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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MAY 31, 2005
COMMISSION FILE NUMBER 0-5905
CHATTEM, INC.
-------------
A TENNESSEE CORPORATION
I.R.S. EMPLOYER IDENTIFICATION NO. 62-0156300
1715 WEST 38TH STREET
CHATTANOOGA, TENNESSEE 37409
TELEPHONE: 423-821-4571
REGISTRANT HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS, AND HAS BEEN
SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.
THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12b-2 OF THE EXCHANGE
ACT).
AS OF JULY 1, 2005, 19,784,032 SHARES OF THE COMPANY'S COMMON STOCK, WITHOUT PAR
VALUE, WERE OUTSTANDING.
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CHATTEM, INC.
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INDEX
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PAGE NO.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of May 31, 2005 and
November 30, 2004 3
Condensed Consolidated Statements of Operations for the Three and
Six Months Ended May 31, 2005 and May 31, 2004 5
Condensed Consolidated Statements of Cash Flows for the Six Months
Ended May 31, 2005 and May 31, 2004 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 26
Item 3. Quantitative and Qualitative Disclosures About Market Risks 37
Item 4. Controls and Procedures 37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 38
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 38
Item 3. Defaults Upon Senior Securities 38
Item 4. Submission of Matters to a Vote of Security Holders 38
Item 5. Other Information 38
Item 6. Exhibits and Reports on Form 8-K 39
SIGNATURES 40
2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
(In thousands)
MAY 31, NOVEMBER 30,
ASSETS 2005 2004
- ------ ---------- ----------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 35,817 $ 40,193
Accounts receivable, less allowances of $ 3,396 at
May 31, 2005 and $1,682 at November 30, 2004 45,526 32,098
Inventories 21,995 21,690
Refundable income taxes -- 4,702
Deferred income taxes 2,511 4,308
Prepaid expenses and other current assets 5,417 3,683
---------- ----------
Total current assets 111,266 106,674
---------- ----------
PROPERTY, PLANT AND EQUIPMENT, NET 28,012 28,765
---------- ----------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net 222,163 225,560
Debt issuance costs, net 4,331 5,174
Other 5,074 5,551
---------- ----------
Total other noncurrent assets 231,568 236,285
---------- ----------
TOTAL ASSETS $ 370,846 $ 371,724
========== ==========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
(In thousands)
MAY 31, NOVEMBER 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 2005 2004
- ------------------------------------ ---------- ----------
(Unaudited)
CURRENT LIABILITIES:
Accounts payable and other $ 17,730 $ 13,341
Accrued liabilities 16,943 23,763
---------- ----------
Total current liabilities 34,673 37,104
---------- ----------
LONG-TERM DEBT 182,500 200,000
---------- ----------
DEFERRED INCOME TAXES 29,883 25,732
---------- ----------
OTHER NONCURRENT LIABILITIES 1,832 1,776
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 17)
SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized 1,000,
none issued -- --
Common shares, without par value, authorized 50,000,
issued and outstanding 19,849 at May 31, 2005 and
19,882 at November 30, 2004 77,994 85,949
Retained earnings 48,060 23,888
---------- ----------
126,054 109,837
Unamortized value of restricted common shares issued (3,452) (2,386)
Cumulative other comprehensive income, net of tax:
Interest rate cap adjustment (515) (316)
Foreign currency translation adjustment (129) (23)
---------- ----------
Total shareholders' equity 121,958 107,112
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $ 370,846 $ 371,724
========== ==========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
-----------------------------------------------
(Unaudited and in thousands, except per share amounts)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED MAY 31, ENDED MAY 31,
------------------------ ------------------------
2005 2004 2005 2004
--------- --------- --------- ---------
REVENUES:
Net sales $ 75,640 $ 69,886 $ 147,120 $ 130,813
Royalties 47 206 98 516
--------- --------- --------- ---------
Total revenues 75,687 70,092 147,218 131,329
--------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales 21,116 20,556 41,376 37,508
Advertising and promotion 20,731 19,080 41,082 37,612
Selling, general and administrative 12,335 10,671 24,219 21,306
Litigation settlement (5,587) 3,463 (2,832) 3,657
--------- --------- --------- ---------
Total costs and expenses 48,595 53,770 103,845 100,083
--------- --------- --------- ---------
INCOME FROM OPERATIONS 27,092 16,322 43,373 31,246
--------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense (3,458) (3,639) (6,953) (8,394)
Investment and other income, net 255 115 402 160
Loss on early extinguishment of debt (744) (1,649) (744) (12,958)
--------- --------- --------- ---------
Total other income (expense) (3,947) (5,173) (7,295) (21,192)
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 23,145 11,149 36,078 10,054
PROVISION FOR INCOME TAXES 7,638 3,902 11,906 3,519
--------- --------- --------- ---------
NET INCOME $ 15,507 $ 7,247 $ 24,172 $ 6,535
========= ========= ========= =========
NUMBER OF COMMON SHARES:
Weighted average outstanding-basic 19,595 19,286 19,621 19,193
========= ========= ========= =========
Weighted average and potential dilutive outstanding 20,474 20,176 20,474 20,038
========= ========= ========= =========
NET INCOME PER COMMON SHARE:
Basic $ .79 $ .38 $ 1.23 $ .34
========= ========= ========= =========
Diluted $ .76 $ .36 $ 1.18 $ .33
========= ========= ========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------
(Unaudited and in thousands, except per share amount)
FOR THE SIX MONTHS ENDED
------------------------
MAY 31, MAY 31,
2005 2004
--------- ---------
OPERATING ACTIVITIES:
Net income $ 24,172 $ 6,535
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 3,107 3,072
Deferred income taxes 6,120 5,218
Tax (expense) benefit realized from stock option plans (2,807) 2,504
Loss on early extinguishment of debt 744 12,958
Other, net 51 49
Changes in operating assets and liabilities:
Accounts receivable (13,428) (13,579)
Inventories (305) (1,280)
Refundable income taxes 4,702 (2,138)
Prepaid expenses and other current assets 1,487 2,295
Accounts payable and accrued liabilities (2,431) (2,103)
--------- ---------
Net cash provided by operating activities 21,412 13,531
--------- ---------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (956) (1,240)
Sales (purchases) of patents, trademarks and other product rights 3,252 (19)
Increase in other assets, net (2,309) (701)
--------- ---------
Net cash used in investing activities (13) (1,960)
--------- ---------
FINANCING ACTIVITIES:
Repayment of long-term debt (17,500) (212,288)
Proceeds from long-term debt -- 200,000
Proceeds from borrowings under revolving credit facility -- 25,000
Repayment of policy loans (1,031) (25,000)
Proceeds from exercise of stock options 1,618 2,880
Repurchase of common shares (8,596) (3,234)
Increase in debt issuance costs -- (5,718)
Debt retirement costs (282) (7,861)
Premium on interest rate cap agreement -- (1,375)
--------- ---------
Net cash used in financing activities (25,791) (27,596)
--------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 16 (16)
--------- ---------
CASH AND CASH EQUIVALENTS:
Decrease for the period (4,376) (16,041)
At beginning of period 40,193 26,931
--------- ---------
At end of period $ 35,817 $ 10,890
========= =========
SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Issuance of 50 and 70 shares of restricted common stock at a
value of $35.37 and $19.98 per share for the six months
ended May 31, 2005 and 2004, respectively $ 1,768 $ 1,399
PAYMENTS FOR:
Interest $ 6,641 $ 7,807
Taxes $ 342 $ 196
The accompanying notes are an integral part of these condensed
consolidated financial statements.
6
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
(UNAUDITED)
All monetary and share amounts are expressed in thousands.
1. BASIS OF PRESENTATION
---------------------
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions to Form 10-Q and Rule 10-01
of Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. These condensed consolidated financial statements should
be read in conjunction with the audited consolidated financial statements and
related notes thereto included in our Annual Report on Form 10-K for the year
ended November 30, 2004. The accompanying unaudited condensed consolidated
financial statements, in the opinion of management, include all adjustments
necessary for a fair presentation. All such adjustments are of a normal
recurring nature.
2. CASH AND CASH EQUIVALENTS
-------------------------
We consider all short-term deposits and investments with original
maturities of three months or less to be cash equivalents.
3. RECENT ACCOUNTING PRONOUNCEMENTS
--------------------------------
In December 2003, the Financial Accounting Standards board ("FASB") issued
Interpretation No. 46R, "Consolidation of Variable Interest Entities" ("FIN
46R"), which supercedes Interpretation No. 46, "Consolidation of Variable
Interest Entities" issued in January 2003. FIN 46R requires a company to
consolidate a variable interest entity ("VIE"), as defined, when the company
will absorb a majority of the VIE's expected losses, receives a majority of the
VIE's expected residual returns or both. FIN 46R also requires consolidation of
existing, non-controlled affiliates if the VIE is unable to finance its
operations without investor support, or where the other investors do not have
exposure to the significant risks and rewards of ownership. FIN 46R applies
immediately to a VIE created or acquired after January 31, 2003. For a VIE
created before February 1, 2003, FIN 46R applies in the first fiscal year or
interim period beginning after March 15, 2004, our third fiscal quarter
beginning June 1, 2004. Application of FIN 46R is also required in financial
statements that have interests in structures that are commonly referred to as
special-purpose entities for periods ending after December 15, 2003. The
adoption of FIN 46R did not have an impact on our financial position, results of
operations or cash flows.
In November 2004, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 151, "Inventory Costs" ("SFAS 151"). SFAS 151 amends the
guidance in Accounting Research Bulletin No. 43, Chapter 4, "Inventory Pricing",
to clarify that abnormal amounts of idle facility expense, freight, handling
costs and wasted materials (spoilage) should be recognized as current-period
charges and requires the allocation of fixed production overheads to inventory
based on normal capacity of the production facilities. This statement is
effective for inventory costs incurred during fiscal years beginning after June
15, 2005. The adoption of SFAS 151 is not expected to have an impact on our
financial position, results of operations or cash flows.
In November 2004, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 03-13, "Applying the Conditions in Paragraph 42 of FASB
Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" in Determining Whether to Report Discontinued Operations" ("EITF
03-13"). Under the consensus, the approach for assessing whether cash flows of
the component have been eliminated from the ongoing operations of the entity
focuses on whether continuing cash flows are direct or indirect cash flows. Cash
flows of the component would not be eliminated if the continuing cash flows to
the entity are considered direct cash flows. The consensus should be applied to
a component of an enterprise that is either disposed of or classified as held
for sale in fiscal periods beginning after December 15, 2004. The adoption of
EITF 03-13 did not have an impact on our financial position, results of
operations or cash flows.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment" ("SFAS 123R"), which is a revision of SFAS No. 123, "Accounting for
Stock-Based Compensation". SFAS 123R supercedes APB Opinion No. 25, "Accounting
for Stock Issued to Employees" and amends SFAS No. 95, "Statement of Cash
Flows". SFAS 123R focuses primarily on accounting for transactions in which an
entity obtains employee services in share-based payment transactions and
requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the income statement based on their fair
values. Accordingly, the adoption of SFAS 123R's fair value method will have a
significant impact on our results of operations, although it will have no impact
on our overall financial position. The impact of
7
the adoption of SFAS 123R cannot be predicted at this time because it will
depend on the levels of share-based payments granted in the future. However, had
we adopted SFAS 123R in prior periods the impact of that standard would have
approximated the impact of SFAS 123 as described in the disclosure of proforma
net income and earnings per share in Note 4. SFAS 123R also requires the
benefits of tax deductions in excess of recognized compensation costs to be
reported as a financing cash flow, rather than as an operating cash flow as
required under current literature. This requirement will reduce net operating
cash flows and increase net financing cash flows in periods after adoption.
While we cannot estimate what those amounts will be in the future (because they
depend on, among other things, when employees exercise stock options), the
amount of operating cash flows recognized in prior periods for such excess tax
deductions were not material to our consolidated financial position or results
of operations. This statement is effective for our first fiscal year that begins
after June 15, 2005.
In December 2004, the FASB issued SFAS 153, "Exchanges of Nonmonetary
Assets" ("SFAS 153"). SFAS 153 amends the guidance in APB Opinion No. 29,
"Accounting for Nonmonetary Transactions" to eliminate certain exceptions to the
principle that exchanges of nonmonetary assets be measured based on the fair
value of the assets exchanged. SFAS 153 eliminates the exception for nonmonetary
exchanges of similar productive assets and replaces it with a general exception
for exchanges of nonmonetary assets that do not have commercial substance. This
statement is effective for nonmonetary asset exchanges in fiscal years beginning
after June 15, 2005. The adoption of SFAS 153 is not expected to have an impact
on our financial position, results of operations or cash flows.
The American Jobs Creation Act of 2004 (the "AJCA") was enacted on October
22, 2004. The AJCA repeals an export incentive, creates a new deduction for
qualified domestic manufacturing activities and includes a special one-time
deduction of 85% of certain foreign earnings repatriated to the U.S.
The FASB issued Staff Position FAS 109-1, "Application of FASB Statement
No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified
Production Activities Provided by the American Jobs Creation Act of 2004" ("FSP
FAS 109-1") on December 21, 2004. In accordance with FSP FAS 109-1, we will
treat the deduction for qualified domestic manufacturing activities, which is
effective upon issuance, as a reduction of the income tax provision in future
years as realized.
In December 2004, the FASB issued Staff Position FAS 109-2, "Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within the
American Jobs Creation Act of 2004," allowing companies additional time to
evaluate the effect of the AJCA on plans for reinvestment or repatriation of
foreign earnings. We are in the process of evaluating the effects of the
repatriation provision.
4. STOCK-BASED COMPENSATION
------------------------
Our 1998 Non-Statutory Stock Option Plan provides for the issuance of up to
1,400 shares of common stock to key employees, while the 1999 Non-Statutory
Stock Option Plan for Non-Employee Directors allows for the issuance of up to
200 shares of common stock. The 2000 Non-Statutory Stock Option Plan provides
for the issuance of up to 1,500 shares of common stock. The 2003 and 2005 Stock
Incentive Plans provide for the issuance of up to 1,500 shares of common stock
each. Options vest ratably over four years and are exercisable for a period of
up to ten years from the date of grant.
For SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123")
purposes, as amended by SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure", the fair value of each option grant has been
estimated as of the date of grant using the Black-Scholes option-pricing model
with the following weighted average assumptions for grants in 2005 and 2004:
expected dividend yield of 0%, expected volatility of 56% and 60%, respectively,
risk-free interest rates of 3.98% and 4.65%, respectively, and expected lives of
approximately five years, respectively.
8
Had compensation expense for stock option grants been determined based on
the fair value at the grant dates consistent with the method prescribed by SFAS
123, our net income and net income per share would have been adjusted to the pro
forma amounts for the three and six months ended May 31, 2005 and 2004,
respectively, as indicated below:
For the Three Months For the Six Months
Ended May 31, Ended May 31,
---------------------- ----------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Net income:
As reported $ 15,507 $ 7,247 $ 24,172 $ 6,535
Fair value method compensation cost, net 1,464 1,110 2,732 1,999
--------- --------- --------- ---------
Pro forma $ 14,043 $ 6,137 $ 21,440 $ 4,536
========= ========= ========= =========
Net income per share, basic:
As reported $ .79 $ .38 $ 1.23 $ .34
Pro forma $ .72 $ .32 $ 1.09 $ .24
Net income per share, diluted:
As reported $ .76 $ .36 $ 1.18 $ .33
Pro forma $ .69 $ .30 $ 1.05 $ .23
5. EARNINGS PER SHARE
------------------
The following table presents the computation of per share earnings for the
three and six months ended May 31, 2005 and 2004, respectively:
For the Three Months For the Six Months
Ended May 31, Ended May 31,
---------------------- ----------------------
2005 2004 2005 2004
--------- --------- --------- ---------
NET INCOME $ 15,507 $ 7,247 $ 24,172 $ 6,535
========= ========= ========= =========
NUMBER OF COMMON SHARES:
Weighted average outstanding 19,595 19,286 19,621 19,193
Issued upon assumed exercise of outstanding
stock options 811 814 793 783
Effect of issuance of restricted common shares 68 76 60 62
--------- --------- --------- ---------
Weighted average and potential
dilutive outstanding (1) 20,474 20,176 20,474 20,038
========= ========= ========= =========
NET INCOME PER COMMON SHARE:
Basic $ .79 $ .38 $ 1.23 $ .34
========= ========= ========= =========
Diluted $ .76 $ .36 $ 1.18 $ .33
========= ========= ========= =========
(1) Because their effects are anti-dilutive, excludes shares issuable under
stock option plans and restricted stock issuance whose grant price was
greater than the average market price of common shares outstanding as
follows: 211 and 199 shares for the three months ended May 31, 2005 and
2004, respectively, and 107 and 100 shares for the six months ended May 31,
2005 and 2004, respectively.
6. ADVERTISING EXPENSES
--------------------
We incur significant expenditures on television, radio and print
advertising to support our nationally branded over-the-counter ("OTC") health
care products and toiletries. Customers purchase products from us with the
understanding that the brands will be supported by our extensive media
advertising. This advertising supports the retailers' sales effort and maintains
the important brand franchise with the consuming public. Accordingly, we
consider our advertising program to be clearly implicit in our sales
arrangements with our customers. Therefore, we believe it is appropriate to
allocate a percentage of the necessary supporting advertising expenses to each
dollar of sales by charging a percentage of sales on
9
an interim basis based upon anticipated annual sales and advertising
expenditures (in accordance with Accounting Principles Board Opinion No. 28,
"Interim Financial Reporting") and adjusting that accrual to the actual expenses
incurred at the end of the year.
7. SHIPPING AND HANDLING
---------------------
Shipping and handling costs of $2,204 and $1,999 are included in selling
expenses for the three months ended May 31, 2005 and 2004, respectively, and
$4,061 and $3,434 for the six months ended May 31, 2005 and 2004, respectively.
8. PATENT, TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS
-----------------------------------------------------
The carrying value of trademarks, which are not subject to amortization
under the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"), was $221,653 and $224,797 as of May 31, 2005 and November 30,
2004, respectively. The gross carrying amount of intangible assets subject to
amortization at May 31, 2005 and November 30, 2004, which consist primarily of
non-compete agreements, was $2,139 and $2,400, respectively. The related
accumulated amortization of intangible assets at May 31, 2005 and November 30,
2004 was $1,629 and $1,637, respectively. Amortization of our intangible assets
subject to amortization under the provisions of SFAS 142 for the three months
ended May 31, 2005 and 2004 was $73 and $73, respectively, and for the six
months ended May 31, 2005 and 2004 was $145 and $149, respectively. Estimated
annual amortization expense for these assets for the years ended November 30,
2006, 2007, 2008, 2009 and 2010 is $290, $123, $40, $20 and $0, respectively.
On February 28, 2005, we entered into an agreement to sell the trademark
and product rights of our SELSUN business in certain countries in Africa and
Asia. As a result of the sale, $3,143 of indefinite-lived assets and $108 of
intangible assets subject to amortization were retired, which resulted in an
insignificant loss.
9. INVENTORIES
-----------
Inventories consisted of the following as of May 31, 2005 and November 30,
2004:
2005 2004
--------- ---------
Raw materials and work in process $ 11,938 $ 10,728
Finished goods 11,490 12,395
Excess of current cost over LIFO values (1,433) (1,433)
--------- ---------
Total inventories $ 21,995 $ 21,690
========= =========
10. ACCRUED LIABILITIES
-------------------
Accrued liabilities consisted of the following as of May 31, 2005 and
November 30, 2004:
2005 2004
--------- ---------
Interest $ 3,021 $ 3,152
Salaries, wages and commissions 3,413 4,886
Product advertising and promotion 2,839 3,750
Litigation settlement and legal fees 2,686 10,046
Taxes payable 3,721 --
Other 1,263 1,929
--------- ---------
Total accrued liabilities $ 16,943 $ 23,763
========= =========
10
11. LONG-TERM DEBT
--------------
Long-term debt consisted of the following as of May 31, 2005 and November
30, 2004:
2005 2004
--------- ---------
Revolving Credit Facility due 2009 at a variable
rate of 6.5% and 5.5% as of May 31, 2005 and
November 30, 2004, respectively $ -- $ --
Floating Rate Senior Notes due 2010 at a variable
rate of 5.91% and 4.78% as of May 31, 2005 and
November 30, 2004, respectively 75,000 75,000
7.0% Senior Subordinated Notes due 2014 107,500 125,000
--------- ---------
Total long-term debt 182,500 200,000
Less: current maturities -- --
--------- ---------
Total long-term debt, net of current maturities $ 182,500 $ 200,000
========= =========
On February 26, 2004, we entered into a new Senior Secured Revolving Credit
Facility that matures February 26, 2009 (the "Revolving Credit Facility") with
Bank of America, N.A. that provided an initial borrowing capacity of $25,000 and
an additional $25,000, subject to successful syndication. On March 9, 2004, we
entered into a new commitment agreement with a syndicate of commercial banks led
by Bank of America, N.A., as agent, that enables us to borrow up to a total of
$50,000 under the Revolving Credit Facility. Borrowings under our Revolving
Credit Facility bear interest at LIBOR plus applicable percentages of 1.75% to
2.50% or a base rate (the higher of the federal funds rate plus 0.5% or the
prime rate) plus applicable percentages of 0.25% to 1.0%. The applicable
percentages are calculated based on our leverage ratio. As of May 31, 2005, no
amounts were outstanding under the Revolving Credit Facility, and the variable
rate was 6.5%. Borrowings under our Revolving Credit Facility are secured by
substantially all of our assets, except real property, and shares of capital
stock of our domestic subsidiaries held by us and by the assets of the
guarantors (our domestic subsidiaries). The Revolving Credit Facility contains
covenants, representations, warranties and other agreements by us that are
customary in credit agreements and security instruments relating to financings
of this type. The significant financial covenants include fixed charge coverage
ratio, leverage ratio, senior secured leverage ratio, net worth and brand value
calculations. On July 1, 2005, we had no borrowings outstanding under our
Revolving Credit Facility.
On March 28, 2002, we obtained a $60,000 senior secured credit facility
from a syndicate of commercial banks led by Bank of America, N.A., as agent (the
"Credit Facility"). The Credit Facility included a $15,000 revolving credit line
and a $45,000 term loan. The remaining balance of the term loan under the Credit
Facility was repaid as part of the refinancing transactions discussed herein,
and the revolving credit line under the Credit Facility was terminated on
February 26, 2004.
On February 10, 2004, we commenced a cash tender offer and consent
solicitation for the $204,538 outstanding principal amount of our 8.875% Senior
Subordinated Notes due 2008 (the "8.875% Subordinated Notes"). The consent
solicitation expired on February 24, 2004, and a total of approximately
$174,530, or approximately 85.3% of the 8.875% Subordinated Notes, were tendered
and accepted for payment on February 26, 2004. The remaining principal
outstanding, call premium, accrued interest and interest to call date amounting
to $32,227 was placed in escrow with the indenture trustee to fund the purchase
of additional 8.875% Subordinated Notes tendered prior to March 9, 2004, the
expiration date of the tender offer, and the redemption of the remaining 8.875%
Subordinated Notes not tendered. The remaining 8.875% Subordinated Notes not
tendered in such offer were called in accordance with their terms on April 1,
2004 at a redemption price of 102.9583% of their aggregate principal amount. On
April 1, 2004, the remaining amount held in escrow was released for payment and
all outstanding 8.875% Subordinated Notes were redeemed.
The completion of our refinancing of the Credit Facility and purchase of
approximately $174,530 of our 8.875% Subordinated Notes that were tendered on
February 26, 2004 resulted in a loss on early extinguishment of debt of $11,309
in the first quarter of fiscal 2004. Also in the second quarter of fiscal 2004,
we recorded a loss on early extinguishment of debt of $1,649 related to the
redemption of the remaining $30,008 of our 8.875% Subordinated Notes.
Due to our refinancing transactions, during the six months ended May 31,
2004 tender premiums and related fees of $7,861 were paid and net debt issuance
costs of $5,097 were written off and charged to loss on early extinguishment of
debt in the Condensed Consolidated Statements of Operations. In addition, new
debt issuance costs of $5,718 were capitalized.
Also on February 26, 2004, we issued and sold $75,000 of Floating Rate
Senior Notes due March 1, 2010 (the "Floating Rate Notes") and $125,000 of 7.0%
Senior Subordinated Notes due March 1, 2014 (the "7.0% Subordinated
11
Notes"), the proceeds of which were used to purchase our 8.875% Subordinated
Notes and refinance the Credit Facility as discussed above.
During the second quarter of fiscal 2005, we repurchased $17,500 of our
7.0% Subordinated Notes in the open market at an average premium of 1.6% over
the principal amount of the notes. The repurchases resulted in a loss on early
extinguishment of debt of $744. The outstanding balance of the remaining 7.0%
Subordinated Notes was reduced to $107,500.
The Floating Rate Notes bear interest at a three-month LIBOR plus 3.00% per
year (5.91% as of May 31, 2005). Interest payments are due quarterly in arrears
commencing on June 1, 2004. On March 8, 2004, we entered into an interest rate
cap agreement effective June 1, 2004 with decreasing annual notional principal
amounts of $15,000 beginning March 1, 2006 and cap rates ranging from 4.0% to
5.0% over the life of the agreement. We paid a $1,375 premium to enter into the
interest rate cap agreement, which will be amortized over the life of the
agreement. The current portion of the premium on the interest rate cap agreement
of $264 is included in prepaid expenses and other current assets, and the
long-term portion of $292 is included in other noncurrent assets. The amortized
value of the premium on the interest rate cap was compared to its fair value as
of May 31, 2005, and a charge of $515, net of tax, was recorded to other
comprehensive income. The fair value of the interest rate cap agreement is
valued by a third party. The interest rate cap agreement terminates on March 1,
2010. Our domestic subsidiaries are guarantors of the Floating Rate Notes. The
guarantees of the Floating Rate Notes are unsecured senior obligations of the
guarantors and rank equally with all of the current and future unsecured senior
debt of the guarantors. The guarantees of the Floating Rate Notes effectively
rank junior to any secured debt of the guarantors, including the guarantors'
guarantee of our indebtedness under the Revolving Credit Facility. At any time
after March 1, 2005, we may redeem any of the Floating Rate Notes upon not less
than 30 nor more than 60 days' notice at redemption prices (expressed in
percentages of principal amount), plus accrued and unpaid interest, if any, and
liquidated damages, if any, to the applicable redemption rate, if redeemed
during the twelve-month periods beginning March 1, 2005 at 102.0%, March 1, 2006
at 101.0% and March 1, 2007 and thereafter at 100.0%.
Interest payments on the 7.0% Subordinated Notes are due semi-annually in
arrears on March 1 and September 1, commencing on September 1, 2004. Our
domestic subsidiaries are guarantors of the 7.0% Subordinated Notes. The
guarantees of the 7.0% Subordinated Notes are unsecured senior subordinated
obligations of the guarantors. At any time after March 1, 2009, we may redeem
any of the 7.0% Subordinated Notes upon not less than 30 nor more than 60 days'
notice at redemption prices (expressed in percentages of principal amount), plus
accrued and unpaid interest, if any, and liquidated damages, if any, to the
applicable redemption rate, if redeemed during the twelve-month periods
beginning March 1, 2009 at 103.500%, March 1, 2010 at 102.333%, March 1, 2011 at
101.167% and March 1, 2012 and thereafter at 100.000%. At any time prior to
March 1, 2007, we may redeem up to 35% of the aggregate principal amount of the
7.0% Subordinated Notes (including any additional 7.0% Subordinated Notes) at a
redemption price of 107.0% of the principal amount thereof, plus accrued and
unpaid interest and liquidated damages, if any, thereon to the applicable
redemption rate, with the net cash proceeds of one or more qualified equity
offerings; provided, that (i) at least 65.0% of the aggregate principal amount
of the 7.0% Subordinated Notes remains outstanding immediately after the
occurrence of such redemption (excluding 7.0% Subordinated Notes held by us and
our subsidiaries); and (ii) the redemption must occur within 90 days of the date
of the closing of such qualified equity offering.
The indentures governing the Floating Rate Notes and 7.0% Subordinated
Notes, among other things, limit our ability and the ability of our restricted
subsidiaries to: (i) borrow money or sell preferred stock, (ii) create liens,
(iii) pay dividends on or redeem or repurchase stock, (iv) make certain types of
investments, (v) sell stock in our restricted subsidiaries, (vi) restrict
dividends or other payments from restricted subsidiaries, (vii) enter into
transactions with affiliates, (viii) issue guarantees of debt and (ix) sell
assets or merge with other companies. In addition, if we experience specific
kinds of changes in control, we must offer to purchase the Floating Rate Notes
and 7.0% Subordinated Notes at 101.0% of their principal amount plus accrued and
unpaid interest.
The future maturities of long-term debt outstanding as of May 31, 2005 are
as follows:
2006 $ --
2007 --
2008 --
2009 --
2010 75,000
Thereafter 107,500
---------
$ 182,500
=========
12
12. COMPREHENSIVE INCOME
--------------------
Comprehensive income consisted of the following components for the three
and six months ended May 31, 2005 and 2004, respectively:
For the Three Months For the Six Months
Ended May 31, Ended May 31,
---------------------- ----------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Net income $ 15,507 $ 7,247 $ 24,172 $ 6,535
Other - interest rate cap adjustment (168) -- (199) --
Other - foreign currency translation adjustment (112) (151) (106) 119
--------- --------- --------- ---------
Total $ 15,227 $ 7,096 $ 23,867 $ 6,654
========= ========= ========= =========
13. STOCK BUYBACK
-------------
In January 2005, our board of directors increased the total authorization
to repurchase our common stock under our stock buyback program to $30,000.
During the six months ended May 31, 2005, we repurchased 239 shares of our
common stock for $8,596. All repurchased shares were retired and returned to
unissued. We, however, are limited in our ability to repurchase shares due to
restrictions under the terms of our Revolving Credit Facility, Floating Rate
Notes and 7.0% Subordinated Notes. As of July 1, 2005, we have repurchased 146
shares of our common stock for $6,068 subsequent to May 31, 2005.
14. RETIREMENT PLANS AND POSTRETIREMENT HEALTH CARE BENEFITS
--------------------------------------------------------
RETIREMENT PLANS
We have a noncontributory defined benefit pension plan ("the Plan"), which
covers substantially all employees as of December 31, 2000. The Plan provides
benefits based upon years of service and the employee's compensation. Our
contributions are based on computations by independent actuaries. Plan assets at
May 31, 2005 and November 30, 2004 were invested primarily in United States
government and agency securities and corporate debt and equity securities. In
October 2000, our board of directors adopted an amendment to the Plan that
freezes benefits of the Plan and prohibits new entrants to the Plan effective
December 31, 2000.
Net periodic pension cost for the three and six months ended May 31, 2005
and 2004 comprised the following components:
For the Three Months For the Six Months
Ended May 31, Ended May 31,
---------------------- ----------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Service cost $ -- $ -- $ -- $ --
Interest cost on projected benefit obligation 155 155 310 310
Actual return on plan assets (214) (178) (428) (356)
Net amortization and deferral 7 28 14 56
--------- --------- --------- ---------
Net pension cost (benefit) $ (52) $ 5 $ (104) $ 10
========= ========= ========= =========
No employer contributions were made for the six months ended May 31, 2005
and 2004, and no employer contributions are expected to be made in fiscal 2005.
POSTRETIREMENT HEALTH CARE BENEFITS
We maintain certain postretirement health care benefits for eligible
employees. Employees become eligible for these benefits if they meet certain age
and service requirements. We pay a portion of the cost of medical benefits for
certain retired employees over the age of 65. Effective January 1, 1993, our
contribution is a service-based percentage of the full premium. We pay these
benefits as claims are incurred. Employer contributions expected for fiscal 2005
are approximately $70.
13
Net periodic postretirement health care benefits cost for the three and six
months ended May 31, 2005 and 2004, included the following components:
For the Three Months For the Six Months
Ended May 31, Ended May 31,
---------------------- ----------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Service cost $ 18 $ 16 $ 36 $ 32
Interest cost on accumulated postretirement
benefit obligation 21 20 42 40
Amortization of prior service cost 4 4 8 8
Amortization of net gain (4) (8) (8) (16)
--------- --------- --------- ---------
Net periodic postretirement benefits cost $ 39 $ 32 $ 78 $ 64
========= ========= ========= =========
15. INCOME TAXES
------------
We account for income taxes using the asset and liability approach as
prescribed by SFAS No. 109, "Accounting for Income Taxes". This approach
requires recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been included in the consolidated
financial statements or tax returns. Using the enacted tax rates in effect for
the year in which the differences are expected to reverse, deferred tax assets
and liabilities are determined based on the differences between the financial
reporting and the tax basis of an asset or liability. We record income tax
expense in our consolidated financial statements based on an estimated annual
effective income tax rate. Our tax rate for the three and six months ended May
31, 2005 was 33%, as compared to 35% for the three and six months ended May 31,
2004. The lower rate for the three and six months ended May 31, 2005 reflects
the implementation of a number of foreign and state tax planning initiatives,
which include our determination during the third quarter of fiscal 2004 to
reinvest indefinitely all undistributed earnings of Chattem Canada, a
wholly-owned subsidiary.
Undistributed earnings of Chattem Canada amounted to approximately $470 and
$751 for the three and six months ended May 31, 2005. These earnings are
considered to be reinvested indefinitely and, accordingly, no provision for U.S.
federal and state income taxes has been provided thereon. Upon distribution of
those earnings in the form of dividends or otherwise, we would be subject to
U.S. income taxes (subject to an adjustment for foreign tax credits).
16. PRODUCT SEGMENT INFORMATION
---------------------------
Net sales of our domestic product categories within our single healthcare
business segment for the three and six months ended May 31, 2005 and 2004 are as
follows:
For the Three Months For the Six Months
Ended May 31, Ended May 31,
---------------------- ----------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Topical analgesics $ 25,044 $ 18,134 $ 46,452 $ 33,846
Medicated skin care products 15,833 17,330 33,457 30,663
Dietary supplements 10,283 10,369 18,943 18,880
Medicated dandruff shampoos and conditioner 7,888 7,406 17,688 16,627
Other OTC and toiletry products 9,636 10,445 17,713 19,275
--------- --------- --------- ---------
Total $ 68,684 $ 63,684 $ 134,253 $ 119,291
========= ========= ========= =========
17. COMMITMENTS AND CONTINGENCIES
-----------------------------
GENERAL LITIGATION
We were named as a defendant in a number of lawsuits alleging that the
plaintiffs were injured as a result of ingestion of products containing
phenylpropanolamine ("PPA"), which was an active ingredient in most of our
DEXATRIM products until November 2000. The lawsuits filed in federal court were
transferred to the United States District Court for the Western District of
Washington before United States District Judge Barbara Jacobs Rothstein (IN RE
PHENYLPROPANOLAMINE ("PPA") PRODUCTS LIABILITY LITIGATION, MDL NO. 1407). The
remaining lawsuits were filed in state court in a number of different states.
On April 13, 2004, we entered into a class action settlement agreement with
representatives of the plaintiffs' settlement class, which provided for a
national class action settlement of all DEXATRIM PPA claims. On November 12,
2004, Judge Barbara J. Rothstein of the United States District Court for the
Western District of Washington entered a final order and judgment certifying the
class and granting approval of the DEXATRIM PPA settlement. After the final
judgment was entered,
14
two parties who had objected to the settlement filed appeals challenging and
seeking to set aside the final judgment. Both of these appeals have now been
dismissed.
The DEXATRIM PPA settlement includes claims against us involving alleged
injuries by DEXATRIM products containing PPA in which the alleged injury
occurred after December 21, 1998, the date we acquired the DEXATRIM brand. In
accordance with the terms of the class action settlement agreement, we
previously published notice of the settlement and details as to the manner in
which claims could be submitted. The deadline for submission of claims was July
7, 2004. A total of 391 claims were certified by the court as timely submitted.
Of these 391 claims, 173 alleged stroke as an injury and 218 alleged other
non-stroke injuries. A total of 14 claimants with alleged injuries that occurred
after December 21, 1998 elected to opt out of the class settlement.
Subsequently, we have settled eight of the opt out claims. The six remaining opt
out claimants may pursue claims for damages against us in separate lawsuits. As
of July 1, 2005, three of the six remaining opt out claimants have filed
lawsuits against us that we are continuing to defend.
We previously reached an agreement with Kemper Indemnity Insurance Company
("Kemper") to settle its lawsuit that sought to rescind our policy for $50,000
of excess coverage for product liability claims. After giving effect to the
settlement with Kemper, we have available for the claims against us related to
the PPA litigation, through our first three layers of insurance coverage,
approximately $60,885 of the $77,000 of product liability coverage provided by
these insurance policies. The $60,885 of available coverage consists of $37,500
of insurance under the Kemper policy and approximately $23,385 under policies
with two other insurance companies. In accordance with the terms of the class
action settlement agreement, this $60,885 of coverage has been funded into a
settlement trust. In addition, on July 14, 2004, we entered into a settlement
agreement with Sidmak Laboratories, Inc. ("Sidmak"), the manufacturer of
DEXATRIM products containing PPA, pursuant to which Sidmak has contributed
$10,000 into the settlement trust. We have also entered into a settlement
agreement with Interstate Fire & Casualty Company ("Interstate") with regard to
its $25,000 of coverage in excess of the insurance funds available in the
settlement trust. In accordance with the settlement agreement, Interstate has
agreed to provide coverage of DEXATRIM PPA claims that are covered by its policy
after $78,500 has been paid toward covered claims. If the $78,500 threshold is
met, Interstate has agreed to pay 100% of the next $4,000 of claims covered by
its policy; 75% of the next $8,500 of such claims; and 50% of the last $12,500
of such claims. Pursuant to our settlement agreement with Interstate, we are
responsible for any claims not covered by the Interstate policy either because
the alleged injury did not occur before May 31, 2001, or the claim was first
made against us after May 31, 2004. However, to the extent that all claims
within the class settlement are valued at an amount less than the amount funded
into the settlement trust, the claims that are not covered by the Interstate
policy will be paid from funds available in the settlement trust.
Prior to the fourth quarter of fiscal 2004, we were unable to reasonably
estimate the amount of liability related to the DEXATRIM litigation, due to the
significant assumptions and uncertainty involved in estimating the value of the
claims involved. As a result of the final approval of the DEXATRIM PPA
settlement on November 12, 2004 and the term sheet of settlement reached with
Interstate on December 13, 2004, as of November 30, 2004 we were able to
estimate reasonably the probable loss related to the DEXATRIM litigation. Based
upon the then-estimated litigation settlement costs relating to our DEXATRIM
products, we recorded a litigation settlement charge of $11,345 in the fourth
quarter of fiscal 2004, of which $9,519 was included in accrued liabilities in
our Consolidated Balance Sheet as of November 30, 2004.
During the second quarter of fiscal 2005, we resolved approximately 125, or
approximately 75%, of the alleged stroke claims submitted in the settlement. The
value of these claims was determined through negotiations with representatives
of the claimants during which we valued claims using the settlement matrix
contained in the court-approved class action settlement agreement. Based on the
agreed upon values of the resolved stroke claims as compared to previous
estimates, the number of claims actually submitted in accordance with the
requirements of the settlement agreement and the estimated remaining settlement
costs, we revised our previous estimate of the DEXATRIM litigation settlement
costs. As a result of the revised estimate, in the second quarter of fiscal 2005
we reversed $6,009 of the litigation settlement charge that was previously taken
in the fourth quarter of fiscal 2004. During the second quarter of fiscal 2005,
we incurred and recorded $957 of legal expenses related to the DEXATRIM
litigation offset by a $535 reimbursement from the settlement trust for
previously incurred administrative costs. As a result of the reversed charge and
the net DEXATRIM related expenses incurred in the six months ended May 31, 2005,
$2,607 is included in accrued liabilities in our May 31, 2005 Condensed
Consolidated Balance Sheet relating to the DEXATRIM litigation.
We currently do not expect to record any additional charges relative to the
settlement costs of the PPA litigation, although we will continue to incur and
record future DEXATRIM related legal expenses in the period incurred. Based on
our current estimate of the DEXATRIM PPA litigation settlement costs, we believe
that the amount funded into the settlement trust from our first three layers of
insurance coverage and Sidmak will be sufficient to fully fund all claims in the
settlement. Any funds remaining in the settlement trust after all claims and
expenses of the trust have been paid will be distributed as approved by the
court in accordance with the class action settlement agreement and our
settlement agreements with each of Kemper and Sidmak. At this time, given the
uncertainty of the final settlement costs, we are unable to estimate
15
reasonably whether we will recover any funds from the settlement trust or the
timing or the amount of any potential recovery from the settlement trust.
We are also named as a defendant in approximately 206 lawsuits relating to
DEXATRIM containing PPA which involve alleged injuries by DEXATRIM products
containing PPA manufactured and sold prior to our acquisition of DEXATRIM on
December 21, 1998. In these lawsuits, we are being defended on the basis of
indemnification obligations assumed by The DELACO Company ("DELACO"), successor
by merger to the Thompson Medical Company, Inc., which owned the brand prior to
December 21, 1998. On February 12, 2004, DELACO filed a Chapter 11 bankruptcy
petition in the United States Bankruptcy Court for the Southern District of New
York. Accordingly, it is uncertain whether DELACO will be able to indemnify us
for claims arising from products manufactured and sold prior to our acquisition
of DEXATRIM on December 21, 1998. However, DELACO is seeking to resolve all
DEXATRIM cases with injury dates prior to December 21, 1998 as part of a
liquidating Chapter 11 bankruptcy plan. We understand that DELACO's product
liability insurance carriers and other sources are expected to fund this plan.
We have filed a claim in DELACO's bankruptcy case in order to preserve our
claims for indemnification against DELACO.
In order to resolve DELACO's indemnity obligations to us, we have entered
into a settlement agreement with DELACO dated June 30, 2005 ("the DELACO
Agreement"). Pursuant to the DELACO Agreement, we will accept liability for all
claims against DELACO and its predecessor, Thompson Medical Company, Inc., or us
relating to DEXATRIM products involving an injury date after December 21, 1998,
and will hold the DELACO bankruptcy estate completely harmless from any such
claims. In exchange, a settlement trust to be established under DELACO's
bankruptcy plan will pay us $8,750 and will assume potential liability for all
claims related to DEXATRIM products alleging injury dates on or before December
21, 1998. Upon the effective date of the bankruptcy plan, we will be released
from liability for all such claims whether the claim is brought by a plaintiff
or co-defendant to any DEXATRIM PPA lawsuit. All claims with injury dates prior
to December 21, 1998 will be channeled to the DELACO settlement trust, which we
expect to come into existence and be funded prior to the effective date of the
DELACO bankruptcy plan. This payment and the channeling injunction and release
described above will conclusively compromise and settle the claim we previously
filed in the DELACO bankruptcy case. The DELACO Agreement is conditioned upon
and subject to Bankruptcy Court approval, confirmation of a DELACO bankruptcy
plan that contains the terms provided for in the DELACO Agreement and funding of
the DELACO settlement trust by a cash contribution to be paid by DELACO's
insurance carriers and other parties. In addition, the DELACO Agreement is
related to and conditioned upon an agreement DELACO reached with one of its
insurance carriers, which also must receive Bankruptcy Court approval.
Our product liability insurance, as described above, would not apply to
claims arising from products manufactured and sold prior to our acquisition of
DEXATRIM. If the DELACO bankruptcy plan does not resolve these cases as we
expect, we will also seek to defend ourselves in these lawsuits on the basis
that we did not manufacture and sell products containing PPA prior to December
21, 1998. In the approximately 206 cases that have been filed against us for
products manufactured and sold prior to December 21, 1998, approximately half of
the plaintiffs are in cases filed in states that we believe do not under current
law impose liability upon a successor. The remaining plaintiffs are in cases
filed in states that may in some circumstances permit liability against a
successor. Even in these cases, although there can be no assurances, we do not
believe that successor liability would be imposed against us. The reasons for
our belief, among others, are that we did not purchase all of DELACO's assets
and DELACO continued to operate its remaining business after December 21, 1998;
we did not cause DELACO's bankruptcy; and many plaintiffs included in cases
filed in states that in some circumstances impose successor liability are
actually residents of other states. If the DELACO Agreement receives Bankruptcy
Court approval and the DELACO bankruptcy plan is confirmed with the terms
required by the DELACO Agreement, we will be released from potential liability
in these cases.
We maintain a significantly lower level of insurance coverage for all other
potential claims relating to our products including DEXATRIM products containing
ephedrine. For the current policy period, we are insured for product liability
insurance for all of our other products, including DEXATRIM products containing
ephedrine, for up to $20,000 through our captive insurance subsidiary, of which
approximately $3,200 is funded as of July 1, 2005. We also have $30,000 of
excess coverage through third party insurers. There are two lawsuits currently
pending against us related to DEXATRIM containing ephedrine.
On December 30, 2003, the United States Food and Drug Administration
("FDA") issued a consumer alert on the safety of dietary supplements containing
ephedrine alkaloids and on February 6, 2004 published a final rule with respect
to these products. The final rule prohibits the sale of dietary supplements
containing ephedrine alkaloids because such supplements present an unreasonable
risk of illness or injury. The final rule became effective on April 11, 2004.
Although we discontinued the manufacturing and shipment of DEXATRIM containing
ephedrine in September 2002, the FDA's final rule may result in additional
lawsuits being filed against us alleging damages related to the use or purchase
of DEXATRIM containing ephedrine. On April 13, 2005, the United States District
Court for the District of Utah ruled that FDA erred in
16
using a risk-benefit analysis as the basis for its ban of ephedra at all dosage
levels. This ruling potentially calls into question the FDA's final rule on
ephedrine alkaloids. However, FDA is appealing the District Court's decision.
We previously were named in a class action filed in the United States
District Court for the Southern District of New York seeking certification of a
class consisting of New York residents who have purchased DEXATRIM Results or
DEXATRIM Natural since January 2000. The class action lawsuit sought
compensatory and punitive damages arising out of allegedly false advertising in
connection with the sale of DEXATRIM Results and DEXATRIM Natural products. None
of the plaintiffs in this action alleged personal injury as a result of the
ingestion of a DEXATRIM product. On March 29, 2004, a stipulation was submitted
to the court dismissing the case on jurisdictional grounds. Pursuant to the
stipulation, the plaintiffs may re-file the class action in New York state
court. These plaintiffs have not refiled this lawsuit as of July 1, 2005.
We have been named as a defendant in a putative class action suit filed in
the Superior Court of the State of California for the County of Los Angeles on
February 11, 2004. The lawsuit seeks certification of classes consisting of
residents of the United States, or residents of the State of California, who
have purchased our BULLFROG sun care products during the past four years. The
lawsuit seeks injunctive relief and compensatory damages under the California
Business and Professions Code against us arising out of alleged deceptive,
untrue or misleading advertising, and breach of warranty, in connection with the
manufacturing, labeling, advertising, promotion and sale of BULLFROG products.
The plaintiff has stipulated that the amount in controversy with respect to
plaintiffs' individual claim and each member of the proposed class does not
exceed $75. We filed an answer on June 28, 2004 and are vigorously defending the
lawsuit.
We have been named as a defendant in a putative class action suit filed in
the Superior Court of the State of California, County of Los Angeles, on January
13, 2005. The lawsuit seeks injunctive relief, compensatory damages and attorney
fees against us under the California Business and Professions Code, arising out
of alleged deceptive, untrue or misleading advertising and breach of express
warranty in connection with the manufacturing, labeling, advertising, promotion
and sale of certain DEXATRIM Natural products. The lawsuit seeks certification
of a class consisting of all persons who purchased DEXATRIM Natural in
California during the four year period prior to the filing of the lawsuit up to
the date of any judgment obtained. The plaintiff has stipulated that the amount
in controversy with individual claim and each member of the proposed class in
the action does not exceed $75. We intend to defend vigorously the lawsuit.
Other claims, suits and complaints arise in the ordinary course of our
business involving such matters as patents and trademarks, product liability,
environmental matters, employment law issues and other alleged injuries or
damage. The outcome of such litigation cannot be predicted, but, in the opinion
of management, based in part upon assessments from counsel, all such other
pending matters are without merit or are of such kind or involve such other
amounts as would not have a material adverse effect on our financial position,
results of operations or cash flows if disposed of unfavorably.
REGULATORY
The FDA, the Drug Enforcement Administration and a number of state and
local governments have enacted or proposed restrictions or prohibitions on the
sale of products that contain ephedrine. Ephedrine can refer to the herbal
substance derived from the plant ephedra or the plant heart leaf, which, until
September 2002, was used in the manufacturing of some forms of DEXATRIM Natural
and DEXATRIM Results, or synthetic ephedrine, a FDA regulated ingredient used in
some OTC drug products, which has not been used in our products. These
restrictions include the prohibition of OTC sales, required warnings or labeling
statements, record keeping and reporting requirements, the prohibition of sales
to minors, per transaction limits on the quantity of product that may be
purchased and limitations on advertising and promotion. The enactment of further
restrictions or prohibitions on sales, the perceived safety concerns related to
ephedrine and the possibility of further regulatory action could result in an
increase in the number of ephedrine related lawsuits filed including ones in
which we are named as a defendant.
In 1997, the FDA published a proposed rule on the use of dietary
supplements containing ephedrine alkaloids. In June 2002, the United States
Department of Health and Human Services ("HHS") proposed an expanded scientific
evaluation of ephedra which led to the issuance of a report by the RAND-based
Southern California Evidence-Based Practice Center (the "RAND Report"). The RAND
Report concluded that ephedrine, ephedrine plus caffeine and ephedra-containing
dietary supplements with or without herbs containing caffeine all promote modest
amounts of weight loss over the short term and use of ephedra or ephedrine plus
caffeine is associated with an increased risk of gastrointestinal, psychiatric
and autonomic symptoms. The adverse event reports contained a smaller number of
more serious adverse events. Given the small number of such events, the RAND
Report concluded that further study would be necessary to determine whether
consumption of ephedra or ephedrine may be causally related to these serious
adverse events. In connection with the RAND Report, HHS has sought public
comment on whether additional measures are required concerning the sale and
distribution of dietary supplements containing ephedrine alkaloids.
17
On December 30, 2003, the FDA issued a consumer alert on the safety of
dietary supplements containing ephedrine alkaloids and on February 6, 2004
published a final rule with respect to these products. The final rule prohibits
the sale of dietary supplements containing ephedrine alkaloids because such
supplements present an unreasonable risk of illness or injury. The final rule
became effective on April 11, 2004. Although we discontinued the manufacturing
and shipment of DEXATRIM containing ephedrine in September 2002, the FDA's final
rule may result in lawsuits in addition to those we currently have being filed
against us alleging damages related to the use or purchase of DEXATRIM
containing ephedrine. On April 13, 2005, the United States District Court for
the District of Utah ruled that FDA erred in using a risk-benefit analysis as
the basis for its ban of ephedra at all dosage levels. This ruling potentially
calls into question the FDA's final rule on ephedrine alkaloids. However, FDA is
appealing the District Court's decision.
We were notified in October 2000 that the FDA denied a citizen petition
submitted by Thompson Medical Company, Inc., the previous owner of SPORTSCREME
and ASPERCREME. The petition sought a determination that 10% trolamine
salicylate, the active ingredient in SPORTSCREME and ASPERCREME, was clinically
proven to be an effective active ingredient in external analgesic OTC drug
products and should be included in the FDA's yet-to-be finalized monograph for
external analgesics. We have met with the FDA and submitted a proposed protocol
study to evaluate the efficacy of 10% trolamine salicylate as an active
ingredient in OTC external analgesic drug products. We are working to develop
alternate formulations for SPORTSCREME and ASPERCREME in the event that the FDA
does not consider the available clinical data to conclusively demonstrate the
efficacy of trolamine salicylate when the OTC external analgesic monograph is
finalized. If 10% trolamine salicylate is not included in the final monograph,
we would likely be required to discontinue these products as currently
formulated and remove them from the market after expiration of an anticipated
grace period. If this occurred, we believe we could still market these products
as homeopathic products and could also reformulate them using ingredients
included in the FDA monograph. We are uncertain as to when the monograph is
likely to become final.
Certain of our topical analgesic products are currently marketed under an
FDA tentative final monograph. The FDA has proposed that the final monograph
exclude external analgesic products in patch, plaster or poultice form, unless
the FDA receives additional data supporting the safety and efficacy of these
products. On October 14, 2003, we submitted to the FDA information regarding the
safety of our ICY HOT patches and arguments to support our product's inclusion
in the final monograph. We have also participated in an industry effort
coordinated by Consumer Healthcare Products Association ("CHPA") to establish
with the FDA a protocol of additional research that will allow the patches to be
marketed under the final monograph even if the final monograph does not
explicitly allow them. The CHPA submission to FDA was made on October 15, 2003.
Thereafter, in April 2004, we launched the ICY HOT Sleeve, a flexible,
non-occlusive fabric patch with menthol levels consistent with the OTC
monograph. If additional research is required either as a preliminary to final
FDA monograph approval and/or as a requirement of future individual product
sale, we may need to invest in a considerable amount of expensive testing and
data analysis. Any preliminary cost may be shared with other patch
manufacturers. Because the submissions made into the FDA docket have been
forwarded from its OTC Division to its Dermatological Division within the Center
for Drug Evaluation and Research ("CDER"), we are uncertain as to when the
monograph is likely to become final. If neither action described above is
successful and the final monograph excludes such products, we will have to file
a new drug application ("NDA") in order to continue to market the ICY HOT Patch,
ICY HOT Sleeve or similar delivery systems under our other topical analgesic
brands. In such case, we would have to remove the existing products from the
market one year from the effective date of the final monograph, pending FDA
review and approval of an NDA. The preparation of an NDA would likely take us
six to 18 months and would be expensive. It typically takes the FDA at least 12
months to rule on an NDA once it is submitted.
We have responded to certain questions with respect to efficacy received
from the FDA in connection with clinical studies for pyrilamine maleate, one of
the active ingredients used in certain of the PAMPRIN and PREMSYN PMS products.
While we addressed all of the FDA questions in detail, the final monograph for
menstrual drug products, which has not yet been issued, will determine if the
FDA considers pyrilamine maleate safe and effective for menstrual relief
products. If pyrilamine maleate is not included in the final monograph, we would
be required to reformulate the products to continue to provide the consumer with
multi-symptom relief benefits. We have been actively monitoring the process and
do not believe that either PAMPRIN or PREMSYN PMS will be materially adversely
affected by the FDA review. We believe that any adverse finding by the FDA would
likewise affect our principal competitors in the menstrual product category. We
are also aware of the FDA's concern about the potential toxicity due to
concomitant use of OTC and prescription drugs that contain the ingredient
acetaminophen, an ingredient also found in PAMPRIN and PREMSYN PMS. We are
participating in an industry-wide effort to reassure the FDA that the current
recommended dosing regimen is safe and effective and that proper labeling and
public education by both OTC and prescription drug companies are the best
policies to abate the FDA's concern. There can be no assurance as to what
action, if any, the FDA may take with respect to acetaminophen.
In early 2005, infrequent, but serious, adverse cardiovascular events were
reported to the FDA associated with patients who were prescribed a subclass of
COX-2 inhibitor non-steroidal anti-inflammatory drugs ("NSAIDs") for long
periods to relieve pain of chronic diseases such as arthritis. These products
include Vioxx(R), Bextra(R), and Celebrex(R). In February 2005, the FDA held a
joint advisory committee meeting to seek external counsel on the extent to which
manufacturers might
18
further warn patients of these cardiovasular risks on prescription product
labeling, or prohibit sale of these prescription products. As part of its
response on this issue, the FDA has recommended labeling changes for both the
prescription and OTC NSAIDs. Well-known OTC NSAIDs such as ibuprofen and
naproxen, which have been sold in vast quantities since the 1970s, will be
affected by this regulatory action. Manufacturers of OTC NSAIDs are being asked
to revise their labeling to provide more specific information about the
potential cardiovascular and gastrointestinal risks recognizing the limited dose
and duration of treatment of these products. Our PAMPRIN ALL DAY product, which
contains naproxen sodium, will be subject to these new labeling requirements.
PAMPRIN ALL DAY is manufactured for us by The Perrigo Company ("Perrigo"),
holder of an abbreviated NDA for naproxen sodium. As holder of the abbreviated
NDA, Perrigo expects to make the mandated labeling changes within the time-frame
required by the FDA. We do not currently expect the distribution of PAMPRIN ALL
DAY to be adversely affected as a result of the required labeling changes.
Our business is also regulated by the California Safe Drinking Water and
Toxic Enforcement Act of 1986, known as Proposition 65. Proposition 65 prohibits
businesses from exposing consumers to chemicals that the state has determined
cause cancer or reproduction toxicity without first giving fair and reasonable
warning unless the level of exposure to the carcinogen or reproductive toxicant
falls below prescribed levels. From time to time, one or more ingredients in our
products could become subject to an inquiry under Proposition 65. If an
ingredient is on the state's list as a carcinogen, it is possible that a claim
could be brought, in which case we would be required to demonstrate that
exposure is below a "no significant risk" level for consumers. Any such claims
may cause us to incur significant expense, and we may face monetary penalties or
injunctive relief, or both, or be required to reformulate our product to
acceptable levels. The State of California under Proposition 65 is also
considering the inclusion of titanium dioxide on the state's list of suspected
carcinogens. Titanium dioxide has a long history of widespread use as an
excipient in prescription and OTC pharmaceuticals, cosmetics, dietary
supplements and skin care products and is an active ingredient in our BULLFROG
Superblock products. We have participated in an industry-wide submission to the
State of California, facilitated through the CHPA, presenting evidence that
titanium dioxide presents "no significant risk" to consumers.
18. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
--------------------------------------------
The condensed consolidating financial statements, for the dates or periods
indicated, of Chattem, Inc. ("Chattem"), Signal Investment & Management Co.
("Signal"), SunDex, LLC ("SunDex") and Chattem (Canada) Holdings, Inc.
("Canada"), the guarantors of the long-term debt of Chattem, and the
non-guarantor direct and indirect wholly-owned subsidiaries of Chattem are
presented below. Signal is 89% owned by Chattem and 11% owned by Canada. SunDex
and Canada are wholly-owned subsidiaries of Chattem. The guarantees of Signal,
SunDex and Canada are full and unconditional and joint and several. The
guarantees of Signal, SunDex and Canada as of May 31, 2005 arose in conjunction
with Chattem's Revolving Credit Facility and Chattem's issuance of the Floating
Rate Notes and the 7.0% Subordinated Notes (See Note 11). The maximum amount of
future payments the guarantors would be required to make under the guarantees as
of May 31, 2005 is $182,500.
19
Note 18
CHATTEM, INC. AND SUBSIDIARIES
- ------------------------------
CONDENSED CONSOLIDATING BALANCE SHEETS
- --------------------------------------
MAY 31, 2005
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
--------- --------- --------- ------------ ------------
ASSETS
- ------
CURRENT ASSETS:
Cash and cash equivalents $ 25,666 $ 2,588 $ 7,563 $ -- $ 35,817
Accounts receivable, less allowances of $3,396 38,822 21,410 6,704 (21,410) 45,526
Interest receivable 17 1,237 -- (1,254) --
Inventories 17,341 2,093 2,561 -- 21,995
Deferred income taxes 2,511 -- -- -- 2,511
Prepaid expenses and other current assets 1,944 -- 3,473 -- 5,417
--------- --------- --------- --------- ---------
Total current assets 86,301 27,328 20,301 (22,664) 111,266
--------- --------- --------- --------- ---------
PROPERTY, PLANT AND EQUIPMENT, NET 26,993 775 244 -- 28,012
--------- --------- --------- --------- ---------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net 509 283,944 -- (62,290) 222,163
Debt issuance costs, net 4,331 -- -- -- 4,331
Investment in subsidiaries 266,105 33,000 70,266 (369,371) --
Note receivable -- 33,000 -- (33,000) --
Other 5,414 -- (340) -- 5,074
--------- --------- --------- --------- ---------
Total other noncurrent assets 276,359 349,944 69,926 (464,661) 231,568
--------- --------- --------- --------- ---------
TOTAL ASSETS $ 389,653 $ 378,047 $ 90,471 $(487,325) $ 370,846
========= ========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable and other $ 14,725 $ -- $ 3,005 $ -- $ 17,730
Accrued liabilities 32,234 3,025 4,348 (22,664) 16,943
--------- --------- --------- --------- ---------
Total current liabilities 46,959 3,025 7,353 (22,664) 34,673
--------- --------- --------- --------- ---------
LONG-TERM DEBT 182,500 -- 33,000 (33,000) 182,500
--------- --------- --------- --------- ---------
DEFERRED INCOME TAXES 683 29,200 -- -- 29,883
--------- --------- --------- --------- ---------
OTHER NONCURRENT LIABILITIES 1,832 -- -- -- 1,832
--------- --------- --------- --------- ---------
INTERCOMPANY ACCOUNTS 35,715 (35,888) 173 -- --
--------- --------- --------- --------- ---------
SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized 1,000,
none issued -- -- -- -- --
Common shares, without par value, authorized 50,000,
issued and outstanding 19,849 77,994 -- -- -- 77,994
Share capital of subsidiaries -- 329,704 43,209 (372,913) --
Retained earnings 48,060 52,006 6,618 (58,624) 48,060
--------- --------- --------- --------- ---------
Total 126,054 381,710 49,827 (431,537) 126,054
--------- --------- --------- --------- ---------
Unamortized value of restricted common shares issued (3,452) -- -- -- (3,452)
Cumulative other comprehensive income, net of taxes:
Interest rate cap adjustment (515) -- -- -- (515)
Foreign currency translation adjustment (123) -- 118 (124) (129)
--------- --------- --------- --------- ---------
Total shareholders' equity 121,964 381,710 49,945 (431,661) 121,958
--------- --------- --------- --------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 389,653 $ 378,047 $ 90,471 $(487,325) $ 370,846
========= ========= ========= ========= =========
20
Note 18
CHATTEM, INC. AND SUBSIDIARIES
- ------------------------------
CONDENSED CONSOLIDATING BALANCE SHEETS
- --------------------------------------
NOVEMBER 30, 2004
(In thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
--------- --------- --------- ------------ ------------
ASSETS
- ------
CURRENT ASSETS:
Cash and cash equivalents $ 28,344 $ 1,967 $ 9,882 $ -- $ 40,193
Accounts receivable, less allowances of $1,682 26,727 8,733 5,376 (8,738) 32,098
Interest receivable -- 619 -- (619) --
Inventories 16,681 3,020 1,989 -- 21,690
Refundable income taxes 4,702 -- -- -- 4,702
Deferred income taxes 4,308 -- -- -- 4,308
Prepaid expenses and other current assets 3,489 -- 194 -- 3,683
--------- --------- --------- --------- ---------
Total current assets 84,251 14,339 17,441 (9,357) 106,674
--------- --------- --------- --------- ---------
PROPERTY, PLANT AND EQUIPMENT, NET 27,724 775 266 -- 28,765
--------- --------- --------- --------- ---------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net 763 287,087 -- (62,290) 225,560
Debt issuance costs, net 5,174 -- -- -- 5,174
Investment in subsidiaries 249,999 33,000 68,477 (351,476) --
Note receivable -- 33,000 -- (33,000) --
Other 4,681 -- 870 -- 5,551
--------- --------- --------- --------- ---------
Total other noncurrent assets 260,617 353,087 69,347 (446,766) 236,285
--------- --------- --------- --------- ---------
TOTAL ASSETS $ 372,592 $ 368,201 $ 87,054 $(456,123) $ 371,724
========= ========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable and other $ 11,398 $ -- $ 1,943 $ -- $ 13,341
Accrued liabilities 27,435 1,107 4,578 (9,357) 23,763
--------- --------- --------- --------- ---------
Total current liabilities 38,833 1,107 6,521 (9,357) 37,104
--------- --------- --------- --------- ---------
LONG-TERM DEBT 200,000 -- 33,000 (33,000) 200,000
--------- --------- --------- --------- ---------
DEFERRED INCOME TAXES (511) 26,243 -- -- 25,732
--------- --------- --------- --------- ---------
OTHER NONCURRENT LIABILITIES 1,776 -- -- -- 1,776
--------- --------- --------- --------- ---------
INTERCOMPANY ACCOUNTS 25,382 (25,484) 102 -- --
--------- --------- --------- --------- ---------
SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized 1,000,
none issued -- -- -- -- --
Common shares, without par value, authorized 50,000,
issued and outstanding 19,882 85,949 -- -- -- 85,949
Share capital of subsidiaries -- 329,705 41,100 (370,805) --
Retained earnings 23,888 36,630 6,115 (42,745) 23,888
--------- --------- --------- --------- ---------
Total 109,837 366,335 47,215 (413,550) 109,837
--------- --------- --------- --------- ---------
Unamortized value of restricted common shares issued (2,386) -- -- -- (2,386)
Cumulative other comprehensive income, net of taxes:
Interest rate cap adjustment (316) -- -- -- (316)
Foreign currency translation adjustment (23) -- 216 (216) (23)
--------- --------- --------- --------- ---------
Total shareholders' equity 107,112 366,335 47,431 (413,766) 107,112
--------- --------- --------- --------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 372,592 $ 368,201 $ 87,054 $(456,123) $ 371,724
========= ========= ========= ========= =========
21
Note 18
CHATTEM, INC. AND SUBSIDIARIES
- ------------------------------
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
- ------------------------------------------------
FOR THE SIX MONTHS ENDED MAY 31, 2005
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
--------- --------- --------- ------------ ------------
TOTAL REVENUES $ 119,374 $ 40,447 $ 10,372 $ (22,975) $ 147,218
--------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales 33,290 4,964 4,687 (1,565) 41,376
Advertising and promotion 31,881 7,009 2,192 -- 41,082
Selling, general and administrative 23,311 193 715 -- 24,219
Litigation settlement (4,908) -- 2,076 -- (2,832)
Equity in subsidiary income (15,878) -- -- 15,878 --
--------- --------- --------- --------- ---------
Total costs and expenses 67,696 12,166 9,670 14,313 103,845
--------- --------- --------- --------- ---------
INCOME FROM OPERATIONS 51,678 28,281 702 (37,288) 43,373
--------- --------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense (6,953) -- (1,255) 1,255 (6,953)
Investment and other income, net 324 1,248 1,335 (2,505) 402
Loss on early extinguishment of debt (744) -- -- -- (744)
Royalties (18,385) (3,025) -- 21,410 --
Corporate allocations 1,722 (1,690) (32) -- --
--------- --------- --------- --------- ---------
Total other income (expense) (24,036) (3,467) 48 20,160 (7,295)
--------- --------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 27,642 24,814 750 (17,128) 36,078
PROVISION FOR INCOME TAXES 3,470 8,189 247 -- 11,906
--------- --------- --------- --------- ---------
NET INCOME $ 24,172 $ 16,625 $ 503 $ (17,128) $ 24,172
========= ========= ========= ========= =========
22
Note 18
CHATTEM, INC. AND SUBSIDIARIES
- ------------------------------
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
- ------------------------------------------------
FOR THE SIX MONTHS ENDED MAY 31, 2004
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
--------- --------- --------- ------------ ------------
TOTAL REVENUES $ 104,264 $ 38,417 $ 8,942 $ (20,294) $ 131,329
--------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales 29,428 5,698 3,574 (1,192) 37,508
Advertising and promotion 28,903 6,427 2,282 -- 37,612
Selling, general and administrative 20,234 216 856 -- 21,306
Litigation settlement 3,657 -- -- -- 3,657
Equity in subsidiary income (15,476) -- -- 15,476 --
--------- --------- --------- --------- ---------
Total costs and expenses 66,746 12,341 6,712 14,284 100,083
--------- --------- --------- --------- ---------
INCOME FROM OPERATIONS 37,518 26,076 2,230 (34,578) 31,246
--------- --------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense (8,394) -- (1,238) 1,238 (8,394)
Investment and other income, net 94 1,240 689 (1,863) 160
Loss on early extinguishment of debt (12,958) -- -- -- (12,958)
Royalties (15,988) (3,114) -- 19,102 --
Corporate allocations 1,791 (1,731) (60) -- --
--------- --------- --------- --------- ---------
Total other income (expense) (35,455) (3,605) (609) 18,477 (21,192)
--------- --------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 2,063 22,471 1,621 (16,101) 10,054
--------- --------- --------- --------- ---------
(BENEFIT FROM) PROVISION FOR INCOME TAXES (4,472) 7,865 126 -- 3,519
--------- --------- --------- --------- ---------
NET INCOME $ 6,535 $ 14,606 $ 1,495 $ (16,101) $ 6,535
========= ========= ========= ========= =========
23
Note 18
CHATTEM, INC. AND SUBSIDIARIES
- ------------------------------
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
- ------------------------------------------------
FOR THE SIX MONTHS ENDED MAY 31, 2005
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
--------- --------- --------- ------------ ------------
OPERATING ACTIVITIES:
Net income $ 24,172 $ 16,625 $ 503 $ (17,128) $ 24,172
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 3,075 -- 32 -- 3,107
Deferred income taxes 3,163 2,957 -- -- 6,120
Tax (expense) benefit realized from stock option plans (2,807) -- -- -- (2,807)
Loss on early extinguishment of debt 744 -- -- -- 744
Other, net 67 -- (16) -- 51
Equity in subsidiary income (17,128) -- -- 17,128 --
Changes in operating assets and liabilities:
Accounts receivable (15,239) (9,533) (1,328) 12,672 (13,428)
Interest receivable (17) (619) -- 636 --
Inventories (660) 927 (572) -- (305)
Refundable income taxes 4,702 -- -- -- 4,702
Prepaid expenses and other current assets 1,545 -- (58) -- 1,487
Accounts payable and accrued liabilities 8,126 1,919 832 (13,308) (2,431)
--------- --------- --------- --------- ---------
Net cash provided by (used in) operating activities 9,743 12,276 (607) -- 21,412
--------- --------- --------- --------- ---------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (946) -- (10) -- (956)
Sales of patents, trademarks and other product rights 3,252 -- -- -- 3,252
Increase in other assets, net (199) -- (2,110) -- (2,309)
--------- --------- --------- --------- ---------
Net cash provided by (used in) investing activities 2,107 -- (2,120) -- (13)
--------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Repayment of long-term debt (17,500) -- -- -- (17,500)
Repayment of policy loans (1,031) -- -- -- (1,031)
Proceeds from exercise of stock options 1,618 -- -- -- 1,618
Repurchase of common shares (8,596) -- -- -- (8,596)
Debt retirement costs (282) -- -- -- (282)
Changes in intercompany accounts 11,263 (10,405) (858) -- --
Dividends paid -- (1,250) 1,250 -- --
--------- --------- --------- --------- ---------
Net cash (used in) provided by financing activities (14,528) (11,655) 392 -- (25,791)
--------- --------- --------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS -- -- 16 -- 16
--------- --------- --------- --------- ---------
CASH AND CASH EQUIVALENTS:
(Decrease) increase for the period (2,678) 621 (2,319) -- (4,376)
At beginning of period 28,344 1,967 9,882 -- 40,193
--------- --------- --------- --------- ---------
At end of period $ 25,666 $ 2,588 $ 7,563 $ -- $ 35,817
========= ========= ========= ========= =========
24
Note 18
CHATTEM, INC. AND SUBSIDIARIES
- ------------------------------
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
- ------------------------------------------------
FOR THE SIX MONTHS ENDED MAY 31, 2004
(Unaudited and in thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARY SUBSIDIARY
CHATTEM COMPANIES COMPANIES ELIMINATIONS CONSOLIDATED
--------- --------- --------- ------------ ------------
OPERATING ACTIVITIES:
Net income $ 6,535 $ 14,606 $ 1,495 $ (16,101) $ 6,535
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,028 -- 44 -- 3,072
Deferred income taxes 2,687 2,529 2 -- 5,218
Tax benefit realized from stock option exercises 2,504 -- -- -- 2,504
Loss on early extinguishment of debt 12,958 -- -- -- 12,958
Other, net 33 -- 16 -- 49
Equity in subsidiary income (16,101) -- -- 16,101 --
Changes in operating assets and liabilities:
Accounts receivable (12,640) (6,280) (939) 6,280 (13,579)
Interest receivable -- (619) -- 619 --
Inventories (1,183) (251) 154 -- (1,280)
Refundable income taxes (2,119) -- (19) -- (2,138)
Prepaid expenses and other current assets 3,317 -- (22) (1,000) 2,295
Accounts payable and accrued liabilities 2,729 1,167 (100) (5,899) (2,103)
--------- --------- --------- --------- ---------
Net cash provided by operating activities 1,748 11,152 631 -- 13,531
--------- --------- --------- --------- ---------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (1,232) -- (8) -- (1,240)
Purchases of patents, trademarks and other product rights -- (19) -- -- (19)
Increase in note receivable -- (33,000) -- 33,000 --
(Increase) decrease in other assets, net (818) -- 117 -- (701)
--------- --------- --------- --------- ---------
Net cash (used in) provided by investing activities (2,050) (33,019) 109 33,000 (1,960)
--------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Repayment of long-term debt (212,288) -- -- -- (212,288)
Proceeds from long-term debt 200,000 -- -- -- 200,000
Proceeds from borrowings under revolving credit facility 25,000 -- -- -- 25,000
Payments of revolving credit facility (25,000) -- -- -- (25,000)
Proceeds from exercise of stock options 2,880 -- -- -- 2,880
Repurchase of common shares (3,234) -- -- -- (3,234)
Increase in debt issuance costs (5,718) -- -- -- (5,718)
Debt retirement costs (7,861) -- -- -- (7,861)
Premium on interest rate cap agreement (1,375) -- -- -- (1,375)
Intercompany debt proceeds, net -- -- 33,000 (33,000) --
Changes in intercompany accounts 9,514 23,102 (32,616) -- --
Dividends paid -- (625) 625 -- --
--------- --------- --------- --------- ---------
Net cash (used in) provided by financing activities (18,082) 22,477 1,009 (33,000) (27,596)
--------- --------- --------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS -- -- (16) -- (16)
--------- --------- --------- --------- ---------
CASH AND CASH EQUIVALENTS:
(Decrease) increase for the period (18,384) 610 1,733 -- (16,041)
At beginning of period 18,702 1,964 6,265 -- 26,931
--------- --------- --------- --------- ---------
At end of period $ 318 $ 2,574 $ 7,998 $ -- $ 10,890
========= ========= ========= ========= =========
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -----------------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with the audited
consolidated financial statements and related notes thereto included in our 2004
Annual Report on Form 10-K filed with the Securities and Exchange Commission.
This discussion and analysis contains forward-looking statements that involve
risks, uncertainties and assumptions. The actual results may differ materially
from those anticipated in these forward-looking statements as a result of a
number of factors, including, but not limited to, those described in our filings
with the Securities and Exchange Commission.
OVERVIEW
We are a leading marketer and manufacturer of a broad portfolio of branded
over-the-counter ("OTC") healthcare products, toiletries and dietary supplements
including such categories as topical analgesics, medicated skin care products,
medicated dandruff shampoos and conditioner, dietary supplements and other OTC
and toiletry products. Our portfolio of products includes well-recognized brands
such as:
o Topical analgesics such as ICY HOT and ASPERCREME;
o Medicated skin care products such as GOLD BOND medicated skin care
powder, cream, lotion, first aid and foot care products; and PHISODERM
medicated acne treatment products and skin cleansers;
o SELSUN BLUE medicated dandruff shampoos and conditioner;
o Dietary supplements including DEXATRIM, GARLIQUE and NEW PHASE; and
o Other OTC and toiletry products such as PAMPRIN, a menstrual
analgesic; HERPECIN-L, a lip care product; BENZODENT, a dental
analgesic cream; and toiletries such as BULLFROG, a line of sunblocks;
ULTRASWIM, a chlorine-removing shampoo; and SUN-IN, a hair lightener.
Our products typically target niche markets that are often outside the core
product areas of larger companies where we believe we can achieve and sustain
significant market penetration through innovation and strong advertising and
promotion support. Many of our products are among the U.S. market leaders in
their respective categories. For example, our portfolio of topical analgesic
brands and our GOLD BOND medicated body powders have the leading U.S. market
share in these categories. We support our brands through extensive and
cost-effective advertising and promotion, the expenditures for which represented
approximately 28% of our total revenues in the six months ended May 31, 2005. We
sell our products nationally through mass merchandiser, drug and food channels
principally utilizing our own sales force.
Our net income margin (net income/total revenues) was 20.5% and 10.3% for
the second quarter of fiscal 2005 and 2004, respectively, and 16.4% and 5.0% for
the six months ended May 31, 2005 and 2004, respectively. Our net income
(excluding debt extinguishment charge and litigation settlement items) margin
(net income (excluding debt extinguishment charge and litigation settlement
items/total revenues) was 16.2% and 15.1% for the second quarter of fiscal 2005
and 2004, respectively, and 15.5% and 13.2% for the six months ended May 31,
2005 and 2004, respectively. Net income (excluding debt extinguishment charge
and litigation settlement items) margin is a non-GAAP financial measure. We
believe that disclosure of net income (excluding debt extinguishment charge and
litigation settlement items) margin provides investors with useful information
regarding our financial performance and allows for easier comparison with net
income margin without the effect of the charges in prior periods. We use this
non-GAAP financial measure to analyze our performance to forecasted and prior
period results and for other internal purposes. A reconciliation of net income
(excluding debt extinguishment charge and litigation settlement items) to net
income for the three and six months ended May 31, 2005 and 2004 is presented in
the following table:
26
For the Three Months Ended For the Six Months Ended
May 31, May 31, May 31, May 31,
2005 2004 2005 2004
--------- --------- --------- ---------
(dollars in thousands, except per share data)
Net income $ 15,507 $ 7,247 $ 24,172 $ 6,535
Add:
Loss on early extinguishment of debt 744 1,649 744 12,958
Litigation settlement items (5,587) 3,463 (2,832) 3,657
Provision for (benefit from) income taxes 1,598 (1,789) 689 (5,815)
--------- --------- --------- ---------
Net income (excluding debt extinguishment charge and litigation
settlement items) $ 12,262 $ 10,570 $ 22,773 $ 17,335
========= ========= ========= =========
Net income (excluding debt extinguishment charge and litigation
settlement items) per common share (diluted) $ .60 $ .52 $ 1.11 $ .87
========= ========= ========= =========
Net income (excluding debt extinguishment charge and litigation
settlement items) margin 16.2% 15.1% 15.5% 13.2%
========= ========= ========= =========
EBITDA, earnings before interest, taxes, depreciation and amortization, is
a key non-GAAP financial measure used by us to measure operating performance but
may not be comparable to similarly titled measures reported by other companies.
The most directly comparable U.S. generally accepted accounting principles
("GAAP") financial measure is net income. EBITDA and EBITDA (excluding
litigation settlement items) are used by us to supplement net income as an
indicator of operating performance and not as an alternative to measures defined
and required by GAAP. We consider EBITDA and EBITDA (excluding litigation
settlement items) as well as EBITDA margin and EBITDA (excluding litigation
settlement items) margin as important indicators of our operational strength and
performance, including our ability to pay interest, service debt and fund
capital expenditures. We believe that EBITDA and EBITDA margin, both adjusted to
exclude litigation settlement items, provides investors with a useful measure of
our ongoing operating performance. Further, EBITDA adjusted to exclude
litigation settlement items is one measure used in the calculation of certain
ratios to determine our compliance with the terms of our Revolving Credit
Facility. Our presentation of EBITDA and EBITDA margin, as we have adjusted such
measures, should not be construed as an inference that our future results will
be unaffected by items similar to those excluded from the calculation of EBITDA
and EBITDA margin, as we have adjusted such measures. EBITDA and EBITDA
(excluding litigation settlement items) are not measurements of financial
performance and liquidity under GAAP and should not be considered as
alternatives to operating income, net income and other measures of financial
performance reported in accordance with GAAP or as alternatives to cash flows
provided by operating, investing or financing activities.
A reconciliation of EBITDA and EBITDA (excluding litigation settlement
items) to net income is presented in the following tables:
For the Three Months Ended
-------------------------------------------------
Dollar Percentage
May 31, May 31, Increase Increase
2005 2004 (Decrease) (Decrease)
--------- --------- --------- ---------
(dollars in thousands)
Net income $ 15,507 $ 7,247 $ 8,260 114.0%
Add:
Provision for income taxes 7,638 3,902 3,736 95.7
Interest expense, net (1) 3,947 5,173 (1,226) (23.7)
Depreciation and amortization less amounts included in
interest 1,292 1,349 (57) (4.2)
--------- --------- ---------
EBITDA $ 28,384 $ 17,671 $ 10,713 60.6
========= ========= =========
Litigation settlement items (5,587) 3,463 (9,050) (261.3)
--------- --------- ---------
EBITDA (excluding litigation settlement items) $ 22,797 $ 21,134 $ 1,663 7.9
========= ========= =========
EBITDA margin (EBITDA/total revenues) 37.5% 25.2%
========= =========
EBITDA (excluding litigation settlement items) margin (EBITDA
(excluding litigation settlement items)/total revenues) 30.1% 30.2%
========= =========
(1) The three months ended May 31, 2005 and 2004 includes a loss on early
extinguishment of debt of $0.7 million and $1.6 million, respectively.
27
For the Six Months Ended
-------------------------------------------------
Dollar Percentage
May 31, May 31, Increase Increase
2005 2004 (Decrease) (Decrease)
--------- --------- --------- ---------
(dollars in thousands)
Net income $ 24,172 $ 6,535 $ 17,637 269.9%
Add:
Provision for income taxes 11,906 3,519 8,387 238.3
Interest expense, net (1) 7,295 21,192 (13,897) (65.6)
Depreciation and amortization less amounts included in
interest 2,726 2,617 109 4.2
--------- --------- ---------
EBITDA $ 46,099 $ 33,863 $ 12,236 36.1
========= ========= =========
Litigation settlement items (2,832) 3,657 (6,489) (177.4)
--------- --------- ---------
EBITDA (excluding litigation settlement items) $ 43,267 $ 37,520 $ 5,747 15.3
========= ========= =========
EBITDA margin (EBITDA/total revenues) 31.3% 25.8%
========= =========
EBITDA (excluding litigation settlement items) margin (EBITDA
(excluding litigation settlement items)/total revenues) 29.4% 28.6%
========= =========
(1) The six months ended May 31, 2005 and 2004 includes a loss on early
extinguishment of debt of $0.7 million and $13.0 million,
respectively.
DEVELOPMENTS DURING FISCAL 2005
In the first quarter of fiscal 2005, we introduced the following product
line extensions: ASPERCREME Odor-Free Therapy Back and Body Patch, GOLD BOND
Ultimate Comfort Powder, PHISODERM pH2O, NEW PHASE Extra Strength, DEXATRIM Max
and BULLFROG Kids UV Defender.
On December 13, 2004, we entered into a term sheet of settlement with
Interstate Fire & Casualty Company ("Interstate") with regard to Interstate's
lawsuit to rescind its $25.0 million of excess coverage for product liability
claims relating to DEXATRIM products containing PPA. On March 18, 2005, we
entered into a settlement and coverage-in-place agreement with Interstate
consistent with the term sheet of settlement (the "Settlement Agreement"). In
accordance with the Settlement Agreement, Interstate will provide coverage of
DEXATRIM PPA claims that are covered by its policy after $78.5 million has been
paid toward covered claims. If the $78.5 million threshold is met, Interstate
has agreed to pay 100% of the next $4.0 million of claims covered by its policy;
75% of the next $8.5 million of such claims; and 50% of the last $12.5 million
of such claims. We are responsible for any claims not covered by the Interstate
policy either because the alleged injury did not occur before May 31, 2001, or
the claim was first made against us after May 31, 2004.
In the first quarter of fiscal 2005, we sold our SELSUN business in certain
countries in Africa and Asia to The Mentholatum Co., Inc. We maintain our rights
to SELSUN in Australia, New Zealand and worldwide (except India). The divested
territory was not compatible with our strategic goals for the remainder of our
international SELSUN operations and contributed only $1.3 million in net sales
in fiscal 2004.
During the second quarter of fiscal 2005, we repurchased $17.5 million of
our 7.0% Senior Subordinated Notes due March 1, 2014 ("7.0% Subordinated Notes")
in the open market at an average premium of 1.6% over the principal amount of
the notes. The repurchase resulted in a loss on early extinguishment of debt of
$0.7 million. The outstanding balance of the remaining 7.0% Subordinated Notes
was reduced to $107.5 million.
Prior to the fourth quarter of fiscal 2004, we were unable to estimate
reasonably the amount of liability related to the DEXATRIM litigation, due to
the significant assumptions and uncertainty involved in estimating the value of
the claims involved. As a result of the final approval of the DEXATRIM PPA
settlement on November 12, 2004 and the term sheet of settlement reached with
Interstate on December 13, 2004, as of November 30, 2004 we were able to
estimate reasonably the probable loss related to the DEXATRIM litigation. Based
upon the then-estimated litigation settlement costs relating to our DEXATRIM
products, we recorded a litigation settlement charge of $11.3 million in the
fourth quarter of fiscal 2004, of which $9.5 million was included in accrued
liabilities in our Consolidated Balance Sheet as of November 30, 2004.
During the second quarter of fiscal 2005, we resolved approximately
125, or approximately 75%, of the alleged stroke claims submitted in the
settlement. The value of these claims was determined through negotiations with
representatives of the claimants during which we valued claims using the
settlement matrix contained in the court-approved class action settlement
28
agreement. Based on the agreed upon values of the resolved stroke claims as
compared to previous estimates, the number of claims actually submitted in
accordance with the requirements of the settlement agreement and the estimated
remaining settlement costs, we revised our previous estimate of the DEXATRIM
litigation settlement costs. As a result of the revised estimate, in the second
quarter of fiscal 2005 we reversed $6.0 million of the litigation settlement
charge that was previously taken in the fourth quarter of fiscal 2004. During
the second quarter of fiscal 2005, we incurred and recorded $1.0 million of
legal expenses related to the DEXATRIM litigation offset by a $0.5 million
reimbursement from the settlement trust for previously incurred administrative
costs. As a result of the reversed charge and the net DEXATRIM related expenses
incurred in the six months ended May 31, 2005, $2,607 is included in accrued
liabilities in our May 31, 2005 Condensed Consolidated Balance Sheet related to
the DEXATRIM litigation.
We currently do not expect to record any additional charges relative to the
settlement costs of the PPA litigation, although we will continue to incur and
record future DEXATRIM related legal expenses in the period incurred. We
currently believe that the amount of these future expenses will be in the range
of $1.0-2.0 million, incurred over the balance of fiscal 2005.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain items
from our Condensed Consolidated Statements of Operations expressed as a
percentage of total revenues:
For the Three Months Ended For the Six Months Ended
May 31, 2005 May 31, 2004 May 31, 2005 May 31, 2004
------------ ------------ ------------ ------------
TOTAL REVENUES 100.0% 100.0% 100.0% 100.0%
------- ------- ------- -------
COSTS AND EXPENSES:
Cost of sales 27.9 29.3 28.1 28.6
Advertising and promotion 27.4 27.2 27.9 28.6
Selling, general and administrative 16.3 15.2 16.5 16.2
Litigation settlement (7.4) 5.0 (1.9) 2.8
------- ------- ------- -------
Total costs and expenses 64.2 76.7 70.6 76.2
------- ------- ------- -------
INCOME FROM OPERATIONS 35.8 23.3 29.4 23.8
------- ------- ------- -------
OTHER INCOME (EXPENSE):
Interest expense (4.5) (5.2) (4.7) (6.4)
Investment and other income, net 0.3 0.2 0.3 0.1
Loss on early extinguishment of debt (1.0) (2.4) (0.5) (9.8)
------- ------- ------- -------
Total other income (expense) (5.2) (7.4) (4.9) (16.1)
------- ------- ------- -------
INCOME BEFORE INCOME TAXES 30.6 15.9 24.5 7.7
PROVISION FOR INCOME TAXES 10.1 5.6 8.1 2.7
------- ------- ------- -------
NET INCOME 20.5% 10.3% 16.4% 5.0%
======= ======= ======= =======
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with U.S. generally
accepted accounting principles requires management to use estimates. Several
different estimates or methods can be used by management that might yield
different results. The following are the significant estimates used by
management in the preparation of the May 31, 2005 condensed consolidated
financial statements:
ALLOWANCE FOR DOUBTFUL ACCOUNTS
As of May 31, 2005, an estimate was made of the collectibility of the
outstanding accounts receivable balances. This estimate requires the utilization
of outside credit services, knowledge about the customer and the customer's
industry, new developments in the customer's industry and operating results of
the customer as well as general economic conditions and historical trends. When
all these facts are compiled, a judgment as to the collectibility of the
individual account is made. Many factors can impact this estimate, including
those noted in this paragraph. The adequacy of the estimated allowance may be
impacted by the deterioration in the financial condition of a large customer,
weakness in the economic environment resulting in a higher level of customer
bankruptcy filings or delinquencies and the competitive environment in which the
customer operates.
29
During the six months ended May 31, 2005, we performed a detailed assessment of
the collectibility of trade accounts receivable and reduced our estimate of
allowance for doubtful accounts by approximately $0.3 million, which resulted in
a decrease to selling, general and administrative expense in our condensed
consolidated financial statements.
REVENUE RECOGNITION
Revenue is recognized when our products are shipped to our customers. It is
generally our policy across all classes of customers that all sales are final.
As is common in the consumer products industry, customers return products for a
variety of reasons including products damaged in transit, discontinuance of a
particular size or form of product and shipping errors. As sales are recorded,
we accrue an estimated amount for product returns, as a reduction of these
sales, based upon our historical experience and any known specific events that
affect the accrual. We charge the allowance account resulting from this accrual
with any authorized deduction from remittance by the customer or product returns
upon receipt of the product.
In accordance with industry practice, we allow our customers to return
unsold sun care products (i.e. BULLFROG and SUN IN lines of products) at the end
of the sun care season. We record the sales at the time the products are shipped
and title transfers. At the time of shipment, we also record a reduction in
sales and an allowance on our balance sheet for anticipated returns based upon
an estimated return level. The level of returns may fluctuate from our estimates
due to several factors including weather conditions, customer inventory levels
and competitive conditions. Each percentage point change in our return rate
would impact our net sales by approximately $0.2 million. As a result of higher
sales volumes in the six months ended May 31, 2005 and 2004, we increased our
estimate of seasonal returns by approximately $0.9 million and $0.5 million,
respectively, which resulted in a decrease to net sales in our condensed
consolidated financial statements. During the six months ended May 31, 2005, as
a result of our estimate of customer inventory levels and based on historical
non-seasonal product returns, we increased our estimate of non-seasonal returns
by approximately $0.8 million, which resulted in a decrease to net sales in our
condensed consolidated financial statements, as compared to a $0.3 million
decrease in our estimate for the six months ended May 31, 2004.
We routinely enter into agreements with our customers to participate in
promotional programs. These programs generally take the form of coupons,
temporary price reductions, scan downs, display activity and participations in
advertising vehicles provided uniquely by the customer. The ultimate cost of
these programs is often variable based on the number of units actually sold.
Estimated unit sales of a product under a promotional program are used to
estimate the total cost of the program, which is recorded as a reduction of
sales. Actual results can differ from the original estimate. We also consider
customer delays in requesting promotional program payments when evaluating the
required accrual. Many customers audit programs significantly after the date of
performance to determine the actual amount due and make a claim for
reimbursement at that time. As a result, changes in the unit sales trends under
promotional programs as well as the timing of payments could result in changes
in the accrual. During the six months ended May 31, 2005, primarily as a result
of the sales volume impact on variable based programs, we increased our estimate
of promotional accruals by approximately $0.4 million, which resulted in a
decrease to net sales in our condensed consolidated financial statements, as
compared to a $0.5 million decrease in our estimate for the six months ended May
31, 2004.
INCOME TAXES
We account for income taxes using the asset and liability approach as
prescribed by Statement of Financial Accounting Standards ("SFAS") No. 109,
"Accounting for Income Taxes". This approach requires recognition of deferred
tax assets and liabilities for the expected future tax consequences of events
that have been included in our condensed consolidated financial statements or
tax returns. Using the enacted tax rates in effect for the year in which the
differences are expected to reverse, deferred tax assets and liabilities are
determined based on the differences between the financial reporting and the tax
basis of an asset or liability. We record income tax expense in our condensed
consolidated financial statements based on an estimated annual effective income
tax rate. Our tax rate for the three and six months ended May 31, 2005 was 33%,
as compared to 35% in the three and six months ended May 31, 2004, respectively.
The lower rates for the three and six months ended May 31, 2005 reflect the
implementation of a number of foreign and state tax planning initiatives, which
include our determination during the third quarter of fiscal 2004 to reinvest
indefinitely all undistributed earnings of Chattem Canada, a wholly-owned
subsidiary.
Undistributed earnings of Chattem Canada amounted to approximately $0.5
million and $0.8 million for the three and six months ended May 31, 2005,
respectively. These earnings are considered to be reinvested indefinitely and,
accordingly, no provision for U.S. federal and state income taxes has been
provided thereon. Upon distribution of those earnings in the form of dividends
or otherwise, we would be subject to U.S. income taxes (subject to an adjustment
for foreign tax credits).
For a summary of our significant accounting policies, see Note 2 of Notes
to Consolidated Financial Statements included in our Annual Report on Form 10-K
for the year ended November 30, 2004 filed with the Securities and Exchange
Commission.
30
COMPARISON OF THREE MONTHS ENDED MAY 31, 2005 AND MAY 31, 2004
- --------------------------------------------------------------
To facilitate discussion of our operating results for the three months
ended May 31, 2005 and May 31, 2004, we have included the following selected
data from our Condensed Consolidated Statements of Operations:
Increase (Decrease)
-----------------------
2005 2004 Amount Percentage
-------- -------- -------- ----------
(dollars in thousands)
Domestic net sales $ 68,684 $ 63,684 $ 5,000 7.9%
International revenues (including royalties) 7,003 6,408 595 9.3
Total revenues 75,687 70,092 5,595 8.0
Cost of sales 21,116 20,556 560 2.7
Advertising and promotion expense 20,731 19,080 1,651 8.7
Selling, general and administrative expense 12,335 10,671 1,664 15.6
Litigation settlement (5,587) 3,463 (9,050) (261.3)
Interest expense 3,458 3,639 (181) (5.0)
Loss on early extinguishment of debt 744 1,649 (905) (54.9)
Net income 15,507 7,247 8,260 114.0
DOMESTIC NET SALES
Domestic net sales for the three months ended May 31, 2005 increased $5.0
million, or 7.9%, as compared to the comparable period of 2004. A comparison of
domestic net sales for the categories of products included in our portfolio of
OTC healthcare products is as follows:
Increase (Decrease)
-----------------------
2005 2004 Amount Percentage
-------- -------- -------- ----------
(dollars in thousands)
Topical analgesics $ 25,044 $ 18,134 $ 6,910 38.1%
Medicated skin care products 15,833 17,330 (1,497) (8.6)
Dietary supplements 10,283 10,369 (86) (0.8)
Medicated dandruff shampoos and
conditioner 7,888 7,406 482 6.5
Other OTC and toiletry products 9,636 10,445 (809) (7.7)
-------- -------- ---------
Total $ 68,684 $ 63,684 $ 5,000 7.9
======== ======== =========
Net sales growth in the topical analgesics category was led by a 102%
increase in sales of ASPERCREME, which was driven by the launch of the Odor-Free
Therapy Back and Body Patch. Net sales growth in this category also resulted
from 47%, 44%, 40% and 23% sales increases in FLEXALL, SPORTSCREME, CAPZASIN and
ICY HOT, respectively. ICY HOT continued to benefit from the strength of the ICY
HOT Medicated Sleeve and Back Patch and the advertising campaign featuring
Shaquille O'Neal. The growth from the balance of the portfolio was due to
successful advertising and promotional campaigns.
The decrease in net sales in the medicated skin care products category was
due to a decline in sales of PHISODERM and GOLD BOND. Although PHISODERM
benefited from the launch of the new pH2O line, this was more than offset by
weakness in sales and lost distribution from its acne and base skin care
business. The net sales decline in the GOLD BOND franchise was due to declines
in the foot swab and first aid business due to curtailed media support. Also,
the adult powder and foot care lines declined because of a slow start to the
summer season due to unfavorable weather. The declines were partially offset by
increases in the cream and lotion lines.
Net sales for the dietary supplements category declined primarily due to a
16% decrease in DEXATRIM, resulting from declining sales of the DEXATRIM ALL IN
ONE BAR. The decline in sales of the DEXATRIM ALL IN ONE BAR was partially
offset by sales of the newly launched DEXATRIM MAX diet pill as well as 27% and
19% increases in net sales of GARLIQUE and NEW PHASE, respectively. Net sales of
GARLIQUE increased due to effective new advertising, and net sales of NEW PHASE
increased due to the introduction of NEW PHASE Extra Strength in the first
quarter of fiscal 2005.
Domestic net sales of SELSUN BLUE medicated dandruff shampoo increased 6.5%
compared to the year-ago period.
The decrease in net sales for the other OTC and toiletry products category
was due primarily to sales declines of BULLFROG and PAMPRIN. The decrease in net
sales of BULLFROG was principally attributable to unfavorable weather, and the
decline in net sales of PAMPRIN resulted from lost distribution at a major
retailer.
31
Domestic sales variances were principally the result of changes in unit
sales volumes with the exception of certain selected products, for which we
implemented a unit sales price increase.
INTERNATIONAL REVENUES
For the second quarter of fiscal 2005, international revenues increased
$0.6 million, or 9.3%, as compared to the second quarter of fiscal 2004 due
principally to strengthening distributor sales of SELSUN in certain European and
Middle Eastern countries. Sales variances for international operations were
principally the result of changes in unit sales volumes.
COST OF SALES
Cost of sales as a percentage of total revenues was 27.9% for the second
quarter of fiscal 2005 as compared to 29.3% for the second quarter of fiscal
2004. Gross margin of 72.1% was attributable to favorable product mix,
purchasing and manufacturing efficiencies and ongoing cost savings programs.
ADVERTISING AND PROMOTION EXPENSE
Advertising and promotion expenses in the second quarter of fiscal 2005
increased $1.7 million, or 8.7%, as compared to the same quarter of fiscal 2004
and were 27.4% of total revenues for the three months ended May 31, 2005
compared to 27.2% for the comparable period of fiscal 2004. Support for new
product introductions drove an increase in advertising and promotion
expenditures in the current period for ASPERCREME, PHISODERM, GOLD BOND powder
and DEXATRIM.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expenses increased $1.7 million, or
15.6%, as compared to the same quarter of fiscal 2004. Selling, general and
administrative expenses were 16.3% and 15.2% of total revenues for the second
quarter of fiscal 2005 and 2004, respectively. An increase in sales was
primarily responsible for the increase in selling expense. In addition, freight
expenses increased due to an increase in fuel costs. The increase in general and
administrative expenses was largely a result of an increase in new product
development expenses, compensation expense and insurance expense.
LITIGATION SETTLEMENT ITEMS
Litigation settlement items decreased $9.1 million as compared to the same
quarter of fiscal 2004 due to a change in estimate of $6.0 million related to
the DEXATRIM litigation. In the second quarter of fiscal 2005, legal expenses of
$1.0 million related to the settlement of DEXATRIM litigation were offset by a
$0.5 million reimbursement from the settlement trust for previously incurred
administrative costs as compared to charges of $3.5 million in the prior year
period relating to legal and administrative costs and settlement costs relating
to a settlement with one of our insurance providers.
INTEREST EXPENSE
Interest expense decreased $0.2 million, or 5.0%, in the second quarter of
fiscal 2005 as compared to the same quarter of fiscal 2004. The decrease was
largely the result of a reduction in outstanding debt as a result of the
repurchase of $17.5 million of our 7.0% Subordinated Notes. Until our
indebtedness is reduced substantially, interest expense will continue to
represent a significant percentage of our total revenues.
LOSS ON EARLY EXTINGUISHMENT OF DEBT
During the second quarter of fiscal 2005, we repurchased $17.5 million of
our 7.0% Subordinated Notes, which resulted in a loss on early extinguishment of
debt of $0.7 million.
32
COMPARISON OF SIX MONTHS ENDED MAY 31, 2005 AND 2004
- ----------------------------------------------------
To facilitate discussion of our operating results for the six months ended
May 31, 2005 and 2004, we have included the following selected data from our
Condensed Consolidated Statements of Operations:
Increase (Decrease)
-----------------------
2005 2004 Amount Percentage
-------- -------- -------- ----------
(dollars in thousands)
Domestic net sales $ 134,253 $ 119,291 $ 14,962 12.5%
International revenues (including royalties) 12,965 12,038 927 7.7
Total revenues 147,218 131,329 15,889 12.1
Cost of sales 41,376 37,508 3,868 10.3
Advertising and promotion expense 41,082 37,612 3,470 9.2
Selling, general and administrative expense 24,219 21,306 2,913 13.7
Litigation settlement (2,832) 3,657 (6,489) (177.4)
Interest expense 6,953 8,394 (1,441) (17.2)
Loss on early extinguishment of debt 744 12,958 (12,214) (94.3)
Net income 24,172 6,535 17,637 269.9
DOMESTIC NET SALES
Domestic net sales for the six months ended May 31, 2005 increased $15.0
million, or 12.5%, as compared to the corresponding period of 2004. A comparison
of domestic net sales for the categories of products included in our portfolio
of OTC healthcare products is as follows:
Increase (Decrease)
-----------------------
2005 2004 Amount Percentage
-------- -------- -------- ----------
(dollars in thousands)
Topical analgesics $ 46,452 $ 33,846 $ 12,606 37.2%
Medicated skin care products 33,457 30,663 2,794 9.1
Dietary supplements 18,943 18,880 63 0.3
Medicated dandruff shampoos and conditioner 17,688 16,627 1,061 6.4
Other OTC and toiletry products 17,713 19,275 (1,562) (8.1)
--------- --------- --------
Total $ 134,253 $ 119,291 $ 14,962 12.5
========= ========= ========
Net sales growth in the topical analgesic category was led by 77% and 34%
increases in sales of ASPERCREME and ICY HOT, respectively. ASPERCREME'S sales
increase was driven by the launch of the Odor-Free Therapy Back and Body Patch.
ICY HOT continued to benefit from the strength of the ICY HOT Medicated Sleeve
and the Back Patch and the advertising campaign featuring Shaquille O'Neal. Net
sales growth in this category also resulted from 28%, 23% and 15% sales
increases in SPORTSCREME, CAPZASIN and FLEXALL, respectively. The growth from
the balance of the portfolio was due to successful advertising and promotional
campaigns.
Net sales growth in the medicated skin care products category resulted from
a 14% increase in the GOLD BOND franchise. GOLD BOND sales growth was
attributable to 41%, 11%, 11% and 6% increases from the lotion, foot care, cream
and powder product lines, respectively. The increase in sales from the GOLD BOND
lotion line of products was attributable to increased sales of GOLD BOND
ULTIMATE Healing Skin Therapy Lotion. The increase in net sales of GOLD BOND
foot resulted from increased distribution, GOLD BOND cream benefited from an
effective advertising campaign, and GOLD BOND powder sales were driven by the
launch of GOLD BOND ULTIMATE Comfort Powder. Although PHISODERM benefited from
the launch of the new pH2O line, this was more than offset by weakness in sales
and lost distribution from its acne and base skin care business.
Net sales for the dietary supplements category remained consistent to the
corresponding period of fiscal 2004. A 10% decrease in DEXATRIM, resulting from
declining sales of the DEXATRIM ALL IN ONE BAR, was partially offset by sales of
the newly launched DEXATRIM MAX diet pill as well as 26% and 9% increases in net
sales of NEW PHASE and GARLIQUE, respectively. Net sales of GARLIQUE increased
due to effective new advertising, and net sales of NEW PHASE increased due to
the introduction of NEW PHASE Extra Strength in the first quarter of fiscal
2005.
Domestic net sales of SELSUN BLUE medicated dandruff shampoo increased 6%
due to an effective advertising campaign.
The decrease in net sales for the other OTC and toiletry products category
was due primarily to sales declines of BULLFROG, PAMPRIN and PREMSYN. The
decrease in net sales of BULLFROG was principally attributable to unfavorable
weather, and
33
the decline in net sales of PAMPRIN and PREMSYN resulted from lost distribution
at a major retailer. The decrease was partially offset by an increase in net
sales of SUN-IN as a result of expanded distribution.
Domestic sales variances were principally the result of changes in unit
sales volumes with the exception of certain selected products, for which we
implemented a unit sales price increase.
INTERNATIONAL REVENUES
For the six months ended May 31, 2005, international revenues increased
$0.9 million, or 7.7%, as compared to the same period in fiscal 2004 due
principally to strengthening distributor sales of SELSUN in certain European and
Middle Eastern countries. Sales variances for international operations were
principally the result of changes in unit sales volumes.
COST OF SALES
Cost of sales as a percentage of total revenues was 28.1% for the six
months ended May 31, 2005 as compared to 28.6% for the comparable period of
fiscal 2004. Gross margin of 71.9% was attributable to favorable product mix,
purchasing and manufacturing efficiencies and ongoing cost savings programs.
ADVERTISING AND PROMOTION EXPENSE
Advertising and promotion expenses in the six months ended May 31, 2005
increased $3.5 million, or 9.2%, as compared to the same period in fiscal 2004
and were 27.9% of total revenues for the six months ended May 31, 2005 compared
to 28.6% for the comparable period of fiscal 2004. The decrease in advertising
and promotion expense as a percentage of revenue represents a more effective use
of advertising to generate sales. Support for new product introductions drove an
increase in advertising and promotion expenditures in the current period for
PHISODERM, ASPERCREME and GOLD BOND powder. Increases in advertising and
promotion expenditures also were recorded for ICY HOT, GOLD BOND foot and
lotion, SELSUN Blue, GARLIQUE and NEW PHASE. Decreases in advertising and
promotion expenditures were recorded for the balance of the GOLD BOND franchise
and PAMPRIN.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expenses increased $2.9 million, or
13.7%, as compared to the same period of fiscal 2004. Selling, general and
administrative expenses were 16.5% and 16.2% of total revenues for the six
months ended May 31, 2005 and 2004, respectively. An increase in sales was
primarily responsible for the increase in selling expense. In addition, freight
expenses increased due to an increase in fuel costs. The increase in general and
administrative expenses was largely a result an increase in new product
development expenses, compensation expense and insurance expense.
LITIGATION SETTLEMENT ITEMS
Litigation settlement items decreased $6.5 million as compared to the same
period of fiscal 2004 due to a change in estimate of $6.0 million related to the
DEXATRIM litigation recorded in the second quarter of fiscal 2005. In the six
months ended May 31, 2005, legal expenses and ephedrine-related claims of $3.7
million related to the settlement of DEXATRIM litigation were offset by a $0.5
million reimbursement from the settlement trust for previously incurred
administrative costs as compared to charges of $3.7 million in the prior year
period relating to legal and administrative costs and settlement costs relating
to a settlement with one of our insurance providers.
INTEREST EXPENSE
Interest expense decreased $1.4 million, or 17.2%, in the six months ended
May 31, 2005 as compared to the same period in fiscal 2004. The decrease was
largely the result of lower interest rates and a reduction in outstanding debt
as a result of our debt refinancing completed during the first quarter of fiscal
2004. Until our indebtedness is reduced substantially, interest expense will
continue to represent a significant percentage of our total revenues.
LOSS ON EARLY EXTINGUISHMENT OF DEBT
During the second quarter of fiscal 2005, we repurchased $17.5 million of
our 7.0% Subordinated Notes, which resulted in a loss on early extinguishment of
debt of $0.7 million.
34
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
We have historically financed our operations with a combination of
internally generated funds and borrowings. Our principal uses of cash are for
operating expenses, working capital, acquisitions, repurchases of our common
stock and outstanding debt, servicing long-term debt, payment of income taxes
and capital expenditures.
Cash of $21.4 million and $13.5 million was provided by operations for the
six months ended May 31, 2005 and 2004, respectively. The increase in cash flows
from operations over the prior period was primarily attributable to an increase
in refundable income taxes which changed from a receivable to a payable in the
current period. The increase was partially offset by a tax expense related to
our stock option plans. In addition, in the prior year a $13.0 million loss on
early extinguishment of debt was incurred compared to $0.7 million in the
current period.
Investing activities used cash of $13,000 and $2.0 million in the six
months ended May 31, 2005 and 2004, respectively. The decrease in usage of cash
in the current period was primarily due to proceeds received from the sale of
our SELSUN business in certain countries in Africa and Asia.
Financing activities used cash of $25.8 million and $27.6 million in the
six months ended May 31, 2005 and 2004, respectively. The decrease in usage of
cash was due to the debt refinancing transaction in the prior period partially
offset by the repurchase of $8.6 million of common stock and $17.5 million of
our 7.0% Subordinated Notes in the current period.
In January 2005, our board of directors increased the total authorization
to repurchase our common stock under our stock buyback program to $30.0 million.
For the six months ended May 31, 2005, we repurchased 239,300 shares for $8.6
million. All repurchased shares were retired and returned to unissued. We,
however, are limited in our ability to repurchase shares of our common stock due
to restrictions under the terms of our Revolving Credit Facility, Floating Rate
Notes and 7.0% Subordinated Notes. As of July 1, 2005, we have repurchased
146,400 of our shares for $6.1 million subsequent to May 31, 2005.
We believe that cash provided by operating activities, our cash and cash
equivalents balance and funds available under our Revolving Credit Facility will
be sufficient to fund our operating expenses, debt service, capital expenditures
and working capital requirements for the foreseeable future as our business is
currently conducted. It is likely that any acquisitions we make in the future
will require us to obtain additional financing.
FOREIGN OPERATIONS
- ------------------
Historically, our primary foreign operations have been conducted through
our Canadian and United Kingdom ("U.K.") subsidiaries. Effective November 1,
2004, we transitioned our European business to Chattem Global Consumer Products
Limited, a wholly-owned subsidiary located in Limerick, Ireland. The functional
currencies of these subsidiaries are Canadian dollars, British pounds and Euros,
respectively. Fluctuations in exchange rates can impact operating results,
including total revenues and expenses, when translations of the subsidiary
financial statements are made in accordance with SFAS No. 52, "Foreign Currency
Translation". For the six months ended May 31, 2005 and 2004, these subsidiaries
accounted for 7% of total revenues, respectively, and 5% and 4% of total assets,
respectively. It has not been our practice to hedge our assets and liabilities
in Canada, the U.K. and Ireland or our intercompany transactions due to the
inherent risks associated with foreign currency hedging transactions and the
timing of payments between us and our foreign subsidiaries. Following our
acquisition of SELSUN BLUE, which is sold in approximately 70 foreign countries,
our international business operations have expanded significantly, which has
increased our exposure to fluctuations in foreign exchange rates. During fiscal
2004, a portion of these foreign sales was reflected as royalties, which have
been paid to us in U.S. dollars. In addition, Abbott has continued to supply a
portion of our international product, and beginning April 1, 2004, Abbott began
billing us in local currencies. Historically, gains or losses from foreign
currency transactions have not had a material impact on our operating results.
Gains (losses) of $1,000 and ($3,000) for the six months ended May 31, 2005 and
2004, respectively, resulted from foreign currency transactions and are included
in selling, general and administrative expenses in the Condensed Consolidated
Statements of Operations.
RECENT ACCOUNTING PRONOUNCEMENTS
- --------------------------------
In December 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46R, "Consolidation of Variable Interest Entities" ("FIN
46R"), which supercedes Interpretation No. 46, "Consolidation of Variable
Interest Entities" issued in January 2003. FIN 46R requires a company to
consolidate a variable interest entity ("VIE"), as defined, when the company
will absorb a majority of the VIE's expected losses, receives a majority of the
VIE's expected residual returns or both. FIN 46R also requires consolidation of
existing, non-controlled affiliates if the VIE is unable to finance its
operations without investor support, or where the other investors do not have
exposure to the significant risks and rewards of ownership. FIN 46R applies
immediately to a VIE created or acquired after January 31, 2003. For a VIE
created before February 1, 2003, FIN 46R applies in the first fiscal year or
interim period beginning after March 15, 2004, our third fiscal quarter
beginning June 1, 2004.
35
Application of FIN 46R is also required in financial statements that have
interests in structures that are commonly referred to as special-purpose
entities for periods ending after December 15, 2003. The adoption of FIN 46R did
not have an impact on our financial position, results of operations or cash
flows.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs" ("SFAS
151"). SFAS 151 amends the guidance in Accounting Research Bulletin No. 43,
Chapter 4, "Inventory Pricing", to clarify that abnormal amounts of idle
facility expense, freight, handling costs and wasted materials (spoilage) should
be recognized as current-period charges and requires the allocation of fixed
production overheads to inventory based on normal capacity of the production
facilities. This statement is effective for inventory costs incurred during
fiscal years beginning after June 15, 2005. The adoption of SFAS 151 is not
expected to have an impact on our financial position, results of operations or
cash flows.
In November 2004, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 03-13, "Applying the Conditions in Paragraph 42 of FASB
Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" in Determining Whether to Report Discontinued Operations" ("EITF
03-13"). Under the consensus, the approach for assessing whether cash flows of
the component have been eliminated from the ongoing operations of the entity
focuses on whether continuing cash flows are direct or indirect cash flows. Cash
flows of the component would not be eliminated if the continuing cash flows to
the entity are considered direct cash flows. The consensus should be applied to
a component of an enterprise that is either disposed of or classified as held
for sale in fiscal periods beginning after December 15, 2004. The adoption of
EITF 03-13 did not have an impact on our financial position, results of
operations or cash flows.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment" ("SFAS 123R"), which is a revision of SFAS No. 123, "Accounting for
Stock-Based Compensation". SFAS 123R supercedes APB Opinion No. 25, "Accounting
for Stock Issued to Employees" and amends SFAS No. 95, "Statement of Cash
Flows". SFAS 123R focuses primarily on accounting for transactions in which an
entity obtains employee services in share-based payment transactions and
requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the income statement based on their fair
values. Accordingly, the adoption of SFAS 123R's fair value method will have a
significant impact on our results of operations, although it will have no impact
on our overall financial position. The impact of the adoption of SFAS 123R
cannot be predicted at this time because it will depend on the levels of
share-based payments granted in the future. However, had we adopted SFAS 123R in
prior periods the impact of that standard would have approximated the impact of
SFAS 123 as described in the disclosure of proforma net income and earnings per
share in Note 4 to our condensed consolidated financial statements. SFAS 123R
also requires the benefits of tax deductions in excess of recognized
compensation costs to be reported as a financing cash flow, rather than as an
operating cash flow as required under current literature. This requirement will
reduce net operating cash flows and increase net financing cash flows in periods
after adoption. While we cannot estimate what those amounts will be in the
future (because they depend on, among other things, when employees exercise
stock options), the amount of operating cash flows recognized in prior periods
for such excess tax deductions were not material to our consolidated financial
position or results of operations. This statement is effective for our first
fiscal year that begins after June 15, 2005.
In December 2004, the FASB issued SFAS 153, "Exchanges of Nonmonetary
Assets" ("SFAS 153"). SFAS 153 amends the guidance in APB Opinion No. 29,
"Accounting for Nonmonetary Transactions" to eliminate certain exceptions to the
principle that exchanges of nonmonetary assets be measured based on the fair
value of the assets exchanged. SFAS 153 eliminates the exception for nonmonetary
exchanges of similar productive assets and replaces it with a general exception
for exchanges of nonmonetary assets that do not have commercial substance. This
statement is effective for nonmonetary asset exchanges in fiscal years beginning
after June 15, 2005. The adoption of SFAS 153 is not expected to have an impact
on our financial position, results of operations or cash flows.
The American Jobs Creation Act of 2004 (the "AJCA") was enacted on October
22, 2004. The AJCA repeals an export incentive, creates a new deduction for
qualified domestic manufacturing activities and includes a special one-time
deduction of 85% of certain foreign earnings repatriated to the U.S.
The FASB issued Staff Position FAS 109-1, "Application of FASB Statement
No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified
Production Activities Provided by the American Jobs Creation Act of 2004" ("FSP
FAS 109-1") on December 21, 2004. In accordance with FSP FAS 109-1, we will
treat the deduction for qualified domestic manufacturing activities, which is
effective upon issuance, as a reduction of the income tax provision in future
years as realized.
In December 2004, the FASB issued Staff Position FAS 109-2, "Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within the
American Jobs Creation Act of 2004," allowing companies additional time to
evaluate the effect of the AJCA on plans for reinvestment or repatriation of
foreign earnings. We are in the process of evaluating the effects of the
repatriation provision.
36
FORWARD LOOKING STATEMENTS
- --------------------------
Statements in this Quarterly Report on Form 10-Q which are not historical
facts are forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. These forward-looking statements
involve risks, uncertainties and assumptions that could cause actual outcomes
and results to differ materially from those expressed or projected.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
- -------------------------------------------------------------------
We are exposed to market risk from changes in interest rates and foreign
currency exchange rates, which may adversely affect our results of operations
and financial condition. We seek to minimize the risks from these interest rates
and foreign currency exchange rate fluctuations through our regular operating
and financing activities.
Our exposure to interest rate risk currently consists of our Floating Rate
Notes and our Revolving Credit Facility. The aggregate balance outstanding under
the Floating Rate Notes as of May 31, 2005, was $75 million. The Floating Rate
Notes bear interest at a three-month LIBOR plus 3.00% per year (5.91% as of May
31, 2005). Loans under our Revolving Credit Facility bear interest at LIBOR plus
applicable percentages of 1.75% to 2.50% or a base rate (the higher of the
federal funds rate plus 0.5% or the prime rate) plus applicable percentages of
0.25% to 1.0%. The applicable percentages are calculated based on our leverage
ratio. As of May 31, 2005, no amounts were outstanding under the Revolving
Credit Facility, and the variable rate on the Revolving Credit Facility was
6.5%. The 7.0% Subordinated Notes are fixed interest rate obligations. On March
8, 2004, we entered into an interest rate cap agreement effective June 1, 2004
with decreasing annual notional principal amounts of $15.0 million beginning
March 1, 2006 and cap rates ranging from 4.0% to 5.0% over the life of the
agreement. The amortized value of the premium on the interest rate cap was
compared to its fair value as of May 31, 2005, and a charge of $0.5 million, net
of tax, was recorded to other comprehensive income. The interest rate cap
agreement terminates on March 1, 2010. The impact on our results of operations
of a one-point rate change on the balance currently outstanding of our Floating
Rate Notes for the next twelve months would be approximately $ 0.5 million, net
of tax.
We are subject to risk from changes in the foreign exchange rates relating
to our Canadian, U.K. and Irish subsidiaries. Assets and liabilities of these
subsidiaries are translated to U.S. dollars at year-end exchange rates. Income
and expense items are translated at average rates of exchange prevailing during
the year. Translation adjustments are accumulated as a separate component of
shareholders' equity. Gains and losses, which result from foreign currency
transactions, are included in the Condensed Consolidated Statements of
Operations. In addition, Abbott has continued to supply a portion of our
international product, and beginning April 1, 2004, Abbott began billing us in
local currencies. The potential loss resulting from a hypothetical 10.0% adverse
change in the quoted foreign currency exchange rate amounts to approximately $
1.5 million as of May 31, 2005.
This market risk discussion contains forward-looking statements. Actual
results may differ materially from this discussion based upon general market
conditions and changes in financial markets.
ITEM 4. CONTROLS AND PROCEDURES
- -------------------------------
(a) Evaluation of Disclosure Controls and Procedures. Our Chief Executive
Officer and Chief Financial Officer have evaluated the effectiveness of our
disclosure controls and procedures (as such terms are defined in Rules
13(a)-15(e) and 15(d)-15(e)) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act") as of May 31, 2005 of this Form 10-Q (the
"Evaluation Date"). Based on such evaluation, such officers have concluded that,
as of the Evaluation Date, our disclosure controls and procedures are effective
in alerting them on a timely basis to material information relating to us
(including our consolidated subsidiaries) required to be included in our
periodic filings under the Exchange Act.
(b) Changes in Internal Controls. Since the Evaluation Date, there have not
been any significant changes in our internal controls over financial reporting
or in other factors that could significantly affect such controls.
37
PART II. OTHER INFORMATION
--------------------------
ITEM 1. LEGAL PROCEEDINGS
- -------------------------
See Note 17 of Notes to Condensed Consolidated Financial Statements
included in Part 1, Item 1 of this Report.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
- -------------------------------------------------------------------
A summary of the common stock repurchase activity for our second quarter of
fiscal 2005 is as follows:
Total Number of Maximum Dollar
Shares Purchased Value that may yet
Total Number as Part of Publicly be Purchased under
of Shares Average Price Announced Plans or the Plans or
Period Purchased Paid Per Share(1) Programs(2) Programs
------ --------- ----------------- ----------- --------
March 1 - March 31 115,800 $ 36.45 115,800 $24,178,122
April 1 - April 30 -- -- -- $24,178,122
May 1 - May 31 21,000 $ 40.96 21,000 $23,317,959
-------- --------
Total Second Quarter 136,800 $ 37.15 136,800 $23,317,959
(1) Average price paid per share includes broker commissions.
(2) Our stock buyback program authorizing the purchase of up to $20.0
million of our common stock was announced in January 2004. In January
2005, our board of directors increased the total authorization to
repurchase our common stock under our stock buyback program to $30.0
million. There is no expiration date specified for our stock buyback
program.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- ---------------------------------------
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------
Our annual meeting of shareholders was held on April 13, 2005 in
Chattanooga, Tennessee. At the meeting, the following persons were elected as
directors to serve for a three-year term: Samuel E. Allen (16,565,921 votes for
and 2,525,759 votes withheld), Phillip H. Sanford (17,933,042 votes for and
1,158,638 votes withheld) and A. Alexander Taylor II (16,562,367 votes for and
2,529,313 votes withheld). Other directors whose terms of office continued after
the annual meeting are: Bill W. Stacy, Zan Guerry, Robert E. Bosworth and
Richard E. Cheney
The shareholders also approved the Company's Stock Incentive Plan - 2005
(8,161,248 votes for, 8,086,036 votes against, 62,924 votes abstained and
2,781,472 broker non-votes) and an amendment to our Restated Charter to increase
the authorized number of shares of Common Stock (15,537,923 votes for, 3,529,678
votes against and 24,079 votes abstained.)
ITEM 5. OTHER INFORMATION
- -------------------------
2005 Stock Incentive Plan
- -------------------------
On January 25, 2005, the Company's Board of Directors unanimously adopted
and recommended to the shareholders for approval the Chattem, Inc. Stock
Incentive Plan - 2005 (the "2005 Stock Incentive Plan"). On April 13, 2005, the
2005 Stock Incentive Plan was approved by the Company's shareholders. The 2005
Stock Incentive Plan and the forms of Stock Option Grant Agreement and
Restricted Stock Agreement that will be utilized under the 2005 Stock Incentive
Plan are filed as exhibits to this report.
2005 Corporate Bonus Plan
- -------------------------
On January 25, 2005, the Compensation Committee of the Board of Directors
approved the Company's Corporate Bonus Plan for fiscal 2005. A summary
description of the 2005 Corporate Bonus Plan is filed as an exhibit to this
report.
38
Director Compensation
- ---------------------
On April 19, 2005, the Compensation Committee of the Board of Directors
approved director compensation for fiscal year 2005. A summary description of
director compensation for fiscal year 2005 is filed as an exhibit to this
report.
DELACO Settlement Agreement
- ---------------------------
We have entered into a settlement agreement with The DELACO Company dated
June 30, 2005. See Note 17 of Notes to Condensed Consolidated Financial
Statements included in Part I, Item 1 of this report. A copy of the DELACO
Settlement Agreement is filed as an exhibit to this report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ----------------------------------------
(a) Exhibits (numbered in accordance with Item 601 of Regulation S-K):
Exhibit Number Description
-------------- -----------
10.1 Chattem, Inc. Stock Incentive Plan - 2005
10.2 Form of Stock Option Grant Agreement under Chattem,
Inc. Stock Incentive Plan - 2005
10.3 Form of Restricted Stock Agreement under Chattem, Inc.
Stock Incentive Plan - 2005
10.4 Summary Description of 2005 Corporate Bonus Plan
10.5 Summary Description of Director Compensation for Fiscal
Year 2005
10.6 Settlement Agreement dated as of June 30, 2005 by and
between Chattem, Inc. and The DELACO Company
31.1 Certification required by Rule 13a-14(a) under the
Securities Exchange Act of 1934
31.2 Certification required by Rule 13a-14(a) under the
Securities Exchange Act of 1934
32 Certification required by Rule 13a-14(b) under the
Securities Exchange Act of 1934 and 18 U.S.C. Section
1350
(b) During the second quarter ended May 31, 2005, we filed the following Form
8-K reports with the Securities and Exchange Commission:
Form 8-K, filed April 26, 2005, announcing a change in our certifying
accountants.
Form 8-K, filed March 23, 2005, containing a copy of our press release
announcing our financial results for the first fiscal quarter of 2005.
Form 8-K, filed March 22, 2005, announcing Chattem, Inc. entering into a
Final Settlement Trust Agreement with AmSouth Bank, as trustee.
39
CHATTEM, INC.
-------------
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CHATTEM, INC.
(Registrant)
Dated: July 6, 2005 /s/ A. Alexander Taylor II
------------ --------------------------
A. Alexander Taylor II
President, Chief Operating Officer and Director
(Chief Operating Officer)
Dated: July 6, 2005 /s/ Richard D. Moss
------------ --------------------------
Richard D. Moss
Vice President and Chief Financial Officer
(Principal Financial Officer)
40
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
EXHIBIT INDEX
-------------
Exhibit Number Description of Exhibit
- -------------- ----------------------
10.1 Chattem, Inc. Stock Incentive Plan-2005
10.2 Form of Stock Option Grant Agreement under Chattem, Inc.
Stock Incentive Plan - 2005
10.3 Form of Restricted Stock Agreement under Chattem, Inc.
Stock Incentive Plan - 2005
10.4 Summary Description of 2005 Corporate Bonus Plan
10.5 Summary Description of Director Compensation for Fiscal
Year 2005
10.6 Settlement Agreement dated as of June 30, 2005 by and
between Chattem, Inc. and The DELACO Company
31.1 Certification required by Rule 13a-14(a) under the
Securities Exchange Act of 1934
31.2 Certification required by Rule 13a-14(a) under the
Securities Exchange Act of 1934
32 Certification required by Rule 13a-14(b) under the
Securities Exchange Act of 1934 and 18 U.S.C. Section 1350
41