UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarter Ended March 31, 1999 Commission File Number 1-6787
HEALTH-CHEM CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 13-2682801
(State of Incorporation) (I.R.S. Employer Identification No.)
460 Park Avenue, Suite 1300, New York, NY 10002
(Address of principal executive offices)
Registrant's Telephone Number: 212-751-5600
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, Yes No X ; (2) and has been subject to such filing requirements
for the past 90 days. Yes X No
As of October 31, 1999, 7,665,018 shares of Common Stock, $.01 Par Value, were
outstanding.
page 1
<PAGE>
<PAGE> HEALTH-CHEM CORPORATION Part I
CONSOLIDATED CONDENSED STATEMENTS OF ASSETS AND LIABILITIES Item 1
<TABLE> (LIQUIDATION BASIS) Page 2
<CAPTION> (In thousands)
March 31, December 31,
1999 1998
ASSETS (Unaudited)
<S> <C> <C>
Cash and cash equivalents $ 135 $ 154
Accounts receivable 859 2,502
Inventories (Note 4) 606 1,006
Assets held for sale 13,782 13,782
Property, plant and equipment 4,588 4,588
Cash surrender value of life insurance policies,
net of loans of $1,579 1,051 1,051
Other assets 678 845
TOTAL ASSETS $21,699 $23,928
Liabilities and Capital Deficiency
Collateralized obligations
IBJ Whitehall Business Credit Corporation debt $ 8,856 $10,022
Capitalized lease obligations 123 21
8,979 10,043
Uncollateralized obligations
Taxes payable 155 155
Payroll and related costs payable 55 93
10.375% convertible subordinated debentures, 8,000 8,000
Accounts payable 1,630 1,930
Accrued expenses and other liabilities 4,040 4,323
Estimated expenses in connection
with sale of assets 575 700
Estimated liquidation expenses (Note 2) 5,662 6,081
20,117 21,282
Capital deficiency
Convertible special stock, 7 7
Common stock 145 145
Additional paid-in capital 18,286 18,286
Accumulated deficit <18,152> <18,152>
Subtotal 286 286
Less treasury stock <7,683> <7,683>
Total capital deficiency <7,397> <7,397>
TOTAL LIABILITIES AND CAPITAL DEFICIENCY $21,699 $23,928
CONSOLIDATED STATEMENT OF CHANGES IN ASSETS AND LIABILITIES
(LIQUIDATION BASIS)
(In thousands)
(Unaudited)
<S> <C> <C>
Capital deficiency at January 1, 1999 $ <7,397>
Changes or adjustments: -
Capital deficiency at March 31, 1999 $ <7,397>
</TABLE>
[FN]
See Notes to Consolidated Financial Statements.
<PAGE>
<PAGE>
HEALTH-CHEM CORPORATION Part I
<TABLE> CONSOLIDATED STATEMENT OF OPERATIONS Item 1
(In thousands, except per share amounts) Page 3
(Unaudited)
For the Three Months
Ended March 31, 1998
<S> <C> <C>
REVENUE:
Net sales $ 2,139
Cost of goods sold 990
Gross profit 1,149
OPERATING EXPENSES:
Selling, general and administrative expense 958
Legal expense 346
Research and development expense 190
Net interest expense 412
Total operating expenses 1,906
LOSS FROM OPERATIONS: <757>
Other income - net 0
LOSS FROM CONTINUING OPERATIONS BEFORE TAXES AND
DISCONTINUED OPERATIONS <757>
Income tax benefit 28
LOSS FROM CONTINUING OPERATIONS BEFORE
DISCONTINUED OPERATIONS <729>
DISCONTINUED OPERATIONS:
Income from discontinued operations 607
NET LOSS $ <122>
Earnings <Loss> per common share
(basic & diluted) (Note 6):
Continuing operations $ <.09>
Discontinued operations .08
NET LOSS PER SHARE $ <.01>
Average number of common shares outstanding,
basic & diluted (Note 6) 7,982
</TABLE>
[FN]
See Notes to Consolidated Financial Statements.
<PAGE>
<PAGE> HEALTH-CHEM CORPORATION Part I
<TABLE> CONSOLIDATED STATEMENT OF CASH FLOW Item 1
(In thousands) Page 4
(Unaudited)
For the Three Months
Ended March 31, 1999
<S> <C> <C>
Cash was Provided by <Used for>:
Operating Activities:
Continuing operations:
Cash received from customers $ 3,603
Cash paid to suppliers and employees <2,780>
Interest paid - bank <200>
Other 167
Net cash used for discontinued operations 503
Net cash provided by operating activities 1,293
Investing activities:
Expenses in connection with sale of assets (125)
Net cash used in Investing activies (125)
Financing activities:
Payment of long-term debt <1,166>
Payment of capital lease <21>
Net cash used in financing activities <1,187>
Net decrease in cash and cash equivalents <19>
Cash and cash equivalents at beginning of period 154
Cash and cash equivalents at end of period $ 135
Supplemental disclosure of non-cash
investing and financing activities:
Acquisition of plant and equipment
through capital lease obligations $ 123
(related asset was written down during the period)
</TABLE>
[FN]
See Notes to Consolidated Financial Statements.
<PAGE>
<PAGE>
HEALTH-CHEM CORPORATION Part I
<TABLE> CONSOLIDATED STATEMENT OF CASH FLOW Item 1
(In thousands) Page 5
(Unaudited)
For the Three Months
Ended March 31, 1998
<S> <C> <C>
Cash was Provided by <Used for>:
Operating Activities:
Net Loss $ <122>
Less:
Income from discontinued operations 607
Income from continued operations 485
Adjustments to reconcile net loss
to cash used in operating activities:
Depreciation 142
Gain on disposal of property, plant and equipment 0
Deferred tax 0
Accounts receivable <363>
Inventories 219
Other assets <170>
Accounts payable and accrued expenses <440>
Net cash used in continuing operations <127>
Net cash used in discontinued operations <922>
Net cash used in operating activities <1,049>
Investing Activities:
Additions to property plant and equipment <8>
Investment in life insurance policies-net 126
Payment received on notes receivable 75
Net cash provided by investing activities 193
Financing Activities:
Long-term debt proceeds 847
Net cash provided by financing activities 847
Net decrease in cash
and cash equivalents <9>
Cash and cash equivalents at beginning of period 18
Cash and cash equivalents at end of period $ 9
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest $ 194
Income taxes 3
</TABLE>
[FN]
See Notes to Consolidated Financial Statements.
<PAGE>
<PAGE> HEALTH-CHEM CORPORATION Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 6
1. Financial Condition and Basis of Presentation
The consolidated financial statements include the accounts of Health-Chem
Corporation ("Health-Chem") and all of its subsidiaries (collectively the
"Company"). The operations of Pacific Combining Corporation("Pacific"), a
wholly-owned subsidiary, were discontinued in November 1998 and its assets
were auctioned off in 1999. In August 1999, the sale of substantially all of
the assets and liabilities of two subsidiaries, Herculite Products, Inc.
("Herculite") and Hercon Environmental Corporation ("Hercon Environmental")
was completed for approximately $14.2 million with $550,000 placed in escrow
pending resolution of certain contingencies. These businesses have been
accounted for, and reported as, discontinued operations in the consolidated
financial statements. Presently, the Company is conducting its business
primarily through its 90%-owned subsidiary, Transderm Laboratories Corporation
("Transderm").
The Company failed to repay $8 million in principal as well as the accrued
interest due of $.4 million on its 10.375% convertible subordinated debentures
at maturity, on April 15, 1999. In January 1997, the Company entered into a
secured financing agreement with IBJ Whitehall Business Credit Corporation.
The loan was repaid in August 1999 with the proceeds from the sale of assets
of the Company's Herculite Products, Inc. and Hercon Environmental Corporation
subsidiaries aggregating $14.2 million. The Company also made a $1.9 million
partial payment of it debt obligations in respect of the debentures in
September 1999. The Company's ability to repay the balance of the obligations
on the debentures is contingent, among other things, upon the Company's
ability to effect a business solution with regard to the manufacture of its
new nitroglycerin products and the Company's ability to secure additional
financing. There can be no assurance that the Company will achieve profitable
results or obtain adequate funding. Under the terms of the indenture between
the Company and Bankers Trust Company as indenture trustee, (the "Trustee"),
the Trustee can institute an action or proceeding at law or in equity for the
collection of the sums due and unpaid. There can be no assurance that either
the Trustee or the debenture holders will continue to abstain from exercising
such rights. Therefore, in compliance with generally accepted accounting
principles, the Company's Statement of Assets and Liabilities effective
December 31, 1998 are being presented on a liquidation basis. Accordingly,
the net assets of the Company are stated at liquidation value whereby assets
are stated at their estimated net realizable values and liabilities, which
include estimated liquidation expenses to be incurred through the date of the
Company's dissolution, are stated at their anticipated settlement amounts.
The valuation of assets and liabilities necessarily requires estimates and
assumptions. The actual value of any liquidating distributions, therefore,
would depend on a variety of factors including among others, the proceeds from
the sale of any of the Company's remaining assets and the timing of actual
distributions. The valuations presented in the accompanying consolidated
Statement of Assets and Liabilities represent estimates, based on present
facts and circumstances, of the estimated realizable values of assets and
settlement amounts of liabilities. The actual values could be higher or lower
than the amounts recorded. Particularly sensitive estimates include
assumptions about the dissolution of the Company fifteen months after March
31, 1999 and the level of expenses that will be incurred through such date.
Also, the assumptions underlying the valuation of convertible subordinated
debentures are similarly sensitive.
Transderm owns 98.5% of Hercon Laboratories Corporation ("Hercon
Laboratories") which develops and manufactures controlled-release dispensers
for pharmaceuticals, and over-the-counter pharmaceutical and cosmetic
products. Since 1986, Hercon Laboratories has manufactured and marketed a
transdermal nitroglycerin patch which was the first such product introduced
for the generic market in the United States. An improved version of the patch
was introduced by a competitor and approved by the U.S. Food and Drug
Administration ("FDA").
<PAGE> HEALTH-CHEM CORPORATION Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 7
On October 30, 1998, the Company received United States Food and Drug
Administration ("FDA") approval for its improved nitroglycerin patches which
have been rated by the FDA as an accepted generic alternative to Novartis
Pharmaceutical Corporation's Transderm Nitro(R) products. The Company is
currently not commercially exploiting its newly-approved nitroglycerin
products as a result of an unfavorable decision in the Company's litigation
with Key Pharmaceuticals, Inc. The Company has been involved in discussions
to secure the right to manufacture its improved patch, but there can be no
assurance that such right will be obtained.
In March 1999, the FDA released a proposal to withdraw their approval of a
number of drug applications relating to transdermal nitroglycerin products,
including the patch that the Company developed in 1986. The Company filed
documents in May 1999 requesting rescission of the proposal, and submitted a
timely request for a hearing in the event that the proposal is not rescinded.
To date, there has been no further action by the FDA relating to these
matters. There can be no assurance that the FDA will not proceed to withdraw
its approval of the Company's original transdermal nitroglycerin patch, which
would preclude further production or sale of the product. At present, the
Company has only two customers for this product and sales have steadily
declined through 1999.
Since 1998, the Company also has manufactured and sold to two customers over-
the-counter pharmaceutical and cosmetic products which are used to clean
facial pores. Sales of these products have declined substantially and
management cannot predict if, or when, sales of these products may pick up
again.
In addition to its transdermal nitroglycerin products, the Company is
developing transdermal products for hormone replacement therapies. Further,
the Company has additional products in early development, and is conducting a
number of feasibility studies on drugs to be developed independently or for
client companies. There can be no assurance that any applications for new
products will be filed with the FDA, nor that the FDA would approve any such
application that was filed.
The consolidated statement of assets and liabilities on a liquidation basis as
of March 31, 1999, consolidated statement of changes in assets and liabilities
for the interim period ended March 31, 1999 and the consolidated statements of
operations and of cash flows for the interim periods ended March 31, 1999 and
1998 represent unaudited information. In management's opinion, all necessary
adjustments, consisting of normal recurring items, have been made to present
fairly the financial position, changes in assets and liabilities, results of
operations and cash flows at March 31, 1999 and for all periods presented.
Certain amounts included in the consolidated financial statements relating to
prior periods have been reclassified to conform to the current presentation.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. These consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's Annual Report on Form
10-K for the year ended December 31, 1998. The results of operations for the
periods ended March 31, 1999 and 1998 are not necessarily indicative of the
operating results for the full years.
<PAGE>
<PAGE> HEALTH-CHEM CORPORATION Part I
<TABLE> NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 8
2. Estimated Liquidation Expenses (In thousands)
The following represents changes in an estimate for liquidation expenses for
activity through March 31, 1999. Management has estimated June 30, 2000 as the
date of dissolution unless the current status of the Company's financial
condition improves. This estimate was originally established at December 31,
1998 for the eighteen month period January 1, 1999 through June 30, 2000.
<S> <C> <C>
Net sales $ 1,960
Cost of goods sold 1,106
Gross profit 854
Expenses:
Selling, general and administrative 1,044
Legal 108
Research and development 213
Net interest 411
1,776
Decrease before changes attributable
to activities of Herculite and Hercon Environmental <922>
Net Change attributable to activities of
Herculite and Hercon Environmental 503
Net decrease <419>
Estimated liquidation expenses
established at December 31, 1998 6,081
Estimated liquidation expenses at March 31, 1999 $ 5,662
</TABLE>
3. Discontinued Operations
The consolidated statement of operations and cash flows of the Company,
including footnotes, and supplemental financial data have been reclassified
to reflect the results of operations and net assets of Herculite, Hercon
Environmental and Pacific as discontinued operations in accordance with
generally accepted accounting principles. On November 20, 1998 ("measurement
date"), the Company adopted a plan to discontinue the operations of its
Pacific located in Los Angeles, California. The Company reached this decision
in light of previously reported declining revenues and accelerating losses at
this synthetic fabric manufacturing operation. The Pacific's operations were
essentially terminated in November 1998 and the plant was closed on July 19,
1999.
Early in 1999, management decided, after considering available options, that
a sale of assets of the Company's Herculite and Hercon Environmental
subsidiaries was the best alternative to generate some or all of the funds
required to satisfy current financial obligations. In June 1999, the Company
entered into a Letter of Intent for the sale of Herculite and Hercon
Environmental for an estimated $14.4 million and estimated the transaction to
be consummated within 60 days. On August 19, 1999, substantially all of the
assets and liabilities of these subsidiaries were sold to Aberdeen Road
Company for approximately $14.2 million with $550,000 remaining in escrow to
cover certain contingencies. The proceeds of this sale were used primarily to
repay the entire amount due to IBJ under the term loans and the revolving
credit line and to make a $1.9 million partial payment on the balance of $8.0
million principal amount outstanding of the Company's convertible subordinated
debentures.
Net assets of the discontinued operations at March 31, 1999 aggregating $13.8
million consist primarily of equipment and leasehold improvements and are
reported on the consolidated balance sheet as "Assets being held for sale".
Effective January 1, 1999 no depreciation expense is being recognized on such
assets.
<PAGE> HEALTH-CHEM CORPORATION Part I
<TABLE> NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 9
4. Inventories (In thousands)
Inventories are stated at estimated net realizable value. The Company's
ability to recover the cost of inventory is dependent upon action by the FDA
on a recent proposal regarding the Company's nitroglycerin patch (see Note 1),
and the residual demand for its products.
March 31, 1999 December 31, 1998
Raw materials $ 377 $ 484
Finished goods and work-in-process 229 522
Total $ 606 $1,006
5. Taxes on Income (In thousands)
For the Three Months
Ended March 31,
1999 1998
<S> <C> <C>
The income tax <benefit> provision includes:
State and local income taxes $ 0 $ <28>
Federal income taxes 0 <0>
Total $ 0 $ <28>
Taxes on income are comprised of:
Current payable 0 <28>
Deferred benefit 0 0
Total $ 0 $ <28>
Taxes are charged <credited> to:
Operations $ 0 $ <28>
Extraordinary gain on repurchase of
debentures 0 0
Total $ 0 $ <28>
A reconciliation of taxes on income to the federal statutory rate is as
follows:
For the Three Months
Ended March 31,
1999 1998
<S> <C> <C>
Tax benefit at statutory rate $ 0 $ <51>
Decrease to tax benefit resulting from:
Intangibles and officers life insurance
premiums 0 2
State and local taxes, net of federal
tax benefit 0 3
Valuation allowance 0 11
Other 0 7
Tax benefit $ 0 $ <28>
</TABLE>
Deferred tax assets and liabilities are provided by charges or credits to
income tax expense for differences between the financial statement and tax
bases of assets and liabilities that will affect the determination of taxable
income in the future. The income tax expense, or the income tax benefit of a
loss, reported in the consolidated statements of operations comprises the
amount of tax payable or refund based on the income or loss for the period
plus, or minus, the change during the period in the recorded amounts of
deferred tax assets and liabilities. At December 31, 1997, the Company had
moved into a three year cumulative loss status. In accordance with SFAS 109,
this required the Company to assess the likelihood that all or a portion of
its deferred tax asset would not be realized, in which case the asset would
have to be reduced by a valuation allowance. To determine the amount of the
valuation allowance, all positive and negative information regarding financial
position and results of operations of the Company for the current, preceding
<PAGE> HEALTH-CHEM CORPORATION Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 10
and future years was considered. A valuation allowance is provided for
deferred tax assets when, in management's opinion, it is unlikely that the
value of such assets will be realized through the reduction of taxes to be
paid in the future.
At December 31, 1998, the Company has approximately $22 million of net
operating loss carryforwards for Federal income tax purposes which expire in
various years from 2000 through 2013, and tax credit carryforwards in various
states that expire in various years from 1999 through 2013. The realization
of the value of the deferred tax assets represented by these loss and credit
carryforwards is very uncertain at this time and, accordingly, a valuation
allowance has been provided for all of the deferred tax assets that are
presented on the consolidated financial statements at March 31, 1999 and at
December 31, 1998.
6. Earnings Per Share
Basic and diluted earnings per share are computed based upon the weighted
average number of common shares outstanding during each year after adjustment
for any dilutive effect of the Company's outstanding 10.375% convertible
subordinated debentures and stock options and excluding the weighted average
number of redeemable common shares outstanding. Interest on the subordinated
debentures, when dilutive, net of applicable taxes, is deducted from net loss
for the purpose of computing earnings per share. Convertible subordinated
debentures and stock options are anti-dilutive for each of the periods
presented.
A reconciliation of the numerators and denominators of the basic and diluted
earnings per common share computations for income from continuing operations
for the periods ended March 31, 1999 and 1998 is presented below (in
thousands, except per share amounts):
<TABLE>
1999 1998
Income Shares Per- Income Shares Per
(Numer- (Denom- Share (Numer- (Denom- Share
ator) inator) Amt. ator) inator) Amt.
<S> <C> <C> <C> <C> <C> <C>
Net Loss $ 0 $<122>
Basic Earnings
Per Common Share
Net loss
applicable
to common
stockholders 0 7,982 $ .00 $<122> 7,982 $<0.02>
Effect of
Dilutive
Securities
Stock options 0 0 0 0
Convertible debentures 0 0 0 0
Diluted Earnings
Per Common Share
Net loss applicable
to common stockholders
and assumed conversions $ 0 7,982 $ .00 $<122> 7,982 $<0.02>
</TABLE>
7. Litigation
In August 1995, Key Pharmaceuticals, Inc., a subsidiary of Schering-Plough
Corporation ("Key"), commenced an action against Hercon Laboratories in the
United States District Court for the District of Delaware ("Delaware District
Court") alleging that Hercon Laboratories' submission to the United States
<PAGE> HEALTH-CHEM CORPORATION Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 11
Food and Drug Administration ("FDA") of three Abbreviated New Drug
Applications ("ANDAs") relating to some of Hercon Laboratories' transdermal
nitroglycerin products, for which Hercon Laboratories has applied for FDA
approval, constituted infringement of Key's patent for its Nitro-Dur(R)
products. Key sought certain injunctive relief, monetary damages if
commercial manufacture, use or sale occurs, and a judgment that the effective
date for FDA approval of the above-referenced ANDAs be not earlier than
February 16, 2010, the expiration date of Key's patent. Hercon Laboratories
denied the material allegations of the complaint, asserting, among other
things, that the Key patent is invalid and unenforceable and that Hercon
Laboratories had not infringed and did not infringe any claim of the patent.
Hercon Laboratories counterclaimed against Key for declaratory judgment of
patent noninfringement, invalidity and unenforceability. On September 30,
1997, the Delaware District Court ruled in favor of Key on its infringement
claim and on Hercon Laboratories' claim that Key's patent is invalid and
unenforceable. On December 17, 1997, the Delaware District Court issued an
injunction, enjoining Hercon Laboratories, except as provided for by statute,
from making, using, offering for sale, selling or importing any transdermal
nitroglycerin patches that have been found to infringe claim 14 of Key's
patent, before the expiration of Key's patent on February 16, 2010. In
November 1998, the United States Court of Appeals for the Federal Circuit in
Washington, D.C. (the "CAFC") affirmed the Delaware District Court's ruling in
favor of Key. In January 1999, the CAFC denied Hercon Laboratories' petition
for rehearing of its appeal. Hercon Laboratories is currently reviewing its
options with respect to the manufacture and marketing of its improved
nitroglycerin patches.
Item 2. Management's Discussion and Analysis of Financial Conditions and
Results of Operations
In connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the Company provides the following cautionary
remarks regarding important factors which, among others, could cause future
results to differ materially from the forward-looking statements, expectations
and assumptions expressed or implied herein. The following discussion
includes certain forward-looking statements. Such forward-looking statements
are subject to a number of factors, including material risks and
uncertainties, including those referred to herein and in the Company's Reports
on Form 10-K, which could cause actual results to differ materially from the
forward-looking statements.
Since late November 1998, the make-up of the Company has changed dramatically.
Operations of the Company's Pacific subsidiary located in Los Angeles,
California were discontinued in accordance with a plan adopted by management
in November 1998. In response to pressing needs for funds to satisfy debt
service obligations, a financial advisory firm was retained late in 1998 to
assist in restructuring some or all of the Company's financial obligations.
It was ultimately determined to realize the value of the Herculite and Hercon
Environmental subsidiaries through a sale of assets. A sale of the assets of
these businesses and the assumption by the buyer of certain related
liabilities was completed on August 19, 1999. Funds received from the sale of
these assets have primarily been used to repay amounts outstanding under the
term loan and line of credit with IBJ Whitehall Business Credit Corporation
and to make a $1.9 million payment on the Company's $8.0 million outstanding
subordinated debentures which matured on April 15, 1999. These actions have
provided management with some additional time to take action to attempt to
increase cash flow from operations and to secure new funding sources to enable
the Company to continue operating.
The Company's ability to repay the balance of subordinated debentures is
dependent upon its ability to generate cash flows sufficient to sustain
operations by increasing sales of existing products, to introduce commercially
viable new products based on similar technology and to more fully utilize its
existing manufacturing capacity. Although the Company has a competitive design
<PAGE> HEALTH-CHEM CORPORATION Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION & RESULTS OF OPERATIONS Page 12
for its transdermal nitroglycerin products that were approved by the FDA in
1998, it has not sold such patches due to the result of litigation with Key
Pharmaceuticals, Inc. Arrangements that would allow for the production and
sale of the improved patch are being pursued but there can be no assurance
that such efforts will be successful. Sales of the Company's pore strip
products have also declined. Management cannot predict if or when sales of its
pore strip products may recover. Research and development activities are
ongoing but there can be no assurance that commercially viable products will
be developed.
Under the terms of the subordinated debenture indenture between the Company
and Bankers Trust Company as indenture (the "Trustee"), the Trustee can
institute an action or proceeding at law or in equity for the collection of
the sums due and unpaid. No forebearance has been offered by the Trustee that
it will abstain from exercising such rights. In the circumstances, the
Company is not able to meet its payment obligations and does not have in place
an effective plan to mitigate such conditions. In compliance with generally
accepted accounting principals, the Company's Statement of Assets and
Liabilities as of March 31, 1999 has been presented on a liquidation basis.
Accordingly, the net assets of the Company as of that date are stated at
liquidation value whereby assets are stated at their estimated net realized
values and liabilities, which include estimated liquidation expenses
representing certain corporate expenses that would continue to be incurred
through the date of the dissolution of the Company, are stated at their
anticipated settlement amounts. Estimates used in the liquidation basis of
accounting are forward-looking statements within the meaning of Section 21E of
the Securities Exchange Act of 1934. There are a number of important factors
that could cause actual results to differ from these estimates.
As of August 31, 1999, the Company and its subsidiaries entered into two
agreements with the Trustee for the debentures. Under a Security and Pledge
Agreement, a security interest in the $550,000 escrow deposit created at the
closing of the sale of assets of Herculite and Hercon Environmental on August
19, 1999 was granted in favor of debentureholders. Pursuant to a second
agreement with the Trustee, the Company and its subsidiaries agreed: (i) to
exercise their best efforts to effect a repayment plan to pay the debentures
at the earliest practical date; (ii) that pending a repayment plan, they will
not make any payments to insiders except for salaries and benefits due and
becoming due to them and that insiders can receive pari passu payments on
debentures they hold; and (iii) to give the Trustee not less than two business
days' notice before engaging in any extraordinary transactions.
The Company, through Transderm, is engaged in the development, manufacture and
marketing of transdermal drug delivery systems and over-the-counter
pharmaceutical and cosmetic products. Since 1986, the Company has
manufactured and marketed a transdermal nitroglycerin patch which it currently
sells to one customer for distribution in the United States (two customers
through December 31, 1998) and one customer for distribution in Spain. The
Company also has manufactured and marketed, since 1998, deep cleansing facial
pore strips which it has sold to two customers for distribution in the United
States, Canada and certain other foreign countries. Sales of these pore strip
products have declined substantially and management cannot predict if, or
when, sales of these products may pick up again.
The Company received FDA approval in October 1998 for its improved
nitroglycerin patches which have been rated by the FDA as an accepted generic
alternative to Novartis Pharmaceutical Corporation's Transderm Nitro(R)
products. However, at this time, the Company is not commercially exploiting
its newly-approved nitroglycerin products due to the unfavorable decision in
the Company's litigation with Key Pharmaceuticals, Inc. (the "Key
Litigation"), discussed in Note 7 to the Consolidated Financial Statements.
In March 1999, the FDA released a proposal to withdraw their approval of a
number of drug applications relating to transdermal nitroglycerin products,
<PAGE> HEALTH-CHEM CORPORATION Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION & RESULTS OF OPERATIONS Page 13
including the patch that the Company developed in 1986. The Company filed
documents in May 1999 requesting rescission of the proposal, and submitted a
timely request for a hearing in the event that the proposal is not rescinded.
To date, there has been no further action by the FDA relating to these
matters. There can be no assurance that the FDA will not proceed to withdraw
its approval of the Company's original transdermal nitroglycerin patch, which
would preclude further production or sale of the product. This would have a
material adverse impact on the business of the Company.
In addition to its transdermal nitroglycerin products, the Company is
developing transdermal products for hormone replacement therapies. Further,
the Company has additional products in early development, and is conducting a
number of feasibility studies on drugs to be developed independently or for
client companies. There can be no assurance that any applications for new
products will be filed with the FDA, or that the FDA would approve any such
application that was filed.
The viability of the Company is dependent upon its ability to obtain adequate
funds to fulfill its near-term financial obligations, and to generate positive
cash flow from continuing operations. Although there have been some
preliminary discussions with financial institutions, there can be no assurance
that any external financing will be obtained. The current level of operations
at Hercon Laboratories is not generating cash flow sufficient to sustain
operations, and sales of the Company's original transdermal nitroglycerin
patch continue to decline. The Company's ability to sell any of these patches
in the future is threatened by the FDA proposal to withdraw its approval of
these product applications. Although the Company has FDA approval for its
improved transdermal nitroglycerin patches, it is precluded from
manufacturing or selling the new patches by the decision of the court in the
Key Litigation. The Company has been involved in discussions to secure the
right to manufacture its improved patch, but there can be no assurance that
such right will be obtained. Finally, work on new applications for the
Company's technology and on new products continues, but there can be no
assurance that the Company will be able to bring any new product to the market
in the near-term, nor at any time in the future.
The Consolidated Statements of Operations and of Cash Flow for prior periods
presented have been reclassified to report the results of operations of
Pacific, Herculite and Hercon Environmental as discontinued operations in
accordance with generally accepted accounting principles. Accordingly, the
consolidated results of continuing operations reflect primarily the results of
operations of the remaining operating subsidiary, Transderm for 1998 and 1999.
Results of Operations
In December 1998, the financial statements were presented on a liquidation
basis due to the financial status of the Company. Accordingly, a date was
established (approximately June 30, 2000) for the Company's dissolution and an
accrual was established for ongoing expenses through that date, taking into
consideration expected income from Herculite and Hercon Environmental through
August 19, 1999, the date of sale of such businesses. Results of operations
are now being charged against such accrual. This method of reporting results
of operations will continue until the financial status of the Company improves
or the dissolution of the Company occurs.
Liquidity and Capital Resources
Accounts receivable and inventory for March 31, 1999 as compared to December
31, 1998 decreased $1.6 million and $.4 million, respectively, reflecting the
lower level of business. Accounts payable and accrued expenses each decreased
$.3 million for March 31, 1999 as compared to December 31, 1998. Cash
provided by operating activities for the three months ended March 31, 1999 was
$1.3 million as compared to cash used for operations of $1.0 million for the
same period in 1998. The increase is due primarily to decreasing accounts
<PAGE> HEALTH-CHEM CORPORATION Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION & RESULTS OF OPERATIONS Page 14
receivable of $1.6 million and decreasing inventories of $.4 million in 1999
as compared to increasing accounts receivable of $.4 million and decreasing
inventories of $.2 million in 1998. Cash provided by discontinued operations
for the three months ended March 31, 1999 was $.5 million as compared to cash
used by discontinued operations of $.9 million for the same period in 1998.
Investing activities for the three month period in 1998 provided cash of
$193,000. Financing activities for the three months ended March 31, 1999 used
$1.2 million of cash as compared to the same period in 1998 which provided $.8
million of cash. In 1998, financing activities provided cash for operations,
compared to 1999 when cash from operations was used by financing activities to
reduce outstanding debt.
On January 9, 1997, the Company replaced a $6,000,000 line of credit and a
$1,750,000 term loan from The First National Bank of Maryland ("First
National") with secured financing from IBJ Whitehall Business Credit
Corporation (f/k/a IBJ Schroder Business Credit Corporation) (as successor in
interest to IBJ Schroder Bank & Trust Company) ("IBJ"). Pursuant to a
Revolving Credit Term Loan and Security Agreement ("Loan Agreement") dated as
of January 9, 1997, the Company was provided with up to $7,000,000 in term
loans and up to $8,000,000 in revolving credit. Proceeds from borrowing under
the Loan Agreement were used by the Company to repay outstanding indebtedness
under the aggregate $7,750,000 facility with First National. The term loans
were intended to be used to repurchase, repay and/or redeem up to $7,000,000
of the Company's 10 3/8% Convertible Subordinated Debentures due April 15,
1999, as market conditions warrant. The IBJ loan was repaid in August 1999
with proceeds from the sale of assets of Herculite and Hercon Environmental.
Borrowings under the IBJ facility were collateralized by a pledge of
substantially all of the assets of the Company. The Loan Agreement, which
would have expired on January 9, 2002, was subject to various covenants which,
among other things, required the Company to maintain specified ratios of net
worth, current ratio, fixed charge coverage, minimum level of earnings before
taxes, depreciation and amortization and limits capital expenditures. On
January 21, 1998, the Company entered into a First Amendment (the "First
Amendment") to the Loan Agreement with IBJ. The First Amendment, among other
things, amended the terms for drawing upon the term loan and amended certain
financial covenants. Pursuant to the First Amendment, the maximum term loan
amount was reduced from $7,000,000 to $3,998,000 providing an aggregate of up
to $11,998,000 in senior secured financing. In addition, an overadvance
facility of $400,000 was provided through July 31, 1998. The interest rates
on the revolving credit line and term loans were increased to IBJ's prime plus
.50% and IBJ's prime plus .875%, respectively. The Company paid a facility
fee of 3/8 of 1% on the amount of the unused available financing facility.
In April 1998, the Company borrowed the remaining $1.2 million allowable by
IBJ in term loans to purchase the Company's convertible subordinated
debentures to meet the April 1998 sinking fund requirements. In May 1998, the
Company commenced required monthly payments on the term loan of $56,000.
Monthly payments would have continued until the termination of the loan on
January 9, 2002. The $8,000,000 revolving credit line borrowing base was
limited to the sum of 85% of eligible accounts receivable, 50% of eligible
inventory and an overadvance facility of $1,200,000 which effectively
increased the eligible amount by $1,200,000. On July 31, 1998, the Company
entered into a Second Amendment to the Loan Agreement with IBJ. The Second
Amendment, among other things, increased the Company's overadvance facility to
$600,000 through December 31, 1998.
At March 31, 1999, the Company had borrowed $5.5 million on its revolving line
of credit from IBJ and $3.3 million in term loans. For the three months ended
March 31, 1998, the maximum eligible amount of the $8,000,000 revolving credit
line, ranged from $6,215,000 to $7,620,000, or from 78% to 95% exclusive of
the $1,200,000 overadvance facility. At March 31, 1999, the Company was not
in compliance with the following covenants, as amended: the net worth,
current ratio, fixed charge coverage and minimum level of earnings before
<PAGE> HEALTH-CHEM CORPORATION Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION & RESULTS OF OPERATIONS Page 15
taxes, depreciation and amortization covenants.
The required $1.5 million sinking fund payment on the Company's convertible
subordinated debentures due on April 15, 1998 was satisfied by application of
$.3 million debentures previously repurchased or redeemed, of which $.1
million were purchased in 1996, and by calling for redemption of the remaining
$1.2 million. In October 1998, the Company paid $.5 million in interest on its
debentures. In April 1999, the Company defaulted on its obligations to repay
the remaining $8 million in principal as well as the accrued interest due on
the debentures at maturity aggregating $.4 million. The Company made a $1.9
million partial repayment of its debt obligations in respect of the debentures
out of the proceeds of the sale of assets of Herculite and Hercon
Environmental in August 1999 aggregating $14.2 million. The Company's ability
to repay the balance of its obligations on the debentures is contingent upon
the Company's effecting a business solution with regard to the manufacture of
its new nitroglycerin products and the Company's ability to secure up to $1.5
million financing from a financial institution. A failure to effect such a
business solution or to secure such financing for short-term capital
requirements would have a material adverse effect on the financial status and
operations of the Company.
The Company has not paid cash dividends and does not anticipate paying such
dividends on its common stock in the foreseeable future. The terms of the
indenture relating to the debentures restricted the Company's ability to pay
cash dividends and/or repurchase its capital stock pursuant to a formula based
upon the consolidated net income of the Company and other factors. Under the
formula, at March 31, 1999, no amount was available for the payment of
dividends and/or the repurchase of capital stock.
Transderm, the Company's 90%-owned subsidiary, had outstanding stock options
of 11,450,000 at March 31, 1999 and 11,450,000 at December 31, 1998. At March
31, 1999 and December 31, 1998, respectively, 560,000 stock options were
exercisable. The Company's ownership in Transderm would be reduced to
approximately 70% in the event that all outstanding options to purchase common
stock of Transderm were exercised. There would be no impact on minority
interest due to the deficit equity position of Transderm. The exercise of all
such options would not affect the method by which the Company is consolidated
from a financial reporting standpoint. Such exercises would preclude the
Company from utilizing any tax attributes available to Transderm.
Expenditures in 1999 such as capital expenditures, research and development
costs and other operating expenses have been financed, in part, by the
utilization of a credit facility and in part by capital generated by the
realization of proceeds from the sale of assets of Herculite and Hercon
Environmental. The Company anticipates capital expenditures for property,
plant and equipment in the remaining portion of 1999 not to exceed $.1
million. These capital expenditures will primarily consist of manufacturing
equipment. In 1998, the Company had expended $590,000 for capital
expenditures for property, plant and equipment. As of March 31, 1999, the
Company spent $134,000 for property, plant and equipment in 1999.
Inflation
The Company believes that inflation has not had a material effect upon its
results of operations and liquidity and capital resources for any of the
periods presented.
Impact of the Year 2000 Issue
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a
system failure or miscalculations causing disruptions of operations,
<PAGE> HEALTH-CHEM CORPORATION Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION & RESULTS OF OPERATIONS Page 16
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
Prior to August 19, 1999, the Company maintained an IBM AS400 computer system
for which it completed a Year 2000 project upgrade in July 1999. This system
was sold to Aberdeen Road Company on August 19, 1999 as part of the sale of
assets of Herculite and Hercon Environmental. The Company has access to the
AS400 computer system for six months after the sale for historical
information. The Company currently leases a new personal computer based
system which is Year 2000 compliant. The Company presently believes that it
has resolved its Year 2000 Issue concerns. If unforseen problems arise,
although the Company is uncertain about the duration of a worst case scenario,
the Company's most reasonably likely worst case scenario would be to
temporarily lose the ability to process transactions, send invoices or engage
in similar normal business activities. The Company has developed a contingency
plan which includes maintaining records on a manual system until a portion or
all of the computer system recovers. The Company believes a worst case
scenario is unlikely but if it did occur it could have a material adverse
effect on the operations of the Company.
The Company has assessed the effect of the Year 2000 Issue on its non-
information technology systems, and believes that it will not have a material
impact on the operations of the Company. The Company has addressed Year 2000
issues relating to third parties with which it has a material relationship by
sending questionnaires to vendors, suppliers and customers who could have a
material impact on the Company's operations if their operations were
disrupted. The Company's operations could be adversely affected if such
vendors, suppliers and customers do not prepare for the impact of the Year
2000. Companies responding to the Company's questionnaires have indicated an
awareness of and preparation for dealing with the impact of the Year 2000 on
their operations.
Part II
Item 1
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There were no material developments in any pending legal proceedings in the
quarter ended March 31, 1999 that were not previously reported.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - none.
(b) During the quarter ended March 31, 1999 the Company did not file any
reports on Form 8-K.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to the signed on its behalf by the
undersigned thereunto duly authorized.
HEALTH-CHEM CORPORATION
November 23, 1999 /s/ Marvin M. Speiser
By: Marvin M. Speiser
Chairman of the Board and President
(Principal Executive Officer)
/s/ David J. Heath, Jr.
By: David J. Heath, Jr.
Vice President - Finance
(Principal Financial Officer)
(Principal Accounting Officer)
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