust as described above has conclusively compromised and settled our indemnity claim filed in the DELACO bankruptcy. As of February 28, 2006, we recorded a settlement receivable of $8,750, which is reflected, net of legal expenses, as a litigation settlement item on our consolidated statements of income.
We maintain a significantly lower level of insurance coverage for all other potential claims relating to our products including Dexatrim products containing ephedrine. For the current policy period, we are insured for product liability insurance for all of our other products, including Dexatrim products containing ephedrine, for up to $20,000 through our captive insurance subsidiary, of which approximately $6,481 is funded as of April 7, 2006. We also have $30,000 of excess coverage through third party insurers. There are currently two Dexatrim with ephedrine products liability lawsuits pending against us.
On December 30, 2003, the United States Food and Drug Administration ("FDA") issued a consumer alert on the safety of dietary supplements containing ephedrine alkaloids and on February 6, 2004 published a final rule with respect to these products. The final rule prohibits the sale of dietary supplements containing ephedrine alkaloids because such supplements present an unreasonable risk of illness or injury. The final rule became effective on April 11, 2004. Although we discontinued the manufacturing and shipment of Dexatrim containing ephedrine in September 2002, the FDA's final rule may result in additional lawsuits being filed against us alleging damages related to the use or purchase of Dexatrim containing ephedrine.
We were named as a defendant in a putative class action lawsuit filed in the Superior Court of the State of California for the County of Los Angeles on February 11, 2004, relating to the labeling, advertising, promotion and sale of our Bullfrog suncare products. We filed an answer to this lawsuit on June 28, 2004. An amended complaint was filed March 29, 2006, pursuant to a court order formally consolidating this lawsuit with eight existing lawsuits involving other manufacturers of sunscreen products into a coordinated proceeding in California state court. The amended lawsuit seeks class certification of all persons who purchased our Bullfrog sun care products in California during a four-year period prior to February 11, 2004. The amended lawsuit seeks restitution and/or disgorgement of profits, actual damages, injunctive relief, punitive damages and attorneys fees and costs arising out of alleged deceptive, untrue or misleading advertising and breach of warranty, fraudulent or negligent misrepresentations, in connection with the manufacturing, labeling, advertising, promotion and sale of Bullfrog products in California. An answer to this amended complaint is due mid April, 2006, and we are vigorously defending this lawsuit.
We have been named as a defendant in a putative class action suit filed in the Superior Court of the State of California, County of Los Angeles, on January 13, 2005. The lawsuit seeks injunctive relief, compensatory damages and attorneys fees against us under the California Business and Professions Code, arising out of alleged deceptive, untrue or misleading advertising and breach of express warranty in connection with the manufacturing, labeling, advertising, promotion and sale of certain Dexatrim Natural products. The lawsuit seeks certification of a class consisting of all persons who purchased Dexatrim Natural in California during the four-year period prior to the filing of the lawsuit up to the date of any judgment obtained. The plaintiff has stipulated that the amount in controversy with respect to each individual claim and each member of the proposed class in the action does not exceed $75. We filed an answer on March 1, 2005, and are vigorously defending the lawsuit.
Other claims, suits and complaints arise in the ordinary course of our business involving such matters as patents and trademarks, product liability, environmental matters, employment law issues and other alleged injuries or damage. The outcome of such litigation cannot be predicted, but, in the opinion of management, based in part upon assessments from 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 financial position, results of operations or cash flows if disposed of unfavorably.
REGULATORY
The 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 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 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.
On December 30, 2003, the FDA issued a consumer alert on the safety of dietary supplements containing ephedrine alkaloids and on February 6, 2004 published a final rule with respect to these products. The final rule prohibits the sale of dietary supplements containing ephedrine alkaloids because such supplements present an unreasonable risk of illness or injury. The final rule became effective on April 11, 2004. Although we discontinued the manufacturing and shipment of Dexatrim containing ephedrine in September 2002, the FDA’s final rule may result in lawsuits in addition to those we currently have being filed against us alleging damages related to the use or purchase of Dexatrim containing ephedrine. In April 2005, a Utah federal court called into question the 2004 final rule. The court decision is being appealed and may have an effect on the FDA’s enforcement of the ephedrine alkaloid final rule.
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 or reformulate them using ingredients included in the FDA monograph. We are uncertain as to when the monograph is likely to become final.
Certain of our topical analgesic products are currently marketed under a FDA tentative final external analgesic monograph. The FDA has 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. On October 14, 2003, we submitted to the FDA information regarding the safety of our Icy Hot patches and arguments to support our product’s inclusion in the final monograph. We have also participated in an industry effort coordinated by Consumer
Healthcare Products Association (“CHPA”) 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. The CHPA submission to FDA was made on October 15, 2003. Thereafter, in April 2004, we launched the Icy Hot Sleeve, a flexible, non-occlusive fabric patch containing 16% menthol. In February 2006, we launched the Icy Hot Pro-Therapy Medicated Foam Pad with Knee Wrap containing 5% menthol, and the Capzasin Back & Body patch containing 0.025% capsaicin. All of these drug products contain levels of active ingredients consistent with levels permitted in the OTC monograph. If additional research is required either as a preliminary to final FDA monograph approval and/or as a requirement of future individual product sale, we may need to invest in a considerable amount of expensive testing and data analysis. Any preliminary cost may be shared with other patch manufacturers. Because the submissions made into the FDA docket have been forwarded from its OTC Division to its Dermatological Division within the Center for Drug Evaluation and Research (“CDER”), we are uncertain as to when this matter is likely to become final. For example, the FDA could choose to hold in abeyance a final ruling on alternative dose forms even if the monograph is otherwise finalized. If neither action described above is successful and the final monograph excludes such products, we will have to file a new drug application (“NDA”) for previously marketed drugs in order to continue to market the Icy Hot and Aspercreme Patches, the Icy Hot Sleeve, the Icy Hot Pro-Therapy Medicated Foam Pad with Knee Wrap, Capzasin Back & Body Patch and/or similar delivery systems under our other topical analgesic brands. In such case, we would have to remove the existing products from the market one year from the effective date of the final monograph, pending FDA review and approval of an NDA. The preparation of an 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 an NDA once it is submitted.
We have responded to certain questions with respect to efficacy received from the FDA in connection with clinical studies for pyrilamine maleate, one of the active ingredients used in certain of the Pamprin and Prēmsyn PMS products. While we addressed all of the FDA questions in detail, the final monograph for menstrual drug products, which has not yet been issued, will determine if the FDA considers pyrilamine maleate safe and effective for menstrual relief products. If pyrilamine maleate were not included in the final monograph, we would be required to reformulate the products to continue to provide the consumer with multi-symptom relief benefits. We have been actively monitoring the process and do not believe that either Pamprin or Prēmsyn PMS, as brands, will be materially affected by the FDA review. We believe that any adverse finding by the FDA would likewise affect our principal competitors in the menstrual product category and that finalization of the menstrual products monograph is not imminent. Moreover, we have formulated alternative Pamprin products that fully comply with both the internal analgesic and menstrual product monographs.
In early 2005, infrequent, but serious, adverse cardiovascular events were reported to the FDA associated with patients who were prescribed a subclass of COX-2 inhibitor non-steroidal anti-inflammatory drugs (“NSAID’s”) for long periods to relieve pain of chronic diseases such as arthritis. These products include Vioxx®, Bextra®, and Celebrex®. In February 2005, the FDA held a joint advisory committee meeting to seek external counsel on the extent to which manufacturers might further warn patients of these cardiovascular risks on prescription product labeling, or prohibit sale of these prescription products. As part of its response on this issue, the FDA has recommended labeling changes for both the prescription and OTC NSAID’s. Well-known OTC NSAID’s such as ibuprofen and naproxen, which have been sold in vast quantities since the 1970s, were affected by this regulatory action. Manufacturers of OTC NSAID’s were asked to revise their labeling to provide more specific information about the potential cardiovascular and gastrointestinal risks recognizing the limited dose and duration of treatment of these products. Our Pamprin All Day product, which contains naproxen sodium, is subject to these new labeling requirements. Pamprin All Day is manufactured for us by The Perrigo Company (“Perrigo”), holder of an abbreviated NDA for naproxen sodium. As holder of the abbreviated NDA, Perrigo has made the mandated labeling changes within the time frame required by the FDA. Product with revised labeling compliant with new FDA regulations is being shipped in February, 2006. We are also aware of the FDA's concern about the potential toxicity due to concomitant use of OTC and prescription products that contain the analgesic ingredient acetaminophen, an ingredient also found in Pamprin and Prēmsyn PMS. We are participating in an industry-wide effort to reassure the FDA that the current recommended dosing regimen is safe and effective and that proper labeling and public education by both OTC and prescription drug companies are the best policies to abate the FDA's concern. The FDA will address this issue in its effort to finalize the monograph on internal analgesic products. We believe the FDA may issue revised labeling requirements within the next year, perhaps prior to monograph closure, that will cause the industry to relabel its analgesic products to better inform consumers of concomitant use.
During the finalization of the monograph on sunscreen products the FDA chose to hold in abeyance specific requirements relating to the characterization of a product’s ability to reduce UVA radiation. A final ruling on this matter would be expected to result in new UVA testing requirements and subsequent labeling changes related to sun protection factor, or SPF, ratings, and other labeling claims. We expect that the FDA may take action on this matter within the next six to twelve months. If implemented, the final rules would likely result in new testing requirements and revised labeling of our Bullfrog product line, and all of our competitors’ products in the suncare category, within one year after issuance of the final rules.
Our business is also regulated by the California Safe Drinking Water and Toxic Enforcement Act of 1986, known as Proposition 65. Proposition 65 prohibits businesses from exposing consumers to chemicals that the state has determined cause cancer or reproduction toxicity without first giving fair and reasonable warning unless the level of exposure to the carcinogen or reproductive toxicant falls below prescribed levels. From time to time, one or more ingredients in our products could become subject to an inquiry under Proposition 65. If an ingredient is on the state’s list as a carcinogen, it is possible that a claim could be brought, in which case we would be required to demonstrate that exposure is below a “no significant risk” level for consumers. Any such claims may cause us to incur significant expense, and we may face monetary penalties or injunctive relief, or both, or be required to reformulate our product to acceptable levels. The State of California under Proposition 65 is also considering the inclusion of titanium dioxide on the state’s list of suspected carcinogens. Titanium dioxide has a long history of widespread use as an excipient in prescription and OTC pharmaceuticals, cosmetics, dietary supplements and skin care products and is an active ingredient in our Bullfrog Superblock products. We have participated in an industry-wide submission to the State of California, facilitated through the CHPA, presenting evidence that titanium dioxide presents “no significant risk” to consumers.
In March, 2006, the FDA conducted a routine site audit of our manufacturing plants and laboratories. There were no material adverse findings resulting from the audit.
| 19. | CONDENSED CONSOLIDATING FINANCIAL STATEMENTS |
The condensed consolidating financial statements, for the dates or periods indicated, of Chattem, Inc. (“Chattem”), Signal Investment & Management Co. (“Signal”), SunDex, LLC (“SunDex”) and Chattem (Canada) Holdings, Inc. (“Canada”), the guarantors of the long-term debt of Chattem, and the non-guarantor direct and indirect wholly-owned subsidiaries of Chattem are presented below. Signal is 89% owned by Chattem and 11% owned by Canada. SunDex and Canada are wholly-owned subsidiaries of Chattem. The guarantees of Signal, SunDex and Canada are full and unconditional and joint and several. The guarantees of Signal, SunDex and Canada as of February 28, 2006 arose in conjunction with Chattem’s Amended Revolving Credit Facility and Chattem’s issuance of the 7.0% Subordinated Notes (See Note 12). The maximum amount of future payments the guarantors would be required to make under the guarantees as of February 28, 2006 is $150,500.
Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
FEBRUARY 28, 2006
(Unaudited and in thousands)
| | | CHATTEM | | GUARANTOR SUBSIDIARY COMPANIES | | NON-GUARANTOR SUBSIDIARY COMPANIES | | ELIMINATIONS | | CONSOLIDATED | |
ASSETS | | | | | | | | | | | |
| | | | | | | | | | | | |
| CURRENT ASSETS: | | | | | | | | | | | |
| Cash and cash equivalents | | $ | (1,116 | ) | $ | 1,986 | | $ | 7,255 | | $ | | | $ | 8,125 | |
| Accounts receivable, less allowances of $3,083 | | | 47,147 | | | 23,686 | | | 4,797 | | | (23,686 | ) | | 51,944 | |
| Other receivable | | | 9,103 | | | | | | | | | | | | 9,103 | |
| Interest receivable | | | 17 | | | 1,244 | | | | | | (1,261 | ) | | | |
| Inventories | | | 19,774 | | | 2,969 | | | 2,684 | | | | | | 25,427 | |
| Refundable income taxes | | | — | | | | | | | | | | | | | |
| Deferred income taxes | | | 2,478 | | | | | | | | | | | | 2,478 | |
| Prepaid expenses and other current assets | | | 3,402 | | | | | | 1,284 | | | (225 | ) | | 4,461 | |
| Total current assets | | | 80,805 | | | 29,885 | | | 16,020 | | | (25,172 | ) | | 101,538 | |
| | | | | | | | | | | | | | | | | |
| PROPERTY, PLANT AND EQUIPMENT, NET | | | 28,818 | | | 775 | | | 533 | | | | | | 30,126 | |
| | | | | | | | | | | | | | | | | |
| OTHER NONCURRENT ASSETS: | | | | | | | | | | | | | | | | |
| Patents, trademarks and other purchased product rights, net | | | 344 | | | 268,273 | | | | | | (62,290 | ) | | 206,327 | |
| Debt issuance costs, net | | | 2,867 | | | | | | | | | | | | 2,867 | |
| Investment in subsidiaries | | | 287,091 | | | 33,000 | | | 66,860 | | | (386,951 | ) | | | |
| Note receivable | | | | | | 33,000 | | | | | | (33,000 | ) | | | |
| Other | | | 5,001 | | | | | | 524 | | | | | | 5,525 | |
| Total other noncurrent assets | | | 295,303 | | | 334,273 | | | 67,384 | | | (482,241 | ) | | 214,719 | |
| | | | | | | | | | | | | | | | | |
| TOTAL ASSETS | | $ | 404,926 | | $ | 364,933 | | $ | 83,937 | | $ | (507,413 | ) | $ | 346,383 | |
| | | | | | | | | | | | | | | | | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| CURRENT LIABILITIES: | | | | | | | | | | | | | | | | |
| Current maturities of long-term debt | | $ | | | $ | | | $ | | | $ | | | $ | | |
| Accounts payable and other | | | 9,750 | | | | | | 2,181 | | | | | | 11,931 | |
| Accrued liabilities | | | 39,698 | | | 2,376 | | | 6,583 | | | (25,172 | ) | | 23,485 | |
| Total current liabilities | | | 49,448 | | | 2,376 | | | 8,764 | | | (25,172 | ) | | 35,416 | |
| | | | | | | | | | | | | | | | | |
| LONG-TERM DEBT, less current maturities | | | 150,500 | | | | | | 33,000 | | | (33,000 | ) | | 150,500 | |
| | | | | | | | | | | | | | | | | |
| DEFERRED INCOME TAXES | | | (659 | ) | | 28,531 | | | | | | | | | 27,872 | |
| | | | | | | | | | | | | | | | | |
| OTHER NONCURRENT LIABILITIES | | | 1,890 | | | | | | | | | | | | 1,890 | |
| | | | | | | | | | | | | | | | | |
| INTERCOMPANY ACCOUNTS | | | 73,039 | | | (72,944 | ) | | (95 | ) | | | | | | |
| | | | | | | | | | | | | | | | | |
| SHAREHOLDERS’ EQUITY: | | | | | | | | | | | | | | | | |
| Preferred shares, without par value, authorized 1,000, none issued | | | | | | | | | | | | | | | | |
| Common shares, without par value, authorized 50,000, issued and outstanding 19,421 | | | 56,590 | | | | | | | | | | | | 56,590 | |
| Shares of subsidiaries | | | | | | 329,705 | | | 39,803 | | | (369,508 | ) | | | |
| Retained earnings | | | 75,626 | | | 77,265 | | | 2,233 | | | (79,498 | ) | | 75,626 | |
| Total | | | 132,216 | | | 406,970 | | | 42,036 | | | (449,006 | ) | | 132,216 | |
| Unamortized value of restricted common shares issued | | | (1,522 | ) | | | | | | | | | | | (1,522 | ) |
| Cumulative other comprehensive income: | | | | | | | | | | | | | | | | |
| Interest rate cap adjustment | | | (30 | ) | | | | | | | | | | | (30 | ) |
| Foreign currency translation adjustment | | | 44 | | | | | | 232 | | | (235 | ) | | 41 | |
| Total shareholders’ equity | | | 130,708 | | | 406,970 | | | 42,268 | | | (449,241 | ) | | 130,705 | |
| | | | | | | | | | | | | | | | | |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | | $ | 404,926 | | $ | 364,933 | | $ | 83,937 | | $ | (507,413 | ) | $ | 346,383 | |
Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEETS
NOVEMBER 30, 2005
(In thousands)
| | | | | GUARANTOR SUBSIDIARY COMPANIES | | NON-GUARANTOR SUBSIDIARY COMPANIES | | | | | |
ASSETS | | | | | | | | | | | |
| | | | | | | | | | | | |
| CURRENT ASSETS: | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 36,647 | | $ | 1,982 | | $ | 8,698 | | $ | | | $ | 47,327 | |
| Accounts receivable, less allowances of $2,338 | | | 29,220 | | | 11,181 | | | 4,452 | | | (11,181 | ) | | 33,672 | |
| Other receivables | | | 9,600 | | | | | | | | | | | | 9,600 | |
| Interest receivable | | | 17 | | | 625 | | | | | | (642 | ) | | | |
| Inventories | | | 18,192 | | | 2,429 | | | 3,010 | | | | | | 23,631 | |
| Refundable income taxes | | | 1,207 | | | | | | | | | | | | 1,207 | |
| Deferred income taxes | | | 2,478 | | | | | | | | | | | | 2,478 | |
| Prepaid expenses and other current assets | | | 4,241 | | | | | | 1,285 | | | (420 | ) | | 5,106 | |
| Total current assets | | | 101,602 | | | 16,217 | | | 17,445 | | | (12,243 | ) | | 123,021 | |
| | | | | | | | | | | | | | | | | |
| PROPERTY, PLANT AND EQUIPMENT, NET | | | 28,567 | | | 775 | | | 542 | | | | | | 29,884 | |
| | | | | | | | | | | | | | | | | |
| OTHER NONCURRENT ASSETS: | | | | | | | | | | | | | | | | |
| Patents, trademarks and other purchased product rights, net | | | 404 | | | 268,273 | | | | | | (62,290 | ) | | 206,387 | |
| Debt issuance costs, net | | | 4,297 | | | | | | | | | | | | 4,297 | |
| Investment in subsidiaries | | | 276,987 | | | 33,000 | | | 66,860 | | | (376,847 | ) | | | |
| Note receivable | | | — | | | 33,000 | | | | | | (33,000 | ) | | | |
| Other | | | 4,704 | | | | | | | | | | | | 4,704 | |
| Total other noncurrent assets | | | 286,392 | | | 334,273 | | | 66,860 | | | (472,137 | ) | | 215,388 | |
| | | | | | | | | | | | | | | | | |
| TOTAL ASSETS | | $ | 416,561 | | $ | 351,265 | | $ | 84,847 | | $ | (484,380 | ) | $ | 368,293 | |
| | | | | | | | | | | | | | | | | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| CURRENT LIABILITIES: | | | | | | | | | | | | | | | | |
| Current maturities of long-term debt | | $ | 37,000 | | $ | | | $ | | | $ | | | $ | 37,000 | |
| Accounts payable and other | | | 14,841 | | | | | | 2,397 | | | | | | 17,238 | |
| Accrued liabilities | | | 21,432 | | | 969 | | | 6,169 | | | (12,243 | ) | | 16,327 | |
| Total current liabilities | | | 73,273 | | | 969 | | | 8,566 | | | (12,243 | ) | | 70,565 | |
| | | | | | | | | | | | | | | | | |
| LONG-TERM DEBT, less current maturities | | | 145,500 | | | | | | 33,000 | | | (33,000 | ) | | 145,500 | |
| | | | | | | | | | | | | | | | | |
| DEFERRED INCOME TAXES | | | (795 | ) | | 28,531 | | | | | | | | | 27,736 | |
| | | | | | | | | | | | | | | | | |
| OTHER NONCURRENT LIABILITIES | | | 1,865 | | | | | | | | | | | | 1,865 | |
| | | | | | | | | | | | | | | | | |
| INTERCOMPANY ACCOUNTS | | | 74,088 | | | (75,941 | ) | | 1,853 | | | | | | | |
| | | | | | | | | | | | | | | | | |
| SHAREHOLDERS’ EQUITY: | | | | | | | | | | | | | | | | |
| Preferred shares, without par value, authorized 1,000, none issued | | | | | | | | | | | | | | | | |
| Common shares, without par value, authorized 50,000, issued 19,668 | | | 63,876 | | | | | | | | | | | | 63,876 | |
| Share capital of subsidiaries | | | | | | 329,705 | | | 39,803 | | | (369,508 | ) | | | |
| Retained earnings | | | 60,853 | | | 68,001 | | | 1,582 | | | (69,583 | ) | | 60,853 | |
| Total | | | 124,729 | | | 397,706 | | | 41,385 | | | (439,091 | ) | | 124,729 | |
| Unamortized value of restricted common shares issued | | | (1,818 | ) | | | | | | | | | | | (1,818 | ) |
| Cumulative other comprehensive income, net of taxes: | | | | | | | | | | | | | | | | |
| Interest rate cap adjustment | | | (83 | ) | | | | | | | | | | | (83 | ) |
| Foreign currency translation adjustment | | | (198 | ) | | | | | 43 | | | (46 | ) | | (201 | ) |
| Total shareholders’ equity | | | 122,630 | | | 397,706 | | | 41,428 | | | (439,137 | ) | | 122,627 | |
| | | | | | | | | | | | | | | | | |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | | $ | 416,561 | | $ | 351,265 | | $ | 84,847 | | $ | (484,380 | ) | $ | 368,293 | |
Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2006
(Unaudited and in thousands)
| | | | GUARANTOR SUBSIDIARY COMPANIES | | NON-GUARANTOR SUBSIDIARY COMPANIES | | | | | |
| | | | | | | | | | | | |
| TOTAL REVENUES | | $ | 71,077 | | $ | 21,432 | | $ | 4,625 | | $ | (13,110 | ) | $ | 84,024 | |
| | | | | | | | | | | | | | | | | |
| COSTS AND EXPENSES: | | | | | | | | | | | | | | | | |
| Cost of sales | | | 22,567 | | | 2,121 | | | 1,938 | | | (606 | ) | | 26,020 | |
| Advertising and promotion | | | 22,773 | | | 2,829 | | | 1,585 | | | | | | 27,187 | |
| Selling, general and administrative | | | 11,529 | | | (102 | ) | | 164 | | | | | | 11,591 | |
| Litigation settlement | | | (8,613 | ) | | | | | | | | | | | (8,613 | ) |
| Equity in subsidiary income | | | (9,915 | ) | | | | | | | | 9,915 | | | | |
| Total costs and expenses | | | 38,341 | | | 4,848 | | | 3,687 | | | 9,309 | | | 56,185 | |
| | | | | | | | | | | | | | | | | |
| INCOME FROM OPERATIONS | | | 32,736 | | | 16,584 | | | 938 | | | (22,419 | ) | | 27,839 | |
| | | | | | | | | | | | | | | | | |
| OTHER INCOME (EXPENSE): | | | | | | | | | | | | | | | | |
| Interest expense | | | (2,844 | ) | | | | | (619 | ) | | 619 | | | (2,844 | ) |
| Investment and other income, net | | | 124 | | | 630 | | | 684 | | | (1,244 | ) | | 194 | |
| Loss on early extinguishment of debt | | | (2,805 | ) | | | | | | | | | | | (2,805 | ) |
| Royalties | | | (11,099 | ) | | (1,406 | ) | | | | | 12,505 | | | | |
| Corporate allocations | | | 841 | | | (825 | ) | | (16 | ) | | | | | | |
| Total other income (expense) | | | (15,783 | ) | | (1,601 | ) | | 49 | | | 11,880 | | | (5,455 | ) |
| | | | | | | | | | | | | | | | | |
| INCOME BEFORE INCOME TAXES | | | 16,953 | | | 14,983 | | | 987 | | | (10,539 | ) | | 22,384 | |
| | | | | | | | | | | | | | | | | |
| PROVISION FOR INCOME TAXES | | | 2,180 | | | 5,095 | | | 336 | | | | | | 7,611 | |
| | | | | | | | | | | | | | | | | |
| NET INCOME | | $ | 14,773 | | $ | 9,888 | | $ | 651 | | $ | (10,539 | ) | $ | 14,773 | |
Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005
(Unaudited and in thousands)
| | | | | GUARANTOR SUBSIDIARY COMPANIES | | NON-GUARANTOR SUBSIDIARY COMPANIES | | ELIMINATIONS | | CONSOLIDATED | |
| | | | | | | | | | | | |
| TOTAL REVENUES | | $ | 58,790 | | $ | 19,062 | | $ | 4,873 | | $ | (11,194 | ) | $ | 71,531 | |
| | | | | | | | | | | | | | | | | |
| COSTS AND EXPENSES: | | | | | | | | | | | | | | | | |
| Cost of sales | | | 16,614 | | | 2,323 | | | 2,139 | | | (816 | ) | | 20,260 | |
| Advertising and promotion | | | 15,459 | | | 3,803 | | | 1,089 | | | | | | 20,351 | |
| Selling, general and administrative | | | 11,521 | | | 73 | | | 290 | | | | | | 11,884 | |
| Litigation settlement | | | 1,070 | | | | | | 1,685 | | | | | | 2,755 | |
| Equity in subsidiary income | | | (6,831 | ) | | | | | | | | 6,831 | | | | |
| Total costs and expenses | | | 37,833 | | | 6,199 | | | 5,203 | | | 6,015 | | | 55,250 | |
| | | | | | | | | | | | | | | | | |
| INCOME (LOSS) FROM OPERATIONS | | | 20,957 | | | 12,863 | | | (330 | ) | | (17,209 | ) | | 16,281 | |
| | | | | | | | | | | | | | | | | |
| OTHER INCOME (EXPENSE): | | | | | | | | | | | | | | | | |
| Interest expense | | | (3,489 | ) | | | | | (623 | ) | | 617 | | | (3,495 | ) |
| Investment and other income, net | | | 95 | | | 623 | | | 671 | | | (1,242 | ) | | 147 | |
| Royalties | | | (9,017 | ) | | (1,362 | ) | | | | | 10,379 | | | | |
| Corporate allocations | | | 715 | | | (699 | ) | | (16 | ) | | | | | | |
| Total other income (expense) | | | (11,696 | ) | | (1,438 | ) | | 32 | | | 9,754 | | | (3,348 | ) |
| | | | | | | | | | | | | | | | | |
| INCOME (LOSS) BEFORE INCOME TAXES | | | 9,261 | | | 11,425 | | | (298 | ) | | (7,455 | ) | | 12,933 | |
| | | | | | | | | | | | | | | | | |
| PROVISION FOR (BENEFIT FROM) INCOME TAXES | | | 596 | | | 3,770 | | | (98 | ) | | | | | 4,268 | |
| | | | | | | | | | | | | | | | | |
| NET INCOME (LOSS) | | $ | 8,665 | | $ | 7,655 | | $ | (200 | ) | $ | (7,455 | ) | $ | 8,665 | |
Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2006
(Unaudited and in thousands)
| | | CHATTEM | | GUARANTOR SUBSIDIARY COMPANIES | | NON-GUARANTOR SUBSIDIARY COMPANIES | | ELIMINATIONS | | CONSOLIDATED | |
| | | | | | | | | | | | |
| OPERATING ACTIVITIES: | | | | | | | | | | | |
| Net income | | $ | 14,773 | | $ | 9,888 | | $ | 651 | | $ | (10,539 | ) | $ | 14,773 | |
| Adjustments to reconcile net income to net cash provided by (used in) operating activities: | | | | | | | | | | | | | | | | |
| Depreciation and amortization | | | 1,379 | | | | | | 46 | | | | | | 1,425 | |
| Deferred income taxes | | | 233 | | | | | | 6 | | | | | | 239 | |
Excess tax benefit from stock-based compensation | | | (309 | ) | | | | | | | | | | | (309 | ) |
| Stock-based compensation | | | 852 | | | | | | | | | | | | 852 | |
| Loss on early extinguishment of debt | | | 2,805 | | | | | | | | | | | | 2,805 | |
| Other, net | | | 51 | | | | | | 15 | | | | | | 66 | |
| Equity in subsidiary income | | | (10,539 | ) | | | | | | | | 10,539 | | | | |
| Changes in operating assets and liabilities: | | | | | | | | | | | | | | | | |
| Accounts receivable and other | | | (17,430 | ) | | (12,505 | ) | | (345 | ) | | 12,505 | | | (17,775 | ) |
| Interest receivable | | | | | | (619 | ) | | | | | 619 | | | | |
| Inventories | | | (1,430 | ) | | (539 | ) | | 325 | | | | | | (1,644 | ) |
| Refundable income taxes | | | 1,516 | | | | | | | | | | | | 1,516 | |
| Prepaid expenses and other current assets | | | 838 | | | | | | 9 | | | (195 | ) | | 652 | |
| Accounts payable and accrued liabilities | | | 14,451 | | | 1,406 | | | 198 | | | (12,929 | ) | | 3,126 | |
| Net cash provided by (used in) operating activities | | | 7,190 | | | (2,369 | ) | | 905 | | | | | | 5,726 | |
| | | | | | | | | | | | | | | | | |
| INVESTING ACTIVITIES: | | | | | | | | | | | | | | | | |
| Purchases of property, plant and equipment | | | (1,276 | ) | | | | | | | | | | | (1,276 | ) |
| Increase in other assets, net | | | (271 | ) | | | | | (340 | ) | | | | | (611 | ) |
| Net cash used in investing activities | | | (1,547 | ) | | | | | (340 | ) | | | | | (1,887 | ) |
| | | | | | | | | | | | | | | | | |
| FINANCING ACTIVITIES: | | | | | | | | | | | | | | | | |
| Repayment of long-term debt | | | (75,000 | ) | | | | | | | | | | | (75,000 | ) |
| Proceeds from borrowings under revolving credit facility | | | 43,000 | | | | | | | | | | | | 43,000 | |
| Proceeds from exercise of stock options | | | 311 | | | | | | | | | | | | 311 | |
| Repurchase of common shares | | | (10,130 | ) | | | | | | | | | | | (10,130 | ) |
| Increase in debt issuance costs | | | (15 | ) | | | | | | | | | | | (15 | ) |
| Retirement of debt issuance costs | | | (1,501 | ) | | | | | | | | | | | (1,501 | ) |
Excess tax benefit from stock-based compensation | | | 309 | | | | | | | | | | | | 309 | |
| Changes in intercompany accounts | | | (380 | ) | | 2,998 | | | (2,618 | ) | | | | | | |
| Dividends paid | | | | | | (625 | ) | | 625 | | | | | | | |
| Net cash (used in) provided by financing activities | | | (43,406 | ) | | 2,373 | | | (1,993 | ) | | | | | (43,026 | ) |
| | | | | | | | | | | | | | | | | |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS | | | | | | | | | (15 | ) | | | | | (15 | ) |
| | | | | | | | | | | | | | | | | |
| CASH AND CASH EQUIVALENTS: | | | | | | | | | | | | | | | | |
| Decrease for the period | | | (37,763 | ) | | 4 | | | (1,443 | ) | | | | | (39,202 | ) |
| At beginning of period | | | 36,647 | | | 1,982 | | | 8,698 | | | | | | 47,327 | |
| At end of period | | $ | (1,116 | ) | $ | 1,986 | | $ | 7,255 | | $ | | | $ | 8,125 | |
Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005
(Unaudited and in thousands)
| | | CHATTEM | | GUARANTOR SUBSIDIARY COMPANIES | | NON-GUARANTOR SUBSIDIARY COMPANIES | | ELIMINATIONS | | CONSOLIDATED | |
| | | | | | | | | | | | |
| OPERATING ACTIVITIES: | | | | | | | | | | | |
| Net income (loss) | | $ | 8,665 | | $ | 7,655 | | $ | (200 | ) | $ | (7,455 | ) | $ | 8,665 | |
| Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities: | | | | | | | | | | | | | | | | |
| Depreciation and amortization | | | 1,585 | | | | | | 39 | | | | | | 1,624 | |
| Deferred income taxes | | | 487 | | | 1,291 | | | | | | | | | 1,778 | |
| Tax benefit realized from stock option plans | | | 186 | | | | | | | | | | | | 186 | |
| Other, net | | | 49 | | | | | | 312 | | | | | | 361 | |
| Equity in subsidiary income | | | (7,455 | ) | | | | | | | | 7,455 | | | | |
| Changes in operating assets and liabilities: | | | | | | | | | | | | | | | | |
| Accounts receivable | | | (11,307 | ) | | 1,498 | | | (547 | ) | | 1,644 | | | (8,712 | ) |
| Inventories | | | (462 | ) | | 628 | | | (452 | ) | | | | | (286 | ) |
| Refundable income taxes | | | 2,172 | | | | | | | | | | | | 2,172 | |
| Prepaid expenses and other current assets | | | 1,072 | | | | | | (690 | ) | | | | | 382 | |
| Accounts payable and accrued liabilities | | | (70 | ) | | 255 | | | 3,237 | | | (1,644 | ) | | 1,778 | |
| Net cash (used in) provided by operating activities | | | (5,078 | ) | | 11,327 | | | 1,699 | | | | | | 7,948 | |
| | | | | | | | | | | | | | | | | |
| INVESTING ACTIVITIES: | | | | | | | | | | | | | | | | |
| Purchases of property, plant and equipment | | | (566 | ) | | | | | (33 | ) | | | | | (599 | ) |
| Decrease in other assets, net | | | 155 | | | | | | 512 | | | | | | 667 | |
| Net cash (used in) provided by investing activities | | | (411 | ) | | | | | 479 | | | | | | 68 | |
| | | | | | | | | | | | | | | | | |
| FINANCING ACTIVITIES: | | | | | | | | | | | | | | | | |
| Repayment of policy loans | | | (1,031 | ) | | | | | | | | | | | (1,031 | ) |
| Proceeds from exercise of stock options | | | 187 | | | | | | | | | | | | 187 | |
| Repurchase of common shares | | | (3,514 | ) | | | | | | | | | | | (3,514 | ) |
| Changes in intercompany accounts | | | 10,529 | | | (10,700 | ) | | 171 | | | | | | | |
| Dividends paid | | | | | | (625 | ) | | 625 | | | | | | | |
| Net cash provided by (used in) financing activities | | | 6,171 | | | (11,325 | ) | | 796 | | | | | | (4,358 | ) |
| | | | | | | | | | | | | | | | | |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS | | | | | | | | | (312 | ) | | | | | (312 | ) |
| | | | | | | | | | | | | | | | | |
| CASH AND CASH EQUIVALENTS: | | | | | | | | | | | | | | | | |
| Increase for the period | | | 682 | | | 2 | | | 2,662 | | | | | | 3,346 | |
| At beginning of period | | | 28,344 | | | 1,967 | | | 9,882 | | | | | | 40,193 | |
| At end of period | | $ | 29,026 | | $ | 1,969 | | $ | 12,544 | | $ | | | $ | 43,539 | |
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 2005 Annual Report on Form 10-K filed with the Securities and Exchange Commission. 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.
Overview
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 pain care products, medicated skin care products, medicated dandruff shampoos and conditioner, dietary supplements, and other OTC and toiletry products. Our portfolio of products includes well-recognized brands such as:
• Topical pain care products such as Icy Hot, Icy Hot Pro-Therapy and Aspercreme;
• Medicated skin care products such as Gold Bond medicated skin care powder, cream, lotion, first aid, and foot care products;
• Selsun Blue and Selsun Salon medicated dandruff shampoos;
• Dietary supplements including Dexatrim, Garlique and New Phase; and
• Other OTC and toiletry products such as Pamprin, a menstrual analgesic; Herpecin-L, a lip care product; Benzodent, a dental analgesic cream; Bullfrog, a line of suncare products; and toiletries such as Ultraswim, a chlorine-removing shampoo; and Sun-In, a hair lightener.
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 innovation and 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 pain care brands and our Gold Bond medicated body powders have the leading U.S. market share in these categories. We support our brands through extensive and cost-effective advertising and promotion, the expenditures for which represented approximately 32.4% of our total revenues in the first quarter of fiscal 2006. We sell our products nationally through mass merchandiser, drug and food channels principally utilizing our own sales force.
Developments During Fiscal 2006
Products
In the first quarter of fiscal 2006, we introduced the following product line extensions: Icy Hot Pro-Therapy, Bullfrog Mosquito Coast, Garlique CardioAssist, Capzasin Back & Body Patch and Pamprin Max.
Debt
On November 30, 2005, we called our $75.0 million of Floating Rate Senior Notes for full redemption on December 30, 2005. The terms of the indenture for the Floating Rate Senior Notes required the repayment at a price of 102% of the principal amount of the notes plus accrued interest. The $75.0 million of Floating Rate Senior Notes were fully redeemed on December 30, 2005. We utilized borrowings of $38.0 million under our Amended Revolving Credit Facility and $38.9 million of our cash on hand to fund the redemption of the Floating Rate Senior Notes. As a result of the redemption, a loss on early extinguishment of debt of $2.8 million was recorded in the first quarter of fiscal 2006.
Litigation
During the fourth quarter of fiscal 2005, we resolved substantially all of the claims submitted in the Dexatrim PPA settlement and now estimate that the total cost of the Dexatrim settlement will be approximately $56.0 million. A total of $70.9 million was previously funded into a settlement trust by our insurers and Sidmak Laboratories, Inc., the manufacturer of Dexatrim
products containing PPA, for the purpose of paying claims in the settlement. Any funds remaining in the settlement trust after all claims and expenses of the trust have been paid will be distributed as approved by the court in accordance with the class action settlement agreement and our settlement agreements with each of Kemper Indemnity Insurance Company and the product manufacturer. Payment of claims through the settlement trust is now substantially complete and we currently expect that we could recover up to approximately $8.5 million from the settlement trust after all claims and expenses of the settlement trust have been paid. If realized, this potential recovery is estimated to occur during mid 2006. We currently do not expect to record any additional charges relative to the settlement of the PPA litigation, except for legal expenses that will be recorded in the period incurred. During the first quarter of fiscal 2006, we incurred and recorded $0.1 million of legal expenses related to the Dexatrim litigation.
During the third quarter of fiscal 2005, we entered into a settlement agreement with the DELACO Company (“DELACO”), successor by merger to the Thompson Medical Company, Inc., which owned the Dexatrim brand prior to December 21, 1998 (the “DELACO Agreement”). The DELACO Agreement was approved by the DELACO bankruptcy court on July 28, 2005. Pursuant to the DELACO Agreement, we agreed to assume responsibility for all claims against DELACO and its predecessor, Thompson Medical Company, Inc., or us relating to Dexatrim products involving an injury date after December 21, 1998 and hold the DELACO bankruptcy estate harmless from any such claims. In exchange, a settlement trust to be established under DELACO’s bankruptcy plan agreed to pay us $8.75 million and assume responsibility for all claims related to Dexatrim products alleging injury dates on or before December 21, 1998. On February 17, 2006, the DELACO bankruptcy court entered an order confirming the DELACO bankruptcy plan which incorporated the terms of the DELACO Agreement. In accordance with the DELACO bankruptcy plan, the settlement trust established under the plan paid us $8.75 million on March 17, 2006. In addition, this order will allow us to dismiss all cases against us with injury dates prior to December 21, 1998, and channel these cases to the DELACO settlement trust whether brought by an injured party or a co-defendant to a Dexatrim products liability case. We expect all claims with injury dates prior to December 21, 1998 to be channeled to the DELACO settlement trust.
The confirmation of the DELACO bankruptcy plan effectively releases us from liability for all PPA products liability cases with injury dates prior to December 21, 1998. The payment to us by the DELACO settlement trust of $8.75 million and the channeling of cases to the DELACO settlement trust as described above has conclusively compromised and settled our indemnity claim filed in the DELACO bankruptcy. As of February 28, 2006, we recorded a settlement receivable of $8.75 million, which is reflected, net of legal expenses, as a litigation settlement item on our consolidated statements of income.
Results of Operations
The following table sets forth, for the periods indicated, certain items from our Condensed Consolidated Statements of Income expressed as a percentage of total revenues:
| | | For the Three Months Ended | |
| | | February 28, 2006 | | February 28, 2005 | |
| TOTAL REVENUES | | | 100.0 | % | | 100.0 | % |
| | | | | | | | |
| COSTS AND EXPENSES: | | | | | | | |
| Cost of sales | | | 31.0 | | | 28.3 | |
| Advertising and promotion | | | 32.4 | | | 28.5 | |
| Selling, general and administrative | | | 13.8 | | | 16.6 | |
| Litigation settlement | | | (10.3 | ) | | 3.8 | |
| Total costs and expenses | | | 66.9 | | | 77.2 | |
| | | | | | | | |
| INCOME FROM OPERATIONS | | | 33.1 | | | 22.8 | |
| | | | | | | | |
| OTHER INCOME (EXPENSE): | | | | | | | |
| Interest expense | | | (3.4 | ) | | (4.9 | ) |
| Investment and other income, net | | | 0.2 | | | 0.2 | |
| Loss on early extinguishment of debt | | | (3.3 | ) | | -- | |
| Total other income (expense) | | | (6.5 | ) | | (4.7 | ) |
| | | | | | | | |
| INCOME BEFORE INCOME TAXES | | | 26.6 | | | 18.1 | |
| | | | | | | | |
| PROVISION FOR INCOME TAXES | | | 9.1 | | | 6.0 | |
| | | | | | | | |
| NET INCOME | | | 17.5 | % | | 12.1 | % |
Critical Accounting Policies
The preparation of financial statements in accordance with U.S. generally accepted accounting principles 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 February 28, 2006 condensed consolidated financial statements:
Allowance for Doubtful Accounts
As of February 28, 2006, 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. Many factors can impact this estimate, including those noted in this paragraph. The adequacy of the estimated allowance may be impacted by the deterioration in the financial condition of a large customer, weakness in the economic environment resulting in a higher level of customer bankruptcy filings or delinquencies and the competitive environment in which the customer operates. During the first quarter of fiscal 2006, we performed a detailed assessment of the collectibility of trade accounts receivable and did not make any significant adjustments to our estimate of allowance for doubtful accounts. The balance of allowance for doubtful accounts was $0.3 million at February 28, 2006 and November 30, 2005, respectively.
Revenue Recognition
Revenue is recognized when our products are shipped to our customers. It is generally 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 including 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, as a reduction of these sales, 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 deduction from remittance by the customer or product returns upon receipt of the product.
In accordance with industry practice, we allow our customers to return unsold sun care products (i.e. Bullfrog and Sun In lines of 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 $0.2 million. As a result of higher sales volumes in the first quarter of fiscal 2006 and 2005, we increased our estimate of seasonal returns by approximately $0.4 million and $0.1 million, respectively, which resulted in a decrease to net sales in our condensed consolidated financial statements. During the first quarter of fiscal 2006 and 2005, as a result of our estimate of customer inventory levels and based on historical non-seasonal product returns, we increased our estimate of non-seasonal returns by approximately $0.3 and $0.6 million, which resulted in a decrease to net sales in our condensed consolidated financial statements. At November 30, 2005, we recorded an allowance for returns of pHisoderm of $0.7 million as a result of the sale of pHisoderm. At February 28, 2006 the allowance for pHisoderm returns is $0.4 million.
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 provided uniquely 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, which is recorded as a reduction of sales. Actual results can differ from the original estimate. In addition, increases and decreases in total program commitments each year impact the accrual. We also consider customer delays in requesting promotional program payments when evaluating the required accrual. Some 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. During the first quarter of fiscal 2006 and 2005, primarily as a result of sales volume related promotional programs, we increased our estimate of promotional accruals by approximately $2.5 million and $0.5 million, respectively, which resulted in an increase in advertising and promotion expense in our condensed consolidated financial statements.
Income Taxes
We account for income taxes using the asset and liability approach as prescribed by Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes”. This approach requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in our condensed consolidated financial statements or tax returns. Using the enacted tax rates in effect for the year in which the differences are expected to reverse, deferred tax assets and liabilities are determined based on the differences between the financial reporting and the tax basis of an asset or liability. We record income tax expense in our condensed consolidated financial statements based on an estimated annual effective income tax rate. Our tax rate for the three months ended February 28, 2006 was 34%, as compared to 33% in the three months ended February 28, 2005, respectively.
For a summary of our significant accounting policies, see Note 2 of Notes to Condensed Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended November 30, 2005 filed with the Securities and Exchange Commission.
Comparison of Three Months Ended February 28, 2006 and 2005
To facilitate discussion of our operating results for the three months ended February 28, 2006 and 2005, we have included the following selected data from our Condensed Consolidated Statements of Income:
| | | | | | | Increase (Decrease) | |
| | | 2006 | | 2005 | | Amount | | Percentage | |
| | | (dollars in thousands) | |
| Domestic net sales | | $ | 78,443 | | $ | 65,569 | | $ | 12,874 | | | 19.6 | % |
| International revenues (including royalties) | | | 5,581 | | | 5,962 | | | (381 | ) | | (6.4 | ) |
| Total revenues | | | 84,024 | | | 71,531 | | | 12,493 | | | 17.5 | |
| Cost of sales | | | 26,020 | | | 20,260 | | | 5,760 | | | 28.4 | |
| Advertising and promotion expense | | | 27,187 | | | 20,351 | | | 6,836 | | | 33.6 | |
| Selling, general and administrative expense | | | 11,591 | | | 11,884 | | | (293 | ) | | (2.5 | ) |
| Litigation settlement | | | (8,613 | ) | | 2,755 | | | (11,368 | ) | | (412.6 | ) |
| Interest expense | | | 2,844 | | | 3,495 | | | (651 | ) | | (18.6 | ) |
| Loss on early extinguishment of debt | | | 2,805 | | | — | | | nm | | | nm | |
| Net income | | | 14,773 | | | 8,665 | | | 6,108 | | | 70.5 | |
Domestic Net Sales
Domestic net sales for the three months ended February 28, 2006 increased $12.9 million, or 19.6%, to $78.4 million from $65.6 million in the prior year quarter. A comparison of domestic net sales for the categories of products included in our portfolio of OTC healthcare products is as follows:
| | | | |
| | | | | | | Increase (Decrease) | |
| | | 2006 | | 2005 | | Amount | | Percentage | |
| | | (dollars in thousands) | |
| Topical pain care products | | $ | 32,441 | | $ | 21,407 | | $ | 11,034 | | | 51.5 | % |
| Medicated skin care products | | | 16,892 | | | 17,624 | | | (732 | ) | | (4.2 | ) |
| Dietary supplements | | | 8,853 | | | 8,660 | | | 193 | | | 2.2 | |
| Medicated dandruff shampoos and conditioner | | | 11,816 | | | 9,800 | | | 2,016 | | | 20.6 | |
| Other OTC and toiletry products | | | 8,441 | | | 8,078 | | | 363 | | | 4.5 | |
| Total | | $ | 78,443 | | $ | 65,569 | | $ | 12,874 | | | 19.6 | |
Net sales in the topical pain care category increased 52% for the first quarter of fiscal 2006 compared to the prior year quarter, due primarily to the initial sell-in of the new Icy Hot Pro-Therapy line of elastic support braces and pain relieving insert products. Excluding sales of Icy Hot Pro-Therapy, the category declined 3% compared to the prior year quarter.
Net sales in the medicated skin care products category decreased 4% in the first quarter of fiscal 2006 compared to the prior year quarter which included pHisoderm sales of $2.9 million. Net sales of Gold Bond increased 13% behind strong sales of Gold Bond Medicated Body Lotion and Gold Bond Ultimate Healing Lotion. Sampling and enhanced media support behind the Gold Bond lotion products resulted in record first quarter sales for both the lotion line and the brand as a whole. Net sales of Gold Bond powder products declined 15% for the first quarter of fiscal 2006 compared to the prior year quarter due in part to the pipeline volume of Gold Bond Ultimate Comfort Body Powder during the first quarter of fiscal 2005.
Net sales in the dietary supplements category increased 2% for the first quarter of fiscal 2006 compared to the prior year quarter driven primarily by a 15% increase in sales of Dexatrim due to the continued strong performance of the Dexatrim Max diet pill. Net sales of Garlique increased 10% for the first quarter, reflecting renewed advertising support and the initial sell-in of the new Garlique CardioAssist dietary supplement. These strong increases were offset by the discontinuance of the Dexatrim All In One Bar, which accounted for approximately $1.0 million of net sales in the first quarter of fiscal 2005.
Net sales in the medicated dandruff shampoos and conditioner category increased 21% in the first quarter of fiscal 2006 compared to the prior year quarter as a result of strong distribution of Selsun Salon. Sales of Selsun Blue declined for the quarter primarily due to increased media support and in-store promotional activity among competitive brands.
Net sales in the other OTC and toiletry products category increased 5% due primarily to increased sales of Pamprin, which were driven by media support and the initial sell-in of Pamprin Max. The balance of this category was essentially flat compared to the prior year quarter.
Domestic sales variances were principally the result of changes in unit sales volumes with the exception of certain selected products for which we implemented a unit sales price increase.
International Revenues
For the first quarter of fiscal 2006, international revenues decreased $0.4 million, or 6.4%, compared to the first quarter of fiscal 2005, primarily due to the reduction of sales as a result of the divestiture of pHisoderm at the end of fiscal 2005 and the suspension of distribution in a single European market in mid-2005, partially offset by the successful introductions of Icy Hot in Canada and Mexico. Sales variances for our international operations were principally the result of changes in unit sales volume.
Cost of Sales
Cost of sales as a percentage of total revenues was 31.0% for the first quarter of fiscal 2006 as compared to 28.3% in the prior year quarter. Gross margin for the first quarter of fiscal 2006 was 69.0% compared to 71.7% in the prior year quarter. The gross margin decline was largely attributable to the launch of Icy Hot Pro-Therapy which has lower gross margins than our other products.
Advertising and Promotion Expense
Advertising and promotion expenses in the first quarter of fiscal 2006 increased $6.8 million, or 33.6%, as compared to the same quarter of fiscal 2005 and were 32.4% of total revenues for the three months ended February 28, 2006 compared to 28.5% for the prior year quarter. Support for new product introductions drove an increase in advertising and promotion expense in the current period.
Selling, General and Administrative Expense
Selling, general and administrative expenses decreased $0.3 million, or 2.5%, compared to the prior year quarter. Selling, general and administrative expenses were 13.8% and 16.6% of total revenues for the first quarter of fiscal 2006 and 2005, respectively. The decrease was attributable to lower compensation expense in the current period reflecting restricted stock grants in the prior year quarter, offset in part by share-based payment expense under SFAS 123R (as defined below in Recent Accounting Pronouncements) and higher freight costs in the current period.
Litigation Settlement
Litigation settlement items decreased $11.4 million as compared to the same quarter of fiscal 2005 due to the $8.75 million recovery from the DELACO settlement trust ($8.6 million net of legal expense) in the Dexatrim litigation settlement in the current period compared to Dexatrim litigation costs of $2.8 million in the prior year quarter.
Interest Expense
Interest expense decreased $0.7 million, or 18.6%, in the first quarter of fiscal 2006 as compared to the prior year quarter, reflecting the impact of the previously announced refinancing transactions. Until our indebtedness is reduced substantially, interest expense will continue to represent a significant percentage of our total revenues.
Loss on Early Extinguishment of Debt
Our $75.0 million of Floating Rate Senior Notes were fully redeemed in the first quarter of fiscal 2006. As a result of the redemption, a loss on early extinguishment of debt of $2.8 million was recorded in the first quarter of fiscal 2006. No corresponding charge was incurred in first quarter of fiscal 2005.
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 $5.7 million and $7.9 million was provided by operations for the three months ended February 28, 2006 and 2005, respectively. The decreases in cash flows from operations over the prior year quarter was primarily attributable to the increase in accounts receivable and other, which includes the $8.75 million DELACO settlement receivable and trade receivables related to new product launches such as Icy Hot Pro-Therapy, offset by a loss on early extinguishment of debt of $2.8 million related to the redemption of our $75.0 million of Floating Rate Senior Notes.
Investing activities used cash of $1.9 million and provided cash of $0.1 million in the three months ended February 28, 2006 and 2005, respectively. The increase in cash used is primarily related to an increase in capital expenditures as compared to the prior year quarter.
Financing activities used cash of $43.0 million and $4.4 million in the three months ended February 28, 2006 and 2005, respectively. The increase in cash used in the current period was primarily attributable to the redemption of our $75.0 million of Floating Rate Senior Notes offset by borrowings under our Amended Revolving Credit Facility of $43.0 million and $10.1 million of common stock repurchases as compared to prior period cash used for the $3.5 million repurchase of common stock and the repayment of loans related to executive and director life insurance policies.
Foreign Operations
Historically, our primary foreign operations have been conducted through our Canadian and United Kingdom (“U.K.”) subsidiaries. Effective November 1, 2004, we transitioned our European business to Chattem Global Consumer Products Limited, a wholly-owned subsidiary located in Limerick, Ireland. The functional currencies of these subsidiaries are Canadian dollars and Euros, 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 three months ended February 28, 2006 and 2005, these subsidiaries accounted for 6% and 7% of total revenues, respectively, and 3% and 4% of total assets, respectively. It has not been our practice to hedge our assets and liabilities in Canada, the U.K. and Ireland or our intercompany transactions due to the inherent risks associated with foreign currency hedging transactions and the timing of payments between us and our foreign subsidiaries. Following our acquisition of Selsun Blue, which is sold in approximately 70 foreign countries, our international business operations have expanded significantly, which will increase our exposure to fluctuations in foreign exchange rates. During fiscal 2005, a portion of these foreign sales was reflected as royalties, which have been paid to us in U.S. dollars. In addition, until July 2005 Abbott Laboratories (“Abbott”), from whom we acquired Selsun Blue, continued to supply a portion of our international product and billed us in U. S. dollars in certain instances. Beginning April 1, 2004, a portion of our international supply of Selsun was billed to us in local currencies. Historically, gains or losses from foreign currency transactions have not had a material impact on our operating results. Losses of $800 and $10,000 for the three months ended February 28, 2006 and 2005, respectively, resulted from foreign currency transactions and are included in selling, general and administrative expenses in the Condensed Consolidated Statements of Income.
Recent Accounting Pronouncements
In December 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN 46R”), which supersedes Interpretation No. 46, “Consolidation of Variable Interest Entities” issued in January 2003. FIN 46R 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 46R 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 46R applies immediately to a VIE created or acquired after January 31, 2003. For a VIE created before February 1, 2003, FIN 46R applies in the first fiscal year or interim period beginning after March 15, 2004, our third fiscal quarter beginning June 1, 2004. Application of FIN 46R is also required in financial statements that have interests in structures that are commonly referred to as special-purpose entities for periods ending after December 15, 2003. The adoption of FIN 46R did not have a material impact on our financial position, results of operations or cash flows.
In November 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 151, “Inventory Costs” (“SFAS 151”). SFAS 151 amends the guidance in Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing”, to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage) should be recognized as current-period charges and requires the allocation of fixed production overheads to inventory based on normal capacity of the production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS 151 on December 1, 2005 did not have an impact on our financial position, results of operations or cash flows.
In November 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” in Determining Whether to Report Discontinued Operations” (“EITF 03-13”). Under the consensus, the approach for assessing whether cash flows of the component have been eliminated from the ongoing operations of the entity focuses on whether continuing cash flows are direct or indirect cash flows. Cash flows of the component would not be eliminated if the continuing cash flows to the entity are considered direct cash flows. The consensus should be applied to a component of an enterprise that is either disposed of or classified as held for sale in fiscal periods beginning after December 15, 2004. The adoption of EITF 03-13 on December 1, 2005 did not have an impact on our financial position, results of operations or cash flows.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”. SFAS 123R supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and amends SFAS No. 95, “Statement of Cash Flows”. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions and requires all share-based payments to employees, including grants of employee stock options, to be recognized as additional compensation expense in the financial statements based on the calculated fair value of the awards. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation costs to be reported as a financing cash flow. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. We adopted this statement effective for our fiscal year beginning December 1, 2005. We have described the impact of adopting SFAS 123R in our condensed consolidated financial statements in Note 5, Stock-Based Compensation.
In December 2004, the FASB issued SFAS 153, “Exchanges of Nonmonetary Assets” (“SFAS 153”). SFAS 153 amends the guidance in APB Opinion No. 29, “Accounting for Nonmonetary Transactions” to eliminate certain exceptions to the principle that exchanges of nonmonetary assets be measured based on the fair value of the assets exchanged. SFAS 153 eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. This statement is effective for nonmonetary asset exchanges in fiscal years beginning after June 15, 2005. The adoption of SFAS 153 on December 1, 2005 did not have an impact on our financial position, results of operations or cash flows.
The American Jobs Creation Act of 2004 (the “AJCA”) was enacted on October 22, 2004. The AJCA repeals an export incentive, creates a new deduction for qualified domestic manufacturing activities and includes a special one-time deduction of 85% of certain foreign earnings repatriated to the U.S.
In December 2004, the FASB issued FASB Staff Position No. 109-1, “Application of FASB Statement No. 109 (SFAS 109), Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (FSP 109-1). FSP 109-1 clarifies that the manufacturer’s deduction provided for under the American Jobs Creation Act of 2004 (AJCA) should be accounted for as a special deduction in accordance with SFAS 109 and not as a tax rate reduction. In accordance with FSP 109-1, we treat the deduction for qualified domestic manufacturing activities, which became effective beginning December 1, 2005, as a reduction of the income tax provision in future years when realized.
The FASB also issued FASB Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 (FSP 109-2). The AJCA introduces a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. FSP 109-2 provides accounting and disclosure guidance for the repatriation provision. We have described the impact of FSP 109-2 in our condensed consolidated financial statements in Note 16, Income Taxes.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” or (“SFAS No. 154.”) SFAS No. 154 replaces APB No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements” and establishes retrospective application as the required method for reporting a change in accounting principle. The reporting of a correction of an error by restating previously issued financial statements is also addressed. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 is not expected to have an impact on our financial position, results of operations or cash flows.
In October 2005, the FASB issued FASB Staff Position (“FSP”) 123R-2, “Practical Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123(R) (“FSP 123R-2”)”. FSP 123R-2 provides companies with a “practical accommodation” when determining the grant date of an award that is subject to the accounting provisions in SFAS 123R. Specifically, assuming a company meets all of the other criteria in the definition of grant date in SFAS 123R, a mutual understanding (between the company and the recipient) of the key terms and conditions of an award is presumed to exist at the date the award is approved (in accordance with the company’s normal corporate governance policy) if (1) the award is unilateral grant meaning that the recipient does not have the ability to negotiate the key terms and conditions of the award, and (2) the key terms and conditions of the award are expected to be communicated to the recipient within a relatively short period of time (as defined in the FSP 123R-2) after the grant was approved. This FSP was effective upon initial adoption of SFAS 123R on December 1, 2005.
In November 2005, the FASB issued FSP 123R-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” (“FSP 123R-3”). FSP 123R-3 provides a practical exception when a company transitions to the accounting requirements in SFAS 123R. SFAS 123R requires a company to calculate the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to adopting SFAS 123R (“APIC Pool”), assuming the company had been following the recognition provisions prescribed by SFAS 123. The FASB learned that several companies do not have the necessary historical information to calculate the APIC pool as envisioned by SFAS 123R and accordingly, the FASB decided to allow a practical exception as documented in FSP 123R-3. This FSP was effective on its issuance date.
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 or be made orally in publicly accessible conferences or conference calls. 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, the lack of availability, limits of coverage and expense related to product liability insurance, the reduction of available insurance coverage as proceeds are used to fund any product liability settlements or awards; the possibility of other product liability claims, including claims relating to the prior existence of ephedrine in Dexatrim products or arising from the FDA’s rule banning the sale of dietary supplements containing ephedrine; 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 divestures; the impact of gains or losses resulting from product acquisitions or divestures; 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 internationally where we have only limited experience and infrastructure; constraints resulting from our financial condition, including the degree to which we are leveraged, debt service requirements and restrictions under indentures and loan agreements; government regulations; risks of loss of material customers; public perception regarding our products; dependence on third party manufacturers; environmental matters; and other risks described in our Securities and Exchange Commission filings.
Item 3. Quantitative and Qualitative Disclosures About Market Risks
We are exposed to market risk 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 risk currently consists of our Amended Revolving Credit Facility. Loans under our Amended Revolving Credit Facility bear interest at LIBOR plus applicable percentages of 1.00% to 2.00% or a base rate (the higher of the federal funds rate plus 0.5% or the prime rate) plus applicable percentages of 0.0% to 0.5%. The applicable percentages are calculated based on our leverage ratio. As of February 28, 2006, $43,000 was outstanding under the Amended Revolving Credit Facility, and the variable rate on the Amended Revolving Credit Facility was LIBOR plus 1.25%, or 5.93%. The 7.0% Subordinated Notes are fixed interest rate obligations. On March 8, 2004, we entered into an interest rate cap agreement effective June 1, 2004 with decreasing annual notional principal amounts of $15.0 million beginning March 1, 2006 and cap rates ranging from 4.0% to 5.0% over the life of the agreement. The amortized value of the premium on the interest rate cap was compared to its fair value as of February 28, 2006, and a gain of $98,000, net of tax, was recorded to other comprehensive income. The interest rate cap agreement terminates on March 1, 2010. The impact on our results of operations of a one-point rate change on the April 7, 2006 outstanding balance of $38.0 million of our Amended Revolving Credit Facility for the next twelve months would be approximately $0.3 million, net of tax.
We are subject to risk from changes in the foreign exchange rates relating to our Canadian, U.K. and Irish subsidiaries. Assets and liabilities of these subsidiaries are translated to U.S. 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 Condensed Consolidated Statements of Income. Until July 2005, Abbott continued to supply us with a portion of our international supply of Selsun and billed us in U.S. dollars in certain instances. Beginning April 1, 2004, a portion of our international supply of Selsun was billed to us in local currencies. The potential loss resulting from a hypothetical 10.0% adverse change in the quoted foreign currency exchange rate amounts to approximately $0.4 million as of February 28, 2006.
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
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures (as such terms are defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of February 28, 2006 (the “Evaluation Date”). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in alerting them on a timely basis to material information relating to us (including our consolidated subsidiaries) required to be included in our reports filed or submitted under the Exchange Act. During the quarter ended February 28, 2006, we implemented a quarterly inventory control process that management believes will ensure that inventory balances will include the appropriate amounts of overhead costs each quarter. Except for this change, there has been no change in our internal control over financial reporting during the quarter ended February 28, 2006 that has materially affected, or is reasonably likely to materially affect, such internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See Note 18 of Notes to Condensed Consolidated Financial Statements included in Part 1, Item 1 of this Report.
Item 1A. Risk Factors
There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended November 30, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
A summary of the common stock repurchase activity for our first quarter of fiscal 2006 is as follows:
Period | | Total Number of Shares Purchased | | Average Price Paid Per Share (1) | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2) | | Approximate Dollar Value that may yet be Purchased under the Plans or Programs (2) | |
| | | | | | | | | | |
| December 1- December 31 | | | | | $ | | | | | | | 30,000,000 | |
| January 1 - January 31 | | | — | | | | | | | | | 30,000,000 | |
| February 1 - February 28 | | | 275,000 | | | 36.84 | | | 275,000 | | | 19,869,517 | |
| Total First Quarter | | | 275,000 | | $ | 36.84 | | | 275,000 | | | 19,869,517 | |
| | | | | | | | | | | | | | |
| (1) | Average price paid per share includes broker commissions. |
| (2) | In January 2005, our board of directors increased the total authorization to repurchase our common stock under our stock buyback program to $30.0 million. A total of $17.3 million remained available under the stock buyback authority prior to July 29, 2005, when our board of directors increased the total buyback authorization back to $30.0 million. Subsequent to share purchases made in the fourth quarter of fiscal 2005, our board of directors again increased the total buyback authorization back to $30.0 million, effective November 29, 2005. There is no expiration date specified for our stock buyback program. |
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
Exhibits (numbered in accordance with Item 601 of Regulation S-K):
| | Exhibit Number | | Description |
| | | | |
| | 31.1 | | Certification required by Rule 13a-14(a) under the Securities Exchange Act of 1934 |
| | 31.2 | | 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 |
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: April 10, 2006 | | /s/ Zan Guerry |
| |
Zan Guerry |
| | Chairman and Chief Executive Officer |
| | | |
| | CHATTEM, INC. (Registrant) |
|
|
|
| Dated: April 10, 2006 | | /s/ Robert E. Bosworth |
| |
Robert E. Bosworth |
| | President and Chief Operating Officer |
Chattem, Inc. and Subsidiaries
Exhibit Index
| | Exhibit Number | | Description of Exhibit |
| | | | |
| | 31.1 | | Certification required by Rule 13a-14(a) under the Securities Exchange Act of 1934 |
| | 31.2 | | 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 |
