United States
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended July 31, 2007
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-20424
Hi-Tech Pharmacal Co., Inc.
(Exact name of registrant as specified in its charter)
| | |
| Delaware | | 11-2638720 |
(State or other jurisdiction of incorporation or organization) | | (IRS Employer Identification No.) |
369 Bayview Avenue, Amityville, New York 11701
(Address of principal executive offices) (zip code)
631 789-8228
(Registrant’s telephone number including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act 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 x 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 ¨ Accelerated filer x 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 x
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act subsequent to the distribution of securities under a plan confirmed by a court. Yes ¨ No ¨
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:
Common Stock, $.01 Par Value—11,376,000 shares outstanding as of September 7, 2007
INDEX
HI-TECH PHARMACAL CO., INC.
2
PART I.ITEM 1.
HI-TECH PHARMACAL CO., INC.
CONDENSED BALANCE SHEETS
| | | | | | | | |
| | | July 31, 2007 | | | April 30, 2007 | |
| | | (unaudited) | | | | |
ASSETS | | | | | | | | |
CURRENT ASSETS | | | | | | | | |
Cash and cash equivalents | | $ | 6,189,000 | | | $ | 9,198,000 | |
Investments in marketable securities – available for sale | | | 24,245,000 | | | | 24,070,000 | |
Accounts receivable—net | | | 4,911,000 | | | | 9,331,000 | |
Inventory | | | 17,027,000 | | | | 14,485,000 | |
Prepaid taxes | | | 4,200,000 | | | | 2,772,000 | |
Deferred income taxes | | | 3,461,000 | | | | 3,226,000 | |
Other current assets | | | 3,299,000 | | | | 3,961,000 | |
| | | | | | | | |
TOTAL CURRENT ASSETS | | $ | 63,332,000 | | | $ | 67,043,000 | |
Property, plant and equipment—net | | | 16,597,000 | | | | 16,597,000 | |
Other assets | | | 431,000 | | | | 420,000 | |
Intangible assets - net | | | 5,958,000 | | | | 6,093,000 | |
Investment in Neuro-Hitech | | | 5,554,000 | | | | 7,589,000 | |
| | | | | | | | |
TOTAL ASSETS | | $ | 91,872,000 | | | $ | 97,742,000 | |
| | | | | | | | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | |
CURRENT LIABILITIES | | | | | | | | |
Accounts payable | | $ | 4,699,000 | | | $ | 3,237,000 | |
Accrued expenses | | | 5,416,000 | | | | 8,266,000 | |
| | | | | | | | |
TOTAL CURRENT LIABILITIES | | $ | 10,115,000 | | | $ | 11,503,000 | |
Deferred income taxes | | | 2,552,000 | | | | 3,254,000 | |
| | | | | | | | |
TOTAL LIABILITIES | | $ | 12,667,000 | | | $ | 14,757,000 | |
| | | | | | | | |
STOCKHOLDERS’ EQUITY | | | | | | | | |
Preferred stock, par value $.01 per share; authorized 3,000,000 shares, none issued | | | | | | | | |
Common stock, par value $.01 per share; authorized 50,000,000 shares, issued 13,424,000 at July 31, 2007 and April 30, 2007 | | | 134,000 | | | | 134,000 | |
Additional paid-in capital | | | 51,541,000 | | | | 50,783,000 | |
Retained earnings | | | 43,707,000 | | | | 46,585,000 | |
Accumulated other comprehensive income, net of tax | | | 3,540,000 | | | | 4,873,000 | |
Treasury stock, 2,030,000 shares of common stock, at cost on July 31, 2007 and 1,997,000 on April 30, 2007 | | | (19,717,000 | ) | | | (19,390,000 | ) |
| | | | | | | | |
TOTAL STOCKHOLDERS’ EQUITY | | $ | 79,205,000 | | | $ | 82,985,000 | |
| | | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | $ | 91,872,000 | | | $ | 97,742,000 | |
| | | | | | | | |
See notes to condensed financial statements
3
HI-TECH PHARMACAL CO., INC.
CONDENSED STATEMENTS OF OPERATIONS (unaudited)
| | | | | | | | |
| | | Three months ended July 31, | |
| | | 2007 | | | 2006 | |
NET SALES | | $ | 10,098,000 | | | $ | 11,318,000 | |
Cost of goods sold | | | 8,033,000 | | | | 7,161,000 | |
| | | | | | | | |
GROSS PROFIT | | | 2,065,000 | | | | 4,157,000 | |
| | | | | | | | |
Selling, general and administrative expenses | | | 5,618,000 | | | | 5,394,000 | |
Research and product development costs | | | 1,324,000 | | | | 1,289,000 | |
Interest expense | | | 4,000 | | | | 3,000 | |
Interest income and other | | | (340,000 | ) | | | (463,000 | ) |
| | | | | | | | |
TOTAL | | | 6,606,000 | | | | 6,223,000 | |
| | | | | | | | |
Loss before benefit from income taxes | | | (4,541,000 | ) | | | (2,066,000 | ) |
Benefit from income taxes | | | (1,663,000 | ) | | | (1,107,000 | ) |
| | | | | | | | |
NET LOSS | | $ | (2,878,000 | ) | | $ | (959,000 | ) |
| | | | | | | | |
BASIC AND DILUTED LOSS PER SHARE | | $ | (0.25 | ) | | $ | (0.08 | ) |
| | | | | | | | |
Weighted average common shares outstanding—basic and diluted | | | 11,424,000 | | | | 12,188,000 | |
| | | | | | | | |
See notes to condensed financial statements
4
HI-TECH PHARMACAL CO., INC.
CONDENSED STATEMENTS OF CASH FLOWS (unaudited)
| | | | | | | | |
| | | Three months ended July 31, | |
| | | 2007 | | | 2006 | |
NET CASH FLOWS (USED IN) PROVIDED BY OPERATING ACTIVITIES | | $ | (1,961,000 | ) | | $ | 4,968,000 | |
| | | | | | | | |
CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | |
Purchases of property, plant and equipment | | | (551,000 | ) | | | (288,000 | ) |
Purchase of marketable securities, net | | | (175,000 | ) | | | (8,800,000 | ) |
| | | | | | | | |
NET CASH (USED IN) INVESTING ACTIVITIES | | | (726,000 | ) | | | (9,088,000 | ) |
| | | | | | | | |
CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | |
Issuance of common stock and exercise of options | | | 5,000 | | | | 1,000 | |
Purchase of treasury stock | | | (327,000 | ) | | | — | |
| | | | | | | | |
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES | | | (322,000 | ) | | | 1,000 | |
| | | | | | | | |
NET DECREASE IN CASH AND CASH EQUIVALENTS | | | (3,009,000 | ) | | | (4,119,000 | ) |
Cash and cash equivalents at beginning of the period | | | 9,198,000 | | | | 18,512,000 | |
| | | | | | | | |
CASH AND CASH EQUIVALENTS AT END OF PERIOD | | | 6,189,000 | | | | 14,393,000 | |
| | | | | | | | |
Supplemental and non cash disclosures of cash flow information: | | | | | | | | |
Interest paid | | | 4,000 | | | | 3,000 | |
Income taxes paid | | | — | | | | — | |
See notes to condensed financial statements
5
HI-TECH PHARMACAL CO., INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
July 31, 2007
1. BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The preparation of the Company’s financial statements in conformity with generally accepted accounting principles necessarily requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenues and expense during the reporting periods. Actual results could differ from these estimates and assumptions. Operating results for the three month period ended July 31, 2007 are not necessarily indicative of the results that may be expected for the year ending April 30, 2008. For further information, refer to the financial statements and footnotes thereto for the year ended April 30, 2007 in the Company’s Annual Report on Form 10-K.
2. BUSINESS
Hi-Tech Pharmacal Co., Inc. (the “Company” or “Hi-Tech”) manufactures and sells prescription and over-the-counter generic and branded drugs, specializing in liquid and semi-solid dosage forms including higher margin prescription products. The Company markets its products in the United States through distributors, retail drug and mass-merchandise chains and mail order companies. Sales of the Company are seasonal and usually peak between September and March of each year, since a significant portion of the Company’s products are pharmaceutical preparations acting on the human respiratory system.
Net sales for generic pharmaceutical products, which include some private label contract manufacturing and limited branded prescription sales, for the three months ended July 31, 2007 were $8,027,000 compared to sales of $9,528,000 for the three months ended July 31, 2006. Sales of Sulfamethoxazole with Trimethoprim were approximately $1,000,000 for both periods.
The Health Care Products division, which markets the Company’s branded products, for the three months ended July 31, 2007 and 2006 had net sales of $2,071,000 and $1,790,000, respectively. Diabetic Tussin® accounted for net sales of approximately $1,000,000 for the three months ended July 31, 2007 and $800,000 for the three months ended July 31, 2006.
3. REVENUE RECOGNITION
Revenue is recognized for product sales upon shipment and passing of risk to the customer and when estimates of discounts, rebates, promotional adjustments, price adjustments, returns, chargebacks, and other potential adjustments are reasonably determinable, collection is reasonably assured and the Company has no further performance obligations. These estimates are presented in the financial statements as reductions to net revenues and accounts receivable. The Company has estimated sales returns, allowances and discounts. Contract research income is recognized as work is completed and as billable costs are incurred. In certain cases, contract research income is based on attainment of designated milestones. Advance payments may be received to fund certain development costs.
4. NET LOSS PER SHARE
Net loss per common share is computed based on the weighted average number of common shares outstanding for basic earnings per share and on the weighted average number of common shares and share equivalents (stock options) outstanding for diluted earnings per share. The weighted average number of shares outstanding used in the computation of basic and diluted net loss per share does not include the effect of potentially outstanding common stock because the effect would have been antidilutive. Such outstanding options totaled 2,652,000 shares at July 31, 2007 and 2,478,000 at July 31, 2006.
5. INVENTORY
The components of inventory consist of the following:
| | | | | | |
| | | July 31, 2007 | | April 30, 2007 |
Raw materials | | $ | 10,459,000 | | $ | 5,484,000 |
Finished products and work in process | | | 6,568,000 | | | 9,001,000 |
| | | | | | |
TOTAL INVENTORY | | $ | 17,027,000 | | $ | 14,485,000 |
| | | | | | |
6
6. PROPERTY AND EQUIPMENT
The components of net plant and equipment consist of the following:
| | | | | | | | |
| | | July 31, 2007 | | April 30, 2007 | | Useful Lives |
Land and Building | | $ | 12,701,000 | | $ | 12,534,000 | | 27.5 Yrs. |
Machinery and equipment | | | 19,381,000 | | | 19,040,000 | | 7 and 10 Yrs. |
Transportation equipment | | | 50,000 | | | 50,000 | | 7 Yrs. |
Computer equipment | | | 2,381,000 | | | 2,352,000 | | 3 and 7 Yrs. |
Furniture and fixtures | | | 1,040,000 | | | 1,026,000 | | 7 Yrs. |
| | | | | | | | |
| | $ | 35,553,000 | | $ | 35,002,000 | | |
Accumulated depreciation and amortization | | | 18,956,000 | | | 18,405,000 | | |
| | | | | | | | |
TOTAL PROPERTY AND EQUIPMENT | | $ | 16,597,000 | | $ | 16,597,000 | | |
| | | | | | | | |
7. INTANGIBLE ASSETS
The components of net intangible assets are as follows:
| | | | | | | | |
| | | July 31, 2007 | | April 30, 2007 | | Amortization Period |
Zostrix® intangible assets, net | | $ | 4,137,000 | | | 4,260,000 | | 3-11.5 years |
Tanafed® license agreement, net | | | 421,000 | | | 433,000 | | 10 years |
Choice DM® trademark, net | | | 400,000 | | | 400,000 | | 10 years |
Capsaisin and Lidocaine patented formula | | | 300,000 | | | 300,000 | | 10 years |
Vosol® and Vosol® HC intangible assets | | | 700,000 | | | 700,000 | | 10 years |
| | | | | | | | |
TOTAL INTANGIBLE ASSETS | | $ | 5,958,000 | | $ | 6,093,000 | | |
| | | | | | | | |
Intangible assets are stated at cost and amortized using the straight line method over the expected useful lives of the product rights. Amortization expense of the intangible assets for the three months ended July 31, 2007 and 2006 was $135,000 and $200,000, respectively. Amortization is included in selling, general and administrative expenses for all periods presented. Accumulated amortization was $996,000 and $861,000 at July 31, 2007 and April 30, 2007, respectively. The Company tests for impairment of intangible assets when events or circumstances indicate that the carrying value of the assets may not be recoverable.
7
8. COMMON STOCK
The Company’s Board of Directors, over several years, has authorized the repurchase of $23,000,000 of the Company’s common stock. Pursuant to the terms of a Rule 10b5-1 stock repurchase plan, the repurchases of the Company’s common stock may be made from time to time in the open market or in private transactions as market conditions dictate. To date the Company has purchased 2,030,000 shares for $19,717,000. During the three months ended July 31, 2007, the Company repurchased 33,000 shares of the Company’s common stock for $327,000.
9. FREIGHT EXPENSE
Freight costs are included in selling, general, and administrative expense.
10. STOCK-BASED COMPENSATION:
Effective May 1, 2006, the Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payments,” which establishes the accounting for employee stock-based awards. Under the provisions of SFAS No. 123(R), stock-based compensation is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the requisite employee service period (generally the vesting period of the grant).
The Company recognized stock-based compensation for awards issued under the Company’s Stock Option Plans and Employee Stock Purchase Plan in the following line items in the Consolidated Statement of Operations:
| | | | | | |
| | | Three months ended July 31, 2007 | | Three months ended July 31, 2006 |
Cost of sales | | $ | 153,000 | | $ | 145,000 |
Selling, general and administrative expenses | | | 543,000 | | | 486,000 |
Research and development expenses | | | 57,000 | | | 55,000 |
| | | | | | |
Stock-based compensation expense | | $ | 753,000 | | $ | 686,000 |
| | | | | | |
Stock-based compensation expense resulted in an increase of $0.07 and $0.04, respectively, in basic and diluted loss per share for the three months ended July 31, 2007 and July 31, 2006 as a result of the adoption of SFAS 123(R).
SFAS No. 123 (R) requires the use of a valuation model to calculate the fair value of stock-based awards. The Company has elected to use the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rate. The expected volatility is based on the historical volatility of the Company’s common stock. The interest rates for periods within the contractual life of the award are based on the U.S. Treasury yield on the date of each option grant.
During the three month periods ended July 31, 2007 and 2006, the Company did not grant any options.
All options granted through July 31, 2007 had exercise prices equal to the fair market value of the stock on the date of grant, a contractual term of ten years and generally a vesting period of four years. In accordance with SFAS No. 123(R), the Company adjusts share-based compensation on a quarterly basis for changes to the estimate of expected equity award forfeitures based on actual forfeiture experience. The effect of adjusting the forfeiture rate for all expense amortization after May 1, 2007 is recognized in the period the forfeiture estimate is changed. As of July 31, 2007, the weighted average forfeiture rate was 8% and the effect of forfeiture adjustments in the first quarter of 2007 was insignificant.
The actual income tax benefit recorded relating to the exercise of stock option awards was $0 for the three months ended July 31, 2007.
The intrinsic value of options exercised for the 1992 Stock Option Plan and the 1994 Stock Option Plan was $2,000 for both three-month periods ended July 31, 2007 and July 31, 2006. As of July 31, 2007, $7,518,000 of total unrecognized compensation cost related to stock options for both plans is expected to be recognized over a weighted average period of 2.2 years.
11. INCOME TAXES
On May 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109,(“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 requires that the Company determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of
8
being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. Upon the adoption of FIN 48, the Company analyzed filing positions in all of the federal and state jurisdictions where the Company is required to file income tax returns, as well as all open tax years in these jurisdictions. In connection with the adoption of FIN 48, the Company has elected an accounting policy to classify interest and penalties related to unrecognized tax benefits as interest expense. No adjustment was necessary as a result of the implementation of FIN 48.
12. CONTINGENCIES AND OTHER MATTERS
[1]Government regulation:
The Company’s products and facilities are subject to regulation by a number of Federal and State governmental agencies. The Food and Drug Administration (“FDA”), in particular, maintains oversight of the formulation, manufacture, distribution, packaging and labeling of all of the Company’s products.
[2]Legal Proceedings:
On January 30, 2007, Michael Chittenden and Marcy L. Chittenden filed a complaint against Arnold H. Zukow, M.D. et al and the Company, Case No. BC346212, in the Los Angeles Superior Court in the state of California, alleging wrongful death of the defendant’s daughter as a result of her being negligently and improperly treated and prescribed the prescription drug, Phenergan (Promethazine HCI) with Phenylepherine and codeine, which the Company does not manufacture. The Company’s defense costs, after its deductible, are being covered under its product liability policy which has a $10 million limit for defense costs and liability. The Company filed an answer to the complaint on February 28, 2007. The Company believes it has meritorious defenses to the allegations in the Complaint. The Company has filed a motion for summary judgment on the grounds that its medication was not administered to the child. The motion will be heard on October 11, 2007. The Company has also filed a separate motion for summary adjudication on the grounds that the failure to warn claims are preempted by federal law. This motion will be heard in November 2007.
On January 18, 2006, Merck & Co., Inc. filed complaints against the Company in the United States District Court for the District of New Jersey, alleging infringement of Merck’s U.S. Patent No. 4,797,413, based on the Company’s submission to the FDA of ANDAs Nos. 77-846 and 77-847 to obtain approval for generic versions of Merck’s TRUSOPT® and COSOPT® products, which are used for the treatment of elevated intraocular pressure in patients with ocular hypertension or open-angle glaucoma. Merck sought a permanent injunction against the Company to prevent its manufacture and sale of its generic version of Merck’s products until April 28, 2008, which Merck contended was the date on which its patent will expire. The Company filed answers to the complaints on March 1, 2006, and a motion to dismiss, contending that, due to Merck’s filing of a terminal disclaimer, its patent was not enforceable after December 12, 2004. Merck filed a cross-motion for judgment on the pleadings. On April 25, 2006, the court granted Merck’s motion and entered a judgment enjoining the Company’s commercial manufacture, use, offer to sell, or sale within the United States, or importation into the United States, of products covered by Merck’s patent, until April 28, 2008. On May 1, 2006, the Company filed an appeal from that judgment to the U.S. Court of Appeals for the Federal Circuit. On March 27, 2007 the Court ruled in favor of Merck. The Company filed a petition for a rehearing which was denied in June 2007. Legal costs in connection with the appeal are being paid for by a business partner. The Company has no obligation to repay or otherwise issue any credit to such partner for such legal costs.
On November 24, 2003, MedPointe Healthcare, Inc. (“MedPointe”) filed a complaint against the Company in the United States District Court for the District of New Jersey, alleging willful infringement by the Company of MedPointe’s United States Patent No. 6,417,206, based on the Company’s offer to sell its Tannate 12-DS product, as a generic equivalent to MedPointe’s Tussi-12® DS. MedPointe brought a motion for preliminary injunction against the sale of Tannate 12-DS in November 2003. The district court granted that motion in March 2004, but the United States Court of Appeals for the Federal Circuit vacated that ruling in November 2004, finding that MedPointe had not demonstrated a likelihood of success on the merits of its case. Following the Federal Circuit’s ruling, Hi-Tech began selling Tannate 12 DS.
The Company filed, in May 2000, a counterclaim and third-party complaint against Jame Fine Chemicals, Inc., D/B/A JFC Technologies, Inc. and MedPointe in the United States District Court for the District of New Jersey in which it has asserted various claims, including claims of breach of contract, breach of the covenant of good faith and fair dealing, tortious interference with current and prospective contractual relations and for violation of Section 1 of the Sherman Antitrust Act. On May 29, 2007 the Company entered into a settlement and release agreement regarding the claims brought by MedPointe. This agreement also resolves the various claims brought by Hi-Tech against MedPointe and Jame Fine Chemicals, Inc. Under the terms of the settlement and release agreement, Hi-Tech immediately ceased distribution of its generic version of Tussi-12® DS and paid MedPointe $2.5 million and MedPointe transferred to Hi-Tech its Vosol® and Vosol® HC brands, and the related New Drug Applications. The Company allocated $700,000 to the value of the trademarks for Vosol® and Vosol® HC brands which is included in intangible assets on the balance sheet.
9
From time to time, the Company becomes involved in various legal matters in addition to the above described matters that the Company considers to be in the ordinary course of business. While the Company is not presently able to determine the potential liability, if any, related to such matters, the Company believes none of such matters, individually or in the aggregate, will have a material adverse effect on its financial position.
| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
This Report on Form 10-Q and certain information incorporated herein by reference contain forward-looking statements which are not historical facts made pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not promises or guarantees and investors are cautioned that all forward looking statements involve risks and uncertainties, including but not limited to the impact of competitive products and pricing, product demand and market acceptance, new product development, the regulatory environment, including without limitation, reliance on key strategic alliances, availability of raw materials, fluctuations in operating results and other risks detailed from time to time in the Company’s filings with the Securities and Exchange Commission. These statements are based on management’s current expectations and are naturally subject to uncertainty and changes in circumstances. We caution you not to place undue reliance upon any such forward-looking statements which speak only as of the date made. Hi-Tech is under no obligation to, and expressly disclaims any such obligation to, update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JULY 31, 2007 COMPARED TO THREE MONTHS ENDED JULY 31, 2006
Net sales for the three months ended July 31, 2007 were $10,098,000, a decrease of $1,220,000 or 11% as compared to the net sales of $11,318,000 for the three months ended July 31, 2006.
Net sales for generic pharmaceutical products, which include some private label contract manufacturing and sales of prescription brands, for the three months ended July 31, 2007 were $8,027,000, a decrease of $1,501,000 or 16%, compared to the fiscal 2006 respective period sales of $9,528,000. The decrease is due to lower unit sales of branded and generic prescription cough and flu products including Tanafed DMX®, the discontinuation of tannate 12 DS as part of a legal settlement and lower pricing on many generic products. Branded prescription products are no longer broken out separately since, with the sale of Naprelan® to Victory, they now constitute a small percentage of our business. Sales of Sulfamethoxazole with Trimethoprim were approximately $1,000,000 for both periods.
The Health Care Products division, which markets the Company’s branded products, for the three months ended July 31, 2007 and 2006, had net sales of $2,071,000 and $1,790,000, respectively, an increase of $281,000 or 16%. This increase is the result of an increase in sales of products for diabetics. Diabetic Tussin® accounted for net sales of approximately $1,000,000 for the three months ended July 31, 2007 and $800,000 for the three months ended July 31, 2006.
During the quarter ended July 31, 2007 the Company did not have any customers with over 10% of the Company’s total sales.
Cost of sales increased to $ 8,033,000 from $7,161,000, or to 80% from 63% as a percentage of sales in the three months ended July 31, 2007 and July 31, 2006, respectively. The increase in cost of sales as a percentage of net sales is due to decreased unit sales of higher margin products including Tanafed DMX®, increased unit sales of lower margin products and pricing pressure which lowered margins on several products.
Research and product development costs for the three months ended July 31, 2007 increased to $1,324,000, or 13% of net sales compared to $1,289,000 or 11% of net sales for the same period ended July 31, 2006. The increase is primarily due to increased costs on externally developed projects.
Selling, general and administrative expense increased to $5,618,000 from $5,394,000. This was primarily the result of increased promotional efforts in our Health Care Products division.
For the three months ended July 31, 2007 the Company experienced a net loss of $2,878,000 compared to net loss of $959,000 in 2006. The overall change is primarily due to the factors noted above. The Company incurred a loss of $0.25 per share for the three months ended July 31, 2007 compared to a loss of $0.08 per share for the three months ended July 31, 2006.
10
LIQUIDITY AND CAPITAL RESOURCES
The Company’s operations are historically financed principally by cash flow from operations. At July 31, 2007 and April 30, 2007, working capital was approximately $53,217,000 and $55,540,000, respectively, a decrease of $2,323,000 during the three months ended July 31, 2007.
Cash flows used in operating activities were approximately $1,961,000 which is primarily due to the loss for the quarter. A significant portion of the increase in inventory is due to increases in components, raw materials and finished product for a planned launch of fluticusone propionate upon FDA approval. Cash flows used in investing activities were approximately $726,000 and were principally purchases of fixed assets.
In May 2006 the Company entered into a three year $10,000,000 revolving credit facility. The revolving credit facility bears interest at a rate elected by the Company equal to the Prime Rate or the LIBOR plus 0.75%. Loans are collateralized by inventory, accounts receivable and other assets. The agreement contains covenants with respect to working capital, net worth and certain ratios, as well as other covenants and prohibits the payment of cash dividends. As of July 31, 2007 the Company has not borrowed against this facility and the lender has waived our compliance with certain covenants.
The Company believes that its financial resources consisting of current working capital and anticipated future operating revenue will be sufficient to enable it to meet its working capital requirements for at least the next 12 months.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2007, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue No. 07-3, Accounting for Advance Payments for Goods or Services Received for Use in Future Research and Development Activities (“Issue 07-3”), which is effective January 1, 2008 and is applied prospectively for new contracts entered into on or after the effective date. Issue 07-3 addresses nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities. Issue 07-3 will require these payments be deferred and capitalized and recognized as an expense as the related goods are delivered or the related services are performed. The Company is assessing the effects of adoption of Issue 07-3 on its financial position and results of operations.
In February 2007, the FASB issued SFAS No. 159 (“SFAS 159”), “The Fair Value Option for Financial Assets and Financial Liabilities,” providing companies with an option to report selected financial assets and liabilities at fair value. The Standard’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. Generally accepted accounting principles have required different measurement attributes for different assets and liabilities that can create artificial volatility in earnings. SFAS 159 helps to mitigate this type of accounting-induced volatility by enabling companies to report related assets and liabilities at fair value, which would likely reduce the need for companies to comply with detailed rules for hedge accounting. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The Standard requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the Company’s choice to use fair value on its earnings. It also requires entities to display the fair value of those assets and liabilities for which they have chosen to use fair value on the face of the balance sheet. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of adopting SFAS 159 on our financial statements.
In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. Where applicable, SFAS No. 157 simplifies and codifies related guidance within GAAP and does not require any new fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier adoption is encouraged. The Company does not expect the adoption of SFAS No. 157 to have a significant effect on its financial position or results of operation.
SEASONALITY
Historically, the months of September through March account for a greater portion of the Company’s sales than the other months of the fiscal year. However, this sales pattern can vary significantly depending on the cough, cold and flu season. Accordingly, period-to-period comparisons within the same fiscal year are not necessarily meaningful and should not be relied on as indicative of future results.
CRITICAL ACCOUNTING POLICIES
In preparing financial statements in conformity with generally accepted accounting principles in the United States of America, we are required to make estimates and assumptions that affect reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses for the reporting period covered thereby. As a result, these estimates are subject to an inherent degree of uncertainty. We base our estimates and judgments on our historical experience, the terms of existing contracts, our observance of trends in the industry, information that we obtain from our customers and outside sources, and on various assumptions that we believe to be reasonable and appropriate under the circumstances, the results of which form the basis for making judgments which impact our reported operating results and the carrying values of assets and liabilities. These assumptions include but are not limited to the percentage of new products which may have chargebacks and the percentage of items which will be subject to price decreases. Actual results may differ from these estimates.
Revenue recognition and accounts receivable, adjustments for returns and price adjustments, allowance for doubtful accounts and carrying value of inventory represent significant estimates made by management.
Revenue Recognition and Accounts Receivable: Revenue is recognized for product sales upon shipment and when risk is passed to the customer and when estimates of discounts, rebates, promotional adjustments, price adjustments, returns, chargebacks, and other potential adjustments are reasonably determinable, collection is reasonably assured and the Company has no further performance obligations. These estimates are presented in the financial statements as reductions to net revenues and accounts receivable. Estimated sales returns, allowances and discounts are provided for in determining net sales. Contract research income is recognized as work is completed and billable costs are incurred. In certain cases, contract research income is based on attainment of designated milestones.
11
Adjustments for Returns and Price Adjustments: Our product revenues are typically subject to agreements with customers allowing chargebacks, rebates, rights of return, pricing adjustments and other allowances. Based on our agreements and contracts with our customers, we calculate adjustments for these items when we recognize revenue and we book the adjustments against accounts receivable and revenue. Chargebacks, primarily from wholesalers, are the most significant of these items. Chargebacks result from arrangements we have with retail customers establishing prices for products for which the end user independently selects a wholesaler from which to purchase. A chargeback represents the difference between our invoice price to the wholesaler, which is typically stated at wholesale acquisition cost, and the end customer’s contract price, which is lower. We credit the wholesaler for purchases by end customers at the lower price. Therefore, we record these chargebacks at the time we recognize revenue in connection with our sales to wholesalers.
The reserve for chargebacks is computed by analyzing the number of units sold for the past twenty-four months and the number of units sold through to retailers. The difference represents the inventory which could potentially have chargebacks due to wholesalers. This inventory is multiplied by the historical percentage of units that are charged back and by the price adjustment per unit to arrive at the chargeback accrual. This calculation is performed by product by customer. The Company currently obtains wholesaler inventory data for the wholesalers which represent over 95% of our chargeback activity. This data is used to verify the information calculated in the chargeback accrual.
The calculated amount of chargebacks could be affected by other factors such as:
| | • | | A change in retail customer mix |
| | • | | A change in negotiated terms with retailers |
| | • | | Product sales mix at the wholesaler |
| | • | | Retail inventory levels |
| | • | | Changes in Wholesale Acquisition Cost (WAC) |
The Company continually monitors the chargeback activity and adjusts the provisions for chargebacks when we believe that the actual chargebacks will differ from our original provisions.
Consistent with industry practice, the Company maintains a return policy that allows our customers to return product within a specified period. The Company’s estimate for returns is based upon its historical experience with actual returns. While such experience has allowed for reasonable estimation in the past, history may not always be an accurate indicator of future returns. The Company continually monitors its estimates for returns and makes adjustments when it believes that actual product returns may differ from the established accruals.
Included in the adjustment for sales allowances and returns is a reserve for credits taken by our customers for rebates, return authorizations and other.
Sales discounts are granted for prompt payment. The reserve for sales discounts is based on invoices outstanding and assumes that 100% of available discounts will be taken.
Price adjustments, including shelf stock adjustments, are credits issued from time to time to reflect decreases in the selling prices of our products which our customer has remaining in its inventory at the time of the price reduction. Decreases in our selling prices are discretionary decisions made by us to reflect market conditions. Amounts recorded for estimated price adjustments are based upon specified terms with direct customers, estimated launch dates of competing products, estimated declines in market price and inventory held by the customer. The Company analyzes this on a case by case basis and makes adjustments to reserves as necessary.
The Company adequately reserves for chargebacks, discounts, allowances and returns in the period in which the sales takes place. No material amounts included in the provision for chargebacks and the provision for sales discounts recorded in the current period relate to sales made in the prior periods. The current provision for sales allowances and returns includes reserves for items sold in the current period, while the ending balance includes reserves for items sold in the current and prior periods. The Company has substantially and consistently used the same estimating methods. We have refined the methods as new data became available. There have been no material differences between the estimates applied and actual results.
The Company determines amounts that are material to the financial statements in consideration of all relevant circumstances including quantitative and qualitative factors. Among the items considered is the impact on individual financial statement classification, operating income and footnote disclosures and the degree of precision that is attainable in estimating judgmental items.
12
The following table presents the roll forward of each significant estimate as of July 31, 2007 and July 31, 2006 and for the three months then ended, respectively.
| | | | | | | | |
For the three months ended July 31, 2007 | | Beginning Balance May 1 | | Current Provision | | Actual Credits in Current Period | | Ending Balance July 31 |
Chargebacks | | $3,509,000 | | $5,612,000 | | $5,561,000 | | $3,560,000 |
Sales Discounts | | 257,000 | | 378,000 | | 429,000 | | 206,000 |
Sales Allowances & Returns | | 5,520,000 | | 1,798,000 | | 2,004,000 | | 5,314,000 |
| | | | | | | | |
Total Adjustment for Returns & Price Allowances | | $9,286,000 | | $7,788,000 | | $7,994,000 | | $9,080,000 |
| | | | | | | | |
| | | | |
For the three months ended July 31, 2006 | | | | | | | | |
Chargebacks | | $3,359,000 | | $3,981,000 | | $4,621,000 | | $2,719,000 |
Sales Discounts | | 303,000 | | 400,000 | | 474,000 | | 229,000 |
Sales Allowances & Returns | | 3,741,000 | | 2,794,000 | | 3,038,000 | | 3,497,000 |
| | | | | | | | |
Total Adjustment for Returns & Price Allowances | | $7,403,000 | | $7,175,000 | | $8,133,000 | | $6,445,000 |
| | | | | | | | |
Allowance for Doubtful Accounts: We have historically provided credit terms to customers in accordance with what management views as industry norms. Financial terms for credit-approved customers are generally on either a net 30 or 60 day basis, though most customers are entitled to a prompt payment discount. Management periodically and regularly reviews customer account activity in order to assess the adequacy of allowances for doubtful accounts, considering factors such as economic conditions and each customer’s payment history and creditworthiness. If the financial condition of our customers were to deteriorate, or if they were otherwise unable to make payments in accordance with management’s expectations, we would have to increase our allowance for doubtful accounts.
Inventories: We state inventories at the lower of average cost or market, with cost being determined based upon the average method. In evaluating whether inventory is to be stated at cost or market, management considers such factors as the amount of inventory on hand, estimated time required to sell existing inventory and expected market conditions, including levels of competition. We establish reserves for slow-moving and obsolete inventories based upon our historical experience, product expiration dates and management’s assessment of current product demand.
Intangible Assets: The Company’s intangible assets consist primarily of acquired product rights. Intangible assets are stated at cost and amortized using the straight line method over the expected useful lives of the product rights. We regularly review the appropriateness of the useful lives assigned to our product rights taking into consideration potential future changes in the markets for our products. The Company reviews each intangible asset with finite useful lives for impairment by comparing the undiscounted cash flows of each asset to the respective carrying value. The Company performs this impairment testing when events occur or circumstances change that would more likely than not reduce the undiscounted cash flows of the asset below its carrying value.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of July 31, 2007 we are not involved in any material unconsolidated transactions.
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
In May 2006 the Company entered into a three year $10,000,000 revolving credit facility. The revolving credit facility bears interest at a rate elected by the Company equal to the Prime Rate or the LIBOR plus 0.75%. Loans are collateralized by inventory, accounts receivable and other assets. The agreement contains covenants with respect to working capital, net worth and certain ratios, as well as other covenants and prohibits the payment of cash dividends. As of July 31, 2007 the Company has not borrowed against this facility and the lender has waived our compliance with certain covenants.
The Company invests in U.S. treasury notes, government asset backed securities and corporate bonds, all of which are exposed to interest rate fluctuations. The interest earned on these investments may vary based on fluctuations in the market interest rate.
13
| ITEM 4. | CONTROLS AND PROCEDURES |
Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures within 90 days of the filing date of this quarterly report, and, based on their evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
PART II. OTHER INFORMATION
The disclosure under Note 12, Contingencies and Other Matters, Legal Proceedings included in Part I of this report is incorporated in this Part II, Item 1 by reference.
Not applicable
| ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
| | | | | | | | | | |
Period | | Total Number of Shares Purchased | | Average Price per Share | | Total Number of Shares Purchased as Part of Publicly Announced Plans | | Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans (1) |
05/01/07 – 05/31/07 | | 0 | | | — | | 0 | | $ | 3,610,000 |
06/01/07 – 06/30/07 | | 0 | | | — | | 0 | | $ | 3,610,000 |
07/01/07 – 07/31/07 | | 33,000 | | $ | 9.97 | | 33,000 | | $ | 3,283,000 |
| (1) | The Company’s Board of Directors has authorized $23,000,000 to repurchase the Company’s common stock. Pursuant to the terms of a Rule 10b5-1 stock repurchase plan, these repurchases may be made from time to time in the open market or in private transactions as market conditions dictate. To date the Company has purchased 2,030,000 shares for $19,717,000. |
| ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
None
| ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
None
None
(a) Exhibits
| | |
| 31.1 | | Rule 13A-14(a)/15D-14(a) Certification |
| |
| 31.2 | | Rule 13A-14(a)/15D-14(a) Certification |
| |
| 32 | | Certification of Officers Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003 |
14
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.
HI-TECH PHARMACAL CO., INC.
(Registrant)
| | | | | | |
| | | | | | Date: September 10, 2007 |
| | | |
| By: | | /s/ DAVID S. SELTZER | | | | |
| | David S. Seltzer (President and Chief Executive Officer) | | | | |
| | | | | | |
| | | | | | | Date: September 10, 2007 |
| By: | | /s/ WILLIAM PETERS | | | | |
| | William Peters (Vice President and Chief Financial Officer) | | | | |
15
