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ACCESSION NUMBER: 0001072613-03-000358
CONFORMED SUBMISSION TYPE: 10-K
PUBLIC DOCUMENT COUNT: 8
CONFORMED PERIOD OF REPORT: 20021130
FILED AS OF DATE: 20030227
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: CHATTEM INC
CENTRAL INDEX KEY: 0000019520
STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834]
IRS NUMBER: 620156300
STATE OF INCORPORATION: TN
FISCAL YEAR END: 1130
FILING VALUES:
FORM TYPE: 10-K
SEC ACT: 1934 Act
SEC FILE NUMBER: 000-05905
FILM NUMBER: 03583766
BUSINESS ADDRESS:
STREET 1: 1715 W 38TH ST
CITY: CHATTANOOGA
STATE: TN
ZIP: 37409
BUSINESS PHONE: 4238214571
MAIL ADDRESS:
STREET 1: 1715 W 38TH ST
CITY: CHATTANOOGA
STATE: TN
ZIP: 37409
FORMER COMPANY:
FORMER CONFORMED NAME: CHATTEM DRUG & CHEMICAL CO
DATE OF NAME CHANGE: 19790111
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-K
<SEQUENCE>1
<FILENAME>form10-k_11769.txt
<DESCRIPTION>FORM 10-K - YEAR ENDED NOVEMBER 30, 2002
<TEXT>
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 2002 COMMISSION FILE NUMBER 0-5905
CHATTEM, INC.
--------------------------------
A TENNESSEE CORPORATION
IRS EMPLOYER IDENTIFICATION NO. 62-0156300
1715 WEST 38TH STREET
CHATTANOOGA, TENNESSEE 37409
TELEPHONE: 423-821-4571
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- -------------------
NONE NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, WITHOUT PAR VALUE
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 ACT).
DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405 OF REGULATION S-K WILL NOT
BE CONTAINED IN THE DEFINITIVE PROXY STATEMENT INCORPORATED BY REFERENCE IN PART
III OF THIS FORM 10-K.
AS OF FEBRUARY 21, 2003 THE AGGREGATE MARKET VALUE OF VOTING SHARES HELD BY
NON-AFFILIATES WAS $186,611,549. FOR PURPOSES OF THIS COMPUTATION, ALL EXECUTIVE
OFFICERS, DIRECTORS AND FIVE PERCENT BENEFICIAL OWNERS OF THE COMMON STOCK OF
THE REGISTRANT HAVE BEEN DEEMED TO BE AFFILIATES. SUCH DETERMINATION SHALL NOT
BE DEEMED TO BE AN ADMISSION THAT SUCH OFFICERS, DIRECTORS OR FIVE PERCENT
OWNERS ARE IN FACT AFFILIATES OF THE REGISTRANT. AS OF FEBRUARY 21, 2003
19,120,845 SHARES OF COMMON STOCK WERE OUTSTANDING.
DOCUMENTS INCORPORATED BY REFERENCE:
PORTIONS OF THE REGISTRANT'S ANNUAL REPORT TO SHAREHOLDERS FOR FISCAL YEAR ENDED
NOVEMBER 30, 2002 (THE "2002 ANNUAL REPORT TO SHAREHOLDERS") ARE INCORPORATED BY
REFERENCE IN PARTS I, II AND IV OF THIS FORM 10-K. PORTIONS OF THE REGISTRANT'S
DEFINITIVE PROXY STATEMENT DATED MARCH 10, 2003 (THE "PROXY STATEMENT") ARE
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K.
================================================================================
<PAGE>
PART I
ITEM 1. BUSINESS
- -----------------
GENERAL
- -------
We are a leading marketer and manufacturer of a broad portfolio of
branded over-the-counter healthcare products, toiletries and dietary
supplements, in such categories as topical analgesics, skin care products,
appetite suppressants and medicated dandruff shampoos. Our product portfolio
includes well-recognized brands, such as:
o ICY HOT, ASPERCREME and FLEXALL topical analgesics;
o GOLD BOND medicated skin care powder, cream, lotion and spray
products;
o PHISODERM medicated acne treatment products and skin cleansers;
o DEXATRIM appetite suppressants; and
o SELSUN BLUE medicated dandruff shampoos.
Our products 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 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 constituted 30.6% of our
total revenues in fiscal 2002. We sell our products nationally through mass
merchandiser, drug and food channels, principally utilizing our own sales force.
Our experienced management team has grown our business by acquiring
brands, developing product line extensions and increasing market penetration of
our existing products. On March 28, 2002, we acquired the SELSUN BLUE line of
medicated dandruff shampoos from Abbott Laboratories, expanding our brand
portfolio into another attractive niche category. We intend to leverage our
marketing, distribution, product development and manufacturing capabilities to
improve on SELSUN BLUE'S strong existing franchise. We expect to continue to
make brand acquisitions, such as SELSUN BLUE, as larger consumer products and
pharmaceutical companies rationalize their product portfolios.
GROWTH STRATEGY
- ---------------
Our strategy to achieve future growth is to acquire new brands,
generate profitable internal growth and expand our international business.
ACQUISITIONS. We intend to identify and acquire brands in niche markets
where we believe we can achieve a significant market presence through our
established advertising and promotion platform, sales and distribution network
and research and development capabilities. We target brands with sales that are
highly responsive to increased advertising support, provide an opportunity for
product line extensions through our research and development efforts and have
the potential to meet our high gross margin goals. We believe we will continue
to have opportunities to acquire attractive brands in niche markets, especially
as larger consumer products and pharmaceutical companies rationalize their
product portfolios.
2
<PAGE>
BRAND MANAGEMENT AND GROWTH. We will seek to increase market share for
our major brands through focused marketing of our existing products and product
line extensions, while maintaining market share for our smaller brands. Our
marketing strategy is to position our products to meet consumer preferences
identified through extensive use of market and consumer research. We intend to
channel advertising and promotion resources to those brands that we feel exhibit
the most potential for growth. We also intend to increase our new product line
extension activities, as evidenced by our recent hiring of a vice president of
research and development and a product development director, who have extensive
experience at larger consumer products and pharmaceutical companies. In
addition, we continually evaluate the profit potential of and markets for our
brands and, in instances where our objectives are not realized, will dispose of
these under-performing brands and redeploy the assets. For example, in fiscal
2000 we sold the Ban product line of antiperspirants and deodorants in response
to major shifts in the competitive environment in this product category and the
resulting prospect of declining sales.
EXPANSION OF INTERNATIONAL BUSINESS. In fiscal 2002, our international
revenues were $21,000,000, or 9.4% of total revenues. We believe that our
acquisition of SELSUN BLUE and our recent hiring of an experienced vice
president of international operations will allow us to expand our international
presence. In 2001, SELSUN BLUE was sold in approximately 90 countries, with
aggregate international sales of $20,100,000, or approximately 50% of its total
net sales. We plan to focus our efforts on expanding SELSUN BLUE'S international
presence in the existing key markets, as well as new markets such as China and
Japan. As we initially focus on the existing key markets, we may discontinue the
sale of SELSUN BLUE in certain smaller markets and may experience a short term
decrease in international sales of SELSUN BLUE. We also intend to leverage
SELSUN BLUE's international marketing and distribution network to launch our
other brands in countries where they are not currently sold.
DEVELOPMENTS DURING FISCAL 2002
- -------------------------------
Fiscal 2002 was highlighted by our acquisition of the SELSUN BLUE line
of medicated dandruff shampoos from Abbott Laboratories. On March 28, 2002, we
acquired SELSUN BLUE from Abbott Laboratories for $75,000,000 plus inventories
of $1,380,000 and assumed liabilities of $1,178,000. We financed the acquisition
with a $45,000,000 term loan under our senior credit facility and $31,380,000 of
cash. We acquired the worldwide rights (except in India) to manufacture, sell
and market SELSUN BLUE plus related intellectual property and certain
manufacturing equipment.
Abbott Laboratories, or manufacturers under contract to Abbott
Laboratories, are manufacturing the product for us domestically until June 2003,
or such earlier date as we move production to our Chattanooga, Tennessee
facilities, and internationally until March 2004, or such earlier date as we
enter into our own agreements with contract manufacturers. Certain of the SELSUN
BLUE product lines are presently being manufactured at our facilities. We
generally pay Abbott Laboratories 10% over standard manufacturing costs. Abbott
Laboratories is also marketing, selling and distributing SELSUN BLUE products
for us in certain foreign countries until we satisfy various foreign regulatory
requirements, new distributors are in place and any applicable marketing permits
are transferred. During the transition period, Abbott Laboratories pays us a
royalty equal to 28% of international sales of SELSUN BLUE in these countries
with the royalty reduced to 14% of international sales in certain countries if
foreign regulatory requirements are satisfied prior to our assumption of sales
and marketing responsibility in such countries. Abbott Laboratories will pay all
costs and expenses related to the manufacture, marketing and sales of SELSUN
BLUE in these countries. As we assume responsibility for the sales and marketing
effort in a country, the royalty arrangement with respect to such country will
terminate and we will record these international sales directly, as well as the
costs and expenses associated with these sales. We have completed the transition
for certain key markets and expect to complete the transition for all other
relevant foreign countries by March 2004.
In 2001, SELSUN BLUE was sold in approximately 90 countries, with
aggregate international sales of $20,100,000, or approximately 50% of its total
net sales. We plan to focus our efforts on expanding SELSUN BLUE's international
presence in the existing key markets, as well as new markets such as China
3
<PAGE>
and Japan. As we initially focus on the existing key markets, we may discontinue
the sale of SELSUN BLUE in certain smaller markets and may experience a short
term decrease in international sales of SELSUN BLUE. We also intend to leverage
SELSUN BLUE's international marketing and distribution network to launch other
brands in countries where they are not currently being sold.
On March 28, 2002, we obtained a $60,000,000 senior secured credit
facility from a syndicate of commercial banks led by Bank of America, N.A., as
agent. The senior credit facility includes a $15,000,000 revolving credit
facility and a $45,000,000 term loan. The senior credit facility together with
our available cash was used to finance the acquisition of SELSUN BLUE.
Given the perceived safety concerns and the regulatory uncertainties
relating to ephedrine, we have developed alternative formulations for DEXATRIM
Natural and DEXATRIM Results to exclude ephedrine, and on September 20, 2002 we
discontinued the manufacturing and shipment of DEXATRIM Natural and DEXATRIM
Results containing ephedrine. Our DEXATRIM products containing ephedrine may
continue to be sold in the trade until our customers' existing supply of
inventory is exhausted or until the products are returned to us. Negative
publicity relating to the possible harmful effects of ephedrine and the
possibility of further regulatory action to restrict or prohibit the sale of
products containing ephedrine could result in a return of products from
retailers or our decision to accept product returns of DEXATRIM with ephedrine.
On January 12, 2002, Kmart Corporation, a customer of ours representing
approximately 5% of our fiscal 2001 consolidated total revenues, filed a
petition under Chapter 11 of the United States Bankruptcy Code. At the time of
the filing, Kmart Corporation owed us approximately $1,200,000. In the first
quarter of 2002, we increased our allowance for doubtful accounts by $1,000,000
for this potential loss. In the second quarter of fiscal 2002, we sold the
$1,200,000 of accounts receivable related to Kmart Corporation to Bank of
America, N.A. for approximately $0.34 for each $1.00. We continue to sell to
Kmart Corporation at decreased volume levels and as of November 30, 2002 our
receivables from Kmart Corporation were $796,000.
On October 29, 2002, our board of directors approved a two-for-one
stock split of our common stock by means of a stock dividend of one share for
each share held by shareholders of record on November 15, 2002 with a
distribution date of November 29, 2002. As a result of the stock split, the
number of outstanding shares of our common stock doubled.
During fiscal 2002, we repurchased, and returned to unissued, 79,200
shares of our common stock for $1,650,000 in accordance with our previously
announced stock buyback program.
We will continue to seek sales increases through a combination of
acquisitions and internal growth while maintaining high operating income levels.
As previously high-growth brands mature, sales increases will become even more
dependent on acquisitions and development of successful line extensions. During
fiscal 2002, we introduced DEXATRIM Results, GOLD BOND Foot Spray, PHISODERM
CLEAR CONFIDENCE Acne Body Wash, PHISODERM CLEAR CONFIDENCE Acne Facial Masque
and PHISODERM CLEAR CONFIDENCE Clear Swab. Line extensions, product
introductions and acquisitions require a significant amount of introductory
advertising and promotional support. For a period of time, these products do not
generate a commensurate amount of sales and/or earnings. As a result, we may
experience a short-term impact on our profitability due to acquisitions and line
extensions.
4
<PAGE>
PRODUCTS
- --------
We currently market a diverse and broad portfolio of branded over-the-counter
healthcare products, toiletries and dietary supplements, in such categories as
topical analgesics, skin care products, appetite suppressants and medicated
dandruff shampoos. Our branded products by category consist of:
- --------------------------------------------------------------------------------
CATEGORY AND BRANDS PRODUCT DESCRIPTION
- ------------------- -------------------
TOPICAL ANALGESICS
ICY HOT Dual action muscular and arthritis pain relievers
ASPERCREME Odor-free arthritis pain reliever
FLEXALL Aloe-vera based pain reliever
CAPZASIN Deep penetrating, odor-free arthritis pain reliever
SPORTSCREME Muscular pain reliever
ARTHRITIS HOT Value-priced arthritis pain reliever
SKIN CARE PRODUCTS
GOLD BOND Medicated powder, cream, lotion and spray products
PHISODERM Medicated acne treatment products and skin cleansers
MUDD Facial deep cleanser
APPETITE SUPPRESSANTS
DEXATRIM Diet pills
MEDICATED DANDRUFF SHAMPOOS
SELSUN BLUE Medicated dandruff shampoos
DIETARY SUPPLEMENTS
GARLIQUE Garlic tablets
MELATONEX Sleep aid
NEW PHASE Menopausal supplement
REJUVEX Menopausal supplement
OMNIGEST EZ Digestive aid
PROPALMEX Prostate Health
INTERNAL ANALGESICS
PAMPRIN Menstrual pain reliever
PREMSYN PMS Premenstrual pain reliever
SEASONAL PRODUCTS
BULLFROG Sunscreens and sunblocks
SUN-IN Spray-on hair lightener
ULTRASWIM Chlorine-removing shampoo, conditioner and soap
OTHER PRODUCTS
HERPECIN-L Cold sore lip balm
BENZODENT Denture pain relief cream
- --------------------------------------------------------------------------------
5
<PAGE>
TOPICAL ANALGESICS
Our portfolio of topical analgesics contains a variety of brands, each
with characteristics designed to meet the demands of different end users. ICY
HOT, available in a cream, balm, patch and stick form, is a dual action, extra
strength muscular and arthritis pain reliever that appeals to a large group of
users, ranging from young athletes to older consumers desiring to maintain an
active lifestyle. We introduced the ICY HOT Patch in fiscal 2001 to offer
concentrated pain relief in an easy to apply patch form. ASPERCREME provides
odor-free pain relief for sufferers of arthritis or other chronic pain. FLEXALL
is marketed toward those who seek an aloe vera based pain reliever for
conditions such as chronic back pain or muscle strain. CAPZASIN is an arthritis
pain reliever that contains capsicin, the active ingredient that doctors
recommend most for arthritis sufferers.
SKIN CARE PRODUCTS
The GOLD BOND brand, which is more than one hundred years old, competes
in the adult and baby medicated powder, foot powder and spray, therapeutic
lotion, anti-itch cream and antibiotic ointment markets. GOLD BOND is the
leading brand in the medicated body powder category in the United States. We
have grown the GOLD BOND franchise through successful line extensions and plan
to introduce additional new products under our GOLD BOND brand to drive future
growth. In fiscal 1997 we added GOLD BOND Foot Powder and in fiscal 1998 GOLD
BOND Medicated Body Lotion as line extensions. GOLD BOND Antibiotic Ointment was
introduced during the first quarter of fiscal 1999, while GOLD BOND Sensitive
Skin Body Lotion was added to the product line in fiscal 2000. In the first
quarter of fiscal 2002, we introduced GOLD BOND Foot Spray, an aerosol delivery
form of our successful foot powder, to meet the needs of customers who desire
the same efficacy found in other GOLD BOND products, but prefer a spray form.
PHISODERM is a line of medicated acne treatment products and skin
cleansers. In fiscal 2001, we continued to focus on the growing acne portion of
the business with our introduction of the 4-Way Daily Acne Cleanser. In the
first quarter of fiscal 2002, we further expanded our line of acne treatment
products with the introduction of PHISODERM Acne Body Wash and PHISODERM Acne
Facial Masque, and we recently began shipping PHISODERM Clear Swab, which
incorporates a patented swab delivery system that we license on a non-exclusive
basis from the patent holder. The line also includes several formulas of liquid
skin cleansers, including one for infants. The entire PHISODERM line has
recently been repackaged in clear, contemporary looking packaging.
MUDD is a line of deep cleaning clay based products for the face.
Target consumers for MUDD are women between the ages of 18 and 49. MUDD Masque
is available in four formulas and is a strong market leader in the masque
category.
APPETITE SUPPRESSANTS
DEXATRIM, acquired in December 1998, is a leading brand in the diet
pill category. In fiscal 2001, DEXATRIM enjoyed strong growth in the herbal diet
aid category with DEXATRIM Natural. We currently offer two versions of DEXATRIM:
DEXATRIM Natural, a drug-free, all natural, dietary supplement available in
green tea and caffeine free versions, and DEXATRIM Results, a nutrition based
weight control product which contains vitamins and minerals. We introduced
DEXATRIM Results in the first quarter of fiscal 2002. Given the perceived safety
concerns and the regulatory uncertainties relating to ephedrine, we have
developed alternative formulations for DEXATRIM Natural and DEXATRIM Results to
exclude ephedrine, and discontinued the manufacturing and shipment of DEXATRIM
products containing ephedrine in September 2002. We discontinued marketing
DEXATRIM with phenylpropanolamine ("PPA") in November 2000.
6
<PAGE>
MEDICATED DANDRUFF SHAMPOOS
In March 2002, we purchased the SELSUN BLUE line of medicated dandruff
shampoos from Abbott Laboratories. SELSUN BLUE was introduced in 1953 as a
prescription product and was converted to an over-the-counter product in 1974.
SELSUN BLUE is a well recognized brand name in the medicated dandruff shampoo
market. SELSUN BLUE is positioned as a medicated dandruff shampoo which is the
higher end, more efficacious segment of the dandruff treatment market. SELSUN
BLUE is marketed and sold in the United States and in approximately 90 foreign
countries.
DIETARY SUPPLEMENTS
We compete in the dietary supplements category with our SUNSOURCE line
of products. GARLIQUE garlic tablets support cardiovascular health and are
positioned in the market place as a "one per day" high potency garlic
supplement. Most major GARLIQUE competitors require multiple daily doses. NEW
PHASE is a menopausal supplement which helps relieve hormonal imbalance and
discomfort associated with menopause. NEW PHASE contains 80 milligrams per
tablet of natural phytoestrogens, double the isoflavone content of many leading
brands. OMNIGEST EZ contains a blend of seven plant derived digestive enzymes
that work along with the digestive enzymes produced by one's own body to aid in
the digestion of fats, proteins, carbohydrates, cellulose, and dairy products.
INTERNAL ANALGESICS
PAMPRIN is a combination drug targeted towards relief of menstrual
symptoms. PREMSYN PMS is targeted towards the specific symptoms of premenstrual
syndrome.
SEASONAL PRODUCTS
We market several seasonal brands, the bulk of whose sales typically
occur in the first two quarters of our fiscal year. Our seasonal brands include
BULLFROG, our line of waterproof sunscreens and sunblocks, ULTRASWIM, our line
of chlorine-removing shampoos, conditioners and soaps, and SUN-IN, a hair
lightener.
OTHER PRODUCTS
Our remaining products are smaller brands in a variety of niche
markets. We generally attempt to maintain market share for these brands, while
focusing the bulk of our marketing and product development efforts on our major
brands. These smaller brands include HERPECIN-L, a lip care product that treats
cold sores and protects lips from the harmful rays of the sun, and BENZODENT, a
dental analgesic cream for pain related to dentures.
INTERNATIONAL
- -------------
Historically, our international business has been concentrated in
Canada, Europe and Central and South America, and represented 9.4% of our total
revenues in fiscal 2002. Following our acquisition of SELSUN BLUE, which is sold
in approximately 90 foreign countries and had $20,100,000 of international sales
in 2001, our international business will be significantly larger. We plan to
focus our efforts on expanding SELSUN BLUE'S international presence in the
existing key markets, as well as new markets such as China and Japan. As we
initially focus on the existing key markets, we may discontinue the sale of
SELSUN BLUE in certain smaller markets and may experience a short term decrease
in international sales of SELSUN BLUE. We also intend to leverage SELSUN BLUE'S
international marketing and distribution network to launch some of our other
brands in countries where they are not currently being sold. We have recently
hired an experienced vice president of international operations to manage SELSUN
BLUE'S international growth and develop new business opportunities for our
existing brands. Abbott Laboratories is marketing, selling and distributing
SELSUN BLUE products for us in certain foreign countries until we satisfy
7
<PAGE>
various foreign regulatory requirements, new distributor arrangements are in
place and any applicable marketing permits are transferred. During the
transition period, Abbott Laboratories pays us royalties based on international
net sales of SELSUN BLUE. As we take over responsibility for the sales and
marketing effort in a country, the royalty arrangement with respect to such
country terminates and we record these international sales directly as well as
the costs and expenses associated with these sales. We have completed the
transition for certain key markets and expect to complete the transition for all
other relevant foreign countries by March 2004. We have recently entered into
distributor agreements for the distribution of SELSUN BLUE in Mexico, Italy and
Australia and in parts of Asia previously covered by Abbott Laboratories.
Additional financial information regarding our geographic segments,
domestic and international, is provided in our financial statements that are
included in our 2002 Annual Report to Shareholders. See Note 13 of Notes to
Consolidated Financial Statements.
MARKETING, SALES AND DISTRIBUTION
- ---------------------------------
ADVERTISING AND PROMOTION
We aggressively seek to build brand awareness and usage through
extensive and cost effective advertising strategies that emphasize the strengths
of our products. We allocate a significant portion of our revenues to the
advertising and promotion of our products. Expenditures for these purposes were
30.6% of total revenues in fiscal 2002.
We will seek to increase market share for our major brands through
focused marketing of our existing products and product line extensions, while
maintaining market share for our smaller brands. Our marketing strategy is to
position our products to meet consumer preferences identified through extensive
use of market and consumer research. We intend to channel advertising and
promotion resources to those brands that we feel exhibit the most potential for
growth. We rely principally on television and radio advertising and to a lesser
extent print advertising and promotional programs. We strive to achieve cost
efficiencies in our advertising by being opportunistic in our purchase of media
and controlling our production costs. We also maintain the flexibility to
allocate purchased media time among our key brands to respond quickly to
changing consumer trends and to support our growing brands. We believe our
well-developed advertising and promotion platform allows us to quickly and
efficiently launch and support new brands and product line extensions, as well
as increase market penetration of existing brands.
We work directly with retailers to develop promotional calendars and
campaigns for each brand, customizing the promotion to the particular
requirements of the individual retailer. These programs, which include
cooperative advertising, temporary price reductions, in-store displays and
special events, are designed to obtain or enhance distribution at the retail
level and to reach the ultimate consumers of the product. We also utilize
consumer promotions such as coupons, samples and trial sizes to increase the
trial and consumption of the products.
CUSTOMERS
Our customers consist of mass merchandiser, drug and food retailers in
the United States, including Wal-Mart Stores, Inc., Walgreen Co. and The Kroger
Co. In fiscal 2002, our ten largest customers represented approximately 59% of
total revenues, and our 20 largest customers represented approximately 73% of
total revenues, which allows us to target our selling efforts to our key
customers and tailor specific programs to meet their needs. Our fiscal 2002
sales to Wal-Mart Stores, Inc. accounted for approximately 28% of total
revenues. No other customer accounts for more than 10% of consolidated total
revenues. Shoppers Drug Mart, a Canadian retailer, accounts for more than 10% of
international sales. Consistent with industry practice, we do not operate under
a long-term written supply contract with any of our customers.
8
<PAGE>
SALES AND DISTRIBUTION
We have an established national sales and distribution network that
sells to mass merchandiser, drug and food retailers. We utilize our national
sales network, consisting primarily of our own sales force, to effectively sell
and distribute newly acquired brands and product line extensions while
maintaining tight controls over our selling expenses. Our experienced sales
force of over 50 people serves our largest accounts on an individual basis and
our smaller accounts on a regional basis. Our internal sales force accounts for
95% of domestic dollar sales. For the more fragmented food channel and for the
smaller individual stores, we rely on a national network of regional brokers to
provide retail support. In excess of 80% of our domestic orders are received
electronically through our electronic data interchange, or EDI, system and
accuracy for our order fulfillment has been consistently high. Our sales
department performs significant analysis, helping both our sales people and our
customers to understand sales patterns and create appropriate promotions and
merchandising aids for our products. Although not contractually obligated to do
so, in certain circumstances, primarily for seasonal products, we allow our
customers to return unsold merchandise and, for seasonal products, we provide
extended payment terms to our customers.
Internationally, our products are sold by a national broker in Canada
and by distributors in Western Europe (other than the United Kingdom) and
Central and South America. In the United Kingdom, we sell our products directly
to the major accounts and engage national brokers to service the remaining
accounts. Abbott Laboratories is marketing, selling and distributing SELSUN BLUE
products for us in certain foreign countries until we satisfy various foreign
regulatory requirements, new distributor arrangements are in place and any
applicable marketing permits are transferred. We have completed the transition
for certain key markets and expect to complete the transition for all other
relevant foreign countries by March 2004. We recently entered into distributor
agreements for the distribution of SELSUN BLUE in Australia and in parts of Asia
previously covered by Abbott Laboratories.
Most of our products, including those manufactured by third party
manufacturers, are currently shipped from a leased warehouse located in
Chattanooga, Tennessee. We also use a third party logistics service located in
California to warehouse and distribute our products to the West coast area. We
use outside carriers to transport our products. We do not generally experience
wide variances in the amount of inventory we maintain. At present, we have no
significant backlog of customer orders and are promptly meeting customer
requirements.
MANUFACTURING AND QUALITY CONTROL
- ---------------------------------
We currently manufacture approximately 65% of the sales volume of our
products at our two Chattanooga, Tennessee facilities. The balance of our
products are manufactured by third party contract manufacturers, including our
GOLD BOND medicated powders and spray, the ICY HOT Patch, HERPECIN-L, DEXATRIM,
the PHISODERM Clear Swab and our SUNSOURCE line of dietary supplements. Newly
acquired products that are similar to our currently manufactured products
generally can be manufactured by us with the adaptation of existing equipment
and facilities or the addition of new equipment at relatively small cost. We
contract with third party manufacturers to manufacture products that are not
compatible with our existing manufacturing facilities or which can be more
cost-effectively manufactured by others. In many cases, third party
manufacturers are not obligated under contracts that fix the term of their
commitment. We believe we have adequate capacity to meet anticipated demand for
our products through our own manufacturing facilities and third party
manufacturers.
Abbott Laboratories, or manufacturers under contract to Abbott
Laboratories, are manufacturing SELSUN Blue products for us until we move
domestic production to one of our Chattanooga, Tennessee facilities, which we
expect to complete by June 2003; certain of the SELSUN BLUE product lines are
presently being manufactured at our facilities. Abbott Laboratories, or
manufacturers under contract to Abbott Laboratories, will manufacture SELSUN
BLUE internationally for
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us until March 2004 or until we enter our own agreements with foreign contract
manufacturers. Abbott Laboratories is not required to continue manufacturing
SELSUN BLUE for us after June 2003 for domestic manufacturing or after March
2004 for international manufacturing.
To monitor the quality of our products, we maintain an internal quality
control system supported by an onsite microbiology laboratory. We have quality
control inspectors who regularly test our products and processes, and shepherd
the products through the manufacturing cycle. Consultants also are employed from
time to time to test our quality control procedures and the compliance of our
manufacturing operations with FDA regulations. We rely on our third party
manufacturers to comply with applicable current good manufacturing practices.
We purchase raw materials and packaging materials from a number of
third party suppliers, primarily on a purchase order basis. Except for
pamabrom and pyrilamine maleate, active ingredients used in our PAMPRIN and
PREMSYN PMS products, we are not limited to a single source of supply for the
ingredients used in the manufacture of our products. We believe that our current
sources of supply and potential alternative sources will be adequate to meet
future product demands.
PRODUCT DEVELOPMENT
- -------------------
We strive to increase the value of our base brands and obtain an
increased market presence through product line extensions. We rely on internal
market research as well as consultants to identify new product formulations and
line extensions that we believe appeal to the needs of consumers. Our growth
strategy includes an increased emphasis on new product development as evidenced
by our recent hiring of a vice president of research and development and a
product development director, both of whom have extensive experience at large
consumer products and pharmaceutical companies. We currently employ 19 persons
in our research and development department and also engage consultants from time
to time to provide expertise or research in a particular product area. Our
product development expenditures were $1,761,000 in fiscal 2002.
COMPETITION
- -----------
We compete in the over-the-counter health care, toiletries and dietary
supplements markets. These markets are highly competitive and are characterized
by the frequent introduction of new products, including the migration of
prescription drugs to the over-the-counter market, often accompanied by major
advertising and promotional support. Our competitors include large
over-the-counter pharmaceutical companies such as Pfizer, Inc. and Johnson &
Johnson, consumer products companies such as Procter & Gamble Co. and dietary
supplements companies such as Twin Lab, Inc. and Pharmaton Natural Health
Products, many of which have considerably greater financial and other resources
than we do and are not as highly leveraged as we are. Our competitors are thus
better positioned to spend more on research and development, employ more
aggressive pricing strategies, utilize greater purchasing power, build stronger
vendor relationships and develop broader distribution channels than we. In
addition, our competitors have often been willing to use aggressive spending on
trade promotions and advertising as a strategy for building market share at the
expense of their competitors, including us. The private label or generic
category has also become increasingly more competitive in certain of our product
markets. Our products continue to compete for shelf space among retailers who
are increasingly consolidating.
TRADEMARKS AND PATENTS
- ----------------------
Our trademarks are of material importance to our business and among our
most important assets. We own all of our trademarks associated with brands that
we currently market except for PHISODERM, which we license from Valmont, Inc.
under a perpetual royalty free license. In fiscal 2002, substantially all of our
total revenues were from products bearing proprietary or licensed brand names.
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Accordingly, our future success may depend in part upon the goodwill associated
with our brand names, particularly GOLD BOND, ICY HOT, DEXATRIM, SELSUN BLUE and
PHISODERM.
Our principal brand names are registered trademarks in the United
States and certain foreign countries. We maintain, or have applied for, patent
and copyright protection in the United States relating to certain of our
existing and proposed products and processes. We license the patented swab
delivery system used in our PHISODERM Clear Swab on a non-exclusive basis from
the patent holder. We also license other intellectual property from third
parties that is used in certain of our products. The sale of these products
relies on our ability to maintain and extend our licensing agreements with these
third parties.
GOVERNMENT REGULATION
- ---------------------
The manufacturing, distribution, processing, formulation, packaging,
labeling and advertising of our products are subject to regulation by federal
agencies, including, but not limited to:
o the United States Food and Drug Administration;
o the Federal Trade Commission;
o the Drug Enforcement Administration;
o the Consumer Product Safety Commission;
o the United States Postal Service;
o the Environmental Protection Agency; and
o the Occupational Safety and Health Administration.
These activities are also regulated by various agencies of the states,
localities and foreign countries in which our products are sold. In particular,
the United States Food and Drug Administration, or the FDA, regulates the
safety, manufacturing, labeling and distribution of dietary supplements,
including vitamins, minerals and herbs, food additives, over-the-counter and
prescription drugs, medical devices and cosmetics. In addition, the Federal
Trade Commission, or FTC, has primary jurisdiction to regulate the advertising
of over-the-counter drugs, dietary supplements, functional toiletries and skin
care products.
The Federal Food, Drug and Cosmetic Act, or FDC Act, defines a "new
drug" as a drug that is not generally recognized among scientifically qualified
experts as safe and effective for use under the conditions stated in its
labeling. A drug might also be a new drug if it has not been used, outside of
clinical investigations, to a material extent or for a material time under
conditions described for a product. Under the FDC Act, all new drugs, including
over-the-counter products, are subject to premarket approval by the FDA under
the new drug application, or NDA, process. However, a drug that is generally
regarded as safe and effective is not a "new drug," and therefore does not
require premarketing approval.
The FDA adopted an administrative process, the OTC Drug Review, to
determine which active ingredients and indications are safe and effective for
use in over-the-counter products. With the aid of independent expert advisory
review panels, the FDA develops rules, referred to as monographs, that define
categories of safe and effective over-the-counter drugs. The monographs group
drug products into therapeutic classes, such as over-the-counter external
analgesics. Products that comply with monograph conditions do not require
pre-marketing approval from the FDA.
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The FDA has finalized some monographs for certain categories of
over-the-counter drugs, such as drug products for the control of dandruff and
topical acne drug products. If a product is marketed beyond the scope of a
particular final monograph, such as making a labeling claim not covered by the
monograph, the FDA will consider the product to be unapproved and misbranded and
can take enforcement action against the drug company and product including, but
not limited to, issuing a warning letter or initiating a product seizure. In
order to market a product covered by a final monograph for a formulation or use
outside the monograph, a company must submit a marketing application to the FDA.
There are several categories of over-the-counter drugs where the FDA
has not completed its review, such as for external analgesics. In such cases,
the FDA has established tentative final monographs. These tentative final
monographs are similar to final monographs in that they establish conditions
under which over-the-counter drugs can be marketed for certain uses without FDA
pre-marketing approval. However, the FDA will likely not take enforcement action
against an over-the-counter drug subject to a tentative final monograph whose
ingredients and claims are in the OTC Review, unless there is a safety problem
or a substantial effectiveness question.
All of our over-the-counter drug products are regulated pursuant to the
FDA monograph system. Most of our products are sold under tentative final
monographs. Therefore, we face the risk that the FDA could finalize these
monographs and, if our products were no longer in compliance, we may be forced
to reformulate or relabel our products, if possible, or submit a new drug
application or an abbreviated new drug application to have our existing
formulation approved by the FDA. The submission of a new application may require
the preparation and submission of clinical tests, which would be time-consuming
and expensive. We may not receive FDA approval of any application in a timely
manner, or at all. If we were not able to reformulate or relabel our product, or
submit a new application and obtain approval in a timely manner, we would be
required to discontinue selling the affected product. Changes in monographs
could also require us to change our product formulation or dosage form, revise
our labeling, modify our production process or provide additional scientific
data, each of which would involve additional costs, which may be prohibitive.
For our products that are sold according to final monographs, we cannot
deviate from the conditions described in the final monograph, such as changes in
product formulation or labeling claims, unless we obtain pre-marketing approval
from the FDA. Similarly, we may only market the prescription form of SELSUN BLUE
dandruff shampoo according to the conditions and terms described in the
FDA-approved new drug application. Failure to comply with the conditions in the
final monographs or new drug application, where applicable, can result in an FDA
enforcement action.
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. 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 over-the-counter 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 over-the-counter and prescription drug
companies are the best policies to abate the FDA's concern. There can be no
assurance what action, if any, the FDA may take with respect to acetaminophen.
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The Dietary Supplement Health and Education Act of 1994, or DSHEA, was
enacted on October 25, 1994. DSHEA amends the Federal Food, Drug and Cosmetic
Act by defining dietary supplements, which include vitamins, minerals, amino
acids, nutritional supplements, herbs and botanicals, as a new category of food
separate from conventional food. DSHEA provides a regulatory framework to ensure
safe, quality dietary supplements and to foster the dissemination of accurate
information about such products. Under DSHEA, the FDA is generally prohibited
from regulating dietary supplements as food additives or as drugs unless product
claims, such as claims that a product may diagnose, mitigate, cure or prevent an
illness, disease or malady, permit the FDA to attach drug status to a product.
Manufacturers are not required to obtain prior FDA approval before producing or
selling dietary supplements unless the ingredient is considered "new," or was
not on the market as of October 15, 1994.
DSHEA provides for specific nutritional labeling requirements for
dietary supplements. DSHEA permits substantiated, truthful and non-misleading
statements of nutritional support to be made in labeling, such as statements
describing general well-being resulting from consumption of a dietary ingredient
or the role of a nutrient or dietary ingredient in affecting or maintaining a
structure or function of the body. The FDA distinguishes between permitted
structure/function claims for dietary supplements that do not require FDA
preapproval and disease-related claims that require prior FDA approval. A
dietary supplement label must include a disclaimer that the FDA has not
evaluated a particular structure/function claim.
An article marketed as a dietary supplement and subsequently approved
for use as a drug or biologic may continue to be sold and regulated as a dietary
supplement, unless the FDA specifically finds that it is unsafe for use as a
dietary supplement. A substance that has not been marketed as a dietary
supplement prior to its approval as a drug or biologic, or prior to initiation
of substantial clinical investigations for such uses, may be sold as a dietary
supplement pursuant only to an FDA regulation authorizing its use as a dietary
supplement.
Manufacturers of dietary supplements must also comply with
postmarketing responsibilities, including safety and reporting requirements.
The FDA has finalized some of its regulations to implement DSHEA,
including those relating to nutritional labeling requirements and nutritional
support claims. The FDA also has under development additional regulations and
guidelines to implement DSHEA. Newly adopted and future regulations may require
expanded or different labeling for our vitamin and nutritional products. We
cannot determine what effect these regulations, when fully implemented, will
have on our business in the future. These regulations could require the
reformulation or discontinuance of certain products, additional recordkeeping,
warnings, notification procedures and expanded documentation of the properties
of certain products and scientific substantiation regarding ingredients, product
claims and safety. Failure to comply with applicable FDA requirements can result
in sanctions being imposed on us or the manufacture of our products, including
warning letters, product recalls and seizures, injunctions or criminal
prosecution.
Pursuant to the FDC Act, the FDA has promulgated regulations relating
to the manufacturing process for over-the-counter drugs, which are known as
current good manufacturing practices, or GMPs. We anticipate that the FDA will
promulgate GMPs which are specific to dietary supplements and require at least
some of the quality control provisions contained in the GMPs for drugs, which
are more rigorous than the GMPs for foods. As part of its regulatory authority,
the FDA may periodically conduct audits of the physical facilities, machinery,
processes and procedures that we and our competitors use to manufacture
products. The FDA may perform these audits at any time without advanced notice.
As a result of these audits, the FDA may order us to make certain changes in our
manufacturing facilities and processes. We may be required to make additional
expenditures to comply with these orders or possibly discontinue selling certain
products until we comply with these orders. As a result, our business could be
adversely affected. In connection with our acquisition of SELSUN BLUE, we
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must notify the FDA when we assume manufacturing responsibilities at our
Chattanooga facility, which could prompt an FDA facility inspection.
In 1994, the Nonprescription Drug Manufacturers Association (now the
Consumer Healthcare Products Association, or CHPA), initiated a large scale
study in conjunction with the Yale University School of Medicine to investigate
a possible association, if any, of stroke in women aged 18 to 49 using PPA,
formerly the active ingredient in certain of our DEXATRIM products (the "Yale
Study"). PPA is also used in other over-the-counter medications which were also
part of the study. In May 2000, the results of the Yale Study were filed with
the FDA. The investigators concluded that the results of the Yale Study suggest
that PPA increases the risk of hemorrhagic stroke. The FDA indicated at that
time that no immediate action was required and scheduled an FDA advisory panel
to meet in October 2000 to discuss the results of this study.
In October 2000, a Nonprescription Drugs Advisory Committee, or NDAC,
commissioned by the FDA to review the safety of PPA, determined that there is an
association between PPA and hemorrhagic stroke and recommended that PPA not be
considered generally recognized as safe for over-the-counter use as a nasal
decongestant or for weight control. In response to a request from the FDA to
voluntarily cease marketing DEXATRIM with PPA, we announced on November 7, 2000
our decision to immediately cease shipping DEXATRIM with PPA and to accept
product returns from any retailers who decide to discontinue marketing DEXATRIM
with PPA.
The FDA, the Drug Enforcement Administration and a number of state,
local and foreign 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 heartleaf,
which, until September 2002, was used in the manufacturing of some forms of
DEXATRIM Natural and DEXATRIM Results, or synthetic ephedrine, an FDA regulated
ingredient used in some over-the-counter drug products, which has not been used
in our products. These restrictions include the prohibition of over-the-counter
sales, required warnings or labeling statements, recordkeeping 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 prohibition on sales, the
perceived safety concerns relating to ephedrine and the possibility of further
regulatory action increases the likelihood that claims relating to the existence
of naturally-occurring sources of ephedrine in DEXATRIM Natural and DEXATRIM
Results may be filed against us. We are currently defending one lawsuit alleging
product liability arising from ephedrine in DEXATRIM and we understand that
lawsuits have been filed against other manufacturers of appetite suppressants
containing ephedrine. In late 2000, the FDA requested the National Institutes of
Health to commission a review of the safety and efficacy of ephedrine in herbal
products used to control weight. This review will be based on all adverse
events, records and scientific data available to the reviewers. It is expected
that the report will be issued in the Spring of 2003. In September 2001, the
Public Citizen Health Research Group petitioned the FDA to ban the production
and sale of dietary supplements containing ephedrine alkaloids. As of February
21, 2003, the FDA's parent entity, the Department of Health and Human Services,
has decided to defer making a decision on the petition until it has further
scientific information on the safety of ephedrine alkaloids.
We have developed alternative formulations for DEXATRIM Natural and
DEXATRIM Results to exclude ephedrine and discontinued the manufacturing and
shipment of DEXATRIM products containing ephedrine in September 2002. Our
DEXATRIM products containing ephedrine may continue to be sold in the trade
until our customers' existing supply of inventory is exhausted or until the
products are returned to us. Negative publicity relating to the possible harmful
effects of ephedrine and the possibility of further regulatory action to
restrict or prohibit the sale of products containing ephedrine could result in a
return of products from retailers or our decision to accept product returns of
DEXATRIM with ephedrine.
We were notified in October, 2000 that the FDA denied a citizen
petition submitted by Thompson Medical Company, Inc., previous owner of
SPORTSCREME and ASPERCREME, seeking 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
over-the-counter drug
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products, and thus 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 over-the-counter external analgesic drug products. Based on
comments received from the FDA at the meeting, we may revise and resubmit the
protocol. After final comments from the FDA, we expect that it will take one to
two years to produce the clinical data for FDA review. The FDA could finalize
the over-the-counter external analgesic monograph before the protocol and
clinical data results are finalized, which would place 10% trolamine salicylate
in non-monograph status, thus requiring the submission of a new drug application
to market and sell over-the-counter products with 10% trolamine salicylate. This
submission would likely require us to provide clinical data, which would be
expensive. 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
over-the-counter external analgesic monograph is finalized. If 10% trolamine
salicylate is not included in the final monograph, we would likely be required
to discontinue selling these products and remove them from the market after the
expiration of an anticipated grace period or we would review the option of
marketing these products as homeopathic products.
Some of our products are regulated as cosmetics or drug-cosmetics by
the FDA. There are fewer regulatory requirements for cosmetics than for drugs or
dietary supplements. Cosmetics marketed in the United States must comply with
the FDC Act, the Fair Packaging and Labeling Act and the FDA's implementing
regulations. Cosmetics must also comply with quality and labeling requirements
proscribed by the FDA. In addition, several of our products are subject to
product packaging regulation by the Consumer Product Safety Commission and the
FDA.
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. Selenium sulfide, an
ingredient in SELSUN BLUE, is on the state's list as a carcinogen. Although we
are not aware of any action that has been brought with respect to selenium
sulfide under Proposition 65, it is possible that such a claim could be brought,
in which case we would be required to demonstrate that exposure to selenium
sulfide in SELSUN BLUE 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 the
product to acceptable levels of selenium sulfide.
ENVIRONMENTAL MATTERS
- ---------------------
We continuously assess the compliance of our operations with applicable
federal, state and local environmental laws and regulations. Our policy is to
record liabilities for environmental matters when loss amounts are probable and
reasonably determinable. Our manufacturing site utilizes chemicals and other
potentially hazardous materials and generates both hazardous and non-hazardous
waste, the transportation, treatment, storage and disposal of which are
regulated by various governmental agencies. We have engaged environmental
consultants on a regular basis to assist with our compliance efforts. We believe
we are currently in compliance with all applicable environmental permits and are
aware of our responsibilities under applicable environmental laws. Any
expenditures necessitated by changes in law and permitting requirements cannot
be predicted at this time, although such costs are not expected to be material
to our financial position or results of operations.
PRODUCT LIABILITY AND INSURANCE
- -------------------------------
We currently maintain product liability insurance, principally through
third party insurers, that provides coverage for product liability claims,
including those asserted in the lawsuits currently pending and anticipated to be
filed against us relating to the existence of PPA in DEXATRIM. We have
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$102,000,000 of product liability insurance coverage for injuries related to
DEXATRIM containing PPA occurring after our acquisition of DEXATRIM in December,
1998 and prior to May 31, 2001, if the claims are made before May 31, 2004.
Injuries occurring before December 1998 or after May 31, 2001, or claims made
after May 31, 2004, would not be covered by these insurance policies. We
currently have one claim that relates to injuries occurring after May 31, 2001.
Our insurance policies are subject to certain other limitations that are
generally customary for policies of this type.
Approximately half of the existing PPA suits represent cases involving
alleged injuries by products manufactured and sold prior to our acquisition of
DEXATRIM in December 1998. We are being defended and are indemnified from
liability by The DELACO Company, Inc. ("DELACO"), successor to Thompson Medical
Company, Inc. which owned DEXATRIM prior to December 1998. We understand that
DELACO maintains product liability insurance coverage for products manufactured
and sold prior to December 1998 with annual limits of coverage and has an excess
liability policy, but otherwise has only nominal assets. Accordingly, it is
unlikely that DELACO will be able to indemnify us beyond its insurance coverage.
In addition, there can be no assurance that the insurance maintained by DELACO
will be sufficient to cover claims related to products manufactured or sold
prior to our acquisition of DEXATRIM or that ultimately we will not be held
liable for these claims. Our product liability insurance, as described above,
would not apply to claims arising from products manufactured and sold prior to
our acquisition of DEXATRIM.
In addition, we have also been named as a defendant in a lawsuit
alleging that the plaintiff was injured as a result of the ingestion of DEXATRIM
containing ephedrine. Our available insurance for the defense of this lawsuit
and all other product liability claims arising after May 31, 2001 is
significantly less than the level of insurance coverage for claims relating to
DEXATRIM with PPA. Our existing product liability insurance coverage for all
product liability claims arising after May 31, 2001, consists of $2,000,000 of
coverage through a third party insurer, $8,000,000 of self-insured coverage
through our captive insurance subsidiary, of which $1,325,000 is currently
funded, and $25,000,000 of excess coverage through a third party insurer.
All of our insurance policies are subject to certain other limitations
that are generally customary for policies of this type, such as deductibles and
exclusions for exemplary and punitive damages. Since plaintiffs in product
liability claims may seek exemplary and punitive damages, if these damages were
awarded, some of our insurance coverage would not cover these amounts and we may
not have sufficient resources to pay these damages.
The existence of PPA lawsuits and potential concerns relating to
ephedrine in DEXATRIM Natural and DEXATRIM Results have decreased the
availability, limited the available coverage and increased the cost of product
liability insurance to us. Any amounts paid by our insurance to satisfy product
liability claims would decrease product liability insurance coverage available
for any other claims. If our liability for product liability claims is
significant, our existing insurance is likely to be insufficient to cover these
claims and we may not have sufficient resources to pay the liabilities in excess
of our insurance coverage. Furthermore, our product liability insurance provided
by third parties will expire at the end of each annual policy period. We may
incur significant additional costs to obtain insurance coverage upon the
expiration of our current policies and may not be able to obtain coverage in the
future sufficient to satisfy future claims.
EMPLOYEES
- ---------
We employ approximately 396 persons on a full-time basis and 17 persons
on a part-time basis in the United States. In addition, we employ approximately
31 persons at our foreign subsidiaries' offices. Our employees are not
represented by any organized labor union, and we consider our labor relations to
be good.
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LEGAL PROCEEDINGS
- -----------------
As of February 21, 2003, we have been named as a defendant in
approximately 302 lawsuits involving claims by approximately 1,357 plaintiffs
alleging that the plaintiffs were injured as a result of ingestion of products
containing PPA, which was an active ingredient in most of our DEXATRIM products
until November 2000. Most of the lawsuits seek an unspecified amount of
compensatory and exemplary damages or punitive damages. The lawsuits that are
federal cases have now been 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 cases are state court cases which have been filed
in a number of different states.
We anticipate that additional lawsuits will be filed with similar or
other allegations related to our DEXATRIM products containing PPA. None of these
lawsuits has, to date, been resolved by settlement or judicial ruling. The
earliest scheduled trial date in the state cases is May 19, 2003 for Jennifer
Villarreal, et al. v. Chattem, Inc., et al., which was filed in the District
Court of Brazoria County, Texas. It is anticipated that other state cases will
be set for trial during the course of the year and that significant evidentiary
and other hearings will be heard during the course of the year in the federal
cases.
Approximately half of the existing suits represent cases involving
alleged injuries by products manufactured and sold prior to our acquisition of
DEXATRIM in December 1998. We are being defended and are indemnified from
liability by The DELACO Company, Inc. ("DELACO"), successor to Thompson Medical
Company, Inc. which owned DEXATRIM prior to December 1998. We understand that
DELACO maintains product liability insurance coverage for products manufactured
and sold prior to December 1998 with annual limits of coverage and has an excess
liability policy, but otherwise has only nominal assets. Accordingly, it is
unlikely that DELACO will be able to indemnify us beyond its insurance coverage.
In addition, there can be no assurance that the insurance maintained by DELACO
will be sufficient to cover claims related to products manufactured or sold
prior to our acquisition of DEXATRIM or that ultimately we will not be held
liable for these claims. Our product liability insurance, as described more
fully above, would not apply to claims arising from products manufactured and
sold prior to our acquisition of DEXATRIM.
Of the existing lawsuits, about two-thirds of the cases make
non-specific factual allegations against a broad group of PPA manufacturers.
There are approximately 20 identified cases which we currently believe contain
allegations that the plaintiff suffered a hemorrhagic stroke within three days
of ingesting DEXATRIM products containing PPA that were sold after our
acquisition of DEXATRIM in December 1998. As additional lawsuits are filed and
discovery in the existing lawsuits continues, we expect to know more about the
characteristics of the cases, which will result in a fluctuation in the number
of cases ascribed to the categories listed above.
In addition, we have also been named as a defendant in a lawsuit
alleging that the plaintiff was injured as a result of the ingestion of DEXATRIM
containing ephedrine. Our available insurance for the defense of this lawsuit is
significantly less than the level of insurance coverage for claims relating to
DEXATRIM with PPA.
We are aggressively defending these lawsuits. It is too early in the
litigation to evaluate fully the risks that these lawsuits pose, or express a
range of likely outcomes. It is also too early to estimate the number of
lawsuits related to DEXATRIM with PPA or DEXATRIM with ephedrine that will be
filed or whether our available insurance is sufficient to cover these claims.
Other claims, suits and complaints arise in the ordinary course of our
business involving such matters as patents and trademarks, product liability,
environmental matters and other alleged injuries or damage. The outcome of such
litigation cannot be predicted, but, in our opinion, based in part upon the
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opinion of our counsel, all such pending matters are without merit or are of
such kind or involve such amounts as would not have a material adverse effect on
our consolidated operating results or financial position if disposed of
unfavorably.
For a discussion of our other material litigation, see Item 3, "Legal
Proceedings," of this Form 10-K.
RISK FACTORS
- ------------
Our business is subject to a number of risks. Some of the risks
associated with our operations are described in the "Competition," "Government
Regulation," "Environmental," and "Manufacturing and Quality Control" portions
of this Form 10-K. In addition to the other information contained in this Form
10-K, the following risk factors should be carefully considered.
WE ARE A DEFENDANT IN NUMEROUS LAWSUITS ALLEGING INJURY FROM THE USE OF DEXATRIM
PRODUCTS CONTAINING PPA.
As of February 21, 2003, we have been named as a defendant in
approximately 302 lawsuits involving claims by approximately 1,357 plaintiffs
alleging that the plaintiffs were injured as a result of ingestion of products
containing PPA, which was an active ingredient in most of our DEXATRIM products
until November 2000. Most of the lawsuits seek an unspecified amount of
compensatory and exemplary damages or punitive damages. The lawsuits that are
federal cases have now been 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 cases are state court cases which have been filed
in a number of different states.
We anticipate that additional lawsuits will be filed with similar or
other allegations related to our DEXATRIM products containing PPA. None of these
lawsuits has, to date, been resolved by settlement or judicial ruling. The
earliest scheduled trial date in the state cases is May 19, 2003 for Jennifer
Villarreal, et al. v. Chattem, Inc., et al., which was filed in the District
Court of Brazoria County, Texas. It is anticipated that other state cases will
be set for trial during the course of the year and that significant evidentiary
and other hearings will be heard during the course of the year in the federal
cases.
Approximately half of the existing suits represent cases involving
alleged injuries by products manufactured and sold prior to our acquisition of
DEXATRIM in December 1998. We are being defended and are indemnified from
liability by The DELACO Company, Inc. ("DELACO"), successor to Thompson Medical
Company, Inc. which owned DEXATRIM prior to December 1998. We understand that
DELACO maintains product liability insurance coverage for products manufactured
and sold prior to December 1998 with annual limits of coverage and has an excess
liability policy, but otherwise has only nominal assets. Accordingly, it is
unlikely that DELACO will be able to indemnify us beyond its insurance coverage.
In addition, there can be no assurance that the insurance maintained by DELACO
will be sufficient to cover claims related to products manufactured or sold
prior to our acquisition of DEXATRIM or that ultimately we will not be held
liable for these claims. Our product liability insurance, as described more
fully above, would not apply to claims arising from products manufactured and
sold prior to our acquisition of DEXATRIM. If we are forced to assume
PPA-related liabilities arising prior to our acquisition of DEXATRIM or if
PPA-related lawsuits resulted in liabilities greater than amounts under or
exceed the scope of our insurance coverage, we may not have sufficient resources
to satisfy these obligations.
Of the existing lawsuits, about two-thirds of the cases make
non-specific factual allegations against a broad group of PPA manufacturers.
There are approximately 20 identified cases which we currently believe contain
allegations that the plaintiff suffered a hemorrhagic stroke within three days
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of ingesting DEXATRIM products containing PPA that were sold after our
acquisition of DEXATRIM in December 1998. As additional lawsuits are filed and
discovery in the existing lawsuits continues, we expect to know more about the
characteristics of the cases, which will result in a fluctuation in the number
of cases ascribed to the categories listed above.
We are aggressively defending these lawsuits. It is too early in the
litigation to evaluate fully the risks that these lawsuits pose, or express a
range of likely outcomes. It is also too early to estimate the number of
lawsuits related to DEXATRIM with PPA that will be filed or whether our
available insurance is sufficient to cover these claims.
WE MAY FACE ADDITIONAL LAWSUITS ALLEGING INJURY FROM THE USE OF DEXATRIM
PRODUCTS CONTAINING EPHEDRINE, OR FROM OTHER PRODUCTS THAT WE CURRENTLY PRODUCE
OR MAY PRODUCE IN THE FUTURE.
The Food and Drug Administration, or FDA, the Drug Enforcement
Administration and a number of state, local and foreign 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 heartleaf, which, until September 2002, was used in the
manufacturing of some forms of DEXATRIM Natural and DEXATRIM Results, or
synthetic ephedrine, an FDA regulated ingredient used in some over-the-counter
drug products, which has not been used in our products. We have developed
alternative formulations for DEXATRIM Natural and DEXATRIM Results to exclude
ephedrine and discontinued the manufacturing and shipment of DEXATRIM products
containing ephedrine in September 2002. Our DEXATRIM products containing
ephedrine may continue to be sold in the trade until our customers' existing
supply of inventory is exhausted or until the products are returned to us.
Negative publicity relating to the possible harmful effects of ephedrine and the
possibility of further regulatory action to restrict or prohibit the sale of
products containing ephedrine could result in a return of products from
retailers or our decision to accept product returns of DEXATRIM with ephedrine.
We are currently defending one lawsuit alleging product liability
arising from ephedrine in DEXATRIM and we understand that lawsuits have been
filed against other manufacturers of appetite suppressants containing ephedrine,
which claim that these products cause harmful effects, including strokes and
heart attacks. Furthermore, in late 2000, the FDA asked the National Institute
of Health to commission a review of the safety of ephedrine in herbal products
used to control weight, which is expected to be issued in the Spring of 2003.
The enactment of further restrictions or prohibitions on sales, the safety
concerns relating to ephedrine, the publication of studies relating to the
adverse effects of ephedrine or the possibility of further regulatory action, as
with PPA, could result in a sharp increase in the number of ephedrine related
lawsuits filed, including ones in which we are named as defendants. We only have
limited product liability insurance for these potential claims, as discussed
below, a substantial portion of which is self-insurance. In the future, if we
face significant liabilities relating to the DEXATRIM products which included
ephedrine, our product liability insurance is likely to be insufficient and we
may not have sufficient resources to satisfy these liabilities in excess of our
insurance coverage.
An inherent risk of our business is exposure to product liability
claims by users of our products. We may also experience significant product
liability exposure related to our other products in the future.
OUR PRODUCT LIABILITY INSURANCE COVERAGE MAY BE INSUFFICIENT TO COVER EXISTING
OR FUTURE PRODUCT LIABILITY CLAIMS.
Our business inherently makes us the potential target of product
liability claims. We currently maintain product liability insurance, principally
through third party insurers, that provides coverage for product liability
claims, including those asserted in the lawsuits currently pending and
anticipated to be filed against us relating to the existence of PPA in DEXATRIM.
We have $102,000,000 million of product liability insurance coverage for
injuries related to DEXATRIM with PPA occurring after our acquisition of
DEXATRIM in December 1998 and prior to May 31, 2001, if the claims are made
before May 31, 2004. Injuries occurring before December 1998 or after May 31,
2001, or claims made after
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May 31, 2004, would not be covered by this insurance policy. We currently have
one claim that relates to injuries occurring after May 31, 2001. A settlement or
final judgment in any of these PPA lawsuits would reduce the amount of insurance
coverage available for the remaining PPA lawsuits. We maintain a significantly
lower level of insurance coverage for all product liability claims arising after
May 31, 2001. Our product liability insurance coverage for all product liability
claims arising after May 31, 2001 consists of $2,000,000 of coverage through a
third party insurer, $8,000,000 of self-insured coverage through our captive
insurance subsidiary, of which $1,325,000 is currently funded, and $25,000,000
of excess coverage through a third party insurer.
All of our insurance policies are subject to certain other limitations
that are generally customary for policies of this type, such as deductibles and
exclusions for exemplary and punitive damages. Since plaintiffs in product
liability claims may seek exemplary and punitive damages, if these damages were
awarded, some of our insurance coverage would not cover these amounts and we may
not have sufficient resources to pay these damages.
The existence of PPA lawsuits and potential concerns relating to
ephedrine in DEXATRIM Natural and DEXATRIM Results have decreased the
availability, limited the available coverage and increased the cost of product
liability insurance to us. Any amounts paid by our insurance to satisfy product
liabilities would decrease product liability insurance coverage available for
any other claims. If our liability for product liability claims is significant,
our existing insurance is likely to be insufficient to cover these claims and we
may not have sufficient resources to pay the liabilities in excess of our
insurance coverage. Furthermore, our product liability insurance provided by
third parties will expire at the end of each annual policy period. We may incur
significant additional costs to obtain insurance coverage upon the expiration of
our current policies and may not be able to obtain coverage in the future
sufficient to satisfy future claims.
OUR ACQUISITION STRATEGY IS SUBJECT TO RISK AND MAY NOT BE SUCCESSFUL.
An important component of our growth strategy depends on our ability to
successfully execute acquisitions, which involves numerous risks, including:
o not accurately identifying suitable products or brands for
acquisition;
o difficulties in integrating the operations, technologies and
manufacturing processes of the acquired products;
o the diversion of management's attention from other business
concerns; and
o incurring substantial additional indebtedness.
Any future acquisitions, or potential acquisitions, may result in
substantial costs, disrupt our operations, or materially adversely affect our
operating results.
WE FACE SIGNIFICANT COMPETITION IN THE OVER-THE-COUNTER HEALTH CARE, TOILETRIES
AND DIETARY SUPPLEMENTS MARKETS.
The over-the-counter health care, toiletries and dietary supplements
markets are highly competitive and are characterized by the frequent
introduction of new products, including the migration of prescription drugs to
the over-the-counter market, often accompanied by major advertising and
promotional support. These introductions may adversely affect our business,
especially because we compete in categories in which product sales are highly
influenced by advertising and promotions. Our competitors include large
over-the-counter pharmaceutical companies such as Pfizer, Inc. and Johnson &
Johnson, consumer products companies such as Procter & Gamble Co. and dietary
supplements companies such as Twin Lab, Inc. and Pharmaton Natural Health
Products, many of which have
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considerably greater financial and other resources than we do and are not as
highly leveraged as we are. These competitors are thus better positioned to
spend more on research and development, employ more aggressive pricing
strategies, utilize greater purchasing power, build stronger vendor
relationships and develop broader distribution channels than we. In addition,
our competitors have often been willing to use aggressive spending on trade
promotions and advertising as a strategy for building market share, at the
expense of their competitors, including us. The private label or generic
category has also become increasingly more competitive in certain of our product
markets. If we are unable to continue to introduce new and innovative products
that are attractive to consumers, or are unable to allocate sufficient resources
to effectively advertise and promote our products so that they achieve wide
spread market acceptance, we may not be able to compete effectively, and our
operating results and financial condition may be adversely affected.
OUR BUSINESS IS REGULATED BY NUMEROUS FEDERAL, STATE AND FOREIGN GOVERNMENTAL
AUTHORITIES WHICH SUBJECTS US TO ELEVATED COMPLIANCE COSTS AND RISKS OF
NON-COMPLIANCE.
The manufacturing, distribution, processing, formulation, packaging,
and advertising of our products are subject to numerous and complicated federal,
state and foreign governmental regulations. Compliance with these regulations is
difficult and expensive. In particular, the FDA regulates the safety,
manufacturing, labeling and distribution of our over-the-counter products, our
prescription strength SELSUN BLUE products and our dietary supplements. The FDA
also has primary jurisdiction to regulate any advertising that we might use for
the prescription strength form of SELSUN BLUE. In addition, the Federal Trade
Commission, or FTC, has overlapping jurisdiction with the FDA to regulate the
promotion and advertising of our over-the-counter products and our prescription
strength SELSUN BLUE products.
All of our over-the-counter drug products are regulated pursuant to the
FDA's monograph system. The monographs, both tentative and final, set out the
active ingredients and labeling indications that are permitted for certain broad
categories of over-the-counter drug products, such as topical analgesics. Where
the FDA has finalized a particular monograph, it has concluded that a properly
labeled product formulation is generally recognized as safe and effective and
not misbranded. A tentative final monograph indicates that the FDA has not made
a final determination about products in a category to establish safety and
efficacy for a product and its uses. However, companies may sell products
conforming to a tentative final monograph until the final monograph is
published. Products that comply with either final or tentative final monograph
standards do not require pre-marketing approval from the FDA.
Most of our products are regulated pursuant to tentative final
monographs. We face the risk that the FDA may finalize a monograph and exclude a
formulation, including dosage form or a labeling claim that would negatively
affect one or more of our products. If we desire to continue to sell a product
that is outside the scope of a monograph, we would reformulate the product, if
possible, or submit a new drug application to have our existing formulation
approved by the FDA. The submission of a new drug application requires the
preparation and submission of clinical tests, which may be time-consuming and
expensive. We may not receive FDA approval of any application in a timely
manner, or at all. If we were not able to conform our product to the conditions
described in a final monograph, or submit a new drug application and obtain
approval in a timely manner, we would be required to discontinue selling the
affected product. Changes in monographs could also require us to revise our
labeling, modify our production process or provide additional scientific data,
each of which would involve additional costs, which may be prohibitive.
In connection with the FDA's review of tentative final monographs, it:
o is studying the efficacy of the active ingredient in ASPERCREME
and SPORTSCREME, two of our topical analgesics; and
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o has expressed concerns about the safety and efficacy of an active
ingredient in our PAMPRIN and PREMSYN PMS products.
We expect that we will need to produce clinical data in support of the
active ingredient in ASPERCREME and SPORTSCREME, two of our topical analgesics,
or reformulate these products. Producing this clinical data could take at least
one year, if not longer, and ultimately may not be successful. In each case
referred to above, the FDA may revise the monograph to remove any of these
specific active ingredients or labeling claims. Following a short grace period,
if any, we would need to discontinue production of the affected product until we
complied with FDA standards. The suspension or discontinuation of one or more
these products may have a material adverse effect on our business. In fiscal
2002, sales of ASPERCREME and SPORTSCREME represented 8% of total revenues and
sales of PAMPRIN and PREMSYN PMS represented 6% of total revenues.
In accordance with the Federal Food, Drug, and Cosmetic Act and FDA
regulations, our manufacturing processes must also comply with the FDA's current
good manufacturing practices, or GMPs. The FDA inspects our facilities
periodically to determine if we are complying with GMPs.
If we fail to comply with federal, state or foreign regulations, we
could be required to:
o suspend manufacturing operations;
o change product formulations;
o suspend the sale of products with non-complying specifications;
o prepare and submit a new drug application or abbreviated new drug
application; or
o change product labeling, packaging or advertising or take other
corrective action.
Any of these actions could materially and adversely affect our
financial results.
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. Selenium sulfide, an
ingredient in SELSUN BLUE, is on the state's list as a carcinogen. Although we
are not aware of any action that has been brought with respect to selenium
sulfide under Proposition 65, it is possible that such a claim could be brought,
in which case we would be required to demonstrate that exposure to selenium
sulfide in SELSUN BLUE, 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
the product to acceptable levels of selenium sulfide.
OUR SUCCESS DEPENDS ON OUR ABILITY TO ANTICIPATE AND RESPOND IN A TIMELY MANNER
TO CHANGING CONSUMER DEMANDS.
Our success depends on our products' appeal to a broad range of
consumers whose preferences cannot be predicted with certainty and are subject
to change. If our current products do not meet consumer demands, our sales may
decline. In addition, our growth depends upon our ability to develop new
products through product line extensions and product modifications, which
involve numerous risks. We may not be able to accurately identify consumer
preferences and translate our knowledge into customer-accepted products or
successfully integrate these products with our existing product platform or
operations. We may also experience increased expenses incurred in connection
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with product development, marketing and advertising that are not subsequently
supported by a sufficient level of sales, which would negatively affect our
margins. Furthermore, product development may divert management's attention from
other business concerns which could cause sales of our existing products to
suffer. Regardless, newly developed products may not contribute favorably to our
operating results.
WE RELY ON A FEW LARGE CUSTOMERS, AND IN PARTICULAR WAL-MART STORES, INC. FOR A
SIGNIFICANT PORTION OF OUR SALES.
In fiscal 2002, Wal-Mart Stores, Inc. represented approximately 28% of
our total revenues, our ten largest customers represented approximately 59% of
our total revenues and our 20 largest customers represented approximately 73% of
our total revenues. Consistent with industry practice, we do not operate under a
long-term written supply contract with Wal-Mart Stores, Inc. or any of our other
customers. Our business would materially suffer if we lose Wal-Mart Stores, Inc.
as a continuing major customer or if our business with Wal-Mart Stores, Inc.
significantly decreases. The loss of sales to any other large customer could
also materially and adversely affect our financial results.
On January 22, 2002, Kmart Corporation, a customer representing
approximately 5% of our consolidated total revenues in fiscal 2001, filed a
petition under Chapter 11 of the United States Bankruptcy Code. We continue to
sell to Kmart Corporation at decreased volume levels and as of November 30, 2002
our receivables from Kmart Corporation were $796,100. However, we have no
assurances of the future viability of Kmart Corporation. We may be unable to
collect amounts owed to us by Kmart Corporation in a timely manner, or at all,
which may negatively affect our results of operations and cash flow.
WE MAY BE ADVERSELY AFFECTED BY FLUCTUATIONS IN BUYING DECISIONS OF MASS
MERCHANDISERS, DRUG AND FOOD TRADE BUYERS AND THE TREND TOWARD RETAIL TRADE
CONSOLIDATION.
We sell our products to mass merchandiser, food and drug retailers in
the United States. Consequently, our total revenues are affected by fluctuations
in the buying patterns of these customers. These fluctuations may result from
seasonality, pricing, wholesale buying decisions, economic conditions and other
factors. In addition, with the growing trend towards retail consolidation, we
are increasingly dependent upon a few leading retailers whose bargaining
strength continues to grow due to their size. Such retailers have demanded, and
may continue to demand, increased service and order accommodations, as well as
price concessions. As a result, we may face downward pressure on our prices and
increased expenses to meet these demands, which would reduce our margins. We
also may be negatively affected by changes in the policies of our retail trade
customers, such as inventory destocking, limitations on access to shelf space
and other conditions.
WE RELY ON THIRD PARTY MANUFACTURERS FOR A PORTION OF OUR PRODUCT PORTFOLIO,
INCLUDING PRODUCTS UNDER OUR GOLD BOND, ICY HOT AND DEXATRIM BRANDS.
We use third party manufacturers to make products representing
approximately 35% of our fiscal 2002 sales volume, including our GOLD BOND
medicated powders and spray, the ICY HOT Patch, HERPECIN-L, DEXATRIM and our
SUNSOURCE line of dietary supplements. In many cases, third party manufacturers
are not obligated under contracts that fix the term of their commitments and
they may discontinue production upon little or no advance notice. Manufacturers
also may experience problems with product quality or timeliness of product
delivery. We rely on these manufacturers to comply with applicable current good
manufacturing practices. The loss of a contract manufacturer may force us to
shift production to in-house facilities and possibly cause manufacturing delays,
disrupt our ability to fill orders, or require us to suspend production until we
find another third party manufacturer. We are not able to control the
manufacturing efforts of these third party manufacturers as closely as we
control our business. Should any of these manufacturers fail to meet our
standards, we may face regulatory
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sanctions, additional product liability claims or customer complaints, which
could harm our reputation and our business.
FOR A TRANSITION PERIOD, WE WILL RELY ON ABBOTT LABORATORIES, THE PRIOR OWNER OF
SELSUN BLUE, TO MANUFACTURE PRODUCTS FOR US DOMESTICALLY AND MANUFACTURE,
MARKET, SELL AND DISTRIBUTE PRODUCTS FOR US INTERNATIONALLY.
Abbott Laboratories, the prior owner of SELSUN BLUE, or manufacturers
under contract to Abbott Laboratories, are manufacturing SELSUN BLUE products
for us until we move domestic production to our Chattanooga, Tennessee
facilities, which we expect to do by the end of April 2003. Abbott Laboratories,
or manufacturers under contract to Abbott Laboratories, are manufacturing SELSUN
BLUE for us internationally until we enter our own agreements with foreign
contract manufacturers. Abbott Laboratories is not required to continue
manufacturing SELSUN BLUE for us after June 2003 for domestic manufacturing and
after March 2004 for international manufacturing. If we are unable to transition
these manufacturing operations to our facilities or third party manufacturers,
our production of SELSUN BLUE would be disrupted, which could materially
adversely affect our business.
Abbott Laboratories is also marketing, selling and distributing SELSUN
BLUE products for us in certain foreign countries until we satisfy various
foreign regulatory requirements, new distributors are in place and any
applicable marketing permits are transferred. During this transition period,
Abbott Laboratories pays us royalties based on international net sales of SELSUN
BLUE for such foreign countries. As we take over responsibility for the sales
and marketing effort in a country, the royalty arrangement with respect to such
country will terminate and we will record these international sales directly, as
well as the costs and expenses associated with these sales. We have completed
the transition for certain key markets and expect to complete the transition for
all other relevant foreign countries by March 2004. We cannot assure you,
however, that we will be able to complete this transition in a timely manner. If
we fail to assume the international marketing, selling and distribution
activities by the end of the scheduled transition period in any particular
country, the royalties we receive will decrease substantially and our
international sales will not increase as we currently expect.
Until we complete the transition, we will not be able to control the
manufacturing, marketing, selling and distribution efforts of Abbott
Laboratories for SELSUN BLUE as closely as we control our own business. Because
Abbott Laboratories has sold its SELSUN BLUE product line to us, it may not
devote the level of resources or attention to these activities as it had prior
to the acquisition, which may cause international sales of SELSUN BLUE to
decline relative to last year and may harm the reputation of the brand and,
consequently, our business.
OUR DIETARY SUPPLEMENT AND APPETITE SUPPRESSANT BUSINESS COULD SUFFER AS A
RESULT OF INJURIES CAUSED BY DIETARY SUPPLEMENTS IN GENERAL, UNFAVORABLE
SCIENTIFIC STUDIES OR NEGATIVE PRESS.
Our dietary supplements consist of DEXATRIM and the SUNSOURCE product
line. We generally do not conduct or sponsor clinical studies relating to the
ability of our dietary supplements to provide specific health benefits. As a
result, we are highly dependent upon consumers' perception of the benefit and
integrity of the dietary supplements business, as well as the safety and quality
of products in that industry. Injuries caused by dietary supplements or
unfavorable scientific studies or news relating to products in this category may
negatively affect consumers' overall perceptions of products in this category,
including our products, which could harm the goodwill of these brands and cause
our sales to decline.
OUR BUSINESS COULD BE ADVERSELY AFFECTED IF WE ARE UNABLE TO SUCCESSFULLY
PROTECT OUR INTELLECTUAL PROPERTY.
Our trademarks are of material importance to our business and are among
our most important assets. In fiscal year 2002, substantially all of our total
revenues were from products bearing proprietary
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or licensed brand names. Accordingly, our future success may depend in part upon
the goodwill associated with our brand names, particularly GOLD BOND, SELSUN
BLUE, ICY HOT, PHISODERM and DEXATRIM. Although our principal brand names are
registered trademarks in the United States and certain foreign countries, we
cannot assure you that the steps we take to protect our proprietary rights in
our brand names will be adequate to prevent the misappropriation of these
registered brand names in the United States or abroad. In addition, the laws of
some foreign countries do not protect proprietary rights in brand names to the
same extent as do the laws of the United States. We cannot assure you that we
will be able to successfully protect our trademarks from infringement or
otherwise. The loss or infringement of our trademarks could impair the goodwill
associated with our brands, harm our reputation and materially adversely affect
our financial results.
We license additional intellectual property from third parties that is
used in certain of our products, and we cannot assure you that these third
parties can successfully maintain their intellectual property rights. In
addition, the sale of these products relies on our ability to maintain and
extend our licensing agreements with third parties, and we cannot assure you
that we will be successful in maintaining these licensing agreements. Any
significant impairment of the intellectual property covered by these licenses,
or in our rights to use this intellectual property, may cause our sales to
decline.
In addition, our product line extensions are often based on new or
unique delivery methods for those products, like our ICY HOT Patch and our
PHISODERM Clear Swab. These delivery methods may not be protected by
intellectual property rights that we own or license on an exclusive basis or by
exclusive manufacturing agreements. As a result, we may be unable to prevent any
competitor or customer from duplicating our delivery methods to compete directly
with these product line extensions, which could cause sales to suffer.
We may face litigation in the future, either to protect our
intellectual property rights or to defend against claims that we have infringed
the intellectual property fights of others. Intellectual property litigation can
be extremely expensive, and such expense could materially adversely affect our
business.
WE DEPEND ON SOLE SOURCE SUPPLIERS FOR TWO ACTIVE INGREDIENTS USED IN OUR
PAMPRIN AND PREMSYN PMS PRODUCTS AND, IF WE ARE UNABLE TO BUY THESE INGREDIENTS,
WE WILL NOT BE ABLE TO MANUFACTURE THESE PRODUCTS.
Pamabrom and pyrilamine maleate, active ingredients used in our PAMPRIN
and PREMSYN PMS products are purchased from single sources of supply. Pamabrom
is sold only by Chattem Chemicals, Inc. and pyrilamine maleate is produced only
in India and sold only by Lonza, Inc. Financial, regulatory or other
difficulties faced by these single source suppliers or significant changes in
demand for these active ingredients could limit the availability and increase
the price of these active ingredients. We may not be able to obtain necessary
supplies in a timely manner and we may be required to pay higher than expected
prices for these active ingredients, which could adversely affect our gross
margin contribution from these products. Any interruption or significant delay
in the supply of these active ingredients would impede our ability to
manufacture these products, which would cause our sales to decline. We would not
be able to find an alternative supplier and would either need to reformulate
these products or discontinue their production. While we do not currently know
of any facts or circumstances that would adversely affect the supply of pamabrom
or pyrilamine maleate, we cannot assure you that we will be able to continue to
purchase adequate quantities of these active ingredients at acceptable prices in
the future.
WE ARE SUBJECT TO THE RISK OF DOING BUSINESS INTERNATIONALLY.
In fiscal 2002, approximately 9.4% of our total revenues were
attributable to our international business. Our acquisition of SELSUN BLUE has
greatly expanded our international business. We
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anticipate that our ownership of SELSUN BLUE will create the opportunity to
introduce certain of our other brands in countries where they are not currently
sold. We expect to operate in regions and countries where we have little or no
experience and we may not be able to market our products in, or develop new
products successfully for, these markets. We may also encounter other risks of
doing business internationally, including:
o unexpected changes in, or impositions of, legislative or
regulatory requirements;
o fluctuations in foreign exchange rates, which could cause
fluctuations in the price of our products in foreign markets or
cause fluctuations in the cost of certain raw materials purchased
by us;
o delays resulting from difficulty in obtaining export licenses,
tariffs and other barriers and restrictions, potentially longer
payment cycles, greater difficulty in accounts receivable
collection and potentially adverse tax treatment;
o potential trade restrictions and exchange controls;
o differences in protection of our intellectual property rights; and
o the burden of complying with a variety of foreign laws.
In addition, we will be increasingly subject to general geopolitical
risks in foreign countries where we operate, such as political and economic
instability and changes in diplomatic and trade relationships, which could
affect, among other things, customers' inventory levels and consumer purchasing
which could cause our results to fluctuate and our stock price to decline. It
has not been our practice to engage in foreign exchange hedging transactions to
manage the risk of fluctuations in foreign exchange rates because of the limited
nature of our past international operations. Due to the significant expansion of
our international operations as a result of the SELSUN BLUE acquisition, our
exposure to fluctuations in foreign exchange rates has increased.
WE HAVE A SIGNIFICANT AMOUNT OF DEBT THAT COULD ADVERSELY AFFECT OUR BUSINESS
AND GROWTH PROSPECTS.
As of November 30, 2002, our long-term debt was $217,458,000. In the
future we may incur significant additional debt. Our debt could have significant
adverse effects on our business, including:
o requiring us to dedicate a substantial portion of our available
cash for interest payments and the repayment of principal;
o limiting our ability to capitalize on significant business
opportunities;
o making us more vulnerable to economic downturns;
o limiting our ability to withstand competitive pressures; and
o making it more difficult for us to obtain additional financing on
favorable terms.
If we are unable to generate sufficient cash flow from operations in
the future, we may not be able to service our debt and may have to refinance all
or a portion of our debt, obtain additional financing or sell assets to repay
such debt. We cannot assure you that we will be able to effect such refinancing,
additional financing or asset sale on favorable terms or at all.
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The terms of our indenture and our senior credit facility impose
operating and financial restrictions on us, including restrictions on:
o incurrence of additional indebtedness;
o dividends and restricted payments;
o investments;
o loans and guarantees;
o creation of liens;
o transactions with affiliates;
o use of proceeds from sales of assets and subsidiary stock; and
o certain mergers, consolidations and transfers of assets.
The terms of our senior credit facility also require us to comply with
financial maintenance covenants. In the future, we may have other indebtedness
with similar or even more restrictive covenants. These restrictions may impair
our ability to respond to changing business and economic conditions or to grow
our business. In the event that we fail to comply with these covenants, there
could be an event of default under the applicable debt instrument which in turn
could cause a cross default to other debt instruments. As a result, all amounts
outstanding under our various debt instruments may become immediately due and
payable.
OUR OPERATIONS ARE SUBJECT TO SIGNIFICANT ENVIRONMENTAL LAWS AND REGULATIONS.
Our manufacturing site utilizes chemicals and other potentially
hazardous materials and generates both hazardous and non-hazardous waste, the
transportation, treatment, storage and disposal of which are regulated by
various governmental agencies and federal, state and local laws. Under these
laws, we are exposed to liability primarily as an owner or operator of real
property, and as such, we may be responsible for the clean-up or other
remediation of contaminated property. Environmental laws and regulations can
change rapidly and we may become subject to more stringent environmental laws
and regulations in the future which may be retroactively applied to earlier
events. In addition, compliance with more stringent environmental laws and
regulations could involve significant costs.
WE ARE DEPENDENT ON CERTAIN KEY EXECUTIVES, THE LOSS OF WHOM COULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
Our future performance depends significantly upon the efforts and
abilities of certain members of senior management, in particular those of Zan
Guerry, our chairman and chief executive officer, and A. Alexander Taylor II,
our president and chief operating officer. If we were to lose any key senior
executive, our business could be materially adversely affected.
ARTHUR ANDERSEN LLP AUDITED CERTAIN FINANCIAL INFORMATION INCLUDED OR
INCORPORATED IN THIS FORM 10-K. IN THE EVENT SUCH FINANCIAL INFORMATION IS LATER
DETERMINED TO CONTAIN FALSE STATEMENTS, YOU MAY BE UNABLE TO RECOVER DAMAGES
FROM ARTHUR ANDERSEN LLP.
Our consolidated statements of income, shareholders' equity and cash
flows and Schedule II-Valuation and Qualifying Accounts for the fiscal year
ending November 30, 2000 were audited by Arthur Andersen LLP. In May 2002,
Arthur Andersen ceased operations at
27
<PAGE>
its Chattanooga, Tennessee office, from which we were primarily serviced. We are
unable to obtain Arthur Andersen's consent to the incorporation by reference of
its report on such financial statements, dated January 23, 2002, into this Form
10-K and such report has not been reissued. As a result, you may be limited in
your ability to recover damages from Arthur Andersen under Section 11 of the
Securities Act of 1933 if it is later determined that there are false statements
contained in or incorporated by reference into any portions of this Form 10-K
that have been prepared in reliance on financial statements audited by Arthur
Andersen.
OUR SHAREHOLDER RIGHTS PLAN AND RESTATED CHARTER CONTAIN CERTAIN PROVISIONS THAT
MAY DELAY OR PREVENT A MERGER, TENDER OFFER OR OTHER CHANGE OF CONTROL OF US.
Provisions of our shareholder rights plan and our restated charter, as
well as certain provisions of Tennessee corporation law, may deter unfriendly
offers or other efforts to obtain control over us and could deprive you of your
ability to receive a premium on your common stock.
Generally, if any person attempts to acquire 15% or more of our common
stock then outstanding without the approval of our independent directors,
pursuant to our shareholder rights plan, our shareholders may purchase a
significant amount of additional shares of our common stock at 50% of the then
applicable market price. This threat of substantial dilution will discourage
takeover attempts not approved by our board, despite significant potential
benefits to our shareholders.
Our restated charter contains the following additional provisions which
have the effect of discouraging takeover attempts:
o our directors are divided into three classes, with only one class
of directors elected at each annual meeting for a term of three
years, making it difficult for new shareholders to quickly gain
control of our board of directors;
o directors may be removed only for cause prior to the expiration
of their terms; and
o we are prohibited from engaging in certain business combination
transactions with any interested shareholder unless such
transaction is approved by the affirmative vote of at least 80%
of the outstanding shares of our common stock held by
disinterested shareholders, unless disinterested members of our
board of directors approve the transaction or certain fairness
conditions are satisfied, in which case such transaction may be
approved by either the affirmative vote of the holders of not
less than 75% of our outstanding shares of common stock and the
affirmative vote of the holders of not less than 66 2/3% of the
outstanding shares of our common stock which are not owned by the
interested shareholder, or by a majority of disinterested members
of our board of directors, provided that certain quorum
requirements are met.
The Tennessee Business Combination Act prevents an interested
shareholder, which is defined generally as a person owning 10% or more of our
voting stock, from engaging in a business combination with us for five years
following the date such person became an interested shareholder unless before
such person became an interested shareholder, our board of directors approved
the transaction in which the interested shareholder became an interested
shareholder or approved the business combination, and the proposed business
combination satisfied any additional applicable requirements imposed by law and
by our charter or bylaws. If the requisite approval for the business combination
or share acquisition has not been obtained, any business combination is
prohibited until the expiration of five years following the date such person
became an interested shareholder.
28
<PAGE>
THE TRADING PRICE OF OUR COMMON STOCK MAY BE VOLATILE.
The trading price of our common stock could be subject to significant
fluctuations in response to several factors, some of which are beyond our
control, including variations in our quarterly operating results, our leveraged
financial position, potential sales of additional shares of our common stock,
general trends in the consumer products industry, changes by securities analysts
in their estimates or investment ratings, the relative illiquidity of our common
stock, news regarding PPA-related product liability litigation and other
potential product liability litigation and stock market conditions generally.
WE HAVE NO CURRENT INTENTION OF PAYING DIVIDENDS TO HOLDERS OF OUR COMMON STOCK.
We presently intend to retain our earnings, if any, for use in our
operations and repayment of outstanding indebtedness and have no current
intention of paying dividends to holders of our common stock.
FORWARD-LOOKING STATEMENTS
- --------------------------
This Annual Report on Form 10-K and the documents incorporated by
reference herein contain "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. All statements, other than
statements of historical facts, included or incorporated by reference in this
Form 10-K, or in documents incorporated by reference into this Form 10-K,
regarding our strategy, future operations, financial position and results of
operations, projected costs, prospects, plans and objectives of management are
forward-looking statements. The words "anticipates," "believes," "estimates,"
"expects," "potential," "intends," "continue," "may," "plans," "will," "should,"
"could," "would," and similar expressions are intended to identify
forward-looking statements, although not all forward-looking statements contain
these identifying words. We cannot guarantee that we actually will achieve the
plans, intentions or expectations disclosed in our forward-looking statements,
and you should not place undue reliance on our forward-looking statements.
Forward-looking statements are inherently subject to risks, uncertainties and
assumptions. Actual results or events could differ materially from the plans,
intentions and expectations disclosed in the forward-looking statements that we
make. We have included important factors in the cautionary statements included
in this Form 10K, particularly under the heading "Risk Factors," that we believe
could cause actual results or events to differ materially from the
forward-looking statements that we make. Our forward-looking statements do not
reflect the potential impact of any future acquisitions, mergers, dispositions,
joint ventures, or investments that we may be a party to or make. We do not
assume any obligation to update any forward-looking statement.
MARKET DATA
- -----------
We use market and industry data throughout this Annual Report on Form
10-K and the documents incorporated by reference herein, which we have obtained
from market research, publicly available information and industry publications.
These sources generally state that the information that they provide has been
obtained from sources believed to be reliable, but that the accuracy and
completeness of such information are not guaranteed. The market and industry
data is often based on industry surveys and the preparers' experience in the
industry. Similarly, although we believe that the surveys and market research
that others have performed are reliable, we have not independently verified this
information. In particular, market share information has been coordinated and
prepared for us by A.C. Nielsen at our request, based on market segments that we
defined and for which we have paid customary fees. Therefore, such data,
including the market category delineations that form the basis for such data,
are not necessarily representative of results that would have been obtained from
an independent source.
29
<PAGE>
ITEM 2. PROPERTIES
- -------------------
Our headquarters and administrative offices are located at 1715 West
38th Street, Chattanooga, Tennessee. Our primary production facilities are in
close proximity to our headquarters on land owned by us. We lease our primary
warehouse and distribution centers in Chattanooga, Tennessee for our domestic
consumer products. The following table describes in detail the principal
properties owned and leased by us:
<TABLE><CAPTION>
Total Area Total Buildings Square
(Acres) (Square Feet) Use Feet
---------- --------------- ---------------------- ------
<S> <C> <C> <C> <C>
Owned Properties:
Chattanooga, Tennessee 10.0 116,700 Manufacturing 77,000
Office & Administration 39,700
Chattanooga, Tennessee 8.3 68,300 Manufacturing
& Warehousing 58,100
Office 10,200
Leased Properties:
Chattanooga, Tennessee (1) 5.0 135,200 Warehousing 103,800
Chattanooga, Tennessee (2) 0.1 3,800 Warehousing &
Manufacturing 35,200
Chattanooga, Tennessee (3) 5.0 50,000 Warehousing 49,300
Office 700
Mississauga, Ontario, Canada (4) 0.3 20,015 Warehousing 15,515
Office & Administration 3,000
Packaging 1,500
Basingstoke, Hampshire, England (5) 0.5 21,900 Warehousing 13,900
Office & Administration 6,500
Packaging 1,500
</TABLE>
NOTES:
(1) Leased on a month-to-month basis for a monthly rental of $26,533. A twelve
month termination notice is required.
(2) Leased on a month-to-month basis for a monthly rental of $1,575.
(3) Leased under a one year lease ended December 31, 2001, with two one year
term renewal options, for a monthly rental of $12,500. Both renewal options
have been exercised.
(4) Leased under a lease ending November 30, 2004 at a monthly rental,
including property taxes and other incidentals, of approximately $8,327.
(5) Leased under leases ending in 2014 and 2015 at a monthly rental, including
property taxes and other incidentals, of approximately $17,073.
We are currently operating our facilities at approximately 70% of total
capacity. These facilities are FDA registered and are capable of further
utilization through the use of a full-time second shift and the addition of a
third shift.
30
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
See Item 1 "Legal Proceedings" of this Form 10-K and Note 9 of Notes to
Consolidated Financial Statements on pages 41 to 43 of our 2002 Annual Report to
Shareholders, which is incorporated herein by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
- --------------------------------------------------------------
SHAREHOLDER MATTERS
------------------------------------------------------
The information found on pages 25 and 39 to 41 of our 2002 Annual
Report to Shareholders is incorporated herein by reference.
We have not paid dividends on our common stock during the past two
fiscal years. We are restricted from paying dividends by the terms of the
indenture under which our 8.875% Notes were issued and by the terms of our
current credit facility. (See Note 4 of Notes to Consolidated Financial
Statements).
In fiscal 2001, we issued 100,000 shares (after the two-for-one split
of our common stock on November 29, 2002) of restricted common stock to Zan
Guerry and A. Alexander Taylor II, in accordance with the terms of a restricted
stock agreement. The restrictions lapse as to 25% of the restricted shares on
each anniversary beginning one year after the date of grant. The issuance of
these shares of common stock was exempt from registration under Section 4(2) of
the Securities Act of 1933.
In fiscal 2002, we issued 50,000 shares (after the two-for-one stock
split of our common stock on November 29, 2002) of restricted common stock to A.
Alexander Taylor II, in accordance with the terms of a restricted stock
agreement. The restrictions lapse as to 25% of the restricted shares on each
anniversary beginning one year after the date of grant. The issuance of these
shares of common stock was exempt from registration under Section 4(2) of the
Securities Act of 1933.
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
The information found on page 24 of our 2002 Annual Report to
Shareholders is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------------------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
The information found on pages 16 to 29 of our 2002 Annual Report to
Shareholders is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
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.
31
<PAGE>
Our exposure to interest rate risk currently consists of our 8.875%
Senior Notes and our senior credit facility. The aggregate balance outstanding
under the 8.875% Senior Notes as of November 30, 2002 was $204,708,000. Should
interest rates increase or decrease, the estimated fair value of these notes
would decrease or increase, respectively. Loans under our senior credit facility
bear interest at a rate equal to the higher of LIBOR or the federal funds rate
plus .05% plus percentages ranging from .75% to 1.5% depending on our leverage.
As of November 30, 2002, the variable rate on the term loan under our senior
credit facility was 4.8%. The balance outstanding under our term loan was
$20,000,000 as of November 30, 2002. The impact on our results of operations of
a one-point rate change on the outstanding balance of our term loan as of the
end of fiscal 2002 would be approximately $124,000 net of tax. As of November
30, 2002, no revolving credit loans or letters of credit were outstanding under
our senior credit facility.
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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------
The consolidated balance sheets as of November 30, 2002 and 2001 and
the consolidated statements of income, stockholders' equity and cash flows for
each of the three years in the period ended November 30, 2002 together with the
reports of independent auditors (which includes explanatory paragraphs that
describe accounting changes discussed in Note 2 and the two-for-one stock split
in Note 8 to the financial statements) contained on pages 24 through 58 of our
2002 Annual Report to Shareholders are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
On May 7, 2002 our board of directors, upon the recommendation of its
Audit Committee, decided not to renew its engagement of Arthur Andersen LLP as
our auditors and engaged Ernst & Young LLP to serve as our auditors for fiscal
year 2002 and to re-audit fiscal year 2001. During the years ended November 30,
2001 and 2000 there were no disagreements with Arthur Andersen LLP on any
matters of accounting principles or practices, financial statement disclosure,
or auditing scope or procedure.
32
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -----------------------------------------------------------
(a) Directors
The information found in our 2003 Proxy Statement under the heading
"Information about Nominees and Continuing Directors" is hereby incorporated by
reference.
(b) Executive Officers
The following table lists the names of the executive officers and other
key employees of the Company as of February 21, 2003, their ages, their
positions and offices with the Company and the year in which they were first
elected or appointed to these positions:
<TABLE><CAPTION>
NAME AGE POSITION WITH REGISTRANT FIRST ELECTED
- ---------------------- --- ---------------------------- -------------
<S> <C> <C> <C>
Zan Guerry 54 Chairman of the Board and 1990
Chief Executive Officer; Director
A. Alexander Taylor II 49 President and Chief Operating Officer; 1998
Director
Andrea M. Crouch 44 Vice-President - Brand Management 1995
Ron Galante 59 Vice-President - New Business Development 1996
Richard W. Kornhauser 48 Vice-President - Brand Management 2000
Luke J. Lenahan 53 Vice-President - International 2002
Richard D. Moss 45 Vice-President and Chief Financial Officer 2002
B. Derrill Pitts 60 Vice-President - Operations 1984
Donald K. Riker, Ph.D. 57 Vice-President - Research and Development 2001
and Chief Scientific Officer
Scott J. Sloat 40 Controller 2002
Charles M. Stafford 52 Vice-President - Sales 1994
</TABLE>
ZAN GUERRY. Mr. Guerry became our chairman of the board and chief
executive officer in June 1990. Previously he served as our vice president and
chief financial officer from 1980 until 1983, as executive vice president from
1983 to 1990, as president of Chattem Consumer Products from 1989 to 1994, as
chief operating officer from 1989 to 1990 and as president from 1990 to 1998.
Mr. Guerry became one of our directors in 1981. He is also a director of
SunTrust Bank, Chattanooga, N.A.
A. ALEXANDER TAYLOR II. Mr. Taylor became our president and chief
operating officer in January 1998. Prior to joining us, he was a partner with
the law firm of Miller & Martin LLP, our general counsel, from 1983 to 1998. Mr.
Taylor became one of our directors in 1993. He is also a director of
33
<PAGE>
U.S. Xpress Enterprises, Inc., a transportation company, and The Krystal
Company, a restaurant company.
ANDREA M. CROUCH. Ms. Crouch became our vice president-brand management
in 1995. Ms. Crouch joined us in 1985 as an assistant brand manager. Prior to
joining us she served as product planner for Hayes Microcomputer Products, a
manufacturer of modems and communication equipment, and previously was a systems
consultant with Arthur Andersen LLP, an accounting firm.
RON GALANTE. Mr. Galante became our vice-president-new business
development in June 1996. Previously, he was director - new business
development. Prior to that, Mr. Galante served as general manager of Chattem
(Canada), Inc., our Canadian subsidiary, from June 1990 to May 1993, and as
director of marketing for many of our domestic brands from 1980 until 1990.
RICHARD W. KORNHAUSER. Mr. Kornhauser joined us in May, 2000 as our
vice-president-brand management. Prior to joining us, Mr. Kornhauser served as
vice-president group marketing director for Combe Incorporated, a consumer
products company, from October 1990 until May 2000. Previously, he served as a
marketing director at Del Laboratories, a consumer products company.
LUKE J. LENAHAN. Mr. Lenahan joined us in February 2002 as our
vice-president - international. Prior to joining us, he served as general
manager, adult skin care with Johnson & Johnson, a diversified health company,
from 1985 to 2001 in Japan. Previously, he held senior marketing positions with
consumer products companies Combe Incorporated and Procter & Gamble Co. in the
United States and Japan.
RICHARD D. MOSS. Mr. Moss joined us in August 2002 as our vice
president and chief financial officer. Prior to joining us, he served as vice
president and treasurer for Sealy Corporation, a bedding manufacturing company,
from February 1999 until August 2002, and previously was a group treasurer for
Ansaldo Signal N.V., a railway signaling company, from November 1996 to December
1998.
B. DERRILL PITTS. Mr. Pitts joined us in 1961 and since that time has
served us in all manufacturing operation disciplines. He was promoted to vice
president-operations in 1984.
DONALD K. RIKER, PH.D. Dr. Riker joined us in November 2001 as our
vice-president-research and development and chief scientific officer. Prior to
joining us, he was employed by Richardson-Vicks, Inc., a health and personal
care products company, from 1982 to 1986, and the Procter & Gamble Co., a
consumer products company, from 1986 to 2001, in various research capacities,
the last of which was as P&G Corporate Fellow, Personal Health Care.
SCOTT J. SLOAT. Mr. Sloat, a certified public accountant, joined us in
February 2001, as our controller. Prior to joining us, he served as vice
president of finance of Four Seasons Environmental, Inc., an environmental
consulting firm, from 2000 to 2001, as vice president of accounting for Check
Into Cash, Inc., a deferred presentment finance company, from 1998 to 2000, and
as controller and then vice president - finance of Silverman Retail Consultants,
Inc., a consulting firm, from 1994 to 1998. Prior to 1995, Mr. Sloat served as
an audit manager for Touche, Ross & Co. (currently Deloitte & Touche LLP), an
accounting firm.
CHARLES M. STAFFORD. Mr. Stafford became our vice president-sales in
June 1994. Previously he served as our director of field sales and zone sales
manager. Prior to joining us in 1983, Mr. Stafford held sales management
positions with Johnson & Johnson, a pharmaceutical company, and Schering
Corporation (now Schering-Plough Corporation), a research-based pharmaceutical
company.
34
<PAGE>
(c) Compliance with Section 16 (a) of the Exchange Act
The information found in our 2003 Proxy Statement under the heading
"Section 16 (a) Beneficial Reporting Compliance" is hereby incorporated by
reference.
ITEM 11. EXECUTIVE COMPENSATION
- -------------------------------
The information found in our 2003 Proxy Statement under the heading
"Executive Compensation and Other Information" is hereby incorporated by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -----------------------------------------------------------------------
The information found in our 2003 Proxy Statement under the heading
"Voting Securities and Principal Holders Thereof" is hereby incorporated by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------------------------------------------------------
None.
ITEM 14. 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)-14(c) and 15(d)-14(c) under the Securities Exchange Act
of 1934, as amended (the "Exchange Act") (as of the date within 90 days prior to
the filing date of this annual report (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 or in other factors that could significantly affect
such controls.
35
<PAGE>
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORT ON FORMS 8-K
- ------------------------------------------------------------------------
(a) 1. The consolidated financial statements and the related reports of
independent auditors required to be filed with this Form 10-K are incorporated
by reference from pages 24 to 58 of our 2002 Annual Report to Shareholders.
2. The following financial statement schedule is included on page
64 of this Annual Report on Form 10-K:
Schedule II-Valuation and Qualifying Accounts
All other schedules for which provision is made in the
applicable accounting regulation of the Securities and Exchange
Commission are not required under the related instructions or
are inapplicable and therefore have been omitted.
3. The following documents are filed or incorporated by reference
as exhibits to this report:
Exhibit
Number Description of Exhibit References
------ ---------------------- ----------
3.1 Restated Charter of Chattem, Inc., as
amended (10)
3.2 Amended and Restated By-Laws of Chattem, Inc. (1)
4.1 Rights Agreement dated January 27, 2000
between Chattem, Inc. and SunTrust Bank,
Atlanta, N.A. (2)
4.2 Form of Indenture dated March 24, 1998
between Chattem, Inc. and SouthTrust Bank
of Alabama, N.A. relating to the 8.875%
Senior Subordinated Notes due 2008 (3)
4.3 First Amendment and Supplemental Indenture
dated January 3, 2001 to Form of Indenture
dated March 24, 1998 between Chattem, Inc.
and SouthTrust Bank of Alabama, N.A. relating
to the 8.875% Senior Subordinated Notes due 2008. (12)
10.1 Lease Agreements, as amended, dated February 1,
1996 between Tammy Development Company and Chattem,
Inc. for warehouse space at 3100 Williams Street,
Chattanooga, Tennessee (4) and (5)
10.2 Asset Purchase Agreement dated June 6, 1996
between Campbell Laboratories, Inc., seller, and
Chattem, Inc. and Signal Investment & Management Co.,
purchasers, for the HERPECIN-L business (5)
36
<PAGE>
Exhibit
Number Description of Exhibit References
------ ---------------------- ----------
10.3 Asset Purchase and Sale Agreement dated May 23,
1997 by and among Chattem, Inc., Signal
Investment & Management Co., and Sunsource
International, Inc. and Mindbody, Inc. (without
schedules and exhibits) for the SUNSOURCE business (6)
10.4 First Amended and Restated Master Trademark License
Agreement between Signal Investment & Management Co.
and Chattem, Inc., effective June 30, 1992 (7)
10.5* Chattem, Inc. Non-Statutory Stock Option Plan- 1998 (7)
10.6 Commercial Lease dated April 1, 1998 between Chattem,
Inc., lessee, and Kenco Group, Inc., lessor, for
warehouse space Located at 4309 Distribution Avenue,
Chattanooga, Tennessee. (8)
10.7 Purchase and Sale Agreement dated November 16, 1998
by and among Thompson Medical Company, Inc., Chattem,
Inc. and Signal Investment & Management Co. for
certain products (9)
10.8 Termination Agreement dated November 30, 1999 to
SUNSOURCE Asset Purchase and Sale Agreement dated
May 23, 1997 (10)
10.9* Chattem, Inc. Non-Statutory Stock Option Plan - 2000 (10)
10.10 Asset Sale Agreement dated August 24, 2000 by and
among The Andrew Jergens Company, Chattem, Inc.
and Signal Investment & Management Co. for the
Ban business. (11)
10.11* Form of Employment Agreements-
Zan Guerry
A. Alexander Taylor II (12)
37
<PAGE>
Exhibit
Number Description of Exhibit References
------ ---------------------- ----------
10.12* Form of Amended and Restated Severance Agreements-
Zan Guerry
A. Alexander Taylor II (12)
10.13* Form of Amended and Restated
Non-Competition and Severance Agreements-
Andrea M. Crouch
Ron Galante
Luke J. Lenahan
Richard W. Kornhauser
Richard D. Moss
B. Derrill Pitts
Don K. Riker (12)
Charles M. Stafford
10.14* Form of Restricted Stock Agreements -
Zan Guerry
A. Alexander Taylor II (13)
10.15 Asset Purchase Agreement dated March 5, 2002 by
and between Abbott Laboratories and Chattem, Inc.
for the SELSUN BLUE product line (14)
10.16 Credit Agreement dated as of March 28, 2002 among
Chattem, Inc., its domestic subsidiaries, identified
Lenders and Bank of America, N.A., as Agent (14)
10.17* Restricted Stock Agreement with A.
Alexander Taylor II dated October 29, 2002.
11 Statement Regarding Computation of Per Share Earnings
13 2002 Annual Report to Shareholders of Chattem, Inc.
21 Subsidiaries of the Company
23 Consent of Independent Auditors
99.27.1 Copy of Previously Issued Report of Arthur Andersen LLP
99.27.2 Schedule II - Valuation and Qualifying Accounts
- ----------------------
* This item is a management contract or compensatory plan or
arrangement required to be filed as an exhibit to this Form
10-K pursuant to Item 15(c) of this report.
38
<PAGE>
References:
Previously filed as an exhibit to and incorporated by reference from the
indicated report filed with the Securities and Exchange Commission:
(1) Form 8-K filed February 1, 2000.
(2) Form 8-A filed February 1, 2000.
(3) Form S-4 filed May 26, 1998.
(4) Form 10-K for the year ended November 30, 1995.
(5) Form 10-K for the year ended November 30, 1996.
(6) Form 8-K filed July 11, 1997.
(7) Form 10-K for the year ended November 30, 1997.
(8) Form 10-K for the year ended November 30, 1998.
(9) Form 8-K filed December 28, 1998.
(10) Form 10-K for the year ended November 30, 1999.
(11) Form 8-K filed October 2, 2000.
(12) Form 10-K for the year ended November 30, 2000.
(13) Form 10-K for the year ended November 30, 2001.
(14) Form 8-K filed April 10, 2002, as amended.
(b) The following reports on Form 8-K were filed with the Securities
and Exchange Commission during the three months ended November 30, 2002:
Form 8-K, filed September 17, 2002, relating to the sale of shares of
the Company's common stock by three affiliates of the Company.
Form 8-K, filed November 1, 2002, relating to the declaration by the
Company's Board of Directors of a two-for-one split of the Company's
common stock by means of a stock dividend of one share of the Company's
stock for each share held by shareholders of record on November 15,
2002, with a distribution date of November 29, 2002.
39
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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.
Dated: February 27, 2003 CHATTEM, INC.
By: /s/ Zan Guerry
-----------------------------------
Zan Guerry
Title: Chairman and Chief
Executive Officer
By: /s/ Richard D. Moss
-----------------------------------
Richard D. Moss
Title: Vice President
(Principal Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant in
the capacities and on the dates indicated:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Zan Guerry Chairman of the Board 2-21-03
- --------------------------- and Director ---------
Zan Guerry (Chief Executive Officer)
/s/ A. Alexander Taylor II President and Director 2-21-03
- --------------------------- (Chief Operating Officer) ---------
A. Alexander Taylor II
/s/ Samuel E. Allen Director 2-21-03
- --------------------------- ---------
Samuel E. Allen
/s/ Louis H. Barnett Director 2-21-03
- --------------------------- ---------
Louis H. Barnett
/s/ Robert E. Bosworth Director 2-21-03
- --------------------------- ---------
Robert E. Bosworth
/s/ Richard E. Cheney Director 2-21-03
- --------------------------- ---------
Richard E. Cheney
/s/ Bill W. Stacy. Director 2-21-03
- --------------------------- ---------
Bill W. Stacy
/s/ Philip H. Sanford Director 2-21-03
- --------------------------- ---------
Philip H. Sanford
40
<PAGE>
CERTIFICATIONS
I, Zan Guerry, Chairman and Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Chattem, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusion about the effectiveness
of this disclosure controls and procedures based on our evaluation as
of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: February 27, 2003 /s/ Zan Guerry
----------------- ------------------------
Zan Guerry, Chairman and
Chief Executive Officer
41
<PAGE>
CERTIFICATIONS
I, Richard D. Moss, Vice President and Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Chattem, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusion about the effectiveness
of this disclosure controls and procedures based on our evaluation as
of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: February 27, 2003 /s/ Richard D. Moss
----------------- -------------------------------
Richard D. Moss, Vice President
and Chief Financial Officer
42
<PAGE>
CERTIFICATION
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
(SUBSECTIONS (A) AND (B) OF SECTION 1350,
CHAPTER 63 OF TITLE 18, UNITED STATES CODE)
Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections
(a) and (b) of section 1350, chapter 63 of title 18, United States Code), each
of the undersigned officers of Chattem, Inc., a Tennessee corporation (the
"Company"), does hereby certify, to such officer's knowledge, that:
The Annual Report on Form 10-K for the year ended November 30, 2002
(the "Form 10-K") of the Company fully complies with the requirements of section
13 (a) or 15(d) of the Securities Exchange Act for 1934 and information
contained in the Form 10-K fairly presents, in all material respects, the
financial condition and results of operations of the Company.
Dated: February 27, 2003 /s/ Zan Guerry
------------------------------------------
Zan Guerry,
Chairman and Chief Executive Officer
Dated: February 27, 2003 /s/ Richard D. Moss
------------------------------------------
Richard D. Moss
Vice President and Chief Financial Officer
The foregoing certification is being furnished solely pursuant to
section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of
section 1350, chapter 63 of title 18, United States Code) and is not being filed
as part of the Form 10K, Form 10Q, Form 8-K or as a separate disclosure
document.
43
<PAGE>
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
EXHIBIT INDEX
-------------
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------ ----------------------
10.17 Restricted Stock Agreement with A. Alexander
Taylor II, dated October 29, 2002.
11 Statement Regarding Computation of Per Share Earnings
13 2002 Annual Report to Shareholders of Chattem, Inc.
21 Subsidiaries of the Company
23 Consent of Independent Auditors
99.27.1 Copy of Previously Issued Report of Arthur Andersen
LLP
99.27.2 Schedule II - Valuation and Qualifying Accounts
Officers Certifications
43
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-10.17
<SEQUENCE>3
<FILENAME>exh10-17_11769.txt
<DESCRIPTION>RESTRICTED STOCK AGREEMENT
<TEXT>
EXHIBIT 10.17
-------------
RESTRICTED STOCK AGREEMENT
The Compensation Committee (the "Committee") of the Board of Directors of
Chattem, Inc. ("Chattem") has selected A. Alexander Taylor II as the recipient
("Recipient") of the following described shares of restricted common stock (the
"Restricted Shares") in accordance with the following terms:
Administration: The Committee of the Board of Directors of
Chattem will administer the grant of
Restricted Shares.
Shares Subject to Grant: Chattem hereby awards the Recipient
Twenty-Five Thousand (25,000) Restricted
Shares. Chattem shall instruct its transfer
agent to deliver a certificate to the
Recipient representing the Restricted Shares
as soon as reasonably practicable. The
certificate representing the Restricted
Shares shall include an appropriate legend
concerning the restrictions upon such
Restricted Shares.
Restrictions: The Restricted Shares shall be owned free of
restrictions with respect to Six Thousand Two
Hundred Fifty (6,250) of the Restricted
Shares on the first anniversary of this
Agreement and an additional Six Thousand Two
Hundred Fifty (6,250) of such Restricted
Shares shall be owned free of restrictions,
on a cumulative basis, on each of the three
(3) succeeding anniversaries of this
Agreement so that four (4) years from the
date of this Agreement all Twenty-Five
Thousand (25,000) of such Restricted Shares
shall be owned free of restrictions.
Transferability: The restricted portion of the Restricted
Shares are not transferable.
Termination of Employment: If prior to lapse of restrictions the
Recipient's employment has terminated for any
reason other than death, retirement,
disability or a Change in Control (as defined
in the Recipient's Employment Agreement),
then the portion of the Restricted Shares
that remain subject to restrictions shall
automatically be forfeited to Chattem.
Death, Disability or Change Upon the death or disability of the Recipient
in Control: or a Change in Control, all of the Restricted
Shares shall immediately be owned free of
restrictions.
<PAGE>
Taxes: The Recipient currently intends to make a
"Section 83(b) election" under the Internal
Revenue Code with respect to the Restricted
Shares, immediately triggering the payment of
ordinary income tax with respect to the fair
market value of the Restricted Shares on the
date hereof. Chattem shall reimburse the
Recipient on a "grossed up" basis for the
payment of federal income or any other tax
resulting from Recipient's making the Section
83(b) election or receipt of the Restricted
Shares.
Plan: The Restricted Shares are being granted under
Chattem's Non-Statutory Stock Option Plan-
2000.
Section 16: It is intended that the Restricted Shares be
granted in compliance with the provisions of
Rule 16(b)(3) of the Securities Exchange Act
of 1934, as amended.
This Restricted Stock Agreement is dated to be effective this 29th day of
October, 2002.
Chattem, Inc.
By:
-----------------------------
Zan Guerry, Chairman
Recipient:
---------------------------------
A. Alexander Taylor II
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-11
<SEQUENCE>4
<FILENAME>exh-11_11769.txt
<DESCRIPTION>COMPUTATION OF PER SHARE EARNINGS
<TEXT>
EXHIBIT 11
----------
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
FOR THE YEARS ENDED NOVEMBER 30, 2002, 2001 AND 2000
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE><CAPTION>
2002 2001 2000
---------- ---------- ----------
<S> <C> <C> <C>
NET INCOME (LOSS):
Income (loss) before extraordinary gain
(loss) and change in accounting principle ....... $ 18,900 $ 8,395 $ (197)
Extraordinary gain (loss) ......................... -- 6,948 (920)
Change in accounting principle .................... (8,877) -- (542)
---------- ---------- ----------
Net income (loss) .............................. $ 10,023 $ 15,343 $ (1,659)
========== ========== ==========
NUMBER OF COMMON SHARES:
Weighted average outstanding ...................... 18,607 17,854 18,822
Issued upon assumed exercise of outstanding stock
options and stock warrants ..................... 644 190 --
Effect of issuance of restricted common shares .... 93 32 --
---------- ---------- ----------
Weighted average and potential dilutive outstanding 19,344 18,076 18,822
========== ========== ==========
NET INCOME (LOSS) PER COMMON SHARE:
Basic:
Income (loss) before extraordinary gain (loss)
and change in accounting principle ........... $ 1.02 $ .47 $ (.01)
Extraordinary gain (loss) ...................... -- .39 (.05)
Change in accounting principle ................. (.48) -- (.03)
---------- ---------- ----------
Total basic ................................. $ .54 $ .86 $ (.09)
========== ========== ==========
Diluted:
Income (loss) before extraordinary gain (loss)
and change in accounting principle ........... $ .98 $ .47 $ (.01)
Extraordinary gain (loss) ...................... -- .38 (.05)
Change in accounting principle ................. (.46) -- (.03)
---------- ---------- ----------
Total diluted ............................... $ .52 $ .85 $ (.09)
========== ========== ==========
</TABLE>
Note: The share and per share amounts have been adjusted for the effect of the
2 for 1 split of the Company's common stock on November 29, 2002.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-13
<SEQUENCE>5
<FILENAME>exh-13_11769.txt
<DESCRIPTION>CHATTEM, INC. 2002 ANNUAL REPORT
<TEXT>
EXHIBIT 13
----------
To the Shareholders
Fiscal 2002 Review
Chattem's fiscal 2002 results were quite simply "as good as it gets." A 51%
increase in earnings per diluted share before extraordinary items, numerous
marketing successes, the SELSUN BLUE acquisition, and a dramatically
strengthened balance sheet combined to make 2002 an exceptional year.
Total revenues for the year were $223.1 million, a 23% increase over 2001.
Earnings per diluted share before extraordinary items rose 51% to $.98 while net
income before extraordinary items increased 62% to $18.9 million without
amortization of trademarks in 2002.
The year was highlighted by strong performances from a number of our brands. ICY
HOT gross sales jumped 46% led by the ICY HOT Patch and backed by record levels
of advertising support. PHISODERM gross sales increased 38% due to the launch of
three new acne products as well as a 150% increase in media spending.
In a very difficult diet product market, DEXATRIM gross sales increased 9% led
by the introduction of DEXATRIM Results. GARLIQUE and NEW PHASE gross sales rose
36% and 40%, respectively, due to increased marketing support.
These successes were offset slightly by lower gross sales from PAMPRIN, PREMSYN
PMS, MUDD and the smaller SUNSOURCE brands.
Another major highlight of the year was the acquisition of SELSUN BLUE.
Domestically, sales of SELSUN BLUE during our eight months of ownership exceeded
our expectations by over 25%. Internationally, SELSUN BLUE significantly
increased our presence in a number of foreign markets, creating the opportunity
for the introduction of other Chattem brands in those markets.
In terms of our balance sheet, an important measure of strength is net debt
(long-term debt less cash)/EBITDA (earnings before interest, taxes, depreciation
and amortization). At year-end, with net debt of $209 million and EDITDA of
$56.1 million, this ratio was 3.7x versus 4.0x for 2001. Based on expected cash
flows for 2003, we believe this ratio should approach 3.0, assuming no
acquisitions and the use of available cash to retire debt.
*Fiscal 2003 Outlook
While 2002 was certainly an extraordinary year, we are also excited about our
prospects for the coming year as well as the next several years.
The primary reason for our optimism is a strong pipeline of new products, some
of which will affect 2003 but many of which will be launched late in 2003 or
2004.
In terms of 2003 impact, GOLD BOND has three new products: GOLD BOND Antifungal
Foot Swabs, GOLD BOND First Aid Quick Spray and GOLD BOND First Aid Wipes. GOLD
BOND Antifungal Foot
<PAGE>
Swabs introduce the patented swab delivery form that we license into the $250
million athletes foot category. The Spray and Wipes products take the trusted
GOLD BOND name into the first aid category. Each of these launches will be
supported by strong advertising campaigns.
A second area of great opportunity is the anticipated June 2003 launch of the
ICY HOT Back Patch. This exciting product achieved some of our best market
research scores ever and should lead ICY HOT to another outstanding year.
Third, we will continue to implement our 2002 launch of three PHISODERM acne
products with another year of record marketing support.
For late 2003 or early 2004, we have additional new product launches planned for
GOLD BOND, DEXATRIM, PHISODERM, ICY HOT and BULLFROG.
In addition to our planned new product launches, we are focusing our energies on
acquisitions, international growth and research and development.
With our stronger balance sheet, we are very committed to an active acquisition
strategy. We feel the next several years should be a favorable environment for
acquisitions as larger companies rationalize their product portfolio and smaller
companies struggle with critical mass issues.
We have made a substantial commitment to growing international sales by hiring
key new professional management. The acquisition of SELSUN BLUE opens up a
number of new foreign markets for us, where we believe we can launch several of
our existing brands. We have already seen substantial growth in Eastern Europe,
which we think can be replicated in Central and South America and Asia and
Australia.
During the past year we have made great strides in terms of strengthening
research and development. We have invested significantly in professionals to
improve our expertise. This year we will further our investment with the
construction of a new 10,000 square foot research facility. Continued
strengthening of this area will be of vital importance for our future growth
plans.
In terms of our financial goals for fiscal 2003, we are forecasting total
revenues of $240-$245 million and earnings per share of $1.10-$1.15, although
this forecast is of course subject to a number of risks, uncertainties and
assumptions, including those described in our filings with the Securities and
Exchange Commission.
It is great to have strong results but it is particularly pleasing when the
market recognizes our performance. For the second consecutive year, we have been
in the top 25 NASDAQ stocks with a percentage gain in stock price for 2002 of
114%.
We are extremely proud of the achievements of our directors, managers, and
employees during the past year and we look forward to sharing continued
successes with you this year.
2
<PAGE>
* The statements in this section constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995 and are
made in reliance upon the safe-harbor contained therein.
** Brand names that are italicized in this Annual Report refer to trademarks
that we own or license.
3
<PAGE>
CHATTEM CONSUMER PRODUCTS
DOMESTIC PRODUCT OVERVIEW
TOPICAL ANALGESICS
Our portfolio of topical analgesics contains a variety of brands, each with
characteristics designed to meet the demands of different end users. ICY HOT,
available in a cream, balm, patch and stick form, is a dual action, extra
strength muscular and arthritis pain reliever that appeals to a large group of
users, ranging from young athletes to older consumers desiring to maintain an
active lifestyle. We introduced the ICY HOT Patch in fiscal 2001 to offer
concentrated pain relief in an easy to apply patch form. In fiscal 2003, the ICY
HOT Patch will be extended with a uniquely designed patch specifically designed
to meet the needs of adults who suffer from back pain. ASPERCREME provides
odor-free pain relief for sufferers of arthritis or other chronic pain. FLEXALL
is marketed toward those who seek an aloe vera based pain reliever for
conditions such as chronic back pain or muscle strain. CAPZASIN is an arthritis
pain reliever that contains capsicin, the active ingredient that doctors
recommend most for arthritis sufferers. SPORTSCREME is targeted at serious
athletes as well as "weekend warriors." ARTHRITIS HOT provides relief at a value
price. We support the topical analgesic brands with extensive national
television and radio advertising as well as targeted consumer promotions.
SKIN CARE PRODUCTS
The GOLD BOND brand, which is more than 100 years old, competes in the
adult and baby medicated powder, foot powder and spray, therapeutic lotion,
anti-itch cream and antibiotic ointment markets. GOLD BOND is the leading brand
in the domestic medicated powder category. We have grown the GOLD BOND franchise
through successful line extensions and plan to introduce additional new products
under our GOLD BOND brand to drive future growth. In fiscal 1997, we added GOLD
BOND Foot Powder and in 1998 GOLD BOND Medicated Body Lotion as line extensions.
GOLD BOND Antibiotic Ointment was introduced during the first quarter of 1999,
while GOLD BOND Sensitive Skin Body Lotion was added to the product line in
2000. In the first quarter of fiscal 2002, we introduced GOLD BOND Foot Spray,
an aerosol delivery form of our successful foot powder, to meet the needs
customers who desire the same efficacy found in other GOLD BOND products, but
prefer a spray form. In fiscal 2003, three new GOLD BOND products will be
offered: GOLD BOND Antifungal Swabs, the first truly no mess way to treat
athlete's foot, GOLD BOND First Aid Wipes and GOLD BOND First Aid Quick Spray,
both offering unique approaches to stopping pain and itch and helping to prevent
infection. The GOLD BOND product line is heavily supported by national
television and radio advertising throughout most of the year, as well as with
consumer promotions. We believe GOLD BOND continues to represent an opportunity
for growth both through our existing products and the introduction of line
extensions.
PHISODERM is a line of medicated acne treatment products and skin
cleansers. In fiscal 2002, we expanded our line of acne treatment products with
the introduction of PHISODERM CLEAR CONFIDENCE Acne Body Wash, PHISODERM CLEAR
CONFIDENCE Acne Facial Masque, and PHISODERM CLEAR CONFIDENCE Clear Swab, which
incorporates a patented swab delivery system that we license on a non-exclusive
basis from the patentholder. The PHISODERM line also includes
4
<PAGE>
several formulas of liquid skin cleansers, including one for infants. The entire
PHISODERM line has been repackaged in clear, contemporary-looking packages.
Consumer support behind the brand is concentrated on the acne business and
includes print advertising in teen magazines, targeted television advertising on
teen cable programs and extensive sampling.
MUDD is a line of facial cleansers developed by dermatologists which
retains an ethical troubled skin reputation. Target consumers for MUDD are women
between the ages of 18 and 49. MUDD Masque is available in four formulas.
APPETITE SUPPRESSANTS
DEXATRIM, acquired in December 1998, is a leading brand in the diet pill
category. We currently offer two versions of DEXATRIM: DEXATRIM Natural, a
drug-free, all natural, dietary supplement available in green tea and
caffeine-free versions, and DEXATRIM Results, a nutrition based weight control
product which contains vitamins and minerals. We introduced DEXATRIM Results in
the first quarter of fiscal 2002. Given the perceived safety concerns and the
regulatory uncertainties relating to ephedrine, we discontinued the
manufacturing and shipment of DEXATRIM products containing ephedrine in
September 2002. We discontinued marketing DEXATRIM with phenalpropanolamine
("PPA") in November 2000.
MEDICATED DANDRUFF SHAMPOOS
On March 28, 2002, we acquired the SELSUN BLUE line of medicated shampoos
from Abbott Laboratories. SELSUN BLUE relieves the flakes and itching associated
with dandruff and seborrheic dermatitis with a unique formula that does more
than just wash dandruff flakes away; it actually inhibits the overactive skin
cell turnover that "signals" a dandruff or seborrheic dermatitis condition.
SELSUN BLUE offers four formulations: medicated, with a unique cooling
clean feel; moisturizing, with aloe and moisturizers; 2-in-1, with a patented
conditioning system; and pH balanced for color treated hair. Each formula blends
the active medication (selenium sulfide) with extra hair care properties to
ensure that there is a formula just right for virtually all individuals who need
a medicated shampoo. Consumer research indicates that 8 out of 10 users of
SELSUN BLUE are extremely or very satisfied with the results.
SELSUN BLUE has been marketed for over 49 years and is a well recognized
brand name in the medicated dandruff shampoo market. We believe that significant
future growth opportunities exist for SELSUN BLUE through increased advertising
and media support and the introduction of new medicated products. SELSUN BLUE is
currently sold in approximately 90 countries and offers us a strong platform for
future international growth. The SELSUN Blue product line is supported
domestically with national television and radio advertising and consumer
promotions.
DIETARY SUPPLEMENTS
We compete in the dietary supplements category with our SUNSOURCE line of
products. We continue to refine our approach to marketing all natural dietary
supplements and have
5
<PAGE>
successfully focused on two health areas in recent years: cholesterol control
and women's health. GARLIQUE garlic tablets support cardiovascular health and
are positioned in the market place as a "one per day" high potency garlic
supplement. Most major GARLIQUE competitors require multiple daily doses. NEW
PHASE and REJUVEX are menopausal supplements that help relieve hormonal
imbalance and discomfort associated with menopause. MELATONEX is formulated to
support a natural sleep cycle by supplementing the body's production of
melatonin, a hormone necessary for a good night's sleep. OMNIGEST EZ contains a
blend of seven plant derived digestive enzymes that work along with the
digestive enzymes produced by one's own body to aid in the digestion of fats,
proteins, carbohydrates, cellulose, and dairy products. PROPALMEX supports
prostate health and promotes free urinary flow with a unique formula that
contains saw palmetto, lycopene and zinc. All SUNSOURCE products are specially
formulated to provide consumers with an all-natural, drug-free way to support
their specific health care goals.
INTERNAL ANALGESICS
We compete in the menstrual analgesics segment with two brands: PAMPRIN and
PREMSYN PMS. PAMPRIN is a combination over-the-counter drug product targeted
towards the complete relief of all menstrual symptoms. PREMSYN PMS is a
combination over-the-counter drug product targeted towards the specific symptoms
of premenstrual syndrome. The target consumer for our menstrual analgesic
business falls into two main sub-segments: teen girls who have started
menstruating and women aged 18-34. For teen consumers at the point of entry into
the category, we utilize teen print advertising. For women aged 18-34, we rely
on television advertising to communicate the important message that PAMPRIN
provides more complete relief from menstrual symptoms than regular headache
medicine. For these brands we also use point of entry sampling to gain trial and
awareness among the female target audience.
SEASONAL PRODUCTS
We market several seasonal brands, the bulk of whose sales typically occur
in the first two quarters of our fiscal year. Our seasonal brands include
BULLFROG, ULTRASWIM and SUN-IN. BULLFROG is a line of waterproof sunscreens and
sunblocks. We support this brand through network and spot radio advertising and
by unique sponsorships of baseball teams located in sun markets throughout the
United States. ULTRASWIM is our line of chlorine removing shampoos and
conditioners. We support this brand through print advertising targeted to
competitive, recreational and exercise swimmers and triathletes and through
event sponsorships with targeted sampling programs. SUN-IN, a hair lightener, is
available in two varieties of spray-on and a highlighting gel, Super Streaks,
and is supported by print advertising in teen magazines, an interactive web site
and promotional prepacks.
OTHER PRODUCTS
Our remaining products are smaller brands in a variety of niche markets. We
generally attempt to maintain market share for these brands, while focusing the
bulk of our marketing and product development efforts on our major brands. These
smaller brands include HERPECIN-L, a lip care product that treats cold sores and
protects lips from the harmful rays of the sun, and BENZODENT, a dental
analgesic cream for pain related to dentures.
6
<PAGE>
INTERNATIONAL MARKET OVERVIEW
Historically, our international business has been concentrated in Canada,
Europe and Central and South America, and represented 9.4% of our total revenues
in fiscal 2002. Following our acquisition of SELSUN BLUE, which is currently
sold in approximately 90 foreign countries and had $20,100,000 of international
sales in 2001, our international business will be significantly larger. We plan
to focus our efforts on expanding SELSUN BLUE'S international presence in the
existing key markets, as well as new markets such as China and Japan. As we
initially focus on the existing key markets, we may discontinue the sale of
SELSUN BLUE in certain smaller markets and may experience a short term decrease
in international sales of SELSUN BLUE. We also intend to leverage SELSUN BLUE'S
international marketing and distribution network to launch some of our other
brands in countries where they are not currently being sold. We have recently
hired an experienced vice president of international operations to manage SELSUN
BLUE'S international growth and develop new business opportunities for our
existing brands. Abbott Laboratories will market, sell and distribute SELSUN
BLUE products for us in most foreign countries until we satisfy various foreign
regulatory requirements, new distributor arrangements are in place and any
applicable marketing permits are transferred. During the transition period,
Abbott Laboratories will pay us royalties based on international net sales of
SELSUN BLUE. As we take over responsibility for the sales and marketing effort
in a country, the royalty arrangement with respect to such country will
terminate and we will record these international sales. We have completed the
transition for certain key markets and expect to complete the transition for all
other relevant foreign countries by March 2004. We have recently entered into
distributor agreements for the distribution of SELSUN BLUE in Mexico, Italy and
Australia and in parts of Asia previously covered by Abbott Laboratories.
EUROPE
Our European business is conducted through Chattem (U.K.) Limited, a
wholly-owned subsidiary located in Basingstoke, Hampshire, England. This unit
also services distributors in various other worldwide locations. Manufacturing
and packaging of the products are conducted principally in the United Kingdom
with a limited number of ingredients sourced by us. Chattem (U.K.) uses a
national broker in the United Kingdom while distributors are used to market and
sell our products on the Western European continent and elsewhere. Due to the
difficulty and expense involved in the registration of over-the-counter health
care brands in the United Kingdom and Western Europe, Chattem (U.K.) markets
only our toiletries and skin care products in these areas. Our products sold in
Europe include SUN-IN, MUDD face and body products and ULTRASWIM. Cornsilk(R) is
sold under a licensing arrangement with another company. SPRAY BLOND Spray-In
Hair Lightener is marketed only on the European continent. Certain of our
over-the-counter health care products are also sold by Chattem (U.K.) to
customers in parts of Europe and in the Middle and Far East.
CANADA
Chattem (Canada) Inc. is a wholly-owned subsidiary based in Mississauga,
Ontario, Canada which markets and distributes certain of our consumer products
throughout Canada. The
7
<PAGE>
manufacturing of these products is principally done in our facilities in
Chattanooga, Tennessee while some packaging is done in Mississauga. Chattem
(Canada) utilizes a national broker for its sales efforts. Brands marketed and
sold in Canada include SELSUN Blue, GOLD BOND, PAMPRIN, MUDD, SUN-IN, ULTRASWIM,
PHISODERM, ASPERCREME, FLEXALL and DEXATRIM.
UNITED STATES EXPORT
Our United States Export division services various distributors primarily
located in the Caribbean and Central and South America. We distribute SELSUN
BLUE, ICY HOT, GOLD BOND, PHISODERM, ASPERCREME and DEXATRIM into these markets
with the primary focus being the development of our over-the-counter health care
products.
Cornsilk(R) is the registered trademark of Del Laboratories, Inc.
8
<PAGE>
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 elsewhere in this Annual Report.
Fiscal 2001 and 2000 amounts have been restated to give effect to the adoption
of the provisions of EITF Issue Nos. 00-14 and 00-25 on December 1, 2001 and the
two-for-one split of our common stock on November 29, 2002. In this discussion
and analysis, our fiscal years ended November 30, 2000, November 30, 2001 and
November 30, 2002 are referred to as fiscal 2000, fiscal 2001 and fiscal 2002,
respectively. 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.
GENERAL
- -------
We are a leading marketer and manufacturer of a broad portfolio of branded
over-the-counter healthcare products, toiletries and dietary supplements,
including such categories as topical analgesics, skin care products, appetite
suppressants and medicated dandruff shampoos. Our portfolio of products includes
well-recognized brands, such as:
o ICY HOT, ASPERCREME and FLEXALL topical analgesics;
o GOLD BOND medicated skin care powder, cream, lotion and spray products;
o PHISODERM medicated acne treatment products and skin cleansers;
o DEXATRIM appetite suppressants; and
o SELSUN BLUE medicated dandruff shampoos.
Our products target niche markets that are often outside the core product areas
of large companies where we believe we can achieve and sustain significant
market penetration through 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 constituted 30.6% of our total revenues in fiscal 2002.
We sell our products nationally through mass merchandiser, drug and food
channels, principally utilizing our own sales force.
We have grown by actively acquiring new brands and expanding our existing
brands. Our strategy to achieve future growth is to acquire new brands, generate
profitable internal growth and expand our international business.
9
<PAGE>
Fiscal 2002 was highlighted by our acquisition of the SELSUN BLUE line of
medicated dandruff shampoos in March 2002 from Abbott Laboratories. On March 28,
2002, we acquired SELSUN BLUE from Abbott Laboratories for $75,000,000 plus
inventories of $1,380,000 and assumed liabilities of $1,178,000. We financed the
acquisition with a $45,000,000 term loan under our senior credit facility and
$31,380,000 of cash. We acquired worldwide rights (except in India) to
manufacture, sell and market SELSUN BLUE plus related intellectual property and
certain manufacturing equipment.
Abbott Laboratories, or manufacturers under contract to Abbott Laboratories, are
manufacturing the product for us domestically until June 2003, or such earlier
date as we move production to our Chattanooga, Tennessee facilities, and
internationally until March 2004, or such earlier date as we enter into our own
agreements with contract manufacturers. Certain of our SELSUN BLUE product lines
are presently being manufactured at our facilities. We generally pay Abbott
Laboratories ten percent over standard manufacturing costs. Abbott Laboratories
is also marketing, selling and distributing SELSUN BLUE products for us in
certain foreign countries until we satisfy various foreign regulatory
requirements, new distributors are in place and any applicable marketing permits
are transferred. During the transition period, Abbott Laboratories initially
pays us a royalty equal to 28% of international sales of SELSUN BLUE in these
countries with the royalty reduced to 14% of international sales in certain
countries if foreign regulatory requirements are satisfied prior to our
assumption of sales and marketing responsibility in such countries. Abbott
Laboratories pays all costs and expenses related to the manufacture, marketing
and sales of SELSUN BLUE in these countries. As we assume responsibility for the
sales and marketing effort in a country, the royalty arrangement with respect to
such country terminates and we record these international sales directly, as
well as the costs and expenses associated with these sales. We have completed
the transition for certain key markets and expect to complete the transition for
all other relevant foreign countries by March 2004.
In fiscal 2002, our international revenues were $21,042,000, or 9.4% of total
revenues. In 2001, SELSUN BLUE was sold in approximately 90 countries, with
aggregate international sales of $20,100,000, or approximately 50% of its total
net sales. We plan to focus our efforts on expanding SELSUN BLUE'S international
presence in the existing key markets, as well as new markets such as China and
Japan. As we initially focus on the existing key markets, we may discontinue the
sale of SELSUN BLUE in certain smaller markets and may experience a short term
decrease in international sales of SELSUN BLUE. We also intend to leverage
SELSUN BLUE'S international marketing and distribution network to launch other
brands in countries where they are not currently being sold.
In connection with our acquisition of SELSUN BLUE, on March 28, 2002, we
obtained a $60,000,000 senior secured credit facility from a syndicate of
commercial banks led by Bank of America, N.A., as agent. The senior credit
facility includes a $15,000,000 revolving credit facility and a $45,000,000 term
loan. The senior credit facility together with our available cash was used to
finance the acquisition of SELSUN BLUE.
Given the perceived safety concerns and the regulatory uncertainties relating to
ephedrine, we have developed alternative formulations for DEXATRIM Natural and
DEXATRIM Results to exclude ephedrine and on September 20, 2002 we discontinued
the manufacturing and shipment of DEXATRIM Natural and DEXATRIM Results
containing ephedrine. Our DEXATRIM products containing ephedrine may continue to
be sold in the trade until our customers' existing supply of inventory is
exhausted or until the products are returned to us. Negative publicity relating
to the possible harmful effects of ephedrine and the possibility of further
regulatory action to restrict or prohibit the sale of products containing
ephedrine could result in a return of products from retailers or our decision to
accept product returns of DEXATRIM with ephedrine.
10
<PAGE>
On January 12, 2002, Kmart Corporation, a customer of ours representing
approximately 5% of our fiscal 2001 consolidated total revenues, filed a
petition under Chapter 11 of the United States Bankruptcy Code. At the time of
the filing, Kmart Corporation owed us approximately $1,200,000. In the first
quarter of 2002, we increased our allowance for doubtful accounts by $1,000,000
for this potential loss. In the second quarter of fiscal 2002, we sold the
$1,200,000 of accounts receivable related to Kmart Corporation to Bank of
America, N.A. for approximately $0.34 for each $1.00. We continue to sell to
Kmart Corporation at decreased volume levels and as of November 30, 2002 our
receivables from Kmart Corporation were $796,000.
On October 29, 2002, our board of directors approved a two-for-one stock split
of our common stock by means of a stock dividend of one share for each share
held by shareholders of record on November 15, 2002 with a distribution date of
November 29, 2002. As a result of the stock split, the number of outstanding
shares of our common stock doubled.
During fiscal 2002, we repurchased, and returned to unissued, 79,200 shares of
our common stock for $1,650,000 in accordance with our previously announced
stock buyback program. In January 2003 our board of directors increased the
total authorization to repurchase stock under our stock buyback program to
$10,000,000.
We will continue to seek sales increases through a combination of acquisitions
and internal growth while maintaining high operating income levels. As
previously high-growth brands mature, sales increases will become even more
dependent on acquisitions and development of successful line extensions. During
fiscal 2002, we introduced DEXATRIM Results, GOLD BOND Foot Spray, PHISODERM
CLEAR CONFIDENCE Acne Body Wash, PHISODERM CLEAR CONFIDENCE Acne Facial Masque
and PHISODERM CLEAR CONFIDENCE Clear Swab. Line extensions, product
introductions and acquisitions require a significant amount of introductory
advertising and promotional support. For a period of time, these products do not
generate a commensurate amount of sales and/or earnings. As a result, we may
experience a short-term impact on our profitability due to acquisitions and line
extensions.
RESULTS OF OPERATIONS
- ---------------------
The following table sets forth, for income (loss) before extraordinary gain
(loss) and change in accounting principle and for the periods indicated, certain
items from our consolidated statements of income expressed as a percentage of
total revenues:
11
<PAGE>
Year Ended November 30
--------------------------
2002 2001 2000
------ ------ ------
TOTAL REVENUES..................................... 100.0% 100.0% 100.0%
----- ----- -----
COST AND EXPENSES:
Cost of sales.................................. 28.1 29.0 34.4
Advertising and promotion...................... 30.6 34.0 33.7
Selling, general and administrative............ 18.0 18.7 14.1
----- ----- -----
Total costs and expenses................... 76.7 81.7 82.2
----- ----- -----
INCOME FROM OPERATIONS 23.3 18.3 17.8
----- ----- -----
OTHER INCOME (EXPENSE):
Interest expenses.............................. (9.5) (12.0) (16.4)
Investment and other income(expense), net...... (0.1) 1.2 0.7
Loss on product divestitures................... -- -- (2.3)
----- ----- -----
Total other income (expense)............... (9.6) (10.8) (18.0)
----- ----- -----
INCOME (LOSS) BEFORE INCOME TAXES, EXTRAORDINARY
GAIN (LOSS) AND CHANGE IN ACCOUNTING PRINCIPLE 13.7 7.5 (0.2)
PROVISION FOR (BENEFIT FROM) INCOME TAXES.......... 5.2 2.8 (0.1)
----- ----- -----
INCOME (LOSS) BEFORE EXTRAORDINARY GAIN (LOSS)
AND CHANGE IN ACCOUNTING PRINCIPLE............... 8.5% 4.7% (0.1)%
===== ===== =====
CRITICAL ACCOUNTING POLICIES
- ----------------------------
The selection and application of accounting principles and methods impact our
financial results. Our most critical accounting policies are described below.
Impairment Testing of Intangible Assets
---------------------------------------
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other
Intangible Assets" ("SFAS No. 142"). The provisions of SFAS No. 142, which were
adopted by us on December 1, 2001, require us to discontinue the amortization of
the cost of intangible assets with indefinite lives and to perform certain fair
value based tests of the carrying value of indefinite lived intangible assets.
SFAS No. 142 requires this testing to be performed at least annually. These
impairment tests are impacted by judgments as to future cash flows and brand
performance. See Note 2 of Notes to Consolidated Financial Statements for a
further discussion of SFAS No. 142.
Product Return Reserves
-----------------------
Revenue is recognized when our products are shipped to our customers. It is our
policy across all classes of customers that all sales are final. As is common in
the consumer products industry, customers occasionally return products for a
variety of reasons. Examples include product damaged in transit, discontinuance
of a particular size or form of product and shipping errors. We record an
estimate of products to be returned by customers as a reserve against sales. We
12
<PAGE>
generally base this reserve on our historical returns experience and sales
volume. Significant judgment is required when estimating the reserves for
product returns.
For a summary of our significant accounting policies, see Note 2 of Notes to
Consolidated Financial Statements.
FISCAL 2002 COMPARED TO FISCAL 2001
- -----------------------------------
Our total revenues in fiscal 2002, comprised of net sales and royalties from the
international sales of SELSUN BLUE, increased $41,950,000, or 23.2%, to
$223,116,000 from $181,166,000 for the previous fiscal year. The increase was
largely the result of the acquisition of SELSUN BLUE in March 2002 and a net
increase in sales of our other brands. The increase consisted of a $34,818,000,
or 20.8%, increase in domestic consumer product sales to $202,074,000 in fiscal
2002 from $167,256,000 in fiscal 2001 and an increase of $7,132,000, or 51.3%,
in international revenues to $21,042,000 in fiscal 2002 from $13,910,000 in
fiscal 2001. Total revenues in fiscal 2002, excluding net sales and royalties
from SELSUN BLUE, increased 12.2% over fiscal 2001.
Our topical analgesic portfolio produced a sales increase in fiscal 2002 as
compared to fiscal 2001, principally attributable to the continued success of
the ICY HOT Patch, introduced in the second quarter of fiscal 2001, as well as
continued marketing support. We recorded sales increases in our topical
analgesics portfolio in fiscal 2002 for ICY HOT, ASPERCREME, CAPZASIN and
ARTHRITIS HOT, while FLEXALL and SPORTSCREME recorded sales declines. Sales
increases were also recorded for DEXATRIM, behind the launch of DEXATRIM Results
during fiscal 2002, GOLD BOND, driven by the GOLD BOND foot care products, and
PHISODERM, due to the launch of three new PHISODERM acne products. In addition,
GARLIQUE and NEW PHASE recorded sales increases in fiscal 2002. We recorded
sales declines in fiscal 2002 for PAMPRIN, PREMSYN PMS, ULTRASWIM, MUDD and
HERPECIN-L. Sales variances were largely the result of changes in the volume of
unit sales of the particular brand.
International revenues from Canadian operations increased $663,000, or 11.0%,
for fiscal 2002, and the United Kingdom business increased $2,796,000 or 40.5%.
International revenues include $2,327,000 of royalties from the international
sales of SELSUN BLUE. These royalties will continue through the transition
period during which Abbott Laboratories is marketing, selling and distributing
SELSUN BLUE for us internationally. The increase in Canadian sales was due
primarily to the acquisition of SELSUN BLUE in March 2002 and strong sales of
PHISODERM partially offset by declines in sales of our other brands. The
increase in the United Kingdom business was driven by the success of our Eastern
European distributor markets across several brands. This increase was partially
offset by a decrease in the United Kingdom domestic business primarily as a
result of reduced sales for SUN-IN, Cornsilk and ULTRASWIM. United States export
sales increased $1,346,000, or 138.1%, primarily due to the acquisition of
SELSUN BLUE in fiscal 2002. Sales variances were principally the result of
changes in the volume of unit sales of the particular brand.
Cost of sales as a percentage of total revenues was 28.1% in fiscal 2002 as
compared to 29.0% in fiscal 2001. The percentage decrease of 0.9% in fiscal 2002
was the result of the inclusion in
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<PAGE>
total revenues of royalty income from the international operations of SELSUN
BLUE, as well as favorable manufacturing costs related to increased volume.
Advertising and promotion expenses were 30.6% of total revenues in fiscal 2002
as compared to 34.0% in fiscal 2001 due to our discontinuance of amortization of
trademarks, partially offset by an increase in advertising spending. The cost of
such expenses increased $6,573,000, or 10.7%, to $68,259,000 in fiscal 2002 from
$61,686,000 in fiscal 2001. Increases in advertising and promotion expenses were
recognized for CAPZASIN, ARTHRITIS HOT, DEXATRIM, PHISODERM, GOLD BOND and
SUNSOURCE while declines were recognized for FLEXALL, ASPERCREME, PAMPRIN,
PREMSYN PMS and ULTRASWIM.
Selling, general and administrative expenses increased $6,422,000, or 19.0%, to
$40,212,000 in fiscal 2002 from $33,790,000 in fiscal 2001, but decreased as a
percentage of total revenues from 18.7% to 18.0%. The dollar increase resulted
from increased bad debt expense due to the $1,000,000 charge taken related to
the bankruptcy filing of Kmart Corporation in January 2002, increased
professional fees and other expenses of $500,000 related to our cancelled
secondary stock offering as well as increases in the variable components of
selling, general and administrative expenses.
Interest expense decreased $564,000, or 2.6%, to $21,292,000 in fiscal 2002 from
$21,856,000 in fiscal 2001, primarily as a result of the retirement of
$70,462,000 principal amount of our 8.875% Notes and the remaining outstanding
principal balance of $29,145,000 of our 12.75% Notes in fiscal 2001, partially
offset by the increased indebtedness incurred in connection with our acquisition
of SELSUN BLUE in March 2002. Until our indebtedness is reduced substantially,
interest expense will continue to represent a significant percentage of our
total revenues.
Investment and other income (expense) decreased $2,332,000, or 105.1%, to
$(114,000) in fiscal 2002 compared to income of $2,218,000 in fiscal 2001
primarily due to decreased interest income from temporary investments due to the
use of $31,380,000 of cash to purchase SELSUN BLUE in March 2002. We also
recorded a charge of approximately $450,000 related to the write-off of deferred
financing costs required after we made prepayments on our existing term loan.
Income before extraordinary items and cumulative effect of change in accounting
principle was $18,900,000 in fiscal 2002 as compared to $8,395,000 in fiscal
2001. The increase was primarily the result of improved margins and increased
operating leverage resulting from increased sales.
EBITDA, earnings before interest, taxes, depreciation and amortization, is a key
standard used by us to measure operating performance, but may not be comparable
to similarly titled measures reported by other companies. EBITDA is used to
supplement operating income as an indicator of operating performance but is not
an alternative to measures defined and required by generally accepted accounting
principles. For fiscal 2002 EBITDA was $56,051,000 compared to $42,261,000 for
fiscal 2001, a 32.6% increase. EBITDA margin (total revenues/EBITDA) increased
from 23.3% of total revenues in fiscal 2001 to 25.1% in fiscal 2002.
14
<PAGE>
FISCAL 2001 COMPARED TO FISCAL 2000
- -----------------------------------
Our total revenues in fiscal 2001 decreased $36,872,000, or 16.9%, to
$181,166,000 from $218,038,000 for the previous fiscal year. The decrease was
largely the result of the sale of Ban(R) in September 2000 and the establishment
of a product returns reserve of $9,600,000 for DEXATRIM with PPA and some of our
SUNSOURCE products in fiscal 2000, partially offset by a net increase in sales
of our other brands. The decrease consisted of a $34,250,000, or 17.0%, decrease
in domestic consumer product sales from $201,506,000 in fiscal 2000 to
$167,256,000 in fiscal 2001 and a decrease of $2,622,000, or 15.9%, in
international sales to $13,910,000 in fiscal 2001 from $16,532,000 in fiscal
2000.
Our topical analgesic portfolio produced a sales increase in fiscal 2001 as
compared to fiscal 2000, principally attributable to the success of the ICY HOT
Patch, introduced in the second quarter of fiscal 2001, as well as related
increases in advertising and promotional support. We recorded sales increases in
our topical analgesic portfolio in fiscal 2001 for ICY HOT, ASPERCREME, CAPZASIN
and ARTHRITIS HOT, while FLEXALL and SPORTSCREME recorded sales decreases. We
recorded sales declines in fiscal 2001 for DEXATRIM, PAMPRIN, SUN-IN, PHISODERM
and GOLD BOND, although GOLD BOND sales in the fourth quarter of fiscal 2001
exceeded those of the same prior year period. Sales variances were largely the
result of changes in the volume of unit sales of the particular brand.
International sales from Canadian operations decreased $324,000, or 5.1%, for
fiscal 2001, and the United Kingdom business decreased $1,210,000, or 14.9%. The
decrease in Canadian sales was due primarily to the sale of Ban in September
2000, and the initial launch of GOLD BOND Medicated Lotion in fiscal 2000 which
favorably impacted fiscal 2000 sales. The decrease in United Kingdom sales
related to volume decreases in sales of SUN-IN, Ban and Cornsilk. United States
export sales decreased $1,088,000, or 52.7%, primarily due to the sale of Ban in
the fourth quarter of fiscal 2000. Sales variances were principally the result
of changes in the volume of unit sales of the particular brand.
Cost of sales as a percentage of total revenues was 29.0% in fiscal 2001 as
compared to 34.4% in fiscal 2000. The 5.4% percentage decrease in fiscal 2001
was primarily the result of a write down of $2,800,000 for inventories of
DEXATRIM with PPA and the establishment of a $1,300,000 inventory obsolescence
reserve against our SUNSOURCE products and a product returns reserve of
$9,600,000 for DEXATRIM with PPA and some of our SUNSOURCE products in fiscal
2000.
Advertising and promotion expenses were 34.0% of total revenues in fiscal 2001
as compared to 33.7% in fiscal 2000. The cost of such expenses decreased
$11,750,000, or 16.0%, to $61,686,000 in fiscal 2001 from $73,436,000 in fiscal
2000. The decrease was primarily the result of the sale of Ban in the fourth
quarter of fiscal 2000, partially offset by additional spending on other brands.
The decrease in the percent of advertising and promotion to total revenues in
fiscal 2001 as compared to fiscal 2000 was primarily due to charges to sales in
the fourth quarter of 2000 of approximately $9,600,000 for allowances for
returns.
Selling, general and administrative expenses increased $3,025,000, or 9.8%, to
$33,790,000 in fiscal 2001 from $30,765,000 in fiscal 2000 and increased as a
percentage of total revenues from
15
<PAGE>
14.1% to 18.7%. The dollar increase was due to increased annual bonus, pension
and insurance costs partially offset by decreased freight, selling commissions
and bad debt expense. The increase in the percent of selling, general and
administrative expenses to total revenues in fiscal 2001 as compared to fiscal
2000 was principally the result of the sale of Ban in the fourth quarter of
fiscal 2000 and the net increase in dollar costs discussed above.
Interest expense decreased $13,873,000, or 38.8%, to $21,856,000 in fiscal 2001
from $35,729,000 in fiscal 2000, primarily as a result of payment of all of the
outstanding revolver and term loan balances under our prior credit facility on
September 15, 2000 and the retirement of $70,462,000 principal amount of our
8.875% Notes and the remaining outstanding principal balance of $29,145,000 of
our 12.75% Notes in fiscal 2001.
Investment and other income increased $652,000, or 41.6%, to $2,218,000 in
fiscal 2001 from $1,566,000 in fiscal 2000 primarily due to interest income from
temporary investments made with the remaining proceeds from the sale of Ban
after the retirement of debt.
Income before extraordinary items and cumulative effect of change in accounting
principle was $8,395,000 in fiscal 2001 as compared to a loss of $197,000 in
fiscal 2000. The loss in fiscal 2000 resulted primarily from reduced sales
related to the sale of Ban and the approximately $19,300,000 of charges recorded
in the fourth quarter of fiscal 2000, primarily for DEXATRIM with PPA and the
SUNSOURCE line of products.
EBITDA decreased 17.5% to $42,300,000 in fiscal 2001 as compared to $51,300,000
in fiscal 2000 due to the sale of Ban. EBITDA margin increased from 20.3% of
total revenues in fiscal 2000 to 21.3% of total revenues in fiscal 2001. We no
longer report cash earnings for periods after fiscal 2001 due to our
discontinuance of amortization of goodwill beginning in the first quarter of
fiscal 2002.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
We have historically financed our operations and acquisitions with a combination
of internally generated funds and borrowings. Our principal uses of cash are
operating expenses, servicing and repayments of long-term debt, acquisitions,
working capital, repurchases of our common stock, capital expenditures and
payment of income taxes.
Net cash provided by operations was $34,726,000 for fiscal 2002 and $23,730,000
for fiscal 2001. The increase was primarily the result of an increase in
accounts payable and accrued liabilities offset in part by an increase in
accounts receivable.
Net cash used in investing activities was $79,201,000 in fiscal 2002 and
$1,584,000 in fiscal 2001. The increase in cash used in investing activities in
fiscal 2002 was principally due to the acquisition of SELSUN BLUE in March 2002.
In fiscal 2002 capital expenditures totaled $3,785,000 compared to $1,854,000 in
fiscal 2001. The increase was primarily the result of the purchase of machinery
and equipment related to the acquisition of SELSUN BLUE in March 2002. Capital
expenditures are expected to be approximately $5,000,000 in fiscal 2003.
16
<PAGE>
Financing activities provided cash of $24,851,000 in fiscal 2002 as compared to
net cash used by financing activities of $89,179,000 in fiscal 2001. The cash
provided in fiscal 2002 consisted primarily of the proceeds from the $45,000,000
term loan obtained to partially fund the acquisition of SELSUN BLUE in March
2002, less repayments thereon, and proceeds from the exercise of stock options.
In fiscal 2001 cash was used for repayment of all of the outstanding balance of
our 12.75% Notes and the retirement of $70,462,000 principal amount of our
8.875% Notes.
Until June 30, 2003, we are obligated to pay an annual royalty on HERPECIN-L for
the greater of $214,000 or 5% of the brand's annual net sales.
The following table presents certain working capital data at November 30, 2002
and 2001 or for the respective years then ended:
ITEM 2002 2001
---- ---- ----
Working capital (current assets less current
liabilities)(at period end)........................ $31,372,000 $53,579,000
Current ratio (current assets divided by current
liabilities)(at period end)........................ 1.76 3.20
Quick ratio (cash and cash equivalents and
receivables divided by current liabilities)
(at period end).................................... 1.01 2.32
Average accounts receivable turnover for the
period then ended.................................. 9.49 5.89
Average inventory turnover for the period then
ended.............................................. 3.80 3.58
Working capital as a percentage of total assets
(at period end).................................... 8.82% 17.88%
The decrease in working capital, the current and quick ratios and working
capital as a percentage of total assets at November 30, 2002 as compared to
November 30, 2001 was primarily due to the reduction in cash and cash
equivalents in connection with the acquisition of SELSUN BLUE in March 2002 and
the prepayment of principal of our term loan.
Total long-term debt outstanding at November 30, 2002 was $217,458,000 compared
to $204,740,000 at November 30, 2001. The net increase of $12,718,000 in fiscal
2002 reflects borrowings of $45,000,000 under the term loan of our senior credit
facility that, together with cash of $31,380,000, was used to finance the
acquisition of SELSUN BLUE in March 2002, less repayments and current maturities
thereon. For a description of our senior credit facility, see Note 4 of Notes to
Consolidated Financial Statements.
Days' sales outstanding in accounts receivable were 41 at both November 30, 2002
and 2001. Our domestic days' sales outstanding were 38 at both November 30, 2002
and 2001.
17
<PAGE>
As of November 30, 2002 the remaining amount authorized by our board of
directors under our stock buyback plan was $4,775,000; however, we are limited
in our ability to repurchase shares due to restrictions under the terms of the
indenture with respect to which our 8.875% Notes were issued and under the terms
of our senior credit facility. In January 2003, our board of directors increased
the amount authorized under our stock buyback plan to $10,000,000.
As of February 21, 2003, we have been named as a defendant in approximately 302
lawsuits involving claims by approximately 1,357 plaintiffs alleging that the
plaintiffs were injured as a result of ingestion of products containing
phenylpropanolamine, which was an active ingredient in most of our DEXATRIM
products until November 2000. See Note 9 of Notes to Consolidated Financial
Statements for a discussion of these lawsuits.
We believe that cash provided by operating activities, our cash and cash
equivalents balance and funds available under the revolver of our senior credit
facility will be sufficient to fund our capital expenditures, debt service and
working capital requirements for the foreseeable future as our business is
currently conducted. It is likely that any acquisitions that we make in the
future will require us to obtain additional financing.
CONTRACTUAL OBLIGATIONS
- -----------------------
The following data summarizes our contractual obligations as of November 30,
2002. We had no commercial obligations at that date.
Payments due by period
---------------------------------------------------------
Contractual Within
Obligations: Total 1 year 2-3 years 4-5 years After 5 years
-------- ------ --------- --------- -------------
Long-term debt $224,538 $7,250 $12,750 $ -- $204,538
Operating leases 2,395 303 404 391 1,297
-------- ------ ------- ------ --------
Total $226,933 $7,553 $13,154 $ 391 $205,835
======== ====== ======= ====== ========
FOREIGN OPERATIONS
- ------------------
Historically, our primary foreign operations have been conducted through our
Canadian and United Kingdom subsidiaries. The currencies of these subsidiaries
are Canadian dollars and British pounds, 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
Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency
Translation." For the years ended November 30, 2002 and 2001, these subsidiaries
accounted for 7.4% and 7.1% of total revenues, respectively, and 3.1% and 3.5%
of total assets, respectively. It has not been our practice to hedge our assets
and liabilities in Canada and the United Kingdom or our intercompany
transactions due to the inherent risks associated with foreign currency hedging
transactions and the timing of payments between us and our two foreign
subsidiaries. Following our acquisition of SELSUN BLUE, which is sold in
approximately 90 foreign countries, and had $20,100,000 of international sales
in 2001, our international business operations will expand significantly, which
will increase our exposure to fluctuations in foreign
18
<PAGE>
exchange rates. During fiscal 2002 a large portion of these foreign sales was
reflected as royalties, which have been paid to us in U.S. dollars.
Historically, gains or losses from foreign currency transactions have not had a
material impact on our operating results. Losses of $69,000 and $7,000 for the
years ended November 30, 2002 and 2001, respectively, resulted from foreign
currency transactions. See "Foreign Currency Translation" in Note 2 of Notes to
Consolidated Financial Statements.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
- -----------------------------------------
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up
Activities"("SOP 98-5"). SOP 98-5 requires costs of start-up activities and
organization costs to be expensed as incurred. The initial adoption of SOP 98-5
was recorded as the cumulative effect of a change in accounting principle. This
one-time charge, net of income tax benefit, was $542,000, or $.03 per diluted
share, in the first quarter of fiscal 2000.
In September 2000, the Emerging Issues Task Force ("EITF") of the FASB reached a
final consensus on EITF Issue No. 00-10, "Accounting for Shipping and Handling
Fees and Costs" ("EITF 00-10"). EITF 00-10 was effective beginning in the fourth
quarter of fiscal 2001 and addressed the income statement classification of
amounts charged to customers for shipping and handling, as well as costs
incurred related to shipping and handling. The EITF concluded that amounts
billed to a customer in a sales transaction related to shipping and handling
should be classified as revenue. The EITF also concluded that if costs incurred
related to shipping and handling are significant and not included in cost of
sales, an entity should disclose both the amount of such costs and the line item
on the income statement that includes them. Otherwise, costs incurred related to
shipping and handling included in revenues were required to be reclassified to
cost of sales. We classify shipping and handling costs as a selling expense. The
amount of shipping and handling costs included in selling expense for fiscal
2002, fiscal 2001 and fiscal 2000 was $5,868,000, $5,551,000 and $7,644,000,
respectively. The adoption of this pronouncement in fiscal 2001 did not have an
impact on our results of operations or financial position in fiscal 2002 or
fiscal 2001.
In November 2000, the EITF finalized EITF Issue No. 00-14, "Accounting for
Certain Sales Incentives" ("EITF 00-14"). EITF 00-14 addresses the recognition,
measurement and income statement classification for sales incentives offered to
customers. Sales incentives include discounts, coupons, rebates, "buy one get
one free" promotions and generally any other offers that entitle a customer to
receive a reduction in the price of a product or service by submitting a claim
for a refund or rebate. Under EITF 00-14 the reduction in or refund of the
selling price of the product or service resulting from any cash sales incentives
should be classified as a reduction of revenue. In prior periods, we recognized
all sales incentives as an advertising and promotion expense. Although this
pronouncement has not had any impact on our results of operations or financial
position, the presentation prescribed has the effect of reducing net sales and
advertising and promotion expense in comparison to prior years. We adopted the
provisions of EITF 00-14 beginning in the first quarter of fiscal 2002. See
"Recent Accounting Pronouncements" of Note 2 of Notes to Consolidated Financial
Statements for a discussion of the impact of the adoption of the provisions of
this pronouncement.
19
<PAGE>
In June 2001, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). The
provisions of SFAS No. 142, which were adopted by us on December 1, 2001,
require us to discontinue the amortization of the cost of intangible assets with
indefinite lives and to perform certain fair value based tests of the carrying
value of indefinite lived intangible assets. Accordingly, we discontinued the
amortization of the cost of these intangible assets. The discontinuation of this
amortization favorably affected net income in fiscal 2002 by $3,456,000, net of
income tax benefit, or $0.18 per diluted share. Had the Company not amortized
these intangibles during fiscal 2001 and 2000, income before extraordinary gain
(loss) and change in accounting principle and net income for the fiscal years
ended November 30, 2001 and 2000 would have been $3,455,000 and $5,496,000
higher than the reported amounts, respectively, and diluted earnings per share
would have been $0.19 and $0.29 higher than the reported amounts, respectively.
Also in connection with the adoption of SFAS No. 142, we obtained independent
appraisals to determine the fair value of the intangible assets at December 1,
2001 and compared their fair values with the carrying values to determine the
write-down of $8,877,000, net of income tax benefit of $5,440,000, or $0.46 per
diluted share. The write-down was primarily related to our SUNSOURCE product
line, which experienced a decline in sales volume from the level at its initial
purchase in 1997, and to a lesser degree our DEXATRIM product line which
discontinued the marketing of one of its products in fiscal 2000. This
adjustment is shown as a cumulative effect of change in accounting principle in
the consolidated statement of income for the year ended November 30, 2002.
In July 2001, the EITF finalized EITF Issue No. 00-25, "Vendor Income Statement
Characterization of Consideration Paid to a Reseller of the Vendor's Products"
("EITF 00-25"). Under the provisions of EITF Issue No. 00-25 we are required to
reclassify certain marketing and selling expenses as reductions of net sales.
Our operating income and financial position, therefore, will not be affected. We
adopted the provisions of EITF 00-25 beginning in the first quarter of fiscal
2002. EITF Issue Nos. 00-14 and 00-25 have been codified in EITF Issue No.
01-09, "Accounting for Consideration Given by a Vendor to a Customer."
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 62, Amendment of FASB Statement No. 13, and Technical Corrections",
("SFAS 145"). SFAS 145, which will be adopted by us effective December 1, 2002,
will require us to classify gains and losses on extinguishments of debt as
income or loss from continuing operations rather than as extraordinary items as
previously required under FASB Statement No. 4. We will also be required to
reclassify any gain or loss on extinguishment of debt previously classified as
an extraordinary item in prior periods presented. Our results of operations,
financial position and cash flows, therefore, will not be affected.
SUBSEQUENT EVENT
- ----------------
During the first quarter of fiscal 2003, we repurchased, and returned to
unissued, 103,000 shares of our common stock for $1,579,000.
FORWARD-LOOKING STATEMENTS
- --------------------------
We may from time to time make written and oral forward-looking statements.
Written forward-looking statements may appear in documents filed with the
Securities and Exchange
20
<PAGE>
Commission, in press releases and in reports to shareholders. The Private
Securities Litigation Reform Act of 1995 contains a safe harbor for
forward-looking statements. We rely on this safe harbor in making such
disclosures. The forward-looking statements are based on management's current
beliefs and assumptions about expectations, estimates, strategies and
projections for us. These statements are not guarantees of future performance
and involve risks, uncertainties and assumptions that are difficult to predict.
Therefore, actual outcomes and results may differ materially from what is
expressed or forecasted in such forward-looking statements. We undertake no
obligation to update publicly any forward-looking statements whether as a result
of new information, future events or otherwise. The risks, uncertainties and
assumptions of the forward-looking statements include, but are not limited to
existing and possible additional future product liability claims relating to the
prior existence of PPA in DEXATRIM; the possible effect of the negative public
perception resulting from product liability claims on sales of DEXATRIM products
without PPA; the lack of availability, limits of coverage and expense related to
product liability insurance; the reduction of available insurance coverage as
proceeds are used to fund any product liability settlements or awards; the
possibility of other product liability claims including claims relating to the
existence of ephedrine in DEXATRIM products; our ability to fund liabilities
from product liability claims greater than our insurance coverage or outside the
scope of our insurance coverage; the impact of brand acquisitions and
divestitures; extraordinary gains or losses resulting from financings or debt
repayments; product demand and market acceptance risks; product development
risks, such as delays or difficulties in developing, producing and marketing new
products or line extensions; the impact of competitive products, pricing and
advertising; our ability to integrate SELSUN BLUE into our own operations; our
ability to sell and market SELSUN BLUE internationally where we have only
limited experience and infrastructure; constraints resulting from our financial
condition, including the degree to which we are leveraged, debt service
requirements and restrictions under indentures and loan agreements; government
regulations; risks of loss of material customers; public perception regarding
our products; dependence on third party manufacturers; environmental matters;
and other risks described in our Securities and Exchange Commission filings.
21
<PAGE>
SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
This selected financial data should be read in conjunction with Management's
Discussion and Analysis of Financial Condition and Results of Operations and our
consolidated financial statements and notes thereto included elsewhere in this
Annual Report. The following data for fiscal 1998 through 2001 has been restated
to give effect to the adoption of the provisions of EITF Issue Nos. 00-14 and
00-25 on December 1, 2001 and the effect of a two-for-one split of the Company's
common stock on November 29, 2002.
<TABLE><CAPTION>
Year Ended November 30,
---------------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- --------- --------- ---------
INCOME STATEMENT DATA:
<S> <C> <C> <C> <C> <C>
TOTAL REVENUES.................. $223,116 $181,166 $218,038 $280,278 $200,460
OPERATING COSTS AND
EXPENSES...................... 171,228 147,988 179,158 208,077 155,241
--------- --------- --------- --------- ---------
INCOME FROM OPERATIONS.......... 51,888 33,178 38,880 72,201 45,219
OTHER EXPENSE, NET.............. (21,406) (19,638) (39,181) (35,993) (16,247)
--------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME
TAXES, EXTRAORDINARY GAIN
(LOSS) AND CHANGE IN
ACCOUNTING PRINCIPLE.......... 30,482 13,540 (301) 36,208 28,972
PROVISION FOR (BENEFIT FROM)
INCOME TAXES.................. 11,582 5,145 (104) 13,667 10,844
--------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE
EXTRAORDINARY GAIN (LOSS)
AND CHANGE IN ACCOUNTING
PRINCIPLE..................... $ 18,900 $ 8,395 $ (197) $ 22,541 $ 18,128
========= ========= ========= ========= =========
PER SHARE DATA:
INCOME (LOSS) PER DILUTED SHARE
BEFORE EXTRAORDINARY GAIN (LOSS)
AND CHANGE IN ACCOUNTING
PRINCIPLE...................... $ .98 $ .47 $ (.01) $ 1.13 $ .93
========= ========= ========= ========= =========
BALANCE SHEET DATA:
(At End of Year)
TOTAL ASSETS.................... $ 355,563 $ 299,673 $ 402,076 $ 491,624 $ 369,012
========= ========= ========= ========= =========
LONG-TERM DEBT, less
current maturities............ $ 217,458 $ 204,740 $ 304,077 $ 358,950 $ 273,913
========= ========= ========= ========= =========
</TABLE>
22
<PAGE>
MARKET PRICES
Our common stock is quoted on the Nasdaq National Market under the symbol
"CHTT." The table below sets forth the high and low closing sales prices of our
common stock (adjusted for the effect of the two-for-one split of our common
stock on November 29, 2002) as reported on the Nasdaq National Market for the
periods indicated.
High Low
------- -------
Fiscal 2002:
First Quarter.................. $ 9.990 $ 6.750
Second Quarter................. 16.250 8.105
Third Quarter.................. 19.870 12.840
Fourth Quarter................. 22.800 17.340
Fiscal 2001:
First Quarter.................. $ 5.000 $ 2.375
Second Quarter................. 5.350 3.844
Third Quarter.................. 6.750 4.250
Fourth Quarter................. 8.145 4.760
As of February 21, 2003, there were approximately 2,500 holders of record of our
common stock. The number of record holders does not include beneficial owners
whose shares are held in the names of banks, brokers, nominees or other
fiduciaries.
23
<PAGE>
CONSOLIDATED BALANCE SHEETS
NOVEMBER 30, 2002 AND 2001
(IN THOUSANDS)
ASSETS 2002 2001
--------- ---------
CURRENT ASSETS:
Cash and cash equivalents........................... $ 15,924 $ 35,445
Accounts receivable, less allowance for doubtful
accounts of $962 in 2002 and $500 in 2001......... 25,673 20,860
Refundable and deferred income taxes................ 9,837 4,646
Inventories......................................... 18,769 14,260
Prepaid expenses and other current assets........... 2,184 2,667
--------- ---------
Total current assets............................. 72,387 77,878
--------- ---------
PROPERTY, PLANT AND EQUIPMENT, NET.................... 26,658 26,275
--------- ---------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased
product rights, net............................... 245,787 185,373
Debt issuance costs, net............................ 7,126 7,665
Other............................................... 3,605 2,482
--------- ---------
Total other noncurrent assets ................... 256,518 195,520
--------- ---------
TOTAL ASSETS.................................. $ 355,563 $ 299,673
========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
24
<PAGE>
CONSOLIDATED BALANCE SHEETS
NOVEMBER 30, 2002 AND 2001
(IN THOUSANDS)
LIABILITIES AND SHAREHOLDERS' EQUITY 2002 2001
--------- ---------
CURRENT LIABILITIES:
Current maturities of long-term debt................ $ 7,250 $ --
Accounts payable.................................... 12,209 9,010
Payable to bank..................................... 452 151
Accrued liabilities................................. 21,104 15,138
--------- ---------
Total current liabilities........................ 41,015 24,299
--------- ---------
LONG-TERM DEBT, less current maturities............... 217,458 204,740
--------- ---------
DEFERRED INCOME TAXES................................. 20,744 16,251
--------- ---------
OTHER NONCURRENT LIABILITIES.......................... 1,602 1,765
--------- ---------
COMMITMENTS AND CONTINGENCIES (Notes 4 and 9)
SHAREHOLDERS' EQUITY:
Preferred shares, without par value,
authorized 1,000, none issued..................... -- --
Common shares, without par value, authorized
50,000, issued 19,177 in 2002 and 17,946
in 2001.......................................... 79,313 67,828
Accumulated deficit................................. (1,097) (11,120)
--------- ---------
78,216 56,708
Unamortized value of restricted common
shares issued.................................... (1,713) (859)
Cumulative other comprehensive income:
Foreign currency translation
adjustment....................................... (1,759) (2,231)
Minimum pension liability adjustment,
net of income taxes.............................. -- (1,000)
--------- ---------
Total shareholders' equity....................... 74,744 52,618
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY....... $ 355,563 $ 299,673
========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
25
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED NOVEMBER 30, 2002, 2001 AND 2000
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2002 2001 2000
--------- --------- ---------
TOTAL REVENUES:
Net sales.............................. $ 220,789 $ 181,166 $ 218,038
Royalties.............................. 2,327 -- --
--------- --------- ---------
Total revenues...................... 223,116 181,166 218,038
--------- --------- ---------
COSTS AND EXPENSES:
Cost of sales.......................... 62,757 52,512 74,957
Advertising and promotion.............. 68,259 61,686 73,436
Selling, general and administrative.... 40,212 33,790 30,765
--------- --------- ---------
Total costs and expenses............ 171,228 147,988 179,158
--------- --------- ---------
INCOME FROM OPERATIONS................... 51,888 33,178 38,880
--------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense....................... (21,292) (21,856) (35,729)
Investment and other income
(expense), net....................... (114) 2,218 1,566
Loss on product divestitures........... -- -- (5,018)
--------- --------- ---------
Total other income (expense)........ (21,406) (19,638) (39,181)
--------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES,
EXTRAORDINARY GAIN (LOSS) AND CHANGE
IN ACCOUNTING PRINCIPLE................. 30,482 13,540 (301)
PROVISION FOR (BENEFIT FROM)
INCOME TAXES............................ 11,582 5,145 (104)
--------- --------- ---------
INCOME (LOSS) BEFORE EXTRAORDINARY
GAIN (LOSS) AND CHANGE IN ACCOUNTING
PRINCIPLE............................... 18,900 8,395 (197)
EXTRAORDINARY GAIN (LOSS) ON EARLY
EXTINGUISHMENT OF DEBT, NET OF
INCOME TAXES............................ -- 6,948 (920)
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE, NET
OF INCOME TAX BENEFIT................... (8,877) -- (542)
--------- --------- ---------
NET INCOME (LOSS)........................ $ 10,023 $ 15,343 $ (1,659)
========= ========= =========
NUMBER OF COMMON SHARES:
Weighted average outstanding - basic... 18,607 17,854 18,822
========= ========= =========
Weighted average and potential
dilutive outstanding.................. 19,344 18,076 18,822
========= ========= =========
NET INCOME (LOSS) PER COMMON SHARE:
Basic:
Income (loss) before extraordinary
gain (loss) and change in accounting
principle............................ $ 1.02 $ .47 $ (.01)
Extraordinary gain (loss)............. -- .39 (.05)
Change in accounting principle........ (.48) -- (.03)
--------- --------- ---------
Total basic........................ $ .54 $ .86 $ (.09)
========= ========= =========
Diluted:
Income (loss) before extraordinary
gain (loss) and change in accounting
principle............................ $ .98 $ .47 $ (.01)
Extraordinary gain (loss)............. -- .38 (.05)
Change in accounting principle........ (.46) -- (.03)
--------- --------- ---------
Total diluted...................... $ .52 $ .85 $ (.09)
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
26
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED NOVEMBER 30, 2002, 2001 AND 2000
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE><CAPTION>
Unamortized Minimum
Value of Foreign Pension
Restricted Currency Liability
Common Accumulated Common Shares Translation Adjustment,
Shares Deficit Issued Adjustment Net Total
--------- --------- --------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance, November 30, 1999............... $ 74,871 $ (24,804) $ -- $ (1,366) $ -- $ 48,701
Comprehensive loss:
Net loss............................ -- (1,659) -- -- -- (1,659)
Foreign currency translation
adjustment........................ -- -- -- (806) -- (806)
---------
Total comprehensive loss............ (2,465)
Stock options exercised................ 853 -- -- -- -- 853
Stock repurchases...................... (9,489) -- -- -- -- (9,489)
Issuance of 6,624 common shares for
non-employee directors' compensation.. 53 -- -- -- -- 53
--------- --------- --------- --------- --------- ---------
Balance, November 30, 2000............... 66,288 (26,463) -- (2,172) -- 37,653
Comprehensive income (loss):
Net income.......................... -- 15,343 -- -- -- 15,343
Foreign currency translation
adjustment........................ -- -- -- (59) -- (59)
Minimum pension liability
adjustment, net................... -- -- -- -- (1,000) (1,000)
---------
Total comprehensive income (loss)... -- -- -- -- -- 14,284
Stock options exercised.................. 682 -- -- -- -- 682
Stock repurchases........................ (174) -- -- -- -- (174)
Issuance of 13,200 common shares for
non-employee directors' compensation... 39 -- -- -- -- 39
Issuance of 200,000 shares of
restricted common stock at a
weighted-average value of $4.965
per share.............................. 993 -- (993) -- -- --
Amortization of value of restricted
common shares issued................... -- -- 134 -- -- 134
--------- --------- --------- --------- --------- ---------
Balance, November 30, 2001............... 67,828 (11,120) (859) (2,231) (1,000) 52,618
Comprehensive income:
Net income.......................... -- 10,023 -- -- -- 10,023
Foreign currency translation
adjustment........................ -- -- -- 472 -- 472
Minimum pension liability
adjustment, net................... -- -- -- -- 1,000 1,000
---------
Total comprehensive income.......... 11,495
Stock options exercised................ 11,973 -- -- -- -- 11,973
Stock repurchases...................... (1,650) -- -- -- -- (1,650)
Issuance of 3,826 common shares for
non-employee directors' compensation.. 36 -- -- -- -- 36
Issuance of 50,000 shares of
restricted common stock at a
value of $22.515 per share............ 1,126 -- (1,126) -- -- --
Amortization of value of restricted
common shares issued.................. -- -- 272 -- -- 272
--------- --------- --------- --------- --------- ---------
Balance, November 30, 2002............. $ 79,313 $ (1,097) $ (1,713) $ (1,759) $ -- $ 74,744
========= ========= ========= ========= ========= =========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
27
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED NOVEMBER 30, 2002, 2001 AND 2000
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
2002 2001 2000
--------- --------- ---------
OPERATING ACTIVITIES:
Net income (loss)...................... $ 10,023 $ 15,343 $ (1,659)
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Depreciation and amortization....... 5,816 10,241 14,943
Deferred income tax provision
(benefit).......................... 8,165 11,362 (5,734)
Loss on product divestitures........ -- -- 5,018
Extraordinary (gain) loss on early
extinguishment of debt, net........ -- (6,948) 920
Cumulative effect of change in
accounting principle, net.......... 8,877 -- 542
Stock option charge................. 175 525 525
Other, net.......................... 269 (61) 15
Changes in operating assets and
liabilities, net of acquisitions
and divestitures:
Accounts receivable............... (4,813) 19,831 14,341
Refundable income taxes........... 1,044 -- --
Inventories....................... (4,509) 792 7,240
Prepaid expenses and other
current assets................... 483 (1,793) (1,538)
Accounts payable and accrued
liabilities...................... 9,196 (25,562) (8,106)
--------- --------- ---------
NET CASH PROVIDED BY OPERATING
ACTIVITIES.................. 34,726 23,730 26,507
--------- --------- ---------
INVESTING ACTIVITIES:
Purchases of property, plant and
equipment............................ (3,785) (1,854) (5,673)
Purchases of patents, trademarks and
other product rights................. (75,040) (277) --
Proceeds from product divestitures..... -- 1,179 160,000
Proceeds from sales of property,
plant and equipment.................. -- 95 11
Increase in other assets............... (376) (727) (1,542)
--------- --------- ---------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES........ (79,201) (1,584) 152,796
--------- --------- ---------
FINANCING ACTIVITIES:
Repayment of long-term debt............ (25,000) (83,746) (95,000)
Proceeds from long-term debt........... 45,000 -- 29,000
Payment of consent fees and other
costs related to repayment of
long-term debt........................ -- (4,000) --
Change in payable to bank.............. 301 (1,378) (3,376)
Repurchase of common shares............ (1,650) (174) (9,489)
Proceeds from exercise of stock
options............................... 7,346 119 237
Debt issuance costs.................... (1,146) -- (363)
--------- --------- ---------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES........ 24,851 (89,179) (78,991)
--------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH
AND CASH EQUIVALENTS................... 103 (56) (86)
--------- --------- ---------
CASH AND CASH EQUIVALENTS:
Increase (decrease) for the year....... (19,521) (67,089) 100,226
At beginning of year................... 35,445 102,534 2,308
--------- --------- ---------
At end of year......................... $ 15,924 $ 35,445 $ 102,534
========= ========= =========
SCHEDULE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
Additions to trademarks and other
product rights by assumption of
certain liabilities................... $ 1,178 $ -- $ --
Issuance of 50,000 shares of restricted
common stock at a value of $22.515
per share in 2002 and 200,000 shares
at a weighted average value of
$4.965 per share in 2001.............. $ 1,126 $ 993 $ --
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ALL MONETARY AMOUNTS ARE EXPRESSED IN THOUSANDS OF DOLLARS UNLESS CONTRARILY
EVIDENT. UNLESS OTHERWISE INDICATED, THE NUMBER OF SHARES OF THE COMPANY'S
COMMON STOCK AND RELATED PER SHARE COMPUTATIONS INCLUDED IN THESE FINANCIAL
STATEMENTS AND NOTES THERETO HAVE BEEN ADJUSTED TO REFLECT THE TWO-FOR-ONE SPLIT
OF THE COMPANY'S COMMON STOCK ON NOVEMBER 29, 2002.
(1) NATURE OF OPERATIONS
--------------------
Chattem, Inc. and its wholly-owned subsidiaries (the "Company") market and
manufacture branded over-the-counter ("OTC") health care products. The products
are sold primarily through mass merchandisers, independent and chain drug
stores, drug wholesalers and food stores in the United States and in various
markets in approximately 90 countries throughout the world.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
BASIS OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Chattem, Inc. and its wholly-owned subsidiaries. All significant intercompany
transactions and balances have been eliminated.
CASH AND CASH EQUIVALENTS
The Company considers all short-term deposits and investments with original
maturities of three months or less to be cash equivalents.
INVENTORIES
Inventory costs include materials, labor and factory overhead. Inventories
in the United States are valued at the lower of last-in, first-out ("LIFO") cost
or market, while international inventories are valued at the lower of first-in,
first-out ("FIFO") cost or market.
At November 30, 2001 certain LIFO inventory quantities were lower than
their respective prior year levels resulting in liquidations of inventory
quantities carried at higher costs prevailing in prior years as compared to
current year costs. The effect of this liquidation increased cost of sales by
$86.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. The Company capitalized
interest of $31 in 2000. Depreciation is computed using the straight-line method
over the estimated useful lives of 10 to 40 years for buildings and improvements
and 3 to 12 years for machinery and equipment. Expenditures for maintenance and
repairs are charged to expense as incurred. Depreciation expense for 2002, 2001
and 2000 was $3,061, $2,618 and $2,504, respectively.
29
<PAGE>
PATENTS, TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS
The costs of acquired patents and other purchased product rights are
capitalized and amortized over their respective useful lives, generally 5 years.
Prior to the adoption of SFAS 142 (see below) trademarks were amortized over 40
years. Total accumulated amortization of these assets at November 30, 2002 and
2001 was $1,003 and $28,090, respectively. Amortization expense for 2002, 2001
and 2000 was $268, $5,783 and $9,151, respectively. Royalty expense related to
other purchased product rights for 2002, 2001 and 2000 was $513, $180, and $23,
respectively. Amortization and royalty expense are included in advertising and
promotion expense in the accompanying consolidated statements of income.
In June 2001 the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
other Intangible Assets ("SFAS 142"). The provisions of SFAS 142, which were
adopted by the Company on December 1, 2001, require the Company to discontinue
the amortization of the cost of intangible assets with indefinite lives and also
require certain fair value based tests of the carrying value of indefinite lived
intangible assets. See "Recent Accounting Pronouncements" of this footnote.
Prior to the adoption of SFAS 142, the Company evaluated whether events and
circumstances had occurred that indicated the remaining useful life of
long-lived assets might warrant revision or that the remaining balance may not
be recoverable. When factors indicated that long-lived assets should have been
evaluated for possible impairment, the Company used an estimate of the future
undiscounted net cash flows of the related assets over the remaining lives of
the assets in measuring whether long-lived assets were recoverable. In
connection with the Company's sale of Norwich Aspirin in fiscal 2001, the
Company determined an impairment had occurred in fiscal 2000, resulting in a
charge of $810 in that year.
DEBT ISSUANCE COSTS
The Company has incurred debt issuance costs in connection with its
long-term debt. These costs are capitalized and amortized over the term of the
related debt. Amortization expense related to debt issuance costs was $1,685,
$1,143 and $1,565 in 2002, 2001 and 2000, respectively. Accumulated amortization
of these costs was $4,300 and $3,104 at November 30, 2002 and 2001,
respectively.
PAYABLE TO BANK
Payable to bank includes checks outstanding in excess of certain cash
balances.
REVENUE RECOGNITION
Revenue is recognized when the Company's products are shipped to its
customers.
It is the Company's policy across all classes of customers that all sales
are final. As is common in the consumer products industry, product is returned
by the customer due to a number of reasons. Examples include product damaged in
transit, discontinuance of a particular size or form of product, shipping error,
etc. The Company maintains and evaluates an allowance for returns and will
record a return upon receipt of the product or deduction from remittance by the
customer.
30
<PAGE>
PRODUCT DEVELOPMENT
Product development costs relate primarily to the development of new
products and are expensed as incurred. Such expenses were $1,761, $1,664, and
$1,901 in 2002, 2001 and 2000, respectively.
ADVERTISING EXPENSES
The cost of advertising is expensed in the fiscal year in which the related
advertising takes place. Production and communication costs are expensed in the
period in which the related advertising begins running. Advertising expense for
2002, 2001 and 2000 was $48,953, $40,516, and $46,028, respectively. At November
30, 2002 and 2001, the Company reported $575 and $857, respectively, of
advertising paid for in 2002 and 2001 which will run or did run in the next
fiscal year. These amounts are included in other noncurrent assets in the
accompanying consolidated balance sheets.
NET INCOME PER COMMON SHARE
For the years ended November 30, 2002, 2001 and 2000 the weighted average
and potential dilutive number of common shares outstanding consisted of the
following (in thousands):
2002 2001 2000
--------- --------- ---------
Weighted average common shares
outstanding............................ 18,607 17,854 18,822
Potential dilutive shares from:
Stock options.......................... 644 190 --
Restricted common shares............... 93 32 --
--------- --------- ---------
Weighted average and potential
dilutive common shares
outstanding (1)........................ 19,344 18,076 18,822
========= ========= =========
(1) Because their effects are anti-dilutive, excludes shares issuable under
stock option plans whose grant price was greater than the average market price
of common shares outstanding as follows: 86,000 shares in 2002 and 960 shares in
2001. Due to the net loss sustained in 2000, the impact of stock options
outstanding was anti-dilutive in that year.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of the Company's Canadian and United Kingdom
subsidiaries are translated to United States 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 accompanying consolidated statements of income.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates.
31
<PAGE>
DERIVATIVE FINANCIAL INSTRUMENTS
The Company has entered into interest rate swap agreements from time to
time as a means of managing its interest rate exposure and not for trading
purposes. These agreements have the effect of converting a portion of the
Company's variable rate obligations to fixed rate obligations. Net amounts paid
or received are reflected as adjustments to interest expense. The Company was
not a party to any interest rate swap agreements at November 30, 2002 and 2001.
On December 1, 2001 the Company adopted the provisions of SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Transactions", which had no
effect on the results of operations and financial position of the Company in
fiscal 2002 and 2001, respectively.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which subject the Company to concentrations of credit
risk consist primarily of accounts receivable and short-term cash investments.
The Company's exposure to credit risk associated with nonpayment of accounts
receivable is affected by conditions or occurrences within the retail industry.
As a result, the Company performs ongoing credit evaluations of its customers'
financial position but generally requires no collateral from its customers. The
Company's largest customer accounted for 28%, 26% and 24% of consolidated sales
in 2002, 2001 and 2000, respectively. No other customer exceeded 10% of the
Company's consolidated sales during the period . Short-term cash investments are
placed with high credit-quality financial institutions or in low risk, liquid
instruments. No losses have been experienced on such investments.
On January 22, 2002 Kmart Corporation ("Kmart"), a customer of the Company
representing approximately 5% of fiscal 2001 consolidated revenues, filed a
petition under Chapter 11 of the United States Bankruptcy Code. This bankruptcy
filing did not impact the Company's results of operations and financial position
for fiscal 2001. At the time of the filing Kmart owed the Company approximately
$1,200. In the first quarter of fiscal 2002 the Company established an allowance
for doubtful accounts of $1,000 to cover its estimated bad debt related to
Kmart. In the second quarter of fiscal 2002 the Company sold its receivable from
Kmart to a financial institution for $367. The Company continues to sell to
Kmart at decreased volume levels and as of November 30, 2002, the Company's
receivables from Kmart were approximately $796.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up
Activities"("SOP 98-5"). SOP 98-5 requires costs of start-up activities and
organization costs to be expensed as incurred. The initial adoption of SOP 98-5
was recorded as a cumulative effect of a change in accounting principle. This
one-time charge, net of income tax benefit, was $542, or $.03 per diluted share,
in the first quarter of fiscal 2000.
In September 2000, the Emerging Issues Task Force ("EITF") of the FASB
reached a final consensus on EITF Issue No. 00-10, "Accounting for Shipping and
Handling Fees and Costs" ("EITF 00-10"). EITF 00-10 was effective the fourth
quarter of 2001 and addressed the income statement classification of amounts
charged to customers for shipping and handling, as well as costs incurred
related to shipping and handling. The EITF concluded that amounts billed to a
customer in a sale transaction related to shipping and handling should be
classified as revenue. The EITF also concluded that if costs incurred related to
shipping and handling are significant and not included in cost of sales, an
entity should disclose both the amount of such costs and the line item on the
income statement that includes them. Costs incurred related to shipping and
handling included in revenues were required to be reclassified to cost of sales.
The Company classifies shipping and handling costs as a selling expense. The
amount of shipping and handling costs included in selling expense for 2002, 2001
and 2000 was $5,868, $5,551 and
32
<PAGE>
$7,644, respectively. The adoption of this pronouncement in 2001 did not have an
impact on the results of operations or the financial position of the Company.
In November 2000, the EITF finalized EITF Issue No. 00-14, "Accounting for
Certain Sales Incentives" ("EITF 00-14"). EITF 00-14 addresses the recognition,
measurement and income statement classification for sales incentives offered to
customers. Sales incentives include discounts, coupons, rebates, "buy one get
one free" promotions and generally any other offers that entitle a customer to
receive a reduction in the price of a product or service by submitting a claim
for a refund or rebate. Under EITF 00-14, the reduction in or refund of the
selling price of the product or service resulting from any cash sales incentives
should be classified as a reduction of revenue. In prior periods, the Company
recognized all sales incentives as an advertising and promotion expense.
Although this pronouncement has not had any impact on the results of operations
or financial position of the Company, the presentation prescribed has the effect
of reducing net sales and advertising and promotion expense in comparison to
prior years. The Company adopted the provisions of EITF 00-14 for all periods
presented in the first quarter of fiscal 2002.
In June 2001, the FASB issued SFAS No.142, "Goodwill and Other Intangible
Assets". The provisions of SFAS No. 142, which were adopted by the Company on
December 1, 2001, require the Company to discontinue the amortization of the
cost of intangible assets with indefinite lives and to perform certain fair
value based tests of the carrying value of indefinite lived intangible assets.
Accordingly, the Company discontinued the amortization of the cost of these
intangible assets. The discontinuation of this amortization favorably affected
net income in fiscal 2002 by $3,456, net of income tax benefit, or $.18 per
diluted share. Had the Company not amortized these intangibles during fiscal
2001 and 2000, income before extraordinary gain (loss) and change in accounting
principle and net income for the fiscal years ended November 30, 2001 and 2000
would have been $3,455 and $5,496 higher than the reported amounts,
respectively, and diluted earnings per share would have been $.19 and $.29
higher than the reported amounts, respectively. Also in connection with the
adoption of SFAS No.142, the Company obtained independent appraisals to
determine the fair value of the intangible assets at December 1, 2001 and
compared their fair values with the carrying values to determine a write-down of
$8,877, net of income tax benefit of $5,440, or $.46 per diluted share. The
write-down was primarily related to the Company's SUNSOURCE product line which
experienced a decline in sales volume since its initial purchase in 1997 and to
a lesser degree the Company's DEXATRIM product line which discontinued the
marketing of one of its products in fiscal 2000. This adjustment is shown as a
cumulative effect of change in accounting principle in the consolidated
statement of income for the year ended November 30, 2002.
Estimated future amortization expense for intangible assets subject to
amortization is as follows:
2003................... $250
2004................... 250
2005................... 250
2006................... 250
2007................... 83
In July 2001, the EITF finalized EITF Issue No. 00-25, "Vendor Income
Statement Characterization of Consideration Paid to a Reseller of the Vendor's
Products" ("EITF 00-25"). Under the provisions of EITF 00-25 the Company is
required to reclassify certain marketing and selling expenses as reductions of
net sales. The results of operations and the financial position of the Company,
therefore, will not be affected. The Company adopted the provisions of EITF
00-25 for all periods presented in the first quarter of fiscal 2002. EITF Issue
Nos. 00-14 and 00-25 have been codified in EITF Issue No. 01-09, "Accounting for
Consideration Given by a Vendor to a Customer."
In April 2002 the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical
Corrections" ("SFAS 145"). SFAS 145, which will be adopted by the Company
effective December 1, 2002, will require the Company to classify gains and
losses on extinguishments of debt as income or loss from continuing operations
rather than as extraordinary items as previously required under FASB Statement
No. 4. The Company will also be required to reclassify any gain or
33
<PAGE>
loss on extinguishment of debt previously classified as extraordinary items in
prior periods presented. The results of operations, financial position and cash
flows of the Company, therefore, will not be affected.
The following table presents the impact of the adoption of the provisions
of EITF Issue Nos. 00-14 and 00-25, discussed above, on the consolidated
statements of income for the years ended November 30, 2002, 2001 and 2000
respectively:
Advertising Selling,
and General and
Promotion Administrative
Net Sales Expense Expense
--------- --------- ---------
For the Year Ended
November 30, 2002:
Previous reporting basis......... $ 236,274 $ 82,724 $ 41,232
Impact of adopting
accounting changes.............. 15,485 14,465 1,020
--------- --------- ---------
Current reporting basis.......... $ 220,789 $ 68,259 $ 40,212
========= ========= =========
For the Year Ended
November 30, 2001:
Previous reporting basis......... $ 198,300 $ 77,964 $ 34,646
Impact of adopting
accounting changes.............. 17,134 16,278 856
--------- --------- ---------
Current reporting basis.......... $ 181,166 $ 61,686 $ 33,790
========= ========= =========
For the Year Ended
November 30, 2000:
Previous reporting basis......... $ 252,699 $ 106,868 $ 31,994
Impact of adopting
accounting changes.............. 34,661 33,432 1,229
--------- --------- ---------
Current reporting basis.......... $ 218,038 $ 73,436 $ 30,765
========= ========= =========
Appropriate adjustments have likewise been made in the consolidating
statements of income for the years ended November 30, 2002, 2001 and 2000,
respectively. (See Note 15 of Notes to Consolidated Financial Statements). The
Company's results of operations for the years ended November 30, 2002, 2001 and
2000 respectively, and its financial position at November 30, 2002 and 2001,
respectively, were not affected by the adoption of the provisions of these two
pronouncements.
STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation plans under
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees". Effective fiscal 1997, the Company adopted the disclosure option of
SFAS No. 123, "Accounting for Stock-Based Compensation".
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
period's presentation.
34
<PAGE>
(3) PENSION PLANS
-------------
The Company has a noncontributory defined benefit pension plan ("the Plan")
which covers substantially all employees. The Plan provides benefits based upon
years of service and the employee's compensation. The Company's contributions
are based on computations by independent actuaries. Plan assets at November 30,
2002 and 2001 were invested primarily in United States government and agency
securities and corporate debt and equity securities. In October 2000 the
Company's 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. This action by the board of directors resulted in a curtailment gain
(loss) of $(179) and $1,912 in 2001 and 2000, respectively.
Net periodic pension cost for the years ended November 30, 2002, 2001 and
2000 comprised the following components:
2002 2001 2000
-------- -------- --------
Service cost........................... $ -- $ -- $ 789
Interest cost on projected benefit
obligation........................... 564 549 794
Actual (return) on plan assets......... (1,700) (1,018) (325)
Net amortization and deferral.......... 1,120 425 (337)
Curtailment (gain) loss................ -- 179 (1,912)
-------- -------- --------
Net pension cost (benefit)............. $ (16) $ 135 $ (991)
======== ======== ========
The change in the projected benefit obligation resulted from the following
components for the years ended November 30, 2002 and 2001:
2002 2001
-------- --------
Projected benefit obligation,
beginning of year................................. $ 8,195 $ 6,446
Interest cost....................................... 564 549
Actuarial loss...................................... 722 1,987
Benefits paid....................................... (427) (1,040)
Settlements......................................... -- 253
-------- --------
Projected benefit obligation, end of year........... $ 9,054 $ 8,195
======== ========
The change in Plan assets resulted from the following components for the
years ended November 30, 2002 and 2001:
2002 2001
-------- --------
Fair value of plan assets, beginning of year........ $ 7,821 $ 6,957
Actual return on plan assets........................ 1,700 1,018
Employer contribution............................... 79 886
Benefits paid....................................... (427) (1,040)
-------- --------
Fair value of plan assets, end of year.............. $ 9,173 $ 7,821
======== ========
35
<PAGE>
The following table sets forth the funded status of the Plan as of November
30, 2002 and 2001:
2002 2001
-------- --------
Plan assets at fair market value.................... $ 9,173 $ 7,821
Projected benefit obligation........................ (9,054) (8,195)
-------- --------
Plan assets greater (less) than projected
benefit obligation................................. 119 (374)
Unrecognized net loss............................... 1,238 1,636
Minimum pension liability adjustment................ -- (1,636)
-------- --------
Pension asset (liability) recognized in
balance sheets at end of year...................... $ 1,357 $ (374)
======== ========
The discount rate used in determining the actuarial present value of the
projected benefit obligation was 6.75% and 7% in 2002 and 2001, respectively.
The expected long-term rate of return on plan assets was 9% in both 2002 and
2001. As of November 30, 2002, we had 70,000 shares of our common stock in the
Plan with a fair value of $1,362.
The Company has a defined contribution plan covering substantially all
employees. Eligible participants can contribute up to 15% of their annual
compensation and receive a 25% matching employer contribution on the first 6% of
compensation contributed by participants. The defined contribution plan expense
was $190, $180 and $171 in 2002, 2001 and 2000, respectively. In fiscal 2001 the
Company enhanced its savings investment plan to include an additional 3%
employer contribution made on behalf of eligible participants. This additional
employer contribution was $608 and $492 in 2002 and 2001, respectively.
(4) LONG-TERM DEBT
--------------
Long-term debt consisted of the following at November 30, 2002 and 2001:
2002 2001
-------- --------
Term loan payable to banks at a 4.8% variable
rate at November 30, 2002.......................... $ 20,000 $ --
8.875% Senior Subordinated Notes, due 2008, plus
unamortized premium of $170 for 2002 and $202
for 2001........................................... 204,708 204,740
-------- --------
Total long-term debt................................ 224,708 204,740
Less: current maturities............................ 7,250 --
-------- --------
Total long-term debt, net of current maturities..... $217,458 $204,740
======== ========
On March 28, 2002 the Company 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 includes a $15,000 revolving
credit line and a $45,000 term loan. The Credit Facility together with the
Company's available cash was used to finance the acquisition of SELSUN BLUE and
was used to provide working capital for general corporate purposes. The $45,000
term loan, which requires principal payments to be made quarterly, and any
outstanding loans under the revolving credit line, mature on March 28, 2007.
Interest on the loans is payable to the bank at the higher of LIBOR or the
federal funds rate plus .05% plus percentages ranging from .75% to 1.5%
depending on the Company's leverage. As of November 30, 2002 the variable rate
on the term loan was 4.8%. As of November 30, 2002 no revolving credit loans or
letters of credit were outstanding. The Credit Facility is secured by the stock
of the Company's domestic subsidiaries and all present and future assets of the
Company, excluding real property. The Credit Facility contains covenants,
representations, warranties and other agreements by the
36
<PAGE>
Company that are customary in credit agreements and security instruments
relating to financings of this type.
On January 17, 2001 the Company completed the consent solicitation and
tender offer pursuant to which it retired $70,462 principal amount of its 8.875%
Senior Subordinated Notes due 2008 (the "8.875% Notes") and $7,397 principal
amount of its 12.75% Senior Subordinated Notes due 2004 (the "12.75% Notes").
Total consideration paid for the consent solicitation and tender offer was
$64,937, which was provided by the proceeds of the Company's divestiture of the
Ban product line in fiscal 2000 (Note 11). On June 15, 2001 the Company retired
all of the remaining outstanding principal balance of $21,748 of the 12.75%
Notes.
On March 24, 1998 the Company issued at par value $200,000 of the 8.875%
Notes. The proceeds of the note offering were used to fund the Ban purchase
(Note 11), repay revolving bank indebtedness and provide additional working
capital.
On May 7, 1999 the Company issued an additional $75,000 of its 8.875%
(priced to yield 8.8125%) Notes under its indenture relating to the issuance of
its $200,000 of 8.875% Notes on March 24, 1998. The additional notes were issued
under the Company's $250,000 shelf registration statement filed on December 21,
1998 with the Securities and Exchange Commission. The net proceeds from the
issuance of the additional notes were used to retire $41,500 of the then
outstanding balance of the Company's $115,000 term bank loan and the outstanding
balance of $25,500 of its revolving bank loan.
The 8.875% Notes mature on April 1, 2008 and interest is payable
semi-annually on April 1 and October 1 of each year. The 8.875% Notes are senior
subordinated obligations of the Company and are subordinated in right of payment
to all existing and future senior debt of the Company. The 8.875% Notes, which
were registered under the Securities Act of 1933, are not callable until April
1, 2003, after which they may be redeemed at the option of the Company. Upon the
occurrence of certain events constituting a change of control, the holders of
the 8.875% Notes may require the Company to repurchase the 8.875% Notes at a
purchase price equal to 101% of the principal amount thereof, plus accrued and
unpaid interest. The 8.875% Notes are guaranteed by Signal Investment &
Management Co., and SunDex, Inc., wholly-owned subsidiaries of the Company.
The 8.875% Notes are issued under an indenture with an indenture trustee,
which restricts, among other things, the ability of the Company and its
subsidiaries to (i) incur additional indebtedness, (ii) pay dividends, (iii)
sell or issue capital stock of a subsidiary, (iv) create encumbrances on the
ability of any subsidiary to pay dividends or make other restricted payments,
(v) engage in certain transactions with affiliates, (vi) dispose of certain
assets, (vii) merge or consolidate with or into, or sell or otherwise transfer
all or substantially all their properties and assets as an entirety to another
person, or (viii) create additional liens.
During 2001 and 2000 the Company prepaid previously outstanding long-term
debt with funds received from refinancings, proceeds from product divestitures
(Note 11), cash from operations, and the issuance of the 8.875% Notes. In
connection with the repayment of those borrowings, the Company incurred
extraordinary gains (losses), net of income tax, in 2001 and 2000 of $6,948 and
$(920), respectively, or $.38 and $(.05) per diluted share, respectively. The
gain and these losses related to the write-off of debt issuance and other
deferred financing costs and the discounts taken and premiums paid on the
retirement of the 8.875% and 12.75% Notes.
37
<PAGE>
Future maturities of long-term debt are as follows:
2003................................... $ 7,250
2004................................... 8,500
2005................................... 4,250
2006................................... --
2007................................... --
Thereafter 204,538
--------
224,538
Unamortized premium.................... 170
--------
$224,708
Cash interest payments during 2002, 2001 and 2000 were $ 19,317, $23,408
and $33,596, respectively, net of $31 capitalized in 2000.
(5) DERIVATIVE FINANCIAL INSTRUMENTS
--------------------------------
On July 21, 1997 the Company entered into two interest rate swap agreements
with a financial institution in notional amounts of $40,000 and $5,000. The
Company entered into these agreements as hedges on its variable rate debt and
not for trading purposes. The swaps were scheduled to expire July 22, 2002. In
connection with the May 1999 refinancing of its long-term debt, the Company
terminated these agreements, which resulted in a $1,155 loss. This loss was
deferred by the Company and was being written off as interest expense over the
original life of the swaps. In connection with the September 2000 retirement of
the underlying variable rate debt, the Company wrote off the unamortized portion
of the loss to interest expense. The amount of this loss charged to interest
expense in 2000 was $942.
(6) FAIR VALUE OF FINANCIAL INSTRUMENTS
-----------------------------------
Unless otherwise indicated elsewhere in the notes to the consolidated
financial statements, the carrying value of the Company's financial instruments
approximates fair value.
At November 30, 2002 the estimated fair value of the 8.875% Notes exceeded
their carrying value by approximately $6,989. The fair value was estimated based
on quoted market prices for the same or similar issues.
(7) INCOME TAXES
------------
The provision for (benefit from) income taxes from income (loss) before
extraordinary gain (loss) and change in accounting principle includes the
following components for the years ending November 30, 2002, 2001 and 2000:
2002 2001 2000
-------- -------- --------
Current:
Federal.............................. $ 7,948 $ (5,534) $ 5,053
State................................ 909 (683) 577
Deferred............................... 2,725 11,362 (5,734)
-------- -------- --------
$ 11,582 $ 5,145 $ (104)
======== ======== ========
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<PAGE>
As of November 30, 2002, the Company had a net operating loss carryforward
of $1,007 which will expire in 20 years, a foreign tax credit of $600 which will
expire in 5 years and a research and development credit of $101 which will
expire in 20 years. In 2002, 2001 and 2000 income tax benefits attributable to
employee stock option transactions of $4,452, $37 and $94, respectively, were
allocated to shareholders' equity.
Deferred income tax assets and liabilities reflect the impact of temporary
differences between the amounts of assets and liabilities for financial
reporting and income tax reporting purposes. Temporary differences and
carryforwards which give rise to deferred tax assets and liabilities at November
30, 2002 and 2001 are as follows:
2002 2001
-------- --------
Deferred tax assets:
Allowances and accruals..................... $ 676 $ 235
Inventory reserve........................... 274 365
Accrued promotional expenses ............... 1,697 438
Allowance for product returns............... 1,144 765
Accrued postretirement health care
benefits.................................. 625 612
Other....................................... 676 1,628
-------- --------
Gross deferred tax assets................. 5,092 4,043
Deferred tax liabilities:
Depreciation and amortization............... 19,590 16,474
Prepaid advertising ........................ 218 315
Inventory................................... 196 195
Other....................................... 1,816 1,062
-------- --------
Gross deferred tax liabilities............ 21,820 18,046
-------- --------
Net deferred liability.................... $ 16,728 $ 14,003
======== ========
The difference between the provision for (benefit from) income taxes and
the amount computed by multiplying income (loss) before income taxes,
extraordinary gain (loss) and change in accounting principle by the United
States statutory rate for the years ended November 30, 2002, 2001 and 2000 is
summarized as follows:
2002 2001 2000
-------- -------- --------
Expected federal tax provision
(benefit)......................... $ 10,669 $ 4,739 $ (105)
State income taxes, net of federal
income tax benefit................ 981 696 (11)
Other, net.......................... (68) (290) 12
-------- -------- --------
$ 11,582 $ 5,145 $ (104)
======== ======== ========
Income taxes paid in 2002, 2001 and 2000 were $4,137, $1,261 and $9,119,
respectively. The Company received income tax refunds of $1,044 and $4,747
during 2002 and 2001, respectively.
39
<PAGE>
(8) SHAREHOLDERS' EQUITY
--------------------
STOCK OPTIONS
The Company's 1993 Non-Statutory Stock Option Plan provides for issuance of
up to 700,000 shares of common stock to key employees. In addition, the
Company's 1994 Non-Statutory Stock Option Plan and the 1994 Non-Statutory Stock
Option Plan for Non-Employee Directors provide for the issuance of up to 700,000
and 160,000 shares, respectively, of common stock. The Company's 1998
Non-Statutory Stock Option Plan provides for issuance of up to 1,400,000 shares
of common stock to key employees, while the 1999 Non-Statutory Stock Option Plan
for Non-Employee Directors allows issuance of up to 200,000 shares of common
stock. The 2000 Non-Statutory Stock Option Plan provides for the issuance of up
to 1,500,000 shares of common stock. 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 purposes, 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 2002, 2001 and
2000: expected dividend yield of 0%, expected volatility of 64%, 65% and 57%,
risk-free interest rates of 4.22%, 4.40% and 6.41% and expected lives of six
years.
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
No. 123, the Company's net income (loss) and net income (loss) per share would
have been adjusted to the pro forma amounts for the years ended November 30,
2002, 2001 and 2000 as indicated below:
2002 2001 2000
-------- -------- --------
Net income (loss):
As reported ........................ $ 10,023 $ 15,343 $ (1,659)
Pro forma .......................... $ 8,215 $ 13,573 $ (2,456)
Net income (loss) per share, basic:
As reported......................... $ .54 $ .86 $ (.09)
Pro forma........................... $ .44 $ .76 $ (.13)
Net income (loss) per share, diluted:
As reported ........................ $ .52 $ .85 $ (.09)
Pro forma .......................... $ .42 $ .75 $ (.13)
40
<PAGE>
A summary of the activity of stock options during 2002, 2001 and 2000 is
presented below (shares in thousands):
<TABLE><CAPTION>
2002 2001 2000
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Weighted Weighted Weighted
Shares Average Shares Average Shares Average
Under Exercise Under Exercise Under Exercise
Option Price Option Price Option Price
Outstanding at beginning of
year............................ 2,952 $ 5.43 1,536 $ 6.25 1,698 $ 7.96
Granted....................... 430 12.74 1,644 4.98 1,348 9.23
Exercised..................... (1,335) 5.50 (40) 5.47 (54) 4.33
Cancelled..................... (134) 5.08 (188) 8.67 (1,456) 11.07
------- ------- -------
Outstanding at end of year........ 1,913 $ 7.05 2,952 $ 5.43 1,536 $ 6.25
======= ======= ======= ======= ======= =======
Options exercisable at
year-end........................ 359 $ 6.41 1,016 $ 5.65 968 $ 5.75
======= ======= ======= ======= ======= =======
Weighted average fair value of
options granted................. $ 4.26 $ 3.87 $ 5.57
======= ======= =======
</TABLE>
Compensation expense for stock option grants with exercise prices below the
market price at the date of grant is recognized ratably over the vesting period.
In 1998 options were granted to purchase 350,000 shares, which were at market
price on the date of approval by the board of directors but at prices below the
market price on the date of shareholder approval. Compensation expense recorded
for this grant was $175 in fiscal 2002 and $525 in each of the fiscal years 2001
and 2000, respectively.
A summary of the exercise prices for options outstanding under the
Company's stock-based compensation plans at November 30, 2002 is presented below
(shares in thousands):
<TABLE><CAPTION>
Weighted Average
Weighted Average Weighted Average Exercise Price
Exercise Price Shares Under Exercise Remaining Life in Shares of Shares
Range Option Price Years Exercisable Exercisable
- --------------- ------------ ----------------- ----------------- ----------- -------------
<C> <C> <C> <C> <C> <C>
$ 2.31 - $ 4.33 50 $ 3.75 3.86 43 $3.81
$ 4.33 - $ 6.35 1,180 4.93 8.40 118 4.93
$ 6.35 - $ 8.37 254 6.97 6.36 180 6.91
$ 8.37 - $10.39 139 8.52 9.24 -- --
$10.39 - $12.41 6 11.72 9.34 -- --
$12.42 - $14.33 42 13.92 9.25 2 13.00
$14.34 - $16.45 172 14.58 9.52 -- --
$16.46 - $18.47 20 18.13 6.38 16 18.13
$18.48 - $20.50 40 19.77 9.76 -- --
$20.50 - $22.52 10 20.90 9.95 -- --
------- ------ -----
Total 1,913 $ 7.05 8.21 359 $6.41
======= ====== ====== ===== =====
</TABLE>
41
<PAGE>
PREFERRED SHARES
The Company is authorized to issue up to 1,000,000 preferred shares in
series and with rights established by the board of directors. At November 30,
2002 and 2001 no shares of any series of preferred stock were issued and
outstanding.
EMPLOYEE STOCK OWNERSHIP PLAN
Effective June 1, 1989 the Company established an Employee Stock Ownership
Plan providing for the issuance of up to 720,000 shares of the Company's common
stock. At November 30, 2002 no contributions had been made to the plan.
STOCK BUYBACK (Number of shares is before the two-for-one split of the
Company's common stock on November 29, 2002.)
In fiscal 1999, the Company's board of directors authorized repurchases of
the Company's common stock, not to exceed $10,000 in the aggregate. In April
2000, the Company's board of directors authorized repurchases of up to an
additional $10,000 of the Company's common stock. Under these authorizations,
172,500 shares at a cost of $3,912 were reacquired in 1999, 876,500 shares at a
cost of $9,489 were repurchased in 2000, 14,000 shares at a cost of $174 were
reacquired in 2001 and 79,200 shares at a cost of $1,650 were repurchased in
2002. The repurchased shares were retired and returned to unissued. As of
November 30, 2002 $4,775 was available for share repurchases under the board of
directors current authorization; however, the Company is limited in its ability
to repurchase shares by restrictions under the terms of the indenture with
respect to which its 8.875% Notes were issued and under the terms of the Credit
Facility. (See Note 4 of Notes to Consolidated Financial Statements for a
description of this facility). In January 2003 the board of directors increased
to $10,000 the total authorization to repurchase the Company's common stock
under the buyback program.
SHAREHOLDER RIGHTS PLAN
On January 26, 2000 the Company's board of directors adopted a Shareholder
Rights Plan. Under the plan, rights were constructively distributed as a
dividend at the rate of one right for each share of common stock, without par
value, of the Company held by shareholders of record as of the close of business
on February 11, 2000. As a result of the two-for-one split of the Company's
common stock on November 29, 2002, there is now one-half (1/2) right associated
with each share of common stock outstanding. Each right initially will entitle
shareholders to buy one one-hundredth of a share of a new Series A Junior
Participating Preferred Stock at an exercise price of $90.00 per right, subject
to adjustment. The rights generally will be exercisable only if a person or
group acquires beneficial ownership of 15% or more of the Company's common
stock. The rights will expire on February 11, 2010. As of November 30, 2002, no
rights had been exercised.
RESTRICTED STOCK ISSUANCE
The Company issued 50,000 and 200,000 restricted shares of its common stock
to certain employees in fiscal 2002 and 2001, respectively. The value of these
shares at dates of issuance was $1,126, in 2002 and $993 in 2001, which amounts
are being amortized using the straight line method over respective four year
periods. The amount of amortization was $272 and $134 in 2002 and 2001,
respectively, with the unamortized value of $1,713 and $859 being shown in the
shareholders' equity section of the November 30, 2002 and 2001 consolidated
balance sheets, respectively. The shares issued in 2002 reduced the number of
shares available for issuance under the Company's 2000 Non-Statutory
42
<PAGE>
Stock Option Plan while the shares issued in 2001 reduced the shares available
for issuance under the Company's 1998 Non-Statutory Stock Option Plan.
STOCK SPLIT
On October 29, 2002, the Company's board of directors approved a
two-for-one split of the Company's common stock to shareholders of record on
November 15, 2002 with a distribution date of November 29, 2002. As a result of
the stock split, the number of outstanding shares doubled.
(9) COMMITMENTS AND CONTINGENCIES
-----------------------------
GENERAL LITIGATION
The Company was named as a defendant in a lawsuit brought by the Center for
Environment Health ("CEH") contending that the Company violated the California
Safe Drinking Water and Toxic Enforcement Act of 1998 (Proposition 65) by
selling to California consumers, without a warning, topical skin care products
containing zinc oxide which in turn contains lead. The lawsuit contended that
the purported failure to comply with Proposition 65 requirements also
constituted a violation of the California Business & Professions Code.
Violations of either Proposition 65 or the California Business and Professions
Code render a defendant liable for civil penalties of up to $2.5 per day per
violation.
The Company was also named as a defendant in a lawsuit filed on December
29, 1999, JOHNSON et al. v. BRISTOL-MYERS SQUIBB CO., et al. This was a putative
class action brought by two named plaintiffs on behalf of the general public in
California, against the same entities that are defendants in the CEH lawsuit. As
with the CEH lawsuit, the Johnson lawsuit alleged that the Company violated
Proposition 65 by selling to California consumers without a warning topical skin
care products containing zinc oxide which in turn contains lead. The lawsuit did
not assert claims directly under Proposition 65, but asserted that the alleged
failure to comply with Proposition 65 gave rise to claims under California's
Business and Professions Code and the California Civil Code. The lawsuit sought
injunctive and equitable relief, restitution, the disgorgement of allegedly
wrongfully obtained revenues and damages.
The plaintiffs in the two separate actions filed a consolidated amended
complaint that included a claim based upon the allegation that zinc oxide
allegedly also contains cadmium. During the third quarter of fiscal 2002 a
settlement was finalized among the parties for these two cases pending final
court approval. Final court approval of the settlement is expected during the
Company's second quarter of fiscal 2003. In the settlement, the Company paid a
settlement amount that was within the expected range that had been previously
accrued by the Company. The settlement amount was not material to the Company's
results of operations.
As of February 21, 2003, the Company has been named as a defendant in
approximately 302 lawsuits involving claims by approximately 1,357 plaintiffs
alleging that the plaintiffs were injured as a result of ingestion of products
containing phenylpropanolamine ("PPA"), which was an active ingredient in most
of the Company's DEXATRIM products until November 2000. Most of the lawsuits
seek an unspecified amount of compensatory and exemplary damages or punitive
damages. The lawsuits that are federal cases have now been transferred to the
United States District Court for the Western District of Washington (In re
Phenylpropanolamine (PPA) Products Liability Litigation, MDL No. 1407). The
remaining cases are state court cases which have been filed in a number of
different states.
The Company anticipates that additional lawsuits will be filed with similar
or other allegations related to the Company's DEXATRIM products containing PPA.
None of these lawsuits has, to date, been
43
<PAGE>
resolved by settlement or judicial ruling. The earliest scheduled trial date in
the state cases is May 19, 2003. It is anticipated that other state cases will
be set for trial during the course of the year and that significant evidentiary
and other hearings will be held during the course of the year in the federal
cases.
Approximately half of the existing suits represent cases involving alleged
injuries by products manufactured and sold prior to the Company's acquisition of
DEXATRIM in December 1998. The Company is being defended and is indemnified from
liability by The DELACO Company, Inc. ("DELACO"), successor to Thompson Medical
Company, Inc. which owned DEXATRIM prior to December 1998. The Company
understands that DELACO maintains product liability insurance coverage for
products manufactured and sold prior to December 1998 with annual limits of
coverage and has an excess liability policy, but otherwise has only nominal
assets. Accordingly, it is unlikely that DELACO will be able to indemnify the
Company beyond its insurance coverage. In addition, there can be no assurance
that the insurance maintained by DELACO will be sufficient to cover claims
related to products manufactured or sold prior to the Company's acquisition of
DEXATRIM or that ultimately the Company will not be held liable for these
claims. The Company's product liability insurance, as described more fully
below, would not apply to claims arising from products manufactured and sold
prior to the Company's acquisition of DEXATRIM. If the Company is forced to
assume PPA-related liabilities arising prior to the Company's acquisition of
DEXATRIM or if PPA-related lawsuits resulted in liabilities greater than amounts
available under or exceed the scope of the Company's insurance coverage, the
Company may not have sufficient resources to satisfy these obligations.
Of the existing lawsuits, about two-thirds of the cases make non-specific
factual allegations against a broad group of PPA manufacturers. There are
approximately 20 identified cases which we currently believe contain allegations
that the plaintiff suffered a hemorrhagic stroke within three days of ingesting
DEXATRIM products containing PPA that were sold after our acquisition of
DEXATRIM in December 1998. As additional lawsuits are filed and discovery in the
existing lawsuits continues, the Company expects to know more about the
characteristics of the cases, which will result in a fluctuation in the number
of cases ascribed to the categories listed above.
In addition, the Company has also been named as a defendant in a lawsuit
alleging that the plaintiff was injured as a result of the ingestion of DEXATRIM
containing ephedrine. The Company's available insurance for the defense of this
lawsuit is substantially less than the level of insurance coverage for claims
relating to Dexatrim with PPA.
The Company is aggressively defending these lawsuits. It is too early in
the litigation to evaluate fully the risks that these lawsuits pose, or express
a range of likely outcomes. It is also too early to estimate the number of
lawsuits related to DEXATRIM with PPA or DEXATRIM with ephedrine that will be
filed or whether the Company's available insurance is sufficient to cover these
claims.
The Company currently maintains product liability insurance, principally
through third party insurers, that provides coverage for product liability
claims, including those asserted in the lawsuits currently pending and
anticipated to be filed against the Company relating to the existence of PPA in
DEXATRIM. The Company has $102 million of product liability insurance coverage
for injuries related to DEXATRIM containing PPA occurring after the Company's
acquisition of DEXATRIM in December, 1998 and prior to May 31, 2001, if the
claims are made before May 31, 2004. Injuries occurring before December 1998 or
after May 31, 2001, or claims made after May 31, 2004, would not be covered by
these insurance policies. The Company currently has one claim that relates to
injuries occurring after May 31, 2001. The Company's insurance policies are
subject to certain other limitations that are generally customary for policies
of this type.
The Company maintains a significantly lower level of insurance coverage for
all other potential claims relating to its products, including DEXATRIM products
containing ephedrine. The Company's
44
<PAGE>
product liability insurance coverage for all its other products, including those
containing ephedrine, consists of $2,000 of coverage through a third party
insurer, $8,000 of self-insured coverage through the Company's captive insurance
subsidiary, of which $1,325 is currently funded, and $25,000 of excess coverage
through a third party insurer.
The Company has also been named as a defendant in a lawsuit brought in the
State of California by Citizens for Responsible Business, Inc. under the
California Business and Professional Code. The lawsuit charges that the
Company's alleged failure to comply with newly-added provisions of the Federal
Food, Drug, and Cosmetic Act with respect to the labeling of products purported
to contain "ginseng," constitutes a violation of the Code. Numerous other retail
and manufacturing companies are named as defendants in the suit. It is too early
to determine the Company's potential liability or possible damages.
Other claims, suits and complaints arise in the ordinary course of the
Company's business involving such matters as patents and trademarks, product
liability, environmental matters and other alleged injuries or damage. The
outcome of such litigation cannot be predicted, but, in the opinion of
management, based in part upon the opinion of 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 the consolidated operating results
or financial position of the Company if disposed of unfavorably.
REGULATORY
In 1994 the Nonprescription Drug Manufacturers Association (now the
Consumer Healthcare Products Association) ("CHPA") initiated a large-scale study
in conjunction with the Yale University School of Medicine to investigate a
possible association, if any, of stroke in women aged 18 to 49 using PPA which,
until November 2000, was the active ingredient in certain of the DEXATRIM
products (the "Yale Study"). PPA is also used in other OTC medications, which
were also part of the Yale Study. In May 2000, the results of the Yale Study
were filed with the Food and Drug Administration ("FDA"). The investigators
concluded that the results of the Yale Study suggest that PPA increases the
risks of hemorrhagic stroke. The FDA indicated at that time that no immediate
action was required and scheduled a FDA advisory panel to meet in October 2000
to discuss the results of the study.
On October 19, 2000, a Nonprescription Drugs Advisory Committee ("NDAC"),
commissioned by the FDA to review the safety of PPA, determined that there is an
association between PPA and hemorrhagic stroke and recommended that PPA not be
considered generally recognized as safe for OTC use as a nasal decongestant or
for weight control. In response to a request from the FDA to cease voluntarily
marketing DEXATRIM with PPA, the Company announced on November 7, 2000 its
decision to cease immediately shipping DEXATRIM with PPA and to accept product
returns from any retailers who decide to discontinue marketing DEXATRIM with
PPA.
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 a
sharp increase in the number of ephedrine related lawsuits filed, including ones
in which the Company is named as a defendant. In late 2000, the FDA requested
the National Institutes of Health to commission a review of
45
<PAGE>
the safety and efficacy of ephedrine in herbal products used to control weight.
This review will be based on all adverse events, records and scientific data
available to the reviewers. It is expected that the report will be issued in the
Spring of 2003. In September 2001, the Public Citizen Health Research Group
petitioned the FDA to ban the production and sale of dietary supplements
containing ephedrine alkaloids. As of February 21, 2003 the FDA's parent entity,
the Department of Health and Human Services, has decided to defer making a
decision on the petition until it has further scientific information on the
safety of ephedrine alkaloids.
The Company has developed alternative formulations for DEXATRIM Natural and
DEXATRIM Results to exclude ephedrine and discontinued the manufacturing and
shipment of DEXATRIM products containing ephedrine in September 2002. Our
DEXATRIM products containing ephedrine may continue to be sold in the trade
until our customers' existing supply of inventory is exhausted or until the
products are returned to us. Negative publicity relating to the possible harmful
effects of ephedrine and the possibility of further regulatory action to
restrict or prohibit the sale of products containing ephedrine could result in a
return of products from retailers or our decision to accept product returns of
DEXATRIM with ephedrine.
The Company was notified in October 2000 that the FDA denied a citizen
petition submitted by Thompson Medical Company, Inc., the previous owner of
SPORTSCREME and ASPERCREME, seeking 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 thus should be included in the FDA's yet-to-be finalized monograph
for external analgesics. The Company has 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. Based on comments
received from the FDA at the meeting, the Company may revise and resubmit the
protocol. After final comments from the FDA, the Company expects that it will
take one or two years to produce the clinical data for FDA review. The FDA could
finalize the OTC external analgesic monograph before the protocol and clinical
data results are finalized, which would place 10% trolamine salicylate in
non-monograph status, thus requiring the submission of a new drug application to
market and sell OTC products with 10% trolamine salicylate. This submission
would likely require the Company to provide clinical data, which would be
expensive. The Company is 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, the Company would
likely be required to discontinue these products and remove them from the market
after expiration of an anticipated grace period or review the option of
marketing these products as homeopathic products
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. Selenium sulfide, an ingredient in SELSUN BLUE,
is on the state's list as a carcinogen. Although we are not aware of any action
that has been brought with respect to selenium sulfide under Proposition 65, it
is possible that such a claim could be brought, in which case we would be
required to demonstrate that exposure to selenium sulfide in SELSUN BLUE, 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 the product to acceptable levels
of selenium sulfide.
LEASES
The minimum rental commitments under all noncancelable operating leases,
primarily real estate, in effect at November 30, 2002 are as follows:
46
<PAGE>
2003........................ $ 303
2004........................ 206
2005........................ 198
2006........................ 197
2007........................ 194
Thereafter.................. 1,297
------
$2,395
Rental expense was $1,394, $1,442 and $1,802 for 2002, 2001 and 2000,
respectively.
(10) SUPPLEMENTAL FINANCIAL INFORMATION
----------------------------------
Inventories consisted of the following at November 30, 2002 and 2001:
2002 2001
--------- ---------
Raw materials and work in process ......... $ 9,104 $ 8,108
Finished goods............................. 11,392 8,191
Excess of current cost over LIFO value .... (1,727) (2,039)
--------- ---------
Total inventories........................ $ 18,769 $ 14,260
========= =========
International inventories included above, valued on a lower of FIFO cost or
market at November 30, 2002 and 2001 were $2,896 and $2,279, respectively.
Property, plant and equipment consisted of the following at November 30,
2002 and 2001:
2002 2001
--------- ---------
Land....................................... $ 886 $ 879
Buildings and improvements................. 5,956 5,707
Machinery and equipment.................... 46,537 44,043
Construction in progress................... 866 286
Less - accumulated depreciation ........... (27,587) (24,640)
--------- ---------
Property, plant and equipment, net $ 26,658 $ 26,275
========= =========
Accrued liabilities consisted of the following at November 30, 2002 and
2001:
2002 2001
--------- ---------
Interest................................... $ 3,366 $ 3,070
Salaries, wages and commissions ........... 3,739 3,462
Product advertising and promotion.......... 7,524 3,654
Product acquisitions and divestitures...... 737 2,205
Taxes...................................... 1,993 290
Consulting fees............................ 747 --
Legal fees................................. 789 281
Insurance.................................. 934 842
Other...................................... 1,275 1,334
--------- ---------
Total accrued liabilities................ $ 21,104 $ 15,138
========= =========
(11) ACQUISITION AND SALE OF BRANDS
------------------------------
On March 28, 2002 the Company completed the acquisition of SELSUN BLUE, a
line of leading medicated dandruff shampoos, from Abbott Laboratories ("Abbott")
for $75,000, plus inventories of
47
<PAGE>
$1,380 and assumed liabilities of $1,178. This acquisition includes worldwide
rights (except in India) to manufacture, sell and market SELSUN BLUE plus
related intellectual property and certain manufacturing equipment. The purchase
price of $77,558 was allocated $1,518 to inventory, $1,000 to equipment, $73,790
to the trademark which was assigned an indefinite life and $1,250 to other
purchased product rights which were assigned useful lives of 5 years. This is a
preliminary allocation which will be revised upon completion of appraisals of
the assets. Abbott will continue to manufacture the product for the Company
until June 2003 domestically, or such earlier date as the Company moves
production to its Chattanooga, Tennessee facilities, and until March 2004
internationally, or such earlier date as the Company enters into its own
agreements with contract manufacturers. The Company will generally pay Abbott a
fee of ten percent over standard manufacturing costs until the Company assumes
manufacturing or enters into third party agreements, except as discussed below.
The Company will also rely on Abbott to market, sell and distribute SELSUN BLUE
products in most foreign countries until the Company satisfies various foreign
regulatory requirements, new distributors are in place and any applicable
marketing permits are transferred. During the marketing transition period,
Abbott will initially pay the Company a royalty equal to 28% of international
sales of SELSUN BLUE in these countries with the royalty reduced to 14% of
international sales in certain countries if foreign regulatory requirements are
satisfied prior to the Company's assumption of sales and marketing
responsibility in such countries. Abbott will pay all costs and expenses related
to the manufacture, marketing and sales of SELSUN BLUE in these countries. As
the Company assumes responsibility for the sales and marketing effort in a
country, the royalty arrangement with respect to such country will terminate and
the Company will record these international sales directly, as well as the costs
and expenses associated with these sales.
The following table summarizes the Company's estimate of how the results
for SELSUN BLUE international for the three and twelve months ended November 30,
2002 would have been presented had the transition period been finalized on the
date of acquisition, and has been derived from historical financial data
received from the prior owner of SELSUN BLUE.
SELECTED SELSUN BLUE INTERNATIONAL DATA (Unaudited)
For the Three For the Twelve
Months Ended Months Ended
November 30, 2002 November 30, 2002
----------------- -----------------
NET SALES............................ $ 4,351 $ 12,052
--------- ---------
COSTS AND EXPENSES:
Cost of sales...................... 1,684 4,667
Advertising and promotion.......... 644 1,783
Selling, general and
administrative................... 1,569 3,275
--------- ---------
Total costs and expenses......... 3,897 9,725
--------- ---------
INCOME FROM OPERATIONS............... $ 454 $ 2,327
========= =========
48
<PAGE>
The following unaudited consolidated pro forma information assumes the
acquisition of SELSUN BLUE had occurred at the beginning of the periods
presented:
PRO FORMA CONSOLIDATED RESULTS OF OPERATIONS (Unaudited)
<TABLE><CAPTION>
For the Three Months For the Year
Ended November 30, Ended November 30,
2001 2002 2001
----------------- ---------- ----------
<S> <C> <C> <C>
Total revenue..................... $ 52,524 $ 233,847 $ 221,817
Income before extraordinary
gain (loss) and change in
accounting principle........... 3,167 19,441 13,803
Net income........................ 3,167 10,564 20,751
Earnings per share - basic:
Income before extraordinary
gain (loss) and change in
accounting principle.......... 0.18 1.04 0.77
Net income...................... 0.18 .57 1.16
Earnings per share- diluted:
Income before extraordinary
gain (loss) and change in
accounting principle........... 0.17 1.00 0.76
Net income...................... 0.17 0.55 1.15
</TABLE>
On September 15, 2000 the Company completed the sale of its Ban product
line to The Andrew Jergens Company, a wholly-owned subsidiary of Kao
Corporation. Under the terms of the sales agreement, the Company received
$160,000 cash at closing, plus the right to receive up to an additional $6,500
in future payments based upon levels of sales of Ban in 2001 and 2002. The
Company recognized a loss of $4,208 on the divestiture. Concurrent with the
closing of the sale of Ban the Company used $52,194 of the net proceeds to
retire all of the outstanding balances of the revolving line of credit and term
loans and accrued interest thereon, with the balance of the net proceeds being
retained by the Company.
The following unaudited consolidated pro forma information assumes the
divestiture of Ban and related long-term borrowings and repayment thereof had
occurred on December 1, 1999:
PRO FORMA CONSOLIDATED RESULTS OF OPERATIONS (unaudited)
2000
---------
Net sales..................................... $ 191,256
Income (loss) before extraordinary loss
and change in accounting principle.......... (5,610)
Net income (loss)............................. (7,072)
Earnings (loss) per share - basic:
Income (loss) before extraordinary
loss and change in accounting
principle................................. (.30)
Net income (loss)............................ (.38)
Earnings (loss) per share - diluted:
Income (loss) before extraordinary
loss and change in accounting
principle................................. (.30)
Net income (loss)............................ (.38)
49
<PAGE>
The pro forma consolidated results of operations include adjustments to give
effect to amortization of intangible assets, interest expense on acquisition
debt or repayment thereof and certain other adjustments, together with related
income tax effects. The pro forma information is for comparative purposes only
and does not purport to be indicative of the results that would have occurred
had the acquisition, disposition and borrowings occurred at the beginning of the
periods presented, or indicative of the results that may occur in the future.
(12) ACCRUED POSTRETIREMENT HEALTH CARE BENEFITS
-------------------------------------------
The Company maintains certain postretirement health care benefits for
eligible employees. Employees become eligible for these benefits if they meet
certain age and service requirements. The Company pays a portion of the cost of
medical benefits for certain retired employees over the age of 65. Effective
January 1, 1993, the Company's contribution is a service-based percentage of the
full premium. The Company pays these benefits as claims are incurred.
Net periodic postretirement health care benefits cost for the years ended
November 30, 2002, 2001 and 2000, included the following components:
2002 2001 2000
------ ------ ------
Service cost.................................. $ 50 $ 40 $ 32
Interest cost on accumulated postretirement
benefit obligation.......................... 72 75 80
Amortization of prior service cost............ 15 15 --
Amortization of net gain...................... (41) (44) (22)
------ ------ ------
Net periodic postretirement benefits cost .... $ 96 $ 86 $ 90
====== ====== ======
The change in the accumulated benefit obligation resulted from the
following components for the years ended November 30, 2002 and 2001:
2002 2001
------- -------
Accumulated benefit obligation,
beginning of year........................... $ 1,075 $ 1,051
Service cost.................................. 50 40
Interest cost................................. 72 75
Actuarial gain................................ (21) (52)
Benefits paid................................. (70) (39)
------- -------
Accumulated benefit obligation, end of year... $ 1,106 $ 1,075
======= =======
The following table sets forth the funded status of the plan at November
30, 2002 and 2001:
2002 2001
------- -------
Accumulated benefit obligation................ $ 1,106 $ 1,075
Fair value of plan assets..................... -- --
------- -------
Funded status................................. (1,106) (1,075)
Unrecognized prior service cost............... 114 129
Unrecognized actuarial gain................... (610) (630)
------- -------
Accrued postretirement benefits cost.......... $(1,602) $(1,576)
======= =======
For measurement purposes, a 6% annual rate of increase in the per capita
cost of covered health care benefits was assumed in 2002 and 2001. The
weighted-average discount rate used in determining the accumulated
postretirement benefit obligation was 6.75% and 7% at November 30, 2002 and
2001,
50
<PAGE>
respectively. Due to premium caps in place which limit the Company's expense, a
1% increase in the assumed health care cost trend rate would not affect the
accumulated postretirement benefit obligation as of November 30, 2002, or the
aggregate of the service and interest cost components of the net annual
postretirement benefit cost for the year ended November 30, 2002.
(13) PRODUCT AND GEOGRAPHICAL SEGMENT INFORMATION
--------------------------------------------
In 2000 the Company operated in two primary segments - (1) OTC health care
and (2) toiletries and skin care. Upon the sale of Ban in September 2000, the
Company currently operates in only one primary segment - OTC health care. This
segment includes medicated skin care products, topical analgesics, internal
analgesics, lip care, appetite suppressant, dietary supplement products and
other skin care products.
Geographical segment information is as follows for the years ended November
30, 2002, 2001 and 2000:
2002 2001 2000
---------- ---------- ----------
Revenues:
Domestic.......................... $ 202,074 $ 167,256 $ 201,506
International (1)................. 21,042 13,910 16,532
---------- ---------- ----------
Total........................... $ 223,116 $ 181,166 $ 218,038
========== ========== ==========
Long-Lived Assets (2)
Domestic.......................... $ 272,129 $ 211,252 $ 218,739
International..................... 316 396 300
---------- ---------- ----------
Total........................... $ 272,445 $ 211,648 $ 219,039
========== ========== ==========
(1) International sales include export sales from United States operations.
(2) Consists of book value of property, plant, equipment, trademarks and
other product rights.
(14) SUBSEQUENT EVENT
----------------
During the first quarter of fiscal 2003 the Company repurchased, and
returned to unissued, 103,000 shares of its common stock for $1,579.
(15) CONSOLIDATING FINANCIAL STATEMENTS
----------------------------------
The condensed consolidating financial statements, for the dates or periods
indicated, of Chattem, Inc. ("Chattem"), Signal Investment & Management Co.
("Signal") and SunDex, LLC. ("SunDex"), the guarantors of the long-term debt of
Chattem, and the non-guarantor wholly-owned subsidiary companies of Chattem are
presented below. Signal and SunDex are wholly-owned subsidiaries of Chattem; the
guarantee of Signal and SunDex is full and unconditional and joint and several.
51
<PAGE>
Note 15
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING BALANCE SHEETS
----------------------------
NOVEMBER 30, 2002
-----------------
(In thousands)
<TABLE><CAPTION>
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
- ------
CURRENT ASSETS:
Cash and cash equivalents ................... $ 11,505 $ 1,133 $ 5 $ 3,281 $ -- $ 15,924
Accounts receivable, less allowance for
doubtful accounts of $962 .................. 21,585 -- -- 4,088 -- 25,673
Refundable and deferred income taxes ........ 9,791 -- -- 46 -- 9,837
Inventories ................................. 12,734 -- 3,139 2,896 -- 18,769
Prepaid expenses and other current assets ... 2,064 -- -- 120 -- 2,184
--------- --------- --------- --------- --------- ---------
Total current assets ..................... 57,679 1,133 3,144 10,431 -- 72,387
--------- --------- --------- --------- --------- ---------
PROPERTY, PLANT AND EQUIPMENT, NET ............ 25,567 -- 775 316 -- 26,658
--------- --------- --------- --------- --------- ---------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased
product rights, net ........................ 1,397 182,100 62,290 -- -- 245,787
Debt issuance costs, net .................... 7,126 -- -- -- -- 7,126
Investment in subsidiaries .................. 70,714 -- -- -- (70,714) --
Other ....................................... 3,590 -- -- 15 -- 3,605
--------- --------- --------- --------- --------- ---------
Total other noncurrent assets ............ 82,827 182,100 62,290 15 (70,714) 256,518
--------- --------- --------- --------- --------- ---------
TOTAL ASSETS ............................. $ 166,073 $ 183,233 $ 66,209 $ 10,762 $ (70,714) $ 355,563
========= ========= ========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Current maturities of long-term debt ........ $ 7,250 $ -- $ -- $ -- $ -- $ 7,250
Accounts payable ............................ 10,957 -- -- 1,252 -- 12,209
Payable to bank ............................. 452 -- -- -- -- 452
Accrued liabilities ......................... 20,015 -- -- 1,089 -- 21,104
--------- --------- --------- --------- --------- ---------
Total current liabilities ................ 38,674 -- -- 2,341 -- 41,015
--------- --------- --------- --------- --------- ---------
LONG-TERM DEBT, less current maturities ....... 217,458 -- -- -- -- 217,458
--------- --------- --------- --------- --------- ---------
DEFERRED INCOME TAXES ......................... (1,065) 21,809 -- -- -- 20,744
--------- --------- --------- --------- --------- ---------
OTHER NONCURRENT LIABILITIES .................. 1,602 -- -- -- -- 1,602
--------- --------- --------- --------- --------- ---------
INTERCOMPANY ACCOUNTS ......................... (169,271) 170,530 (1,803) 544 -- --
--------- --------- --------- --------- --------- ---------
SHAREHOLDERS' EQUITY:
Preferred shares, without par value,
authorized 1,000, none issued .............. -- -- -- -- --
Common shares, without par value,
authorized 50,000, issued 19,177 ........... 79,313 2 63,065 7,647 70,714 79,313
Retained earnings (deficit) ................. 1,563 (9,108) 4,947 1,501 -- (1,097)
--------- --------- --------- --------- --------- ---------
Total .................................... 80,876 (9,106) 68,012 9,148 70,714 78,216
Unamortized value of restricted common
shares issued .............................. (1,713) -- -- -- -- (1,713)
Cumulative other comprehensive income:
Foreign currency translation adjustment .. (488) -- -- (1,271) -- (1,759)
--------- --------- --------- --------- --------- ---------
Total shareholders' equity (deficit) ..... 78,675 (9,106) 68,012 7,877 70,714 74,744
--------- --------- --------- --------- --------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY ................ $ 166,073 $ 183,233 $ 66,209 $ 10,762 $ 70,714 $ 355,563
========= ========= ========= ========= ========= =========
</TABLE>
52
<PAGE>
Note 15
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING BALANCE SHEETS
----------------------------
NOVEMBER 30, 2001
-----------------
(In thousands)
<TABLE><CAPTION>
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
ASSETS
- ------
CURRENT ASSETS:
Cash and cash equivalents ................... $ 20,648 $ 10,003 $ 4,794 $ -- $ 35,445
Accounts receivable, less allowance for
doubtful accounts of $500 ................ 17,690 -- 3,170 -- 20,860
Refundable and deferred income taxes ........ 4,545 -- 101 -- 4,646
Inventories ................................. 12,409 -- 1,851 -- 14,260
Prepaid expenses and other current assets ... 2,517 -- 150 -- 2,667
--------- --------- --------- --------- ---------
Total current assets ...................... 57,809 10,003 10,066 -- 77,878
--------- --------- --------- --------- ---------
PROPERTY, PLANT AND EQUIPMENT, NET ............ 25,879 -- 396 -- 26,275
--------- --------- --------- --------- ---------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased
product rights, net ...................... 3,987 181,386 -- -- 185,373
Debt issuance costs, net .................... 7,665 -- -- -- 7,665
Investment in subsidiaries .................. 8,280 -- -- (8,280) --
Other ....................................... 2,436 -- 46 -- 2,482
--------- --------- --------- --------- ---------
Total other noncurrent assets ............. 22,368 181,386 46 (8,280) 195,520
--------- --------- --------- --------- ---------
TOTAL ASSETS ............................ $ 106,056 $ 191,389 $ 10,508 $ (8,280) $ 299,673
========= ========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable ............................ $ 8,523 $ -- $ 487 $ -- $ 9,010
Payable to bank ............................. 151 -- -- -- 151
Accrued liabilities ......................... 13,851 -- 1,287 -- 15,138
--------- --------- --------- --------- ---------
Total current liabilities ................. 22,525 -- 1,774 -- 24,299
--------- --------- --------- --------- ---------
LONG-TERM DEBT ................................ 204,740 -- -- -- 204,740
--------- --------- --------- --------- ---------
DEFERRED INCOME TAXES ......................... 1,401 14,850 -- -- 16,251
--------- --------- --------- --------- ---------
OTHER NONCURRENT LIABILITIES .................. 1,765 -- -- -- 1,765
--------- --------- --------- --------- ---------
INTERCOMPANY ACCOUNTS ......................... (178,860) 179,833 (973) -- --
--------- --------- --------- --------- ---------
SHAREHOLDERS' EQUITY:
Preferred shares, without par value,
authorized 1,000, none issued ............ -- -- -- -- --
Common shares, without par value,
authorized 50,000, issued 17,946 ......... 67,828 2 8,278 8,280 67,828
Retained earnings (deficit) ................. (10,994) (3,296) 3,170 -- (11,120)
--------- --------- --------- --------- ---------
Total ..................................... 56,834 (3,294) 11,448 8,280 56,708
Unamortized value of restricted common
shares issued ............................ (859) -- -- -- (859)
Cumulative other comprehensive income:
Foreign currency translation adjustment .... (490) -- (1,741) -- (2,231)
Minimum pension liability adjustment, net .. (1,000) -- -- -- (1,000)
--------- --------- --------- --------- ---------
Total shareholders' equity ................ 54,485 (3,294) 9,707 8,280 52,618
--------- --------- --------- --------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY ................ $ 106,056 $ 191,389 $ 10,508 $ 8,280 $ 299,673
========= ========= ========= ========= =========
</TABLE>
53
<PAGE>
Note 15
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF INCOME
----------------------------------
FOR THE YEAR ENDED NOVEMBER 30, 2002
------------------------------------
(In thousands)
<TABLE><CAPTION>
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
TOTAL REVENUES ................................ $ 177,514 $ -- $ 27,487 $ 18,115 $ -- $ 223,116
--------- --------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales ............................... 48,964 -- 6,821 6,972 -- 62,757
Advertising and promotion ................... 54,385 -- 8,299 5,575 -- 68,259
Selling, general and administrative ......... 36,793 8 260 3,151 -- 40,212
--------- --------- --------- --------- --------- ---------
Total costs and expenses .................. 140,142 8 15,380 15,698 -- 171,228
--------- --------- --------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS ................. 37,372 (8) 12,107 2,417 -- 51,888
--------- --------- --------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense ............................ (21,292) -- -- -- -- (21,292)
Investment and other income, net ............ (230) 66 -- 50 -- (114)
Royalties ................................... (8,874) 10,647 (1,450) (323) -- --
Insurance premiums .......................... (578) -- -- 578 -- --
Corporate allocations ....................... 2,776 -- (2,678) (98) -- --
--------- --------- --------- --------- --------- ---------
Total other income (expense) ............. (28,198) 10,713 (4,128) 207 -- (21,406)
--------- --------- --------- --------- --------- ---------
INCOME BEFORE INCOME TAXES AND
CHANGE IN ACCOUNTING PRINCIPLE ............. 9,174 10,705 7,979 2,624 -- 30,482
PROVISION FOR INCOME TAXES .................... 4,131 3,640 3,032 779 -- 11,582
--------- --------- --------- --------- --------- ---------
INCOME BEFORE CHANGE IN
ACCOUNTING PRINCIPLE ....................... 5,043 7,065 4,947 1,845 -- 18,900
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE, NET OF
INCOME TAX BENEFIT ......................... -- (8,877) -- -- -- (8,877)
--------- --------- --------- --------- --------- ---------
NET INCOME (LOSS) ............................. $ 5,043 $ (1,812) $ 4,947 $ 1,845 $ -- $ 10,023
========= ========= ========= ========= ========= =========
</TABLE>
54
<PAGE>
Note 15
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF INCOME
----------------------------------
FOR THE YEAR ENDED NOVEMBER 30, 2001
------------------------------------
(In thousands)
<TABLE><CAPTION>
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
NET SALES ..................................... $ 168,231 $ -- $ 12,935 $ -- $ 181,166
--------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales ............................... 47,596 -- 4,916 -- 52,512
Advertising and promotion ................... 52,365 5,572 3,749 -- 61,686
Selling, general and administrative ......... 31,565 25 2,200 -- 33,790
--------- --------- --------- --------- ---------
Total costs and expenses .................. 131,526 5,597 10,865 -- 147,988
--------- --------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS ................. 36,705 (5,597) 2,070 -- 33,178
--------- --------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense ............................ (21,856) -- -- -- (21,856)
Investment and other income, net ............ 556 1,606 56 -- 2,218
Royalties ................................... (8,900) 9,167 (267) -- --
Premium revenue ............................. (79) -- 79 -- --
Corporate allocations ....................... 23 -- (23) -- --
--------- --------- --------- --------- ---------
Total other income (expense) ............. (30,256) 10,773 (155) -- (19,638)
--------- --------- --------- --------- ---------
INCOME BEFORE INCOME TAXES AND
EXTRAORDINARY GAIN ......................... 6,449 5,176 1,915 -- 13,540
PROVISION FOR INCOME TAXES .................... 2,698 1,760 687 -- 5,145
--------- --------- --------- --------- ---------
INCOME BEFORE EXTRAORDINARY
GAIN ....................................... 3,751 3,416 1,228 -- 8,395
EXTRAORDINARY GAIN ON EARLY
EXTINGUISHMENT OF DEBT, NET OF
INCOME TAXES ............................... 6,948 -- -- -- 6,948
--------- --------- --------- --------- ---------
NET INCOME .................................... $ 10,699 $ 3,416 $ 1,228 $ -- $ 15,343
========= ========= ========= ========= =========
</TABLE>
55
<PAGE>
Note 15
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF INCOME
----------------------------------
FOR THE YEAR ENDED NOVEMBER 30, 2000
------------------------------------
(In thousands)
<TABLE><CAPTION>
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
NET SALES ..................................... $ 203,569 $ -- $ 14,469 $ -- $ 218,038
--------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales ............................... 69,700 -- 5,257 -- 74,957
Advertising and promotion ................... 59,501 8,865 5,070 -- 73,436
Selling, general and administrative ......... 28,477 14 2,274 -- 30,765
--------- --------- --------- --------- ---------
Total costs and expenses .................. 157,678 8,879 12,601 -- 179,158
--------- --------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS ................. 45,891 (8,879) 1,868 -- 38,880
--------- --------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense ............................ (35,729) -- -- -- (35,729)
Investment and other income, net ............ 129 1,352 85 -- 1,566
Loss on product divestitures ................ -- (5,018) -- -- (5,018)
Royalties ................................... (11,754) 12,051 (297) -- --
Corporate allocations ....................... 37 -- (37) -- --
--------- --------- --------- --------- ---------
Total other income (expense) ............. (47,317) 8,385 (249) -- (39,181)
--------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES,
EXTRAORDINARY LOSS AND CHANGE
IN ACCOUNTING PRINCIPLE .................... (1,426) (494) 1,619 -- (301)
PROVISION FOR (BENEFIT FROM)
INCOME TAXES ............................... (373) (168) 437 -- (104)
--------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE
EXTRAORDINARY LOSS AND CHANGE
IN ACCOUNTING PRINCIPLE .................... (1,053) (326) 1,182 -- (197)
EXTRAORDINARY LOSS ON EARLY
EXTINGUISHMENT OF DEBT, NET OF
INCOME TAX BENEFIT ......................... (920) -- -- -- (920)
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE, NET OF
INCOME TAX BENEFIT ......................... (542) -- -- -- (542)
--------- --------- --------- --------- ---------
NET INCOME (LOSS) ............................. $ (2,515) $ (326) $ 1,182 $ -- $ (1,659)
========= ========= ========= ========= =========
</TABLE>
56
<PAGE>
Note 15
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF CASH FLOWS
--------------------------------------
FOR THE YEAR ENDED NOVEMBER 30, 2002
------------------------------------
(In thousands)
<TABLE><CAPTION>
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) .................................... $ 5,043 $ (1,812) $ 4,947 $ 1,845 $ -- $ 10,023
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization ...................... 5,685 -- -- 131 -- 5,816
Deferred income tax provision ...................... 1,150 6,959 -- 56 -- 8,165
Provision for income taxes ......................... (6,672) 3,640 3,032 -- -- --
Cumulative effect of change in accounting
principle, net ................................... -- 8,877 -- -- -- 8,877
Stock option charge ................................ 175 -- -- -- -- 175
Other, net ......................................... 269 -- -- -- -- 269
Changes in operating assets and liabilities:
Accounts receivable .............................. (4,100) -- -- (713) -- (4,813)
Refundable income taxes .......................... 1,044 -- -- -- -- 1,044
Inventories ...................................... (470) -- (3,139) (900) -- (4,509)
Prepaid expenses and other current assets ........ 444 -- -- 39 -- 483
Accounts payable and accrued liabilities ......... 8,708 -- -- 488 -- 9,196
-------- -------- -------- -------- -------- --------
Net cash provided by operating
activities ................................... 11,276 17,664 4,840 946 -- 34,726
-------- -------- -------- -------- -------- --------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment ........... (2,981) -- (775) (29) -- (3,785)
Purchase of trademarks and other product rights ...... (1,250) (73,790) -- -- -- (75,040)
Investment in subsidiary companies ................... 1,012 -- -- (1,012) -- --
Change in other assets, net .......................... (408) -- -- 32 -- (376)
-------- -------- -------- -------- -------- --------
Net cash used in investing activities .......... (3,627) (73,790) (775) (1,009) -- (79,201)
-------- -------- -------- -------- -------- --------
FINANCING ACTIVITIES:
Repayment of long-term debt .......................... (25,000) -- -- -- -- (25,000)
Proceeds from long-term debt ......................... 45,000 -- -- -- -- 45,000
Change in payable to bank ............................ 301 -- -- -- -- 301
Repurchase of common shares .......................... (1,650) -- -- -- -- (1,650)
Proceeds from exercise of stock options .............. 7,346 -- -- -- -- 7,346
Increase in debt issuance costs ...................... (1,146) -- -- -- -- (1,146)
Changes in intercompany accounts ..................... (47,374) 51,256 (4,060) 178 -- --
Dividends paid ....................................... 5,850 (4,000) -- (1,850) -- --
-------- -------- -------- -------- -------- --------
Net cash provided by (used in) financing
activities .................................. (16,673) 47,256 (4,060) (1,672) -- 24,851
-------- -------- -------- -------- -------- --------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS ........................... (119) -- -- 222 -- 103
-------- -------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS:
Increase (decrease) for the year ..................... (9,143) (8,870) 5 (1,513) -- (19,521)
At beginning of year ................................. 20,648 10,003 -- 4,794 -- 35,445
-------- -------- -------- -------- -------- --------
At end of year ....................................... $ 11,505 $ 1,133 $ 5 $ 3,281 $ -- $ 15,924
======== ======== ======== ======== ======== ========
</TABLE>
57
<PAGE>
Note 15
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF CASH FLOWS
--------------------------------------
FOR THE YEAR ENDED NOVEMBER 30, 2001
------------------------------------
(In thousands)
<TABLE><CAPTION>
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income .......................................... $ 10,699 $ 3,416 $ 1,228 $ -- $ 15,343
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ..................... 4,523 5,572 146 -- 10,241
Deferred income tax provision ..................... 4,827 6,489 46 -- 11,362
Extraordinary gain on early extinguishment of
debt, net ....................................... (6,948) -- -- -- (6,948)
Stock option charge ............................... 525 -- -- -- 525
Other, net ........................................ 18 (79) -- -- (61)
Changes in operating assets and liabilities:
Accounts receivable ............................. 18,115 1,154 562 -- 19,831
Inventories ..................................... 210 -- 582 -- 792
Prepaid expenses and other current assets ....... (1,767) -- (26) -- (1,793)
Accounts payable and accrued liabilities ........ (25,656) -- 94 -- (25,562)
--------- --------- --------- --------- ---------
Net cash provided by operating
activities .................................. 4,546 16,552 2,632 -- 23,730
--------- --------- --------- --------- ---------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment .......... (1,615) -- (239) -- (1,854)
Additions to trademarks and other product rights .... -- (277) -- -- (277)
Proceeds from product divestiture ................... 1,179 -- -- -- 1,179
Proceeds from sales of property, plant and
equipment ......................................... 95 -- -- -- 95
Increase in other assets, net ....................... (727) -- -- -- (727)
--------- --------- --------- --------- ---------
Net cash used in investing activities ......... (1,068) (277) (239) -- (1,584)
--------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Repayment of long-term debt ......................... (83,746) -- -- -- (83,746)
Payment of consent fees and other costs related
to repayment of long-term debt .................... (4,000) -- -- -- (4,000)
Change in payable to bank ........................... (1,378) -- -- -- (1,378)
Repurchase of common shares ......................... (174) -- -- -- (174)
Proceeds from exercise of stock options ............. 119 -- -- -- 119
Changes in intercompany accounts .................... 96,871 (98,019) 1,148 -- --
Dividends paid ...................................... 4,000 (4,000) -- -- --
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing
activities ................................. 11,692 (102,019) 1,148 -- (89,179)
--------- --------- --------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS .......................... (37) -- (19) -- (56)
--------- --------- --------- --------- ---------
CASH AND CASH EQUIVALENTS:
Increase (decrease) for the year .................... 15,133 (85,744) 3,522 -- (67,089)
At beginning of year ................................ 5,515 95,747 1,272 -- 102,534
--------- --------- --------- --------- ---------
At end of year ...................................... $ 20,648 $ 10,003 $ 4,794 $ -- $ 35,445
========= ========= ========= ========= =========
</TABLE>
58
<PAGE>
Note 15
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF CASH FLOWS
--------------------------------------
FOR THE YEAR ENDED NOVEMBER 30, 2000
------------------------------------
(In thousands)
<TABLE><CAPTION>
NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL COMPANIES DR. (CR.) CONSOLIDATED
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) ................................... $ (2,515) $ (326) $ 1,182 $ -- $ (1,659)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization ..................... 5,978 8,865 100 -- 14,943
Deferred income tax benefit ....................... (5,410) (168) (156) -- (5,734)
Loss on product divestitures ...................... -- 5,018 -- -- 5,018
Extraordinary loss on early extinguishment of
debt, net ....................................... 920 -- -- -- 920
Cumulative effect of change in accounting
principle, net .................................. 542 -- -- -- 542
Stock option charge ............................... 525 -- -- -- 525
Other, net ........................................ 9 -- 6 -- 15
Changes in operating assets and liabilities, net
of acquisitions and divestitures:
Accounts receivable ............................. 15,178 (1,154) 317 -- 14,341
Inventories ..................................... 7,618 -- (378) -- 7,240
Prepaid and other current assets ................ (1,873) -- 335 -- (1,538)
Accounts payable and accrued liabilities ........ (8,318) -- 212 -- (8,106)
--------- --------- --------- --------- ---------
Net cash provided by operating
activities .................................. 12,654 12,235 1,618 -- 26,507
--------- --------- --------- --------- ---------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment .......... (5,582) -- (91) -- (5,673)
Proceeds from product divestiture ................... 160,000 -- -- -- 160,000
Proceeds from sales of property, plant and
equipment ......................................... 11 -- -- -- 11
Increase in other assets, net ....................... (1,542) -- -- -- (1,542)
--------- --------- --------- --------- ---------
Net cash provided by (used in) investing
activities .................................. 152,887 -- (91) -- 152,796
--------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Repayment of long-term debt ......................... (95,000) -- -- -- (95,000)
Proceeds from long-term debt ........................ 29,000 -- -- -- 29,000
Change in payable to bank ........................... (3,376) -- -- -- (3,376)
Repurchase of common shares ......................... (9,489) -- -- -- (9,489)
Proceeds from exercise of stock options ............. 237 -- -- -- 237
Debt issuance costs ................................. (363) -- -- -- (363)
Changes in intercompany accounts .................... (85,678) 87,496 (1,818) -- --
Dividends paid ...................................... 4,000 (4,000) -- -- --
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing
activities ................................. (160,669) 83,496 (1,818) -- (78,991)
--------- --------- --------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS .......................... 93 -- (179) -- (86)
--------- --------- --------- --------- ---------
CASH AND CASH EQUIVALENTS:
Increase (decrease) for the year .................... 4,965 95,731 (470) -- 100,226
At beginning of year ................................ 550 16 1,742 -- 2,308
--------- --------- --------- --------- ---------
At end of year ...................................... $ 5,515 $ 95,747 $ 1,272 $ -- $ 102,534
========= ========= ========= ========= =========
</TABLE>
59
<PAGE>
(16) QUARTERLY INFORMATION (UNAUDITED AND IN THOUSANDS, EXCEPT PER SHARE
-------------------------------------------------------------------
AMOUNTS)
--------
The quarterly data for fiscal 2001 has been restated to give effect to the
adoption of the provisions of EITF Issue Nos. 00-14 and 00-25 on December 1,
2001 and to the effect of a two-for-one split of the Company's common stock on
November 29, 2002.
<TABLE><CAPTION>
Quarter Ended
--------------------------------------------------
Total February 28 May 31 August 31 November 30
----- ----------- ------ --------- -----------
<S> <C> <C> <C> <C> <C>
FISCAL 2002:
Total revenues .................... $223,116 48,414 58,672 64,404 51,626
Gross profit ...................... $160,359 33,953 41,986 46,878 37,542
Before change in accounting
principle:
Income .......................... $ 18,900 2,372 5,635 6,417 4,476
Income per share,
diluted (1) ................... $ .98 .13 .29 .33 .23
Total:
Net income ...................... $ 10,023 (6,505) 5,635 6,417 4,476
Net income per share,
diluted (1) ................... $ .52 (.35) .29 .33 .23
FISCAL 2001:
Net sales ......................... $181,166 42,457 52,310 45,209 41,190
Gross profit ...................... $128,654 29,973 36,904 32,546 29,231
Before extraordinary loss and
change in accounting principle:
Income (loss) ................... $ 8,395 586 3,409 2,748 1,652
Income (loss) per share,
diluted (1) ................... $ .47 .04 .19 .15 .09
Total:
Net income (loss) ............... $ 15,343 8,145 3,401 2,145 1,652
Net income (loss) per share,
diluted (1) ................... $ .85 .46 .19 .12 .09
- --------------------
</TABLE>
(1) The sum of the quarterly earnings per share amounts may differ from annual
earnings per share because of the differences in the weighted average
number of common shares and dilutive potential shares used in the
quarterly and annual computations.
60
<PAGE>
REPORT OF INDEPENDENT
AUDITORS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS
CHATTEM, INC.
We have audited the accompanying consolidated balance sheets of Chattem, Inc.
and subsidiaries as of November 30, 2002 and 2001, and the related consolidated
statements of income, shareholders' equity and cash flows for the years then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. The consolidated financial statements of
Chattem, Inc. and subsidiaries for the year ended November 30, 2000 were audited
by other auditors who have ceased operations and whose report dated January 23,
2002, expressed an unqualified opinion on those statements before the
restatement adjustments described in Notes 2 and 8.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Chattem, Inc. and subsidiaries
as of November 30, 2002 and 2001, and the consolidated results of their
operations and their cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States.
As explained in Note 2 to the consolidated financial statements, the Company
adopted Financial Accounting Standards Board Statement No. 142, GOODWILL AND
OTHER INTANGIBLE ASSETS in fiscal 2002.
As discussed above, the consolidated financial statements of Chattem, Inc. and
subsidiaries as of November 30, 2000 and for the year then ended were audited by
other auditors who have ceased operations. As described in Note 2, these
consolidated financial statements have been revised to include the transitional
disclosures required by Statement of Financial Accounting Standards No. 142,
GOODWILL AND OTHER INTANGIBLE ASSETS, which was adopted by the Company as of
December 1, 2001. Our audit procedures with respect to these disclosures in Note
2 for 2000 included (a) agreeing the previously reported net loss to the
previously issued consolidated financial statements and the adjustments to
reported net loss representing amortization expense (including any related tax
effects) recognized in those periods related to trademarks that are no longer
being amortized as a result of initially applying Statement No. 142 (including
any related tax effects) to the Company's underlying records obtained from
management and (b) testing the mathematical accuracy of the reconciliation of
pro forma net income to reported net loss. As also discussed in Note 2, these
consolidated financial statements have been revised to include the
reclassification of certain financial statement amounts related to the adoption
of EITF Issue Nos. 00-14, ACCOUNTING FOR CERTAIN SALES INCENTIVES and 00-25
VENDOR INCOME STATEMENT CHARACTERIZATION OF CONSIDERATION PAID TO A RESELLER OF
THE VENDOR'S PRODUCTS, codified in EITF Issue No. 01-09, ACCOUNTING FOR
CONSIDERATION GIVEN BY A VENDOR TO A CUSTOMER which were adopted by the Company
as of December 1, 2001. Our audit procedures for these disclosures in Note 2
with respect to 2000 included (a) agreeing the amounts included in the
reclassification adjustments to the underlying records provided by management,
(b) ensuring the amounts provided by management included all applicable amounts
as prescribed by EITF Issue Nos. 00-14 and 00-25, (c) agreeing previously
reported net sales, advertising and promotion expense and selling, general and
administrative expense to the previously issued consolidated financial
statements and (d) testing the mathematical accuracy of the
61
<PAGE>
reconciliation of amounts previously reported to amounts currently reported. As
described in Note 8, in 2002 the Company's Board of Directors approved a
two-for-one stock split distributed in the form of a stock dividend, and all
references to number of shares and per share information in the financial
statements have been adjusted to reflect the stock split on a retroactive basis.
We audited the adjustments that were applied to restate the number of shares and
per share information reflected in the 2000 financial statements. Our procedures
included (a) agreeing the authorization for the two-for-one stock split to the
Company's underlying records obtained from management and (b) testing the
mathematical accuracy of the restated number of shares, basic and diluted
earnings per share and other applicable disclosures such as stock options. In
our opinion, such adjustments are appropriate and have been properly applied.
However, we were not engaged to audit, review, or apply any procedures to the
2000 financial statements of the Company other than with respect to such
adjustments and, accordingly, we do not express an opinion or any other form of
assurance on the 2000 consolidated financial statements taken as a whole.
ERNST & YOUNG LLP
Chattanooga, Tennessee
January 23, 2003
except for Note 14, as to which the date is
February 21, 2003
62
<PAGE>
<TABLE><CAPTION>
<S> <C> <C>
BOARD OF DIRECTORS
OFFICERS CORPORATE OFFICE
ZAN GUERRY
Chairman and Chief Executive Officer ZAN GUERRY CHATTEM, INC.
Chattem, Inc. Chairman and Chief Executive Officer 1715 West 38th Street
Chattanooga, Tennessee Chattanooga, Tennessee 37409
A. ALEXANDER TAYLOR II
A. ALEXANDER TAYLOR II President and Chief Operating Officer SUBSIDIARIES AND AFFILIATED COMPANIES
President and Chief Operating Officer
Chattem, Inc. ANDREA M. CROUCH CHATTEM (U.K.) LIMITED
Chattanooga, Tennessee Vice President Guerry House
Brand Management Ringway Centre
SAMUEL E. ALLEN Edison Road
Chairman and Chief Executive Officer RON GALANTE Basingstoke, Hampshire RG21 2YH
GLOBALT, Inc. Vice President England
Atlanta, Georgia New Business Development
CHATTEM (CANADA) INC.
LOUIS H. BARNETT RICHARD W. KORNHAUSER 2220 Argentia Road
Business Consultant Vice President Mississauga, Ontario L5N 2K7
Fort Worth, Texas Brand Management
SIGNAL INVESTMENT & MANAGEMENT CO.
ROBERT E. BOSWORTH LUKE J. LENAHAN 1105 North Market Street
Vice President - Corporate Finance Vice President Suite 1300
Livingston Company International Wilmington, Delaware 19890
Chattanooga, Tennessee
RICHARD D. MOSS SUNDEX, LLC
RICHARD E. CHENEY Vice President and 3350 Broad Street
Former Chairman Emeritus Chief Financial Officer Chattanooga, Tennessee 37409
Hill and Knowlton, Inc.
New York, New York B. DERRILL PITTS HBA INDEMNITY COMPANY, LTD.
Vice President P.O. Box 10073 APO
PHILIP H. SANFORD Operations Grand Pavillion Corporate Centre
Chairman and Chief Executive Officer West Bay Road
The Krystal Company DONALD K. RIKER, PH.D. Grand Cayman,
Chattanooga, Tennessee Vice President Cayman Islands
Research and Development and
BILL W. STACY Chief Scientific Officer
Chancellor COMMON STOCK LISTING
University of Tennessee at Chattanooga SCOTT J. SLOAT
Chattanooga, Tennessee Controller NASDAQ National Market
NASDAQ Symbol: CHTT
ADDITIONAL FINANCIAL INFORMATION CHARLES M. STAFFORD
Vice President TRANSFER AGENT AND REGISTRAR
COPIES OF QUARTERLY PRESS Sales
RELEASES AND/OR QUARTERLY SUNTRUST BANK, ATLANTA, N.A.
REPORTS ON FORM 10-Q AND OUR P.O. Box 4625
ANNUAL REPORT ON FORM 10-K, BOTH HUGH F. SHARBER Atlanta, Georgia 30302
FORMS FILED WITH THE SECURITIES Secretary
AND EXCHANGE COMMISSION, MAY BE
OBTAINED WITHOUT CHARGE BY ANNUAL MEETING
WRITING TO THE CONTROLLER,
CHATTEM, INC., BY CALLING Wednesday, April 16, 2003
1-800-366-6077 OR BY VISITING 1:00 P.M.
OUR WEBSITE AT WWW.CHATTEM.COM. 1715 West 38th Street
--------------- Chattanooga, TN 37409
</TABLE>
63
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-21
<SEQUENCE>6
<FILENAME>exh-21_11769.txt
<DESCRIPTION>SUBSIDIARIES OF THE COMPANY
<TEXT>
EXHIBIT 21
----------
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
SUBSIDIARIES OF THE COMPANY
NAME OF SUBSIDIARY STATE OR COUNTRY OF INCORPORATION
- ------------------ ---------------------------------
Chattem (Canada) Inc. Canada
Chattem (U.K.) Limited England
HBA Indemnity Insurance, Ltd. Cayman Islands
Signal Investment & Management Co. Delaware
SunDex, LLC Tennessee
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-23
<SEQUENCE>7
<FILENAME>exh-23_11769.txt
<DESCRIPTION>CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
<TEXT>
EXHIBIT 23
----------
CONSENT OF INDEPENDENT AUDITORS
-------------------------------
We consent to the incorporation by reference in this Annual Report (Form 10-K)
of Chattem, Inc. and in the Company's Registration Statements on Form S-8 (Nos.
33-35386, 33-78524, 33-78922 and 33-61267), Form S-3 (Nos. 33-69961, 33-69397,
33-31113, 33-03091 and 33-85348) and Form S-4 (No. 33-53627) of our report dated
January 23, 2003, included in the 2002 Annual Report to Shareholders of Chattem,
Inc.
Our audits also included financial statement Schedule II for the years ended
November 30, 2002 and 2001 of Chattem, Inc. listed in Item 15. This schedule is
the responsibility of the Company's management. Our responsibility is to express
an opinion based on our audits. In our opinion the financial statement schedule
referred to above, when considered in relation to the basic financial statements
taken as a whole, presents fairly in all material respects the information set
forth therein. The financial statement Schedule II for the year ended November
30, 2000 listed in item 15 was audited by other auditors who have ceased
operations and whose report dated January 23, 2002, expressed an unqualified
opinion on the schedule.
Ernst & Young LLP
Chattanooga, Tennessee
February 21, 2003
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-99.27.1
<SEQUENCE>8
<FILENAME>exh27-1_11769.txt
<DESCRIPTION>PREVIOUSLY ISSUED REPORT OF ARTHUR ANDERSEN LLP
<TEXT>
EXHIBIT 99.27.1
---------------
THIS REPORT IS A COPY OF THE PREVIOUSLY ISSUED REPORT OF ARTHUR ANDERSEN LLP
WHICH HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Chattem, Inc.
We have audited in accordance with auditing standards generally accepted in the
United States, the consolidated financial statements included in Chattem, Inc.
and subsidiaries' annual report to shareholders incorporated by reference in
this Form 10-K, and have issued our report thereon dated January 23, 2002. Our
audit was made for the purpose of forming an opinion on those statements taken
as a whole. Schedule II is the responsibility of the Company's management and is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audit of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Chattanooga, Tennessee
January 23, 2002
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-99.27.2
<SEQUENCE>9
<FILENAME>exh27-2_11769.txt
<DESCRIPTION>SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
<TEXT>
EXHIBIT 99.27.2
---------------
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
<TABLE><CAPTION>
Charged
Balance at Charged to to Other Balance at
Beginning Costs and Accounts Accounts End of
of Period Expenses Describe Written off Period
--------- -------- -------- ----------- ------
<S> <C> <C> <C> <C> <C>
Year ended November 30, 2000:
Reserves deducted from asset accounts:
Allowance for doubtful accounts $ 900 $1,237 $ -- $1,112 $1,025
Year ended November 30, 2001:
Reserves deducted from asset accounts:
Allowance for doubtful accounts $1,025 $ 533 $ -- $1,058 $ 500
Year ended November 30, 2002:
Reserves deducted from asset accounts:
Allowances for doubtful accounts $ 500 $1,537 $ -- $1,075 $ 962
</TABLE>
</TEXT>
</DOCUMENT>
</SEC-DOCUMENT>
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