<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the Quarterly Period Ended December 31, 1998
Commission File Number 333-33121
LEINER HEALTH PRODUCTS INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 95-3431709
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
901 EAST 233RD STREET, CARSON, CALIFORNIA 90745
(310) 835-8400
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
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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 (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
Yes X No
----------- ----------
COMMON STOCK, $.01 PAR VALUE, OUTSTANDING AT FEBRUARY 9, 1999:
1,000 SHARES
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<PAGE>
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LEINER HEALTH PRODUCTS INC.
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
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<TABLE>
<S> <C>
PART I. Financial Information............................................. 3
ITEM 1. Financial Statements .................................... 3
Condensed Consolidated Statements of Operations (Unaudited) -
For the three and nine months ended December 31, 1998 and 1997 .. 3
Condensed Consolidated Balance Sheets -
As of December 31, 1998 (Unaudited) and March 31, 1998 .......... 4
Condensed Consolidated Statements of Cash Flows (Unaudited) -
For the nine months ended December 31, 1998 and 1997 ............ 5
Notes to Condensed Consolidated Financial Statements (Unaudited).. 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................... 10
PART II. Other Information ............................................... 17
SIGNATURE PAGE ............................................................ 17
</TABLE>
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<PAGE>
PART I ITEM 1
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Leiner Health Products Inc.
Condensed Consolidated Statements of Operations
Unaudited
(in thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
----------------------------- --------------------------------
1998 1997 1998 1997
------------- ------------- ------------ ----------------
<S> <C> <C> <C> <C>
Net sales $ 162,151 $ 132,524 $ 433,888 $ 338,837
Cost of sales 121,206 95,532 323,116 250,713
------------- ------------- ------------ -------------
Gross profit 40,945 36,992 110,772 88,124
Marketing, selling and distribution expenses 19,161 17,477 56,327 44,032
General and administrative expenses 7,679 6,809 26,205 20,348
Expenses related to recapitalization of parent -- 418 -- 33,056
Amortization of goodwill 417 407 1,253 1,243
Closure of facilities 143 -- 464 --
Other charges (income) 375 430 (440) 893
------------- ------------- ------------ -------------
Operating income (loss) 13,170 11,451 26,963 (11,448)
Other expenses 85 -- 212 --
Interest expense, net 7,581 5,897 21,472 13,513
------------- ------------- ------------ -------------
Income (loss) before income taxes and
extraordinary item 5,504 5,554 5,279 (24,961)
Provision (benefit) for income taxes before
extraordinary item 2,316 3,011 2,244 (4,207)
------------- ------------- ------------ -------------
Income (loss) before extraordinary item 3,188 2,543 3,035 (20,754)
Extraordinary loss on the early extinguishment
of debt, net of income taxes of $761 -- -- -- 1,109
------------- ------------- ------------ -------------
Net income (loss) $ 3,188 $ 2,543 $ 3,035 $ (21,863)
------------- ------------- ------------ -------------
------------- ------------- ------------ -------------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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<PAGE>
PART I ITEM 1
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Leiner Health Products Inc.
Condensed Consolidated Balance Sheets
(in thousands)
<TABLE>
<CAPTION>
ASSETS DECEMBER 31, MARCH 31,
1998 1998
------------ ---------
UNAUDITED
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 2,959 $ 1,026
Accounts receivable, net 86,062 89,358
Inventories 183,585 137,853
Deferred income taxes 8,581 8,578
Prepaid expenses and other current assets 2,585 2,298
------------ ---------
Total current assets 283,772 239,113
Property, plant and equipment, net 53,769 48,899
Goodwill, net 54,660 56,412
Deferred financing charges 10,996 11,465
Other noncurrent assets 12,118 9,937
------------ ---------
Total assets $415,315 $365,826
------------ ---------
------------ ---------
LIABILITIES AND SHAREHOLDER'S DEFICIT
Current liabilities:
Bank checks outstanding, less cash on deposit $ 8,949 $ 3,730
Current portion of long-term debt 3,513 1,733
Accounts payable 85,574 93,226
Customer allowances payable 12,165 14,063
Accrued compensation and benefits 7,083 10,132
Accrued interest expense 5,284 3,116
Income taxes payable 512 3,349
Other accrued expenses 2,557 3,709
------------ ---------
Total current liabilities 125,637 133,058
Long-term debt 311,959 257,059
Deferred income taxes 2,574 2,600
Other noncurrent liabilities 2,030 1,997
Commitments and contingent liabilities
Minority interest in subsidiary -- 1,028
Shareholder's deficit:
Common stock 1 1
Capital in excess of par value 1,851 1,825
Retained deficit net of charges from recapitalization of parent of $31,543 (28,569) (31,604)
Accumulated other comprehensive loss:
Cumulative translation adjustment (168) (138)
------------ ---------
Total shareholder's deficit (26,885) (29,916)
------------ ---------
Total liabilities and shareholder's deficit $415,315 $365,826
------------ ---------
------------ ---------
See accompanying notes to condensed consolidated financial statements.
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</TABLE>
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<PAGE>
PART I ITEM 1
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Leiner Health Products Inc.
Condensed Consolidated Statements of Cash Flows
Unaudited
(in thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
DECEMBER 31,
----------------------------
1998 1997
---------- -----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 3,035 $ (21,863)
Adjustments to reconcile net income (loss) to net cash used in operating
activities:
Depreciation 5,654 5,400
Amortization 6,344 5,288
Stock option compensation expense -- 8,300
Deferred income taxes (20) (3,327)
Extraordinary loss on the early extingishment of debt -- 1,870
Translation adjustment 30 10
Changes in operating assets and liabilities:
Accounts receivable 3,028 14,108
Inventories (46,498) (38,185)
Bank checks outstanding, less cash on deposit 5,292 1,606
Accounts payable (7,425) 15,281
Customer allowances payable (1,869) 5,127
Accrued compensation and benefits (3,017) 896
Other accrued expenses 1,054 4,730
Income taxes payable/receivable (2,559) (4,267)
Other (563) 289
------- --------
Net cash used in operating activities (37,514) (4,737)
INVESTING ACTIVITIES:
Additions to property, plant and equipment, net (9,812) (8,195)
Increase in other noncurrent assets (3,357) (3,906)
------- --------
Net cash used in investing activities (13,169) (12,101)
FINANCING ACTIVITIES:
Net borrowings (payments) under bank revolving credit facility (3,296) 44,555
Borrowings under bank term credit facility 59,763 85,000
Payments under bank term credit facility (998) (425)
Net payments under former bank credit facility -- (100,405)
Capital contribution from parent 26 1,834
Repurchase of minority interest (947) (3,599)
Increase in deferred financing charges (995) (9,976)
Net payments on other long-term debt (870) (848)
------- --------
Net cash provided by financing activities 52,683 16,136
Effect of exchange rate changes (67) 71
------- --------
Net increase (decrease) in cash and cash equivalents 1,933 (631)
Cash and cash equivalents at beginning of period 1,026 2,066
------- --------
Cash and cash equivalents at end of period $ 2,959 $ 1,435
------- --------
------- --------
See accompanying notes to condensed consolidated financial statements.
</TABLE>
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<PAGE>
PART I ITEM 1
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Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
NOTE 1 -- Basis of Presentation
The accompanying unaudited condensed consolidated financial statements for
the three and nine months ended December 31, 1998 include the accounts of
Leiner Health Products Inc. (the "Company") and its subsidiaries, including
Vita Health Products Inc. ("Vita Health") which was acquired January 30, 1997
in a transaction accounted for as a purchase, and have been prepared by the
Company in accordance with generally accepted accounting principles for
interim financial information and in accordance with the rules of the
Securities and Exchange Commission ("SEC"). Accordingly, they do not include
all of the information and notes required by generally accepted accounting
principles for complete financial statements.
In the opinion of management, all adjustments necessary for a fair
presentation of such financial statements have been included. Such
adjustments consisted only of normal recurring items. This report should be
read in conjunction with the Company's audited consolidated financial
statements and notes thereto for the year ended March 31, 1998, which are
included in the Company's Annual Report on Form 10-K, on file with the SEC
(Commission file number 333-33121). The results of operations for the periods
indicated should not be considered as indicative of operations for the full
year.
As of April 1, 1998, the Company adopted the Financial Accounting Standards
Board Statement No. 130, REPORTING COMPREHENSIVE INCOME ("SFAS No. 130").
SFAS No. 130 establishes new rules for the reporting and display of
comprehensive income and its components; however, the adoption of this
Statement had no impact on the Company's net income (loss) or shareholder's
equity. SFAS No. 130 requires foreign currency translation adjustments, which
prior to adoption were reported separately in shareholder's equity, to be
included in other comprehensive income.
The components of comprehensive income (loss) for the three and nine month
periods ended December 31, 1998 and 1997, are as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------ ----------- ------------ ------------
1998 1997 1998 1997
------------ ----------- ------------ ------------
<S> <C> <C> <C> <C>
Net income (loss)...................................... $ 3,188 $ 2,543 $ 3,035 $(21,863)
Foreign currency translation adjustment................ 24 (121) (30) (10)
------------ ----------- ------------ ------------
Comprehensive income (loss)............................ $ 3,212 $ 2,422 $ 3,005 $(21,873)
------------ ----------- ------------ ------------
------------ ----------- ------------ ------------
</TABLE>
NOTE 2 -- Inventories
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1998
---------------- ---------------
<S> <C> <C>
Raw materials, bulk vitamins and packaging materials.......................... $ 119,432 $ 83,475
Work-in-process............................................................... 12,725 9,832
Finished products............................................................. 51,428 44,546
---------------- ---------------
$ 183,585 $137,853
---------------- ---------------
---------------- ---------------
</TABLE>
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<PAGE>
PART I ITEM 1
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Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
(continued)
NOTE 3 - The Recapitalization
On June 30, 1997, the Company's ultimate parent, Leiner Health Products Group
Inc. ("Leiner Group") completed a leveraged recapitalization
("Recapitalization"). Pursuant to the Recapitalization, Leiner Group repurchased
common stock from its existing shareholders in an amount totaling (together with
equity retained by such shareholders) $211.1 million, issued $80.4 million of
new shares of the recapitalized Leiner Group to North Castle Partners I, L.L.C.
("North Castle"), issued $85 million of Senior Subordinated Notes due 2007 (the
"Notes"), and established a $210 million senior secured credit facility that
provided for both term and revolving credit borrowings.
In connection with the Recapitalization, the Company deducted $1.1 million of
deferred financing charges, net of income taxes of $0.8 million, from net income
(loss) as an extraordinary loss in the nine months ended December 31, 1997.
Additionally, in connection with the Recapitalization, the Company incurred
expenses of approximately $33.1 million in the nine months ended December 31,
1997, consisting of expenses of approximately $12.3 million related to Leiner
Group's equity transactions, transaction bonuses granted to certain management
personnel in the aggregate amount of approximately $5.2 million and compensation
expense related to the in-the-money value of stock options of approximately
$15.6 million. The compensation expense represented the excess of the fair
market value of the underlying common stock over the exercise price of the
options exercised in connection with the Recapitalization.
NOTE 4 - Long-Term Debt
On May 15, 1998, the Company entered into an Amended and Restated Credit
Agreement (the "Amended Credit Agreement"). The Amended Credit Agreement
consists of two U.S. term loans due December 30, 2004 and December 30, 2005 in
the amounts of $68,000,000 and $65,000,000, respectively, and a Canadian dollar
denominated term loan due December 30, 2004 in the amount of approximately U.S.
$12,000,000 (collectively, the "Term Facility"), and a revolving credit facility
in the amount of U.S. $125,000,000 (the "Revolving Facility") a portion of which
is denominated in Canadian dollars and made available to Vita Health. The unpaid
principal amount outstanding on the Revolving Facility is due and payable on
June 30, 2003. The Term Facility requires quarterly amortization payments of
approximately 1% per annum over the next five years. Amortization payments
scheduled during the period January 1, 1999 through December 31, 1999 total $1.5
million. Amounts outstanding under the prior credit facility as in effect at
March 31, 1998 were rolled over into the Amended Credit Agreement. The terms,
conditions and restrictions of the Amended Credit Agreement are consistent with
the terms, conditions and restrictions of the credit facility as previously in
effect.
Borrowings under the Amended Credit Agreement bear interest at floating rates
that are based on the agent lender's base rate (7.75% at December 31, 1998), the
agent lender's Canadian prime rate (6.75% at December 31, 1998), LIBOR (5.06% at
December 31, 1998) or the agent lender's banker's acceptance rate (5.07% at
December 31, 1998), as the case may be, plus an "applicable margin" that is
itself based on the Company's leverage ratio. The leverage ratio is defined
generally as the ratio of total funded indebtedness to the consolidated earnings
before interest, taxes, depreciation and amortization expense and its effect on
the applicable margin varies as follows: (a) for revolving credit borrowings,
from 0.75% to 2.5% for LIBOR- or banker's acceptance-based loans, and from zero
to 1.5% for alternate base rate- or Canadian prime rate-based loans, and (b) for
the two Term B loans and the one Term C loan under the Term Facility, from
2.125% to 2.875% or 2.25% to 3.0%, respectively, for LIBOR-based loans, and from
1.125% to 1.875% or 1.25% to 2.0%, respectively, for alternate base rate-based
loans. As of December 31, 1998, the Company's weighted average interest rates
were 8.08% for U.S. borrowings and 7.75% for Canadian borrowings under the
Amended Credit Agreement. In addition to certain agent and up-front fees, the
Amended Credit Agreement requires a commitment fee of up to 0.5% of the average
daily unused portion of the Revolving Facility based on the Company's leverage
ratio.
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<PAGE>
PART I ITEM 1
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Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
(continued)
The Amended Credit Agreement contains financial covenants that require, among
other things, the Company to comply with certain financial ratios and tests,
including those that relate to the maintenance of specified levels of cash
flow and shareholder's equity. The Company was in compliance with all such
financial covenants as of December 31, 1998. As of December 31, 1998, the
Company had $38.8 million available under its Revolving Facility.
Principal payments on long-term debt as of December 31, 1998 through fiscal
2003 and thereafter are (in thousands):
<TABLE>
<CAPTION>
Fiscal Year
--------------
<S> <C>
1999 .......................... $ 2,400
2000 .......................... 4,044
2001 .......................... 3,271
2002 .......................... 1,518
2003 .......................... 1,442
Thereafter .......................... 302,797
---------
Total .......................... $ 315,472
---------
---------
</TABLE>
NOTE 5 - Related Party Transactions
Upon consummation of the Recapitalization, Leiner Group and the Company
entered into a consulting agreement with North Castle Partners, L.L.C. (the
"Sponsor"), an affiliate of North Castle, to provide the Company with certain
business, financial and managerial advisory services. Mr. Charles F. Baird
Jr., Chairman of Leiner Group's Board of Directors, is the sole member of the
Sponsor. In exchange for such services, Leiner Group and the Company have
agreed to pay the Sponsor an annual fee of $1.5 million, payable
semi-annually in advance, plus the Sponsor's reasonable out-of-pocket
expenses. This fee may be reduced upon completion of an initial public
offering of Leiner Group's shares. The agreement also terminates on June 30,
2007, unless Baird Investment Group ceases to be the managing member of North
Castle, or upon the earliest of June 30, 2007 or the date that North Castle
terminates. Leiner Group and the Company also paid the Sponsor a transaction
fee of $3.5 million during the nine months ended December 31, 1997 for
services related to arranging, structuring and financing the
Recapitalization, and reimbursed the Sponsor's related out-of-pocket expenses.
NOTE 6 -- Contingent Liabilities
The Company has been named in numerous actions brought in federal or state
courts seeking compensatory and, in some cases, punitive damages for alleged
personal injuries resulting from the ingestion of certain products containing
L-Tryptophan. As of January 8, 1999, the Company and/or certain of its
customers, many of whom have tendered their defense to the Company, had been
named in 671 lawsuits, of which 661 have been settled. Settlement
negotiations with respect to eight of the lawsuits are in progress. The
Company entered into an agreement (the "Agreement") with the Company's
supplier of bulk L-Tryptophan, under which the supplier agreed to assume the
defense of all claims and to pay all settlements and judgements, other than
for certain punitive damages, against the Company arising out of the
ingestion of L-Tryptophan products. To date, the supplier has funded all
settlements and paid all legal fees and expenses incurred by the Company
related to these matters. No punitive damages were awarded or paid in any
settlement.
Of the remaining ten cases, management does not expect that the Company will
be required to make any material payments in connection with their resolution
by virtue of the Agreement, or, in the event that the supplier ceases to
honor the Agreement, by virtue of the Company's product liability insurance,
subject to deductibles with respect to the ten currently pending claims not
to exceed $0.8 million in the aggregate. Accordingly, no provision has been
made in the Company's consolidated financial statements for any loss that may
result from these remaining actions.
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<PAGE>
PART I ITEM 1
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Leiner Health Products Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
(continued)
The Company is subject to other legal proceedings and claims which arise in
the normal course of business. While the outcome of these proceedings and
claims cannot be predicted with certainty, management does not believe the
outcome of any of these matters will have a material adverse effect on the
Company's consolidated financial position, results of operations or cash
flows.
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<PAGE>
PART I ITEM 2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
The following discussion explains material changes in the consolidated
results of operations for Leiner Health Products Inc. and its subsidiaries
(the "Company") including Vita Health Products Inc. of Canada ("Vita
Health"), a wholly-owned subsidiary acquired January 30, 1997, for the three
months ended December 31, 1998 ("third quarter of fiscal 1999") and the nine
months ended December 31, 1998 and the significant developments affecting its
financial condition since March 31, 1998. The following discussion should be
read in conjunction with the Company's audited consolidated financial
statements and notes thereto for the year ended March 31, 1998, which are
included in the Company's Annual Report on Form 10-K, on file with the
Securities Exchange Commission.
SEASONALITY
The Company's business is seasonal, as increased vitamin usage corresponds
with the cough, cold and flu season. Accordingly, the Company historically
has realized a significant portion of its sales, and a more significant
portion of its operating income, in the second half of the fiscal year.
RESULTS OF OPERATIONS
The following table summarizes the Company's historical results of operations
as a percentage of net sales for the three and nine months ended December 31,
1998 and 1997.
<TABLE>
<CAPTION>
PERCENTAGE OF NET SALES
-------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------ -------------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Net sales........................................................ 100.0% 100.0% 100.0% 100.0%
Cost of sales.................................................... 74.7 72.1 74.5 74.0
----- ----- ----- -----
Gross profit..................................................... 25.3 27.9 25.5 26.0
Marketing, selling and distribution expenses..................... 11.8 13.2 13.0 13.0
General and administrative expenses.............................. 4.8 5.1 6.0 6.0
Expenses related to recapitalization of parent................... -- 0.3 -- 9.7
Amortization of goodwill......................................... 0.3 0.3 0.3 0.4
Closure of facilities............................................ 0.1 -- 0.1 --
Other charges (income)........................................... 0.2 0.4 (0.1) 0.3
----- ----- ----- -----
Operating income (loss).......................................... 8.1 8.6 6.2 (3.4)
Other expense.................................................... -- -- 0.1 --
Interest expense, net............................................ 4.7 4.4 4.9 4.0
----- ----- ----- -----
Income (loss) before income taxes and extraordinary item......... 3.4 4.2 1.2 (7.4)
Provision (benefit) for income taxes before extraordinary item... 1.4 2.3 0.5 (1.2)
----- ----- ----- -----
Income (loss) before extraordinary item.......................... 2.0 1.9 0.7 (6.2)
Extraordinary item............................................... -- -- -- 0.3
----- ----- ----- -----
Net income (loss)................................................ 2.0% 1.9% 0.7% (6.5) %
----- ----- ----- -----
----- ----- ----- -----
</TABLE>
Net sales for the third quarter of fiscal 1999 were $162.2 million, an
increase of $29.6 million, or 22.4% versus the third quarter of fiscal 1998.
The Company's sales growth was primarily attributable to volume growth in the
Company's sales of vitamins, which was largely due to sales growth in the
vitamin market generally and an increase in private label vitamin sales
resulting from the continuing consumer migration to mass market private label
vitamins. The Company's vitamin product sales in all its markets increased
by $24.0 million, or 21.4%, compared to the third quarter of the prior year.
Management estimates that the overall U.S. vitamin market for food, drug and
mass
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<PAGE>
PART I ITEM 2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
(CONTINUED)
merchandisers ("FDM Market"), which represents over half of the Company's
sales, grew by over 10.0% in the 13 week period ended December 27, 1998
versus the comparable period in 1997. Market growth for the five weeks ending
December 27, 1998 was just under 6.0%. Management expects this slower growth
trend to continue through at least the end of the fiscal year, compared to
the FDM Market's growth rates of 29.0% and 23% in the first and second
quarters of fiscal 1999, respectively. Sales growth among the Company's
products was strongest in herbs and supplements. The Company continues to
emphasize higher growth products and to gain distribution in new channels
outside of the FDM Market. Sales of over-the-counter pharmaceuticals ("OTCs")
increased 17.6% during the third quarter of fiscal 1999 as compared to the
same period in fiscal 1998, due primarily to growth in digestive aid products
including cimetidine which the Company introduced in June 1998.
For the nine months ended December 31, 1998, net sales increased by $95.1
million, or 28.1% compared to the same period in fiscal 1998. The increase in
net sales in the first nine months of the year was primarily due to the volume
growth in vitamin sales compared to the comparable period of fiscal 1998, which
was due primarily to sales growth in the vitamin market generally. Vitamin sales
for the nine months ended December 31, 1998 increased 28.2%, or $79.5 million
from $281.5 million in the comparable period of 1998.
Gross profit for the third quarter increased by $3.9 million, up 10.7% from
$37.0 million in the third quarter of fiscal 1998 to $40.9 million for the
same period in fiscal 1999. The increase in gross profit during the quarter
is primarily attributable to the higher sales volume. Gross profit margin was
25.3% for the third quarter of fiscal 1999, down from 27.9% in the third
quarter of the prior fiscal year due primarily to a change in product mix,
reflecting the increase in sales of lower margin private label vitamins and
the reduction of production volumes in the plants, as the Company continues
to reduce its levels of inventory. For the nine months ended December 31,
1998, gross profit increased by $22.6 million, or 25.7%, compared to the same
period in fiscal 1998. The increase in gross profit in the first nine months
of the year was primarily due to the higher sales volume. Gross profit margin
for the nine months ended December 31, 1998 was 25.5%, a 0.5 percentage point
decrease from 26.0% in the comparable period in fiscal 1998. The decrease in
gross profit margin is attributable to the changing product mix and the
reduction of production volumes in the plants described above.
Marketing, selling and distribution expenses, together with general and
administrative expenses (collectively, "Operating Expenses") for the third
quarter of fiscal 1999 were 16.6% of net sales, an improvement from 18.3% in
the third quarter of the prior year. Operating Expenses in the third quarter
of fiscal 1999 increased by $2.6 million, or 10.5%, as compared to the third
quarter in fiscal 1998. For the nine months ended December 31, 1998,
Operating Expenses totaled $82.5 million, versus $64.4 million for the
comparable period in fiscal 1998 and representing the same 19.0% of net sales
as in fiscal 1998. This increase in Operating Expenses for both the three and
nine month periods ended December 31, 1998 is primarily the result of
infrastructure development in support of new products and diversification
strategies and increased costs associated with changing all the Company's
product labels to comply with the new Dietary Supplement Health and Education
Act of 1994 effective March 23, 1999. The third quarter improvement in
Operating Expenses as a percentage of net sales is the result of a cost
control strategy to maintain a lower percentage growth of Operating Expenses,
and the partial downward adjustment of senior management's bonus accrual rate
based upon the slowing market trend, as indicated by the slower market growth
for the five weeks ending December 27, 1998 versus the 13 week period ended
December 27, 1998 discussed previously.
In the nine months ended December 31, 1997, the Company recorded expenses
relating to the recapitalization of its parent (the "Recapitalization") of
$33.1 million, consisting primarily of compensation expense related to the
in-the-money value of stock options issued to certain management personnel of
$15.6 million, management bonuses of $5.2 million, and expenses incurred by
Leiner Group in connection with its capital raising activities of $12.3
million. There were no Recapitalization-related expenses incurred in fiscal
1999.
For the three months ended December 31, 1998, the Company recorded $0.1
million of expenses in connection with the closing of its West Unity, Ohio
facility. The facility was closed on July 2, 1998 and its packaging lines
have been relocated to the Fort Mill, South Carolina facility. These expenses
were for utilities, property taxes, etc., which were properly not accrued in
the plant closure reserve established in the fourth quarter of fiscal 1998.
Other charges for each of the third quarters of fiscal 1999 and 1998 were
$0.4 million. For the nine months ended December 31, 1998, other income
totaled $0.4 million compared to other charges of $0.9 million in the
comparable period of fiscal 1998. The increase in other income was due to a
non-recurring settlement arising from a dispute involving a service provider
and a former employee in the second quarter of fiscal 1999.
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-11-
<PAGE>
PART I ITEM 2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
(CONTINUED)
In the third quarter of fiscal 1999, operating income was $13.2 million up
15.0%, compared to $11.5 million in the third quarter of fiscal 1998. This
increase was primarily due to increased sales. For the nine months ended
December 31, 1998, the Company recognized an operating income of $27.0
million compared to an operating loss of $11.5 million in the prior year.
This change was primarily attributable to the fact that there were expenses
incurred in the first nine months of fiscal 1998 in connection with the
Recapitalization of Leiner Group which were not incurred in fiscal 1999.
Excluding these Recapitalization expenses, operating income for the nine
months ending December 31, 1998 increased $5.4 million or 24.8% over the
comparable period in fiscal 1998. This increase was primarily due to the
increased sales during the first nine months of fiscal 1999 and secondarily
to the settlement recorded in the second quarter of fiscal 1999.
Net interest expense increased by $1.7 million during the third quarter of
fiscal 1999, versus the third quarter of fiscal 1998. This increase was due
primarily to an increase in the indebtedness of the Company, and to the
extended payment terms received from major suppliers. For the nine months
ended December 31, 1998, interest expense increased by $8.0 million versus
the comparable period of fiscal 1998. This increase was primarily due to
changes in the Company's debt structure and interest rates arising from the
Recapitalization which took effect at the end of the first quarter of fiscal
1998, as well as an increase in indebtedness occurring in the first nine
months of fiscal 1999.
The provision for income taxes for the third quarter of fiscal 1999 was $2.3
million compared to $3.0 million in the third quarter of fiscal 1998. Based
on the latest estimates, the Company expects its effective tax rate to be
approximately 46.3% for the remainder of fiscal 1999, and to be higher than
the combined federal and state rate of 40% primarily because of the
nondeductibility for income tax purposes of goodwill amortization and certain
accrued liabilities.
The extraordinary loss recorded in the first quarter of fiscal 1998
represented the write-off of $1.9 million of deferred financing charges which
had been incurred by the Company when it entered into a credit facility on
January 30, 1997. The income tax effect of that charge was a benefit of $0.8
million.
Primarily as a result of the factors discussed above, net income of $3.2
million was recorded in the third quarter of fiscal 1999 as compared to $2.5
million in the third quarter of fiscal 1998. For the nine months ended
December 31, 1998, a net income of $3.0 million was recorded compared to the
$21.9 million net loss in the comparable period of fiscal 1998.
OTHER INFORMATION
Earnings before interest, taxes, depreciation, amortization, other non-cash
charges and the charges related to the closure of facilities ("EBITDA") totaled
$17.1 million for the third quarter of fiscal 1999, which was $2.1 million
higher than the comparable period in fiscal 1998. EBITDA for the first nine
months of fiscal 1999 was $37.8 million, or $6.4 million greater than EBITDA for
the comparable period of fiscal 1998 excluding Recapitalization-related cash
expenses. EBITDA can be calculated from the financial statements with the
exception of the amortization of deferred debt issuance costs totaling $0.4
million for the three months ending December 31, 1998 and 1997, and $1.4 million
and $0.9 million for the nine month periods ended December 31, 1998 and 1997,
respectively, which is included in interest expense in the statement of
operations and in amortization expense in the statement of cash flows. The
Company believes that EBITDA provides useful information regarding the Company's
debt service ability, but should not be considered in isolation or as a
substitute for the statements of operations or cash flow data.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash has historically been used to fund capital expenditures,
working capital requirements and debt service. As a result of the
Recapitalization, the Company's liquidity requirements have significantly
increased, primarily due to significantly increased interest expense
obligations. In addition, the Company is required to repay the $142.6 million in
currently outstanding term loans under the Amended Credit Agreement (defined
below) over
- -------------------------------------------------------------------------------
-12-
<PAGE>
PART I ITEM 2
- -------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
(CONTINUED)
the seven and one-half year period following May 15, 1998, with scheduled
principal payments of $1.4 million annually for the first five years, $48.5
million in the sixth year, $66.4 million in the seventh year, and $21.6
million in the final six months. The Company is also required to apply
certain asset sale proceeds, as well as 50% of its excess cash flow (as
defined in the Amended Credit Agreement) unless a leverage ratio test is met,
to prepay the borrowings under the Amended Credit Agreement. All outstanding
revolving credit borrowings under the Amended Credit Agreement will become
due on June 30, 2003.
During the first nine months of fiscal year 1999, net cash used in operating
activities totaled $37.5 million. This resulted primarily from an increase in
inventories of $46.5 million and a decrease in accounts payable of $7.4
million, partially offset by a decrease in accounts receivable of $3.0
million, and an increase in bank checks outstanding of $5.3 million. The
increase in inventory is primarily the result of i) a strategic decision to
increase inventories to ensure on-time order delivery to customers during the
period of start-up operations at the Company's newly completed manufacturing
and distribution facility in Fort Mill, South Carolina, ii) the positioning
of the Company to capitalize on certain market opportunities and iii) the
shipment to the Company of back ordered softgel materials. In order to help
address the temporary liquidity demands of higher inventories and capital
spending, the Company received extended terms from its major suppliers and
accelerated payment terms from its major customers, for the second and third
quarters of fiscal 1999. The Company has incurred $0.6 million of expenses
due to the accelerated payment terms given to its customers. The Company
expects inventories to decline to more customary levels by March 31, 1999.
The decrease in accounts payable combined with the increase in bank checks
outstanding, totaled $2.1 million. This decrease was due to fewer inventory
purchases starting in the second quarter of fiscal 1999 as the need for
safety stock during the Fort Mill start-up declined with its opening
September 1998.
Net cash used in investing activities was $13.2 million in the first nine
months of fiscal 1999. This was primarily due to net capital expenditures of
$9.8 million. The major capital expenditures were related to investments in
capacity expansion at the new manufacturing, packaging and distribution
facility in South Carolina, as well as at the Garden Grove, California
tableting plant. The Company expects to invest approximately $62 million in
its business in fiscal 1999, primarily to complete its capacity expansion
program. Of this amount, approximately $22 million is for the Fort Mill,
South Carolina facility, which is being financed by an operating lease. Of
the remaining $40 million, approximately $24 million will be spent on
manufacturing equipment, $6 million on building and office expansion, $7
million on computer hardware and software, and $3 on other capital
investments. The Company will finance approximately $17 million through
operating leases, $3 million will be financed by capitalized leases and the
balance of approximately $20 million will be a use of the Company's cash.
Net cash provided by financing activities was $52.7 million in the first nine
months of fiscal 1999. This was primarily the result of increased net
borrowings under the Amended Credit Agreement. During the first nine months
of fiscal 1999, the Company redeemed the balance of the preferred stock of
its Canadian subsidiary outstanding as of March 31, 1998, which had been
issued in connection with the acquisition of Vita Health and had appeared in
the consolidated balance sheet as minority interest in subsidiary.
FINANCING ARRANGEMENTS
On May 15, 1998, the Company entered into an Amended and Restated Credit
Agreement ("Amended Credit Agreement"). The Amended Credit Agreement provides
for two U.S. term loans due December 30, 2004 and December 30, 2005 in the
amounts of $68,000,000 and $65,000,000, respectively, and a Canadian dollar
denominated term loan due December 30, 2004 in the amount of approximately
U.S. $12,000,000, and a revolving credit facility in the amount of U.S.
$125,000,000 (the "Revolving Facility") a portion of which is denominated in
Canadian dollars and made available to Vita Health. The unpaid principal
amount outstanding on the Revolving Facility is due and payable on June 30,
2003. Amounts outstanding under the Company's credit facility in place at
March 31, 1998, were refinanced with the proceeds from the Amended Credit
Agreement. As of February 5, 1999, the Company's unused availability under
the Amended Credit Agreement was approximately $35.2 million.
The Revolving Credit Facility includes letter of credit and swingline
facilities. Borrowings under the Amended Credit Agreement bear interest at
floating rates that are based on LIBOR or on the applicable alternate base
rate (as defined), and accordingly the Company's financial condition and
performance is and will continue to be affected by changes in
- ------------------------------------------------------------------------------
-13-
<PAGE>
PART I ITEM 2
- -------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
(CONTINUED)
interest rates. The Company has entered into an interest protection
arrangement effective July 30, 1997 with respect to $29.4 million of its
indebtedness under the Amended Credit Agreement that provides a cap of 6.17%
on LIBOR rates plus applicable margin on the interest rates payable thereon.
The Amended Credit Agreement imposes certain restrictions on the Company,
including restrictions on its ability to incur additional debt, enter into
sale-leaseback transactions, incur contingent liabilities, pay dividends or
make distributions, incur or grant liens, sell or otherwise dispose of
assets, make investments or capital expenditures, repurchase or prepay its
Senior Subordinated Notes due 2007 (the "Notes") or other subordinated debt,
or engage in certain other activities. The Company must also comply with
certain financial ratios and tests, including a minimum net worth
requirement, a maximum leverage ratio, a minimum interest coverage ratio and
a minimum cash flow coverage ratio.
The Company may be required to purchase the Notes upon a Change of Control
(as defined) and in certain circumstances with the proceeds of asset sales.
The Notes are subordinated to the indebtedness under the Amended Credit
Agreement. The indenture governing the Notes imposes certain restrictions on
the Company and its subsidiaries, including restrictions on its ability to
incur additional debt, make dividends, distributions or investments, sell or
otherwise dispose of assets, or engage in certain other activities.
A portion of the outstanding borrowings under the Amended Credit Agreement,
amounting to approximately U.S. $17.6 million as of December 31, 1998, is
denominated in Canadian dollars. All other outstanding borrowings under the
Amended Credit Agreement, and all of the borrowings under the Notes, are
denominated in U.S. dollars.
At December 31, 1998, borrowings under the Amended Credit Agreement bore
interest at a weighted average rate of 8.1% per annum. The Notes bear
interest at a rate of 9.625% per annum.
The Company has established a new manufacturing, packaging and distribution
facility in Fort Mill, South Carolina. The West Unity, Ohio packaging plant
was closed the first week of July 1998 and its packaging lines have been
relocated to the Fort Mill, South Carolina facility. The Company expects to
incur start-up expenses estimated at approximately $3.6 million during fiscal
year 1999 in connection with this new facility, of which $2.9 million has
been incurred through December 31, 1998. The Company has leased this new
facility under a prearranged lease at an estimated incremental annual lease
expense, net of lease costs for the facilities currently expected to be
closed, of $1.4 million.
The Company currently believes that cash flow from operating activities,
together with revolving credit borrowings available under the Amended Credit
Agreement, will be sufficient to fund the Company's currently anticipated
working capital, capital spending and debt service requirements until the
maturity of the Revolving Credit Facility (June 30, 2003), but there can be
no assurance in this regard. The Company expects that its working capital
needs will require it to obtain new revolving credit facilities at the time
that the Revolving Credit Facility matures, by extending, renewing, replacing
or otherwise refinancing the Revolving Credit Facility. No assurance can be
given that any such extension, renewal, replacement or refinancing can be
successfully accomplished.
YEAR 2000 COMPLIANCE
Many existing computer systems and applications, and other control devices,
use only two digits to identify a year in the date field, without considering
the impact of the upcoming change in the century. Others do not correctly
process "leap year" dates. As a result, such systems and applications could
fail or create erroneous results unless corrected to process data related to
the year 2000 and beyond. The problems are expected to increase in frequency
and severity as the year 2000 approaches, and are commonly referred to as the
"Year 2000 Problem." The Company relies on its systems, applications and
devices in operating and monitoring all major aspects of its business,
including systems (such as general ledger, accounts payable, and billing
modules), customer services, infrastructure, embedded computer chips,
networks and telecommunications equipment. Recognizing this the Company
started a program in April of 1996 to correct its Year 2000 Problem. The
Company has substantially completed its remediation phase of modifying and
upgrading all affected systems which are critical to the operations of the
business. The Company also relies, directly and indirectly, on external
systems of business enterprises such as customers, suppliers, creditors,
financial organizations and governmental entities, both domestic and
international, for accurate exchange of data.
The Company is continuing to assess the impact that the Year 2000 Problem may
have on its operations and has identified the following three key areas of
its business that may be affected:
- ------------------------------------------------------------------------------
-14-
<PAGE>
PART I ITEM 2
- ------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
(CONTINUED)
INTERNAL BUSINESS SYSTEMS
The Year 2000 Problem could affect the systems, transaction processing
computer applications and devices used by the Company to operate and
monitor all major aspects of its business, including financial systems
(such as general ledger, accounts payable and billing), customer
services, infrastructure, materials requirement planning, master
production scheduling, networks and telecommunications systems. The
Company has completed its assessment phase and believes that it has
identified substantially all of the major systems, software applications
and related equipment used in connection with its internal operations
that must be modified or upgraded in order to minimize the possibility
of a material disruption to its business. The Company has substantially
completed its remediation phase of modifying and upgrading all affected
systems which are critical to the operations of the business. The
Company estimates that all remaining systems will be Year 2000 compliant
by the end of the fourth quarter of fiscal 1999. However, any unforeseen
problems which occur during the testing phase may adversely affect the
Company's Year 2000 readiness.
THIRD-PARTY SUPPLIERS
The Company relies, directly and indirectly, on external systems
utilized by its suppliers for products used in the manufacture of its
products. The Company has requested confirmation from its major suppliers
of their Year 2000 compliance; however, there can be no assurance that
these suppliers will resolve any or all Year 2000 Problems with their
systems in a timely manner. Any failure of these third parties to
resolve their Year 2000 Problems in a timely manner could result in the
material disruption of the business of the Company. Any such disruption
could have a material adverse effect on the Company's business,
financial condition and results of operations. Although, the Company
believes that this is the worst case Year 2000 scenario, it is
developing additional contingency programs that could potentially offset
any negative impact.
FACILITY SYSTEMS
Systems such as heating, sprinklers, elevators, test equipment and
security systems at the Company's facilities may also be affected by the
Year 2000 Problem. The Company has contacted the facility owners seeking
assurances of Year 2000 compliance.
The Company has incurred $0.6 million of expenses during the nine-month
period ended December 31, 1998 to address its Year 2000 issues. The Company
presently estimates that the total cost of addressing its Year 2000 issues
will be approximately $2.0 million to $3.5 million. This estimate was derived
utilizing numerous assumptions, including the assumption that the Company has
already identified its most significant Year 2000 issues and that the plans
of its third party suppliers will be fulfilled in a timely manner without
cost to the Company. However, there can be no guarantee that these
assumptions are accurate, and actual results could differ materially from
those anticipated.
The Company recognizes the need for developing contingency plans to address
the Year 2000 issues that may pose a significant risk to its on-going
operations. Such plans could include the implementation of manual procedures
to compensate for system deficiencies. During the remediation phase of the
internal business systems, the Company will be evaluating potential failures
and attempt to develop responses in a timely manner. However, there can be no
assurance that any contingency plans evaluated and potentially implemented by
the Company would be adequate to meet the Company's needs without materially
impacting its operations, that any such plan would be successful or that the
Company's results of operations would not be materially and adversely
affected by the delays and inefficiencies inherent in conducting operations
in an alternative manner.
- ------------------------------------------------------------------------------
-15-
<PAGE>
PART I ITEM 2
- ------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
(CONTINUED)
THE EURO CONVERSION
On January 1, 1999, eleven of the fifteen member countries of the European
Union (the "participating countries") established fixed conversion rates
between their existing sovereign currencies (the "legacy currencies") and the
euro. The participating countries agreed to adopt the euro as their common
legal currency on that date. The euro now trades on currency exchanges and is
available for non-cash transactions.
As of January 1, 1999, the participating countries no longer control their
own monetary policies by directing independent interest rates for the legacy
currencies. Instead, the authority to direct monetary policy, including money
supply and official interest rates for the euro, are exercised by the new
European Central Bank.
Following introduction of the euro, the legacy currencies are scheduled to
remain legal tender in the participating countries as denominations of the
euro between January 1, 1999 and January 1, 2002 (the "transition period").
During the transition period, public and private parties may pay for goods
and services using either the euro or the participating country's legacy
currency.
The impact of the euro is not expected to materially affect the results of
operations of the Company. The Company operates primarily in U.S.
dollar-denominated purchase orders and contracts, and the Company neither has
a large customer nor vendor base within the countries participating in the
euro conversion.
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
Certain of the statements contained in this report (other than the financial
statements and other statements of historical fact) are forward-looking
statements, including statements regarding, without limitation, (i) the
Company's growth strategies; (ii) trends in the Company's business; and (iii)
the Company's future liquidity requirements and capital resources.
Forward-looking statements are made based upon management's current
expectations and beliefs concerning future developments and their potential
effects upon the Company. There can be no assurance that future developments
will be in accordance with management's expectations or that the effect of
future developments on the Company will be those anticipated by management.
The important factors described elsewhere in this report and in the Company's
Form 10-K for the fiscal year ended March 31, 1998 (including, without
limitation, those factors discussed in the "Business-Risk Factors" section of
Item 1 thereof), on file with the Securities and Exchange Commission, could
affect (and in some cases have affected) the Company's actual results and
could cause such results to differ materially from estimates or expectations
reflected in such forward-looking statements. In light of these factors,
there can be no assurance that events anticipated by the forward-looking
statements contained in this report will in fact transpire.
While the Company periodically reassesses material trends and uncertainties
affecting the Company's results of operations and financial condition in
connection with its preparation of management's discussion and analysis of
results of operations and financial condition contained in its periodic
reports, the Company does not intend to review or revise any particular
forward-looking statement referenced in this report in light of future events.
- -------------------------------------------------------------------------------
-16-
<PAGE>
PART II OTHER INFORMATION
- -------------------------------------------------------------------------------
ITEM 1. LEGAL PROCEEDINGS
The information in Note 6 to the Company's Condensed Consolidated
Financial Statements included herein is hereby incorporated by
reference.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits:
27 Financial Data Schedule - December 31, 1998
Reports on Form 8-K:
None.
SIGNATURE
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.
LEINER HEALTH PRODUCTS INC.
By: /s/ WILLIAM B. TOWNE
----------------------------------
William B. Towne
Executive Vice President, Chief
Financial Officer and Director
Date: February 12, 1999
- -------------------------------------------------------------------------------
-17-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONDENSED CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1998 AND THE
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE NINE MONTHS ENDED
DECEMBER 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> APR-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,959
<SECURITIES> 0
<RECEIVABLES> 89,148
<ALLOWANCES> 3,086
<INVENTORY> 183,585
<CURRENT-ASSETS> 283,772
<PP&E> 85,965
<DEPRECIATION> 32,196
<TOTAL-ASSETS> 415,315
<CURRENT-LIABILITIES> 125,637
<BONDS> 311,959
0
0
<COMMON> 1
<OTHER-SE> (26,885)
<TOTAL-LIABILITY-AND-EQUITY> 415,315
<SALES> 433,888
<TOTAL-REVENUES> 433,888
<CGS> 323,116
<TOTAL-COSTS> 323,116
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 21,472
<INCOME-PRETAX> 5,279
<INCOME-TAX> 2,244
<INCOME-CONTINUING> 3,035
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,035
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
