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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 25, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO _________
COMMISSION FILE NUMBER 0-19725
PERRIGO COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MICHIGAN 38-2799573
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
515 EASTERN AVENUE
ALLEGAN, MICHIGAN 49010
(ADDRESS OF PRINCIPAL (ZIP CODE)
EXECUTIVE OFFICES)
(269) 673-8451
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NOT APPLICABLE
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
LARGE ACCELERATED FILER [X] ACCELERATED FILER [ ] NON-ACCELERATED FILER [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). [ ] YES [X] NO
As of April 21, 2006 the registrant had 94,042,474 outstanding shares of common
stock.
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PERRIGO COMPANY
FORM 10-Q
INDEX
PAGE NUMBER
-----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed consolidated statements of income -- For the quarters
and year-to-date ended March 25, 2006 and March 26, 2005 1
Condensed consolidated balance sheets -- March 25, 2006,
June 25, 2005 and March 26, 2005 2
Condensed consolidated statements of cash flows -- For
year-to-date ended March 25, 2006 and March 26, 2005 3
Notes to condensed consolidated financial statements 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risks 24
Item 4. Controls and Procedures 25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 1A. Risk Factors 26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 27
Item 6. Exhibits 27
SIGNATURES 29
PERRIGO COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
Third Quarter Year-to-Date
-------------------- ----------------------
2006 2005 2006 2005
-------- --------- ---------- ---------
Net sales $332,321 $ 220,093 $1,011,752 $ 699,560
Cost of sales 235,043 157,132 721,988 504,830
-------- --------- ---------- ---------
Gross profit 97,278 62,961 289,764 194,730
-------- --------- ---------- ---------
Operating expenses
Distribution 6,438 4,032 20,541 12,130
Research and development 12,260 7,224 37,135 22,864
Selling and administration 48,225 32,552 141,695 89,808
-------- --------- ---------- ---------
Subtotal 66,923 43,808 199,371 124,802
Write-off of in-process
research and development -- 388,600 -- 388,600
Restructuring -- 6,382 -- 6,382
-------- --------- ---------- ---------
Total 66,923 438,790 199,371 519,784
Operating income (loss) 30,355 (375,829) 90,393 (325,054)
Interest, net 2,465 (454) 11,606 (1,405)
Other income, net (2,310) (1,091) (9,346) (1,584)
-------- --------- ---------- ---------
Income (loss) before income taxes 30,200 (374,284) 88,133 (322,065)
Income tax expense 9,339 5,152 28,995 23,955
-------- --------- ---------- ---------
Net income (loss) $ 20,861 $(379,436) $ 59,138 $(346,020)
======== ========= ========== =========
Earnings (loss) per share
Basic $ 0.23 $ (5.15) $ 0.64 $ (4.81)
Diluted $ 0.22 $ (5.15) $ 0.63 $ (4.81)
Weighted average shares outstanding
Basic 92,683 73,660 92,966 71,970
Diluted 94,044 73,660 94,143 71,970
Dividends declared per share $ 0.043 $ 0.040 $ 0.125 $ 0.115
See accompanying notes to condensed consolidated financial statements.
-1-
PERRIGO COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
March 25, June 25, March 26,
2006 2005 2005
----------- ---------- -----------
(unaudited) (unaudited)
Assets
Current assets
Cash and cash equivalents $ 29,168 $ 16,707 $ 40,735
Investment securities 6,685 17,761 33,200
Accounts receivable 220,425 210,308 203,849
Inventories 273,668 272,980 301,270
Current deferred income taxes 47,088 55,987 47,380
Prepaid expenses and other current assets 16,010 35,064 28,690
---------- ---------- ----------
Total current assets 593,044 608,807 655,124
Property and equipment 599,702 586,306 576,049
Less accumulated depreciation 281,733 262,505 253,316
---------- ---------- ----------
317,969 323,801 322,733
Restricted cash 400,000 400,000 400,000
Goodwill 147,633 150,293 150,226
Other intangible assets 138,043 147,967 142,050
Non-current deferred income taxes 32,725 26,964 13,922
Other non-current assets 41,460 47,144 47,126
---------- ---------- ----------
$1,670,874 $1,704,976 $1,731,181
========== ========== ==========
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable $ 163,494 $ 142,789 $ 141,621
Notes payable 26,969 25,345 22,334
Current maturities of long-term liabilities -- -- 20,000
Payroll and related taxes 48,632 42,326 48,160
Accrued customer programs 46,020 41,666 31,302
Accrued liabilities 46,832 57,532 74,496
Accrued income taxes 7,004 21,225 15,201
Current deferred income taxes 9,002 9,659 9,010
---------- ---------- ----------
Total current liabilities 347,953 340,542 362,124
Non-current liabilities
Long-term debt 594,360 656,128 666,706
Non-current deferred income taxes 68,924 74,379 59,740
Other non-current liabilities 35,274 43,090 33,637
---------- ---------- ----------
Total non-current liabilities 698,558 773,597 760,083
Shareholders' equity
Preferred stock, without par value, 10,000 shares authorized -- -- --
Common stock, without par value, 200,000 shares authorized 518,996 527,748 527,220
Accumulated other comprehensive income (loss) (7,377) (1,687) 6,275
Retained earnings 112,744 64,776 75,479
---------- ---------- ----------
Total shareholders' equity 624,363 590,837 608,974
---------- ---------- ----------
$1,670,874 $1,704,976 $1,731,181
========== ========== ==========
Supplemental Disclosures of Balance Sheet Information
Allowance for doubtful accounts $ 10,619 $ 10,370 $ 8,280
Allowance for inventory $ 43,035 $ 38,095 $ 27,841
Working capital $ 245,091 $ 268,265 $ 293,000
Preferred stock, shares issued -- -- --
Common stock, shares issued 93,087 93,903 93,802
See accompanying notes to condensed consolidated financial statements.
-2-
PERRIGO COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Year-to-Date
--------------------
2006 2005
-------- ---------
Cash Flows (For) From Operating Activities
Net income (loss) $ 59,138 $(346,020)
Adjustments to derive cash flows
Write-off of in-process research and development -- 388,600
Depreciation and amortization 42,155 23,561
Share-based compensation 7,274 4,828
Deferred income taxes (2,707) (5,860)
-------- ---------
Sub-total 105,860 65,109
-------- ---------
Changes in operating assets and liabilities
Accounts receivable (8,701) (11,320)
Inventories 1,201 10,202
Accounts payable 19,180 (7,108)
Payroll and related taxes 5,928 (14,369)
Accrued customer programs 4,354 (2,398)
Accrued liabilities (12,358) 4,090
Accrued income taxes (17,480) 3,805
Other 12,648 6,381
-------- ---------
Sub-total 4,772 (10,717)
-------- ---------
Net cash from operating activities 110,632 54,392
-------- ---------
Cash Flows (For) From Investing Activities
Purchases of securities (29,134) (81,070)
Proceeds from sales of securities 39,384 243,975
Additions to property and equipment (18,672) (15,576)
Acquisition of business, net of cash acquired -- (381,569)
Acquisition of assets -- (5,562)
Increase in restricted cash -- (400,000)
-------- ---------
Net cash for investing activities (8,422) (639,802)
-------- ---------
Cash (For) From Financing Activities
Borrowings of short-term debt, net 1,543 3,622
Borrowings of long-term debt 15,000 615,000
Repayments of long-term debt (75,000) --
Increase in deferred debt issue costs -- (1,017)
Tax effect of stock transactions (762) 1,087
Issuance of common stock 5,223 6,137
Repurchases of common stock (20,488) (122)
Cash dividends (11,660) (8,195)
-------- ---------
Net cash (for) from financing activities (86,144) 616,512
-------- ---------
Net increase in cash and cash equivalents 16,066 31,102
Cash and cash equivalents, at beginning of period 16,707 8,392
Effect of exchange rate changes on cash (3,605) 1,241
-------- ---------
Cash and cash equivalents, at end of period $ 29,168 $ 40,735
======== =========
Supplemental Disclosures of Cash Flow Information
Cash paid/received during the period for:
Interest paid $ 27,093 $ 231
Interest received $ 15,870 $ 2,193
Income taxes paid $ 40,106 $ 22,537
Income taxes refunded $ 5,239 $ 4,196
See accompanying notes to condensed consolidated financial statements.
-3-
PERRIGO COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 25, 2006
(in thousands, except per share amounts)
Perrigo Company is a leading global healthcare supplier and the world's largest
manufacturer of over-the-counter (OTC) pharmaceutical and nutritional products
for the store brand market. The Company also develops and manufactures generic
prescription (Rx) drugs, active pharmaceutical ingredients (API) and consumer
products.
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals and other adjustments) considered necessary for a fair presentation
have been included. The Company has reclassified certain amounts in the prior
years to conform to the current year presentation.
In previously reported results, the Company's New York operations, acquired
through the purchase of Agis Industries (1983) Ltd. (Agis) on March 17, 2005,
were reported on a one-month lag. By the end of the second quarter of fiscal
2006, these operations were reported consistent with the Company's fiscal year.
Current accounting guidance requires that no more than nine months of operations
of a subsidiary may be included in the consolidated statement of income and any
additional months must be recorded directly as a credit or charge to retained
earnings. This reporting change did not have a material effect on the Company's
financial results and did not impact a year-over-year comparison for these
operations. Net income for the New York operations for the one-month period
(stub period) ended September 30, 2005 was $490 and was recorded as a change in
retained earnings. Revenues generated by the New York operations for the stub
period were $9,560. The following table reconciles the changes in retained
earnings:
Retained earnings as of June 25, 2005 $ 64,776
Dividends paid (11,660)
Net income 59,138
Net income - stub period 490
--------
Retained earnings as of March 26, 2006 $112,744
========
Operating results for the three quarters ended March 25, 2006 are not
necessarily indicative of the results that may be expected for a full year. The
unaudited condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and footnotes included in
the Company's annual report on Form 10-K for the year ended June 25, 2005.
Significant Events
Update on Pseudoephedrine Sales - The Company continued to be impacted by the
legislative and market changes related to products containing pseudoephedrine,
which have resulted from concerns
-4-
over the use of pseudoephedrine in the production of methamphetamine, an illegal
drug. Sales of these products in the third quarter of fiscal 2006 were
approximately $26,000 lower than the third quarter of fiscal 2005 and $69,000
lower year-to-date in fiscal 2006 than year-to-date fiscal 2005. The Company
monitors this issue continuously and, consequently, recorded an additional
charge of $720 in the third quarter of fiscal 2006 for estimated obsolete
inventory on hand. Products containing pseudoephedrine generated approximately
$182,000 of the Company's revenues in fiscal 2005. Sales are expected to be
$90,000 to $95,000 for fiscal 2006 and will continue to decline in fiscal 2007.
This sales estimate has been revised due to retailer response to the passage of
federal legislation, which is described below. Based on recent events in the
retail market, legislative actions and the resulting lost sales, management
believes that these issues will continue to have a significant adverse effect on
the Company's results of operations in fiscal 2006 and fiscal 2007.
On March 10, 2006, Congress enacted the Patriot Act which included the Combat
Methamphetamine Epidemic Act of 2005 (the Act). Among the various provisions,
this national legislation places certain restrictions on the purchase and sale
of all products that contain ephedrine, pseudoephedrine, or phenylpropanolamine
("Schedule Listed Chemical Products"). Effective April 7, 2006, the Act imposed
daily restrictions on the amount of Schedule Listed Chemical Products a retailer
may sell to a consumer (3.6 grams per day) and limitations on the amount of
Schedule Listed Chemical Products a consumer may purchase (9.0 grams) over a
thirty-day period. Further, effective September 30, 2006, the Act requires that
(a) sellers place all Schedule Listed Chemical Products behind the counter and
maintain a logbook that tracks the sales of Schedule Listed Chemical Products to
individuals, and (b) purchasers provide valid identification in order to
purchase Schedule Listed Chemical Products.
Supply, Purchase and License Agreement - The Company has entered into a
five-year supply, purchase and license agreement with another pharmaceutical
company pursuant to which the Company will produce API for the other company and
sell certain intellectual property assets. The Company has also entered into a
collaboration agreement with that company pursuant to which the two companies
will collaborate on the development and manufacture of two drug products.
Revenues related to these agreements had a positive impact on gross profit in
the third quarter of fiscal 2006 and will continue to contribute to gross profit
in the fourth quarter of fiscal 2006 and beyond.
Sale of Equity Investment - In November 2005, the Company recorded a gain of
$4,666 in Other income, net on the sale of its non-controlling interest in
Shandex Sales Group Ltd. (Canada). The after-tax gain of $2,939 increased
earnings per share by $0.03 for the second quarter of fiscal 2006.
Product Recall - In September 2005, the Company initiated a voluntary
retail-level recall of all affected lots of mesalamine rectal suspension, an
anti-inflammatory agent used to treat mild to moderate ulcerative colitis,
following reports of leakage related to the bottle closure cap. The recall was
not safety related and there have been no reports of injury or illness related
to the leakage of this product. The cost to write off the Company's on-hand
inventories and the cost of return and disposal are estimated to be $2,750. The
charge reduced operating income by $2,750 and earnings per share by $0.03 for
the first quarter of fiscal 2006.
-5-
Acquisition - On March 17, 2005, the Company acquired all of the outstanding
shares of Agis Industries (1983) Ltd. (Agis), an Israeli public company. The
accompanying condensed consolidated balance sheet as of March 26, 2005 includes
the accounts for Agis. Results of operations for Agis were included for the
first time in the fourth quarter of fiscal 2005. The purchase price amount
allocated to in-process research and development of $388,600 was charged to
operations in the third quarter of fiscal 2005.
Restructuring - In connection with the acquisition of Agis, the Company reviewed
its Consumer Healthcare operating strategies. As a result, the Company approved
a restructuring plan and recorded a charge to the Company's Consumer Healthcare
segment. The implementation of the plan began on March 24, 2005 and is expected
to be completed in its entirety by June 2006. Certain assets were written down
to their fair value resulting in an impairment charge of $3,232. In addition,
the Company terminated 22 employees performing in certain executive and
administrative roles. Accordingly, the Company recorded a charge for employee
termination benefits of $3,150. The charges for asset impairment and employee
termination benefits are included in the restructuring line of the consolidated
statement of income for the third quarter of fiscal 2005.
Product Recall - In November 2004, the Company initiated a retail-level recall
of all lots of loratadine syrup, a liquid antihistamine indicated for the relief
of symptoms due to hay fever or other upper respiratory allergies. The Company
made the decision to recall all product from the retailer and wholesaler
channels due to a detected difference in its stability profile. The recall was
not safety related and there have been no reports of injury or illness related
to the use of this product. The Company recorded a charge in fiscal 2005 for the
value of the Company's on-hand inventories and the cost of return and disposal
of $8,300, which reduced earnings $0.07 per share. The recall is essentially
complete and the Company recorded income of $2,100 in the third quarter of
fiscal 2006 for the reduction in the associated accruals.
NOTE B - EARNINGS PER SHARE
A reconciliation of the numerators and denominators used in the basic and
diluted earnings per share (EPS) calculation follows:
Third Quarter Year-to-Date
------------------- -------------------
2006 2005 2006 2005
------- --------- ------- ---------
Numerator:
Net income (loss) used for both basic and diluted EPS $20,861 $(379,436) $59,138 $(346,020)
======= ========= ======= =========
Denominator:
Weighted average shares outstanding for basic EPS 92,683 73,660 92,966 71,970
Dilutive effect of share-based awards 1,361 -- 1,177 --
------- --------- ------- ---------
Weighted average shares outstanding for diluted EPS 94,044 73,660 94,143 71,970
======= ========= ======= =========
Share-based awards outstanding that are anti-dilutive were 3,291 and 2,816 for
the third quarters of fiscal 2006 and 2005, respectively, and 4,584 and 2,772
for year-to-date fiscal 2006 and 2005, respectively. These share-based awards
were excluded from the diluted EPS calculation.
-6-
NOTE C - INVENTORIES
Inventories are summarized as follows:
March 25, June 25, March 26,
2006 2005 2005
--------- -------- ---------
Finished goods $145,398 $135,955 $147,558
Work in process 60,084 58,588 71,624
Raw materials 68,186 78,437 82,088
-------- -------- --------
$273,668 $272,980 $301,270
======== ======== ========
The Company maintains an allowance for estimated obsolete or unmarketable
inventory based on the difference between the cost of inventory and its
estimated market value. The inventory balances stated above are net of an
inventory allowance of $43,035 at March 25, 2006, $38,095 at June 25, 2005 and
$27,841 at March 26, 2005. The Company recorded additional charges of $3,800 for
year-to-date fiscal 2006 for estimated obsolete pseudoephedrine inventory on
hand.
NOTE D - GOODWILL
The goodwill related to the Agis acquisition has been allocated to the API and
Rx Pharmaceuticals segments and is tested for impairment annually in the third
quarter of the fiscal year. The current year testing resulted in no impairment
charge related to the API and Rx Pharmaceuticals segments. Goodwill allocated to
the Consumer Healthcare segment is tested annually for impairment in the second
quarter of the fiscal year and resulted in no impairment charge in the current
year. Although the testing performed on the Company's U.K. component within this
segment indicated that the estimated fair value exceeded the carrying value,
these values were closer than they had been in previous years. The narrowing of
the difference in these values increases the possibility of an impairment charge
in future periods. The goodwill balance of the U.K. component was $27,814 as of
March 25, 2006. There were no acquisitions or dispositions of goodwill during
fiscal 2006. The Company recorded adjustments to goodwill that were originally
established in connection with the Agis acquisition. The adjustments were for
changes in tax-related assets and liabilities, additional termination
liabilities for the Company's New York facility, and a final evaluation of
certain assets and liabilities. A summary of goodwill, by reportable segment, is
as follows:
Consumer Rx Pharma-
Healthcare ceuticals API Total
---------- ---------- ------- --------
Balance as of June 25, 2005 $35,919 $65,608 $48,766 $150,293
Goodwill adjustments -- (1,931) (729) (2,660)
------- ------- ------- --------
Balance as of March 25, 2006 $35,919 $63,677 $48,037 $147,633
======= ======= ======= ========
-7-
NOTE E - OUTSTANDING DEBT
Total borrowings outstanding are summarized as follows:
March 25, June 25, March 26,
2006 2005 2005
--------- -------- ---------
Short-term debt:
Swingline loan $ 19,867 $ 10,198 $ 5,833
Revolving line of credit - NY subsidiary -- -- 20,000
Bank loan - Germany subsidiary 5,092 8,652 9,285
Bank loan - U.K. subsidiary -- 2,188 2,887
Bank loans - Mexico subsidiary 2,010 4,307 4,329
-------- -------- --------
Total 26,969 25,345 42,334
-------- -------- --------
Long-term debt:
Revolving line of credit 55,000 115,000 115,000
Term loan 100,000 100,000 100,000
Letter of undertaking - Israel subsidiary 400,000 400,000 400,000
Debenture - Israel subsidiary 39,360 41,128 41,706
Revolving line of credit - NY subsidiary -- -- 10,000
-------- -------- --------
Total 594,360 656,128 666,706
-------- -------- --------
Total debt $621,329 $681,473 $709,040
======== ======== ========
The terms of the loan related to the letter of undertaking indicated above
require that the Company maintain a deposit of $400,000 in an uninsured account
with the lender as security for the loan. The deposit is included in the balance
sheet as a non-current asset.
NOTE F - POSTRETIREMENT MEDICAL BENEFITS
The Company has an unfunded postretirement plan (plan) that provides medical
benefits to eligible retired employees and their dependents. The cost of
postretirement medical benefits is accrued by the Company over the service lives
of the employees based on actuarial calculations for the plan.
Third Quarter Year-to-Date
------------- -------------
2006 2005 2006 2005
----- ----- ----- -----
Components of expense as provided
by the Company's actuary:
Service cost $ 151 $ 103 $ 453 $ 309
Interest cost 53 56 159 168
Amortization of prior year service cost (112) (111) (336) (334)
Amortization of unrecognized net actuarial loss 39 34 117 103
----- ----- ----- -----
Net expense $ 131 $ 82 $ 393 $ 246
===== ===== ===== =====
Year-to-date retirement benefit claims paid for fiscal 2006 were $42 and are
expected to be approximately $25 for the remainder of fiscal 2006.
-8-
NOTE G - SHAREHOLDERS' EQUITY
The Company has a common stock repurchase program. Purchases are made on the
open market, subject to market conditions, and are funded by available cash or
borrowings. All common stock repurchased is retired upon purchase. On April 22,
2005, the Board of Directors approved a plan to repurchase shares of common
stock with a value of up to $30,000. This plan expired on April 21, 2006. On
February 15, 2006, the Board of Directors approved an additional plan to
repurchase shares of common stock with a value of up to $60,000. This plan will
expire on February 17, 2007. On June 21, 2005, the Company announced the
implementation of a 10b5-1 plan that allows brokers selected by the Company to
repurchase shares on behalf of the Company at times when it would ordinarily not
be in the market because of the Company's trading policies. The Company
repurchased 262 shares of its common stock for $4,087 during the third quarter
of fiscal 2006. The Company did not repurchase any shares during the third
quarter of fiscal 2005. Year-to-date, the Company repurchased 1,431 shares of
its common stock for $20,488 and 7 shares for $122 in fiscal 2006 and 2005,
respectively. Year-to-date, private party transactions accounted for 112 shares
and 7 shares in fiscal 2006 and 2005, respectively.
The Company's Shareholder Rights Agreement expired on April 10, 2006.
NOTE H - COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is comprised of all changes in shareholders' equity
during the period other than from transactions with shareholders. Comprehensive
income (loss) consists of the following:
Third Quarter Year-to-Date
------------------- --------------------
2006 2005 2006 2005
------- --------- -------- ---------
Net income (loss) $20,861 $(379,436) $ 59,138 $(346,020)
Other comprehensive income (loss):
Change in fair value of derivative instruments, net of tax 964 -- 4,253 --
Foreign currency translation adjustments 510 1,725 (10,131) 3,383
Change in fair value of investment securities, net of tax (206) -- 188 --
------- --------- -------- ---------
Comprehensive income (loss) $22,129 $(377,711) $ 53,448 $(342,637)
======= ========= ======== =========
NOTE I - COMMITMENTS AND CONTINGENCIES
The Company is not a party to any litigation, other than routine litigation
incidental to its business except for the litigation described below. The
Company believes that none of the routine litigation, individually or in the
aggregate, will be material to the business of the Company.
In August 2004, the Company reached a settlement with the FTC and states'
attorneys general offices regarding a now terminated agreement between Alpharma,
Inc. and the Company related to a children's ibuprofen suspension product. In
connection with the Alpharma, Inc. agreement and the related FTC settlement, the
Company has been named as a defendant in three suits, two of which are class
actions that have been consolidated with one another, filed on behalf of Company
customers (i.e., retailers) and the other consisting of four class action suits
filed on behalf of indirect Company customers (i.e., consumers), alleging that
the plaintiffs overpaid for children's ibuprofen suspension product as a result
of the Company's agreement with Alpharma, Inc. While the Company has defended
these claims, it has
-9-
also participated in settlement negotiations with the plaintiffs leading the
Company to believe that it may settle all of the lawsuits for a combination of
cash payments and product donations. The Company recorded a charge of $4,500 in
the fourth quarter of fiscal 2005 as its best estimate of the combined expected
cost of the settlements. While the Company believes the estimate of the charge
is reasonable, the total amount of future payments related to these lawsuits
cannot be assured and may be materially different than the recorded charge.
The Company is currently defending numerous individual lawsuits pending in
various state and federal courts involving phenylpropanolamine (PPA), an
ingredient used in the manufacture of certain OTC cough/cold and diet products.
The Company discontinued using PPA in the U.S. in November 2000 at the request
of the FDA. These cases allege that the plaintiff suffered injury, generally
some type of stroke, from ingesting PPA-containing products. Many of these suits
also name other manufacturers or retailers of PPA-containing products. These
personal injury suits seek an unspecified amount of compensatory, exemplary and
statutory damages. The Company maintains product liability insurance coverage
for the claims asserted in these lawsuits. The Company believes that it has
meritorious defenses to these lawsuits and intends to vigorously defend them. At
this time, the Company cannot determine whether it will be named in additional
PPA-related suits, the outcome of existing suits or the effect that PPA-related
suits may have on its financial condition or operating results.
The Company's Israeli subsidiary has provided a guaranty to a bank to secure the
debt of a 50% owned joint venture for approximately $430, not to exceed 50% of
the joint venture's debt, that is not recorded on the Company's condensed
consolidated balance sheets as of March 25, 2006.
-10-
NOTE J - SEGMENT INFORMATION
The Company has three reportable segments, aligned primarily by product:
Consumer Healthcare, Rx Pharmaceuticals and API, as well as an Other category.
Prior year's segment information has been restated to conform to the current
year presentation. The year-to-date amounts for the Consumer Healthcare segment,
API segment and Other category include charges of $318, $1,747 and $2,697,
respectively, for the write-off of the step-up in the value of inventory
resulting from the Agis acquisition. The write-off of the inventory step-up
value was completed in the first quarter of fiscal 2006. The majority of
corporate expenses, which generally represent shared services, are charged to
operating segments as part of a corporate allocation. Unallocated expenses were
related to one-time acquisition integration costs and certain corporate services
that are not allocated to the segments. Third quarter and year-to-date
acquisition integration costs were $600 and $2,600, respectively, for fiscal
2006. Fiscal 2005 unallocated expenses also included $388,600 for the write-off
of in-process research and development.
Consumer Rx Pharma- Unallocated
Healthcare ceuticals API Other expenses Total
---------- ---------- ------- ------- ----------- ----------
Third Quarter 2006
Net sales $241,238 $30,237 $30,250 $30,596 -- $ 332,321
Operating income (loss) $ 21,471 $ 4,260 $ 7,969 $ (290) $ (3,055) $ 30,355
Operating income (loss) % 8.9% 14.1% 26.3% (0.9)% -- 9.1%
Amortization of intangibles $ 1,009 $ 1,584 $ 429 $ 240 -- $ 3,262
Third Quarter 2005
Net sales $219,690 $ 403 -- -- -- $ 220,093
Operating income (loss) $ 19,283 $(1,887) -- -- $(393,225) $ (375,829)
Operating income (loss) % 8.8% -- -- -- -- (170.8)%
Amortization of intangibles $ 362 -- -- -- -- $ 362
Year-to-Date 2006
Net sales $742,091 $87,976 $83,903 $97,782 -- $1,011,752
Operating income (loss) $ 66,644 $13,396 $21,099 $ (570) $ (10,176) $ 90,393
Operating income (loss) % 9.0% 15.2% 25.1% (0.6)% -- 8.9%
Amortization of intangibles $ 3,466 $ 4,752 $ 1,287 $ 720 -- $ 10,225
Year-to-Date 2005
Net sales $698,993 $ 567 -- -- -- $ 699,560
Operating income (loss) $ 73,708 $(5,537) -- -- $(393,225) $ (325,054)
Operating income (loss) % 10.5% -- -- -- -- (46.5)%
Amortization of intangibles $ 1,283 -- -- -- -- $ 1,283
-11-
NOTE K - RESTRUCTURING
In connection with the Agis acquisition, the Company reviewed its Consumer
Healthcare operating strategies. As a result, the Company approved a
restructuring plan and recorded a charge to the Company's Consumer Healthcare
segment. The implementation of the plan began on March 24, 2005 and is expected
to be completed in its entirety by June 2006. Certain assets were written down
to their fair value resulting in an impairment charge of $3,232. In addition,
the Company terminated 22 employees performing in certain executive and
administrative roles. Accordingly, the Company recorded employee termination
benefits of $3,150 in the third quarter of fiscal 2005. The activity of the
restructuring reserve is as follows:
Fiscal 2006
Restructuring
Employee
Termination
-------------
Balance at June 25, 2005 $ 2,152
Payments (1,563)
-------
Balance at March 25, 2006 $ 589
=======
In connection with the Agis acquisition, the Company accrued $2,727 of
restructuring costs that were included in the allocation of the purchase price.
These restructuring costs consisted of employee termination benefits for 60
employees and certain lease termination costs. The Company accrued an additional
amount of $1,206 for employee termination benefits in the first quarter of
fiscal 2006 and made total payments to employees of $453 in the second and third
quarters of fiscal 2006. The lease termination accrual was adjusted as a result
of a final evaluation of the liability and will be paid out over the next eight
years. Employee termination benefits are expected to be paid over the next six
to nine months. The activity related to these restructuring costs is as follows:
Fiscal 2006 Restructuring
-------------------------
Employee Lease
Termination Termination
----------- -----------
Balance at June 25, 2005 $ 374 $1,592
Additions 1,206 --
Payments (453) --
Adjustments -- (494)
------ ------
Balance at March 25, 2006 $1,127 $1,098
====== ======
-12-
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THIRD QUARTER FISCAL YEARS 2006 AND 2005
(in thousands, except per share amounts)
OVERVIEW
Acquisition
On March 17, 2005, the Company acquired Agis Industries (1983) Ltd. (Agis). The
acquisition resulted in the establishment of new operating and reportable
segments. The results of operations related to the Agis acquisition are
distributed throughout all of the Company's reportable segments, as described
below.
Segments
The Company has three reportable segments, aligned primarily by product:
Consumer Healthcare, Rx Pharmaceuticals and API, as well as an Other category.
Segment information for prior periods has been restated to conform to the
current year presentation. The Consumer Healthcare segment includes the U.S.,
U.K. and Mexico operations supporting the sale of OTC pharmaceutical and
nutritional products worldwide. The Rx Pharmaceuticals segment supports the
development and sale of prescription drug products. The API segment supports the
development and manufacturing of API products in Israel and Germany, with sales
to customers worldwide. The Other category consists of two operating segments,
Israel Consumer Products and Israel Pharmaceutical and Diagnostic Products, with
sales primarily to the Israeli market, including cosmetics, toiletries,
detergents, manufactured and imported pharmaceutical products and medical
diagnostic products. Neither of these operating segments meets the quantitative
thresholds required to be separately reportable segments.
Significant Factors Impacting Earnings
Update on Pseudoephedrine Sales - The Company continued to be impacted by the
legislative and market changes related to products containing pseudoephedrine,
which have resulted from concerns over the use of pseudoephedrine in the
production of methamphetamine, an illegal drug. Sales of these products in the
third quarter of fiscal 2006 were approximately $26,000 lower than the third
quarter of fiscal 2005 and $69,000 lower year-to-date in fiscal 2006 than
year-to-date fiscal 2005. The Company monitors this issue continuously and,
consequently, recorded an additional charge of $720 in the third quarter of
fiscal 2006 for estimated obsolete inventory on hand. Products containing
pseudoephedrine generated approximately $182,000 of the Company's revenues in
fiscal 2005. Sales are expected to be $90,000 to $95,000 for fiscal 2006 and
will continue to decline in fiscal 2007. This sales estimate has been revised
due to retailer response to the passage of federal legislation, which is
described below. Based on recent events in the retail market, legislative
actions and the resulting lost sales, management believes that these issues will
continue to have a significant adverse effect on the Company's results of
operations in fiscal 2006 and fiscal 2007.
On March 10, 2006, Congress enacted the Patriot Act which included the Combat
Methamphetamine Epidemic Act of 2005 (the Act). Among the various provisions,
this national legislation places certain restrictions on the purchase and sale
of all products that contain ephedrine, pseudoephedrine, or phenylpropanolamine
("Schedule Listed Chemical Products"). Effective April 7, 2006, the Act imposed
-13-
daily restrictions on the amount of Schedule Listed Chemical Products a retailer
may sell to a consumer (3.6 grams per day) and limitations on the amount of
Schedule Listed Chemical Products a consumer may purchase (9.0 grams) over a
thirty-day period. Further, effective September 30, 2006, the Act requires that
(a) sellers place all Schedule Listed Chemical Products behind the counter and
maintain a logbook that tracks the sales of Schedule Listed Chemical Products to
individuals, and (b) purchasers provide valid identification in order to
purchase Schedule Listed Chemical Products.
Seasonality - The Company's sales of OTC pharmaceutical and nutritional products
are subject to the seasonal demands for cough/cold/flu and allergy products.
Accordingly, operating results for the first three quarters of fiscal 2006 are
not necessarily indicative of the results that may be expected for a full year.
Supply, Purchase and License Agreement - The Company has entered into a
five-year supply, purchase and license agreement with another pharmaceutical
company pursuant to which the Company will produce API for the other company and
sell certain intellectual property assets. The company has also entered into a
collaboration agreement with that company pursuant to which the two companies
will collaborate on the development and manufacture of two drug products.
Revenues related to these agreements had a positive impact on gross profit in
the third quarter of fiscal 2006 and will continue to contribute to gross profit
in the fourth quarter of fiscal 2006 and beyond.
Sale of Equity Investment - In the second quarter of fiscal 2006, the Company
recorded a gain of $4,666 on the sale of its non-controlling interest in Shandex
Sales Group Ltd. (Canada).
Product Recall - The Company recorded a charge of $2,750 in the first quarter of
fiscal 2006 as the Company initiated a voluntary retail-level recall of all
affected lots of mesalamine rectal suspension, an anti-inflammatory agent used
to treat mild to moderate ulcerative colitis, following reports of leakage
related to the bottle closure cap.
In-Process Research and Development - In connection with the acquisition of
Agis, the purchase price amount allocated to in-process research and development
of $388,600 was charged to operations in the third quarter of fiscal 2005.
Restructuring - In connection with the acquisition of Agis, the Company reviewed
its Consumer Healthcare operating strategies. As a result, the Company approved
a restructuring plan and recorded a $6,382 charge to the Company's Consumer
Healthcare segment related to asset impairment and employee termination
benefits.
Product Recall - The Company recorded a charge of $8,300 in the second quarter
of fiscal 2005 as the Company initiated a retail-level recall of all lots of
loratadine syrup, a liquid antihistamine indicated for the relief of symptoms
due to hay fever or other upper respiratory allergies. The recall is essentially
complete and the Company recorded income of $2,100 in the third quarter of
fiscal 2006 for a reduction in the associated accruals.
-14-
RESULTS OF OPERATIONS
CONSUMER HEALTHCARE
Third Quarter Year-to-Date
------------------- -------------------
2006 2005 2006 2005
-------- -------- -------- --------
Net sales $241,238 $219,690 $742,091 $698,993
Gross profit $ 61,467 $ 62,648 $184,838 $194,499
Gross profit% 25.5% 28.5% 24.9% 27.8%
Operating expenses $ 39,996 $ 43,365 $118,195 $120,791
Operating expenses% 16.6% 19.7% 15.9% 17.3%
Operating income $ 21,471 $ 19,283 $ 66,644 $ 73,708
Operating income% 8.9% 8.8% 9.0% 10.5%
Net Sales
Third quarter net sales for fiscal 2006 increased 10% or $21,548 compared to
fiscal 2005. The increase resulted primarily from $16,000 of sales of topical
OTC products produced at the New York facility acquired in conjunction with the
Agis acquisition and $24,000 of other new product sales, as well as higher unit
sales of existing vitamin products. The increase was partially offset by a
$26,000 decline in sales of pseudoephedrine-containing products in the third
quarter of fiscal 2006 compared to fiscal 2005.
Year-to-date net sales for fiscal 2006 increased 6% or $43,098 compared to
fiscal 2005. The increase resulted primarily from $48,000 of sales of topical
OTC products produced at the New York facility acquired in conjunction with the
Agis acquisition and $51,000 of other new product sales. The increase was
partially offset by a decline of $69,000 in year-to-date sales of
pseudoephedrine-containing products in fiscal 2006 compared to fiscal 2005.
Year-to-date net sales for fiscal 2005 were negatively impacted by a recall of
loratadine syrup, which reduced net sales during that period by $6,300.
Gross Profit
Third quarter gross profit for fiscal 2006 decreased 2% or $1,181 compared to
fiscal 2005. The decrease was primarily a result of lower unit sales of
pseudoephedrine-containing products and higher inventory obsolescence costs,
partially offset by sales volume attributable to new products and acquired
topical OTC products. The decrease in the third quarter gross profit percentage
was primarily due to higher inventory obsolescence costs and lower unit sales of
pseudoephedrine-containing products, which were typically sold at a margin
higher than the average product in the Consumer Healthcare segment, partially
offset by an adjustment of $2,100 to reduce the associated accruals for the
loratadine syrup recall.
Year-to-date gross profit for fiscal 2006 decreased 5% or $9,661 compared to
fiscal 2005. The decrease was primarily a result of lower unit sales of
pseudoephedrine-containing products and higher inventory obsolescence costs,
including a charge of $3,800 for estimated obsolete pseudoephedrine inventory on
hand, partially offset by sales volume attributable to new products and acquired
topical OTC products. The decrease in the year-to-date gross profit percentage
for fiscal 2006 was primarily due to lower unit sales of
pseudoephedrine-containing products, which were typically sold at a margin
higher than the
-15-
average product in the Consumer Healthcare segment, an unfavorable mix of
products sold and higher inventory obsolescence costs. The decrease was
partially offset by an adjustment of $2,100 to reduce the associated accruals
related to the charge of $8,300 that unfavorably impacted fiscal 2005 for the
loratadine syrup recall.
Operating Expenses
Third quarter operating expenses for fiscal 2006 decreased 8% or $3,369 during
fiscal 2006 compared to fiscal 2005 primarily due to the unfavorable impact in
fiscal 2005 related to the restructuring charges described below. This decrease
was partially offset by the timing of payments related to research and
development costs and amortization of intangible assets.
In fiscal 2005, in connection with the acquisition of Agis, the Company reviewed
its Consumer Healthcare operating strategies. As a result, the Company approved
a restructuring plan and recorded a charge of $6,382. The implementation of the
plan began on March 24, 2005 and is expected to be completed in its entirety by
June 2006. Certain assets were written down to their fair value resulting in an
impairment charge of $3,232. In addition, the Company terminated 22 employees
performing in certain executive and administrative roles. Accordingly, the
Company recorded employee termination benefits of $3,150. The charges for asset
impairment and employee termination benefits are included in the restructuring
line of the consolidated statement of income for the third quarter of fiscal
2005.
Year-to-date operating expenses for fiscal 2006 decreased 2% or $2,596 compared
to fiscal 2005. The decrease was primarily due to the unfavorable impact in
fiscal 2005 related to the restructuring charges and lower employee-related
costs, partially offset by increased expenses related to the New York facility
and amortization of intangible assets.
-16-
RX PHARMACEUTICALS
Third Quarter Year-to-Date
----------------- -----------------
2006 2005 2006 2005
------- ------- ------- -------
Net sales $30,237 $ 403 $87,976 $ 567
Gross profit $11,544 $ 313 $34,761 $ 231
Gross profit% 38.2% 78% 39.5% 41%
Operating expenses $ 7,284 $ 2,200 $21,365 $ 5,768
Operating expenses% 24.1% -- 24.3% --
Operating income (loss) $ 4,260 $(1,887) $13,396 $(5,537)
Operating income% 14.1% -- 15.2% --
Net Sales and Gross Profit
Third quarter and year-to-date net sales and gross profit for fiscal 2006
resulted almost entirely from the Agis acquisition. Third quarter and
year-to-date gross profit included the effect of a charge of $1,584 and $4,752
for amortization of product-related intangible assets, respectively.
In September 2005, the Company initiated a voluntary retail-level recall of
defective lots of mesalamine rectal suspension, an anti-inflammatory agent used
to treat mild to moderate ulcerative colitis, following reports of leakage
related to the bottle closure cap. The recall was not safety related and there
have been no reports of injury or illness related to the leakage of this
product. The cost to write off the value of the Company's on-hand inventories
and the cost of return and disposal are estimated to be $2,750. The charge
reduced operating income by $2,750 and earnings per share by $0.03 for the first
quarter of fiscal 2006.
Operating Expenses
Third quarter fiscal 2006 operating expenses increased $5,084, primarily due to
the inclusion of expenses that resulted from the Agis acquisition. Research and
development spending in this segment increased $1,868 from the third quarter of
fiscal 2005.
Year-to-date fiscal 2006 operating expenses increased $15,597, primarily due to
the inclusion of expenses that resulted from the Agis acquisition. Year-to-date
research and development spending increased $7,412 for fiscal 2006 compared to
fiscal 2005.
-17-
ADDITIONAL INFORMATION
API Other
---------------------- ----------------------
Third Third
Quarter Year-to-Date Quarter Year-to-Date
------- ------------ ------- ------------
Fiscal 2006
Net sales $30,250 $83,903 $30,596 $97,782
Gross profit $14,310 $39,111 $ 9,957 $31,054
Gross profit % 47.3% 46.6% 32.5% 31.8%
Operating expenses $ 6,341 $18,011 $10,247 $31,624
Operating expenses % 21.0% 21.5% 33.5% 32.3%
Operating income (loss) $ 7,969 $21,099 $ (290) $ (570)
Operating income % 26.3% 25.1% (0.9)% (0.6)%
Three new operating segments were established as a result of the Agis
acquisition. The API segment is a reportable segment. The remaining two
operating segments, Israel Consumer Products and Israel Pharmaceutical and
Diagnostic Products, which comprise the Other category, do not meet the
quantitative thresholds required to be separately reportable.
Net sales and gross profit for the API and Other category for third quarter and
year-to-date fiscal 2006 resulted entirely from the Agis acquisition. Third
quarter and year-to-date sales of the API segment included $4,000 for
non-product revenues. Year-to-date gross profit of the API segment and Other
category include charges of $1,747 and $2,697, respectively, for the write-off
of the step-up in the value of inventory resulting from the acquisition. The
write-off of this step-up was completed in the first quarter of fiscal 2006.
Third quarter amortization expense was $429 and $240 for the API segment and
Other category, respectively, and year-to-date amortization expense was $1,287
and $720 for the API segment and Other category, respectively.
UNALLOCATED EXPENSES
Third Quarter Year-to-Date
-------------------- --------------------
2006 2005 2006 2005
-------- --------- -------- ---------
Operating expenses $ 3,055 $ 393,225 $ 10,176 $ 393,225
Operating income (loss) $(3,055) $(393,225) $(10,176) $(393,225)
Unallocated expenses related to one-time acquisition integration costs and
certain corporate services that are not allocated to the segments. Fiscal 2005
unallocated expenses also include the $388,600 write-off of in-process research
and development. Third quarter and year-to-date acquisition integration costs
were $600 and $2,600, respectively, for fiscal 2006.
-18-
INTEREST AND OTHER (CONSOLIDATED)
Third quarter fiscal 2006 net interest expense was $2,465, which included
interest expense of $7,884 and interest income of $5,419. Net interest income
was $454 for the third quarter of fiscal 2005. Other income was $2,310 for the
third quarter of fiscal 2006 compared to $1,091 for the third quarter of fiscal
2005.
Year-to-date fiscal 2006 net interest expense was $11,606, which included
interest expense of $27,476 and interest income of $15,870. Year-to-date net
interest income was $1,405 for fiscal 2005. Year-to-date other income was $9,346
and $1,584 for fiscal 2006 and 2005, respectively. Other income for year-to-date
of fiscal 2006 included a gain of $4,666 from the sale of an equity investment.
The overall higher interest expense in fiscal 2006 was due to the level of
long-term debt held by the Company compared to the level of invested cash
balances in fiscal 2005. The gross amounts of interest expense and income were
high in fiscal 2006 due to the outstanding loan and restricted cash deposit of
$400,000 established in connection with the Agis acquisition.
INCOME TAXES (CONSOLIDATED)
Third quarter effective tax rate was 30.9% for fiscal 2006. For year-to-date
fiscal 2006, the effective tax rate was 32.9%. The Agis acquisition changed the
relative composition of U.S. and Foreign income, which is expected to result in
a lower effective tax rate than the Company has historically experienced. This
tax rate will fluctuate from quarter to quarter depending on the composition of
income before tax in the various tax jurisdictions. Thirty-eight percent of
income before tax in the first three quarters of fiscal 2006 was contributed by
foreign entities, generally Israeli, with a tax rate lower than the U.S.
statutory rate. Additionally, due to the sale of an equity investment that
resulted in a capital gain, the Company released a valuation allowance of $1,090
on a capital loss carry forward, which reduced income tax expense in the first
quarter of fiscal 2006. The Company recorded additional year-to-date tax expense
of $867 in fiscal 2006 as certain deferred tax assets and liabilities were
adjusted as a result of changes in statutory tax rates in Israel. The estimated
annualized effective tax rate for fiscal 2006 is expected to be between 32% and
34%.
Tax expense for fiscal 2005 was impacted by the non-deductible charge to
earnings of $388,600 for the write-off of in-process research and development
related to the acquisition of Agis. The effective tax rate was 36.0% for the
quarter and year-to date fiscal 2005, excluding this charge.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and investment securities decreased $38,082 to $35,853 at
March 25, 2006 from $73,935 at March 26, 2005. Working capital, including cash,
decreased $47,909 to $245,091 at March 25, 2006 from $293,000 at March 26, 2005.
Year-to-date net cash provided from operating activities increased by $56,240 to
$110,632 for fiscal 2006 compared to $54,392 for fiscal 2005. The contribution
of cash flow from operating income of the subsidiaries related to the Agis
acquisition offset the reduction in operating income of the Consumer Healthcare
segment. The additional cash from operations was due to favorable changes in
working capital attributable to lower employee bonuses paid in fiscal 2006 and
higher accounts payable, partially offset by payments for income taxes and other
liabilities.
-19-
Year-to-date net cash used for investing activities decreased $631,380 to $8,422
for fiscal 2006 compared to $639,802 for fiscal 2005 primarily due to the
completion of the Agis acquisition in the third quarter of fiscal 2005.
Year-to-date capital expenditures for facilities and equipment were for normal
replacement and productivity enhancements. Capital expenditures are anticipated
to be $25,000 to $35,000 for fiscal 2006.
Year-to-date net cash used for financing activities was $86,144 for fiscal 2006
primarily due to repayments of debt, repurchases of common stock and payments of
cash dividends. Cash provided by financing activities of $616,512 for fiscal
2005 was primarily due to debt incurred in connection with the Agis acquisition.
The Company repurchased 262 shares of its common stock for $4,087 during the
third quarter of fiscal 2006. The Company did not repurchase any shares during
the third quarter of fiscal 2005. Year-to-date, the Company repurchased 1,431
shares of its common stock for $20,488 and 7 shares for $122 in fiscal 2006 and
2005, respectively. Year-to-date, private party transactions accounted for 112
shares and 7 shares in fiscal 2006 and 2005, respectively.
The Company paid quarterly dividends totaling $11,660 and $8,195, or $0.125 and
$0.115 per share, during fiscal 2006 and 2005, respectively. The declaration and
payment of dividends, if any, is subject to the discretion of the Board of
Directors and will depend on the earnings, financial condition and capital and
surplus requirements of the Company and other factors the Board of Directors may
consider relevant.
GUARANTIES AND CONTRACTUAL OBLIGATIONS
The Company's Israeli subsidiary has provided a guaranty to a bank to secure the
debt of a 50% owned joint venture for approximately $430, not to exceed 50% of
the joint venture's debt that is not recorded on the Company's condensed
consolidated balance sheets as of March 25, 2006.
During the third quarter of fiscal 2006, no material change in contractual
obligations occurred.
CRITICAL ACCOUNTING POLICIES
Determination of certain amounts in the Company's financial statements requires
the use of estimates. These estimates are based upon the Company's historical
experiences combined with management's understanding of current facts and
circumstances. Although the estimates are considered reasonable, actual results
could differ from the estimates. The accounting policies, discussed below, are
considered by management to require the most judgment and are critical in the
preparation of the financial statements. These policies are reviewed by the
Audit Committee. Other significant accounting policies are included in Note A of
the notes to the consolidated financial statements in the Company's annual
report on Form 10-K for the fiscal year ended June 25, 2005.
Revenue Recognition and Customer Programs - The Company records revenues from
product sales when the goods are shipped to the customer. For customers with
Free on Board destination terms, a provision is recorded to exclude shipments
estimated to be in-transit to these customers at the end of the reporting
period. A provision is recorded and accounts receivable are reduced as revenues
are recognized for estimated losses on credit sales due to customer claims for
discounts, price
-20-
discrepancies, returned goods and other items. A liability is recorded as
revenues are recognized for estimated customer program liabilities, as discussed
below.
A chargeback relates to an agreement the Company has with a wholesaler, a retail
customer that will ultimately purchase product from a wholesaler or a
pharmaceutical buying group for a contracted price that is different than the
Company's price to the wholesaler. The wholesaler will issue an invoice to the
Company for the difference in the contract prices. The accrual for chargebacks
is based on historical chargeback experience and estimated wholesaler inventory
levels, as well as expected sell-through levels by wholesalers to retailers.
Rebates are payments issued to the customer when certain criteria are met which
may include specific levels of product purchases, introduction of new products
or other objectives. The accrual for rebates is based on contractual agreements
and estimated purchasing levels by customers with such programs. Medicaid
rebates are payments made to states for pharmaceutical products covered by the
program. The accrual for Medicaid rebates is based on historical trends of
rebates paid and current period sales activity.
Shelf stock adjustments are credits issued to reflect decreases in the selling
price of a product and are based upon estimates of the amount of product
remaining in a customer's inventory at the time of the anticipated price
reduction. In many cases, the customer is contractually entitled to such a
credit. The accrual for shelf stock adjustments is based on specified terms with
certain customers, estimated launch dates of competing products and estimated
declines in market price.
Changes in these estimates and assumptions related to customer programs may
result in additional accruals. The following table summarizes the balance sheet
activity for accounts receivable allowances and customer program accruals:
Year-to- Year-to-
Date Date
2006 2005
-------- -------
ACCOUNTS RECEIVABLE ALLOWANCES,
excluding allowance for doubtful accounts
Balance, beginning of period $ 20,394 $ 3,691
Acquisition of Agis -- 15,028
Provision recorded 1,607 --
Credits processed 1,396 --
-------- -------
Balance, end of the period $ 20,605 $18,719
======== =======
CUSTOMER PROGRAM ACCRUALS
Balance, beginning of period $ 41,666 $13,212
Acquisition of Agis -- 20,488
Provision recorded 109,566 20,417
Credits processed 105,212 22,815
-------- -------
Balance, end of the period $ 46,020 $31,302
======== =======
-21-
Allowance for Doubtful Accounts - The Company maintains an allowance for
customer accounts that reduces receivables to amounts that are expected to be
collected. In estimating the allowance, management considers factors such as
current overall economic conditions, industry-specific economic conditions,
historical and anticipated customer performance, historical experience with
write-offs and the level of past-due amounts. Changes in these conditions may
result in additional allowances. The allowance for doubtful accounts was $10,619
at March 25, 2006, $10,370 at June 25, 2005 and $8,280 at March 26, 2005.
Inventory - The Company maintains an allowance for estimated obsolete or
unmarketable inventory based on the difference between the cost of the inventory
and its estimated market value. In estimating the allowance, management
considers factors such as excess or slow moving inventories, product expiration
dating, products on quality hold, current and future customer demand and market
conditions. Changes in these conditions may result in additional allowances. The
allowance for inventory was $43,035 at March 25, 2006, $38,095 at June 25, 2005
and $27,841 at March 26, 2005. The Company recorded year-to-date charges of
$3,800 in fiscal 2006 for estimated obsolete pseudoephedrine inventory on hand.
Goodwill - Goodwill is tested for impairment annually or more frequently if
changes in circumstances or the occurrence of events suggest impairment exists.
The test for impairment requires the Company to make several estimates about
fair value, most of which are based on projected future cash flows. The
estimates associated with the goodwill impairment tests are considered critical
due to the judgments required in determining fair value amounts, including
projected future cash flows. Changes in these estimates may result in the
recognition of an impairment loss. The goodwill related to the Agis acquisition
has been allocated to the API and Rx Pharmaceuticals segments and is tested for
impairment annually in the third quarter of the fiscal year. The current year
testing resulted in no impairment charge related to the API and Rx
Pharmaceuticals segments. Goodwill allocated to the Consumer Healthcare segment
is tested annually for impairment in the second quarter of the fiscal year and
also resulted in no impairment charge in the current year. Although the testing
performed on the Company's U.K. component within this segment indicated that the
estimated fair value exceeded the carrying value, these values were closer than
they had been in previous years. The narrowing of the difference in these values
increases the possibility of an impairment charge in future periods. The
goodwill balance of the U.K. component was $27,814 as of March 25, 2006.
Goodwill was $147,633 at March 25, 2006, $150,293 at June 25, 2005 and $150,226
at March 26, 2005.
Other Intangible Assets - Other intangible assets subject to amortization
consist of developed product technology, distribution and license agreements,
customer relationships and trademarks. Most of these assets are amortized over
their estimated useful economic lives using the straight-line method. An
accelerated method of amortization is used for customer relationships. For
intangible assets subject to amortization, an impairment analysis is performed
whenever events or changes in circumstances indicate that the carrying amount of
the assets may not be recoverable. An impairment loss is recognized if the
carrying amount of the asset is not recoverable and its carrying amount exceeds
its fair value. Other intangible assets were $138,043 at March 25, 2006,
$147,967 at June 25, 2005 and $142,050 at March 26, 2005.
Product Liability and Workers' Compensation - The Company maintains accruals to
provide for claims incurred that are related to product liability and workers'
compensation. In estimating these accruals, management considers actuarial
valuations of exposure based on loss experience. These actuarial valuations
include significant estimates and assumptions, which include, but are not
limited to, loss development, interest rates, product sales, litigation costs,
accident severity and payroll expenses.
-22-
Changes in these estimates and assumptions may result in additional accruals.
The accrual for product liability claims was $1,825 at March 25, 2006, $1,930 at
June 25, 2005 and $2,751 at March 26, 2005. The accrual for workers'
compensation claims was $2,968 at March 25, 2006, $2,472 at June 25, 2005 and
$2,731 at March 26, 2005.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION AND STATEMENTS
Certain statements in Management's Discussion and Analysis of Results of
Operations and Financial Condition and other portions of this report are
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended, and are subject to the safe harbor created
thereby. These statements relate to future events or the Company's future
financial performance and involve known and unknown risks, uncertainties and
other factors that may cause the actual results, levels of activity, performance
or achievements of the Company or its industry to be materially different from
those expressed or implied by any forward-looking statements. In some cases,
forward-looking statements can be identified by terminology such as "may,"
"will," "could," "would," "should," "expect," "plan," "anticipate," "intend,"
"believe," "estimate," "predict," "potential" or other comparable terminology.
Please see the "Cautionary Note Regarding Forward-Looking Statements" in the
Company's Form 10-K for the year ended June 25, 2005 and Item 1A in Part II of
this Form 10-Q for a discussion of certain important risk factors that relate to
forward-looking statements contained in this report. Although the Company
believes that the expectations reflected in these forward-looking statements are
reasonable, it can give no assurance that such expectations will prove to be
correct. Unless otherwise required by applicable securities laws, the Company
disclaims any intention or obligation to update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
-23-
Item 3. Quantitative and Qualitative Disclosures About Market Risks
The Company is exposed to market risks due to changes in currency exchange rates
and interest rates.
The Company is exposed to interest rate changes primarily as a result of
interest expense on borrowings used to finance the Agis acquisition and working
capital requirements and interest income earned on its investment of cash on
hand. As of March 25, 2006, the Company had invested cash, cash equivalents and
investment securities of approximately $36,000 and short and long-term debt, net
of restricted cash, of approximately $221,000.
The Company enters into certain derivative financial instruments, when available
on a cost-effective basis, to hedge its underlying economic exposure,
particularly related to the management of interest rate risk. Because of the use
of certain derivative financial instruments, the Company believes that a
significant fluctuation in interest rates in the near future will not have a
material impact on the Company's consolidated financial statements. These
instruments are managed on a consolidated basis to efficiently net exposures and
thus take advantage of any natural offsets. Derivative financial instruments are
not used for speculative purposes. Gains and losses on hedging transactions are
offset by gains and losses on the underlying exposures being hedged.
The Company has operations in the U.K., Israel, Germany and Mexico. These
operations transact business in their local currency and foreign currencies,
thereby creating exposures to changes in exchange rates. From time to time, the
Company enters into currency derivative instruments to hedge its underlying
exposure to currency fluctuations. Significant currency fluctuations could
adversely impact foreign revenues; however, the Company cannot predict future
changes in foreign currency exposure.
-24-
Item 4. Controls and Procedures
As of March 25, 2006, the Company's management, including its Chief Executive
Officer and its Chief Financial Officer, performed an interim review of the
effectiveness of the Company's disclosure controls and procedures pursuant to
Rule 13a-15(b) of the Securities Exchange Act of 1934. Based on that review, as
well as an evaluation and consideration of the update described below, the Chief
Executive Officer and Chief Financial Officer have concluded the Company's
disclosure controls and procedures are not effective at a reasonable assurance
level. Certain material weaknesses in internal control over financial reporting
(ICFR) were identified in fiscal 2005 in connection with integration and initial
internal control assessment activities related to the Agis acquisition (This
section of Item 4. Controls and Procedures should be read in conjunction with
Item 9A. Controls and Procedures, included in the Company's Form 10-K for the
fiscal year ended June 25, 2005).
The Company is actively seeking to remedy these material weaknesses. Other than
the deficiencies related to the Agis entities, the Chief Executive Officer and
Chief Financial Officer did not identify any other material weaknesses in the
Company's disclosure controls and procedures during their evaluation. The
following is an update on the Company's remediation plan:
- The New York location was converted to an ERP system in accordance
with the plan disclosed in the fiscal 2005 Form 10-K. All material
information systems at this location are now centralized with the
Michigan operations.
- Formal policies to reflect the tone of top management have been
implemented at the Israel, New York and Germany locations.
- Significant progress has been made in the modification of the Israel
locations' information systems infrastructure to align with the
Company's standards.
- The financial statement closing process in Israel has been enhanced by
implementing financial consolidation software, formal policies and
improved processes for general ledger journal entries and account
reconciliations.
- Implementation of an ERP system in Israel is underway with a planned
go-live date in the second quarter of fiscal 2007.
- The Company expects to report the ICFR are effective for approximately
80% of the Company's consolidated fiscal year-to-date revenue by the
end of fiscal 2006. The remaining material locations are expected to
be compliant in fiscal 2007.
In connection with the interim evaluation by the Company's management, including
its Chief Executive Officer and Chief Financial Officer, of the Company's ICFR
pursuant to Rule 13a-15(d) of the Securities Exchange Act of 1934, no changes
during the quarter ended March 25, 2006 were identified that have materially
affected, or are reasonably likely to materially affect, the Company's ICFR.
-25-
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In August 2004, the Company reached a settlement with the FTC and states'
attorneys general offices regarding a now terminated agreement between Alpharma,
Inc. and the Company related to a children's ibuprofen suspension product. In
connection with the Alpharma, Inc. agreement and the related FTC settlement, the
Company has been named as a defendant in three suits, two of which are class
actions that have been consolidated with one another, filed on behalf of Company
customers (i.e., retailers) and the other consisting of four class action suits
filed on behalf of indirect Company customers (i.e., consumers), alleging that
the plaintiffs overpaid for children's ibuprofen suspension product as a result
of the Company's agreement with Alpharma, Inc. While the Company has defended
these claims, it has also participated in settlement negotiations with the
plaintiffs leading the Company to believe that it may settle all of the lawsuits
for a combination of cash payments and product donations. The Company recorded a
charge of $4,500 in the fourth quarter of fiscal 2005 as its best estimate of
the combined expected cost of the settlements. While the Company believes the
estimate of the charge is reasonable, the total amount of future payments
related to these lawsuits cannot be assured and may be materially different than
the recorded charge.
Item 1A. Risk Factors
The Company's Annual Report on Form 10-K filed for the fiscal year ended June
25, 2005 includes a detailed discussion of the Company's risk factors. The
information presented below amends, updates and should be read in conjunction
with the risk factors and information disclosed in that Form 10-K.
The Company continued to be impacted by the legislative and market changes
related to products containing pseudoephedrine, which have resulted from
concerns over the use of pseudoephedrine in the production of methamphetamine,
an illegal drug. Sales of these products in the third quarter of fiscal 2006
were approximately $26,000 lower than the third quarter of fiscal 2005 and
$69,000 lower year-to-date in fiscal 2006 than year-to-date fiscal 2005. The
Company monitors this issue continuously and, consequently, recorded an
additional charge of $720 in the third quarter of fiscal 2006 for estimated
obsolete inventory on hand. Products containing pseudoephedrine generated
approximately $182,000 of the Company's revenues in fiscal 2005. Sales are
expected to be $90,000 to $95,000 for fiscal 2006 and will continue to decline
in fiscal 2007. This sales estimate has been revised due to retailer response to
the passage of federal legislation, which is described below. Based on recent
events in the retail market, legislative actions and the resulting lost sales,
management believes that these issues will continue to have a significant
adverse effect on the Company's results of operations in fiscal 2006 and fiscal
2007.
On March 10, 2006, Congress enacted the Patriot Act which included the Combat
Methamphetamine Epidemic Act of 2005 (the Act). Among the various provisions,
this national legislation places certain restrictions on the purchase and sale
of all products that contain ephedrine, pseudoephedrine, or phenylpropanolamine
("Schedule Listed Chemical Products"). Effective April 7, 2006, the Act imposed
daily restrictions on the amount of Schedule Listed Chemical Products a retailer
may sell to a consumer (3.6 grams per day) and limitations on the amount of
Schedule Listed Chemical Products a consumer may purchase (9.0 grams) over a
thirty-day period. Further, effective September 30, 2006, the Act requires that
(a) sellers place all Schedule Listed Chemical Products behind the counter and
maintain a logbook that tracks the sales of Schedule Listed Chemical Products to
individuals, and (b) purchasers provide valid identification in order to
purchase Schedule Listed Chemical Products.
-26-
The Company manufactures several products that contain the active ingredient,
dextromethorphan, which is indicated for cough suppression. Dextromethorphan has
come under scrutiny because of its potential to be abused. Some states have
introduced legislation that, if passed, is intended to restrict access to
dextromethorphan in finished dosage forms. The restrictions may include
requiring a minimum age to purchase product, limiting the amount a consumer may
purchase, requiring a prescription and/or placing the product in a more
controlled position of sale behind the pharmacy counter of a retailer. In
certain instances, over-the-counter drugs have been exempted from the proposed
legislation. Products containing dextromethorphan generated approximately
$98,000 of the Company's revenues in fiscal 2005. The Company cannot predict
whether any of the proposed legislation will be passed, or if it is passed, its
impact on future revenues attributable to these products.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On April 22, 2005, the Board of Directors approved a plan to repurchase shares
of common stock with a value of up to $30,000. This plan expired on April 21,
2006. On February 15, 2006, the Board of Directors approved and additional plan
to repurchase shares of common stock with a value of up to $60,000. This plan
will expire on February 17, 2007. On June 21, 2005, the Company announced the
implementation of a 10b5-1 plan that allows brokers selected by the Company to
repurchase shares on behalf of the Company at times when it would ordinarily not
be in the market because of the Company's trading policies. All common stock
repurchased is retired upon purchase.
The table below lists the Company's repurchases of shares of common stock during
its most recently completed quarter:
Total Number Average Total Number of Shares Value of
of Shares Price Paid Purchased as Part of Shares Available
Fiscal 2006 Purchased (1) per Share Publicly Announced Plans for Purchase
----------- ------------- ---------- ------------------------ ----------------
December 25 to January 28 123 $15.26 122 $72,334
January 29 to February 25 76 $15.72 76 $70,478
February 26 to March 25 63 $16.11 63 $69,283
--- ---
Total 262 261 $68,265
(1) A private party transaction accounted for the purchase of 1 shares in the
period from January 29 to February 25.
Item 6. Exhibits
Exhibit Number Description
-------------- -----------
2(a) Agreement and Plan of Merger dated as of November 14, 2004,
among Registrant, Agis Industries (1983) Ltd. and Perrigo
Israel Opportunities Ltd., incorporated by reference from
Appendix A to the Registrant's Proxy Statement/Prospectus
included in the Registrant's Registration Statement on Form S-4
(No. 333-121574), filed and declared effective on February 14,
2005.
10(a) Perrigo Company Nonqualified Deferred Compensation Plan,
incorporated by reference from Exhibit 10.1 to the Registrant's
Current Report on Form 8-K filed on March 29, 2006.
-27-
10(b) Letter Agreement by and between Perrigo Company and Ran
Gottfried, dated February 15, 2006 and effective February 16,
2006, incorporated by reference from Exhibit 10.1 to the
Registrant's Current Report on Form 8-K filed on February 22,
2006.
31 Rule 13a-14(a) Certifications.
32 Section 1350 Certifications.
-28-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PERRIGO COMPANY
(Registrant)
Date: April 27, 2006 By: /s/ David T. Gibbons
------------------------------------
David T. Gibbons
Chairman, President and
Chief Executive Officer
Date: April 27, 2006 By: /s/ Douglas R. Schrank
------------------------------------
Douglas R. Schrank
Executive Vice President and
Chief Financial Officer
(Principal Accounting and
Financial Officer)
-29-