<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 1998
Commission file number 0-5905
CHATTEM, INC.
A TENNESSEE CORPORATION
I.R.S. EMPLOYER IDENTIFICATION NO. 62-0156300
1715 WEST 38TH STREET
CHATTANOOGA, TENNESSEE 37409
TELEPHONE: 423-821-4571
Registrant has filed all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding 12 months, and has been
subject to such filing requirements for the past 90 days.
As of October 13, 1998, 9,549,761 shares of the Company's common stock, without
par value, were outstanding.
<PAGE>
CHATTEM, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets as of August 31, 1998 and
November 30, 1997.................................................................... 3
Consolidated Statements of Income for the Three and Nine
Months Ended August 31, 1998 and 1997................................................ 5
Consolidated Statements of Cash Flows for the Nine Months Ended
August 31, 1998 and 1997............................................................ 6
Notes to Consolidated Financial Statements............................................ 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................. 11
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................................... 20
SIGNATURES................................................................................ 21
EXHIBIT 11 - Statement Regarding Computation of Per Share Earnings
EXHIBIT 27 - Financial Data Schedule
</TABLE>
2
<PAGE>
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
AUGUST 31, NOVEMBER 30,
ASSETS 1998 1997
------ ----------- ------------
(Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ................................. $ 1,532 $ 4,858
Accounts receivable, net .................................. 40,989 28,078
Refundable and deferred income taxes ...................... 1,876 1,876
Inventories ............................................... 19,366 14,493
Prepaid expenses and other current assets ................. 898 667
-------- --------
Total current assets .................................... 64,661 49,972
-------- --------
PROPERTY, PLANT AND EQUIPMENT, NET .......................... 13,808 10,988
-------- --------
OTHER NONCURRENT ASSETS:
Investment in Elcat, Inc. ................................. 7,032 6,640
Patents, trademarks and other purchased product rights, net 273,631 104,972
Debt issuance costs, net .................................. 10,310 3,118
Other ..................................................... 2,350 3,054
-------- --------
Total other noncurrent assets ........................... 293,323 117,784
-------- --------
TOTAL ASSETS .......................................... $371,792 $178,744
-------- --------
-------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
AUGUST 31, NOVEMBER 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997
------------ ------------
(Unaudited)
CURRENT LIABILITIES:
<S> <C> <C>
Current maturities of long-term debt ......................................... $ 5,780 $ 8,919
Accounts payable ............................................................. 5,960 9,319
Payable to bank .............................................................. 4,755 2,618
Accrued liabilities .......................................................... 37,870 13,596
--------- ---------
Total current liabilities .................................................. 54,365 34,452
--------- ---------
LONG-TERM DEBT, less current maturities ........................................ 292,358 133,475
--------- ---------
DEFERRED INCOME TAXES 3,290 3,290
--------- ---------
OTHER NONCURRENT LIABILITIES
2,218 3,157
--------- ---------
SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized 1,000,
none issued ................................................................ -- --
Common shares, without par value, authorized 20,000,
issued 9,550 at August 31, 1998 and 9,082 at
November 30, 1997 .......................................................... 2,098 1,945
Paid-in surplus .............................................................. 67,030 63,975
Accumulated deficit .......................................................... (48,031) (60,229)
--------- ---------
21,097 5,691
Unrealized holding loss on investment ........................................ (91) --
Foreign currency translation adjustment ...................................... (1,445) (1,321)
--------- ---------
Total shareholders' equity ............................................... 19,561 4,370
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY ............................................................... $ 371,792 $ 178,744
--------- ---------
--------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited and in thousands, except per share amounts)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED AUGUST 31, ENDED AUGUST 31,
--------------------------- --------------------------
1998 1997 1998 1997
------------ ------------ ------------ ----------
<S> <C> <C> <C> <C>
NET SALES ........................................ $ 67,600 $ 38,909 $ 161,066 $ 106,033
------------ ------------ ------------ ----------
COSTS AND EXPENSES:
Cost of sales .................................. 19,381 10,100 44,917 29,382
Advertising and promotion ...................... 26,088 14,979 64,470 40,848
Selling, general and administrative ............ 7,366 5,522 19,266 15,946
------------ ------------ ------------ ----------
Total costs and expenses ..................... 52,835 30,601 128,653 86,176
------------ ------------ ------------ ----------
INCOME FROM OPERATIONS ........................... 14,765 8,308 32,413 19,857
------------ ------------- ------------ ----------
OTHER INCOME (EXPENSE):
Interest expense ............................... (7,720) (4,205) (19,232) (11,838)
Investment and other income .................... 97 337 571 1,350
Gain on product divestiture .................... (75) -- 10,328 --
------------ ------------- ------------ ----------
Total other income (expense) ................. (7,698) (3,868) ( 8,333) (10,488)
------------ ------------- ------------ ----------
INCOME BEFORE INCOME TAXES AND
EXTRAORDINARY LOSS............................. 7,067 4,440 24,080 9,369
PROVISION FOR INCOME TAXES ....................... 2,676 1,593 9,011 3,329
------------ ------------- ------------ ----------
INCOME BEFORE EXTRAORDINARY LOSS ................. 4,391 2,847 15,069 6,040
EXTRAORDINARY LOSS ON EARLY
EXTINGUISHMENT OF DEBT, NET .................... ( 958) (1,370) (2,859) (1,370)
------------ ------------- ------------ ----------
NET INCOME........................................ $ 3,433 $ 1,477 $ 12,210 $ 4,670
------------ ------------- ------------ ----------
------------ ------------- ------------ ----------
COMMON SHARES:
Weighted average number outstanding............. 9,483 8,882 9,165 8,700
------------ ------------- ------------ ----------
------------ ------------- ------------ ----------
Weighted average and equivalent number
outstanding ................................. 9,846 9,332 9,507 9,020
------------ ------------- ------------ ----------
------------ ------------- ------------ ----------
NET INCOME PER COMMON SHARE:
Basic:
Income before extraordinary loss.............. $ .46 $ .32 $ 1.64 $ .70
Extraordinary loss ........................... (.10) (.15) (.31) (.16)
------------ ------------- ------------ ----------
Total basic ................................ $ .36 $ .17 $ 1.33 $ .54
------------ ------------- ------------ ----------
------------ ------------- ------------ ----------
Diluted:
Income before extraordinary loss ............. $ .45 $ .31 $ 1.58 $ .67
Extraordinary loss ........................... (.10) (.15) (.30) (.15)
------------ ------------- ------------ ----------
Total diluted .............................. $ .35 $ .16 $ 1.28 $ .52
------------ ------------- ------------ ----------
------------ ------------- ------------ ----------
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
CHATTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
AUGUST 31,
-------------------------
1998 1997
----------- ------------
OPERATING ACTIVITIES:
<S> <C> <C>
Net income .................................................................. $ 12,210 $ 4,670
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization ........................................... 6,881 4,646
Extraordinary loss on early extinguishment of debt ...................... 2,859 1,370
Gain on sale of trademarks and other product rights ..................... (10,328) --
Dividend receivable from Elcat, Inc. .................................... (392) (492)
Other, net .............................................................. (32) 902
Changes in operating assets and liabilities:
Increase in accounts receivable ....................................... (12,696) (6,313)
Increase in inventories ............................................... (6,088) (5,069)
Decrease in prepaid expenses .......................................... 675 368
Decrease in refundable and deferred income taxes ...................... -- 2,386
Increase (decrease) in accounts payable and accrued liabilities ....... 9,089 (2,936)
--------- ---------
Net cash provided by (used in) operating activities ................ 2,178 (468)
--------- ---------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment .............................. (4,157) (1,557)
Proceeds from notes receivable .......................................... -- 190
Purchase of trademarks and other product rights ......................... (164,866) (22,718)
Proceeds from sale of trademarks and other product rights ............... 11,750 --
Other, net .............................................................. (977) (592)
--------- ---------
Net cash used in investing activities .............................. (158,250) (24,677)
--------- ---------
FINANCING ACTIVITIES:
Repayment of long-term debt ............................................. (107,065) (74,319)
Proceeds from long-term debt borrowings ................................. 262,365 87,500
Payment to terminate interest rate swaps ................................ -- (384)
Proceeds from exercise of stock options and warrants .................... 3,208 705
Debt issuance costs ..................................................... (7,873) (1,587)
Increase (decrease) in payable to bank .................................. 2,137 (294)
--------- ---------
Net cash provided by financing activities .......................... 152,772 11,621
--------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND ...................................
CASH EQUIVALENTS ............................................................ (26) (26)
--------- ---------
CASH AND CASH EQUIVALENTS:
Decrease for the period ................................................. (3,326) (13,550)
At beginning of period .................................................. 4,858 16,039
--------- ---------
At end of period ........................................................ $ 1,532 $ 2,489
--------- ---------
--------- ---------
PAYMENTS FOR:
Interest ................................................................ $ 12,849 $ 13,916
Taxes ................................................................... $ 448 $ 161
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITY:
Issuance of 300,000 shares of common stock at $13.50 per share
to fund portion of SunSource acquisition............................... $ -- $ 4,050
Additions to trademarks and other product rights by assumption
of certain liabilities................................................. $ 8,000 $ 3,750
</TABLE>
6
See accompanying notes to consolidated financial statements.
<PAGE>
CHATTEM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note: All monetary amounts are expressed in thousands of dollars unless
contrarily evident.
1. The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions to Form 10-Q and Rule
10-01 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. These consolidated financial
statements should be read in conjunction with the audited consolidated
financial statements and related notes thereto included in the Company's
Annual Report to Shareholders for the year ended November 30, 1997. The
1997 Annual Report has previously been filed with the Securities and
Exchange Commission as an exhibit to the Company's Form 10-K. The
accompanying unaudited consolidated financial statements, in the opinion of
management, include all adjustments necessary for a fair presentation. All
such adjustments are of a normal recurring nature.
2. The results of operations for the periods presented are not necessarily
indicative of the results to be expected for the respective full years.
Seasonality is a factor in the Company's overall business, with the first
quarter sales and income traditionally trailing the other fiscal quarters.
3. The Company incurs significant expenditures on television, radio and print
advertising to support its nationally branded over-the-counter
pharmaceuticals, functional toiletries, dietary supplements and
antiperspirant/deodorants. Customers purchase products from the Company
with the understanding that the brands will be supported by the Company's
extensive media advertising. This advertising supports the retailers' sales
effort and maintains the important brand franchise with the consuming
public. Accordingly, the Company considers its advertising program to be
clearly implicit in its sales arrangements with its customers. Therefore,
the Company believes it is appropriate to allocate a percentage of the
necessary supporting advertising expenses to each dollar of sales by
charging a percentage of sales on an interim basis based upon anticipated
annual sales and advertising expenditures (in accordance with APB Opinion
No. 28) and adjusting that accrual to the actual expenses incurred at the
end of the year.
4. Certain amounts in the prior year's financial information have been
reclassified to conform to the current period presentation.
5. For purposes of reporting cash flows, the Company considers all short-term
deposits and investments with original maturities of three months or less
to be cash equivalents.
7
<PAGE>
6. Inventories consisted of the following at August 31, 1998 and November 30,
1997:
<TABLE>
<CAPTION>
August 31, November 30,
1998 1997
----------- ------------
<S> <C> <C>
Raw materials and work in process ...................... $ 12,006 $ 9,107
Finished goods ......................................... 9,824 7,850
Excess of current cost over LIFO
values ............................................... (2,464) (2,464)
-------- --------
Total inventories ................................. $ 19,366 $ 14,493
-------- --------
-------- --------
</TABLE>
5. Accrued liabilities consisted of the following at August 31, 1998 and
November 30, 1997:
<TABLE>
<CAPTION>
August 31, November 30,
1998 1997
---------- ------------
<S> <C> <C>
Income and other taxes ................................. $ 7,365 $ -
Salaries, wages and commissions ........................ 2,032 1,696
Advertising and promotion .............................. 11,764 2,840
Interest ............................................... 9,632 4,119
Product acquisitions and divestitures .................. 2,671 1,489
Other .................................................. 4,406 3,452
------- -------
Total accrued liabilities ........................ $37,870 $13,596
------- -------
------- ------
</TABLE>
6. Effective December 1, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128 (FAS 128), "Earnings per share". This new
standard requires dual presentation of basic and diluted earnings per share
(EPS) on the face of the income statement and requires a reconciliation of
the numerators and denominators of the basic and diluted EPS calculations.
The earnings per share for the three and nine months ended August 31, 1997
have been restated to conform to FAS 128.
7. On March 24, 1998, the Company acquired the BAN line of deodorant and
antiperspirant products from Bristol-Myers Squibb Company for a purchase
price of $167,718. The Company acquired the BAN trademarks, formulae,
certain patents pertaining to antiperspirant/deodorant technology,
technical information, inventory, manufacturing equipment and packaging
related assets used in the manufacture of BAN, but not the right to sell
BAN in Japan.
8. Also on March 24, 1998, the Company issued $200,000 of 8 7/8% Senior
Subordinated Notes due 2008 (the "Notes") to NationsBanc Montgomery
Securities LLC (the "Initial Purchaser") and entered into an amended and
restated senior secured bank credit agreement. The proceeds of the note
offering were used to fund the BAN purchase and related fees and expenses,
repay revolving bank indebtedness and provide additional working capital.
8
<PAGE>
The Notes mature on April 1, 2008 and interest is payable semi-annually on
April 1 and October 1 of each year, commencing October 1, 1998. The Notes
are senior subordinated obligations of the Company and are subordinated in
right of payment to all existing and future senior debt of the Company. The
Notes may not be redeemed until April 1, 2003, after which they may be
redeemed at the option of the Company. Upon the occurrence of certain
events constituting a change of control, the holders of the Notes may
require the Company to repurchase the Notes at a purchase price equal to
101% of the principal amount thereof, plus accrued and unpaid interest.
The Notes are issued under an indenture with SouthTrust Bank, National
Association, as indenture trustee, which restricts, among other things, the
ability of the Company and its subsidiaries to (i) incur additional
indebtedness and issue preferred stock, (ii) incur liens, (iii) pay
dividends or make certain other restricted payments, (iv) apply net
proceeds from certain asset sales, (v) enter into certain transactions with
affiliates, (vi) merge or consolidate with any other person, (vii) sell
stock of its subsidiaries, or (viii) assign, transfer, lease, convey or
otherwise dispose of substantially all of the assets of the Company.
The Notes were issued by the Company to the Initial Purchaser in a
transaction not registered under the Securities Act of 1933 ("Securities
Act") in reliance upon the exemption provided in Section 4(2) of the
Securities Act. The Initial Purchaser subsequently placed the Notes with
qualified institutional buyers and certain accredited investors in reliance
upon Rule 144A under the Securities Act.
Pursuant to a Registration Rights Agreement between the Company and the
Initial Purchaser, the Company filed with the Securities and Exchange
Commission on May 26, 1998 a Registration Statement on Form S-4, which
became effective on June 8, 1998, with respect to its Series B Notes that
are identical in all material respects to the original Notes. The Company
offered the holders of the original Notes the opportunity to exchange their
Notes for a like amount of Series B Notes on or before July 23, 1998.
9. The bank credit agreements, of which NationsBank of Tennessee, N.A. is
agent, include term loans of $27,500 and $34,800 and a working capital
facility of $30,000 (the "Credit Agreements"). The working capital facility
and the $27,500 term loan mature on June 26, 2002 and the $34,800 term loan
matures on June 14, 2004. The Company may elect either the greater of the
prime rate or federal funds plus 1/2% or a floating rate or Eurodollar
interest rate option applicable to loans under the Credit Agreements. The
floating rate and Eurodollar interest rate options are based on a base rate
plus a floating rate margin that fluctuates on the basis of the Company's
leverage ratio. In addition to the foregoing, the Credit Agreements contain
covenants, representations and other agreements by the Company that are
customary in loan agreements and security instruments relating to
financings of this type.
9
<PAGE>
10. On May 12, 1998, the Company sold the CORNSILK oil control makeup brand to
Del Laboratories, Inc. for $10,750 plus inventories and the assumption of
certain liabilities. The Company sold the CORNSILK trademarks, formulae,
technical information, inventory and other related assets but will continue
to operate the CORNSILK business in the United Kingdom pursuant to a
license agreement. The Company used the net proceeds from the sale to
reduce bank indebtedness.
10
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Note: All monetary amounts are expressed in thousands of dollars unless
contrarily evident.
General
On March 24, 1998, the Company acquired the BAN line of deodorant and
antiperspirant products from Bristol-Myers Squibb Company for a purchase price
of $167,718. The Company acquired the BAN trademarks, formulae, certain patents
pertaining to antiperspirant/deodorant technology, technical information,
inventory, manufacturing equipment and packaging related assets used in the
manufacture of BAN, but not the right to sell BAN in Japan.
Also on March 24, 1998, the Company issued $200,000 of 8 7/8% Senior
Subordinated Notes due 2008 (the "Notes") to NationsBanc Montgomery Securities
LLC and entered into an amended and restated senior secured bank credit
agreement. The proceeds of the Notes offering were used to fund the BAN purchase
and related fees and expenses, repay revolving bank indebtedness and provide
additional working capital.
On May 12, 1998, the Company sold the CORNSILK oil control makeup brand to Del
Laboratories, Inc. for $10,750, plus inventories and the assumption of certain
liabilities. The Company sold, for a gain of $10,328 , CORNSILK trademarks,
formulae, technical information, inventory and other related assets but will
continue to operate the CORNSILK business in the United Kingdom pursuant to a
license agreement. The Company used the net proceeds from the sale to reduce
bank indebtedness.
For the third quarter of fiscal 1998, net sales increased 73.7% to $67,600 from
$38,909 for the corresponding prior year period, while operating income rose
more rapidly than sales, growing 77.7% to $14,765 for 1998 from $8,308 in 1997.
Net income before extraordinary loss for the 1998 period was $ 4,391, or $ .45
per share, as compared to $2,847, or $.31 per share, for the comparable 1997
period, an increase of 45.2%. Net income was $3,433 for the 1998 period, or $.35
per share, compared to $1,477, or $.16 per share, for the comparable period of
1997. The increase in earnings per share was achieved despite the weighted
average number of shares increasing 6.7% from 1997 to 1998.
During the third quarter of fiscal 1998 the Company experienced an extraordinary
loss, net of taxes, of $958, or $.10 per share, on the early extinguishment of
$8,750 of its 12 3/4% Senior Subordinated Notes due 2004.
11
<PAGE>
For the first nine months of fiscal 1998, net sales were $161,066 compared to
$106,033 for the same period of 1997, a 51.9% increase. Income from operations
for the 1998 period was $32,413 versus $19,857 in the comparable 1997 period, a
63.2% increase. Net income before extraordinary loss for the first nine months
of fiscal 1998 was $15,069 (including the gain from the sale of the CORNSILK
brand), or $1.58 per share, and $8,666, or $.91 per share, excluding the
CORNSILK gain, while in the fiscal 1997 corresponding period net income was
$6,040, or $.67 per share. The increase in net income before extraordinary loss
and excluding the CORNSILK gain period to period was 43.5%. The calculation of
earnings per share for the first nine months of fiscal 1998 was also impacted by
a 5.3% increase in the weighted average number of outstanding shares of the
Company's common stock for the period ended August 31, 1998.
During the nine months ended August 31, 1998, the Company recorded an
extraordinary loss, net of taxes, of $2,859, or $.30 per share, on the early
extinguishment of bank debt and $17,349 of its 12 3/4% Senior Subordinated
Notes due 2004.
The strong growth in sales, profitability and earnings per share for the third
quarter and nine months of fiscal 1998 was driven primarily by the BAN,
SUNSOURCE and GOLD BOND brands.
The Company will continue to seek increases in sales through a combination of
acquisitions and internal growth while maintaining high operating income. As
growth rates of mature brands stabilize, sales increases will become more
dependent on acquisitions and the development of successful line extensions or
new products under existing brand names.
Strategically, the Company continually evaluates its products as part of its
growth strategy and in instances where the Company's objectives are not
realized, will dispose of the brands and redeploy the assets to products with
greater growth potential or to reduce indebtedness.
12
<PAGE>
Results of Operations
The following table sets forth, for net income before extraordinary loss and for
the periods indicated, certain items from the Company's Consolidated Statements
of Income expressed as a percentage of net sales:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED AUGUST 31, ENDED AUGUST 31,
1998 1997 1998 1997
------- ------- -------- --------
<S> <C> <C> <C> <C>
NET SALES ................................................. 100.0% 100.0% 100.0% 100.0%
--------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales ........................................... 28.7 25.9 27.9 27.7
Advertising and promotion ............................... 38.6 38.5 40.0 38.5
Selling, general and administrative ..................... 10.9 14.2 12.0 15.1
--------- --------- --------- ---------
Total costs and expenses .............................. 78.2 78.6 79.9 81.3
--------- --------- --------- ---------
INCOME FROM OPERATIONS .................................... 21.8 21.4 20.1 18.7
--------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense ........................................ (11.4) (10.8) (11.9) (11.2)
Investment and other income ............................. .1 .8 .3 1.3
Gain on product divestiture ............................. (.1) -- 6.4 -
--------- --------- --------- ---------
Total other income (expense) ......................... (11.4) (10.0) (5.2) (9.9)
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES ................................ 10.4 11.4 14.9 8.8
PROVISION FOR INCOME TAXES ................................ 3.9 4.1 5.6 3.1
--------- --------- --------- ---------
NET INCOME BEFORE EXTRAORDINARY
LOSS .................................................... 6.5% 7.3% 9.3% 5.7%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
13
<PAGE>
Comparison of Three Months Ended August 31, 1998 and 1997
Net sales for the three months ended August 31, 1998 increased $28,691, or
73.7%, to $67,600 from $38,909 for the same period of 1997. This increase in net
sales was attributable to a $26,614, or 75.8%, increase in domestic consumer
products sales to $61,719 from $35,105 last year and an increase of $2,077, or
54.6%, in international consumer products sales to $5,881 from $3,804.
The increase in net sales in the 1998 period over the corresponding 1997 period
for domestic consumer products was due primarily to the acquisitions of the BAN
and SUNSOURCE product lines and the introduction of GOLD BOND Lotion in the
third quarter of fiscal 1998. BAN was purchased on March 24, 1998, while the
SUNSOURCE line was acquired on June 26, 1997. Sales increases were also realized
for the PAMPRIN, FLEXALL and SUN-IN brands, principally as a result of
increased advertising and promotional expenditures. Decreases in sales from the
corresponding 1997 period were recognized for NORWICH Aspirin and CORNSILK, the
latter of which was sold during the second quarter of fiscal 1998. The sales
decline of the NORWICH Aspirin brand reflects the maturation of this product
line, increased competition in its respective category and markets and reduced
marketing support. All sales variances were principally due to volume changes.
International consumer product sales for the 1998 period increased $359, or
29.3%, for the Company's Canadian subsidiary and $984, or 42.6%, for the United
Kingdom subsidiary. U.S. export sales increased $734, or 269.8%, over the prior
year period. Sales increases were realized for the SUN-IN, GOLD BOND and BAN
brands in Canada, while the remainder of the product lines sold in that country
showed modest declines. Sales of all of the brands sold by the United Kingdom
operation recorded increases, except for the CORNSILK product line, rights to
which the Company retained in the U.K. The principal increase in U.S. export
sales was associated with the BAN product line. All sales variances were largely
the result of changes in volume.
Cost of sales as a percentage of net sales increased to 28.7% for the 1998
quarter from 25.9% for the same prior year period. This increase was essentially
due to a shift in product mix of sales of domestic consumer products to lower
margin brands, principally the BAN and GOLD BOND Lotion products.
Advertising and promotion expenses increased $11,109, or 74.2%, in the 1998
period and were 38.6% and 38.5% of net sales for the 1998 and 1997 quarters,
respectively. This increase in the 1998 period was primarily associated with the
SUNSOURCE, BAN and GOLD BOND product lines. Increased spending compared to the
same period of 1997 was also realized for PAMPRIN, BULLFROG, MUDD and BENZODENT.
Selling, general and administrative expenses increased $1,844, or 33.4%, in the
1998 period but declined as a percentage of net sales to 10.9% compared to 14.2%
for the prior year period. The increase was primarily due to increases in direct
selling expenses, resulting from increased sales, bad debts and research and
development expense.
14
<PAGE>
Interest expense increased $3,515, or 83.6%, in the 1998 period, reflecting
primarily the additional debt incurred in connection with the BAN product
acquisition.
Income before extraordinary loss increased by $1,544, or 54.2%, in the 1998
period. The net increase resulted primarily from increased sales, offset in part
by increased advertising and promotion expenditures, selling, general and
administrative expenses, interest expense and income taxes.
Comparison of Nine Months Ended August 31, 1998 and 1997
Net sales for the nine months ended August 31, 1998 increased $55,033, or 51.9%,
to $161,066 from $106,033 for the same period last year. The increase in net
sales was associated with a $52,161, or 54.7%, increase in domestic consumer
product sales to $147,482 from $95,321 last year and an increase of $2,872, or
26.8%, in international consumer products sales to $13,584 from $10,712.
The net sales increase over the prior year period for domestic consumer products
was due primarily to the acquisitions of the BAN and SUNSOURCE product lines and
the introduction of GOLD BOND Lotion in the third quarter of fiscal 1998. BAN
was purchased on March 24, 1998 while the SUNSOURCE brand was acquired during
the third quarter of fiscal 1997. Strong sales increases were also realized for
the PAMPRIN, SUN-IN and BULLFROG product lines, largely as a result of increased
advertising and promotion expenditures. Decreases in sales from the
corresponding 1997 period were recorded for the FLEXALL, ICY HOT, PREMSYN PMS,
NORWICH Aspirin, MUDD, PHISODERM and CORNSILK brands. The decline in sales of
the ICY HOT brand in 1998 reflects the introduction of the Arthritis Therapy Gel
line extension in the first quarter of 1997 in which sales of this product were
unusually high. The CORNSILK brand was sold on May 12, 1998. The sales decreases
for the remainder of the brands listed above reflect the maturation of these
product lines, increased competition in their respective categories and markets
and, in most cases, reduced marketing support. All sales variances were
primarily due to volume changes.
International consumer product sales for the 1998 period increased $146, or
4.1%, for the Canadian operation and $1,856, or 29.7%, for the United Kingdom
business. U.S. export sales increased $870, or 99.8%, over the prior period,
largely as a result of BAN brand sales being reflected solely in the current
period. BAN product sales in Canada accounted for all of the sales increase in
that country, while sales of all of the product lines sold by the United Kingdom
operation increased in the 1998 period. All sales variances were largely the
result of changes in volume.
Cost of sales as a percentage of net sales increased to 27.9% for the 1998
period from 27.7% for the prior year's first nine months. The marginal increase
reflects the effect of the lower margin on BAN and GOLD BOND Lotion products'
sales in the 1998 period.
15
<PAGE>
Advertising and promotion expenses increased $23,622, or 57.8%, in the 1998
period and were 40.0% of net sales compared to 38.5% in the corresponding 1997
period. This increase in the 1998 period was primarily associated with the
SUNSOURCE, BAN and GOLD BOND brands. Increased spending was also realized for
PAMPRIN, BULLFROG and BENZODENT.
Selling, general and administrative expenses increased $3,320, or 20.8%, in
the 1998 period but were reduced to 12.0% of net sales compared to 15.1% in
the corresponding 1997 period. The increase was primarily due to increases in
direct selling expenses, as a result of increased sales, corporate service
departments expenses and special transitional service fees relating to the
BAN brand acquisition.
Interest expense increased $7,394, or 62.5%, in the 1998 period, reflecting
primarily the additional debt incurred for the SUNSOURCE and BAN product
acquisitions in fiscals 1997 and 1998, respectively.
A gain of $10,328 on the sale of the CORNSILK brand was recognized in the 1998
period.
Income before extraordinary loss increased by $9,029, or 149.5%, in the current
period. The net increase resulted primarily from the gain on the CORNSILK
product line sale and increased sales, offset in part by increased advertising
and promotion expenditures, selling, general and administrative expenses,
interest expense and income taxes.
Liquidity and Capital Resources
The Company has historically financed its operations with a combination of
internally generated funds and borrowings. The Company's principal uses of cash
are for operating expenses, acquisitions, working capital, capital expenditures
and servicing long-term debt.
Cash of $2,178 was provided by operations for the nine months ended August 31,
1998, whereas cash of $468 was used in operations for the corresponding period
of fiscal 1997. The increase in cash flows from operations over the prior year
period was primarily the result of changes in accounts receivable, inventories,
accounts payable and accrued liabilities. The changes were due primarily to the
BAN acquisition in the second quarter of fiscal 1998 and the SUNSOURCE
acquisition in the third quarter of fiscal 1997.
Investing activities used cash of $158,250 and $24,677 in the nine months ended
August 31, 1998 and 1997, respectively. The increase of $133,573 in the current
period was largely the result of increased property, plant and equipment
additions and the purchase of the BAN trademarks and other product rights,
offset in part by the proceeds from the sale of the CORNSILK product line.
Financing activities provided cash of $152,772 and $11,621 in the nine months
ended August 31, 1998 and 1997, respectively. The increase of $141,151 in the
current period reflects the issuance of $200,000 of 8 7/8% Senior Subordinated
Notes due 2008 and the refinancing of bank debt, the proceeds of both being used
primarily to fund the purchase of the BAN brand. In addition, $17,349 of the 12
3/4% Senior Subordinated Notes due 2004 and $23,351 of bank loans were retired.
The Company incurred an extraordinary loss, net of tax, of $2,859 as a result of
the early retirement of debt.
16
<PAGE>
The following table presents working capital data at August 31, 1998 and
November 30, 1997 or for the respective periods then ended:
<TABLE>
<CAPTION>
August 31, November 30,
Item 1998 1997
------------ ---------------- ----------
<S> <C> <C>
Working capital (current assets less current liabilities) ....... $ 10,296 $ 15,520
Current ratio (current assets divided by current liabilities) ... 1.19 1.45
Quick ratio (cash and cash equivalents and accounts
receivable divided by current liabilities...................... .78 .96
Average accounts receivable turnover............................. 5.88 5.92
Average inventory turnover....................................... 3.16 3.17
Working capital as a percentage of total assets.................. 2.77% 8.68%
</TABLE>
The decline in the current and quick ratios at August 31, 1998 as compared to
November 30, 1997 resulted primarily from the increase in accrued liabilities
associated with the BAN acquisition, i.e., interest, taxes and advertising and
promotion expenses.
Total loans outstanding were $298,138 at August 31, 1998 compared to $142,394 as
of November 30, 1997, an increase of $155,744 during the first nine months of
1998. The increase in the 1998 period reflects principally the additional
borrowings required to fund the BAN brand acquisition on March 24, 1998. A
revolving line of credit is available to the Company up to $30,000 or such
lesser amount as is determined to be available under the terms of the Company's
bank credit agreement. The availability of credit under the revolver is
determined based on the Company's accounts receivable and inventories. As of
August 31, 1998, the Company had $4,000 outstanding on its $30,000 working
capital line of credit.
Management of the Company believes that the projected cash flows to be generated
by operations, along with funds available from its bank credit facilities, will
be sufficient to fund the Company's current commitments and proposed operations.
Year 2000
The Company recognizes the need to ensure its operations will not be adversely
impacted by year 2000 software failures. Software failures due to processing
errors potentially arising from calculations using the year 2000 date are a
known risk. The Company has developed a plan to ensure its systems are compliant
with the requirements to process transactions in the year 2000. The following is
a status report of the Company's efforts to date for fulfilling those compliance
requirements:
The Company's State of Readiness
The Company is in the process of replacing its current information technology
(IT) systems which are approximately twenty years old; consequently, the new IT
system will be year 2000 compliant. Accordingly, the year 2000 compliance
requirements are considered only a portion of the Company's systems' replacement
effort. This replacement is expected to be completed by December 1, 1999, the
beginning of the Company's 2000 fiscal year.
17
<PAGE>
Costs to Address Year 2000 Issues
The total cost of the software and implementation is estimated to be from $1,500
to $2,000. Approximately $831 had been expended on this system at August 31,
1998.
Risks of Year 2000 Issues
The Company is in the process of execution of its formal year 2000 compliance
plan and expects to achieve implementation on or before December 1, 1999.
The Company has requested and has received from a majority of its principal
customers and suppliers written statements regarding their knowledge of and
plans for meeting the year 2000 compliance requirements. All respondents
indicate that they have knowledge of and are in the process of fulfilling these
requirements. These companies are at various stages of completion of their
compliance plans, but all expect to be in full year 2000 compliance by or before
the end of their 1999 fiscal years.
In the event that any of the Company's significant customers or suppliers does
not successfully and timely achieve year 2000 compliance, the Company's business
or operations could be adversely affected.
Contingency Plans
The Company is currently developing a "Worse Case Contingency Plan", which will
include generally an environment of utilizing "Work Force", "Spreadsheet" and
"Work Around" programming and procedural efforts. This contingency system will
be activated by December 1, 1999. The cost of these temporary measures is
estimated at $500.
The Company's current existing systems are fully capable (except for year 2000
date handling) of processing all present and future transactions of the
business. Accordingly, no major efforts have been delayed or avoided which
affect normal business operations as a result of the incomplete implementation
of the year 2000 IT systems. These current systems will become the foundation of
the Company's contingency system.
Foreign Operations
The Company's primary foreign operations are conducted through its Canadian and
U.K. subsidiaries. The functional currencies of these subsidiaries are Canadian
dollars and British pounds, respectively. Fluctuations in exchange rates can
impact operating results, including total revenues and expenses, when
translations of the subsidiary financial statements are made in accordance with
SFAS No. 52. "Foreign Currency Translation." For the nine months ended August
31, 1998 and 1997, these subsidiaries accounted for 7% and 9% of total revenues,
respectively, and 2% and 4% of total assets, respectively. It has not been the
Company's practice to hedge its assets and liabilities in the U.K. and Canada or
its intercompany transactions due to the inherent risks associated with foreign
currency hedging transactions and the timing of payment between the Company and
its two foreign subsidiaries. Historically, gains or losses from foreign
currency transactions have not had a material impact on the Company's operating
results. Losses of $83 and of $47 for the nine months ended August 31, 1998 and
1997, respectively, resulted from foreign currency transactions.
18
<PAGE>
Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities. The Statement established accounting and reporting
standards requiring that every derivative instrument (including certain
derivative instruments embedded in other contracts) be recorded in the balance
sheet as either an asset or liability measured at its fair value. The Statement
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Special accounting
for qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a company
must formally document, designate and assess the effectiveness of transactions
that receive hedge accounting.
Statement 133 is effective for fiscal years beginning after June 15, 1999. A
company may also implement the Statement as of the beginning of any fiscal
quarter after issuance (that is, fiscal quarters beginning June 16, 1998 and
thereafter). Statement 133 cannot be applied retroactively. Statement 133 must
be applied to (a) derivative instruments and (b) certain derivative instruments
embedded in hybrid contracts that were issued, acquired or substantively
modified after December 31, 1997 (and, at the Company's election, before January
1, 1998).
The Company has not yet quantified the impacts of adopting Statement 133 on its
financial statements and has not determined the timing of or method of its
adoption of Statement 133. However, the Statement could increase volatility in
earnings and other comprehensive income.
Forward Looking Statements
This Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward looking statements that are based on management's
current beliefs and assumptions about expectations, estimates, strategies and
projections for the Company. These statements are not guarantees of future
performance and involve risks, uncertainties and assumptions that are difficult
to predict. Therefore, actual outcomes and results may differ materially from
what is expressed or forecasted in such forward looking statements. The Company
undertakes no obligation to update publicly any forward looking statements
whether as a result of new information, future events or otherwise. The risks,
uncertainties and assumptions regarding forward looking statements include, but
are not limited to, product demand and market acceptance risks; product
development risks, such as delays or difficulties in developing, producing and
marketing new products or line extensions; the impact of competitive products,
pricing and advertising; constraints resulting from financial condition of the
Company, including the degree to which the Company is leveraged, debt service
requirements and restrictions under bank loan agreements and indentures; and
other risks described in the Company's Securities and Exchange Commission
filings.
19
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
(1) Statement regarding computation of per share earnings
(Exhibit 11).
(2) Financial data schedule (Exhibit 27).
(b) No reports on Form 8-K were filed with the Securities and Exchange
Commission during the quarter ended August 31, 1998.
20
<PAGE>
CHATTEM, INC.
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.
CHATTEM, INC.
(Registrant)
Dated: October 15, 1998 \s\ A. Alexander Taylor II
------------------------- --------------------------
A. Alexander Taylor II,
President and Director
(Chief Operating Officer)
\s\ Stephen M. Powell
--------------------------
Stephen M. Powell
(Chief Accounting Officer)
21
<PAGE>
EXHIBIT 11
CHATTEM, INC. AND SUBSIDIARIES
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
(Unaudited and in thousands, except per share amounts)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
AUGUST 31, AUGUST 31,
1998 1997 1998 1997
------------ ------------- ------------ ------------
<S> <C> <C> <C> <C>
NET INCOME:
Income before extraordinary loss ....... $ 4,391 $ 2,847 $ 15,069 $ 6,040
Extraordinary loss ..................... (958) (1,370) (2,859) (1,370)
------------ ------------- ------------ ------------
Net income ........................... $ 3,433 $ 1,477 $ 12,210 $ 4,670
------------ ------------- ------------ ------------
------------ ------------- ------------ ------------
COMMON SHARES:
Weighted average number outstanding 9,483 8,882 9,165 8,700
Number issued upon assumed exercise
of outstanding stock options and
stock warrants ................... 363 450 342 320
------------ ------------- ------------ ------------
Weighted average number of common
and common equivalent shares
outstanding ...................... 9,846 9,332 9,507 9,020
------------ ------------- ------------ ------------
------------ ------------- ------------ ------------
NET INCOME PER COMMON SHARE:
Basic:
Income before extraordinary loss $ 0.46 $ 0.32 $ 1.64 $ 0.70
Extraordinary loss .................. (.10) (.15) (.31) (.16)
------------ ------------- ------------ ------------
Total basic $ 0.36 $ 0.17 $ 1.33 $ 0.54
------------ ------------- ------------ ------------
------------ ------------- ------------ ------------
Diluted:
Income before extraordinary loss .... $ 0.45 $ 0.31 $ 1.58 $ 0.67
Extraordinary loss .................. (.10) (.15) (.30) (.15)
------------ ------------- ------------ ------------
Total diluted ..................... $ 0.35 $ 0.16 $ 1.28 $ 0.52
------------ ------------- ------------ ------------
------------ ------------- ------------ ------------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Chattem,
Inc.'s unaudited financial statements and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> NOV-30-1998
<PERIOD-START> DEC-01-1997
<PERIOD-END> AUG-31-1998
<CASH> 1,532
<SECURITIES> 0
<RECEIVABLES> 41,764
<ALLOWANCES> 775
<INVENTORY> 19,366
<CURRENT-ASSETS> 64,661
<PP&E> 31,859
<DEPRECIATION> 18,051
<TOTAL-ASSETS> 371,792
<CURRENT-LIABILITIES> 54,365
<BONDS> 292,358
0
0
<COMMON> 2,098
<OTHER-SE> 17,463
<TOTAL-LIABILITY-AND-EQUITY> 371,792
<SALES> 161,066
<TOTAL-REVENUES> 161,066
<CGS> 44,917
<TOTAL-COSTS> 128,653
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 19,232
<INCOME-PRETAX> 24,080
<INCOME-TAX> 9,011
<INCOME-CONTINUING> 15,069
<DISCONTINUED> 0
<EXTRAORDINARY> (2,859)
<CHANGES> 0
<NET-INCOME> 12,210
<EPS-PRIMARY> 1.33
<EPS-DILUTED> 1.28
</TABLE>
