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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 SEPTEMBER 30, 1998
COMMISSION FILE NUMBER 333-33121
LEINER HEALTH PRODUCTS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 95-3431709
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
901 EAST 233RD STREET, CARSON, CALIFORNIA 90745
(310) 835-8400
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
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INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO
SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.
Yes X No
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COMMON STOCK, $.01 PAR VALUE, OUTSTANDING AT NOVEMBER 10, 1998:
1,000 SHARES
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LEINER HEALTH PRODUCTS INC.
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
TABLE OF CONTENTS
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PART I. Financial Information . . . . . . . . . . . . . . . . . . . . . . . . . 3
ITEM 1. Financial Statements . . . . . . . . . . . . . . . . . . . . . . . 3
Condensed Consolidated Statements of Operations (Unaudited) -
For the three and six months ended September 30, 1998 and 1997 . . . . 3
Condensed Consolidated Balance Sheets -
As of September 30, 1998 (Unaudited) and March 31, 1998 . . . . . . . 4
Condensed Consolidated Statements of Cash Flows (Unaudited) -
For the three and six months ended September 30, 1998 and 1997 . . . . 5
Notes to Condensed Consolidated Financial Statements (Unaudited) . . . . 6
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations . . . . . . . . . . . . . . . . . . . . 9
PART II. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . 16
SIGNATURE PAGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
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PART I ITEM 1
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Leiner Health Products Inc.
Condensed Consolidated Statements of Operations
Unaudited
(in thousands)
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
1998 1997 1998 1997
--------- --------- --------- ---------
Net sales $ 149,414 $ 112,237 $ 271,737 $ 206,313
Cost of sales 113,033 83,321 201,910 155,181
--------- --------- --------- ---------
Gross profit 36,381 28,916 69,827 51,132
Marketing, selling and distribution expenses 19,356 14,599 37,166 26,555
General and administrative expenses 9,701 7,946 18,526 13,539
Expenses related to recapitalization of parent -- 299 -- 32,638
Amortization of goodwill 417 434 836 836
Closure of facilities 321 -- 321 --
Other charges (income) (1,224) 375 (815) 463
--------- --------- --------- ---------
Operating income (loss) 7,810 5,263 13,793 (22,899)
Other expenses 59 -- 127 --
Interest expense, net 7,572 5,816 13,891 7,616
--------- --------- --------- ---------
Income (loss) before income taxes and
extraordinary item 179 (553) (225) (30,515)
Provision (benefit) for income taxes before
extraordinary item 96 (113) (72) (7,218)
--------- --------- --------- ---------
Income (loss) before extraordinary item 83 (440) (153) (23,297)
Extraordinary loss on the early extinguishment
of debt, net of income taxes of $761 -- -- -- 1,109
--------- --------- --------- ---------
Net income (loss) $ 83 $ (440) $ (153) $ (24,406)
--------- --------- --------- ---------
--------- --------- --------- ---------
See accompanying notes to condensed consolidated financial statements.
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PART I ITEM 1
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Leiner Health Products Inc.
Condensed Consolidated Balance Sheets
(in thousands)
ASSETS SEPTEMBER 30, MARCH 31,
1998 1998
------------- ---------
UNAUDITED
Current assets:
Cash and cash equivalents $ 2,425 $ 1,026
Accounts receivable, net 72,967 89,358
Inventories 180,795 137,853
Income taxes receivable 1,351 323
Deferred income taxes 8,581 8,578
Prepaid expenses and other current assets 2,666 1,975
--------- ---------
Total current assets 268,785 239,113
Property, plant and equipment, net 55,207 48,899
Goodwill, net 55,068 56,412
Deferred financing charges 11,427 11,465
Other noncurrent assets 11,616 9,937
--------- ---------
Total assets $ 402,103 $ 365,826
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDER'S DEFICIT
Current liabilities:
Bank checks outstanding, less cash on deposit $ 8,183 $ 3,730
Current portion of long-term debt 2,981 1,733
Accounts payable 76,771 93,226
Customer allowances payable 12,857 14,063
Accrued compensation and benefits 8,940 10,132
Accrued interest expense 2,971 3,116
Income taxes payable -- 3,349
Other accrued expenses 2,718 3,709
--------- ---------
Total current liabilities 115,421 133,058
Long-term debt 312,187 257,059
Deferred income taxes 2,593 2,600
Other noncurrent liabilities 1,999 1,997
Commitments and contingent liabilities
Minority interest in subsidiary -- 1,028
Shareholder's deficit:
Common stock 1 1
Capital in excess of par value 1,851 1,825
Retained deficit net of charges from recapitalization
of parent of $31,543 (31,757) (31,604)
Accumulated other comprehensive loss:
Cumulative translation adjustment (192) (138)
--------- ---------
Total shareholder's deficit (30,097) (29,916)
--------- ---------
Total liabilities and shareholder's deficit $ 402,103 $ 365,826
--------- ---------
--------- ---------
See accompanying notes to condensed consolidated financial statements.
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PART I ITEM 1
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Leiner Health Products Inc.
Condensed Consolidated Statements of Cash Flows
Unaudited
(in thousands)
SIX MONTHS ENDED
SEPTEMBER 30,
-----------------------
1998 1997
--------- ----------
OPERATING ACTIVITIES:
Net loss $ (153) $ (24,406)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 3,698 3,604
Amortization 3,980 3,093
Stock option compensation expense -- 8,300
Deferred income taxes -- (3,327)
Extraordinary loss on the early extinguishment of debt -- 1,870
Translation adjustment 54 (111)
Changes in operating assets and liabilities:
Accounts receivable 16,119 25,521
Inventories (43,720) (17,371)
Bank checks outstanding, less cash on deposit 4,526 (3,762)
Accounts payable (16,225) (22)
Customer allowances payable (1,176) 1,112
Accrued compensation and benefits (1,159) 913
Other accrued expenses (1,097) 2,446
Income taxes payable/receivable (4,402) (7,006)
Other (695) (246)
--------- ----------
Net cash used in operating activities (40,250) (9,392)
INVESTING ACTIVITIES:
Additions to property, plant, and equipment, net (10,259) (4,440)
Increase in other noncurrent assets (3,816) (3,470)
--------- ----------
Net cash used in investing activities (14,075) (7,910)
FINANCING ACTIVITIES:
Net borrowings (payments) under bank revolving credit facility (2,837) 45,484
Borrowings under bank term credit facility 59,763 85,000
Payments under bank term credit facility (665) (212)
Net payments under former bank credit facility -- (100,405)
Capital contribution from parent 26 --
Repurchase of minority interest (947) (3,599)
Increase in deferred financing charges (983) (9,696)
Net borrowings (payments) on other long-term debt 1,451 (528)
--------- ----------
Net cash provided by financing activities 55,808 16,044
Effect of exchange rate changes (84) 113
--------- ----------
Net increase (decrease) in cash and cash equivalents 1,399 (1,145)
Cash and cash equivalents at beginning of period 1,026 2,066
--------- ----------
Cash and cash equivalents at end of period $ 2,425 $ 921
--------- ----------
--------- ----------
See accompanying notes to condensed consolidated financial statements.
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PART I ITEM 1
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Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
NOTE 1 - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements for
the three and six months ended September 30, 1998 include the accounts of
Leiner Health Products Inc. (the "Company") and its subsidiaries, including
Vita Health Products Inc. ("Vita Health") which was acquired January 30, 1997
in a transaction accounted for as a purchase, and have been prepared by the
Company in accordance with generally accepted accounting principles for
interim financial information and in accordance with the rules of the
Securities and Exchange Commission ("SEC"). Accordingly, they do not include
all of the information and notes required by generally accepted accounting
principles for complete financial statements.
In the opinion of management, all adjustments necessary for a fair
presentation of such financial statements have been included. Such
adjustments consisted only of normal recurring items. This report should be
read in conjunction with the Company's audited consolidated financial
statements and notes thereto for the year ended March 31, 1998, which are
included in the Company's Annual Report on Form 10-K, on file with the SEC
(Commission file number 333-33121). The results of operations for the
periods indicated should not be considered as indicative of operations for
the full year.
As of April 1, 1998, the Company adopted the Financial Accounting Standards
Board Statement No. 130, REPORTING COMPREHENSIVE INCOME ("SFAS No. 130").
SFAS No. 130 establishes new rules for the reporting and display of
comprehensive income and its components; however, the adoption of this
Statement had no impact on the Company's net income (loss) or shareholder's
equity. SFAS No. 130 requires foreign currency translation adjustments,
which prior to adoption were reported separately in shareholder's equity, to
be included in other comprehensive income.
The components of comprehensive income (loss) for the three and six month
periods ended September 30, 1998 and 1997, are as follows (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
1998 1997 1998 1997
----- ------ ------ --------
Net income (loss)............................. $ 83 $ (440) $ (153) $(24,406)
Foreign currency translation adjustment....... (75) (95) (54) 111
----- ------ ------ --------
Comprehensive income (loss)................... $ 8 $ (535) $ (207) $(24,295)
----- ------ ------ --------
----- ------ ------ --------
NOTE 2 - Inventories
Inventories consist of the following (in thousands):
SEPTEMBER 30, MARCH 31,
1998 1998
------------- ---------
Raw materials, bulk vitamins and packaging materials.......... $ 119,149 $ 83,475
Work-in process............................................... 12,116 9,832
Finished products............................................. 49,530 44,546
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$ 180,795 $ 137,853
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PART I ITEM 1
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Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
(continued)
NOTE 3 - The Recapitalization
On June 30, 1997, the Company's ultimate parent, Leiner Health Products Group
Inc. ("Leiner Group") completed a leveraged recapitalization
("Recapitalization"). Pursuant to the Recapitalization, Leiner Group
repurchased common stock from its existing shareholders in an amount totaling
(together with equity retained by such shareholders) $211.1 million, issued
$80.4 million of new shares of the recapitalized Leiner Group to North Castle
Partners I, L.L.C. ("North Castle"), issued $85 million of Senior
Subordinated Notes due 2007 (the "Notes"), and established a $210 million
senior secured credit facility that provided for both term and revolving
credit borrowings.
In connection with the Recapitalization, the Company deducted $1.1 million of
deferred financing charges, net of income taxes of $0.8 million, from net
income (loss) as an extraordinary loss in the six months ended September 30,
1997. Additionally, in connection with the Recapitalization, the Company
incurred expenses of approximately $32.6 million in the six months ended
September 30, 1997, consisting of expenses of approximately $11.8 million
related to Leiner Group's equity transactions, transaction bonuses granted to
certain management personnel in the aggregate amount of approximately $5.2
million and compensation expense related to the in-the-money value of stock
options of approximately $15.6 million. The compensation expense represented
the excess of the fair market value of the underlying common stock over the
exercise price of the options exercised in connection with the
Recapitalization.
NOTE 4 - Long-Term Debt
On May 15, 1998, the Company entered into an Amended and Restated Credit
Agreement (the "Amended Credit Agreement"). The Amended Credit Agreement
consists of two U.S. term loans due December 30, 2004 and December 30, 2005
in the amounts of $68,000,000 and $65,000,000, respectively, and a Canadian
dollar denominated term loan due December 30, 2004 in the amount of
approximately U.S. $12,000,000 (collectively, the "Term Facility"), and a
revolving credit facility in the amount of U.S. $125,000,000 (the "Revolving
Facility") a portion of which is denominated in Canadian dollars and made
available to Vita Health. The unpaid principal amount outstanding on the
Revolving Facility is due and payable on June 30, 2003. The Term Facility
requires quarterly amortization payments of approximately 1% per annum over
the next five years. Amortization payments scheduled during the period
October 1, 1998 through September 30, 1999 total $1.5 million. Amounts
outstanding under the prior credit facility as in effect at March 31, 1998
were rolled over into the Amended Credit Agreement. The terms, conditions and
restrictions of the Amended Credit Agreement are consistent with the terms,
conditions and restrictions of the credit facility as previously in effect.
Borrowings under the Amended Credit Agreement bear interest at floating rates
that are based on the agent lender's base rate (8.25% at September 30, 1998),
the agent lender's Canadian prime rate (4.75% at September 30, 1998), LIBOR
(5.69% at September 30, 1998) or the agent lender's banker's acceptance rate
(3.44% at September 30, 1998), as the case may be, plus an "applicable
margin" that is itself based on the Company's leverage ratio. The leverage
ratio is defined generally as the ratio of total funded indebtedness to the
consolidated earnings before interest, taxes, depreciation and amortization
expense and its effect on the applicable margin varies as follows: (a) for
revolving credit borrowings, from 0.75% to 2.5% for LIBOR- or banker's
acceptance-based loans, and from zero to 1.5% for alternate base rate- or
Canadian prime rate-based loans, and (b) for the two Term B loans and the one
Term C loan under the Term Facility, from 2.125% to 2.875% or 2.25% to 3.0%,
respectively, for LIBOR-based loans, and from 1.125% to 1.875% or 1.25% to
2.0%, respectively, for alternate base rate-based loans. As of September 30,
1998, the Company's weighted average interest rates were 8.12% for U.S.
borrowings and 7.35% for Canadian borrowings under the Amended Credit
Agreement. In addition to certain agent and up-front fees, the Amended
Credit Agreement requires a commitment fee of up to 0.5% of the average daily
unused portion of the Revolving Facility based on the Company's leverage
ratio.
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PART I ITEM 1
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Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
(continued)
The Amended Credit Agreement contains financial covenants that require, among
other things, the Company to comply with certain financial ratios and tests,
including those that relate to the maintenance of specified levels of cash
flow and shareholder's equity. The Company was in compliance with all such
financial covenants as of September 30, 1998. As of November 5, 1998, the
Company had $31.4 million available under its Revolving Facility.
Principal payments on long-term debt as of September 30, 1998 through fiscal
2003 and thereafter are (in thousands):
FISCAL YEAR
- -----------
1999 ......................................... $ 2,316
2000 ......................................... 3,261
2001 ......................................... 3,443
2002 ......................................... 1,450
2003 ......................................... 1,442
Thereafter.................................... 303,256
---------
Total...................................... $ 315,168
---------
---------
NOTE 5 - Related Party Transactions
Upon consummation of the Recapitalization, Leiner Group and the Company
entered into a consulting agreement with North Castle Partners, L.L.C. (the
"Sponsor"), an affiliate of North Castle, to provide the Company with certain
business, financial and managerial advisory services. Mr. Charles F. Baird
Jr., Chairman of Leiner Group's Board of Directors, acts as the managing
member of the Sponsor through Baird Investment Group, L.L.C. In exchange for
such services, Leiner Group and the Company have agreed to pay the Sponsor an
annual fee of $1.5 million, payable semi-annually in advance, plus the
Sponsor's reasonable out-of-pocket expenses. This fee may be reduced upon
completion of an initial public offering of Leiner Group's shares. The
agreement also terminates on June 30, 2007, unless Baird Investment Group
ceases to be the managing member of North Castle, or upon the earliest of
June 30, 2007 or the date that North Castle terminates. Leiner Group and the
Company also paid the Sponsor a transaction fee of $3.5 million during the
six months ended September 30, 1997 for services related to arranging,
structuring and financing the Recapitalization, and reimbursed the Sponsor's
related out-of-pocket expenses.
NOTE 6 - Contingent Liabilities
The Company has been named in numerous actions brought in federal or state
courts seeking compensatory and, in some cases, punitive damages for alleged
personal injuries resulting from the ingestion of certain products containing
L-Tryptophan. As of October 28, 1998, the Company and/or certain of its
customers, many of whom have tendered their defense to the Company, had been
named in 668 lawsuits, 661 of which have been settled. Settlement
negotiations with respect to the remaining seven lawsuits are in progress.
The Company entered into an agreement with the Company's supplier of bulk
L-Tryptophan, under which the supplier agreed to assume the defense of all
claims and to pay all settlements and judgements, other than for certain
punitive damages, against the Company arising out of the ingestion of
L-Tryptophan products. The supplier funded all settlements and paid all
legal fees and expenses incurred by the Company related to these matters. No
punitive damages were awarded or paid in any settlement.
The Company is subject to other legal proceedings and claims which arise in
the normal course of business. While the outcome of these proceedings and
claims cannot be predicted with certainty, management does not believe the
outcome of any of these matters will have a material adverse effect on the
Company's consolidated financial position, results of operations or cash
flows.
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PART I ITEM 2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The following discussion explains material changes in the consolidated
results of operations for Leiner Health Products Inc. and its subsidiaries
(the "Company") including Vita Health Products Inc. of Canada ("Vita
Health"), a wholly-owned subsidiary acquired January 30, 1997, for the three
months ended September 30, 1998 ("second quarter of fiscal 1999") and the six
months ended September 30, 1998 and the significant developments affecting
its financial condition since March 31, 1998. The following discussion
should be read in conjunction with the Company's audited consolidated
financial statements and notes thereto for the year ended March 31, 1998,
which are included in the Company's Annual Report on Form 10-K, on file with
the Securities Exchange Commission.
SEASONALITY
The Company's business is seasonal, as increased vitamin usage corresponds
with the cough, cold and flu season. Accordingly, the Company historically
has realized a significant portion of the its sales, and a more significant
portion of its operating income, in the second half of the fiscal year.
RESULTS OF OPERATIONS
The following table summarizes the Company's historical results of operations
as a percentage of net sales for the three and six months ended September 30,
1998 and 1997.
PERCENTAGE OF NET SALES
--------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ----------------
1998 1997 1998 1997
------- ------- ------- -------
Net sales........................................................ 100.0 % 100.0 % 100.0 % 100.0 %
Cost of sales.................................................... 75.7 74.2 74.3 75.2
------- ------- ------- -------
Gross profit..................................................... 24.3 25.8 25.7 24.8
Marketing, selling and distribution expenses..................... 12.9 13.0 13.7 12.9
General and administrative expenses.............................. 6.5 7.1 6.8 6.6
Expenses related to recapitalization of parent................... -- 0.3 -- 15.8
Amortization of goodwill......................................... 0.3 0.4 0.3 0.4
Closure of facilities............................................ 0.2 -- 0.1 --
Other charges (income)........................................... (0.8) 0.3 (0.3) 0.2
------- ------- ------- -------
Operating income (loss).......................................... 5.2 4.7 5.1 (11.1)
Other expense.................................................... -- -- 0.1 --
Interest expense, net............................................ 5.0 5.2 5.1 3.7
------- ------- ------- -------
Income (loss) before income taxes and extraordinary item......... 0.2 (0.5) (0.1) (14.8)
Provision (benefit) for income taxes before extraordinary item .. 0.1 (0.1) -- (3.5)
------- ------- ------- -------
Income (loss) before extraordinary item.......................... 0.1 (0.4) (0.1) (11.3)
Extraordinary item............................................... -- -- -- 0.5
------- ------- ------- -------
Net income (loss)................................................ 0.1 % (0.4)% (0.1)% (11.8)%
------- ------- ------- -------
------- ------- ------- -------
Net sales for the second quarter of fiscal 1999 were $149.4 million, an
increase of $37.2 million, or 33.1% versus the second quarter of fiscal 1998.
The Company's sales growth was primarily attributable to volume growth in
the Company's sales of vitamins, which was largely due to sales growth in the
vitamin market generally and an increase in private label vitamin sales
resulting from the continuing consumer migration to mass market private label
vitamins. The Company's vitamin product sales increased by $31.0 million, or
32.8%, compared to the second quarter of the prior year. Management
estimates that the overall U. S. vitamin market for food, drug and mass
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PART 1 ITEM 2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Continued)
merchandisers ("FDM Market") grew by over 23% in the 13 week period ended
September 27, 1998 versus the comparable period in 1997. Sales growth among
the Company's products was strongest in herbs and supplements. The Company
continues to emphasize higher growth products and to gain distribution in new
channels outside of the FDM Market. Sales of over-the-counter
pharmaceuticals ("OTCs") declined 4.7 % for the second quarter of fiscal 1999
as compared to the same period in fiscal 1998, due primarily to certain OTC
products being discontinued at certain customers. The Company introduced
private label cimetidine, a digestive aid, in June 1998 and management
expects this new OTC product to help offset the OTC sales decline.
For the six months ended September 30, 1998, net sales increased by $65.4
million, or 31.7% compared to the first half of fiscal 1998. The increase in
net sales in the first half of the year was primarily due to the volume
growth in vitamin sales compared to the comparable period of fiscal 1998,
which was due primarily to sales growth in the vitamin market generally.
Vitamin sales for the six months ended September 30, 1998 increased 32.3%, or
$54.9 million from $170.0 million in the first half of fiscal 1998.
Gross profit for the second quarter increased by $7.5 million, up 25.8% from
$28.9 million in the second quarter of fiscal 1998 to $36.4 million for the
same period in fiscal 1999. The increase in gross profit during the quarter
is primarily attributable to the higher sales volume. Gross profit margin
was 24.3% for the second quarter of fiscal 1999, down from 25.8% in the
second quarter of the prior fiscal year due primarily to a change in product
mix, reflecting the increase in sales of lower margin private label vitamins.
For the six months ended September 30, 1998, gross profit increased by $18.7
million, or 36.6%, compared to the same period in fiscal 1998. Gross profit
margin was 25.7%, a 0.9 percentage point increase in the six months ended
September 30, 1998, up from 24.8% in the comparable period in fiscal 1998.
The increase in gross profit in the first half of the year was primarily due
to the higher sales volume along with a more favorable mix of higher margin
herbs and supplement products year-to-date.
Marketing, selling and distribution expenses, together with general and
administrative expenses (collectively, "Operating Expenses") for the second
quarter of fiscal 1999 were 19.4% of net sales, a slight improvement from
20.1% in the second quarter of the prior year. Operating Expenses in the
second quarter of fiscal 1999 increased by $6.5 million, or 28.9%, as
compared to the second quarter in fiscal 1998. For the six months ended
September 30, 1998, Operating Expenses were 20.5% of net sales versus 19.5%
in the prior year. This increase in Operating Expenses for both the three
and six month periods ended September 30, 1998 is primarily the result of
infrastructure development in support of new products and diversification
strategies and increased costs associated with changing all the Company's
product labels to comply with the new Dietary Supplement Health and Education
Act of 1994 effective March 23, 1999. Additionally, for the six month period
ended September 30, 1998, the increase is due to unusually low spending in
the first quarter of the prior fiscal year.
In the six months ended September 30, 1997, the Company recorded expenses
relating to the recapitalization of its parent (the "Recapitalization") of
$32.6 million, consisting primarily of compensation expense related to the
in-the-money value of stock options issued to certain management personnel of
$15.6 million, management bonuses of $5.2 million, and expenses incurred by
Leiner Group in connection with its capital raising activities of $11.8
million. There were no Recapitalization-related expenses incurred in fiscal
1999.
For the three months ended September 30, 1998, the Company recorded $0.3
million of expenses in connection with the closing of its West Unity, Ohio
facility. The facility was closed on July 2, 1998 and its packaging lines
have been relocated to the Fort Mill, South Carolina facility. These
expenses were for utilities, property taxes, etc., which were properly not
accrued in the plant closure reserve established in the fourth quarter of
fiscal 1998.
Other income for the second quarter of fiscal 1999 was $1.2 million, which
compares to other charges of $0.4 million for the second quarter of fiscal
1998. The increase in other income was due to a non-recurring settlement
arising from a dispute involving a service provider and a former employee.
For the six months ended September 30, 1998, other income totaled $0.8
million compared to the other charges of $0.5 million in the comparable
period of fiscal 1998. This change was due to the aforementioned settlement
in the second quarter of fiscal 1999.
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-10-
PART 1 ITEM 2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Continued)
In the second quarter of fiscal 1999, operating income was $7.8 million,
compared to $5.3 million in the second quarter of fiscal 1998. This increase
was primarily due to increased sales and gross profit and a $1.6 million
settlement recorded in the second quarter of fiscal 1999. For the six months
ended September 30, 1998, the Company recognized an operating income of $13.8
million compared to an operating loss of $22.9 million in the prior year.
This change was primarily attributable to the fact that there were expenses
incurred in the first half of fiscal 1998 in connection with the
Recapitalization of Leiner Group which were not incurred in fiscal 1999.
Excluding these Recapitalization expenses, operating income increased $4.1
million or 41.6% over the first six months of fiscal year 1998. This
increase was primarily due to the increased sales and gross profit during the
first half of fiscal 1999 and secondarily to the settlement recorded in the
second quarter of fiscal 1999.
Net interest expense increased by $1.8 million during the second quarter of
fiscal 1999, versus the second quarter of fiscal 1998. This increase was due
primarily to an increase in the indebtedness of the Company. For the six
months ended September 30, 1998, interest expense increased by $6.3 million
versus the first half of fiscal 1998. This increase was primarily due to
changes in the Company's debt structure and interest rates arising from the
Recapitalization which took effect at the end of the first quarter of fiscal
1998, as well as an increase in indebtedness occurring in the first half of
fiscal 1999.
The provision for income taxes for the second quarter of fiscal 1999 was $0.1
million compared to a tax benefit of $0.1 million in the second quarter of
fiscal 1998. Based on the latest estimates, the Company expects its effective
tax rate to be approximately 43% for the remainder of fiscal 1999, and to be
higher than the combined federal and state rate of 40% primarily because of
the nondeductibility for income tax purposes of goodwill amortization and
certain accruals.
The extraordinary loss recorded in the first quarter of fiscal 1998
represented the write-off of $1.9 million of deferred financing charges which
had been incurred by the Company when it entered into a credit facility on
January 30, 1997. The income tax effect of that charge was a benefit of $0.8
million.
Primarily as a result of the factors discussed above, net income of $0.1
million was recorded in the second quarter of fiscal 1999 as compared to a
net loss of $0.4 million in the second quarter of fiscal 1998. For the six
months ended September 30, 1998, a net loss of $0.1 million was recorded
compared to the $24.4 million net loss in the first half of fiscal 1998.
OTHER INFORMATION
Earnings before interest, taxes, depreciation, amortization, other non-cash
charges and the charges related to the closure of facilities ("EBITDA")
totaled $11.4 million for the second quarter of fiscal 1999, which was $3.0
million higher than the comparable period in fiscal 1998. EBITDA for the
first half of fiscal 1999 was $20.7 million, or $4.7 million greater than
EBITDA for the first half of fiscal 1998 excluding Recapitalization-related
cash expenses. EBITDA can be calculated from the financial statements with
the exception of the amortization of deferred debt issuance costs totaling
$0.5 million and $0.4 million for the three months ending September 30, 1998
and 1997, respectively, and $1.0 million and $0.5 million for the six month
periods ended September 30, 1998 and 1997, respectively, which is included in
interest expense in the statement of operations and in amortization expense
in the statement of cash flows. The Company believes that EBITDA provides
useful information regarding the Company's debt service ability, but should
not be considered in isolation or as a substitute for the statements of
operations or cash flow data.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash has historically been used to fund capital expenditures,
working capital requirements and debt service. As a result of the
Recapitalization, the Company's liquidity requirements have significantly
increased, primarily due to significantly increased interest expense
obligations. In addition, the Company is required to repay the $142.9 million
in currently outstanding term loans under the Amended Credit Agreement
(defined below) over the seven and one-half year period following May 15,
1998, with scheduled principal payments of $1.4 million
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PART 1 ITEM 2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Continued)
annually for the first five years, $48.5 million in the sixth year, $66.4
million in the seventh year, and $21.6 million in the final six months. The
Company will also be required to apply certain asset sale proceeds, as well
as 50% of its excess cash flow (as defined in the Amended Credit Agreement)
unless a leverage ratio test is met, to prepay the borrowings under the
Amended Credit Agreement. All outstanding revolving credit borrowings under
the Amended Credit Agreement will become due on June 30, 2003.
During the first half of fiscal year 1999, net cash used in operating
activities totaled $40.3 million. This resulted primarily from an increase
in inventories of $43.7 million and a decrease in accounts payable of $16.2
million, partially offset by a decrease in accounts receivable of $16.1
million, and an increase in bank checks outstanding of $4.5 million. The
increase in inventory is primarily the result of i) a strategic decision to
increase inventories to ensure on-time order delivery to customers during the
period of start-up operations at its newly completed manufacturing and
distribution facility in Fort Mill, South Carolina, ii) the positioning of
the Company to capitalize on certain market opportunities arising from
service shortfalls by certain of its competitors, and iii) the shipment to
the Company of back ordered softgel materials. In order to help address the
temporary liquidity demands of higher inventories and capital spending, the
Company has received extended terms from its major suppliers and accelerated
payment terms from its major customers, effective for the second and third
quarters of fiscal 1999. The Company expects inventories to decline to more
customary levels by December 31, 1998. Inventories declined by approximately
$22.8 million in the second quarter of fiscal 1999. The decrease in accounts
payable combined with the increase in bank checks outstanding, totaled $11.7
million. This decrease was due to fewer inventory purchases late in the
second quarter of fiscal 1999 as the need for safety stock during the Fort
Mill start-up declined with its opening September 1998. The decrease in
accounts receivable since March 31, 1998, is due primarily to the seasonality
of the Company's business.
Net cash used in investing activities was $14.1 million in the first half of
fiscal 1999. This was primarily due to net capital expenditures of $10.3
million. The major capital expenditures were related to investments in
capacity expansion at the new manufacturing, packaging and distribution
facility in South Carolina, as well as at the Garden Grove, California
tableting plant. The Company expects to invest approximately $62 million in
its business in fiscal 1999, primarily to complete its capacity expansion
program. Of this amount, approximately $22 million is for the Fort Mill,
South Carolina facility, which is being financed by an operating lease. Of
the remaining $40 million which will be spent on equipment and software,
approximately $17 million will be financed through operating leases, $3
million will be financed by capitalized leases and the balance of
approximately $20 million will be a use of the Company's cash.
Net cash provided by financing activities was $55.8 million in the first half
of fiscal 1999. This was primarily the result of increased net borrowings
under the Amended Credit Agreement. During the first half of fiscal 1999, the
Company redeemed the balance of the preferred stock of its Canadian
subsidiary outstanding as of March 31, 1998, which had been issued in
connection with the acquisition of Vita Health and had appeared in the
consolidated balance sheet as minority interest in subsidiary.
FINANCING ARRANGEMENTS
On May 15, 1998, the Company entered into an Amended and Restated Credit
Agreement ("Amended Credit Agreement"). The Amended Credit Agreement
provides for two U.S. term loans due December 30, 2004 and December 30, 2005
in the amounts of $68,000,000 and $65,000,000, respectively, and a Canadian
dollar denominated term loan due December 30, 2004 in the amount of
approximately U.S. $12,000,000, and a revolving credit facility in the amount
of U.S. $125,000,000 (the "Revolving Facility") a portion of which is
denominated in Canadian dollars and made available to Vita Health. The
unpaid principal amount outstanding on the Revolving Facility is due and
payable on June 30, 2003. Amounts outstanding under the Company's credit
facility in place at March 31, 1998, were refinanced with the proceeds from
the Amended Credit Agreement. As of November 5, 1998, the Company's unused
availability under the Amended Credit Agreement was approximately $31.4
million.
The Revolving Credit Facility includes letter of credit and swingline
facilities. Borrowings under the Amended Credit Agreement bear interest at
floating rates that are based on LIBOR or on the applicable alternate base
rate (as defined),
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PART 1 ITEM 2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Continued)
and accordingly the Company's financial condition and performance is and will
continue to be affected by changes in interest rates. The Company has entered
into an interest protection arrangement effective July 30, 1997 with respect
to $29.4 million of its indebtedness under the Amended Credit Agreement that
provides a cap of 6.17% on LIBOR rates plus applicable margin on the interest
rates payable thereon. The Amended Credit Agreement imposes certain
restrictions on the Company, including restrictions on its ability to incur
additional debt, enter into sale-leaseback transactions, incur contingent
liabilities, pay dividends or make distributions, incur or grant liens, sell
or otherwise dispose of assets, make investments or capital expenditures,
repurchase or prepay its Senior Subordinated Notes due 2007 (the "Notes") or
other subordinated debt, or engage in certain other activities. The Company
must also comply with certain financial ratios and tests, including a minimum
net worth requirement, a maximum leverage ratio, a minimum interest coverage
ratio and a minimum cash flow coverage ratio.
The Company may be required to purchase the Notes upon a Change of Control
(as defined) and in certain circumstances with the proceeds of asset sales.
The Notes are subordinated to the indebtedness under the Amended Credit
Agreement. The indenture governing the Notes imposes certain restrictions on
the Company and its subsidiaries, including restrictions on its ability to
incur additional debt, make dividends, distributions or investments, sell or
otherwise dispose of assets, or engage in certain other activities.
A portion of the outstanding borrowings under the Amended Credit Agreement,
amounting to approximately U.S. $17.1 million as of September 30, 1998, is
denominated in Canadian dollars. All other outstanding borrowings under the
Amended Credit Agreement, and all of the borrowings under the Notes, are
denominated in U.S. dollars.
At September 30, 1998, borrowings under the Amended Credit Agreement bore
interest at a weighted average rate of 8.1% per annum. The Notes bear
interest at a rate of 9.625% per annum.
The Company has established a new manufacturing, packaging and distribution
facility in Fort Mill, South Carolina. The West Unity, Ohio packaging plant
was closed the first week of July 1998 and its packaging lines have been
relocated to the Fort Mill, South Carolina facility. The Company expects to
incur expenses estimated at approximately $3.4 million during fiscal year
1999 in connection with this new facility. The Company has leased this new
facility under a prearranged lease at an estimated incremental annual lease
expense, net of lease costs for the facilities currently expected to be
closed, of $1.4 million.
The Company currently believes that cash flow from operating activities,
together with revolving credit borrowings available under the Amended Credit
Agreement, will be sufficient to fund the Company's currently anticipated
working capital, capital spending and debt service requirements until the
maturity of the Revolving Credit Facility (June 30, 2003), but there can be
no assurance in this regard. The Company expects that its working capital
needs will require it to obtain new revolving credit facilities at the time
that the Revolving Credit Facility matures, by extending, renewing, replacing
or otherwise refinancing the Revolving Credit Facility. No assurance can be
given that any such extension, renewal, replacement or refinancing can be
successfully accomplished.
YEAR 2000 COMPLIANCE
Many existing computer systems and applications, and other control devices,
use only two digits to identify a year in the date field, without considering
the impact of the upcoming change in the century. Others do not correctly
process "leap year" dates. As a result, such systems and applications could
fail or create erroneous results unless corrected to process data related to
the year 2000 and beyond. The problems are expected to increase in frequency
and severity as the year 2000 approaches, and are commonly referred to as the
"Year 2000 Problem." The Company relies on its systems, applications and
devices in operating and monitoring all major aspects of its business,
including systems (such as general ledger, accounts payable, and billing
modules), customer services, infrastructure, embedded computer chips,
networks and telecommunications equipment. The Company also relies, directly
and indirectly, on external systems of business enterprises such as
customers, suppliers, creditors, financial organizations and governmental
entities, both domestic and international, for accurate exchange of data.
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PART 1 ITEM 2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Continued)
The Company is continuing to assess the impact that the Year 2000 Problem may
have on its operations and has identified the following three key areas of
its business that may be affected:
INTERNAL BUSINESS SYSTEMS
The Year 2000 Problem could affect the systems, transaction processing
computer applications and devices used by the Company to operate and monitor
all major aspects of its business, including financial systems (such as
general ledger, accounts payable and billing), customer services,
infrastructure, materials requirement planning, master production scheduling,
networks and telecommunications systems. The Company has completed its
assessment phase and believes that it has identified substantially all of the
major systems, software applications and related equipment used in connection
with its internal operations that must be modified or upgraded in order to
minimize the possibility of a material disruption to its business. The
Company has substantially completed its remediation phase of modifying and
upgrading all affected systems which are critical to the operations of the
business. The Company estimates that all remaining systems will be Year 2000
compliant by the end of the fourth quarter of fiscal 1999. However, any
unforeseen problems which occur during the testing phase may adversely affect
the Company's Year 2000 readiness.
THIRD-PARTY SUPPLIERS
The Company relies, directly and indirectly, on external systems utilized by
its suppliers for products used in the manufacture of its products. The
Company has requested confirmation from its suppliers of their Year 2000
compliance; however, there can be no assurance that these suppliers will
resolve any or all Year 2000 Problems with their systems in a timely manner.
Any failure of these third parties to resolve their Year 2000 Problems in a
timely manner could result in the material disruption of the business of the
Company. Any such disruption could have a material adverse effect on the
Company's business, financial condition and results of operations. The
Company believes that this is the worst case Year 2000 scenario and the
Company is unable to predict what the impact would be.
FACILITY SYSTEMS
Systems such as heating, sprinklers, elevators, test equipment and security
systems at the Company's facilities may also be affected by the Year 2000
Problem. The Company has contacted the facility owners seeking assurances of
Year 2000 compliance.
The Company has incurred $0.3 million of expenses during the six-month period
ended September 30, 1998 to address its Year 2000 issues. The Company
presently estimates that the total cost of addressing its Year 2000 issues
will be approximately $2.0 million to $3.5 million. This estimate was
derived utilizing numerous assumptions, including the assumption that the
Company has already identified its most significant Year 2000 issues and that
the plans of its third party suppliers will be fulfilled in a timely manner
without cost to the Company. However, there can be no guarantee that these
assumptions are accurate, and actual results could differ materially from
those anticipated.
The Company recognizes the need for developing contingency plans to address
the Year 2000 issues that may pose a significant risk to its on-going
operations. Such plans could include the implementation of manual procedures
to compensate for system deficiencies. During the remediation phase of the
internal business systems, the Company will be evaluating potential failures
and attempt to develop responses in a timely manner. However, there can be
no assurance that any contingency plans evaluated and potentially implemented
by the Company would be adequate to meet the Company's needs without
materially impacting its operations, that any such plan would be successful
or that the Company's results of operations would not be materially and
adversely affected by the delays and inefficiencies inherent in conducting
operations in an alternative manner.
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PART 1 ITEM 2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Continued)
THE EURO CONVERSION
On January 1, 1999, eleven of the fifteen member countries of the European
Union (the "participating countries") are scheduled to establish fixed
conversion rates between their existing sovereign currencies (the "legacy
currencies") and the euro. The participating countries have agreed to adopt
the euro as their common legal currency on that date. The euro will then
trade on currency exchanges and be available for non-cash transactions.
As of January 1, 1999, the participating countries no longer will control
their own monetary policies by directing independent interest rates for the
legacy currencies. Instead, the authority to direct monetary policy,
including money supply and official interest rates for the euro, will be
exercised by the new European Central Bank.
Following introduction of the euro, the legacy currencies are scheduled to
remain legal tender in the participating countries as denominations of the
euro between January 1, 1999 and January 1, 2002 (the "transition period").
During the transition period, public and private parties may pay for goods
and services using either the euro or the participating country's legacy
currency.
The impact of the euro is not expected to materially affect the results of
operations of the Company. The Company operates primarily in U.S.
dollar-denominated purchase orders and contracts, and the Company neither has
a large customer nor vendor base within the countries participating in the
euro conversion.
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
Certain of the statements contained in this report (other than the financial
statements and other statements of historical fact) are forward-looking
statements, including statements regarding, without limitation, (i) the
Company's growth strategies; (ii) trends in the Company's business; and (iii)
the Company's future liquidity requirements and capital resources.
Forward-looking statements are made based upon management's current
expectations and beliefs concerning future developments and their potential
effects upon the Company. There can be no assurance that future developments
will be in accordance with management's expectations or that the effect of
future developments on the Company will be those anticipated by management.
The important factors described elsewhere in this report and in the Company's
Form 10-K for the fiscal year ended March 31, 1998 (including, without
limitation, those factors discussed in the "Business-Risk Factors" section of
Item 1 thereof), on file with the Securities and Exchange Commission, could
affect (and in some cases have affected) the Company's actual results and
could cause such results to differ materially from estimates or expectations
reflected in such forward-looking statements. In light of these factors,
there can be no assurance that events anticipated by the forward-looking
statements contained in this report will in fact transpire.
While the Company periodically reassesses material trends and uncertainties
affecting the Company's results of operations and financial condition in
connection with its preparation of management's discussion and analysis of
results of operations and financial condition contained in its periodic
reports, the Company does not intend to review or revise any particular
forward-looking statement referenced in this report in light of future
events.
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PART II OTHER INFORMATION
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ITEM 1. LEGAL PROCEEDINGS
The information in Note 6 to the Company's Condensed Consolidated
Financial Statements included herein is hereby incorporated by
reference.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits:
4.1 Agreement to Furnish Sun Data, Inc. Lease
27 Financial Data Schedule - September 30, 1998
Reports on Form 8-K:
None.
SIGNATURE
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.
LEINER HEALTH PRODUCTS INC.
By: /s/ WILLIAM B. TOWNE
---------------------------------
William B. Towne
Executive Vice President, Chief
Financial Officer and Director
Date: November 13, 1998
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