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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: DECEMBER 24, 2005
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 January 27, 2006 the registrant had 93,053,371 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 December 24, 2005 and December 25, 2004 1
Condensed consolidated balance sheets -- December 24, 2005, June 25, 2005,
and December 25, 2004 2
Condensed consolidated statements of cash flows -- For the year-to-date
ended December 24, 2005 and December 25, 2004 3
Notes to condensed consolidated financial statements 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risks 21
Item 4. Controls and Procedures 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 1A. Risk Factors 23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 6. Exhibits 25
SIGNATURES 26
PERRIGO COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
Second Quarter Year-to-Date
--------------------- --------------------
2006 2005 2006 2005
---------- --------- --------- ---------
Net sales $ 359,697 $ 251,748 $ 679,431 $ 479,467
Cost of sales 254,127 184,692 486,945 347,698
---------- --------- --------- ---------
Gross profit 105,570 67,056 192,486 131,769
---------- --------- --------- ---------
Operating expenses
Distribution 6,953 3,905 14,103 8,098
Research and development 12,226 9,286 24,875 15,640
Selling and administration 47,082 29,716 93,470 57,256
---------- --------- --------- ---------
Total 66,261 42,907 132,448 80,994
Operating income 39,309 24,149 60,038 50,775
Interest and other, net (675) (604) 2,105 (1,444)
---------- --------- --------- ---------
Income before income taxes 39,984 24,753 57,933 52,219
Income tax expense 14,618 8,915 19,656 18,803
---------- --------- --------- ---------
Net income $ 25,366 $ 15,838 $ 38,277 $ 33,416
========== ========= ========= =========
Earnings per share
Basic $ 0.27 $ 0.22 $ 0.41 $ 0.47
Diluted $ 0.27 $ 0.22 $ 0.41 $ 0.46
Weighted average shares outstanding
Basic 92,833 71,206 93,063 71,111
Diluted 93,963 73,285 94,167 73,166
Dividends declared per share $ 0.0425 $ 0.040 $ 0.0825 $ 0.075
See accompanying notes to condensed consolidated financial statements.
-1-
PERRIGO COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
December 24, June 25, December 25,
2005 2005 2004
-------------- -------------- ------------
(unaudited) (unaudited)
Assets
Current assets
Cash and cash equivalents $ 15,840 $ 16,707 $ 8,437
Investment securities 10,717 17,761 170,798
Accounts receivable 235,672 210,308 110,931
Inventories 262,855 272,980 166,615
Current deferred income taxes 52,140 55,987 32,242
Prepaid expenses and other current assets 21,841 35,064 10,271
-------------- -------------- ------------
Total current assets 599,065 608,807 499,294
Property and equipment 594,802 586,306 468,718
Less accumulated depreciation 282,196 262,505 248,140
-------------- -------------- ------------
312,606 323,801 220,578
Restricted cash 400,000 400,000 -
Goodwill 150,067 150,293 35,919
Other intangible assets 141,079 147,967 8,467
Non-current deferred income taxes 36,130 26,964 7,899
Other non-current assets 45,129 47,144 14,259
-------------- -------------- ------------
$ 1,684,076 $ 1,704,976 $ 786,416
============== ============== ============
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable $ 149,541 $ 142,789 $ 83,299
Notes payable 20,975 25,345 9,758
Payroll and related taxes 42,021 42,326 23,749
Accrued customer programs 50,775 41,666 15,365
Accrued liabilities 55,898 57,532 32,329
Accrued income taxes 11,539 21,225 6,705
Current deferred income taxes 13,727 9,659 3,079
-------------- -------------- ------------
Total current liabilities 344,476 340,542 174,284
Non-current liabilities
Long-term debt 634,956 656,128 -
Non-current deferred income taxes 64,182 74,379 29,631
Other non-current liabilities 34,807 43,090 7,499
-------------- -------------- ------------
Total non-current liabilities 733,945 773,597 37,130
Shareholders' equity
Preferred stock, without par value, 10,000 shares - - -
authorized
Common stock, without par value, 200,000 shares 518,459 527,748 112,703
authorized
Accumulated other comprehensive income (loss) (8,645) (1,687) 4,523
Retained earnings 95,841 64,776 457,776
-------------- -------------- ------------
Total shareholders' equity 605,655 590,837 575,002
-------------- -------------- ------------
$ 1,684,076 $ 1,704,976 $ 786,416
============== ============== ============
Supplemental Disclosures of Balance Sheet Information
Allowance for doubtful accounts $ 11,088 $ 10,370 $ 7,934
Allowance for inventory $ 44,201 $ 38,095 $ 23,846
Working capital $ 254,589 $ 268,265 $ 325,010
Preferred stock, shares issued - - -
Common stock, shares issued 93,104 93,903 71,555
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 $ 38,277 $ 33,416
Adjustments to derive cash flows
Depreciation and amortization 26,753 15,514
Share-based compensation 4,741 2,827
Deferred income taxes (7,506) (2,967)
--------- ---------
Sub-total 62,265 48,790
Changes in operating assets and liabilities
Accounts receivable (23,845) (24,354)
Inventories 11,956 8,139
Accounts payable 5,480 (5,237)
Payroll and related taxes (580) (17,621)
Accrued customer programs 9,109 2,153
Accrued liabilities (3,133) 1,944
Accrued income taxes (12,811) 6,702
Other 6,797 938
--------- ---------
Sub-total (7,027) (27,336)
Net cash from operating activities 55,238 21,454
--------- ---------
Cash Flows (For) From Investing Activities
Purchase of securities (27,887) (76,815)
Proceeds from sales of securities 34,586 69,890
Additions to property and equipment (12,112) (7,564)
Acquisition of assets - (5,562)
Other - (2,478)
--------- ---------
Net cash for investing activities (5,413) (22,529)
--------- ---------
Cash (For) From Financing Activities
Borrowings (repayments) of short-term debt, net (4,471) 395
Borrowings of long-term debt 15,000 -
Repayments of long-term debt (35,000) -
Tax effect of stock transactions (635) 821
Issuance of common stock 3,006 5,161
Repurchase of common stock (16,401) (122)
Cash dividends (7,702) (5,334)
--------- ---------
Net cash (for) from financing activities (46,203) 921
--------- ---------
Net increase (decrease) in cash and cash 3,622 (154)
equivalents
Cash and cash equivalents, at beginning of period 16,707 8,392
Effect of exchange rate changes on cash (4,489) 199
--------- ---------
Cash and cash equivalents, at end of period $ 15,840 $ 8,437
========= =========
Supplemental Disclosures of Cash Flow Information
Cash paid/received during the period for:
Interest paid $ 17,680 $ 220
Interest received $ 10,614 $ -
Income taxes paid $ 32,361 $ 11,941
Income taxes refunded $ 5,164 $ 4,066
See accompanying notes to condensed consolidated financial statements.
-3-
PERRIGO COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 24, 2005
(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.
An evaluation of the Company's classification of cash equivalents indicated
that, due to their contractual maturity date, floating and adjustable rate
securities were more appropriately classified as investment securities.
Accordingly, the Company reclassified floating and adjustable rate securities of
$167,265 as of December 25, 2004 from cash and cash equivalents to investment
securities in its consolidated balance sheets. The Company has also reclassified
the purchases of and proceeds from sales of these securities in its consolidated
statements of cash flows, which decreased cash flows from investing activities
by $13,555 for the six months ended December 25, 2004.
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. Effective for the three months ended December
24, 2005; these operations are reported consistent with the Company's fiscal
year. Current accounting guidance requires that no more than three 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:
Second Quarter Ended
December 24, 2005
-----------------
Retained earnings as of September 24, 2005 $ 73,946
Dividends paid (3,961)
Net income 25,366
Net income - stub period 490
------------
Retained earnings as of December 24, 2005 $ 95,841
============
-4-
Operating results for the six months ended December 24, 2005 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 over the use of pseudoephedrine in the
production of methamphetamine, an illegal drug. Sales of these products in the
second quarter of fiscal 2006 were approximately $20,000 lower than the second
quarter of fiscal 2005. The Company monitors this issue continuously and,
consequently, recorded an additional charge of $390 in the second 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 for fiscal 2006 are expected to be $110,000 to $120,000.
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.
Product Recall - 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 is
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.
Sale of Equity Investment - In November 2005, the Company recorded a gain of
$4,666 in Interest and other, 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.
NOTE B - EARNINGS PER SHARE
A reconciliation of the numerators and denominators used in the basic and
diluted earnings per share (EPS) calculation follows:
Second Quarter Year-to-Date
---------------- ----------------
2006 2005 2006 2005
------- ------- ------- -------
Numerator:
Net income used for both basic and diluted EPS $25,366 $15,838 $38,277 $33,416
======= ======= ======= =======
Denominator:
Weighted average shares outstanding for basic EPS 92,833 71,206 93,063 71,111
Dilutive effect of share-based awards 1,130 2,079 1,104 2,055
------- ------- ------- -------
Weighted average shares outstanding for diluted EPS 93,963 73,285 94,167 73,166
======= ======= ======= =======
-5-
Share-based awards outstanding that are anti-dilutive were 4,877 and 1,152 for
the second quarters of fiscal 2006 and 2005, respectively, and 4,374 and 958 for
year-to-date fiscal 2006 and 2005, respectively. These share-based awards were
excluded from the diluted EPS calculation.
NOTE C - INVENTORIES
Inventories are summarized as follows:
December 24, June 25, December 25,
2005 2005 2004
------------ -------- ------------
Finished goods $132,841 $135,955 $ 60,581
Work in process 56,988 58,588 58,572
Raw materials 73,026 78,437 47,462
-------- -------- ---------
$262,855 $272,980 $ 166,615
======== ======== =========
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 $44,201 at December 24, 2005, $38,095 at June 25, 2005
and $23,846 at December 25, 2004. The Company recorded a charge of $3,100 for
estimated obsolete pseudoephedrine inventory on hand in the first half of fiscal
2006.
NOTE D - GOODWILL
Goodwill allocated to the Consumer Healthcare segment is tested annually for
impairment in the second quarter of the fiscal year. The current year testing
resulted in no impairment charge related to the Consumer Healthcare segment.
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
December 24, 2005.
The goodwill related to the Agis acquisition has been allocated to the API and
Rx Pharmaceuticals segments and will be tested for impairment annually in the
third quarter of the fiscal year. There were no acquisitions or dispositions of
goodwill during fiscal 2006. The Company recorded an adjustment to goodwill that
was originally established in connection with the Agis acquisition. The
adjustment was for changes in tax-related assets and liabilities and additional
termination liabilities for the Company's New York facility. 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 adjustment - (544) 318 (226)
------- -------- ------- ---------
Balance as of December 24, 2005 $35,919 $ 65,064 $49,084 $ 150,067
======= ======== ======= =========
-6-
NOTE E - OUTSTANDING DEBT
Total borrowings outstanding are summarized as follows:
December 24, June 25, December 25,
2005 2005 2004
------------ -------- ------------
Short-term debt:
Swingline loan $ 8,232 $ 10,198 -
Bank loan - Germany subsidiary 8,301 8,652 -
Bank loan - U.K. subsidiary - 2,188 $ 4,154
Bank loans - Mexico subsidiary 4,442 4,307 5,604
-------- -------- --------
Total 20,975 25,345 9,758
-------- -------- --------
Long-term debt:
Revolving line of credit 95,000 115,000 -
Term loan 100,000 100,000 -
Letter of undertaking - Israel subsidiary 400,000 400,000 -
Debenture - Israel subsidiary 39,956 40,128 -
-------- -------- --------
Total 634,956 656,128 -
-------- -------- --------
Total debt $655,931 $681,473 $ 9,758
======== ======== ========
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. Effective January
1, 2004, the plan was modified to limit the amount of benefits the Company
provides to retirees each year, adjusted annually for inflation.
Second Quarter Year-to-Date
------------------- ---------------
2006 2005 2006 2005
----- ----- ----- -----
Components of expense as provided
by the Company's actuary:
Service cost $ 151 $ 103 $ 302 $ 206
Interest cost 53 56 106 112
Amortization of prior year service cost (112) (111) (224) (223)
Amortization of unrecognized net actuarial loss 39 34 78 69
----- ----- ----- -----
Net expense $ 131 $ 82 $ 262 $ 164
===== ===== ===== =====
Retirement benefit claims paid for the first half of fiscal 2006 were $39 and
are expected to be approximately $90 for the remainder of fiscal 2006.
-7-
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 will expire on April 26, 2006. 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 563 shares of its common
stock for $7,842 during the second quarter of fiscal 2006. The Company did not
repurchase any shares during the second quarter of fiscal 2005. Year-to-date,
the Company repurchased 1,169 shares of its common stock for $16,401 and 7
shares for $122 in fiscal 2006 and 2005, respectively. Year-to-date, private
party transactions accounted for 111 shares and 7 shares in fiscal 2006 and
2005, respectively.
NOTE H - COMPREHENSIVE INCOME
Comprehensive income is comprised of all changes in shareholders' equity during
the period other than from transactions with shareholders. Comprehensive income
consists of the following:
Second Quarter Year-to-Date
---------------- ----------------
2006 2005 2006 2005
------- ------- ------- -------
Net income $25,366 $15,838 $38,277 $33,416
Other comprehensive income:
Change in fair value of derivative instruments, net of tax 1,260 - 3,289 -
Foreign currency translation adjustments (5,567) 1,706 (10,641) 1,631
Change in fair value of investment securities, net of tax
64 - 394 -
------- ------- ------- -------
Comprehensive income $21,123 $17,544 $31,319 $35,047
======= ======= ======= =======
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 agreed to settle with the FTC and states' attorneys
general offices which had been investigating a 1998 agreement between Alpharma,
Inc. and the Company related to a children's ibuprofen suspension product. The
agreement between Alpharma, Inc. and the Company is no longer in effect. The
consent order included payment of $4,750 to resolve all claims by the FTC and
state governments as well as certain restrictions on future contractual
agreements of this nature. These restrictions are not expected to have a
material impact on the Company's future results of operations. The $4,750 charge
was recorded in the fourth quarter of fiscal 2004 and paid in the first quarter
of fiscal 2005.
-8-
In connection with the Alpharma, Inc. agreement and the related FTC settlement
in fiscal 2004, 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 been defending these claims, it has also participated in
settlement negotiations with the plaintiffs. The most recent negotiations lead
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 estimates are
reasonable, the amount of future payments 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 $460, not to exceed 50% of
the joint venture's debt, that is not recorded on the Company's condensed
consolidated balance sheets as of December 24, 2005.
-9-
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. Acquisition integration costs were
$2,000 for the first half of fiscal 2006.
Consumer Rx Pharma- Unallocated
Healthcare ceuticals API Other expenses Total
---------- ---------- ------- -------- ----------- --------
Second Quarter 2006
Net sales $272,220 $ 28,645 $26,863 $ 31,969 - $359,697
Operating income (loss) $ 32,050 $ 5,300 $ 6,545 $ 379 $(4,965) $ 39,309
Operating income % 11.8% 18.5% 24.4% 1.2% - 10.9%
Amortization of intangibles $ 957 $ 1,584 $ 429 $ 240 - $ 3,210
Second Quarter 2005
Net sales $251,584 $ 164 - - - $251,748
Operating income (loss) $ 26,499 $ (2,350) - - - $ 24,149
Operating income % 10.5% - - - - 9.6%
Amortization of intangibles - - - - - -
Year-to-Date 2006
Net sales $500,853 $ 57,739 $53,654 $ 67,185 - $679,431
Operating income (loss) $ 45,172 $ 9,136 $13,131 $ (280) $(7,121) $ 60,038
Operating income (loss)% 9.0% 15.8% 24.5% (0.4)% - 8.8%
Amortization of intangibles $ 2,339 $ 3,168 $ 858 $ 480 - $ 6,845
Year-to-Date 2005
Net sales $479,303 $ 164 - - - $479,467
Operating income (loss) $ 54,424 $ (3,649) - - - $ 50,775
Operating income % 11.4% - - - - 10.6%
Amortization of intangibles - - - - - -
-10-
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 March 2006. The Company terminated 22
employees performing in certain executive and administrative roles. Accordingly,
the Company recorded employee termination benefits of $3,150 in the fourth
quarter of fiscal 2005. The activity of the restructuring reserve is as follows:
Fiscal 2005 Restructuring
Employee Termination
-------------------------
Balance at June 25, 2005 $ 2,152
Payments (1,184)
-------
Balance at December 24, 2005 $ 968
=======
In connection with the Agis acquisition, the Company accrued $2,727 of
restructuring costs, consisting 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 payments to employees of $263 in the second quarter of
fiscal 2006. For accounting purposes, these restructuring costs were included in
the allocation of the total purchase price. 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 2005 Restructuring
-------------------------------------------
Employee Termination Lease Termination
-------------------- -----------------
Balance at June 25, 2005 $ 374 $1,592
Additions 1,206 -
Payments (263) -
------ ------
Balance at December 24, 2005 $1,317 $1,592
====== ======
-11-
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SECOND 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
The Company continued to be impacted by the legislative and market concerns
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 for the first half of fiscal 2006 were
approximately $43,000 lower than the first half of fiscal 2005. The Company took
an additional charge of $3,100 in the first half of fiscal 2006 for estimated
obsolete inventory on hand.
In November 2005, the Company recorded a pre-tax gain of $4,666 on the sale of
its non-controlling interest in Shandex Sales Group Ltd. (Canada).
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 half of fiscal 2006 are not necessarily
indicative of the results that may be expected for a full year.
-12-
RESULTS OF OPERATIONS
CONSUMER HEALTHCARE
Second Quarter Year-to-Date
-------------------- -------------------
2006 2005 2006 2005
-------- --------- -------- --------
Net sales $272,220 $ 251,584 $500,853 $479,303
Gross profit $ 70,580 $ 67,138 $123,371 $131,851
Gross profit % 25.9% 26.7% 24.6% 27.5%
Operating expenses $ 38,530 $ 40,638 $ 78,199 $ 77,426
Operating expenses % 14.2% 16.2% 15.6% 16.2%
Operating income $ 32,050 $ 26,499 $ 45,172 $ 54,424
Operating income % 11.8% 10.5% 9.0% 11.4%
Net Sales
Second quarter net sales for fiscal 2006 increased 8% or $20,636 compared to
fiscal 2005. The increase resulted primarily from sales of topical OTC products
produced at the New York facility acquired in conjunction with the Agis
acquisition of $14,000 and other new product sales of $17,000. The increase was
partially offset by sales of pseudoephedrine-containing products that were
$20,000 lower in the second quarter of fiscal 2006 compared to the second
quarter of fiscal 2005. Net sales in the second quarter of fiscal 2005 were
negatively impacted by a recall of loratadine syrup, which reduced net sales by
$6,300.
Year-to-date net sales for fiscal 2006 increased 4% or $21,550 compared to
fiscal 2005. The increase resulted primarily from sales of topical OTC products
produced at the New York facility acquired in conjunction with the Agis
acquisition of $32,000 and other new product sales of $26,000. The increase was
partially offset by sales of pseudoephedrine-containing products that were
$43,000 lower in the first half of fiscal 2006 compared to the first half of
fiscal 2005. Net sales in the first half of fiscal 2005 were negatively impacted
by a recall of loratadine syrup, which reduced net sales by $6,300.
Gross Profit
Second quarter gross profit for fiscal 2006 increased 5% or $3,442 compared to
fiscal 2005. Second quarter fiscal 2006 gross profit decreased primarily as a
result of lower unit sales of pseudoephedrine-containing products and higher
inventory obsolescence costs. The second quarter of fiscal 2005 was negatively
impacted by a recall of loratadine syrup that resulted in a charge of $8,300.
The decrease in the second quarter gross profit percentage was primarily
attributable to an unfavorable mix of products sold 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 the impact of the loratadine syrup recall in fiscal 2005.
Year-to-date gross profit for fiscal 2006 decreased 6% or $8,480 compared to
fiscal 2005. The first half of fiscal 2006 gross profit decreased primarily as a
result of lower unit sales of pseudoephedrine-containing products and higher
inventory obsolescence costs, including a charge of $3,100 for estimated
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obsolete pseudoephedrine inventory on hand. The first half of fiscal 2005 was
negatively impacted by a recall of loratadine syrup that resulted in a charge of
$8,300. The decrease in the gross profit percentage was attributable on a
roughly equal basis to an unfavorable mix of products sold, the lower unit sales
of pseudoephedrine-containing products and higher inventory obsolescence costs,
partially offset by the impact of the loratadine syrup recall in fiscal 2005.
Operating Expenses
Second quarter operating expenses for fiscal 2006 decreased 5% or $2,108 during
fiscal 2006 compared to fiscal 2005 primarily due to a decrease in
employee-related costs, depreciation and marketing expenses, partially offset by
increased expenses related to the New York facility and amortization of
intangible assets.
Year-to-date operating expenses for fiscal 2006 increased 1% or $773 compared to
fiscal 2005. The increase was primarily due to increased expenses related to the
New York facility and amortization of intangible assets, offset by a decrease in
employee-related expenses and depreciation.
RX PHARMACEUTICALS
Second Quarter Year-to-Date
-------------------- -------------------
2006 2005 2006 2005
-------- --------- -------- --------
Net sales $ 28,645 $ 164 $ 57,739 $ 164
Gross profit (loss) $ 11,592 $ (82) $ 23,217 $ (82)
Gross profit % 40.5% (50.0)% 40.2% (50.0)%
Operating expenses $ 6,292 $ 2,269 $ 14,081 $ 3,568
Operating expenses % 22.0% - 24.4% -
Operating income (loss) $ 5,300 $ (2,350) $ 9,136 $ (3,649)
Operating income % 18.5% - 15.8% -
Net Sales and Gross Profit
Second quarter and year-to-date net sales and gross profit for fiscal 2006
resulted almost entirely from the Agis acquisition. Gross profit included the
effect of a charge of $3,168 for amortization of product-related intangible
assets.
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 is 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.
-14-
Operating Expenses
Second quarter fiscal 2006 operating expenses increased $4,023, primarily due to
the inclusion of expenses that resulted from the Agis acquisition. Research and
development spending in this segment increased $1,301 from the second quarter of
fiscal 2005.
Year-to-date fiscal 2006 operating expenses increased $10,513, primarily due to
the inclusion of expenses that resulted from the Agis acquisition. Research and
development spending increased $5,544 for the first half of fiscal 2006 compared
to fiscal 2005.
ADDITIONAL INFORMATION
Unallocated
API Other Expenses
------- ------- -----------
Second Quarter 2006
Net sales $26,863 $31,969 -
Gross profit $12,797 $10,601 -
Gross profit % 47.6% 33.2% -
Operating expenses $6,252 $10,222 $ 4,965
Operating expenses % 23.3% 32.0% -
Operating income (loss) $6,545 $ 379 $ (4,965)
Operating income % 24.4% 1.2% -
Year-to-Date 2006
Net sales $53,654 $67,185 -
Gross profit $24,801 $21,097 -
Gross profit % 46.2% 31.4% -
Operating expenses $11,670 $21,377 $ 7,121
Operating expenses % 21.8% 31.8% -
Operating income (loss) $13,131 $ (280) $ (7,121)
Operating income (loss) % 24.5% (0.4)% -
-15-
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. 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 Agis acquisition. The write-off of this step-up was completed
in the first quarter of fiscal 2006. Second quarter amortization expense was
$429 and $240 for the API segment and Other category, respectively, and
year-to-date amortization expense was $858 and $480 for the API segment and
Other category, respectively. Unallocated expenses relate to one-time
acquisition integration costs and certain corporate services that are not
allocated to the segments. Acquisition integration costs were $2,000 for the
first half of fiscal 2006.
INTEREST AND OTHER (CONSOLIDATED)
Second quarter fiscal 2006 net interest expense was $4,576, which included
interest expense of $9,550 and interest income of $4,974. Net interest income
was $594 for the second quarter of fiscal 2005. Other income was $5,251 for the
second quarter of fiscal 2006 compared to $10 for the second quarter of fiscal
2005. Other income for the second quarter of fiscal 2006 included a gain of
$4,666 from the sale of an equity investment.
Year-to-date fiscal 2006 net interest expense was $8,445, which included
interest expense of $18,897 and interest income of $10,452. Year-to-date net
interest income was $951 for fiscal 2005. Year-to-date other income was $6,340
and $493 for fiscal 2006 and 2005, respectively. Other income for the second
quarter 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 the first half of fiscal 2006 due to the outstanding loan and restricted
cash deposit of $400,000 established in connection with the Agis acquisition.
INCOME TAXES (CONSOLIDATED)
Second quarter effective tax rate was 36.6% for fiscal 2006 and 36.0% for fiscal
2005. For year-to-date fiscal 2006, the effective tax rate was 33.9% and to
36.0% for fiscal 2005. 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.
Twenty-seven percent of income before tax in the first half 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 tax expense of
$867 in the first half of 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 33% and 34%.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and investment securities decreased $152,678 to $26,557
at December 24, 2005 from $179,235 at December 25, 2004 primarily due to the
Agis acquisition. Working capital, including
-16-
cash, decreased $70,421 to $254,589 at December 24, 2005 from $325,010 at
December 25, 2004.
Year-to-date net cash provided from operating activities increased by $33,784 to
$55,238 for fiscal 2006 compared to $21,454 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 primarily due to lower employee
bonuses paid in fiscal 2006 coupled with reductions in inventory and accounts
payable from lower production volumes.
Year-to-date net cash used for investing activities decreased $17,116 to $5,413
for fiscal 2006 compared to $22,529 for fiscal 2005 primarily due to higher
liquidations of securities. Additionally, in the first half of fiscal 2005, the
Company acquired certain assets from a manufacturer of footcare products for
$5,562 and incurred acquisition costs of $2,478 related to the Agis acquisition.
Year-to-date capital expenditures for facilities and equipment were for normal
replacement and productivity enhancements. Capital expenditures are anticipated
to be $35,000 to $40,000 for fiscal 2006.
Year-to-date net cash used for financing activities increased $47,124 to $46,203
for fiscal 2006 compared to cash provided by financing activities of $921 for
fiscal 2005. The increased use of cash for financing activities was primarily
due to an increase in repurchases of common stock of $16,279, an increase in net
payments of short-term debt of $4,866, an increase in payments of long-term debt
of $35,000 and an increase in dividend payments of $2,368 partially offset by
borrowings of long-term debt of $15,000.
The Company repurchased 563 shares of its common stock for $7,842 during the
second quarter of fiscal 2006. The Company did not repurchase any shares during
the second quarter of fiscal 2005. Year-to-date, the Company repurchased 1,169
shares of its common stock for $16,401 and 7 shares for $122 in fiscal 2006 and
2005, respectively. Year-to-date, private party transactions accounted for 111
shares and 7 shares in fiscal 2006 and 2005, respectively.
The Company paid quarterly dividends totaling $7,702 and $5,334, or $0.0825 and
$0.075 per share, for the first half of 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 September 24, 2005.
During the second 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
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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 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.
-18-
Changes in these estimates and assumptions related to customer programs may
result in additional accruals. The following table summarizes the activity for
the balance sheet for accounts receivable allowances and customer program
accruals:
Second Year-to- Second Year-to-
Quarter Date Quarter Date
2006 2006 2005 2005
--------- -------- ------- --------
ACCOUNTS RECEIVABLE ALLOWANCES, excluding allowance
for doubtful accounts
Balance, beginning of period $ 9,950 $ 10,403 $ 3,691 $ 3,691
Provision recorded 4,185 8,352 - -
Credits processed (4,856) (9,476) - -
--------- -------- ------- --------
Balance, end of the period $ 9,279 $ 9,279 $ 3,691 $ 3,691
========= ======== ======= ========
CUSTOMER PROGRAM ACCRUALS
Balance, beginning of period $ 40,129 $ 41,666 $16,210 $ 13,212
Provision recorded 45,962 75,774 8,323 16,665
Credits processed (35,316) (66,665) (9,168) (14,512)
--------- -------- ------- --------
Balance, end of the period $ 50,775 $ 50,775 $15,365 $ 15,365
========= ======== ======= ========
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 $11,088
at December 24, 2005, $10,370 at June 25, 2005, and $7,934 at December 25, 2004.
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 $44,201 at December 24, 2005, $38,095 at June 25,
2005 and $23,846 at December 25, 2004. The Company recorded a charge of $3,100
for estimated obsolete pseudoephedrine inventory on hand in the first half of
fiscal 2006.
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. Goodwill allocated to the Consumer Healthcare
segment is tested annually for impairment in the second quarter of the fiscal
year. The current year testing resulted in no impairment charge related to the
Consumer Healthcare segment. 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
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impairment charge in future periods. The goodwill balance of the U.K. component
was $27,814 as of December 24, 2005. The goodwill related to the Agis
acquisition has been allocated to the API and Rx Pharmaceuticals segments and
will be tested for impairment annually in the third quarter of the fiscal year.
Goodwill was $150,067 at December 24, 2005, $150,293 at June 25, 2005 and
$35,919 at December 25, 2004.
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 $141,079 at December 24, 2005,
$147,967 at June 25, 2005 and $8,467 at December 25, 2004.
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. Changes in these estimates and
assumptions may result in additional accruals. The accrual for product liability
claims was $2,420 at December 24, 2005, $1,930 at June 25, 2005 and $2,500 at
December 25, 2004. The accrual for workers' compensation claims was $2,987 at
December 24, 2005, $2,472 at June 25, 2005 and $2,736 at December 25, 2004.
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.
-20-
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 December 24, 2005, the Company had invested cash, cash equivalents
and investment securities of approximately $27,000 and short and long-term debt,
net of restricted cash, of approximately $256,000.
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.
-21-
Item 4. Controls and Procedures
As of December 24, 2005, the Company's management, including its Chief Executive
Officer and its Chief Financial Officer, performed an interim review on 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). As of December 24, 2005, total assets subject
to Agis' ICFR represented approximately 40% of the Company's consolidated total
assets. Net sales subject to Agis' ICFR represented approximately 31% of the
Company's consolidated total net sales for the six months ended December 24,
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 the Company's ERP system in
accordance with the plan disclosed in the fiscal 2005 Form 10-K.
- The Company still expects to report the ICFR for the New York and
Germany locations will be effective by the end of fiscal 2006. These
two locations represent approximately 15% of the Company's
consolidated fiscal 2006 year-to-date revenue.
- Formal policies to reflect the tone of top management have been
deployed at the Israel locations.
- Significant progress has been made in the modification of the Israel
locations' information systems infrastructure to align with the
Company's standards.
- Related to the financial statement closing process in Israel, the
Company is enhancing the software used for financial consolidation
and the processes for general ledger journal entries and account
reconciliations.
- Early stages of an ERP system implementation in Israel are underway
with a planned completion date in the second quarter of 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 December 24, 2005 were identified that have materially
affected, or are reasonably likely to materially affect, the Company's ICFR,
other than the ERP conversion at the New York location described above.
-22-
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In August 2004, the Company agreed to settle with the FTC and states' attorneys
general offices which had been investigating a 1998 agreement between Alpharma,
Inc. and the Company related to a children's ibuprofen suspension product. The
agreement between Alpharma, Inc. and the Company is no longer in effect. The
consent order included payment of $4,750 to resolve all claims by the FTC and
state governments as well as certain restrictions on future contractual
agreements of this nature. These restrictions are not expected to have a
material impact on the Company's future results of operations. The $4,750 charge
was recorded in the fourth quarter of fiscal 2004 and paid in the first quarter
of fiscal 2005.
In connection with the Alpharma, Inc. agreement and the related FTC settlement
in fiscal 2004, 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 been defending these claims, it has also participated in
settlement negotiations with the plaintiffs. The most recent negotiations lead
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 estimates are
reasonable, the amount of future payments 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 second quarter of fiscal 2006
were approximately $20,000 lower than the second quarter of fiscal 2005. The
Company monitors this issue continuously and, consequently, recorded an
additional charge of $390 in the second 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 for
fiscal 2006 are expected to be $110,000 to $120,000. 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.
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. 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-
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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 will expire on April
21, 2006. 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 Average Total Number of Value of
Number of Price Shares Purchased Shares
Shares Paid per as Part of Publicly Available for
Fiscal 2006 Purchased (1) Share Announced Plans Purchase
----------- ------------- -------- ------------------- -------------
$20,160
September 25 to October 29 277 $13.48 276 $16,446
October 30 to November 26 188 $14.24 188 $13,771
November 27 to December 24 98 $14.64 98 $12,334
--- ---
Total 563 562
(1) A private party transaction accounted for the purchase of 1 share in the
period from September 25 to October 29.
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Shareholders' Meeting held on October 28, 2005, the
Company's shareholders voted on the following matters:
1. Election of three directors of the Company:
The tabulation of votes provided by the Inspector of Election was as follows:
Nominee For Withheld
Moshe Arkin 80,709,057 2,595,588
Gary K. Kunkle, Jr. 80,874,167 2,430,478
Herman Morris, Jr. 79,339,179 3,965,466
2. Amend the Company's Long-term Incentive Plan by increasing the number of
shares reserved for issuance under the Plan:
The tabulation of votes provided by the Inspector of Election was 66,748,983
votes for approval of the amendment, 9,895,477 votes against approval of the
amendment, 104,676 votes abstained and 6,555,509 broker non-votes.
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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) Amendment to the 2003 Long-term Incentive Plan, incorporated
by reference from Exhibit 10(a) to the Registrant's Current
Report on Form 8-K filed on November 3, 2005.
31 Rule 13a-14(a) Certifications.
32 Section 1350 Certifications.
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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: February 2, 2006 By: /s/David T. Gibbons
-------------------------------
David T. Gibbons
Chairman, President and Chief Executive
Officer
Date: February 2, 2006 By: /s/Douglas R. Schrank
-------------------------------
Douglas R. Schrank
Executive Vice President and
Chief Financial Officer
(Principal Accounting and Financial Officer)
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