Item 1. Business
Except as otherwise indicated, all references in this Form 10-K to “we”, “us”, “our” or “Chattem” refer to Chattem, Inc. and our subsidiaries. In addition, in this Form 10-K, our fiscal years ended November 30, 2004, November 30, 2005 and November 30, 2006 are referred to as fiscal 2004, fiscal 2005 and fiscal 2006, respectively, and our fiscal year ending on November 30, 2007 is referred to as fiscal 2007. Brand names that are italicized in this Form 10-K refer to trademarks that we own or license.
General
Founded in 1879, we are a leading marketer and manufacturer of a broad portfolio of branded over-the-counter (“OTC”) healthcare products, toiletries and dietary supplements, in such categories as topical pain care, medicated skin care products, medicated dandruff shampoos, dietary supplements and other OTC and toiletry products. Our portfolio of products includes well-recognized brands such as:
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Icy Hot, Aspercreme and Capzasin- topical pain care;
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Gold Bond - medicated skin care products;
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Selsun Blue and Selsun Salon - medicated dandruff shampoos;
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Dexatrim, Garlique and New Phase - dietary supplements;
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Other OTC and toiletry products such as Pamprin, a menstrual analgesic; Herpecin-L, a lip care product; Benzodent, a dental analgesic cream; and toiletries such as Bullfrog, a line of sunscreens; UltraSwim, a chlorine-removing shampoo; Sun-In, a hair lightener.
Our products target niche markets that are often outside the focus of larger companies where we believe we can achieve and sustain significant market share through innovation and strong advertising and promotion support. Many of our products are among the U.S. market leaders in their respective categories. For example, our portfolio of topical pain care brands and our Gold Bond medicated body powders have the leading U.S. market share in these categories. We support our brands through extensive and cost-effective advertising and promotion, the expenditures for which represented approximately 32% of our total revenues in fiscal 2006. 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 developing product line extensions, increasing market penetration of our existing products and acquiring brands. Recent product line extensions include Bullfrog Mosquito Coast, Gold Bond Ultimate Softening Lotion and Icy Hot Pro-Therapy knee and back support with therapeutic pain relieving inserts. On January 2, 2007, we acquired the U.S. rights to five consumer and OTC brands for $410 million from Johnson & Johnson (“J&J Acquisition”). The acquired brands are: ACT, an anti-cavity mouthwash/mouth rinse; Unisom, an OTC sleep-aid; Cortizone, a hydrocortisone anti-itch product; Kaopectate, an anti-diarrhea product; and Balmex, a diaper rash product. We will continue to seek opportunities to acquire attractive brands in niche markets. We intend to drive growth through strong marketing and promotional programs, new product development and acquisitions of new brands.
Competitive Strengths
We believe that the following key competitive strengths are critical to our continuing success:
Diverse and broad portfolio of well-recognized branded products. We currently market a diverse and broad portfolio of 27 brands in a variety of different product categories, including topical pain care, medicated dandruff shampoos, medicated skin care products, toiletries and dietary supplements. Our products are marketed under well-recognized brand names, such as our portfolio of topical pain care brands lcy Hot, Aspercreme, Flexall, Sportscreme, Capzasin and Arthritis Hot, as well as Gold Bond, Selsun Blue, Dexatrim and Garlique. The brand names added to our portfolio from the J&J Acquisition are ACT, Unisom, Cortizone, Kaopectate and Balmex. Our presence in diverse product categories reduces our exposure to changing consumer demand or weakness in any single category.
Significant presence in niche markets. We acquire and develop brands that compete in small to medium sized niche markets where we believe we can achieve significant market presence and build brand equity. Our products often face less
competitive pressures because we focus on these markets that are frequently outside the core product areas of larger consumer products and pharmaceutical companies. This focus provides us with the opportunity to develop strong brand equity, identify and respond to consumer trends and leverage our strong selling and distribution capabilities in these markets.
High margins and efficient operating structure. We are able to achieve high gross margins as a result of our ability to build and maintain brand equity, our significant market presence in niche markets and efficiencies in purchasing, manufacturing and distribution. In addition, we seek to tightly control our expenses, which strengthens our operating margins. Our high margins and resulting strong cash flow allow us to withstand temporary fluctuations in our product markets that could have adverse effects on our business.
Proven advertising and promotion strategy. We aggressively build awareness and consumer loyalty of our brands through extensive and cost-effective advertising strategies that emphasize the competitive strengths of our products. 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 through control of 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 newly acquired brands and product line extensions as well as increase market penetration of existing brands. Advertising and promotion expenditures represented approximately 32% of our total revenues in fiscal 2006. Given the importance of our products’ brand equity we expect to maintain a significant level of spending on advertising and promotion.
Established national sales and distribution network. We have an established national sales and distribution network that sells to mass merchandiser, drug and food retailers such as Wal-Mart Stores, Inc., Walgreen Co. and The Kroger Co. In fiscal 2006, sales to our top ten customers constituted approximately 73% of our total sales, which allows us to target our selling efforts to our key customers and tailor specific programs to meet their needs. Our fiscal 2006 sales to Wal-Mart Stores, Inc. accounted for approximately 36% of our total revenues. Through targeted sales and utilization of our established network, including our approximately 43 person sales force, we believe we can effectively sell and distribute newly acquired brands and product line extensions while maintaining tight controls over our selling expenses.
Focused new product development. We strive to increase the value of our base brands while obtaining an increased market presence through product line extensions. In fiscal 2006, our product development expenditures were $4.2 million. During the past several years, we have expanded our product development staff and completed a new 10,000 square foot research and development facility. 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. Recent examples of product line extensions include Bullfrog Mosquito Coast, Gold Bond Ultimate Softening Lotion and Icy Hot Pro-Therapy. In fiscal 2006, we introduced eight new product line extensions and have eight new product launches scheduled for fiscal 2007.
Business Strategy
Our strategy to achieve future growth is to generate new sales through strong marketing and promotional programs, new product development and acquisitions of new brands.
Brand management and growth. We 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 increased research and development spending, the expansion of our product development staff and construction of a research and product development facility in 2003. 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 under-performing brands and redeploy the resulting cash assets. For example, in fiscal 2000, we sold the Ban® (a registered trademark of Kao Corporation) 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, and in fiscal 2005, we sold the pHisoderm line of skin care products, a brand that was no longer consistent with our brand strategy.
Strategic 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. On January 2, 2007, we completed the J&J Acquisition and acquired the U.S. rights to the following
five OTC brands: ACT, an anti-cavity mouthwash/mouth rinse; Unisom, an OTC sleep-aid; Cortizone, a hydrocortisone anti-itch product; Kaopectate, an anti-diarrhea product; and Balmex, a diaper rash product. We will continue to seek opportunities to acquire attractive brands in niche markets.
Developments During Fiscal 2006
In the first quarter of fiscal 2006, we introduced or completed the introduction of the following product line extensions: Icy Hot Pro-Therapy, Selsun Salon, Bullfrog Mosquito Coast, Garlique CardioAssist, Capzasin Back & Body Patch and Pamprin Max. In the second quarter of fiscal 2006, we introduced Dexatrim Max2O. Gold Bond Ultimate Softening Lotion was introduced in the fourth quarter of 2006.
On November 30, 2005, we called our $75.0 million of Floating Rate Senior Notes for full redemption on December 30, 2005. The terms of the indenture for the Floating Rate Senior Notes required the repayment at a price of 102% of the principal amount of the notes plus accrued interest. The $75.0 million of Floating Rate Senior Notes were fully redeemed on December 30, 2005. We utilized borrowings of $38.0 million under our Amended Revolving Credit Facility and $38.9 million of our cash on hand to fund the redemption of the Floating Rate Senior Notes (see Note 5 of the notes to consolidated financial statements in Item 8 “Financial Statements and Supplementary Data”). As a result of the redemption, a loss on early extinguishment of debt of $2.8 million was recorded in the first quarter of fiscal 2006.
Over the past two years, we have resolved all of the claims submitted in the Dexatrim PPA settlement. A total of $70.9 million was previously funded into a settlement trust by our insurers and Sidmak Laboratories, Inc., the manufacturer of Dexatrim products containing PPA, for the purpose of paying claims in the settlement. All claims in the settlement and expenses of the trust have now been paid. On June 14, 2006, we filed a motion to dissolve the settlement trust. The court granted this motion on July 14, 2006. On August 31, 2006, the settlement trust paid us $10.7 million which is included as a component of litigation settlement in our condensed consolidated statement of income. The settlement trust currently has a balance of approximately $2.8 million. We expect to use those funds to resolve the one pending Dexatrim PPA case which opted out of the settlement. Any funds remaining after we resolve the opt-out case will be returned to one of our insurance carriers. We currently do not expect to record any additional charges relative to the settlement of the PPA litigation, except for legal expenses that will be recorded in the period incurred.
During the third quarter of fiscal 2005, we entered into a settlement agreement with the DELACO Company (“DELACO”), successor by merger to the Thompson Medical Company, Inc., which owned the Dexatrim brand prior to December 21, 1998 (the “DELACO Agreement”). The DELACO Agreement was approved by the DELACO bankruptcy court on July 28, 2005. Pursuant to the DELACO Agreement, we agreed to assume responsibility for all claims against DELACO and its predecessor, Thompson Medical Company, Inc., or us relating to Dexatrim products involving an injury date after December 21, 1998 and hold the DELACO bankruptcy estate harmless from any such claims. In exchange, a settlement trust to be established under DELACO’s bankruptcy plan agreed to pay us $8.8 million and assume responsibility for all claims related to Dexatrim products alleging injury dates on or before December 21, 1998. On February 17, 2006, the DELACO bankruptcy court entered an order confirming the DELACO bankruptcy plan which incorporated the terms of the DELACO Agreement. In accordance with the DELACO bankruptcy plan, the settlement trust established under the plan paid us $8.75 million on March 17, 2006, which is included as a component of litigation settlement in our consolidated statement of income. In addition, this order allowed us to dismiss all cases against us with injury dates prior to December 21, 1998. The confirmation of the DELACO bankruptcy plan effectively released us from liability for all PPA products liability cases with injury dates prior to December 21, 1998.
On July 25, 2006, we successfully completed a consent solicitation from the holders of our 7% Subordinated Notes to an amendment to the indenture to increase our capacity to make restricted payments by an additional $85.0 million, including payments for the repurchase of our common stock, and adjust the fixed charge coverage ratio as defined in the indenture. In connection with the consent solicitation, our Board of Directors authorized the repurchase of up to an additional $100.0 million of our common stock under the terms of our existing stock repurchase program. As of February 1, 2007, the current amount available under the repurchase authorization from our Board of Directors was $88.1 million.
On November 22, 2006, we completed a private offering of $125.0 million of 2.0% Convertible Senior Notes due 2013 (“Convertible Notes”), the proceeds of which were used to fund a convertible note hedge transaction designed to offset our exposure to dilution upon conversion of the Convertible Notes, repay existing indebtedness and fund in part the J&J Acquisition. The Convertible Notes bear interest at an annual rate of 2.0%, payable semi-annually on May 15 and November 15 of each year, with the first interest payment due on May 15, 2007. Concurrently with the sale of the Convertible Notes, we purchased a note hedge for $32.0 million and issued warrants for proceeds of $18.6 million with an affiliate of Merrill Lynch (the “Counterparty”). The note hedge and warrants are separate and legally distinct instruments that bind us and the Counterparty and have no binding effect on the holders of the Convertible Notes.
Based on Icy Hot Pro-Therapy performing below expectations, a review of point of sales data throughout fiscal 2006, an estimate of inventory on hand at customers and a review of our on hand inventory and purchase commitments outstanding as of November 30, 2006, during the fourth fiscal quarter we provided for an estimate of returns of $3.3 million and an estimate of obsolete inventory of $2.0 million, which reduced net sales and increased cost of sales, respectively, in our consolidated financial statements as of November 30, 2006.
During fiscal 2006, we repurchased 1.2 million shares of our common stock under our stock repurchase program for $39.3 million at an average price per share of $33.57.
On January 2, 2007, we completed the J&J Acquisition, which added the following five brands: ACT, an anti-cavity mouthwash/mouth rinse; Unisom, an OTC sleep aid; Cortizone, a hydrocortisone anti-itch product; Kaopectate, an anti-diarrhea product; and Balmex, a diaper rash product. On January 2, 2007, we also completed an amended credit facility providing for up to a $100.0 million revolving credit facility and a $300.0 million term loan (the “Credit Facility”). The proceeds from the term loan under the Credit Facility were used to finance in part the J&J Acquisition.
Products
We currently market a diverse and broad portfolio of branded OTC healthcare products, toiletries and dietary supplements in such categories as topical pain care, medicated skin care products, medicated dandruff shampoos, dietary supplements and other OTC and toiletry products. Our branded products by category consist of:
Category and Brands
Product Description
Topical Pain Care
Icy Hot
Dual action muscular and arthritis pain reliever
Icy Hot Pro-Therapy
Elastic support braces and pain relieving inserts
Aspercreme
Odor-free arthritis pain reliever
Flexall
Aloe-vera based pain reliever
Capzasin
Deep penetrating, odor-free arthritis pain reliever
Sportscreme
Odor-free muscular pain reliever
Arthritis Hot
Value-priced arthritis pain reliever
Medicated Skin Care Products
Gold Bond
Medicated powder, cream, lotion, first aid and foot care products
Cortizone
Hydrocortisone anti-itch
Balmex
Diaper rash
Medicated Dandruff Shampoos
Selsun Blue
Medicated dandruff shampoos
Selsun Salon
Medicated dandruff shampoos with enhanced moisturizers and nutrients
Dietary Supplements
Dexatrim
Diet pills
Garlique
Cholesterol health supplement
Melatonex
Sleep aid
New Phase
Menopausal supplement
Omnigest EZ
Digestive aid
Other OTC and Toiletry Products
Internal Analgesics
Pamprin
Menstrual pain reliever
Prēmsyn PMS
Premenstrual pain reliever
Seasonal
Bullfrog
Waterproof sunscreens
Sun-In
Spray-on hair lightener
UltraSwim
Chlorine-removing shampoo and conditioner
Oral Care
ACT
Anti-cavity mouthwash/mouth rinse
Herpecin-L
Cold sore lip treatment
Benzodent
Denture pain relief cream
Other
Unisom
OTC sleep-aid
Kaopectate
Anti-diarrhea
Mudd
Facial masque
Topical Pain Care
Our topical pain care portfolio features six distinctly positioned brands. Our flagship brand, Icy Hot, is a leader in the external analgesic category and receives heavy media support and strong advertising featuring NBA super-star Shaquille O’Neal. In fiscal 2006, we introduced Icy Hot Pro-Therapy, a product line which combines strong knee or back support with therapeutic pain relieving inserts. In the first quarter of fiscal 2007, we extended the Icy Hot brand into the air activated portable heat category with Icy Hot Heat Therapy. Icy Hot will also be introducing new patch and cream line extensions in fiscal 2007 that are intended to capitalize on consumer trends.
Aspercreme provides odor-free pain relief for sufferers of arthritis and other joint and muscle pain. Capzasin is an arthritis pain reliever that contains capsaicin, the active ingredient that doctors and pharmacists recommend for arthritis sufferers. In the first quarter of 2007, we will launch a new no-mess applicator under the Capzasin brand. Sportscreme is targeted at serious athletes as well as “weekend warriors”. Flexall is marketed toward those who seek a menthol and aloe vera based pain reliever for conditions such as chronic back pain or muscle strain. Arthritis Hot rounds out the portfolio and competes against private label products at a value price.
Medicated Skin Care Products
The Gold Bond brand competes in numerous product categories with specially formulated products for both adults and babies, including body powder, therapeutic hand and body lotions, foot care and first aid. Gold Bond has long been the number one selling brand of medicated body powder domestically, and its strong brand equity among consumers has allowed us to successfully launch new line extensions, most recently under the Gold Bond Ultimate line.
Initially launched in fiscal 2003, Gold Bond Ultimate Healing Skin Therapy Lotion helps to heal and nurture extremely dry, cracked and irritated skin with seven intensive moisturizers plus vitamins A, C and E. The Gold Bond Ultimate line expanded into the everyday bath powder category with the introduction of Gold Bond Ultimate Comfort Body Powder during the first quarter of fiscal 2005. Gold Bond Ultimate Comfort Body Powder is a talc-free powder that provides freshness, odor protection and moisture control and features the signature Ultimate fragrance. In the fourth quarter of fiscal 2006, we introduced Gold Bond Ultimate Softening Lotion. The new Ultimate Softening lotion is specially formulated to soften rough dry skin.
As part of the J&J Acquisition on January 2, 2007, we have added two new brands to the medicated skin care category: Cortizone-10, a hydrocortisone anti-itch product, and Balmex, a diaper rash product.
Medicated Dandruff Shampoos
Selsun Blue offers four domestic shampoo 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 provide alternative formulas for individuals who need a medicated dandruff shampoo.
In the fourth quarter of fiscal 2005, we began shipping Selsun Salon, a maximum dandruff control shampoo with enhanced moisturizers and nutrients. All Selsun Salon products are formulated with a unique blend of salon quality moisturizers, vitamins and nutrients to provide great looking hair and the proven dandruff ingredient pyrithione zinc 1% for effective dandruff control.
Dietary Supplements
Dexatrim is a leading brand in the diet pill category. Dexatrim experienced strong growth in fiscal 2006 behind Dexatrim Max and the newly introduced Dexatrim Max2O. Dexatrim Max was introduced in fiscal 2005 and contains Vitamin B complex, ginseng, chromium and ECGC from green tea. In fiscal 2007, we plan to launch Dexatrim Max Evening Appetite Control, a caffeine-free diet pill intended for night time use. Dexatrim Natural, a drug free, all-natural dietary supplement, is available in green tea, caffeine-free and extra energy versions. In fiscal 2006, we launched a unique new diet product, Dexatrim Max2O. Dexatrim Max2O, an effervescent tablet that dissolves in water, contains a Vitamin B complex and ECGC from green tea and is now available in four flavors.
We compete in the dietary supplements category with our Sunsource line of products. We focus the marketing of our Sunsource dietary supplements in two key areas: cardiovascular and menopausal health. Known for its support of cardiovascular health, Garlique leads the garlic supplement category and is positioned as an odor-free, one-per-day supplement that will help maintain cholesterol levels within a healthy range. In fiscal 2006, we launched a new cardiovascular health supplement called Garlique CardioAssist. Garlique CardioAssist is a clinically tested, odor-free dietary supplement containing an ingredient clinically proven to help lower total and LDL cholesterol. The proprietary formula also helps support normal levels of HDL cholesterol, triglycerides and homosysteines for more complete heart health. New Phase is a menopausal supplement that helps relieve the common discomforts of menopause, as well as providing support for strong bones and a healthy heart. All Sunsource products are specially formulated to provide consumers with an all-natural, drug-free way to support their specific health care goals.
Other OTC and Toiletry Products
Internal Analgesics
We compete in the menstrual analgesic category with two brands, Pamprin and Prēmsyn PMS. Pamprin, featuring three distinct formulas, seeks to provide complete relief of a woman’s menstrual symptoms, while Prēmsyn PMS has one formula designed to address specific symptoms of premenstrual syndrome. Pamprin is available in three formulas: Multi-Symptom, Cramp and All Day. In fiscal 2006, Pamprin Max was added to the line. Pamprin Max is formulated with three active ingredients to provide maximum relief from menstrual symptoms.
Seasonal
The majority of sales of our seasonal brands, Bullfrog, Sun-In and UltraSwim, typically occur during the first three quarters of our fiscal year. Bullfrog is a line of high quality, high SPF waterproof sunblocks targeted to outdoor active children and adults. In fiscal 2006, we launched Bullfrog Mosquito Coast, which combines SPF 30 sunblock with a DEET-free insect repellent in a convenient spray form. In the first quarter of fiscal 2007, we will launch Bullfrog Marathon Mist. This new product available in an adult and children’s version combines quick-drying SPF 30 sunblock in a continuous spray format.
Sun-In, a hair lightener, is available in two varieties of spray-on and a highlighting gel. In 2007, Sun-In will introduce an updated package design for its spray-on products. UltraSwim is our niche line of swimmers’ shampoos and conditioner.
Oral Care
Our oral care 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. Herpecin-L is available in a stick and a jar format. With the J&J Acquisition completed January 2, 2007, we have added ACT, a line of anti-cavity mouthwash and mouth rinses.
Other
Our other brands include Mudd, a line of specialty masque products, and a variety of other smaller brands. In connection with the J&J Acquisition on January 2, 2007, we also added the Unisom and Kaopectate brands. Unisom is the leading single ingredient brand in the OTC sleep aid category. Kaopectate is a well established anti-diarrheal remedy.
International Business
Our international business, which represented approximately 8% of our total revenues in fiscal 2006, has been concentrated in Canada, an export market driven from our operations in Ireland and the U.K. and in international countries in which Selsun and certain of our other products are sold.
Selsun International
We plan to focus our efforts on expanding Selsun’s international presence in existing key markets, such as Canada, Mexico, Brazil, the U.K. and Australia. In certain international markets, we sell Selsun through distributors and receive a royalty based on a percentage of distributor sales. We have entered into distributor agreements with third party distributors for Selsun in various international markets other than Canada and the U.K., where we engage national brokers.
Europe
Our European business is conducted through Chattem Global Consumer Products Limited (“Chattem Global”), our Irish subsidiary, located in Limerick, Ireland, and Chattem (U.K.) Limited (“Chattem (U.K.)”), a wholly-owned subsidiary located in Basingstoke, Hampshire, England. This unit also services distributors in various other worldwide locations. Packaging and distribution operations are conducted principally in Ireland with certain products sourced from our U.S. operations. Chattem uses a national broker in the U.K., while distributors are used to market and sell our products on the European continent and elsewhere. Our products sold in Europe include Selsun, Sun-In, Mudd and UltraSwim. Cornsilk® is sold by Chattem (U.K.) under a licensing arrangement with the owner of its registered trademark, Del Laboratories, Inc. Spray Blond Spray-In Hair lightener is marketed only on the European continent. Certain of our OTC health care products are sold by Chattem Global to customers in parts of Central Europe and the Middle East.
Canada
Chattem Canada, a wholly-owned subsidiary based in Mississauga, Ontario, Canada, markets and distributes certain of our consumer products throughout Canada. The 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 Icy Hot, Selsun, Gold Bond, Pamprin, Sun-In, UltraSwim and Aspercreme.
United States Export
Our United States export division services various distributors primarily located in the Caribbean and Latin America. We distribute Selsun, Gold Bond, Dexatrim, Icy Hot, Aspercreme, Capzasin and Sportscreme into these markets.
Marketing, Sales and Distribution
Advertising and Promotion
We aggressively seek to build brand awareness and product 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 approximately 32% of total revenues in fiscal 2006.
We 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 quickly and efficiently to 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 merchandisers such as Wal-Mart Stores, Inc., drug retailers such as Walgreens Co. and food retailers such as The Kroger Co. In fiscal 2006, our ten largest customers represented approximately 73% of total revenues, and our 20 largest customers represented approximately 84% of total revenues, which allows us to target our selling efforts to our key customers and customize programs to meet their needs. Our fiscal 2006 sales to Wal-Mart Stores, Inc. accounted for approximately 36% of total revenues. No other customer accounts for more than 10% of our total revenues. Shoppers Drug Mart, a Canadian retailer, accounted for more than 10% of our international revenues in fiscal 2006. Consistent with industry practice, we do not operate under a long-term written supply contract with any of our customers.
Sales and Distribution
We have an established national sales and distribution sales organization that sells to mass merchandiser, drug and food retailers. We utilize our national sales network, consisting primarily of our own sales force, to sell and distribute newly acquired brands and product line extensions while maintaining tight controls over our selling expenses. Our experienced sales force of approximately 43 people serves all direct buying accounts on an individual basis. Our internal sales force accounts for more than 95% of domestic 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 90% 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 personnel and customers understand sales patterns and create appropriate promotions and merchandising aids for our products. Although not contractually obligated to do so, in certain circumstances, 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 national brokers in Canada and the U.K. and by distributors in Europe and Latin America. We have entered into distribution agreements with third party distributors for Selsun in various international markets except Canada and the U.K.
Most of our products, including those manufactured by third party manufacturers, are 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 of the United States. We use third party common 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
During fiscal 2006, we manufactured approximately 60% 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, Icy Hot patches and sleeves, Herpecin-L, and our dietary supplements, including Dexatrim products. 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.
To monitor the quality of our products, we maintain an internal quality control system supported by onsite microbiology and analytical laboratories. We have trained quality control technicians who test our products and processes and guide 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 the United States Food and Drug Administration (“FDA”) regulations. We audit our third party manufacturers to monitor compliance with applicable current good manufacturing practices (“GMPs”) as defined by FDA regulations.
We purchase raw materials and packaging materials from a number of third party suppliers primarily on a purchase order basis. Except for pamabrom, pyrilamine maleate and compap, active ingredients used in our Pamprin and Prēmsyn PMS products, we are not limited to a single source of supply for the ingredients used in the manufacture of our products. Sales of our Pamprin and Prēmsyn PMS
products represented approximately 4% of our consolidated total revenues in fiscal 2006. In addition, we have a limited source of supply for selenium sulfide, the active ingredient in Selsun Blue. As a result of the limited supply and increase in worldwide demand for selenium metal, a major component in the manufacture of selenium sulfide, prices have been and are expected to be volatile. We believe that our current and potential alternative sources of supply 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 emphasis on new product development as evidenced by our increased research and development spending, the expansion of our product development staff and our 10,000 square foot research and product development facility. We currently employ approximately 28 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 $4.2 million in fiscal 2006 and $3.6 million in fiscal 2005.
Competition
We compete in the OTC 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 OTC market, often accompanied by major advertising and promotional support. Our competitors include large pharmaceutical companies such as Pfizer Inc. and Johnson & Johnson, consumer products companies such as Procter & Gamble Co. and dietary supplements companies such as Nature’s Bounty, Inc. and Pharmaton Natural Health Products, many of which have considerably greater financial and other resources and are not as highly leveraged. Our competitors may be 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 us. 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. In fiscal 2006, substantially all of our total revenues were from products bearing proprietary 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 and Aspercreme, and the newly acquired brands ACT, Unisom and Cortizone.
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 also license from third parties other intellectual property that is used in certain of our products. The sale of these products relies on our ability to maintain and extend our supply and licensing agreements with these third parties.
Government Regulation
The U.S. manufacturing, distribution, processing, formulation, packaging, labeling and advertising of our products are subject to regulation by federal agencies, including, but not limited to:
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the Food & Drug Administration (the “FDA”);
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the Federal Trade Commission (the “FTC”);
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the Drug Enforcement Administration (the “DEA”);
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the Consumer Product Safety Commission (the “CPSC”);
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the United States Postal Service;
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the Environmental Protection Agency (“EPA”); and
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the Occupational Safety and Health Administration (“OSHA”).
These activities are also regulated by various agencies of the states, localities and foreign countries in which our products are sold. In particular, the FDA regulates the safety, manufacturing, labeling and distribution of dietary supplements including vitamins, minerals and herbs, as well as food additives, OTC and prescription drugs, medical devices and cosmetics. In addition, the FTC has primary jurisdiction to regulate the advertising of OTC drugs, medical devices, dietary supplements, functional toiletries and skin care products. In foreign countries these same activities may be regulated by Ministries of Health, or other local regulatory agencies; the manner in which they are registered, or how they are formulated, or what claims may be permitted may differ from similar products and practices in the U.S.
Under the Federal Food, Drug, and Cosmetic Act (“FDC Act”) all “new drugs”, including OTC products, are subject to pre-market approval by the FDA under the new drug application (“NDA”) process. The 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 considered new 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. A drug that is generally regarded as safe and effective is not a “new drug” and therefore does not require pre-market approval.
The FDA has adopted an administrative process, the OTC Drug Review, to determine which active ingredients and indications are safe and effective for use in OTC 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 OTC drugs. These monographs group drug ingredients into therapeutic classes such as OTC external analgesics. Products that comply with monograph conditions do not require pre-market approval from the FDA.
The FDA has finalized monographs for certain categories of OTC drugs such as drug products for the control of dandruff. If a product is marketed beyond the scope of a particular final monograph and without an approved NDA, such as if the manufacturer makes a label 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 whose active ingredients are not permitted by a final monograph, a company must submit an NDA to the FDA.
There are several categories of OTC drugs, such as external analgesics, for which the FDA has not completed its review. 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 OTC drugs can be marketed for certain uses without FDA pre-marketing approval. The FDA generally does not take enforcement action against an OTC drug subject to a tentative final monograph unless there is a safety problem or a substantial effectiveness question.
The majority of our OTC drug products are regulated pursuant to the FDA monograph system with the exception of Pamprin All Day, the subject of an abbreviated NDA held by The Perrigo Company and the newly acquired Unisom SleepTabs, the subject of an approved NDA now held by Chattem. Many of our products are sold according to tentative final monographs. Therefore, we face the risk that the FDA could take action if there is a safety or efficacy issue with respect to one of our products or finalize these monographs with revised conditions as to which of our products do not comply. If any of our products were found not to be in compliance with the final monograph, we may be forced to reformulate or relabel such products, if possible, or submit an NDA or an abbreviated NDA to continue to market our existing formulation. The submission of a marketing 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 obtain FDA approval of an NDA, 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, any of which would involve additional costs and may be prohibitive. For our OTC drug products that are sold according to final monographs, we cannot deviate from the conditions described in the final monograph, such as changes in approved active levels or labeling claims, unless we obtain pre-marketing approval from the FDA. In 2004, we launched Pamprin All Day containing the menstrual pain reliever naproxen sodium. The Perrigo Company (“Perrigo”) manufactures this product for us under its existing abbreviated NDA. Failure to comply with the conditions in a final monograph or NDA, where applicable, could result in an FDA enforcement action.
We have responded to certain questions received from the FDA with respect to efficacy of pyrilamine maleate, one of the active ingredients used in certain of the Pamprin Menstrual Pain Relief and Prēmsyn PMS products. While we addressed all of the FDA questions in detail, the final monograph for menstrual drug products, which has not yet been issued, will determine if the FDA considers pyrilamine maleate safe and effective for menstrual relief products. If pyrilamine maleate is not included in the final monograph, we would be required to reformulate the products to continue to provide the consumer with multi-symptom relief benefits. We have been actively monitoring the process and do not believe that either Pamprin Menstrual Pain Relief or
Prēmsyn 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 and that finalization of the menstrual products monograph is not imminent. Moreover, we have formulated alternative Pamprin products that fully comply with both the internal analgesic and menstrual product monographs. Sales of our Pamprin Menstrual Pain Relief and Prēmsyn PMS products represented approximately 4% of our consolidated total revenues in fiscal 2006.
In early 2005, infrequent, but serious, adverse cardiovascular events were reported to the FDA associated with patients who were prescribed a subclass of COX-2 inhibitor non-steroidal anti-inflammatory drugs (“NSAID’s”) for long periods to relieve pain of chronic diseases such as arthritis. These products include Vioxx®, Bextra® and Celebrex®. In February 2005, the FDA held a joint advisory committee meeting to seek external counsel on the extent to which manufacturers might further warn patients of these cardiovascular risks on prescription product labeling, or prohibit sale of these prescription products. As part of its response on this issue, the FDA has recommended labeling changes for both the prescription and OTC NSAID’s. Well-known OTC NSAID’s such as ibuprofen and naproxen, which have been sold in vast quantities since the 1970s were affected by this regulatory action. Manufacturers of OTC NSAID’s were asked to revise their labeling to provide more specific information about the potential cardiovascular and gastrointestinal risks recognizing the limited dose and duration of treatment of these products. Our Pamprin All Day product, which contains naproxen sodium, is subject to these new labeling requirements. Pamprin All Day is manufactured for us by Perrigo, holder of an abbreviated NDA for naproxen sodium. As holder of the abbreviated NDA, Perrigo has made the mandated labeling changes within the time frame required by the FDA. Product with revised labeling compliant with new FDA regulations began shipping in February, 2006.
We are also aware of the FDA’s concern about the potential toxicity due to concomitant use of OTC and prescription products that contain the analgesic ingredient acetaminophen, an ingredient also found in Pamprin and Prēmsyn PMS . We are participating in an industry-wide effort to reassure the FDA that the current recommended dosing regimen is safe and effective and that proper labeling and public education by both OTC and prescription drug companies are the best policies to abate the FDA’s concern. The FDA will address this issue in its effort to finalize the monograph on internal analgesic products. We believe the FDA may issue revised labeling requirements within the next year, perhaps prior to monograph closure, that will cause the industry to relabel its analgesic products to better inform consumers of concomitant use.
We were notified in October, 2000 that the FDA denied a citizen petition submitted by Thompson Medical Company, Inc., the previous owner of Sportscreme and Aspercreme. The petition sought a determination that 10% trolamine salicylate, the active ingredient in Sportscreme and Aspercreme, was clinically proven to be an effective active ingredient in external analgesic OTC drug products and should be included in the FDA’s yet-to-be finalized monograph for external analgesics. We have met with the FDA and submitted a proposed protocol study to evaluate the efficacy of 10% trolamine salicylate as an active ingredient in OTC external analgesic drug products. We are working to develop alternate formulations for Sportscreme and Aspercreme in the event that the FDA does not consider the available clinical data to conclusively demonstrate the efficacy of trolamine salicylate when the OTC external analgesic monograph is finalized. If 10% trolamine salicylate is not included in the final monograph, we would likely be required to discontinue these products as currently formulated and remove them from the market after expiration of an anticipated grace period. If this occurred, we believe we could market related products as homeopathic products and could also reformulate them using ingredients included in the FDA monograph. We are uncertain as to when the monograph is likely to become final. Sales of our Sportscreme and Aspercreme products represented approximately 8% of our consolidated total revenues in fiscal 2006.
Certain of our topical analgesic products are currently marketed under an FDA tentative final monograph. The FDA has recently proposed that the final monograph exclude external analgesic products in patch, plaster or poultice form, unless the FDA receives additional data supporting the safety and efficacy of these products. On October 14, 2003, we submitted to the FDA information regarding the safety of our Icy Hot patches and arguments to support our product’s inclusion in the final monograph. We have also participated in an industry-wide effort coordinated by Consumer Healthcare Products Association (“CHPA”) to establish with the FDA a protocol of additional research that will allow the patches to be marketed under the final monograph even if the final monograph does not explicitly allow them. The CHPA submission to the FDA was made on October 15, 2003. Thereafter, in April 2004, we launched the Icy Hot Sleeve, a flexible, non-occlusive fabric patch with 16% menthol. In February 2006, we launched the Icy Hot Pro-Therapy Medicated Foam Pad with Knee Wrap containing 5% menthol, and the Capzasin Back & Body Patch containing 0.025% capsaicin. All of these drug products contain levels of active ingredients consistent with the levels permitted in the OTC monograph. If additional research is required either as a preliminary to final FDA monograph approval and/or as a requirement of future individual product sale, we may need to invest in a considerable amount of expensive testing and data analysis. Any preliminary cost may be shared with other patch manufacturers. Because the submissions made into the FDA docket have been forwarded from its OTC Division to its Dermatological Division within the Center for Drug Evaluation and Research (“CDER”), we believe that the monograph is unlikely to become final and take effect before mid-2008 and perhaps thereafter. If neither action described above is successful and the final monograph summarily excludes such products, we will have to file an NDA in order to continue to market the Icy Hot and Aspercreme patches, Icy
Hot Sleeve, Icy Hot Pro-Therapy Medicated Pad with Knee Wrap, Capzasin Back & Body Patch, and/or similar delivery systems under our other topical analgesic brands. In such case, we would have to remove the existing products from the market likely one year from the effective date of the final monograph, or pending FDA review and approval of an NDA. The preparation of an NDA would likely take us six to 18 months and would be expensive. It typically takes the FDA at least 12 months to rule on an NDA once it is submitted. Sales of our Icy Hot and Aspercreme patches and Icy Hot Sleeve products represented approximately 12% of our consolidated total revenues in fiscal 2006.
During the finalization of the monograph on sunscreen products, the FDA chose to hold in abeyance specific requirements relating to the characterization of a product’s ability to reduce UVA radiation. A final ruling on this matter would be expected to result in new UVA testing requirements and subsequent labeling changes related to sun protection factor, or SPF, ratings, and other labeling claims. We expect that the FDA may take action on this matter within the next six months. If implemented, the final rules would likely result in new testing requirements and revised labeling of our Bullfrog product line, and all of our competitors’ products in the suncare category, within one year after issuance of the final rules.
The FDA also regulates the research, testing, manufacturing, safety, labeling, storage, recordkeeping, pre-market clearance or approval, promotion, distribution and production of medical devices in the United States to ensure that medical products distributed domestically are safe and effective for their intended uses. Under the FDC Act, medical devices are classified into one of three classes (Class I, Class II or Class III) depending on the degree of risk associated with each medical device and the extent of control needed to ensure safety and effectiveness. Our Icy Hot Heat Therapy, Icy Hot Pro-Therapy Knee and Back Brace and the Icy Hot Pro-Therapy Disposable Cold and Hot Packs are Class I devices.
Class I devices are subject to the lowest level of regulatory scrutiny because they are considered low risk devices. FDA requires Class I devices to comply with its General Controls, which include compliance with the applicable portions of the FDA’s Quality System Regulation, or QSR, facility registration and product listing, reporting of adverse medical events, and use of appropriate truthful and non-misleading labeling, advertising, and promotional materials. Most Class I devices are not required to submit 510(k) pre-market notifications (so-called “Class I Exempt”), but all are subject to FDA’s general misbranding and adulteration prohibitions. Both the Icy Hot Pro-Therapy Back and Knee Brace and the Icy Hot Pro-Therapy Disposable Cold and Hot Packs, and Icy Hot Heat Therapy are subject to regulations which exempt them from the 510(k) pre-market notification requirements. The FDA may disagree with our conclusion that clearances or approvals for such devices were not required or may require clearance or approval for future modifications of these or other devices. Such submissions may be time consuming and costly and may not ultimately be cleared or approved by FDA. If the FDA determines that we have failed to comply with applicable regulatory requirements, it can impose a variety of enforcement actions which could include public warning letters, fines, injunctions, consent decrees, civil penalties, suspension or delayed issuance of approvals or seizure or recall of our products. The FDA could also require us to repair, replace, or refund the cost of devices that we manufactured or distributed.
The Dietary Supplement Health and Education Act of 1994 (“DSHEA”) was enacted on October 25, 1994. DSHEA amends the FDC 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. In such case, the FDA could require pre-market approval to sell the product. Manufacturers are not required to obtain prior FDA approval before producing or selling a dietary supplement unless the ingredient is considered “new” or was not on the market as of October 15, 1994.
Dietary supplement products may include truthful, non-misleading and substantiated statements of nutritional support. Examples of such claims are 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. These claims are also known as “structure/function” claims. FDA requires companies which include structure/function claims on their labeling to notify the agency of the claim within 30 days of first marketing the dietary supplement with the identified claims. FDA does not typically respond to these notifications, but could issue a “courtesy letter” should the agency question some aspect of the submission. A dietary supplement that includes a structure/function claim on its labeling is also required to include a disclaimer stating that the FDA has not evaluated the claim. FDA distinguishes between structure/function claims which do not require FDA pre-approval and disease-related health claims which require FDA prior approval or the issuance of an authorizing regulation.
A product 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 only pursuant to an FDA regulation authorizing its use as a dietary supplement.
The FDA may take enforcement action against a dietary supplement if the FDA believes the supplement presents a significant or unreasonable risk of illness or injury under conditions of use suggested in the labeling or under ordinary conditions of use. Under DSHEA, the FDA bears the burden of proof to show that a dietary supplement presents a significant or unreasonable risk of illness or injury. The FDA may also take enforcement action for unlawful promotion of a dietary supplement.
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 dietary supplements. 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, but not limited to, warning letters, product recalls and seizures, injunctions or criminal prosecution.
The FDA has promulgated regulations relating to the manufacturing process for drugs, which are known as current GMP’s. We anticipate that the FDA will promulgate GMP’s, which are specific to dietary supplements and require at least some of the quality control provisions contained in the GMP’s for drugs, which are more rigorous than the GMP’s for foods. We source all of our dietary supplement products from outside suppliers, including Dexatrim, New Phase, Garlique, Melatonex, CardioAssist, and Omnigest. As part of its regulatory authority, the FDA may periodically conduct audits of the physical facilities, machinery, processes and procedures that we, or our suppliers, 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, or our suppliers, to make certain changes in manufacturing facilities and processes. We may be required to make additional expenditures to comply with these orders or new GMP requirements, or possibly discontinue selling certain products until we, or our suppliers, comply with these orders and requirements. As a result, our business could be adversely affected.
In 1997, the FDA published a proposed rule on the use of dietary supplements containing ephedrine alkaloids. In June 2002, the United States Department of Health and Human Services (“HHS”) proposed an expanded scientific evaluation of Ephedra which led to the issuance of a report by the RAND-based Southern California Evidence-Based Practice Center (the “RAND Report”). The RAND Report concluded that ephedrine, ephedrine plus caffeine and Ephedra-containing dietary supplements with or without herbs containing caffeine all promote modest amounts of weight loss over the short term and use of Ephedra, or ephedrine plus caffeine, is associated with an increased risk of gastrointestinal, psychiatric and autonomic symptoms. The adverse event reports contained a smaller number of more serious adverse events. Given the small number of such events, the RAND Report concluded that further study would be necessary to determine whether consumption of Ephedra, or ephedrine, may be causally related to these serious adverse events. In connection with the RAND Report, HHS sought public comment on whether additional measures are required concerning the sale and distribution of dietary supplements containing ephedrine alkaloids.
On December 30, 2003, the FDA issued a consumer alert on the safety of dietary supplements containing ephedrine alkaloids and on February 6, 2004 published a final rule with respect to these products. The final rule prohibits the sale of dietary supplements containing ephedrine alkaloids because such supplements present an unreasonable risk of illness or injury. The final rule became effective on April 11, 2004. Although we discontinued the manufacturing and shipment of Dexatrim containing ephedrine in September 2002, the FDA’s final rule may result in lawsuits in addition to those we currently have being filed against us alleging damages related to the use or purchase of Dexatrim containing ephedrine. See “Legal Proceedings”. In April 2005, a Utah federal court called into question the 2004 final rule. The court decision is being appealed and may have an effect on the FDA’s enforcement of the ephedrine alkaloid final rule.
The FDA also regulates some of our products as cosmetics or drug-cosmetics. 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 CPSC and the FDA.
Combination products can be regulated via a memorandum of understanding between federal agencies. In February 2006, we launched Bullfrog Mosquito Coast, a combination of sunscreen and insect repellent. The sunscreen labeling is regulated by the FDA in its sunscreen monograph, but the insect repellent, IR-3535, and its labeling, require pre-market safety and
efficacy testing and approval by the EPA and all 50 states (and U.S. Territories). Bullfrog Mosquito Coast received approval from all states and the EPA prior to launch. Further, the FDA has announced its intention in its November, 2005 Unified Agenda to regulate, under the monograph system, the combination of sunscreens and insect repellents in a notice of proposed rulemaking yet to be published. Any final rule making is years in the future and the FDA might grandfather existing products or otherwise allow time for their compliance.
Our business is also regulated by the California Safe Drinking Water and Toxic Enforcement Act of 1986, known as Proposition 65. Proposition 65 prohibits businesses from exposing consumers to chemicals that the state has determined cause cancer or reproduction toxicity without first giving fair and reasonable warning unless the level of exposure to the carcinogen or reproductive toxicant falls below prescribed levels. From time to time, one or more ingredients in our products could become subject to an inquiry under Proposition 65. If an ingredient is on the state’s list as a carcinogen, it is possible that a claim could be brought, in which case we would be required to demonstrate that exposure is below a “no significant risk” level for consumers. Any such claims may cause us to incur significant expense, and we may face monetary penalties or injunctive relief, or both, or be required to reformulate our product to acceptable levels. The State of California under Proposition 65 is also considering the inclusion of titanium dioxide on the state’s list of suspected carcinogens. Titanium dioxide has a long history of widespread use as an excipient in prescription and OTC pharmaceuticals, cosmetics, dietary supplements and skin care products and is an active ingredient in our Bullfrog Superblock products. We have participated in an industry-wide submission to the State of California, facilitated through CHPA, presenting evidence that titanium dioxide presents “no significant risk” to consumers.
Finally, the FDA regulates the quality of all finished drug, medical device, and food products under GMP’s. As part of its regulatory authority, the FDA may periodically conduct audits of the physical facilities, machinery, processes and procedures that we, or our suppliers, use to manufacture products. The FDA may perform these audits at any time without advanced notice. In February 2006, we registered as a medical device manufacturer with the FDA in connection with our sale of Pro-Therapy products. It might be expected that we could be audited as a new device manufacturer under medical device GMP’s. Working with consultants we have instituted medical device GMP’s pursuant to applicable portions of the medical device Quality System Regulation, or QSR. As a result of any audits, the FDA may order us, or our suppliers, to make certain changes in 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, or our suppliers, comply with these orders. As a result, our business could be adversely affected. In the future, manufacturers of dietary supplements may be mandated by the FDA to comply with more rigorous GMP’s as well as post-marketing responsibilities similar to those applied to OTC drugs or medical devices. Such regulations may include mandatory adverse event reporting requirements as part of new GMP’s regulations.
The FDA has broad regulatory and enforcement powers. If the FDA determines that we have failed to comply with applicable regulatory requirements, it can impose a variety of enforcement actions from public warning letters, fines, injunctions, consent decrees and civil penalties to suspension or delayed issuance of approvals, seizure or recall of our products, total or partial shutdown of production, withdrawal of approvals or clearances already granted, and criminal prosecution. The FDA can also require us to repair, replace or refund the cost of devices that we manufactured or distributed. If any of these events were to occur, it could materially adversely affect us.
Environmental Matters
We continually 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 expenditure 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, results of operations or cash flows.
In late 2005, we began the manufacture of Bullfrog Mosquito Coast at our Chattanooga, Tennessee plant. Bullfrog Mosquito Coast is a combination of sunscreen and insect repellent. The EPA has primary jurisdiction over insect repellants and combination insect repellant products containing sunscreens, such as BullFrog Mosquito Coast. Both products and manufacturing establishments must be registered with EPA. The FDA has published notice that a monograph regulating combination insect repellants and sunscreens will be issued during 2007. This new monograph may change the regulatory enforcement jurisdiction from the EPA to the FDA.
The handling, disposal, and environmental exposure of the insect repellent, IR-3535, is strictly regulated by the EPA under the Clean Waters Act. Any failure to comply with applicable regulations with respect to the use of IR-3535 might result in EPA action against us, including fines or injunctive action.
Employees
We employ approximately 423 persons on a full-time basis and eight persons on a part-time basis in the United States. In addition, we employ approximately 24 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.
Financial Information on Products and Geographical Areas
For financial information on our product categories and geographical areas, see note 12 to our consolidated financial statements.
Additional Information
Our internet website address is www.chattem.com. We make available free of charge on or through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, reports filed pursuant to Section 16, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.
Item 1A.
Item 1A. 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 may not be able to successfully integrate the five brands acquired in the J&J Acquisition into our portfolio of consumer brands or achieve other synergies associated with the acquisition.
In connection with the completion of the J&J Acquisition, we acquired the U.S. rights to the following five brands: ACT, Unisom, Cortizone, Kaopectate and Balmex. The integration of these acquired brands into our existing business involves a number of risks and presents significant financial, operational and managerial challenges. Failure to successfully integrate the new brands into our business may have a material adverse effect on our business, results of operation, financial condition, cash flow or the trading price for our common stock or the trading price and liquidity of the Convertible Notes.
We have a significant amount of debt that could adversely affect our business and growth prospects.
As of November 30, 2006, our total long-term debt was $232.5 million. Additionally, on January 2, 2007, we completed an amended credit facility providing for up to a $100.0 million revolving credit facility and a $300.0 million term loan. The proceeds from the term loan were used to finance in part the J&J Acquisition. In the future, we may incur significant additional debt. Our debt could have significant adverse effects on our business including:
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requiring us to dedicate a substantial portion of our available cash for interest payments and the repayment of principal;
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limiting our ability to capitalize on significant business opportunities;
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making us more vulnerable to economic downturns;
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limiting our ability to withstand competitive pressures; and
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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 obtain such refinancing, additional financing or asset sale on favorable terms or at all.
We face significant competition in the OTC health care, toiletries and dietary supplements markets.
The OTC 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 OTC 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 pharmaceutical companies such as Pfizer Inc. and Johnson & Johnson, consumer products companies such as Procter & Gamble Co. and dietary supplements companies such as Nature’s Bounty, 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. 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 us. 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.
We may face additional lawsuits alleging injury from the use of Dexatrim products containing ephedrine, which we discontinued manufacturing and shipping in September 2002, or from other products that we currently produce or may produce in the future.
We are currently named as a defendant in two lawsuits alleging that the plaintiffs were injured as a result of the ingestion of Dexatrim containing ephedrine. On December 30, 2003, the FDA issued a consumer alert on the safety of dietary supplements containing ephedrine alkaloids and on February 6, 2004 published a final rule with respect to these products. The final rule prohibits the sale of dietary supplements containing ephedrine alkaloids because such supplements present an unreasonable risk of illness or injury. The final rule became effective on April 11, 2004. Although we discontinued the manufacture and shipment of Dexatrim containing ephedrine in September 2002, the FDA’s final rule may result in additional lawsuits being filed against us alleging damages related to the use or purchase of Dexatrim containing ephedrine.
Our available product liability coverage for the defense of 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, consists of $25.0 million of coverage through our captive insurance subsidiary, of which approximately $6.6 million is funded as of February 1, 2007. We also have an additional $20.0 million of excess coverage through a third party reinsurance policy, which excludes coverage for any future claims involving Dexatrim products containing ephedrine. In the future, if we face significant liabilities relating to the Dexatrim products which included ephedrine, our product liability insurance may 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 (including the five brands acquired in the J&J Acquisition) 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 have product liability insurance through our captive insurance subsidiary and a third party reinsurance policy that provides coverage for product liability claims. Our product liability insurance coverage for all of our products, including Dexatrim products containing ephedrine, consists of $25.0 million of coverage through our captive insurance subsidiary, of which approximately $6.6 million is funded as of February 1, 2007, and an additional $20.0 million of excess coverage through a third party reinsurance policy, which excludes coverage for any future claims involving Dexatrim products containing ephedrine.
All of our insurance policies are subject to certain 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. 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, currently in May of each year. 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 in amounts equal to that which we currently have or in amounts sufficient to satisfy future claims. Also, the addition of five new brands to our consumer products portfolio following the completion of the J&J Acquisition may result in increased insurance costs.
Our acquisition strategy is subject to risk and may not be successful.
A component of our growth strategy depends on our ability to successfully execute acquisitions, which involves numerous risks including:
•
not accurately identifying suitable products or brands for acquisition;
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difficulties in integrating the operations, technologies and manufacturing processes of the acquired products;
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the diversion of management’s attention from other business concerns; and
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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.
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, distributing, processing, formulating, 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 distributing of our OTC products, medical devices, and dietary supplements. In addition, the FTC may regulate the promotion and advertising of our drug products, particularly OTC versions and dietary supplements. The EPA regulates our Bullfrog Mosquito Coast insect repellent products. We are also regulated by various state statutes, including the California Safe Drinking Water and Toxic Enforcement Act of 1986. If we fail to adhere to the standards required by these federal and state regulations, or are alleged to have failed to adhere such regulations, our operating results and financial condition may be adversely affected.
Our success depends on our ability to anticipate and respond in a timely manner to changing consumer preferences.
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 conform to consumer preferences, 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 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. We cannot assure you that newly developed products will contribute favorably to our operating results.
We rely on a few large customers, particularly Wal-Mart Stores, Inc., for a significant portion of our sales.
In fiscal 2006, Wal-Mart Stores, Inc. represented approximately 36% of our total revenues, our ten largest customers represented approximately 73% of our total revenues and our 20 largest customers represented approximately 84% 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 lost 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.
We may be adversely affected by fluctuations in buying decisions of mass merchandiser, drug and food trade buyers and the trend toward retail trade consolidation.
We sell our products to mass merchandiser and 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 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, such as Wal-Mart Stores, Inc., 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 and incremental promotional investment concessions. As a result, we may face downward pressure on our prices and increased promotional 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, Selsun and Dexatrim brands and the brands acquired in the J&J Acquisition.
We use third party manufacturers to make products representing approximately 40% of our fiscal 2006 sales volume, including our Gold Bond medicated powders and foot spray, the Icy Hot patches and sleeves, Herpecin-L, and our line of dietary supplements including Dexatrim Max and, internationally, our line of Selsun medicated dandruff shampoos. Pfizer Inc. will manufacture the Cortizone, Unisom and Kaopectate products for us during a transition period of up to 18 months. In the near term, we will also rely on third party manufacturers to manufacture the Act and Balmex product lines. In many cases, third party manufacturers are not bound by fixed term commitments in our contracts with them, and they may discontinue production with 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 GMPs. 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 sanctions, additional product liability claims or customer complaints, any of which could harm our reputation and our business.
Our dietary supplement 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 our Sunsource product line. We are highly dependent upon consumers’ perceptions 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, such as the December 30, 2003 consumer alert on the safety of dietary supplements containing ephedrine alkaloids issued by the FDA and the subsequent FDA rule banning the sale of supplements containing ephedrine alkaloids that became effective on April 11, 2004, 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 2006, substantially all of our total revenues were from products bearing proprietary 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 and Aspercreme as well as the brands acquired in the J&J Acquisition in January 2007. 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. Also, we did not acquire any material intellectual property or trademark rights outside of the United States for the five brands acquired in the J&J Acquisition. 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 patches and sleeves. 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 rights of others. Intellectual property litigation can be extremely expensive, and such expense could materially adversely affect our business.
Because most of our operations are located in Chattanooga, Tennessee, we are subject to regional and local risks.
Approximately 60% of our sales volume in fiscal 2006 was from products manufactured in two plants located in Chattanooga, Tennessee. We store the raw materials used in our manufacturing activities in two warehouses that are also located in Chattanooga. We package and ship most of our products from Chattanooga. Additionally, our corporate headquarters are also located in Chattanooga, and most of our employees live in the area. Because of this, we are subject to regional and local risks, such as:
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changes in state and local government regulations;
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severe weather conditions, such as floods, ice storms and tornadoes;
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natural disasters, such as fires and earthquakes;
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power outages;
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nuclear facility incidents;
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spread of infectious diseases;
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hazardous material incidents; or
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any other catastrophic events in our area.
If our region, city or facilities were to suffer a significant disaster, our operations are likely to be disrupted and our business would suffer.
We depend on sole source suppliers for three active ingredients used in our Pamprin and Prēmsyn PMS products and a limited source of supply for selenium sulfide, the active ingredient in Selsun Blue, and if we are unable to buy these ingredients, we will not be able to manufacture these products.
Pamabrom, pyrilamine maleate and compap, active ingredients used in our Pamprin and Prēmsyn PMS products, are purchased from single sources of supply. Pamabrom is sold only by Chattem Chemicals, Inc. (an unrelated company), pyrilamine maleate is produced only in India and sold only by Lonza, Inc. and compap is sold only by Mallinckrodt, Inc. In addition, we have a limited source of supply for selenium sulfide, the active ingredient in Selsun Blue. Financial, regulatory or other difficulties faced by these 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 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. 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 2006, approximately 8% of our total revenues were attributable to our international business. Our acquisition of Selsun Blue in expanded our international business. We 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:
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unexpected changes in, or impositions of, legislative or regulatory requirements;
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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;
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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;
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potential trade restrictions and exchange controls;
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differences in protection of our intellectual property rights; and
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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 sales 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.
The terms of our outstanding debt obligations limit certain of our activities.
The terms of the indenture under which our 7.0% Subordinated Notes are issued and our Credit Facility impose operating and financial restrictions on us including restrictions on:
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incurrence of additional indebtedness;
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dividends and restricted payments;
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investments;
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loans and guarantees;
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creation of liens;
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transactions with affiliates;
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use of proceeds from sales of assets and subsidiary stock; and
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certain mergers, consolidations and transfers of assets.
The terms of our 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 sites use chemicals and other potentially hazardous materials and generate 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 and regulations. Under these laws and regulations, 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. Product line extensions, such as Bullfrog Mosquito Coast, or acquisitions of new products, such as those acquired in the J&J Acquisition, may also subject our business to new or additional environmental laws and regulations. In addition, compliance with new or 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 Robert E. Bosworth, our president and chief operating officer. If we were to lose any key senior executive, our business could be materially adversely affected.
Our shareholder rights plan and restated charter contain 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 shareholders (including holders of the Convertible Notes which may convert into common stock) of their ability to receive a premium on their 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 may have the effect of discouraging takeover attempts:
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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;
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directors may be removed only for cause prior to the expiration of their terms; and
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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% 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 restated 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.
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 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, to repurchase our common stock and to repay our outstanding indebtedness and have no current intention of paying dividends to holders of our common stock.
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.
Item 1B.
Item 1B. Unresolved Staff Comments
None
Item 2.
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:
We are currently operating our manufacturing facilities at approximately 70% of total capacity. These manufacturing 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.
Item 3.
Item 3. Legal Proceedings
See note 13 of notes to consolidated financial statements included in Item 8 “Financial Statements and Supplementary Data”.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None
Part II
Item 5.
Item 5. Market for the Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock is quoted on the Nasdaq Global Select Market under the symbol “CHTT”. The table below sets forth the high and low closing sales prices of our common stock as reported on the Nasdaq Global Select Market for the periods indicated.
Holders
As of February 1, 2007, there were approximately 243 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.
Dividends
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 7.0% Subordinated Notes were issued and by the terms of our Credit Facility.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
(1)
Average price paid per share includes broker commissions
(2)
In January 2005, our board of directors increased the total authorization to repurchase our common stock under our stock buyback program to $30.0 million. A total of $17.3 million remained available under the stock buyback authority prior to July 29, 2005, when our board of directors increased the total buyback authorization back to $30.0 million. Subsequent to share purchases made in the fourth quarter of fiscal 2005, our board of directors again increased the total buyback authorization back to $30.0 million, effective November 29, 2005. On June 26, 2006, our board of directors authorized the repurchase of up to an additional $100.0 million of our common stock under our existing stock repurchase program. There is no expiration date specified for our stock buyback program.
Item 6.
Item 6. Selected Financial Data
This selected financial data should be read in conjunction with item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. The actual results may differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including, but not limited to, those described in our filings with the Securities and Exchange Commission.
Overview
Founded in 1879, we are a leading marketer and manufacturer of a broad portfolio of branded OTC healthcare products, toiletries and dietary supplements in such categories as topical pain care, medicated skin care products, medicated dandruff shampoos, dietary supplements, and other OTC and toiletry products. Our portfolio of products includes well-recognized brands such as:
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Icy Hot, Aspercreme and Capzasin - topical pain care;
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Gold Bond - medicated skin care products;
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Selsun Blue and Selsun Salon - medicated dandruff shampoos;
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Dexatrim, Garlique and New Phase - dietary supplements;
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Other OTC and toiletry products such as Pamprin, a menstrual analgesic; Herpecin-L, a lip care product; Benzodent, a dental analgesic cream; and toiletries such as Bullfrog, a line of sunscreens; UltraSwim, a chlorine-removing shampoo; Sun-In, a hair lightener.
Our products target niche markets that are often outside the focus of larger companies where we believe we can achieve and sustain significant market share through innovation and strong advertising and promotion support. Many of our products are among the U.S. market leaders in their respective categories. For example, our portfolio of topical pain care brands and our Gold Bond medicated body powders have the leading U.S. market share in these categories. We support our brands through extensive and cost-effective advertising and promotion, the expenditures for which represented approximately 32% of our total revenues in fiscal 2006. We sell our products nationally through mass merchandiser, drug and food channels, principally utilizing our own sales force.
Developments During Fiscal 2006
Products
In the first quarter of fiscal 2006, we introduced or completed the introduction of the following product line extensions: Icy Hot Pro-Therapy, Selsun Salon, Bullfrog Mosquito Coast, Garlique CardioAssist, Capzasin Back & Body Patch and Pamprin Max. In the second quarter of fiscal 2006, we introduced Dexatrim Max2O. Gold Bond Ultimate Softening Lotion was introduced in the fourth quarter of 2006.
Based on Icy Hot Pro-Therapy performing below expectations, a review of point of sales data throughout fiscal 2006, an estimate of inventory on hand at customers and a review of our on hand inventory and purchase commitments outstanding as of November 30, 2006, we have provided for an estimate of returns of $3.3 million and an estimate of obsolete inventory of $2.0 million, which reduced net sales and increased cost of sales, respectively, in our consolidated financial statements as of November 30, 2006.
Debt
On November 30, 2005, we called our $75.0 million of Floating Rate Senior Notes for full redemption on December 30, 2005. The terms of the indenture for the Floating Rate Senior Notes required the repayment at a price of 102% of the principal amount of the notes plus accrued interest. The $75.0 million of Floating Rate Senior Notes were fully redeemed on December 30, 2005. We utilized borrowings of $38.0 million under our Amended Revolving Credit Facility and $38.9 million of our cash on hand to fund the redemption of the Floating Rate Senior Notes. As a result of the redemption, a loss on early extinguishment of debt of $2.8 million was recorded in the first quarter of fiscal 2006.
On November 22, 2006, we completed a private offering of $125.0 million of the Convertible Notes, the proceeds of which were used to fund in part the J&J Acquisition. The Convertible Notes bear interest at an annual rate of 2.0%, payable semi-annually on May 15 and November 15 of each year, with the first interest payment due on May 15, 2007. Concurrently with the sale of the Convertible Notes, we purchased a note hedge for $32.0 million and issued warrants for proceeds of $18.6 million with an affiliate of Merrill Lynch (the “Counterparty”). The note hedge and warrants are separate and legally distinct instruments that bind us and the Counterparty and have no binding effect on the holders of the Convertible Notes.
On January 2, 2007, we completed an amended credit facility providing for up to a $100.0 million revolving credit facility and a $300.0 million term loan (the “Credit Facility”), led by Bank of America. The proceeds from the term loan under the Credit Facility were used to finance in part the J&J Acquisition. The term loan bears interest at LIBOR plus 1.75% or a base rate (the higher of the federal funds rate plus 0.5% or the prime rate) plus 0.75% at our discretion. Maturities of the term loan are $3.0 million annually with any remaining balance due January 2, 2013.
Stock Repurchase
During fiscal 2006, we repurchased 1.2 million shares of our common stock under our stock repurchase program for $39.3 million at an average price per share of $33.57.
On July 25, 2006, we successfully completed a consent solicitation from the holders of the 7.0% Subordinated Notes to an amendment to the indenture to increase our capacity to make restricted payments by an additional $85.0 million, including payments for the repurchase of our common stock and adjust the fixed charge coverage ratio as defined in the indenture. In connection with the consent solicitation, our Board of Directors authorized the repurchase of up to an additional $100.0 million of our common stock under the terms of our existing stock repurchase program. As of February 1, 2007, the current amount available under the authorization from the Board of Directors was $88.1 million.
Litigation
Over the past two years, we have resolved all of the claims submitted in the Dexatrim PPA settlement. A total of $70.9 million was previously funded into a settlement trust by our insurers and Sidmak Laboratories, Inc., the manufacturer of Dexatrim products containing PPA, for the purpose of paying claims in the settlement. All claims in the settlement and expenses of the trust have now been paid. On June 14, 2006, we filed a motion to dissolve the settlement trust. The court granted this motion on July 14, 2006. On August 31, 2006, the settlement trust paid us $10.7 million which is included as a component of litigation settlement in our condensed consolidated statement of income. The settlement trust currently has a balance of approximately $2.8 million. We expect to use those funds to resolve the one pending Dexatrim PPA case which opted out of the settlement. Any funds remaining after we resolve the opt-out case will be returned to one of our insurance carriers. We currently do not expect to record any additional charges relative to the settlement of the PPA litigation, except for legal expenses that will be recorded in the period incurred.
During the third quarter of fiscal 2005, we entered into a settlement agreement with the DELACO Company (“DELACO”), successor by merger to the Thompson Medical Company, Inc., which owned the Dexatrim brand prior to December 21, 1998 (the “DELACO Agreement”). The DELACO Agreement was approved by the DELACO bankruptcy court on July 28, 2005. Pursuant to the DELACO Agreement, we agreed to assume responsibility for all claims against DELACO and its predecessor, Thompson Medical Company, Inc., or us relating to Dexatrim products involving an injury date after December 21, 1998 and hold the DELACO bankruptcy estate harmless from any such claims. In exchange, a settlement trust to be established under DELACO’s bankruptcy plan agreed to pay us $8.75 million and assume responsibility for all claims related to Dexatrim products alleging injury dates on or before December 21, 1998. On February 17, 2006, the DELACO bankruptcy court entered an order confirming the DELACO bankruptcy plan which incorporated the terms of the DELACO Agreement. In accordance with the DELACO bankruptcy plan, the settlement trust established under the plan paid us $8.75 million on March 17, 2006, which is included in our condensed consolidated statements of income, net of legal expenses. In addition, this order allows us to dismiss all cases against us with injury dates prior to December 21, 1998, and channel these cases to the DELACO settlement trust whether brought by an injured party or a co-defendant to a Dexatrim products liability case. We expect all claims with injury dates prior to December 21, 1998 to be channeled to the DELACO settlement trust. The confirmation of the DELACO bankruptcy plan effectively releases us from liability for all PPA products liability cases with injury dates prior to December 21, 1998.
Acquisition
On January 2, 2007, we completed the J&J Acquisition for $410.0 million. The acquisition was funded with the proceeds received from the Convertible Notes, borrowings under our revolving credit facility and funds provided from the term loan under our Credit Facility.
Results of Operations
The following table sets forth for the periods indicated, certain items from our consolidated statements of income expressed as a percentage of total revenues:
Critical Accounting Estimates
The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to use estimates. Several different estimates or methods can be used by management that might yield different results. The following are the significant estimates used by management in the preparation of the November 30, 2006 consolidated financial statements:
Allowance for Doubtful Accounts
As of November 30, 2006, an estimate was made of the collectibility of the outstanding accounts receivable balances. This estimate requires the utilization of outside credit services, knowledge about the customer and the customer’s industry, new developments in the customer’s industry and operating results of the customer as well as general economic conditions and historical trends. When all these facts are compiled, a judgment as to the collectibility of the individual account is made. Many factors can impact this estimate, including those noted in this paragraph. The adequacy of the estimated allowance may be impacted by the deterioration in the financial condition of a large customer, weakness in the economic environment resulting in a higher level of customer bankruptcy filings or delinquencies and the competitive environment in which the customer operates. During the year ended November 30, 2006, we performed a detailed assessment of the collectibility of trade accounts receivable and did not make any significant adjustments to our estimate of allowance for doubtful accounts. The balance of allowance for doubtful accounts was $0.3 million, $0.3 million and $0.8 million at November 30, 2006, 2005 and 2004, respectively.
Revenue Recognition
Revenue is recognized when our products are shipped and title transfers to our customers. It is generally our policy across all classes of customers that all sales are final. As is common in the consumer products industry, customers return products for a variety of reasons including products damaged in transit, discontinuance of a particular size or form of product and shipping errors. As sales are recorded, we accrue an estimated amount for product returns, as a reduction of these sales, based upon our historical experience and consideration of discontinued products, product divestitures, estimated inventory levels held by our customers and retail point of sale data on existing and newly introduced products. The level of returns may fluctuate from our estimates due to several factors including weather conditions, customer inventory levels and competitive conditions. We charge the allowance account for product returns when the customer provides appropriate supporting documentation that the product is properly destroyed or upon receipt of the product.
We separate returns into the two categories of seasonal and non-seasonal products. We use the historical return detail of seasonal and non-seasonal products for at least the most recent three fiscal years on generally all products, which is normalized for any specific occurrence that is not reasonably likely to recur, to determine the amount of product returned as a percentage of sales, and estimate an allowance for potential returns based on product sold in the current period. To consider product sold in current and prior periods, an estimate of inventory held by our retail customers is calculated based on customer inventory detail. This estimate of inventory held by our customers, along with historical returns as a percentage of sales, is used to determine an estimate of potential product returns. This estimate of the allowance for seasonal and non-seasonal returns is further analyzed by considering retail customer point of sale data. We also consider specific events, such as discontinued product or product divestitures, when determining the adequacy of the allowance. Our estimate of product returns for seasonal and non-seasonal products as of November 30, 2006 was $1.2 million and $1.3 million, respectively, $0.2 million and $0.6 million, respectively, as of November 30, 2005 and $0.5 million and $0.1 million, respectively, as of November 30, 2004. As of November 30, 2006 and November 30, 2005, estimated returns of pHisoderm product was $0.3 million and $0.7 million, respectively, due to our November 30, 2005 divestiture of this brand. Based on consideration of the sales of Icy Hot Pro-Therapy performing below expectations, review of retail point of sales data throughout fiscal 2006 and an estimate of inventory on hand at customers, we have estimated returns as of November 30, 2006 of $3.3 million, which decreased net sales on our consolidated financial statements. As a result of higher sales volumes in fiscal 2006, we increased our estimate of returns for seasonal products by approximately $1.0 million, which resulted in a decrease to net sales in our consolidated financial statements. For fiscal 2005 and 2004, we decreased our estimate of seasonal returns by approximately $0.2 million and $0.9 million, respectively, which resulted in an increase to net sales in our consolidated financial statements. During the fiscal years ended November 30, 2006 and 2005, as a result of our estimate of customer inventory levels, historical non-seasonal product returns and retail point of sale data, we increased our estimate of non-seasonal returns by approximately $0.7 million and $0.6 million, respectively, which resulted in a decrease to net sales in our consolidated financial statements. During fiscal 2004, we decreased our estimate of non-seasonal returns by approximately $0.8 million, which resulted in an increase to net sales in our consolidated financial statements. Each percentage point change in the seasonal return rate would impact net sales by approximately $0.2 million. Each percentage point change in the non-seasonal return rate would impact net sales by approximately $0.4 million.
We routinely enter into agreements with customers to participate in promotional programs. The cost of these programs is recorded as either advertising and promotion expense or as a reduction of sales as prescribed by Emerging Issues Task Force 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)”. A significant portion of the programs are recorded as a reduction of sales and generally take the form of coupons and vendor allowances, which are normally taken via temporary price reductions, scan downs, display activity and participations in in-store programs provided uniquely by the customer. We also enter into cooperative advertising programs with certain customers, the cost of which is recorded as advertising and promotion expense. In order for retailers to receive reimbursement under such programs, the retailer must meet specified advertising guidelines and provide appropriate documentation of the advertisement being run. During fiscal 2006, 2005 and 2004, our cooperative advertising reimbursements did not exceed the fair value of the benefits received under those programs.
We analyze promotional programs in two primary categories -- coupons and vendor allowances. Customers normally utilize vendor allowances in the form of temporary price reductions, scan downs, display activity and participations in in-store programs provided uniquely by the customer. We estimate the accrual for outstanding coupons by utilizing a third-party clearinghouse to track coupons issued, coupon value, distribution and expiration dates, quantity distributed and estimated redemption rates that are provided by us. We estimate the redemption rates based on internal analysis of historical coupon redemption rates and expected future retail sales by considering recent point of sale data. The estimate for vendor allowances is based on estimated unit sales of a product under a program and amounts committed for such programs in each fiscal year. Estimated unit sales are determined by considering customer forecasted sales, point of sale data and the nature of the program being offered. The three most recent years of expected program payments versus actual payments made and current year retail point of sale trends are analyzed to determine future expected payments. Customer delays in requesting promotional program payments due to their audit of program participation and resulting request for reimbursement is also considered to evaluate the accrual for vendor allowances. The costs of these programs is often variable based on the number of units actually sold. As of November 30, 2006, the coupon accrual and reserve for vendor allowances were $1.2 million and $3.7 million, respectively, $0.6 million and $1.1 million, respectively, as of November 30, 2005 and $1.3 million and $1.9 million, respectively, as of November 30, 2004. Each percentage point change in promotional program participation would impact net sales by $0.2 million and advertising and promotion expense by an insignificant amount.
Income Taxes
We account for income taxes using the asset and liability approach as prescribed by SFAS No. 109, “Accounting for Income Taxes”. This approach requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Using the enacted tax rates in effect for the year in which the differences are expected to reverse, deferred tax assets and liabilities are determined based on the differences between the financial reporting and the tax basis of an asset or liability. We record income tax expense in our consolidated financial statements based on an estimated annual effective income tax rate. Our estimated annual effective income tax rate during fiscal 2006 was 35%, as compared to 32% in fiscal 2005 and 33% in fiscal 2004, as a result of lower deductions for charitable contributions and greater apportionment in states with higher statutory tax rates.
For additional information regarding our significant accounting policies, see note 2 of notes to consolidated financial statements.
Fiscal 2006 Compared to Fiscal 2005
To facilitate discussion of our operating results for the years ended November 30, 2006 and 2005, we have included the following selected data from our consolidated statements of income:
Domestic Net Sales
Domestic net sales for fiscal 2006 increased $24.0 million, or 9.5%, to $276.4 million from $252.4 million in fiscal 2005. A comparison of domestic net sales for the categories of products included in our portfolio of OTC healthcare products is as follows:
Net sales growth in the topical pain care category was led by the launch of the new Icy Hot Pro-Therapy line of elastic support braces and pain relieving insert product and a 18% increase in sales of Capzasin, led by the new Capzasin Back & Body Patch. Excluding sales of Icy Hot Pro-Therapy, the category declined 3% compared to fiscal 2005, led by decreased sales of Icy Hot and Flexall. Based on Icy Hot Pro-Therapy performing below expectations, a review of retail point of sales data throughout fiscal 2006 and an estimate of inventory on hand at customers, we have provided for an estimate of returns as of November 30, 2006 of $3.3 million, which reduced net sales in our consolidated financial statements.
Net sales growth in the medicated skin care products category resulted from a 24% increase in the Gold Bond franchise. Gold Bond sales growth was attributable to 62%, 5% and 10% increases from the lotion, powder and cream lines, respectively, and was partially offset by lost sales from our discontinued first aid and antifungal foot swab products. The increase in sales from the Gold Bond lotion line of products was attributable to continued sales increases of Gold Bond Ultimate Healing Lotion and the introduction of Gold Bond Ultimate Softening Lotion in fiscal 2006. The increase in net sales of Gold Bond powder was due to continued growth of the medicated powder line. The overall sales growth in this category was offset by the 16% decline in sales resulting from the sale of pHisoderm effective November 30, 2005.
Net sales for the dietary supplements category improved primarily due to a 28% increase in Dexatrim led by the introduction of Dexatrim Max2O in fiscal 2006, which was partially offset by lost sales of the discontinued All-in-One Bar. Net sales of New Phase decreased due to the introduction in fiscal 2005 of New Phase Extra Strength.
Domestic net sales of our medicated dandruff shampoos increased 8% due to a full years sales of Selsun Salon, which was launched in the fourth quarter of fiscal 2005. This sales growth was partially offset by a slight reduction in sales of Selsun Blue.
The increase in net sales for the other OTC and toiletry products category was due primarily to sales increases of Pamprin and Bullfrog of 16% and 17%, respectively, led by the introduction of Pamprin MAX and Bullfrog Mosquito Coast, respectively. The sales growth was partially offset by sales decreases of Mudd, Prēmsyn and Benzodent.
Domestic sales variances were principally the result of changes in unit sales volumes with the exception of certain selected products, for which we implemented a unit sales price increase.
International Revenues
For fiscal 2006, international revenues decreased $2.7 million, or 10.2%, to $24.2 million from $26.9 million in fiscal 2005. The decrease was primarily due to the reduction of sales as a result of the divestiture of pHisoderm at the end of fiscal 2005 and the suspension of distribution in a single European market in 2005, partially offset by a full year sales of Icy Hot in Canada in 2006.
Cost of Sales
Cost of sales in fiscal 2006 increased $14.2 million, or 17.7%, to $94.0 million from $79.9 million in fiscal 2005. Cost of sales as a percentage of total revenues was 31.3% for fiscal 2006 as compared to 28.6% for fiscal 2005. The increase in cost of sales as a percentage of total revenues was primarily due to the launch of Icy Hot Pro-Therapy which has higher product costs than our other products. Based on Icy Hot Pro-Therapy performing below expectations and a review of our on hand inventory and purchase commitments outstanding as of November 30, 2006, we have recorded an estimate for obsolete inventory of $2.0 million, which increased cost of sales in our consolidated financial statements.
Advertising and Promotion Expense
Advertising and promotion expenses in fiscal 2006 increased $19.3 million, or 25.2%, to $96.1 million from $76.8 million in fiscal 2005 and were 32.0% of total revenues for fiscal 2006 compared to 27.5% for the comparable period of fiscal 2005. Support for new product introductions resulted in an increase in advertising and promotion expenditures in fiscal 2006 for Icy Hot Pro-Therapy, Selsun Salon and Bullfrog Mosquito Coast.
Selling, General and Administrative Expense
Selling, general and administrative expenses decreased $0.3 million, or 0.7%, to $47.0 million from $47.3 million in fiscal 2005. Selling, general and administrative expenses were 15.6% and 16.9% of total revenues for fiscal 2006 and fiscal 2005, respectively. The decrease was attributable to lower compensation expense in the current year related to payments associated with restricted stock grants in the prior year and an executive severance charge in fiscal 2005, offset in part by share-based compensation expense under SFAS 123R in fiscal 2006.
Litigation Settlement Charges
Litigation settlement for fiscal 2006 reflected the $8.8 million recovery from the DELACO settlement trust in the first quarter of 2006, the $10.7 million recovery from the settlement trust in the third quarter of 2006 in the Dexatrim litigation settlement and net legal expenses related to the Dexatrim litigation of $0.2 million, compared to the reversal of a charge of $6.0 million related to the Dexatrim litigation, $0.5 million reimbursement from the settlement trust for previously incurred administrative costs for the same period of fiscal 2005, offset by legal expenses and ephedrine-related claims of $4.4 million related to the settlement of Dexatrim litigation.
Interest Expense
Interest expense in fiscal 2006 decreased $2.1 million, or 15.1%, to $11.7 million from $13.8 million in fiscal 2005. The decrease was largely the result of reductions in outstanding debt as a result of the redemption of our $75.0 million Floating Rate Senior Notes on December 30, 2005. Until our indebtedness is reduced substantially, interest expense will continue to represent a significant percentage of our total revenues.
Loss on Early Extinguishment of Debt
Our $75.0 million of Floating Rate Senior Notes were fully redeemed in the first quarter of fiscal 2006, which resulted in a loss on early extinguishment of debt of $2.8 million. During fiscal 2005, we repurchased $17.5 million of our 7.0% Subordinated Notes, which resulted in a loss on early extinguishment of debt of $0.7 million.
Fiscal 2005 Compared to Fiscal 2004
To facilitate discussion of our operating results for the years ended November 30, 2005 and 2004, we have included the following selected data from our consolidated statements of income:
Domestic Net Sales
Domestic net sales for fiscal 2005 increased $18.4 million, or 7.9%, to $252.4 million from $234.0 million in fiscal 2004. For a description of each brand included in the following categories, see “Products” in Item 1 of this Form 10-K. A comparison of domestic net sales for the categories of products included in our portfolio of OTC healthcare products is as follows:
Net sales growth in the topical pain care category was led by 38% and 15% increases in sales of Aspercreme and Icy Hot, respectively. Aspercreme’s sales increase was driven by the launch of the Odor-Free Therapy Back and Body Patch. Icy Hot continued to benefit from the strength of the Icy Hot Back Patch and a full year of sales from the Medicated Sleeve. Net sales growth in this category also resulted from 15%, 9% and 2% sales increases in Capzasin, Sportscreme and Flexall, respectively. The overall sales growth in this category was partially offset by decreased sales of Arthritis Hot.
Net sales growth in the medicated skin care products category resulted from an 8% increase in the Gold Bond franchise. Gold Bond sales growth was attributable to 26%, 7%, 6% and 2% increases from the lotion, powder, foot care and cream lines, respectively, and was partially offset by lost sales from our discontinued first aid and antifungal foot swab products. The increase in sales from the Gold Bond lotion line of products was attributable to continued sales increases of Gold Bond Ultimate Healing Lotion. The increase in net sales of Gold Bond powder was driven by the launch of Gold Bond Ultimate Comfort Body Powder, and the sales increase of Gold Bond foot care products resulted from increased distribution. Although pHisoderm benefited from the launch of the new pH2O line, this line extension was more than offset by weakness in sales and lost distribution from its acne and base skin care business. The pHisoderm brand and related inventories were sold on November 30, 2005 to The Mentholatum Co., Inc.
Net sales for the dietary supplements category improved primarily due to 15% and 8% increases in New Phase and Garlique, respectively. Net sales of New Phase increased due to the introduction of New Phase Extra Strength, and Garlique sales benefited from an effective new advertising campaign. Dexatrim diet pill sales increased 30% due to the successful launch of Dexatrim Max, but were offset in part by declining sales of the Dexatrim All in One bar.
Domestic net sales of our medicated dandruff shampoos increased 11%, reflecting continued sales growth of Selsun Blue resulting from an effective advertising campaign and the launch of Selsun Salon in the fourth quarter of fiscal 2005.
The decrease in net sales for the other OTC and toiletry products category was due primarily to sales decreases of Pamprin, Bullfrog and Prēmsyn. The decreases in sales of Pamprin and Prēmsyn were primarily attributable to lost distribution with a major retailer. The 3% decrease in sales of Bullfrog was primarily attributable to unfavorable weather principally at the beginning of the suncare season and the timing and magnitude of returns in the fourth quarter of fiscal 2005. The decrease in sales was partially offset by sales growth of Sun-In, UltraSwim, Herpecin-L and Benzodent.
Domestic sales variances were principally the result of changes in unit sales volumes with the exception of certain selected products, for which we implemented a unit sales price increase.
International Revenues
For fiscal 2005, international revenues increased $2.7 million, or 11.3%, to $26.9 million from $24.1 million in fiscal 2004. The increase was primarily due to the introduction of Icy Hot in Canada and strengthening distributor sales in certain European and Middle Eastern countries offset in part by sales declines in the U.K. market.
Cost of Sales
Cost of sales in fiscal 2005 increased $6.5 million, or 8.9%, to $79.9 million from $73.4 million in fiscal 2004 due primarily to an increase in sales volume. Cost of sales as a percentage of total revenues was 28.6% for fiscal 2005 as compared to 28.4% for fiscal 2004. The increase in cost of sales as a percentage of total revenues was primarily due to increases in raw materials and transportation costs, offset in part by price increases for several products. It is anticipated that costs of sales may increase as a percentage of sales in fiscal 2006 as a result of the introduction of Icy Hot Pro-Therapy and Selsun Salon.
Advertising and Promotion Expense
Advertising and promotion expenses in fiscal 2005 increased $1.8 million, or 2.4%, to $76.8 million from $74.9 million in fiscal 2004 and were 27.5% of total revenues for fiscal 2005 compared to 29.0% for fiscal 2004. Support for new product introductions resulted in an increase in advertising and promotion expenditures in fiscal 2005 for Dexatrim, Aspercreme, Gold Bond powder, Bullfrog, New Phase and pHisoderm. The decrease in advertising and promotion expense as a percentage of total revenues was attributable to a more cost-effective use of advertising expenditures and higher sales.
Selling, General and Administrative Expense
Selling, general and administrative expenses increased $3.2 million, or 7.1%, to $47.3 million from $44.2 million in fiscal 2004. Selling, general and administrative expenses were 16.9% and 17.1% of total revenues for fiscal 2005 and 2004, respectively. An increase in sales was primarily responsible for higher selling expenses. In addition, freight expenses increased due to higher fuel costs. The increase in general and administrative expenses was largely a result of higher levels of product development expenses, compensation expense and insurance expense during fiscal 2005.
Executive Severance Charges
During the third quarter of fiscal 2005, we entered into a separation agreement with our former president and chief operating officer. In connection with the separation agreement, we incurred a $2.3 million executive severance charge consisting of a $0.9 million lump-sum cash payment and a $1.4 million non-cash charge as a result of accelerating the removal of restrictions on restricted stock.
Impairment of Indefinite-Lived Assets
As a result of a decline in sales and reforecasted expected future cash flows in the fourth quarter of fiscal 2004, we performed the impairment test as prescribed by SFAS 142 and determined that a revaluation was required for our Dexatrim
product line at November 30, 2004. We obtained an independent appraisal to determine the fair value of the indefinite-lived intangible asset related to this product line. As a result, we incurred an impairment charge of $20.0 million in the fourth quarter of fiscal 2004. No corresponding charge was incurred in fiscal 2005.
Loss on Product Divestures
During the fourth quarter of fiscal 2005, we sold the pHisoderm line of skin care products for a purchase price of $8.5 million plus inventories of approximately $1.1 million. As a result of this transaction, we recorded a loss on product divestures of $8.7 million in the fourth quarter of fiscal 2005.
Litigation Settlement Charges
Litigation settlement items decreased $17.9 million in fiscal 2005 to a gain of $2.1 million from an expense of $15.8 million in fiscal 2004. The change was principally due to a $6.0 million reversal of previously estimated costs related to the Dexatrim litigation, net of legal expenses, recorded in the second quarter of fiscal 2005 and reduced Dexatrim legal and administrative costs in fiscal 2005 compared to fiscal 2004.
Interest Expense
Interest expense in fiscal 2005 decreased $1.2 million, or 8.2%, to $13.8 million from $15.0 million in fiscal 2004. The decrease was largely the result of reductions in outstanding debt as a result of our repurchase of $17.5 million of our 7.0% Senior Subordinated Notes completed in the second quarter of fiscal 2005 and the remaining benefit from the debt refinancing completed during the first quarter of fiscal 2004. Until our indebtedness is reduced substantially, interest expense will continue to represent a significant percentage of our total revenues.
Loss on Early Extinguishment of Debt
During the second quarter of fiscal 2005, we repurchased $17.5 million of our 7.0% Senior Subordinated Notes, which resulted in a loss on early extinguishment of debt of $0.7 million. During the fourth quarter of fiscal 2005, we called our $75.0 million Floating Rate Senior Notes for full redemption on December 30, 2005. The $75 million of Floating Rate Senior Notes were fully redeemed on December 30, 2005. As a result of the redemption, a loss on early extinguishment of debt of $2.8 million was recorded in the first quarter of fiscal 2006.
Liquidity and Capital Resources
We have historically funded our operations with a combination of internally generated funds and borrowings. Our principal uses of cash are for operating expenses, servicing long-term debt, acquisitions, working capital, repurchases of our common stock, payment of income taxes and capital expenditures.
Cash of $54.4 million and $55.0 million was provided by operations in fiscal 2006 and 2005, respectively. Increased net income and reduced accounts receivable, due mainly to the receipt of cash from the sale of pHisoderm in 2005, was offset by increased inventory, due primarily to inventory related to Icy Hot Pro-Therapy, and a decrease in accounts payable and accrued liabilities.
Investing activities used cash of $6.8 million and $0.7 million in fiscal 2006 and 2005, respectively. The increase in the usage of cash was primarily due to proceeds received from the sale of our Selsun business in certain countries in Africa and Asia in fiscal 2005.
Financing activities used cash of $4.1 million and $46.5 million in fiscal 2006 and 2005, respectively. The decrease in cash used primarily was attributable to the sale of the $125.0 million Convertible Notes in fiscal 2006 and the sale of warrants for $18.6 million, which offset the payoff of the $75.0 million Floating Rate Senior Notes, the repurchase of $39.3 million of common stock and the purchase of the Convertible Note hedge for $32.0 million.
As of November 30, 2006, our total debt was $232.5 million, consisting of our 7.0% Subordinated Notes of $107.5 million and our Convertible Notes of $125.0 million. As of November 30, 2006, we had no borrowings outstanding under our Amended Revolving Credit Facility with available borrowings of up to $100.0 million. As of February 1, 2007, our total debt was $570.5 million, consisting of borrowings outstanding under our revolving credit facility under our Credit Facility totaling $38.0 million, $107.5 million of our 7.0% Subordinated Notes, $125.0 million of our Convertible Notes and a $300.0 million term loan under our Credit Facility. Borrowings under our revolving credit facility under the Credit Facility bear interest at LIBOR plus applicable percentages of 1.00% to 2.00% or a base
rate (the higher of the federal funds rate plus 0.5% or the prime rate) plus applicable percentages of 0.0% to 0.5% (8.25% as of November 30, 2006). The applicable percentages are calculated based on our leverage ratio. Borrowings under the term loan under our Credit Facility bear interest at LIBOR plus 1.75% or a base rate (the higher of the federal funds rate plus 0.5% or the prime rate) plus 0.75%. On March 8, 2004, we entered into an interest rate cap agreement effective June 1, 2004 with decreasing annual notional principal amounts of $15.0 million beginning March 1, 2006 and cap rates ranging from 4.0% to 5.0% over the life of the agreement. On November 22, 2006, we entered into an interest rate cap (the “forward starting cap”) and an interest rate swap (the “forward starting swap”), both with a future effective date of January 15, 2007. The forward starting cap has decreasing notional principal amounts beginning October 15, 2007 and a cap rate of 5.0% over the life of the agreement. The forward starting swap has decreasing notional principal amounts beginning October 15, 2007 and a swap rate of 4.98% over the life of the agreement.
On July 25, 2006, we successfully completed a consent solicitation from the holders of the 7.0% Subordinated Notes to an amendment to the indenture governing such notes to increase our capacity to make restricted payments by an additional $85.0 million, including payments for the repurchase of our common stock and adjust the fixed charge coverage ratio as defined in the indenture. In connection with the consent solicitation, our Board of Directors authorized the repurchase of up to an additional $100.0 million of our common stock under the terms of our existing stock repurchase program. During fiscal 2006, we repurchased 1,171,663 shares of our common stock for $39.3 million.
We believe that cash provided by operating activities, our cash and cash equivalents balance and funds available under our 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 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, 2006. We had no commercial obligations as of November 30, 2006:
Purchase orders or contracts for the purchase of inventory and other goods and services are not included in the table above. We are not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements. Our purchase orders are based on our current distribution needs and are fulfilled by our vendors within short time horizons. Other than as presented in the table above, we do not have significant agreements for the purchase of inventory or other goods specifying minimum quantities or set prices that exceed our expected requirements for three months.
Foreign Operations
Historically, our primary foreign operations have been conducted through our Canadian and United Kingdom (“U.K.”) subsidiaries. Since November 1, 2004, our European business has been conducted through Chattem Global Consumer Products Limited, a wholly-owned subsidiary located in Limerick, Ireland. The functional currencies of these subsidiaries are Canadian dollars, British pounds and Euros, respectively. Fluctuations in exchange rates can impact operating results, including total revenues and expenses, when translations of the subsidiary financial statements are made in accordance with SFAS No. 52, “Foreign Currency Translation”. For fiscal 2006 and 2005, these subsidiaries accounted for 8% of total revenues, respectively, and 4% of total assets, respectively. It has not been our practice to hedge our assets and liabilities in Canada, the U.K. and Ireland or our intercompany transactions due to the inherent risks associated with foreign currency hedging transactions and the timing of payments between us and our foreign subsidiaries. Following our acquisition of Selsun Blue, our international business operations have expanded significantly, which has increased our exposure to fluctuations in foreign exchange rates. During fiscal 2006, a portion of these foreign sales was reflected as royalties, which have been paid to us in
U.S. dollars. In addition, until July 2005 Abbott Laboratories (“Abbott”), from whom we acquired Selsun Blue, continued to supply a portion of our international supply of Selsun and billed us in U.S. dollars in certain instances. Beginning April 1, 2004, a portion of our international supply of Selsun was billed to us in local currencies. Historically, gains or losses from foreign currency transactions have not had a material impact on our operating results. An insignificant loss for the year ended November 30, 2006 and a gain of $0.2 million for the year ended November 30, 2005 resulted from foreign currency transactions and are included in selling, general and administrative expenses in the consolidated statements of income.
Recent Accounting Pronouncements
See note 2 of notes to consolidated financial statements included in Item 8 “Financial Statements and Supplementary Data.”
Forward Looking Statements
We may from time to time make written and oral forward-looking statements. Written forward-looking statements may appear in documents filed with the Securities and Exchange Commission, in press releases and in reports to shareholders or be made orally in publicly accessible conferences or conference calls. The Private Securities Litigation Reform Act of 1995 contains a safe harbor for forward-looking statements. We rely on this safe harbor in making such disclosures. These forward-looking statements generally can be identified by use of phrases such as “believe,” “plan,” “expect,” “anticipate,” “intend,” “forecast” or other similar words or phrases. These forward-looking statements relate to, among other things, our strategic and business initiatives and plans for growth or operating changes; our financial condition and results of operation; future events, developments or performance; and management’s expectations, beliefs, plans, estimates and projections. The forward-looking statements are based on management’s current beliefs and assumptions about expectations, estimates, strategies and projections. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. We undertake no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. Factors that could cause our actual results to differ materially from those anticipated in the forward-looking statements in this Form 10-K and the documents incorporated herein by reference include the following:
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the inability to successfully integrate the new brands into our portfolio of consumer brands or achieve other synergies associated with the acquisition;
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we have a significant amount of debt that could adversely affect our business and growth prospects;
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we face significant competition in the OTC healthcare, toiletries and dietary supplements markets;
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the possibility of product liability claims, including lawsuits alleging injury from the use of Dexatrim products containing ephedrine, which we discontinued manufacturing and shipping in September 2002, or from other products that we currently produce or may produce in the future;
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our product liability insurance coverage may be insufficient to cover existing or future liability claims;
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our acquisition strategy is subject to risk and may not be successful;
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our business is regulated by numerous federal, state and foreign governmental authorities, which subjects us to elevated compliance costs and risks of non-compliance;
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our success depends on our ability to anticipate and respond in a timely manner to changing consumer demands;
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we rely on a few large customers, particularly Wal-Mart Stores, Inc., for a significant portion of our sales;
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we may be adversely affected by fluctuations in buying decisions of mass merchandise, drug and food trade buyers and the trend toward retail trade consolidation;
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we rely on third party manufacturers for a portion of our product portfolio, including products under our Gold Bond, Icy Hot, Selsun, Dexatrim, ACT, Unisom and Cortizone brands;
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our dietary supplement business could suffer as a result of injuries caused by dietary supplements in general, unfavorable scientific studies or negative press;
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our business could be adversely affected if we are unable to successfully protect our intellectual property;
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because most of our operations are located in Chattanooga, Tennessee, we are subject to regional and local risks;
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we depend on sole or limited source suppliers for ingredients in certain of our products, and our inability to buy these ingredients would prevent us from manufacturing these products;
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we are subject to the risk of doing business internationally;
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the terms of our outstanding debt obligations limit certain of our activities;
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our operations are subject to significant environmental laws and regulations;
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we are dependent on certain key executives, the loss of whom could have a material adverse effect on our business;
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our shareholder rights plan and restated charter contain provisions that may delay or prevent a merger, tender offer or other change of control of us;
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the trading price of our common stock may be volatile; and
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other risks described in our Securities and Exchange Commission filings.
Item 7A.
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.
Our exposure to interest rate risk currently relates to amounts outstanding under our Amended Revolving Credit Facility. Loans under our Amended Revolving Credit Facility bear interest at LIBOR plus applicable percentages of 1.00% to 2.00% or a base rate (the higher of the federal funds rate plus 0.5% or the prime rate) plus applicable percentages of up to 0.5%. The applicable percentages are calculated based on our leverage ratio. As of November 30, 2006, no amounts were outstanding under the Amended Revolving Credit Facility. The 7.0% Subordinated Notes and the 2.0% Convertible Senior Notes are fixed interest rate obligations. On March 8, 2004, we entered into an interest rate cap agreement effective June 1, 2004 with decreasing annual notional principal amounts of $15.0 million beginning March 1, 2006 and cap rates ranging from 4.0% to 5.0% over the life of the agreement. The amortized value of the premium on the interest rate cap was compared to its fair value as of November 30, 2006 resulting in a loss of $0.3 million, reflected in the income statement as interest expense. As of November 30, 2006, the interest rate cap was deemed to be an ineffective cash flow hedge resulting in de-designation of the hedge. The interest rate cap agreement terminates on March 1, 2010. On November 22, 2006, we entered into a forward starting cap agreement effective January 15, 2007. The forward starting cap has decreasing notional principal amounts beginning October 15, 2007 and a cap rate of 5.0% over the life of the agreement. During the year ended November 30, 2006, the value of the premium on the forward starting cap was compared to the fair value of the forward starting cap and the change in the market value of the premium of $0.1 million, net of tax, was recorded to other comprehensive income. The forward starting cap agreement terminates on January 15, 2010. On November 22, 2006, we entered into a forward starting swap agreement effective January 15, 2007. The forward starting swap has decreasing notional principal amounts beginning October 15, 2007 and a swap rate of 4.98% over the life of the agreement. During the year ended November 30, 2006, the change in fair value of $0.5 million, net of tax, was recorded to other comprehensive income. The forward starting swap agreement terminates on January 15, 2010. The impact on our results of operations of a one-point rate change on the February 1, 2007 outstanding revolving credit facility balance of $38.0 million and $300.0 million term loan balance of our Credit Facility for the next twelve months would be approximately $2.2 million, net of tax.
We are subject to risk from changes in the foreign exchange rates relating to our Canadian, U.K. and Irish subsidiaries. Assets and liabilities of these subsidiaries are translated to U.S. dollars at year-end exchange rates. Income and expense items are translated at average rates of exchange prevailing during the year. Translation adjustments are accumulated as a separate component of shareholders’ equity. Gains and losses, which result from foreign currency transactions, are included in the consolidated statements of income. Until July 2005, Abbott continued to supply us with a portion of our international supply of Selsun and billed us in U.S. dollars in certain instances. Beginning April 1, 2004, a portion of our international supply of Selsun was billed to us in local currencies. The potential loss resulting from a hypothetical 10.0% adverse change in the quoted foreign currency exchange rate amounts to approximately $0.8 million as of November 30, 2006.
This market risk discussion contains forward-looking statements. Actual results may differ materially from this discussion based upon general market conditions and changes in financial markets.
Item 8.
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders Chattem, Inc.
We have audited the accompanying consolidated balance sheets of Chattem, Inc.(a Tennessee corporation) and subsidiaries (the “Company”) as of November 30, 2006 and 2005, and the related consolidated statements of income, shareholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Chattem, Inc. and subsidiaries as of November 30, 2006 and 2005, and the consolidated results of its operations and its consolidated cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
Our audits were conducted for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule titled “Schedule II - Valuation and Qualifying Accounts” is presented for purposes of additional analysis and is not a required part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Chattem, Inc. and subsidiaries’ internal control over financial reporting as of November 30, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 8, 2007 expressed an unqualified opinion on management’s assessment of, and the effectiveness of, internal control over financial reporting.
As discussed in Note 2 of the consolidated financial statements, the Company has adopted Financial Accounting Standards Board Statement No. 123(R), Share-Based Payments, in 2006.
/s/ GRANT THORNTON LLP
Charlotte, North Carolina
February 8, 2007
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
Chattem, Inc. and subsidiaries
We have audited the accompanying consolidated statements of income, shareholders’ equity and cash flows of Chattem, Inc. and subsidiaries for the year ended November 30, 2004. 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 audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Chattem, Inc. and subsidiaries for the year ended November 30, 2004, in conformity with U.S. generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Chattanooga, Tennessee
January 31, 2005, except for the section “Inventories” included in Note 2
as to which the date is February 17, 2006
Consolidated Balance Sheets
November 30, 2006 and 2005
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Consolidated Balance Sheets
November 30, 2006 and 2005
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Consolidated Statements of Income
For the Years Ended November 30, 2006, 2005 and 2004
(In thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
Consolidated Statements of Shareholders’ Equity
For the Years Ended November 30, 2006, 2005 and 2004
(In thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
Consolidated Statements of Cash Flows
For the Years Ended November 30, 2006, 2005 and 2004
(In thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
Notes to Consolidated Financial Statements
All monetary and share amounts are expressed in thousands. Our fiscal years ended November 30, 2004, November 30, 2005 and November 30, 2006 are referred to herein as fiscal 2004, fiscal 2005 and fiscal 2006, respectively.
(1) NATURE OF OPERATIONS
Chattem, Inc. and its wholly-owned subsidiaries (“we”, “us”, “our” or “Chattem”) 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 (“U.S.”) and in various markets in approximately 80 countries throughout the world.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of Chattem and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated.
CASH AND CASH EQUIVALENTS
We consider all short-term deposits and investments with original maturities of three months or less to be cash equivalents. Short-term cash investments are placed with high credit-quality financial institutions or in low risk, liquid instruments.
INVENTORIES
Inventory costs include materials, labor and factory overhead. Inventories are valued at the lower of cost using the first-in, first-out (“FIFO”) method or market. During the quarter ended November 30, 2005, our domestic operations changed the method of accounting for the cost of inventories from the last-in, first-out (LIFO) method to FIFO. We estimate reserves for inventory obsolescence based on our judgment of future realization. Based on consideration of Icy Hot Pro-Therapy performing below expectations and reviewing our on-hand inventory and purchase commitments outstanding as of November 30, 2006, we provided for an estimate for obsolete inventory of $1,983, which is included as a component of cost of sales in the accompanying consolidated financial statements.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of 7 to 40 years for buildings and improvements and 3 to 15 years for machinery and equipment. Expenditures for maintenance and repairs are charged to expense as incurred. Depreciation expense for fiscal 2006, fiscal 2005 and fiscal 2004 was $4,191, $3,961 and $3,941 respectively.
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.
The provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), require certain fair-value-based tests of the carrying value of indefinite-lived intangible assets at least annually.
Under SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets”, we evaluate whether events and circumstances have occurred that indicate the remaining useful life of finite-lived assets might warrant revision or that the remaining balance may not be recoverable. When factors indicated that finite-lived assets should have been evaluated for
possible impairment, we used an estimate of the future undiscounted net cash flows of the related assets over the remaining lives of the assets in measuring whether the carrying values of finite-lived assets were recoverable.
DEBT ISSUANCE COSTS
We have incurred debt issuance costs in connection with our long-term debt. These costs are capitalized and amortized over the term of the related debt. Amortization expense related to debt issuance costs was $693, $727 and $843 in fiscal 2006, fiscal 2005 and fiscal 2004, respectively. Accumulated amortization of these costs was $1,356 and $689 at November 30, 2006 and 2005, respectively. Due to the redemption of our $75,000 of Floating Rate Senior Notes on December 30, 2005, we recorded a loss on early extinguishment of debt of $2,805. Due to our refinancing transactions (described in Note 5) in fiscal 2004, tender premiums and related fees of $7,861 were paid and net debt issuance costs of $5,097 were written off and charged to loss on early extinguishment of debt in the accompanying consolidated statements of income. In addition, during fiscal 2004 new debt issuance costs of $5,743 were capitalized. In connection with our refinancing transactions (described in Note 5) in fiscal 2005, a loss on early extinguishment of debt was recorded to the consolidated statements of income of $750. On July 25, 2006, we successfully completed the consent solicitation from the holders of the 7.0% Subordinated Notes resulting in a consent fee of $5,619, which is being amortized as additional interest expense through 2014, the remaining term of the 7.0% Subordinated Notes. On November 22, 2006, we completed a private offering of $125,000 of Convertible Senior Notes due 2013 resulting in the capitalization of additional debt issuance costs of $3,465, which is being amortized as additional interest expense through 2013.
BANK OVERDRAFT
Bank overdraft represents outstanding checks in excess of current cash levels. We fund bank overdrafts from our short-term investments and our operating cash flows.
PRODUCT DEVELOPMENT
Product development costs relate primarily to the development of new products and are expensed as incurred. Such expenses were $4,241, $3,618 and $3,051 in fiscal 2006, 2005 and 2004, 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 fiscal 2006, 2005 and 2004 was $64,411, $53,096 and $54,263, respectively. At November 30, 2006 and 2005, we reported $2,096 and $2,087, respectively, of advertising paid for in fiscal 2006 and fiscal 2005, which will run or did run in the next fiscal year. These amounts are included in prepaid expenses and other current assets in the accompanying consolidated balance sheets.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of our Canadian, United Kingdom (“U.K.”) and Irish subsidiaries are translated to U.S. dollars at year-end exchange rates. Income and expense items are translated at average rates of exchange prevailing during the year. Translation adjustments are accumulated as a separate component of shareholders’ equity. Gains (losses) which result from foreign currency transactions amounted to ($21), $189 and $194 in fiscal 2006, 2005 and 2004, respectively, and are included in the accompanying consolidated statements of income as investment and other income, net of expense.
USE OF ESTIMATES
The preparation of financial statements in accordance 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 disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Several different estimates or methods can be used by management that might yield different results. The following are the significant estimates used by management in the preparation of the consolidated financial statements for fiscal 2006, 2005 and 2004.
Allowance For Doubtful Accounts
As of November 30, 2006, an estimate was made of the collectibility of the outstanding accounts receivable balances. This estimate requires the utilization of outside credit services, knowledge about the customer and the customer’s industry, new developments in the customer’s industry and operating results of the customer as well as general economic conditions and historical trends. When all these facts are compiled, a judgment as to the collectibility of the individual account is made. Many factors can impact this estimate, including those noted in this paragraph. The adequacy of the estimated allowance may be impacted by the deterioration in the financial condition of a large customer, weakness in the economic environment resulting in a higher level of customer bankruptcy filings or delinquencies and the competitive environment in which the customer operates. During the year ended November 30, 2006, we performed a detailed assessment of the collectibility of trade accounts receivable and increased our estimate of allowance for doubtful accounts by approximately $43, which resulted in an increase to selling, general and administrative expense in the accompanying consolidated statement of income. The balance of allowance for doubtful accounts was $346, $303 and $750 at November 30, 2006, 2005 and 2004, respectively.
Revenue Recognition
Revenue is recognized when our products are shipped and title transfers to our customers. It is generally our policy across all classes of customers that all sales are final. As is common in the consumer products industry, customers return products for a variety of reasons including products damaged in transit, discontinuance of a particular size or form of product and shipping errors. As sales are recorded, we accrue an estimated amount for product returns, as a reduction of these sales, based upon our historical experience and consideration of discontinued products, product divestitures, estimated inventory levels held by our customers and retail point of sale data on existing and newly introduced products. The level of returns may fluctuate from our estimates due to several factors including weather conditions, customer inventory levels and competitive conditions. We charge the allowance account for product returns when the customer provides appropriate supporting documentation that the product is properly destroyed or upon receipt of the product.
We separate returns into the two categories of seasonal and non-seasonal products. We use the historical return detail of seasonal and non-seasonal products for at least the most recent three fiscal years on generally all products, which is normalized for any specific occurrence that is not reasonably likely to recur, to determine the amount of product returned as a percentage of sales, and estimate an allowance for potential returns based on product sold in the current period. To consider product sold in current and prior periods, an estimate of inventory held by our retail customers is calculated based on customer inventory detail. This estimate of inventory held by our customers, along with historical returns as a percentage of sales, is used to determine an estimate of potential product returns. This estimate of the allowance for seasonal and non-seasonal returns is further analyzed by considering retail customer point of sale data. We also consider specific events, such as discontinued product or product divestitures, when determining the adequacy of the allowance. Our estimate of product returns for seasonal and non-seasonal products as of November 30, 2006 was $1,204 and $1,321, respectively, $248 and $647, respectively, as of November 30, 2005 and $450 and $65, respectively, as of November 30, 2004. As of November 30, 2006 and November 30, 2005, estimated returns of pHisoderm product was $287 and $650, respectively, due to our November 30, 2005 divestiture of this brand. Based on consideration of the sales of Icy Hot Pro-Therapy performing below expectations, review of retail point of sales data throughout fiscal 2006 and an estimate of inventory on-hand at customers, we have estimated returns as of November 30, 2006 of $3,339, which decreased net sales in the accompanying consolidated statements of income. As a result of higher sales volumes in fiscal 2006, we increased our estimate of seasonal returns by $956, which resulted in a decrease to net sales in the accompanying consolidated statements of income. For fiscal 2005 and 2004, we decreased our estimate of seasonal returns by approximately $202 and $934, respectively, which resulted in an increase to net sales in the accompanying consolidated statements of income. During the fiscal years ended November 30, 2006 and 2005, as a result of our estimate of customer inventory levels, historical non-seasonal product returns and retail point of sale data, we increased our estimate of non-seasonal returns by approximately $674 and $582, respectively, which resulted in a decrease to net sales in the accompanying consolidated statements of income. During fiscal 2004, we decreased our estimate of non-seasonal returns by approximately $765, which resulted in an increase to net sales in the accompanying consolidated statements of income. Each percentage point change in the seasonal return rate would impact net sales by approximately $195. Each percentage point change in the non-seasonal return rate would impact net sales by approximately $437.
We routinely enter into agreements with customers to participate in promotional programs. The cost of these programs is recorded as either advertising and promotion expense or as a reduction of sales as prescribed by Emerging Issues Task Force 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)”. A significant portion of the programs are recorded as a reduction of sales and generally take the form of coupons and vendor allowances, which are normally taken via temporary price reductions, scan downs, display activity and
participations in in-store programs provided uniquely by the customer. We also enter into cooperative advertising programs with certain customers, the cost of which is recorded as advertising and promotion expense. In order for retailers to receive reimbursement under such programs, the retailer must meet specified advertising guidelines and provide appropriate documentation of the advertisement being run. During fiscal 2006 and 2005, our cooperative advertising reimbursements did not exceed the fair value of the benefits received under those programs.
We analyze promotional programs in two primary categories -- coupons and vendor allowances. Customers normally utilize vendor allowances in the form of temporary price reductions, scan downs, display activity and participations in in-store programs provided uniquely by the customer. We estimate the accrual for outstanding coupons by utilizing a third-party clearinghouse to track coupons issued, coupon value, distribution and expiration dates, quantity distributed and estimated redemption rates that are provided by us. We estimate the redemption rates based on internal analysis of historical coupon redemption rates and expected future retail sales by considering recent point of sale data. The estimate for vendor allowances is based on estimated unit sales of a product under a program and amounts committed for such programs in each fiscal year. Estimated unit sales are determined by considering customer forecasted sales, point of sale data and the nature of the program being offered. The three most recent years of expected program payments versus actual payments made and current year retail point of sale trends are analyzed to determine future expected payments. Customer delays in requesting promotional program payments due to their audit of program participation and resulting request for reimbursement is also considered to evaluate the accrual for vendor allowances. The costs of these programs is often variable based on the number of units actually sold. As of November 30, 2006, the coupon and vendor allowances accruals were $1,236 and $3,718, respectively, $566 and $1,079, respectively, as of November 30, 2005 and $1,264 and $1,924, respectively, as of November 30, 2004. Each percentage point change in promotional program participation would impact net sales by approximately $157 and advertising and promotion expense by an insignificant amount.
Income Taxes
We account for income taxes using the asset and liability approach as prescribed by SFAS No. 109, “Accounting for Income Taxes”. This approach requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Using the enacted tax rates in effect for the year in which the differences are expected to reverse, deferred tax assets and liabilities are determined based on the differences between the financial reporting and the tax basis of an asset or liability. We record income tax expense in our consolidated financial statements based on an estimated annual effective income tax rate. Our estimated annual effective income tax rate during fiscal 2006 was 35%, as compared to 32% in fiscal 2005 and 33% in fiscal 2004, as a result of lower deductions for charitable contributions and greater apportionment in states with higher statutory tax rates.
DERIVATIVE FINANCIAL INSTRUMENTS
We entered into an interest rate cap agreement effective June 1, 2004 as a means of managing our interest rate exposure and not for trading purposes. In accordance with SFAS 133, Accounting for Derivative Instruments and Hedging Activities, as of November 30, 2006, the interest rate cap was deemed to be an ineffective cash flow hedge due to the reduction of variable rate debt resulting in a loss of $257, net of tax, reflected in the income statement as interest expense.
On November 10, 2006, we entered into a forward starting interest rate cap agreement effective January 15, 2007 as a means of managing our interest rate exposure and not for trading purposes. We paid a $687 premium to enter into the forward starting cap agreement, which will be amortized over the life of the agreement. In accordance with SFAS 133, as of November 30, 2006, the forward starting cap was deemed to be an effective cash flow hedge and the value of the premium on the forward starting cap was compared to the fair value of the forward starting cap and the change in the market value of the premium of $104, net of tax, was recorded to other comprehensive income.
On November 10, 2006, we entered into a forward starting interest rate swap agreement effective January 15, 2007 as a means of managing our interest rate exposure and not for trading purposes. In accordance with SFAS 133, as of November 30, 2006, the forward starting swap was deemed to be an effective cash flow hedge and the change in fair value of $493, net of tax, was recorded to other comprehensive income.
CONCENTRATIONS OF CREDIT RISK
Financial instruments, which subject us to concentrations of credit risk, consist primarily of accounts receivable and short-term cash investments. Our exposure to credit risk associated with nonpayment of accounts receivable is affected by conditions or occurrences within the retail industry. As a result, we perform ongoing credit evaluations of our customers’ financial position but generally require no collateral from our customers. Our largest customer accounted for 36%, 36% and 34% of consolidated sales in fiscal 2006, 2005 and 2004, respectively. No other customer exceeded 10% of our consolidated sales during the period. Shoppers Drug Mart, a Canadian retailer, accounts for more than 10% of our international revenues. Our ten largest customers represented approximately 73% of total revenues during fiscal 2006, and approximately 71% of our total accounts receivable at November 30, 2006.
OTHER CONCENTRATIONS
We purchase raw materials and packaging materials from a number of third party suppliers primarily on a purchase order basis. Except for pamabrom, pyrilamine maleate and compap, active ingredients used in our Pamprin and Prēmsyn PMS products, we are not limited to a single source of supply for the ingredients used in the manufacture of our products. Net sales of Pamprin and Prēmsyn PMS products in fiscal 2006 represented approximately $12,788 of our consolidated total revenues in that year. In addition, we have a limited source of supply for selenium sulfide, the active ingredient in Selsun Blue. As a result of the limited supply and increase in worldwide demand, prices have been and are expected to be volatile. We believe that our current sources of supply and potential alternative sources will be adequate to meet future product demands.
SHIPPING AND HANDLING COSTS
Shipping and handling costs of $8,947, $7,998, and $7,482 for fiscal 2006, 2005 and 2004, respectively, are included in selling expenses in our consolidated statements of income.
STOCK-BASED COMPENSATION
We currently provide stock-based compensation under five stock incentive plans that have been approved by our shareholders. Our 1998 Non-Statutory Stock Option Plan provides for the issuance of up to 1,400 shares of common stock to key employees while the 1999 Non-Statutory Stock Option Plan for Non-Employee Directors allows for the issuance of up to 200 shares of common stock. The 2000 Non-Statutory Stock Option Plan provides for the issuance of up to 1,500 shares of common stock. The 2003 and 2005 Stock Incentive Plans both provide for the issuance of up to 1,500 shares of common stock. Stock options granted under all of these plans generally vest over four years from the date of grant as specified in the plans or by the compensation committee of our board of directors and are exercisable for a period of up to ten years from the date of grant.
Effective December 1, 2005, we adopted SFAS 123R, using the modified prospective method. SFAS 123R requires the recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements and is measured based on the grant date fair value of the award. SFAS 123R also requires the stock option compensation expense to be recognized over the period during which an employee is required to provide service in exchange for the award (the vesting period). Prior to our adopting SFAS 123R, we accounted for our stock-based compensation plans under APB 25 and adopted the disclosure-only provision of SFAS 123. Under APB 25, generally no compensation expense is recorded when the terms of the award are fixed and the exercise price of the employee stock option equals or exceeds the fair value of the underlying stock on the date of grant.
For fiscal 2006, we recorded compensation expense related to stock options that reduced income from operations by $4,745, provision for income taxes by $1,656, net income by $3,089 and basic and diluted income per share by $0.16. The stock option compensation expense was included partly in cost of sales, advertising and promotion expenses and selling, general and administrative expenses in the accompanying consolidated statements of income. We capitalized $137 of stock options compensation cost as a component of the carrying cost of inventory on-hand as of November 30, 2006.
On October 27, 2005, the compensation committee of our board of directors approved the immediate acceleration of vesting for all unvested outstanding stock options granted under our 2005 Non-Statutory Stock Option Plan whose exercise price exceeded the closing sale price of the shares of our common stock on the last business day prior to November 30, 2005, the effective date of the acceleration. As a result, options to purchase approximately 436 shares, including options to purchase approximately 260 shares held by our executive officers, became immediately exercisable.
The decision to accelerate vesting of these options was made primarily to minimize future compensation expense that we would otherwise recognize in our consolidated statements of income upon effectiveness of SFAS 123R. As a result of the acceleration, stock option expense will be reduced by approximately $6,603, $4,292 net of tax, over the next three fiscal years.
For options granted subsequent to our SFAS 123R adoption date of December 1, 2005, the fair value of each stock option grant was estimated on the date of grant using a Flex Lattice Model. For options granted prior to our adoption date of SFAS 123R, we used the Black-Scholes option pricing model. The following assuptions were used to determine the fair value of stock option grants:
Had compensation expense for stock option grants been determined based on the fair value at the grant dates consistent with the method prescribed by SFAS 123, our net income (loss) and net income (loss) per share would have been adjusted to the pro forma amounts for fiscal 2005 and 2004 as indicated below:
RECLASSIFICATIONS AND ADJUSTMENTS
Certain prior year amounts have been reclassified to conform to the current period’s presentation. The accrual for vendor allowances of $3,718 and $1,079 as of November 30, 2006 and 2005, respectively, which was included as a component of accrued liabilities, has been reclassified as a reduction of accounts receivable and is included as a component of the allowance of $10,907 and $3,417 that reduces accounts receivable as of November 30, 2006 and 2005, respectively, to the estimated net realizable value.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). SFAS 123R supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and amends SFAS No. 95, “Statement of Cash Flows”. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions and requires all share-based payments to employees, including grants of employee stock options, to be recognized as additional compensation expense in the financial statements based on the calculated fair value of the awards. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation costs to be reported as a financing cash flow. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. We adopted SFAS 123R effective for our fiscal year beginning December 1, 2005. We have described the impact of adopting SFAS 123R in our consolidated financial statements in Note 2, Stock-Based Compensation.
The American Jobs Creation Act of 2004 (the “AJCA”) was enacted on October 22, 2004. The AJCA repeals an export incentive, creates a new deduction for qualified domestic manufacturing activities and includes a special one-time deduction of 85% of certain foreign earnings repatriated to the U.S.
In December 2004, the FASB issued FASB Staff Position No. 109-1, “Application of FASB Statement No. 109 (“SFAS 109”), Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (“FSP 109-1”). FSP 109-1 clarifies that the manufacturer’s deduction provided for under the AJCA should be accounted for as a special deduction in accordance with SFAS 109 and not as a tax rate reduction. In accordance with FSP 109-1, we treat the deduction for qualified domestic manufacturing activities, which became effective beginning December 1, 2005, as a reduction of the income tax provision in future years when realized.
In July 2006, FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 provides guidance on the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006, or our fiscal year beginning December 1, 2007. We are evaluating the impact of adopting FIN 48 on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 provides guidance for using fair value to measure assets and liabilities and is intended to respond to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. SFAS 157 also requires expanded disclosure of the effect on earnings for items measured using unobservable data, establishes a fair value hierarchy that prioritizes the information used to develop those assumptions and requires separate disclosure by level within the fair value hierarchy. The provisions of SFAS 157 are effective for interim financial statements issued for fiscal years beginning after November 15, 2007, or our fiscal 2008.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans -- An Amendment of FASB Statements No. 87, 88, 106, and 132R” (“SFAS 158”). SFAS 158 requires an employer to recognize in its balance sheet an asset or liability for a plan’s funded status, measure a plan’s assets and obligations as of the end of the employer’s fiscal year and recognize changes in the funded status in the year in which the changes occur. SFAS 158 also enhances the current disclosure requirements for pension and other postretirement plans to include disclosure related to certain effects on net periodic benefit cost. The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 15, 2006, or
our fiscal 2007. The requirement to measure plan assets and benefit obligations as of the employer’s fiscal year-end is effective for fiscal years ending after December 15, 2008, or our fiscal 2009.
In September 2006, the Securities and Exchange Commission released Staff Accounting Bulletin 108 (“SAB 108”). SAB 108 provides interpretative guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for fiscal years ending after November 15, 2006. SAB 108 did not have an impact on our financial statements.
(3) SHAREHOLDERS’ EQUITY
COMPUTATION OF EARNINGS PER SHARE
The following table presents the computation of per share earnings for the years ended November 30, 2006, 2005 and 2004, respectively:
(1) Because their effects are anti-dilutive, excludes shares issuable under stock option plans and restricted stock issuance whose grant price was greater than the average market price of common shares outstanding as follows: 797 shares in fiscal 2006, 267 shares in fiscal 2005 and 303 shares in fiscal 2004.
STOCK OPTIONS
We have granted stock options to key employees and non-employee directors under the plans described in Note 2. A summary of the activity of stock options during fiscal 2006, 2005 and 2004 is presented below:
As of November 30, 2006, the aggregate intrinsic value of stock options outstanding was $41,543 and the weighted average remaining contractual life was six years. The aggregate intrinsic value of stock options exercisable was $26,985 and the weighted average remaining contractual life was six years.
As of November 30, 2006, we had $8,770 of unrecognized compensation cost related to stock options that will be recorded over a weighted average period of approximately two years.
A summary of the exercise prices for options outstanding under our stock-based compensation plans at November 30, 2006 is presented below:
PREFERRED SHARES
We are authorized to issue up to 1,000 preferred shares in series and with rights established by the board of directors. At November 30, 2006 and 2005, no shares of any series of preferred stock were issued and outstanding.
STOCK REPURCHASE
On July 25, 2006, we successfully completed a consent solicitation from the holders of the 7% Subordinated Notes to an amendment to the indenture to increase our capacity to make restricted payments by an additional $85.0 million, including payments for the repurchase of our common stock and adjust the fixed charge coverage ratio as defined in the indenture. In connection with the consent solicitation, our Board of Directors authorized the repurchase of up to an additional $100.0 million of our common stock under the terms of our existing stock repurchase program.
In fiscal 2006, 1,172 shares were repurchased at a cost of $39,332, in fiscal 2005, 882 shares at a cost of $34,084 were repurchased and 191 shares at a cost of $5,034 were repurchased in fiscal 2004. The repurchased shares were retired and returned to unissued. As of February 1, 2007, the current amount available under the authorization from the Board of Directors was $88,147.
SHAREHOLDER RIGHTS PLAN
On January 26, 2000, our 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 our common stock, without par value, 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 our 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 our common stock. If the rights are triggered, the resulting issued shares would be included in the calculation of diluted earnings per share. The rights will expire on February 11, 2010. As of November 30, 2006, no person or group has acquired beneficial ownership of 15% of our common stock, therefore, no rights have been exercised.
RESTRICTED STOCK ISSUANCE
We issued 50 and 70 restricted shares of common stock to certain employees in fiscal 2005 and 2004, respectively. The market value of these shares on the dates of issuance was $1,769 and $1,399 in fiscal 2005 and 2004, respectively. These amounts are being amortized using the straight-line method over respective four year periods from the date of issuance as additional compensation expense. Amortization was $712, $825 and $1,071 in fiscal 2006, 2005 and 2004, respectively, with the unamortized value of $1,000 and $1,818 being included as a component of shareholders’ equity in the November 30, 2006 and 2005 consolidated balance sheets, respectively. The shares issued in fiscal 2005 and 2004 reduced the number of shares available for issuance under our 2003 Stock Incentive Plan. No restricted shares of common stock were issued in fiscal 2006.
A summary of our nonvested restricted stock activity as of November 30, 2006 is presented below:
Effective September 1, 2005, our former president and chief operating officer, A. Alexander Taylor II, resigned his positions with the Company, after which Robert E. Bosworth assumed responsibility for both positions. In connection with such resignation, Mr. Taylor and the Company entered into a separation agreement, which, among other things, included accelerated removal of restrictions on a portion of his restricted stock, which resulted in a $1,360 non-cash charge in fiscal 2005.
(4) PATENT, TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS
We account for intangible assets within the provisions of SFAS 142. In fiscal 2004, we performed the impairment test as prescribed by SFAS 142 and determined that a revaluation was required for our Dexatrim product line at November 30, 2004. We obtained an independent appraisal to determine the fair value of the indefinite-lived intangible asset related to this product line. As a result, we incurred an impairment charge of $20,000, which is included in our consolidated statement of income for fiscal 2004. During fiscal 2006 and fiscal 2005, we performed impairment testing of our intangible assets as prescribed by SFAS 142. The valuations indicated no impairment. The carrying value of trademarks, which are not subject to amortization under the provisions of SFAS 142, was $205,983 as of November 30, 2006 and November 30, 2005, respectively.
The gross carrying amount of intangible assets subject to amortization at both November 30, 2006 and November 30, 2005, which consist primarily of non-compete agreements, was $2,139, respectively. The related accumulated amortization of these intangible assets at November 30, 2006 and November 30, 2005, was $1,973 and $1,735, respectively. Amortization of our intangible assets subject to amortization under the provisions of SFAS 142 was $238, $251 and $294 for fiscal 2006, 2005 and 2004, respectively. Estimated annual amortization expense for these assets for fiscal 2007, 2008, 2009, 2010 and 2011 is $106, $40, $20, $0 and $0, respectively. Royalty expense related to other purchased product rights for fiscal 2006, 2005 and 2004 was $78, $112 and $107, respectively. Amortization and royalty expense are included in advertising and promotion expense in the accompanying consolidated statements of income.
(5) LONG-TERM DEBT
Long-term debt consisted of the following as of November 30, 2006 and 2005:
On February 26, 2004, we entered into a new Senior Secured Revolving Credit Facility with a maturity date of February 26, 2009 (the “Revolving Credit Facility”) with Bank of America, N.A. that provided an initial borrowing capacity of $25,000 and an additional $25,000, subject to successful syndication. On March 9, 2004, we entered into a new commitment agreement with a syndicate of commercial banks led by Bank of America, N.A., as agent, that enabled us to borrow up to a total of $50,000 under the Revolving Credit Facility and an additional $50,000, subject to successful syndication. On November 29, 2005, we entered into an amendment to our Revolving Credit Facility (the “Amended Revolving Credit Facility”) that, among other things, increased our borrowing capacity under the facility from $50,000 to $100,000, increased our flexibility to repurchase shares of our stock, improved our borrowing rate under the facility and extended the maturity date to November 15, 2010. Upon successful syndication, we are able to increase the borrowing capacity under the Amended Revolving Credit Facility by $50,000 to an aggregate of $150,000. On November 16, 2006, we entered into an amendment to our Amended Revolving Credit Facility that, among other things, permitted the sale of the Convertible Notes. On January 2, 2007, we completed an amended credit facility providing for up to a $100,000 revolving credit facility and a $300,000 term loan (the “Credit Facility”). The proceeds from the term loan under the Credit Facility were used to finance in part the acquisition of the five consumer and OTC brands from Johnson & Johnson. The Credit Facility includes an “accordian” feature that permits us under certain circumstances to increase our borrowings under the revolving credit facility by $50,000 and to borrow an additional $50,000 as a term loan.
Borrowings under our Amended Revolving Credit Facility bear interest at LIBOR plus applicable percentages of 1.0% to 2.0% or a base rate (the higher of the federal funds rate plus 0.5% or the prime rate) plus applicable percentages up to 0.5%. The applicable percentages are calculated based on our leverage ratio. As of November 30, 2006 and 2005, there were no borrowings outstanding under the Amended Revolving Credit Facility, and the variable rate was 8.25% and 7.00%, respectively. Borrowings under our Amended Revolving Credit Facility are secured by substantially all of our assets, except real property, and shares of capital stock of our domestic subsidiaries held by us and by the assets of the guarantors (our domestic subsidiaries). The Amended Revolving Credit Facility contains covenants, representations, warranties and other agreements by us that are customary in credit agreements and security instruments relating to financings of this type. The significant financial covenants include fixed charge coverage ratio, leverage ratio, senior secured leverage ratio, net worth and brand value calculations. As of February 1, 2007, we had $38,000 of borrowings outstanding under the revolving credit facility under our Credit Facility and our borrowing capacity was $62,000.
On February 26, 2004, we issued and sold $75,000 of Floating Rate Senior Notes due March 1, 2010 (the “Floating Rate Senior Notes”) and $125,000 of 7.0% Subordinated Notes due 2014, the proceeds of which were used to purchase the outstanding $204,538 of our 8.875% Senior Subordinated Notes due 2008 on February 26, 2004 and April 1, 2004 and refinance our then existing credit facility. The repurchases resulted in a loss on early extinguishment of debt of $12,958.
On March 8, 2004, we entered into an interest rate cap agreement effective June 1, 2004 with decreasing annual notional principal amounts of $15,000 beginning March 1, 2006 and cap rates ranging from 4.0% to 5.0% over the life of the agreement. We paid a $1,375 premium to enter into the interest rate cap agreement, which will be amortized over the life of the agreement. As of November 30, 2006, increases in the variable interest rate of up to $60,000 of LIBOR based borrowings could be hedged under the provisions of the cap. We had $0 of LIBOR based borrowings with an interest rate capped at 4.0% as of November 30, 2006. During the year ended November 30, 2006, the amortized value of the premium on the interest rate cap was compared to the fair value of the interest rate cap and the change in the market value of the premium of $312, was recorded as a component of interest expense on the accompanying consolidated statement of income. The current portion of the premium on the interest rate cap agreement of $284 is included in prepaid expenses and other current assets, and the long-term portion of $484 is included in other non-current assets. As of November 30, 2006, the interest rate cap was deemed to be an ineffective cash flow hedge resulting in de-designation. A loss of $27 from other comprehensive income was reflected in the income statement as interest expense. The fair value of the interest rate cap agreement is valued by a third party. The interest rate cap agreement terminates on March 1, 2010.
Interest payments on the 7.0% Subordinated Notes are due semi-annually in arrears on March 1 and September 1. Our domestic subsidiaries are guarantors of the 7.0% Subordinated Notes. The guarantees of the 7.0% Subordinated Notes are unsecured senior subordinated obligations of the guarantors. At any time after March 1, 2009, we may redeem any of the 7.0% Subordinated Notes upon not less than 30 nor more than 60 days’ notice at redemption prices (expressed in percentages of principal amount), plus accrued and unpaid interest, if any, and liquidation damages, if any, to the applicable redemption rate, if redeemed during the twelve-month periods beginning March 1, 2009 at 103.500%, March 1, 2010 at 102.333%, March 1, 2011 at 101.167% and March 1, 2012 and thereafter at 100.000%. At any time prior to March 1, 2007, we may redeem up to 35% of the aggregate principal amount of the 7.0% Subordinated Notes (including any additional 7.0% Subordinated Notes) at a redemption price of 107.0% of the principal amount thereof, plus accrued and unpaid interest and liquidated damages, if any, thereon to the applicable redemption rate, with the net cash proceeds of one or more qualified equity offerings; provided, that (i) at least 65.0% of the aggregate principal amount of the 7.0% Subordinated Notes remains outstanding immediately after the occurrence of such redemption (excluding the 7.0% Subordinated Notes held by us and our subsidiaries); and (ii) the redemption must occur within 90 days of the date of the closing of such qualified equity offering.
The indenture governing the 7.0% Subordinated Notes, among other things, limits our ability and the ability of our restricted subsidiaries to: (i) borrow money or sell preferred stock, (ii) create liens, (iii) pay dividends on or redeem or repurchase stock, (iv) make certain types of investments, (v) sell stock in our restricted subsidiaries, (vi) restrict dividends or other payments from restricted subsidiaries, (vii) enter into transactions with affiliates, (viii) issue guarantees of debt and (ix) sell assets or merge with other companies. In addition, if we experience specific kinds of changes in control, we must offer to purchase the 7.0% Subordinated Notes at 101.0% of their principal amount plus accrued and unpaid interest.
During fiscal 2005, we repurchased $17,500 of our 7.0% Subordinated Notes in the open market at an average premium of 1.6% over the principal amount of the notes. The repurchases resulted in a loss on early extinguishment of debt, including related expenses of $750. The outstanding balance of the remaining 7.0% Subordinated Notes was reduced to $107,500.
On November 30, 2005, we called our $75,000 of Floating Rate Senior Notes for full redemption on December 30, 2005. On December 30, 2005, we fully redeemed our $75,000 of Floating Rate Senior Notes at a price of 102% of par plus accrued interest to December 30, 2005. We utilized borrowings of $38,000 under our Amended Revolving Credit Facility and $38,948 of our cash on hand to fund the redemption of the Floating Rate Senior Notes. As a result of the redemption, we paid a 2% premium over par or $1,500, retired associated debt issuance costs of $1,303 and incurred other related call fees, which resulted in a loss on early extinguishment of debt of $2,805 during the first quarter of fiscal 2006.
On July 25, 2006, we successfully completed a consent solicitation from the holders of the 7.0% Subordinated Notes to an amendment to the indenture to increase our capacity to make restricted payments by an additional $85,000, including payments for the repurchase of our common stock, and adjust the fixed charge coverage ratio as defined in the indenture.
On November 22, 2006, we completed a private offering of $125,000 of 2.0% convertible senior notes due 2013 (“Convertible Notes”) to qualified institutional investors pursuant to Section 4(2) of the Securities Act of 1933. The Convertible Notes bear interest at an annual rate of 2.0%, payable semi-annually on May 15 and November 15 of each year, with the first interest payment due on May 15, 2007. The Convertible Notes are convertible into our common stock at an initial conversion price of $58.92 per share, upon the occurrence of certain events, including the closing price of our common stock exceeding 130% of the conversion price per share for 20 of the last 30 trading days of the conversion reference period. The stock price at which the notes would be convertible is $76.59 and as of November 30, 2006 our closing stock price was $48.65. Upon conversion, a holder will receive, in lieu of common stock, an amount of cash equal to the lesser of (i) the principal amount of the convertible note, or (ii) the conversion value, determined in the manner set forth in the indenture governing the Convertible Notes, of a number of shares equal to the conversion rate. If the conversion value exceeds the principal amount of the Convertible Note on the conversion date, we will also deliver, at our election, cash or common stock or a combination of cash and common stock with respect to the conversion value upon conversion. If conversion occurs in connection with a change of control, we may be required to deliver additional shares of our common stock by increasing the conversion rate with respect to such notes. The maximum aggregate number of shares that we would be obligated to issue upon conversion of the Convertible Notes is 2,673.
Concurrently with the sale of the Convertible Notes, we purchased a note hedge from an affiliate of Merrill Lynch (the “Counterparty”), which is designed to mitigate potential dilution from the conversion of Convertible Notes. Under the note hedge, the Counterparty is required to deliver to us the number of shares of our common stock that we are obligated to deliver to the holders of the Convertible Notes with respect to the conversion, calculated exclusive of shares deliverable by us by reason of any additional premium relating to the Convertible Notes or by reason of any election by us to unilaterally increase the conversion rate pursuant to the indenture governing the Convertible Notes. The note hedge expires at the close of trading on November 15, 2013, which is the maturity date of the Convertible Notes, although the Counterparty will have ongoing obligations with respect to Convertible Notes properly converted on or prior to that date of which the Counterparty has been timely notified.
In addition, we issued warrants to the Counterparty that could require us to issue up to approximately 2,122 shares of our common stock on November 15, 2013 upon notice of exercise by the Counterparty. The exercise price is $74.82 per share, which represented a 60.0% premium over the closing price of our shares of common stock on November 16, 2006. If the Counterparty exercises the warrant, we will have the option to settle in cash or shares the excess of the price of our shares on that date over the initially established exercise price.
The note hedge and warrant are separate and legally distinct instruments that bind Chattem and the Counterparty and have no binding effect on the holders of the Convertible Notes.
Pursuant to EITF 90-19, Convertible Bonds with Issuer Option to Settle for Cash upon Conversion, (“EITF 90-19”), Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (“EITF 00-19”), and EITF 01-6, The Meaning of Indexed to a Company’s Own Stock (“EITF 01-6”), the Convertible Notes are accounted for as convertible debt in the accompanying consolidated balance sheet and the embedded conversion option in the Convertible Notes has not been accounted for as a separate derivative. Additionally, pursuant to EITF 00-19 and EITF 01-6, the note hedge and warrants are accounted for as equity transactions, and therefore, the payment associated with the issuance of the note hedge and the proceeds received from the issuance of the warrants were recorded as a charge and an increase, respectively, in common shares in shareholders’ equity as separate equity transactions.
For income tax reporting purposes, we have elected to integrate the Convertible Notes and the note hedge transaction. Integration of the note hedge with the Convertible Notes creates an in-substance original issue debt discount for income tax reporting purposes and therefore the cost of the note hedge will be accounted for as interest expense over the term of the Convertible Notes for income tax reporting purposes. The associated income tax benefit was recognized as a deferred tax asset.
Proceeds from the Convertible Notes were used to repay amounts outstanding under our Amended Revolving Credit Facility at the date of the sale of the notes, pay $32,042 for the cost of the note hedge, pay approximately $3,465 in issuance costs and partially fund the acquisition as described in Note 9.
On November 22, 2006, we entered into a forward starting interest rate cap agreement effective January 15, 2007. The forward starting cap has decreasing notional principal amounts beginning October 15, 2007 and a cap rate of 5.0% over the life of the agreement. We paid a $687 premium to enter into the forward starting cap agreement, which will be amortized over the life of the agreement. During the year ended November 30, 2006, the value of the premium on the forward starting cap was compared to the fair value of the forward starting cap and the change in the market value of the premium of $104, net of tax, was recorded to other comprehensive income. The current portion of the premium on the forward starting cap agreement of $231 is included in prepaid expenses and other current assets, and the long-term portion of $291 is included in other non-current assets. As of November 30, 2006, the entire forward starting cap was deemed to be an effective cash flow hedge. The fair value of the forward starting cap agreement is valued by a third party. The forward starting cap agreement terminates on January 15, 2010.
On November 22, 2006, we entered into a forward starting interest rate swap agreement effective January 15, 2007. The forward starting swap has decreasing notional principal amounts beginning October 15, 2007 and a swap rate of 4.98% over the life of the agreement. During the year ended November 30, 2006, the value of the premium on the forward starting swap was compared to the fair value of the forward starting swap and the change in the market value of $493, net of tax, was recorded to other comprehensive income. The current portion of the fair value of the forward starting swap of $230 is included in accrued liabilities, and the long-term portion of $560 is included in other non-current liabilities. As of November 30, 2006, the entire forward starting swap was deemed to be an effective cash flow hedge. The fair value of the forward starting swap agreement is valued by a third party. The forward starting swap agreement terminates on January 15, 2010.
The future maturities of long-term debt outstanding as of November 30, 2006 are as follows:
$
-
-
-
-
-
Thereafter
232,500
$
232,500
Cash interest payments during 2006, 2005 and 2004 were $10,831, $12,791 and $14,092, respectively.
(6) FAIR VALUE OF FINANCIAL INSTRUMENTS
Unless otherwise indicated elsewhere in the notes to the consolidated financial statements, the carrying value of our financial instruments approximates fair value.
At November 30, 2006, the carrying value of the 7.0% Subordinated Notes and the Convertible Notes equaled their estimated fair market value. The fair value was estimated based on quoted market prices for the same or similar issues.
(7) INCOME TAXES
The provision for income taxes includes the following components for fiscal 2006, 2005 and 2004:
As of November 30, 2006, we had a foreign tax credit of $2,049 which will expire over nine years beginning in fiscal 2009 through 2014, and state net operating loss carry forwards of $6,384, which will begin to expire in 2019 through 2020 if unused. In fiscal 2006, 2005 and 2004 income tax benefits of $1,627, $5,839 and $5,568, respectively, attributable to employee stock option transactions 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, 2006 and 2005, are as follows:
The deferred provision for income taxes excludes the tax effect of the note hedge call option of $12,048 for fiscal 2006, the interest rate cap adjustment of $311 and $131 for fiscal 2006 and 2005, respectively, and the foreign currency translation adjustment of $317 and $191 for fiscal 2006 and 2005, respectively, which are included in the consolidated statements of shareholders’ equity.
In fiscal 2005, we released a previously recorded valuation allowance due to our forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets.
The difference between the provision for income taxes and the amount computed by multiplying income before income taxes by the United States statutory rate for fiscal 2006, 2005 and 2004 is summarized as follows:
Undistributed earnings of Chattem (Canada), a wholly-owned subsidiary, during fiscal amounted to approximately $1,788. These earnings were considered to be reinvested indefinitely and, accordingly, no provision for U.S. federal and state income taxes was provided thereon. During fiscal 2005, pursuant to the provisions of the American Jobs Creation Act of 2004, we adopted a domestic reinvestment plan for purposes of facilitating the repatriation of dividends from our Canadian affiliates. Upon distribution of fiscal 2004 and earnings, we were subject to U.S. income taxes of $213. The majority of the cash distribution was treated as an extraordinary dividend and qualified for the 85 percent dividend received deduction.
Income taxes paid in fiscal 2006, 2005 and 2004 were $21,665, $6,733 and $323, respectively. We received income tax refunds of $376, $97 and $2,554 during fiscal 2006, 2005 and 2004, respectively.
(8) SUPPLEMENTAL FINANCIAL INFORMATION
Inventories consisted of the following at November 30, 2006 and 2005:
International inventories included above were $2,785 and $3,009 at November 30, 2006 and 2005, respectively.
Property, plant and equipment consisted of the following at November 30, 2006 and 2005:
Accrued liabilities consisted of the following at November 30, 2006 and 2005:
(9) ACQUISITION AND SALE OF BRANDS
In March 2002, we acquired worldwide rights (except in India) to manufacture, sell and market Selsun Blue, which is marketed internationally as Selsun, plus related intellectual property and certain manufacturing equipment from Abbott Laboratories (“Abbott”). Abbott, or manufacturers under contract to Abbott, manufactured Selsun Blue for us domestically until June 2003 and internationally until the end of March 2004, except that Abbott continued to manufacture Selsun for us for the European, Middle East and several Latin American markets at agreed upon rates until July 2005. Abbott also continues to serve as our distributor for Selsun in certain foreign countries under separate distribution agreements. All of our North American Selsun Blue product lines are presently being manufactured at our Chattanooga facilities. During a transition period which ended March 28, 2004, Abbott also marketed, sold and distributed Selsun products for us in certain foreign countries until we could satisfy various foreign regulatory requirements, new distributors were in place and any applicable marketing permits were transferred. During the transition period, Abbott paid us an initial royalty equal to 28% of international sales of Selsun in these countries with the royalty reduced to 14% of international sales in certain countries if foreign regulatory requirements were satisfied prior to our assumption of sales and marketing responsibility in such countries. During the transition period, Abbott paid all costs and expenses related to the manufacture, marketing and sales of Selsun in these countries. As we assumed responsibility for the sales and marketing effort in a country, the royalty arrangement with respect to such country terminated. We then recorded these international sales directly as well as the costs and expenses associated with these sales. Abbott has agreed to extend the transition beyond March 28, 2004 in several countries where we are still awaiting regulatory approval of the transfer. In certain international markets, we sell Selsun through a distributor and receive a royalty based on a percentage of distributor sales. In the first quarter of fiscal 2005, we sold our Selsun business in certain countries in Africa and Asia to The Mentholatum Company, Inc. We maintain our rights to Selsun elsewhere in the world (except India).
On November 30, 2005, we sold the pHisoderm line of skin care products to The Mentholatum Company, Inc. for a purchase price of $8,500 plus inventories of approximately $1,100. As a result of this transaction, we recorded a loss on product divestures of $8,678 in the fourth quarter of fiscal 2005.
On January 2, 2007, we acquired the U.S. rights to five leading consumer and OTC brands from Johnson & Johnson for $410,000. The acquisition was funded with the proceeds from a new $300,000 term loan provided under our Credit Facility, borrowings under the revolving credit facility under the Credit Facility and through the use of a portion of the proceeds derived from the Convertible Notes. Due to the timing of the acquisition relative to our year-end and the issuance date of our annual results, we are in the process of obtaining a third-party valuation to assist in the purchase price allocation.
(10) RETIREMENT PLANS
We have 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. Our contributions are based on computations by independent actuaries. Plan assets at November 30, 2006 and 2005 were invested primarily in United States government and agency securities and corporate debt and equity securities. In October 2000, our board of directors adopted an amendment to the Plan that freezes benefits of the Plan and prohibits new entrants to the Plan effective December 31, 2000. In fiscal 2006 and 2004, a curtailment loss of $54 and $88, respectively, resulted from benefits paid exceeding interest costs.
Net periodic pension cost for fiscal 2006, 2005 and 2004 comprised the following components:
The change in the projected benefit obligation, which equals the accumulated benefit obligation at the end of the year for frozen plans, resulted from the following components for fiscal 2006 and 2005:
The change in Plan assets resulted from the following components for fiscal 2006 and 2005:
The following table sets forth the funded status of the Plan as of November 30, 2006 and 2005:
The discount rate used in determining the actuarial present value of the projected benefit obligation was 5.75% in fiscal 2006 and 2005, respectively. The expected long-term rate of return on plan assets was 8% in fiscal 2006 and 2005, respectively. The Plan’s long-term return on assets is based on the weighted-average of the Plan’s invested allocation as of the measurement date and the available historical returns for those asset categories as published by Ibbotson Associates, a leading provider of historical financial market data.
Our existing investment policy of the Plan recognizes that the most significant decision to affect the ability to meet the investment objectives is the asset allocation decision. Therefore, based on the investment objectives and our risk tolerances, the investment policy defines the following asset mix range:
Asset Class
Range
Corporate & Government Bonds
40.0 - 70.0%
Equities
40.0 - 70.0%
In addition, the existing investment policy requires a performance review annually. The weighted-average asset allocations at November 30, 2006 and 2005 by asset class are as follows:
As of November 30, 2006, we had 20 shares of our common stock in the Plan with a fair value of $1,002.
Using the Ibbotson data, the estimated weighted-average asset returns would be 8.4% according to investment policy asset mix. The weighted-average asset returns based on current asset mix (assuming equities are all in large cap) are 8.55% for fiscal 2006 and 8.44% for fiscal 2005.
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
No employer contributions are expected to be required to be paid in fiscal 2007.
We have 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 $249, $235 and $223 in fiscal 2006, 2005 and 2004, respectively. In fiscal 2001, we enhanced our savings investment plan to include an additional 3% employer contribution made on behalf of eligible participants. This additional employer contribution was $758, $751 and $698 in fiscal 2006, 2005 and 2004, respectively.
(11) ACCRUED POSTRETIREMENT HEALTH CARE BENEFITS
We maintain certain postretirement health care benefits for eligible employees. Employees become eligible for these benefits if they meet certain age and service requirements. We pay a portion of the cost of medical benefits for certain retired employees over the age of 65. Effective January 1, 1993, our contribution is a service-based percentage of the full premium. We pay these benefits as claims are incurred. Effective May 31, 2006, we adopted an amendment to change the eligibility requirements for employee participation and limit the annual benefit to be paid. This action resulted in a curtailment gain of
$496 and is included as a component of selling, general and administrative expenses in the accompanying condensed consolidated statements of income.
Net periodic postretirement health care benefits cost for fiscal 2006, 2005 and 2004 included the following components:
The change in the accumulated benefit obligation resulted from the following components for fiscal 2006 and 2005:
The following table sets forth the funded status of the plan at November 30, 2006 and 2005:
The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 5.75% at November 30, 2006 and 2005, respectively.
For measurement purposes in fiscal 2006 and 2005, the trend rate was assumed to be 12% decreasing 1% per year to an ultimate level of 5% by fiscal 2011. Due to premium caps in place which limit our expense, a 1% increase in the assumed health care cost trend rate would not affect the accumulated postretirement benefit obligation as of November 30, 2006 or the aggregate of the service and interest cost components of the net annual postretirement benefit cost for the year ended November 30, 2006.
The following benefit payments, which reflect expected future services, as appropriate, are expected to be paid. Benefit payments are shown net of employee contributions:
Employer contributions expected for fiscal 2007 are approximately $78.
(12) PRODUCT AND GEOGRAPHICAL SEGMENT INFORMATION
We currently operate in only one primary segment - OTC health care. This segment includes topical pain care, medicated skin care, dietary supplement, medicated dandruff shampoo and other OTC products.
Geographical segment information is as follows for fiscal 2006, 2005 and 2004:
(1)
International sales include export sales from United States operations and royalties from international sales of Selsun. These royalties were $228, $178 and $621 for fiscal 2006, 2005 and 2004, respectively.
(2)
Consists of book value of property, plant, equipment, trademarks and other product rights.
Net sales of our domestic product categories within our single healthcare business segment are as follows for fiscal 2006, 2005 and 2004:
(13) COMMITMENTS AND CONTINGENCIES
GENERAL LITIGATION
We were named as a defendant in a number of lawsuits alleging that the plaintiffs were injured as a result of ingestion of products containing phenylpropanolamine (“PPA”), which was an active ingredient in most of our Dexatrim products until November 2000. The lawsuits filed in federal court were transferred to the United States District Court for the Western District of Washington before United States District Judge Barbara J. Rothstein (In Re Phenylpropanolamine (“PPA”) Products Liability Litigation, MDL No. 1407). The remaining lawsuits were filed in state court in a number of different states.
On April 13, 2004, we entered into a class action settlement agreement with representatives of the plaintiffs’ settlement class, which provided for a national class action settlement of all Dexatrim PPA claims. On November 12, 2004, Judge Barbara J. Rothstein of the United States District Court for the Western District of Washington entered a final order and judgment certifying the class and granting approval of the Dexatrim PPA settlement.
The Dexatrim PPA settlement included claims against us involving alleged injuries by Dexatrim products containing PPA in which the alleged injury occurred after December 21, 1998, the date we acquired the Dexatrim brand. In accordance with the terms of the class action settlement agreement, we previously published notice of the settlement and details as to the
manner in which claims could be submitted. The deadline for submission of claims was July 7, 2004. A total of 391 claims were certified by the court as timely submitted. A total of 14 claimants with alleged injuries that occurred after December 21, 1998 elected to opt out of the class settlement. Subsequently, we have settled eleven of the opt out claims. The three remaining opt out claimants may pursue claims for damages against us in separate lawsuits. As of January, 2007, one of the three remaining opt-out claimants has filed a lawsuit against us. The other two opt-outs have not filed lawsuits against us and we believe the applicable statutes of limitation have run against their claims. Consequently, we are currently defending one PPA products liability claim.
In accordance with the terms of the class action settlement, approximately $70,885 was initially funded into a settlement trust. Over the past two years, we have resolved all of the claims submitted in the Dexatrim PPA settlement. All claims in the settlement and expenses of the trust have now been paid. On June 14, 2006, we filed a motion to dissolve the settlement trust. The court granted this motion on July 14, 2006. On August 31, 2006, the settlement trust paid us $10,720, which is included as a component of litigation settlement in our condensed consolidated statement of income for 2006. The settlement trust currently has a balance of approximately $2,805. We expect to use those funds to resolve the pending opt-out PPA case. Any funds remaining after we resolve the opt-out case will be returned to one of our insurance carriers. We currently do not expect to record any additional charges relative to the settlement of the PPA litigation, except for legal expenses that will be recorded in the period incurred. During the past year ending November 30, 2006, we also recorded net expenses of approximately $178 related to the Dexatrim litigation.
We were also named as a defendant in approximately 206 lawsuits relating to Dexatrim containing PPA which involve alleged injuries by Dexatrim products containing PPA manufactured and sold prior to our acquisition of Dexatrim on December 21, 1998. The DELACO Company (“DELACO”), successor by merger to the Thompson Medical Company, Inc., which owned the brand prior to December 21, 1998 owed us an indemnity obligation for any liabilities arising from these lawsuits. On February 12, 2004, DELACO filed a Chapter 11 bankruptcy petition in the United States Bankruptcy Court for the Southern District of New York. We filed a claim in DELACO’s bankruptcy.
We entered into a settlement agreement with DELACO dated June 30, 2005 that resolved DELACO’s indemnity obligations to us (“the DELACO Agreement”). The DELACO Agreement was approved by the DELACO bankruptcy court on July 28, 2005. Pursuant to the DELACO Agreement, we agreed to assume responsibility for all claims against DELACO and its predecessor, Thompson Medical Company, Inc., or us relating to Dexatrim products involving an injury date after December 21, 1998, and hold the DELACO bankruptcy estate harmless from any such claims. In exchange, a settlement trust that was established under DELACO’s bankruptcy plan agreed to pay us $8,750 and assume responsibility for all claims related to Dexatrim products alleging injury dates on or before December 21, 1998. On February 17, 2006, the DELACO bankruptcy court entered an order confirming the DELACO bankruptcy plan which incorporated the terms of the DELACO Agreement. In accordance with the DELACO bankruptcy plan, the settlement trust established under the plan paid us $8,750 on March 17, 2006, which is included in our condensed consolidated statement of income, net of legal expenses, as litigation settlement for 2006. In addition, this order will allow us to dismiss all cases against us with injury dates prior to December 21, 1998. The DELACO settlement trust is currently resolving and paying Dexatrim claims with injury dates prior to December 21, 1998 in accordance with the DELACO bankruptcy plan.
The confirmation of the DELACO bankruptcy plan effectively released us from liability for all PPA products liability cases with injury dates prior to December 21, 1998. The payment to us by the DELACO settlement trust of $8,750 and the channeling of cases to the DELACO settlement trust as described above has conclusively compromised and settled our indemnity claim filed in the DELACO bankruptcy.
On December 30, 2003, the United States Food and Drug Administration (“FDA”) issued a consumer alert on the safety of dietary supplements containing ephedrine alkaloids and on February 6, 2004 published a final rule with respect to these products. The final rule prohibits the sale of dietary supplements containing ephedrine alkaloids because such supplements present an unreasonable risk of illness or injury. The final rule became effective on April 11, 2004. Although we discontinued the manufacturing and shipment of Dexatrim containing ephedrine in September 2002, the FDA’s final rule may result in additional lawsuits being filed against us alleging damages related to the use or purchase of Dexatrim containing ephedrine. There are currently two Dexatrim with ephedrine products liability lawsuits pending against us.
We maintain insurance coverage for product liability claims relating to our products, including Dexatrim products containing ephedrine, under claims-made policies which are subject to annual renewal. For the current annual policy period beginning June 1, 2006, we maintain product liability insurance coverage in the amount of $25,000 through our captive insurance subsidiary, of which approximately $6,610 has been funded as of February 1, 2007. We also have $20,000 of
excess coverage through a third party reinsurance policy, which excludes coverage for our Dexatrim products containing ephedrine.
We were named as a defendant in a putative class action lawsuit filed in the Superior Court of the State of California for the County of Los Angeles on February 11, 2004, relating to the labeling, advertising, promotion and sale of our Bullfrog suncare products. We filed an answer to this lawsuit on June 28, 2004. An amended complaint was filed March 29, 2006, pursuant to a court order formally consolidating this lawsuit with eight existing lawsuits involving other manufacturers of sunscreen products into a coordinated proceeding in California state court. The amended lawsuit seeks class certification of all persons who purchased our Bullfrog sun care products in California during a four-year period prior to February 11, 2004. The amended lawsuit seeks restitution and/or disgorgement of profits, actual damages, injunctive relief, punitive damages and attorneys fees and costs arising out of alleged deceptive, untrue or misleading advertising and breach of warranty, fraudulent or negligent misrepresentations, in connection with the manufacturing, labeling, advertising, promotion and sale of Bullfrog products in California. We filed an answer to the lawsuit in April 2006, and we are vigorously defending this lawsuit.
On March 9, 2006, we were named in a lawsuit filed in the Southern District of New York by Novogen, Inc. Novogen alleges that our product New Phase infringes upon Novogen patents by containing certain phytoestrogens from clover or equivalent sources. Novogen seeks to force us to reformulate our product and to recover damages. We filed an answer to the lawsuit on April 12, 2006 and we are vigorously defending Novogen’s allegations.
Other claims, suits and complaints arise in the ordinary course of our business involving such matters as patents and trademarks, product liability, environmental matters, employment law issues and other alleged injuries or damage. The outcome of such litigation cannot be predicted, but, in the opinion of management, based in part upon assessments from counsel, all such other pending matters are without merit or are of such kind or involve such other amounts as would not have a material adverse effect on our financial position, results of operations or cash flows if disposed of unfavorably.
REGULATORY
On December 30, 2003, the FDA issued a consumer alert on the safety of dietary supplements containing ephedrine alkaloids and on February 6, 2004 published a final rule with respect to these products. The final rule prohibits the sale of dietary supplements containing ephedrine alkaloids because such supplements present an unreasonable risk of illness or injury. The final rule became effective on April 11, 2004. Although we discontinued the manufacturing and shipment of Dexatrim containing ephedrine in September 2002, the FDA’s final rule may result in lawsuits in addition to those we currently have being filed against us alleging damages related to the use or purchase of Dexatrim containing ephedrine. In April 2005, a Utah federal court called into question the 2004 final rule. The court decision is being appealed and may have an effect on the FDA’s enforcement of the ephedrine alkaloid final rule.
We were notified in October 2000 that the FDA denied a citizen petition submitted by Thompson Medical Company, Inc., the previous owner of Sportscreme and Aspercreme. The petition sought a determination that 10% trolamine salicylate, the active ingredient in Sportscreme and Aspercreme, was clinically proven to be an effective active ingredient in external analgesic OTC drug products and should be included in the FDA’s yet-to-be finalized monograph for external analgesics. We have met with the FDA and submitted a proposed protocol study to evaluate the efficacy of 10% trolamine salicylate as an active ingredient in OTC external analgesic drug products. We are working to develop alternate formulations for Sportscreme and Aspercreme in the event that the FDA does not consider the available clinical data to conclusively demonstrate the efficacy of trolamine salicylate when the OTC external analgesic monograph is finalized. If 10% trolamine salicylate is not included in the final monograph, we would likely be required to discontinue these products as currently formulated and remove them from the market after expiration of an anticipated grace period. If this occurred, we believe we could still market these products as homeopathic products or reformulate them using ingredients included in the FDA monograph. We are uncertain as to when the monograph is likely to become final.
Certain of our topical analgesic products are currently marketed under a FDA tentative final external analgesic monograph. The FDA has proposed that the final monograph exclude external analgesic products in patch, plaster or poultice form, unless the FDA receives additional data supporting the safety and efficacy of these products. On October 14, 2003, we submitted to the FDA information regarding the safety of our Icy Hot patches and arguments to support our product’s inclusion in the final monograph. We have also participated in an industry effort coordinated by Consumer Healthcare Products Association (“CHPA”) to establish with the FDA a protocol of additional research that will allow the patches to be marketed under the final monograph even if the final monograph does not explicitly allow them. The CHPA submission to FDA was made on October 15, 2003. Thereafter, in April 2004, we launched the Icy Hot Sleeve, a flexible, non-occlusive fabric patch
containing 16% menthol. In February 2006, we launched the Icy Hot Pro-Therapy Medicated Foam Pad with Knee Wrap containing 5% menthol, and the Capzasin Back & Body patch containing 0.025% capsaicin. All of these drug products contain levels of active ingredients consistent with levels permitted in the OTC monograph. If additional research is required either as a preliminary to final FDA monograph approval and/or as a requirement of future individual product sale, we may need to invest in a considerable amount of expensive testing and data analysis. Any preliminary cost may be shared with other patch manufacturers. Because the submissions made into the FDA docket have been forwarded from its OTC Division to its Dermatological Division within the Center for Drug Evaluation and Research (“CDER”), we are uncertain as to when this matter is likely to become final. For example, the FDA could choose to hold in abeyance a final ruling on alternative dose forms even if the monograph is otherwise finalized. If neither action described above is successful and the final monograph excludes such products, we will have to file a new drug application (“NDA”) for previously marketed drugs in order to continue to market the Icy Hot and Aspercreme Patches, the Icy Hot Sleeve, the Icy Hot Pro-Therapy Medicated Foam Pad with Knee Wrap, Capzasin Back & Body Patch and/or similar delivery systems under our other topical analgesic brands. In such case, we would have to remove the existing products from the market one year from the effective date of the final monograph, pending FDA review and approval of an NDA. The preparation of an NDA would likely take us six to 18 months and would be expensive. It typically takes the FDA at least twelve months to rule on an NDA once it is submitted.
We have responded to certain questions with respect to efficacy received from the FDA in connection with clinical studies for pyrilamine maleate, one of the active ingredients used in certain of the Pamprin and Prēmsyn PMS products. While we addressed all of the FDA questions in detail, the final monograph for menstrual drug products, which has not yet been issued, will determine if the FDA considers pyrilamine maleate safe and effective for menstrual relief products. If pyrilamine maleate were not included in the final monograph, we would be required to reformulate the products to continue to provide the consumer with multi-symptom relief benefits. We have been actively monitoring the process and do not believe that either Pamprin or Prēmsyn PMS, as brands, will be materially affected by the FDA review. We believe that any adverse finding by the FDA would likewise affect our principal competitors in the menstrual product category and that finalization of the menstrual products monograph is not imminent. Moreover, we have formulated alternative Pamprin products that fully comply with both the internal analgesic and menstrual product monographs.
In early 2005, infrequent, but serious, adverse cardiovascular events were reported to the FDA associated with patients who were prescribed a subclass of COX-2 inhibitor non-steroidal anti-inflammatory drugs (“NSAID’s”) for long periods to relieve pain of chronic diseases such as arthritis. These products include Vioxx®, Bextra®, and Celebrex®. In February 2005, the FDA held a joint advisory committee meeting to seek external counsel on the extent to which manufacturers might further warn patients of these cardiovascular risks on prescription product labeling, or prohibit sale of these prescription products. As part of its response on this issue, the FDA has recommended labeling changes for both the prescription and OTC NSAID’s. Well-known OTC NSAID’s such as ibuprofen and naproxen, which have been sold in vast quantities since the 1970s, were affected by this regulatory action. Manufacturers of OTC NSAID’s were asked to revise their labeling to provide more specific information about the potential cardiovascular and gastrointestinal risks recognizing the limited dose and duration of treatment of these products. Our Pamprin All Day product, which contains naproxen sodium, is subject to these new labeling requirements. Pamprin All Day is manufactured for us by The Perrigo Company (“Perrigo”), holder of an abbreviated NDA for naproxen sodium. As holder of the abbreviated NDA, Perrigo made the mandated labeling changes within the time frame required by the FDA. Product with revised labeling compliant with new FDA regulations began shipping in February 2006. We are also aware of the FDA’s concern about the potential toxicity due to concomitant use of OTC and prescription products that contain the analgesic ingredient acetaminophen, an ingredient also found in Pamprin and Prēmsyn PMS. We are also aware that the FDA will revise acetaminophen labeling to reflect the concerns similar to NSAID analgesics such as naproxen. We are participating in an industry-wide effort to reassure the FDA that the current recommended dosing regimen is safe and effective and that proper labeling and public education by both OTC and prescription drug companies are the best policies to abate the FDA’s concern. The FDA will address both issues in its effort to finalize the monograph on internal analgesic products. We believe the FDA may issue revised labeling requirements within the next year, perhaps prior to monograph closure that will cause the industry to relabel its analgesic products to better inform consumers.
During the finalization of the monograph on sunscreen products, the FDA chose to hold in abeyance specific requirements relating to the characterization of a product’s ability to reduce UVA radiation. A final ruling on this matter would be expected to result in new UVA testing requirements and subsequent labeling changes related to sun protection factor, or SPF, ratings, and other labeling claims. We expect that the FDA may take action on this matter within the next six months. If implemented, the final rules would likely result in new testing requirements and revised labeling of our Bullfrog product line, and all of our competitors’ products in the suncare category, within one year after issuance of the final rules.
Our business is also regulated by the California Safe Drinking Water and Toxic Enforcement Act of 1986, known as Proposition 65. Proposition 65 prohibits businesses from exposing consumers to chemicals that the state has determined cause cancer or reproduction toxicity without first giving fair and reasonable warning unless the level of exposure to the carcinogen or
reproductive toxicant falls below prescribed levels. From time to time, one or more ingredients in our products could become subject to an inquiry under Proposition 65. If an ingredient is on the state’s list as a carcinogen, it is possible that a claim could be brought in which case we would be required to demonstrate that exposure is below a “no significant risk” level for consumers. Any such claims may cause us to incur significant expense, and we may face monetary penalties or injunctive relief, or both, or be required to reformulate our product to acceptable levels. The State of California under Proposition 65 is also considering the inclusion of titanium dioxide on the state’s list of suspected carcinogens. Titanium dioxide has a long history of widespread use as an excipient in prescription and OTC pharmaceuticals, cosmetics, dietary supplements and skin care products and is an active ingredient in our Bullfrog Superblock products. We have participated in an industry-wide submission to the State of California, facilitated through the CHPA, presenting evidence that titanium dioxide presents “no significant risk” to consumers.
In March 2006, the FDA conducted a routine site audit of our manufacturing plants and laboratories. There were no material adverse findings resulting from the audit.
LEASES AND ENDORSEMENTS
The minimum rental commitments under all noncancelable operating leases, primarily real estate, in effect at November 30, 2006 are as follows:
$
1,488
Thereafter
$
3,302
Rental expense was $2,060, $2,135 and $1,960 for fiscal 2006, 2005 and 2004, respectively.
The minimum commitments under noncancelable endorsement contracts related to our advertising in effect at November 30, 2006 are as follows:
$
1,675
1,550
$
4,025
We have entered into a supply agreement for the supply of selenium sulfide, the active ingredient in Selsun Blue, which will expire in December 2008 with an automatic renewal for successive one year terms unless written termination notice is given six months prior to the end of the term or any renewal term by either party. As of November 30, 2006, our remaining purchase commitment obligations based on the last price paid are approximately $1,242 and $1,242 for our 2007 and 2008 fiscal years, respectively.
(14) CONSOLIDATING FINANCIAL STATEMENTS
The consolidating financial statements, for the dates or periods indicated, of Chattem, Inc. (“Chattem”), Signal Investment & Management Co. (“Signal”), SunDex, LLC (“SunDex”) and Chattem (Canada) Holdings, Inc. (“Canada”), the guarantors of the long-term debt of Chattem, and the non-guarantor direct and indirect wholly-owned subsidiaries of Chattem are presented below. Signal is 89% owned by Chattem and 11% owned by Canada. SunDex and Canada are wholly-owned subsidiaries of Chattem. The guarantees of Signal, SunDex and Canada are full and unconditional and joint and several. The guarantees of Signal, SunDex and Canada as of November 30, 2006 arose in conjunction with Chattem’s issuance of the Revolving Credit Facility, the Floating Rate Senior Notes and the 7.0% Subordinated Notes (See Note 5). The maximum amount of future payments the guarantors would be required to make under the guarantees as of November 30, 2006 is $232,500.
Note
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEETS
NOVEMBER 30, 2006
(In thousands)
Note
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEETS
NOVEMBER 30, 2005
(In thousands)
Note
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF INCOME
FOR THE YEAR ENDED NOVEMBER 30, 2006
(In thousands)
Note
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF INCOME
FOR THE YEAR ENDED NOVEMBER 30, 2005
(In thousands)
Note
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF INCOME
FOR THE YEAR ENDED NOVEMBER 30, 2004
(In thousands)
Note
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED NOVEMBER 30, 2006
(In thousands)
Note
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED NOVEMBER 30, 2005
(In thousands)
Note
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED NOVEMBER 30, 2004
(In thousands)
(15) QUARTERLY INFORMATION (Unaudited and in thousands, except per share amounts)
(1) Through the performance of our annual inventory control process, as of November 30, 2005 we determined that we did not fully apply manufacturing overhead costs in the first three quarters of fiscal 2005. As a result, cost of sales and promotional expenses were understated in these prior quarterly periods. A pre-tax adjustment of $1,709 was recorded in the fourth quarter of fiscal 2005 to reflect the proper application of manufacturing overhead during the first three quarters of fiscal 2005. The adjustment resulted in increases to cost of sales and promotional expense of $1,242 and $467, respectively, in the fourth quarter of fiscal 2005. These unapplied overhead costs which totaled $506, $655 and $548 for the first, second and third quarters, respectively, were not material to these quarters.
(2) 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.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS
CHATTEM, INC.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Chattem, Inc. (a Tennessee corporation) and subsidiaries maintained effective internal control over financial reporting as of November 30, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Chattem, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Chattem, Inc. maintained effective internal control over financial reporting as of November 30, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, Chattem, Inc. maintained, in all material respects, effective internal control over financial reporting as of November 30, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations on the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the balance sheets of Chattem, Inc. as of November 30, 2006 and 2005, and the related statements of income, shareholders’ equity, and cash flows for the years then ended and our report dated February 8, 2007 expressed an unqualified opinion on those financial statements.
/s/ GRANT THORNTON LLP
Charlotte, North Carolina
February 8, 2007
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our chief executive officer and principal financial officer, we have evaluated the effectiveness of our disclosure controls and procedures (as such terms are defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of November 30, 2006 (the “Evaluation Date”). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in alerting them on a timely basis to material information relating to us (including our consolidated subsidiaries) required to be included in our filings under the Exchange Act.
Management’s Report on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
·
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
·
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
·
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of November 30, 2006 using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Management’s assessment included an evaluation of the design of our internal control over financial reporting and testing the operational effectiveness of our internal control over financial reporting. Management reviewed the results of the assessment with the Audit Committee of the Board of Directors. Based on our assessment, management determined that, at November 30, 2006, we maintained effective internal control over financial reporting.
The Company’s independent registered public accounting firm has issued an attestation report on our assessment of the Company’s internal control over financial reporting, which is included herein.
Item 9B.
Item 9B. Other Information
On February 7, 2007, upon the approval and recommendation of the Compensation Committee, the Company’s Board of Directors approved a special, one-time cash bonus to the Company’s executive officers for their efforts in fiscal 2006 relating to the Company’s acquisition of five consumer and OTC brands from Johnson & Johnson. Bonus amounts payable to the Company’s chief executive officer, principal financial officer and other named executives are as follows: Zan Guerry - $150,000; Robert E. Bosworth - $100,000; Richard W. Kornhauser - $50,000; B. Derrill Pitts - $40,000; and Charles M. Stafford - $40,000.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
(a) Directors
The information found in our 2007 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 1, 2007, their ages and their positions and offices with the Company:
NAME
AGE
POSITION WITH REGISTRANT
Zan Guerry
Chairman of the Board and
Chief Executive Officer; Director
Robert E. Bosworth
President and Chief Operating Officer;
Director
Andrea M. Crouch
Vice President - Brand Management
Ron Galante
Vice President - New Business Development
Richard W. Kornhauser
Vice President - Marketing
Robert B. Long
Chief Accounting Officer
B. Derrill Pitts
Vice President - Operations
J. Blair Ramey
Vice President - Brand Management and Media
Charles M. Stafford
Vice President - Sales
Theodore K. Whitfield, Jr.
Vice President, General Counsel and Secretary
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.
Robert E. Bosworth. Mr. Bosworth became our president and chief operating officer in September 2005. From 2001 to September 2005, Mr. Bosworth served as Vice President-Corporate Finance of Livingston Company, a merchant banking firm.
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, 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. In October 2005, he became our vice president-marketing. 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.
Robert B. Long. Mr. Long became our Chief Accounting Officer in April 2006. Prior to joining us, Mr. Long was Chief Financial Officer of Charleston Hosiery, Inc. and served as a senior audit manager with Ernst & Young LLP from 2003 to 2005.
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.
J. Blair Ramey. Mr. Ramey became our vice president-brand management and media in April 2006. Mr. Ramey joined us in 1998 and previously served as a marketing manager and more recently as a marketing director.
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.
Theodore K. Whitfield, Jr. Mr. Whitfield became our vice president, general counsel and secretary in June 2004. Prior to joining us, Mr. Whitfield was a member with the law firm of Miller & Martin PLLC, from 1999 to 2004.
(c)
Compliance with Section 16(a) of the Exchange Act
The information found in our 2007 Proxy Statement under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” is hereby incorporated by reference.
(d)
Audit Committee; Audit Committee Financial Expert
The information found in our 2007 Proxy Statement regarding the identity of the audit committee members and the audit committee financial expert under the heading “Audit Committee Report - Identification of Members and Functions of Committee” is hereby incorporated by reference.
(e)
Code of Ethics
We have adopted a code of business conduct and ethics that applies to our directors, officers and employees, including our principal executive officer, principal financial officer, principal accounting officer, controller or persons performing similar functions. A copy of this code of business conduct and ethics is posted on the Company’s website at www.chattem.com. In the event waivers are granted under the code of business conduct and ethics, such waivers will be posted on our website for one year from the date the waiver is granted.
Item 11.
Item 11. Executive Compensation
The information found in our 2007 Proxy Statement under the heading “Executive Compensation and Other Information” is hereby incorporated by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information found in our 2007 Proxy Statement under the headings “Executive Compensation and Other Information - Equity Compensation Plan Information” and “Ownership of Common Stock” is hereby incorporated by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information found in our 2007 Proxy Statement under the heading “Executive Compensation and Other Information” is hereby incorporated by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information found in our 2007 Proxy Statement under the headings “Corporate Governance - Audit Committee Pre-Approval of Services by the Independent Auditor” and “Corporate Governance - Audit and Non-Audit Fees” is hereby incorporated by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) 1. Consolidated Financial Statements
The following consolidated financial statements of Chattem, Inc. and Subsidiaries are set forth in Item 8 hereof:
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets as of November 30, 2006 and 2005
Consolidated Statements of Income for the Years Ended November 30, 2006, 2005 and
Consolidated Statements of Shareholders’ Equity for the Years Ended November 30, 2006, 2005 and 2004
Consolidated Statements of Cash Flows for the Years Ended November 30, 2006, 2005 and
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
2. The following financial statement schedule is filed as Exhibit 99.1 to this report:
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
(4), (5), (11) and (20)
3.2
Amended and Restated By-Laws of Chattem, Inc.
(1), (6) and (26)
4.1
Rights Agreement dated January 27, 2000 between Chattem, Inc. and SunTrust Bank, Atlanta, N.A.
(2)
4.2
Indenture dated as of February 26, 2004 among Chattem, Inc., its domestic subsidiaries and SouthTrust Bank, as trustee, relating to the Floating Rate Senior Notes due 2010
(3)
4.3
Indenture dated as of February 26, 2004 among Chattem, Inc., its domestic subsidiaries and SouthTrust Bank, as trustee, relating to the 7% Senior Subordinated Notes due 2014
(3)
4.4
First Amendment to and Supplemental Indenture dated July 25, 2006 among Chattem, Inc., its domestic subsidiaries and U.S. Bank, National Association, as successor trustee, relating to the 7% Senior Subordinated Notes due
(28)
4.5
Indenture dated as of November 22, 2006 between Chattem, Inc. and U.S. Bank, National Association, as trustee, relating to 2% Convertible Senior Notes due 2013
(31)
4.6
Registration Rights Agreement dated November 22, 2006 among Chattem, Inc. and the purchasers of the 2% Convertible Senior Notes due 2013
(31)
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
(6) and (7)
10.2
First Amended and Restated Master Trademark License Agreement between Signal Investment & Management Co. and Chattem, Inc., effective June 30, 1992
(8)
10.3
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
(9)
Exhibit
Number
Description of Exhibit
References
10.4
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
(10)
10.5*
Chattem, Inc. Non-Statutory Stock Option Plan - 1998
(8)
10.6*
Stock Plan for Non-Employee Directors
(27)
10.7*
Chattem, Inc. Non-Statutory Stock Option Plan - 2000
(11)
Exhibit
Number
Description of Exhibit
References
Exhibit
Number
Description of Exhibit
References
10.29
First Amendment to Credit Agreement dated as of December 22, 2004 among Chattem, Inc., its domestic subsidiaries, identified lenders and Bank of America, N.A., as agent
(22)
10.30
Waiver and Second Amendment to Credit Agreement dated as of February 25, 2005 among Chattem, Inc., its domestic subsidiaries, identified lenders and Bank of America, N.A., as agent
(22)
10.31
Third Amendment to Credit Agreement dated as of November 29, 2005 among Chattem, Inc., its domestic subsidiaries, identified lenders and Bank of America, N.A., as agent
(24)
10.32
Fourth Amendment to Credit Agreement dated as of November 16, 2006 among Chattem, Inc. its domestic subsidiaries, identified lenders and Bank of America, N.A., as agent
(30)
10.33
Fifth Amendment to Credit Agreement dated December 22, 2006 among Chattem, Inc., its domestic subsidiaries, identified lenders and Bank of America, N.A., as agent
(32)
10.34
Rate Cap Transaction Agreement dated March 8, 2004 between Chattem, Inc. and JP Morgan Chase Bank
(17)
10.35
First Amendment to the Second Amended and Restated Master Trademark License Agreement between Signal Investment & Management Co. and Chattem, Inc. effective May 31, 2003
(16)
10.36
First Amendment to Master Trademark License Agreement between Signal Investment & Management Co. and SunDex, LLC, effective May 31, 2003
(16)
10.37
Memorandum of Understanding dated December 19, 2003 with Plaintiffs’ Steering Committee in In re: Phenylpropanalomine (PPA) Products Liability Litigation, MDL 1407, pending before the United States District Court for the Western District of Washington
(15)
10.38
Class Action Settlement Agreement dated as of April 13, 2004 between Chattem, Inc. and Class Counsel on behalf of Class Representatives In re: Phenylpropanolamine (PPA) Products Liability Litigation
(17)
Exhibit
Number
Description of Exhibit
References
10.39
Initial Settlement Trust Agreement dated April 12, 2004 between Chattem, Inc. and Amsouth Bank
(17)
10.40
Final Settlement Trust Agreement between Chattem, Inc. and AmSouth Bank dated March 16, 2005
(22)
10.41
Settlement Agreement dated April 26, 2004 between Chattem, Inc. and General Star Indemnity Company
(17)
10.42
Memorandum of Understanding dated December 13, 2003 between and among Chattem, Inc. and Kemper Indemnity Insurance Company
(17)
10.43
Settlement Agreement dated December 30, 2003 between Chattem, Inc. and Admiral Insurance Company
(17)
10.44
Settlement Agreement dated July 14, 2004 between Chattem, Inc. and Sidmak Laboratories
(18)
10.45
Dexatrim Case Scoring System and Matrix for the Chattem Dexatrim Class Action Settlement
(18)
10.46
Settlement and Coverage-In-Place Agreement between Interstate Fire & Casualty Company and Chattem, Inc. effective March 18,
(22)
10.47
Settlement Agreement dated as of June 30, 2005 by and between Chattem, Inc. and The DELACO Company
(21)
10.48*
Retirement Agreement effective January 31, 2007 between Chattem, Inc. and Donald K. Riker, Ph.D.
10.49*
Summary Description of Incentive Compensation Plan
Subsidiaries of the Company
23.1
Consent of Independent Registered Public Accounting Firm
23.2
Consent of Ernst & Young LLP
31.1
Certification required by Rule 13a-14(a) under the Securities Exchange Act
Exhibit
Number
Description of Exhibit
References
31.2
Certification required by Rule 13a-14(a) under the Securities Exchange Act
Certification required by Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350
99.1
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(b) of this report.
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 March 22, 2004.
(4) Form S-8 filed June 2, 1999.
(5) Form 10-K for the year ended November 30, 1992.
(6) Form 10-K for the year ended November 30, 1995.
(7) Form 10-K for the year ended November 30, 1996.
(8) Form 10-K for the year ended November 30, 1997.
(9) Form 10-K for the year ended November 30, 1998.
(10) Form 8-K filed December 28, 1998.
(11) Form 10-K for the year ended November 30, 1999.
(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.
(15) Form 10-K for the year ended November 30, 2003.
(16) Form 10-Q filed for the quarter ended May 31, 2003.
(17) Form 10-Q filed for the quarter ended May 31, 2004.
(18) Form 10-Q filed for the quarter ended August 31, 2004.
(19) Form 10-K for the year ended November 30, 2004.
(20) Schedule 14A filed March 4, 2005.
(21) Form 10-Q filed for the quarter ended May 31, 2005.
(22) Form 10-Q filed for the quarter ended February 28, 2005.
(23) Form 8-K filed November 3, 2005.
(24) Form 8-K filed December 2, 2005.
(25) Form 8-K filed December 5, 2005.
(26) Form 8-K/A filed August 31, 2005.
(27) Schedule 14A filed March 8, 1999.
(28) Form 8-K filed July 19, 2006, as supplemented by Form 8-K filed July 26, 2006.
(29) Form 8-K filed November 15, 2006.
(30) Form 8-K filed November 22, 2006.
(31) Form 8-K filed November 29, 2006.
(32) Form 8-K filed December 28, 2006.
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.
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
Zan Guerry
Chairman of the Board
and Director
(Chief Executive Officer)
2-12-07
/s/ Robert E. Bosworth
Robert E. Bosworth
President and Director
(Chief Operating Officer)
2-12-07
/s/ Samuel E. Allen
Samuel E. Allen
Director
2-12-07
/s/ Ruth W. Brinkley
Ruth W. Brinkley
Director
2-12-07
/s/ Gary D. Chazen
Gary D. Chazen
Director
2-12-07
/s/ Bill W. Stacy
Bill W. Stacy
Director
2-12-07
/s/ Philip H. Sanford
Philip H. Sanford
Director
2-12-07
CHATTEM, INC. AND SUBSIDIARIES
EXHIBIT INDEX
EXHIBIT
NUMBER
___ _______DESCRIPTION OF EXHIBIT_________________
10.48*
Retirement Agreement effective January 31, 2007 between Chattem, Inc. and Donald K. Riker, Ph.D.
10.49*
Summary Description of Incentive Compensation Plan
Subsidiaries of the Company
23.1
Consent of Independent Registered Public Accounting Firm
23.2
Consent of Ernst & Young LLP
31.1
Certification required by Rule 13a-14(a) under the Securities Exchange Act
31.2
Certification required by Rule 13a-14(a) under the Securities Exchange Act
Certification required by Rule 13a-14(b) under the Securities Exchange Act and 18 U.S.C. Section 1350
99.1
Schedule II - Valuation and Qualifying Accounts