SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to ________.
COPLEY PHARMACEUTICAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-2514637
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
25 John Road 02021
Canton, Massachusetts (Zip Code)
(Address of principal executive offices)
Commission file number: 0-20126
Registrant's telephone number, including area code: (781) 821-6111
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No_______
The number of shares outstanding of the registrant's only class of common stock
as of April 30, 1999 was 19,217,658 shares.
<PAGE>
COPLEY PHARMACEUTICAL, INC.
INDEX
For the Three Months Ended March 31, 1999
PAGE NO.
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of March 31,
1999 and December 31, 1998 3
Condensed Consolidated Statements of Operations
for the three months ended March 31, 1999 and 4
1998
Condensed Consolidated Statements of Cash Flows
for the three months ended March 31, 1999 and 1998 5
Notes to Condensed Consolidated Financial Statements 6 - 10
Item 2. Management's Discussion and Analysis of Results of
Operations and Changes in Financial Condition 11 - 15
Item 3. Quantatative and Qualitative Disclosures about 15
Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 6. Exhibits and Reports on Form 8-K 16
Signature 17
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<PAGE>
PART 1. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
COPLEY PHARMACEUTICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<S> <C> <C>
March 31, December 31,
(In thousands, except share data) 1999 1998
----------------------------------------------------------------------------------------------------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 13,102 $ 13,016
Available-for-sale securities 30,248 30,206
Accounts receivable, trade, net 26,308 33,945
Inventories:
Raw materials 12,576 10,771
Work in process 3,928 3,207
Finished goods 7,365 8,463
------------ ---------------
Total inventories 23,869 22,441
Current deferred tax assets 5,546 5,528
Other current assets 5,214 4,742
------------ ---------------
Total current assets 104,287 109,878
Property, plant and equipment, net 42,096 42,800
Due from related party 2,107 2,107
Other assets 564 580
------------ ---------------
Total assets $ 149,054 $ 155,365
------------ ---------------
LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities:
Accounts payable, trade $ 5,025 $ 3,703
Accounts payable, related party 9,784 12,382
Current portion of long-term debt 300 300
Accrued compensation and benefits 1,202 2,175
Accrued rebates 6,582 8,037
Accrued income taxes 277 3,527
Accrued recall related and litigation expenses 8,239 8,010
Accrued expenses 472 618
------------ ---------------
Total current liabilities 31,881 38,752
Accrued compensation and benefits 100 98
Deferred tax liabilities 3,615 3,711
Long-term debt 4,500 4,500
Litigation and Contingencies (Note C)
------------ ---------------
Total liabilities 40,096 47,061
Shareholders' equity:
Preferred stock, $.01 par value; authorized 3,000,000 shares;
none issued --- ---
Common stock, $.01 par value; authorized 60,000,000 shares;
issued 25,370,745 shares 254 254
Additional paid-in capital 78,459 78,340
Unrealized holding gain on available-for-sale securities 22 35
Retained earnings 42,738 42,201
Treasury stock, at cost, 6,153,763 and 6,178,168 shares
respectively (12,515) (12,526)
------------ --------------
Total shareholders' equity 108,958 108,304
------------ --------------
Total liabilities and shareholders' equity $ 149,054 $ 155,365
------------ --------------
</TABLE>
The accompanying notes are an integral part of the Condensed Consolidated
Financial Statements.
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<PAGE>
COPLEY PHARMACEUTICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<S> <C> <C>
(Unaudited)
For the three months ended
March 31,
(In thousands, except per share data) 1999 1998
-------------- --------------
Net sales:
Manufactured products $ 19,284 $ 16,194
Distributed products 7,006 12,014
-------------- --------------
Net sales 26,290 28,208
Cost of goods sold:
Manufactured products 13,718 13,028
Distributed products 5,598 9,439
-------------- --------------
Cost of goods sold 19,316 22,467
-------------- --------------
Gross profit 6,974 5,741
Operating expenses:
Research and development 2,881 2,622
Selling, marketing and distribution 1,000 1,261
General and administrative 2,410 1,283
Recall related and litigation 92 179
-------------- --------------
Income from operations 591 396
Interest and other investment income 422 430
Interest expense (106) (162)
Other income (expenses), net (20) (91)
-------------- --------------
Income before income taxes 887 573
Provision for income taxes 350 170
-------------- --------------
Net income $ 537 $ 403
-------------- --------------
Other comprehensive income (loss), net of taxes
Unrealized gains (loss) on securities (13) 6
Less: reclassification adjustment for gains
included in net income --- (2)
-------------- --------------
Comprehensive income $ 524 $ 407
-------------- --------------
Weighted average common shares outstanding:
Basic 19,215 19,153
Diluted 19,488 19,251
Earnings per share:
Basic $0.03 $0.02
Diluted $0.03 $0.02
</TABLE>
The accompanying notes are an integral part of the Condensed
Consolidated Financial Statements.
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<PAGE>
COPLEY PHARMACEUTICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<S> <C> <C>
(Unaudited)
For the three months ended
March 31,
(In thousands) 1999 1998
-------------- -------------
Cash flows from operating activities:
Net income $ 537 $ 403
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization 1,578 1,755
Losses (gains) on sales of assets (20) (2)
Change in deferred taxes (114) 771
Changes in operating assets and liabilities:
Decreases (increases) in assets:
Accounts receivable 7,637 2,088
Inventories (1,428) (3,284)
Other current assets (472) (3,753)
Other assets, net of amortization (20) (17)
Increases (decreases) in liabilities:
Accounts payable (1,276) 5,160
Accrued income taxes (3,250) 1,099
Accrued expenses (2,343) (3,442)
------------ ------------
Net cash provided by (used in) operating activities 829 778
------------ ------------
Cash flows from investing activities:
Capital expenditures (750) (931)
Purchases of available-for-sale securities (5,525) (6,784)
Proceeds from sales of available-for sale securities --- 1,910
Proceeds from maturities of available-for-sale securities 5,382 2,190
Proceeds from sales of property, plant and equipment 20 ---
------------ ------------
Net cash provided by (used in) investing activities (873) (3,615)
------------ ------------
Cash flows from financing activities:
Stock option exercise 19 ---
Proceeds from issuance of common stock to Employee Stock Purchase Plan 111 90
------------ ------------
Net cash provided by (used in) financing activities 130 90
------------ ------------
Net increase (decrease) in cash and cash equivalents 86 (2,747)
Cash and cash equivalents at beginning of period 13,016 13,847
------------ ------------
Cash and cash equivalents at end of period $ 13,102 $ 11,100
------------ ------------
</TABLE>
The accompanying notes are an integral part of the Condensed
Consolidated Financial Statements.
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<PAGE>
COPLEY PHARMACEUTICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the three months ended March 31, 1999
Note A - General
In the opinion of Copley Pharmaceutical, Inc. ("the Company"), the accompanying
condensed consolidated financial statements contain all normal and recurring
adjustments necessary to present fairly the financial position of the Company as
of March 31, 1999 and December 31, 1998, the results of its operations and its
cash flows for the three months ended March 31, 1999 and 1998. While the Company
believes that the disclosures presented are adequate to make the information not
misleading, these consolidated financial statements should be read in
conjunction with the Notes included in the Company's Form 10-K for the year
ended December 31, 1998. The results for the three-month period ended March 31,
1999 are not necessarily indicative of the results that may be expected for any
future period.
The Company's quarterly and annual operating results are affected by a wide
variety of factors that could have a material adverse effect on the Company's
business, financial condition, results of operations and stock price. Statements
in this Report on Form 10-Q which are not historical facts, so-called
"forward-looking statements", are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. Investors are cautioned
that all forward-looking statements involve risks and uncertainties, including
those detailed in the Company's filings with the Securities and Exchange
Commission. See, for example, "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations - Risk Factors and Future Trends"
contained in the Company's Annual Report or Form 10-K for the year ended
December 31, 1998.
There were 196,154 and 497,589 options outstanding at March 31, 1999 and 1998,
respectively, that were not included in the computation of diluted EPS because
the options' exercise price was greater than the average market price of the
common shares and their inclusion would be antidilutive.
Note B - Related Party Transactions
On July 18, 1995, HC completed its purchase of Marion Merrell Dow Inc.("MMD")
and changed MMD's name to Hoechst Marion Roussel, Inc.("HMRI").
In connection with HC's acquisition of its majority interest in the Company, the
Company is a party to a Product Agreement with HC pursuant to which the Company
is afforded the opportunity under specified conditions to distribute and market
the generic version of products sold by Hoechst-Roussel Pharmaceuticals Inc.
("HRPI"), which was an indirect majority-owned subsidiary of HC. This Product
Agreement will expire June 1, 1999. On January 1, 1996, HRPI was merged into
HMRI. HMRI agreed to be bound by the Product Agreement to the extent that HRPI
was bound; that is, the Product Agreement continues to be in effect for products
manufactured by the former HRPI but not for products manufactured by HMRI prior
to the merger with HRPI nor for products developed by HMRI after January 1,
1996. In furtherance of the Product Agreement, the Company and HMRI entered into
separate contracts relating to specific products as these products became
available for generic distribution and these separate contracts now continue in
effect beyond the expiration of the Product Agreement. For the three months
ended March 31, 1999 and 1998, approximately $5.8 million and $9.0 million,
respectively, of generic versions of products were purchased from HMRI under
this Product Agreement.
The Company obtains its comprehensive general liability, product liability,
umbrella liability and all risks property insurance coverage through an
insurance and risk-sharing arrangement with HC and its parent, Hoechst AG, and
its various subsidiaries. Insurance coverage is provided by HC, through its
wholly-owned insurance subsidiary, as well as by external parties. The Company's
total insurance expense for these insurance policies was approximately $1.1
million for each of the three month periods ended March 31, 1999 and 1998.
-6-
<PAGE>
COPLEY PHARMACEUTICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the three months ended March 31, 1999
Note C - Litigation and Contingencies
Albuterol Class Action Lawsuits
In connection with the Company's December 1993 and January 1994 product recall
of albuterol sulfate inhalation solution, 0.5% ("albuterol"), the Company has
been served with complaints in numerous lawsuits in federal and state court,
some of which are on behalf of numerous claimants. The plaintiffs principally
seek compensatory and punitive damages and allege that injuries and deaths were
caused by inhalation of allegedly contaminated product manufactured and
distributed by the Company.
The federal court lawsuits were consolidated in the United States District Court
for the District of Wyoming as a multi-district litigation for pre-trial
purposes under the caption In Re: Copley Pharmaceutical, Inc. "Albuterol"
Products Liability Litigation. The District Court certified a partial class
action for determination of liability only and commenced a jury trial in June
1995. In August 1995, prior to the conclusion of the jury trial, the Company
entered into a settlement agreement with the representative plaintiffs in the
class action lawsuit. The settlement calls for the Company to receive a general
release of all non-death claims in return for contributions by the Company and
its insurers of a minimum of $65 million and a maximum of $130 million to settle
all non-death claims relating to the Company's manufacture, sale and recall of
albuterol. An additional $20 million is allocated under the terms of the
settlement as an estimate of the cost of settling claims by persons alleging
wrongful death, which claims are limited by the settlement to compensatory
damages only and are subject to non-binding negotiation and arbitration. Within
the Company's minimum and maximum contributions, the amount to be paid by the
Company is subject to the number and seriousness of individual claims eventually
filed. On November 15, 1995, the District Court entered its Order giving final
approval of the settlement. This Order has become final and nonappealable.
The settlement agreement requires the $150 million maximum contribution to be
funded by a non-refundable $65 million cash deposit and issuance of letters of
credit for the remaining balance, to be held by the Albuterol Settlement Trust
Fund as security for potential future payments. The Company negotiated
agreements with its insurers pursuant to which the Company and its insurers have
agreed to pay defined percentages of required settlement payments and related
expenses. The minimum contribution of $65 million to the class action settlement
has been funded by cash contributions from the Company ($7.35 million) and its
insurers ($57.65 million). Most of the remaining balance of the $150 million
maximum contribution has been secured either by a $21 million cash deposit made
pursuant to court order by the Company ($3.15 million) and one of its insurers
($17.85 million) in a separate account (which also is available to pay other
litigation expenses, judgments and settlements) or by letters of credit or other
security totaling $64 million, $11.7 million of which has been posted by the
Company and $52.3 million of which has been provided by the Company's insurers.
Approximately 6,650 proofs of claim have been filed with the Special Master
appointed by the Court to oversee the Albuterol Settlement Trust Fund. The
Special Master has approved approximately 5,240 class action claims totaling
approximately $75 million. No awards have been made to approximately 1,000
rejected class action claims. Appeals from some of these decisions of the
Special Master are being taken to the Court. The Court has ordered that no
further claims may be submitted. (These figures include approximately 850
clients of Jacoby & Meyers, representing nearly all of that firm's clients who
are not alleging a death caused by albuterol, who agreed to be treated as if
they were class members and class counsel have agreed that these claimants will
be paid out of the Albuterol Settlement Trust Fund.) In addition, the Company
has reached settlement agreements with approximately 135 class members alleging
wrongful death; approximately 100 claims of class members alleging wrongful
death remain unresolved.
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<PAGE>
COPLEY PHARMACEUTICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the three months ended March 31, 1999
The settlement also is subject to certain other contingencies and does not cover
certain individuals who previously opted out of the class action, including 40
people who opted out and never filed suit, some of whom now are barred from
bringing suit by the statute of limitations. The Company continues to be a
defendant in lawsuits that were brought by or on behalf of approximately three
people who properly opted out of the class action while the Company has settled
with 81 litigants who had opted out. There also are two active lawsuits brought
by class members alleging wrongful death who are pursuing litigation under the
terms of the class action settlement agreement.
Grand Jury Investigation
On May 28, 1997, the Company announced that it had entered into a plea agreement
pursuant to which it agreed to waive indictment and plead guilty to a one count
Information charging a violation of Title 18, United States Code, Section 371, a
conspiracy to defraud the United States and one of its agencies, the Food and
Drug Administration ("FDA"). The Information alleged that Copley made changes in
the manufacturing processes for four drugs (only two of which, procainamide 500
mg tablets and potassium chloride tablets, currently are being manufactured by
the Company) without proper notification to the FDA and signed false batch
records with respect to two of these drugs. As part of the plea agreement, the
Company agreed to pay a fine of $10.65 million, $7.1 million of which has been
paid with the remaining $3.55 million due in June 1999. The plea was accepted by
the United States District Court for the District of Massachusetts on June 19,
1997.
The plea agreement followed a nearly three-year investigation and grand jury
subpoenas from the United States Attorney's Office in Massachusetts for
documents focusing particularly on albuterol and Brompheril(R) products, which
were recalled by the Company in December 1993 and September 1994, respectively,
but extending beyond these products. The Company complied with the subpoenas and
cooperated with federal authorities throughout the investigation. The
investigation continues with respect to individuals, some of whom are
indemnified by the Company for legal fees and related expenses.
Also on May 28, 1997 the Company announced that it had entered into an agreement
with the FDA providing for an independent audit of 20 of Copley's ANDAs. The
Company is cooperating fully with the FDA, and the independent audit commenced
in July, 1997 and has been substantially completed. The FDA has agreed that
during this audit it will continue to review the Company's pending ANDAs, accept
new ANDAs from the Company and, where appropriate, approve Copley's ANDAs.
SmithKline Beecham Lawsuit
In August 1997, the Company filed an ANDA for nabumetone which certified that
SmithKline Beecham Corporation's ("SB") patent relating to nabumetone was
invalid and unenforceable and that the Company was entitled to manufacture and
sell nabumetone prior to the December 13, 2002 expiration of SB's nabumetone
patent. As a result, on October 31, 1997 the Company was served with a summons
and complaint in a patent infringement action entitled SmithKline Beecham
Corporation and Beecham Group p.l.c. v. Copley Pharmaceutical, Inc. in the
United States District Court for the District of Massachusetts. In their action,
plaintiffs allege that because the Company seeks approval of its ANDA to engage
in the commercial manufacture, use and sale of nabumetone as claimed in their
patent before the patent's expiration, the Company has infringed their
nabumetone patent. Plaintiffs seek damages and an injunction against approval of
the Company's nabumetone ANDA and its sale of nabumetone prior to December 13,
2002. A trial tentatively has been scheduled to begin in October 1999. The
manufacturer and supplier of the nabumetone that the Company has designated for
use in its ANDA has agreed to defend the Company in this action and to indemnify
the Company for any damages that might be assessed as a result of the Company's
sale of nabumetone obtained from the manufacturer. Although the Company believes
that this complaint is without merit and the Company has meritorious defenses to
this action, there can be no assurance that the Company will prevail. A
substantial damages award in this suit could have a material adverse effect on
the Company.
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<PAGE>
COPLEY PHARMACEUTICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the three months ended March 31, 1999
Shareholder Derivative Actions
On September 2, 1998, the Company was served as a nominal defendant in a
shareholder derivative action against six of its nine current Directors. The
lawsuit, which was brought by Great Neck Capital Appreciation Investment
Partnership, the alleged owner of an unspecified number of Company shares, is
pending in Norfolk County, Massachusetts Superior Court. On October 2, 1998,
plaintiff filed a First Amended Shareholder Derivative Complaint that named HCCP
Acquisition Corporation, Hoechst Corporation and Hoechst Aktiengesellschaft as
additional defendants. The amended complaint's allegations include claims of
alleged breach of fiduciary duty and alleged waste of corporate assets and seeks
unspecified money damages and injunctive relief. According to the amended
complaint, "Copley is named as a defendant herein solely in a derivative
capacity. This action is brought on its behalf, and no claims are asserted
against it." The Company is obligated to defend and indemnify the Director
defendants and has put its directors and officers insurance carrier on notice of
this claim. The Company has been served with motions to dismiss the amended
complaint filed by the other defendants; these motions remain pending as of the
date of this report.
On May 10, 1999, the Company learned of the filing in the New Castle County,
Delaware Court of Chancery of a shareholder derivative action entitled Parnes v.
Hoechst Corp. The Company is named as a nominal defendant; amongst the other
defendants are five current directors of the Company. The Complaint alleges
various breaches of duty by Hoechst and the named individuals defendants and
seeks unspecified damages and equitable remedies, including an accounting from
Hoechst and the appointment of a custodian or receiver.
Schering Corporation Lawsuit
In December 1998, the Company filed an ANDA for loratadine syrup which certified
that two of Schering Corporation's patents relating to loratadine syrup were
invalid, unenforceable and/or not infringed and that the Company was entitled to
manufacture and sell loratadine syrup in 2002, following the expiration of one
patent but prior to the expiration of two other of Schering's loratadine
patents. As a result, on March 19, 1999, Schering filed a patent infringement
action entitled Schering Corporation v. Copley Pharmaceutical, Inc. in the
United States District Court for the District of Delaware. In its action,
Schering alleges that because the Company seeks approval of its ANDA to engage
in the commercial manufacture, use and sale of loratadine syrup prior to the
expiration of two patents allegedly relating to loratadine syrup, the Company
has infringed at least one of these patents. Schering seeks an injunction
against approval of the Company's loratadine syrup ANDA and its sale of
loratadine syrup prior to at least April 21, 2004. Although the Company believes
that this complaint is without merit and the Company has meritorious defenses to
this action, there can be no assurance that the Company will prevail. A
substantial damages award in this suit could have a material adverse effect on
the Company.
K-V Pharmaceutical Company Lawsuit
In January 1999 the Company learned that it had been named as a defendant in a
lawsuit entitled K-V Pharmaceutical Company v. Johnson H. Lim, Hoechst
Corporation, and Copley Pharmaceutical, Inc. pending in the St. Louis, Missouri
Circuit Court. Plaintiff alleges that the Company hired one of its former
employees in contravention of an employment agreement between plaintiff and the
individual and seeks actual damages in excess of $1 million as well as punitive
damages and fees and expenses based on a variety of legal theories. Although the
Company believes that this suit is without merit and the Company has meritorious
defenses to this action, there can be no assurance that the Company will
prevail. A substantial damages award in this suit could have a material adverse
effect on the Company.
Other Legal Proceedings
The Company has $8.2 million of estimated recall related and legal contingency
reserves accrued at March 31, 1999. These reserves reflect the Company's
estimate of its exposure at March 31, 1999 in its various legal proceedings
described above. Actual settlement amounts may differ from amounts estimated. In
addition, the Company from time to time is subject to claims arising in the
ordinary course of business. While the outcome of the claims cannot be predicted
with certainty, management does not expect these matters to have a material
adverse effect on the results of operations and financial condition of the
Company.
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<PAGE>
COPLEY PHARMACEUTICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the three months ended March 31, 1999
Note D - Debt
At March 31, 1999, the Company had $11.7 million in stand-by letters of credit
related to the Albuterol Settlement Trust Fund outstanding under this working
capital line of credit agreement. Refer to Note C of the Notes to Consolidated
Financial statements for further discussion of the Settlement Agreement.
-10-
<PAGE>
COPLEY PHARMACEUTICAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
CHANGES IN FINANCIAL CONDITION
Item 2. Management's Discussion and Analysis of Results of Operations and
Changes in Financial Condition
Results of Operations
Net Sales
- --------------------------------------------------------------
Quarter ended
March 31,
In thousands 1999 1998 Change
- --------------------------------------------------------------
Manufactured products $19,284 $16,194 19.1%
Distributed products 7,006 12,014 (41.7)%
----------- -----------
Net sales $26,290 $28,208 (6.8)%
- --------------------------------------------------------------
Net sales for the first quarter of 1999 were $26.3 million, a decrease of $1.9
million, or 6.8%, from the same period in 1998. Manufactured products net sales
increased 19.1% to $19.3 million as compared to $16.2 for the same period in
1998. The increase was due primarily to the launch of new manufactured products
in the fourth quarter of 1998. Distributed products net sales decreased 41.7% to
$7.0 million as compared to $12.0 million for the same period in 1998. This
decrease resulted mainly from continued price erosion accross the distributed
product line.
Gross Profit
- -------------------------------------------------------------
Quarter ended
March 31,
In thousands 1999 1998 Change
- -------------------------------------------------------------
Manufactured products $5,566 $3,166 75.8%
As a % of manufactured
products net sales 28.9% 19.6%
Distributed products $1,408 $2,575 (45.3)%
As a % of distributed
products net sales 20.1% 21.4%
Gross profit $6,974 $5,741 21.5%
As a % of net sales 26.5% 20.4%
- -------------------------------------------------------------
The Company's gross profit was $7.0 million or 26.5% of net sales for the first
quarter of 1999 compared to $5.7 million or 20.4% of net sales for the same
period of 1998. The higher 1999 gross margin resulted from the higher margins
realized on the new manufactured products, a more favorable manufacturing plant
utilization and a favorable mix of higher margin manufactured products.
Operating Expenses
- -------------------------------------------------------------
Quarter ended
March 31,
In thousands 1999 1998 Change
- -------------------------------------------------------------
Research and
development $2,881 $2,622 9.9%
As a % of manufactured
products net sales 14.9% 16.2%
Selling, marketing and
distribution $1,000 $1,261 (20.7)%
As a % of net sales 3.8% 4.5%
General and
administrative $2,410 $1,283 87.8%
As a % of net sales 9.2% 4.5%
Recall related and
litigation $ 92 $ 179 (48.6)%
As a % of net sales 0.3% 0.6%
- -------------------------------------------------------------
-11-
<PAGE>
COPLEY PHARMACEUTICAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
CHANGES IN FINANCIAL CONDITION
General and administrative expenses increased 87.8% to $2.4 million for the
first quarter of 1999 as compared to $1.3 million for the same period of 1998.
Included in this increase are costs associated with the Company's Year 2000
readiness program, higher personnel costs and legal fees, including those
associated with new patent litigation and a shareholder derivative lawsuit.
Refer to Note C of the Notes to Condensed Consolidated Financial statements for
further discussion of these items.
On May 7, 1999, Local 379 of the Teamsters Union was choosen by certain
employees of the Company's South Boston manufacturing facility to be the
representative for purposes of collective bargining.
Recall related and litigation expenses for the first quarter of 1999 and 1998
were primarily comprised of uninsured legal expenses incurred by the Company for
representation in its various legal proceedings at this 15 employee location.
Interest and Other Income (Expenses)
- ------------------------------------------------------------
Quarter ended
March 31,
In thousands 1999 1998 Change
- ------------------------------------------------------------
Interest and other
investment income $422 $ 430 (1.9)%
Interest expense (106) (162) (34.6)%
Other income (expenses) (20) (91) (78.0)%
- -------------------------------------------------------------
Interest and other investment income decreased to $422,000 for the first quarter
of 1999 as compared to $430,000 for the same period of 1998 due to decreased
rates of return on investments.
Interest expense decreased primarily due to the decrease of accrued interest
relating to installments payable under the Company's plea agreement. Refer to
Note C of the Notes to Condensed Consolidated Financial Statements for further
discussion of the plea agreement with the U.S. Attorney.
Tax Expense (Benefit) and Net Income (Loss)
- ------------------------------------------------------------
Quarter ended
March 31,
In thousands 1999 1998
- -------------------------------------------------------------
Income tax expense
(benefit) $350 $170
Effective tax rate 39.5 % 29.7%
Net income (loss) $537 $403
- -------------------------------------------------------------
The net income for the quarter was $0.5 million or $0.03 per share compared to a
net income of $0.4 million or $0.02 per share for the first quarter of 1998.
The effective tax rate increased to 39.5% at March 31, 1998 from 29.7% in the
prior year comparable period due primarily to lower forecasted permanent
deductions during the current period.
Changes in Financial Condition
Capital Resources and Liquidity
- ----------------------------------------------------------
March 31, December 31,
In thousands 1999 1998
- ----------------------------------------------------------
Cash and short-term
investments $43,350 $43,222
Working capital 72,406 71,126
Long-term debt 4,800 4,800
Shareholders' equity 108,958 108,304
- ----------------------------------------------------------
Working capital increased $1.3 million from $71.1 million at December 31, 1998
to $72.4 million at March 31, 1999 primarily due to net income from operations
adjusted for non-cash expenditures.
The Company has a working capital line of credit agreement that provides a
maximum borrowing capacity of $30.0 million. At March 31, 1999, the Company had
$11.7 million of stand-by letters of credit issued under this line of credit.
These stand-by letters of credit were obtained by the Company pursuant to the
requirements of the Albuterol Settlement Trust Fund to cover its uninsured
obligation. Recourse to the letters of credit are contingent on the number of
claims filed within certain categories and will not occur until all claims are
processed and settlement amounts are recommended by the Special Master. Refer to
Note C of the Notes to Condensed Consolidated Financial Statements for further
discussion of the plea agreement with the U.S. Attorney.
-12-
<PAGE>
COPLEY PHARMACEUTICAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
CHANGES IN FINANCIAL CONDITION
Year 2000 Readiness
The Company has a Year 2000 Compliance Program, the purposes of which are to
identify important systems that are not yet Year 2000 ("Y2K") compliant; to
initiate replacement or remedial action to assure that key systems will continue
to operate in the Y2K and to test the replaced or remediated systems; to
identify and contact key suppliers, vendors, customers and business partners to
evaluate their ability to maintain normal operations in the Y2K; and to develop
appropriate contingency plans for dealing with foreseeable Y2K complications.
The Company has appointed a Y2K Project Manager who is responsible for the
Company's Y2K Compliance Program and who reports directly to a member of the
Company's executive committee.
Information Technology Systems
The Company's critical internal information technology ("IT") systems consist of
its Prism manufacturing and JD Edwards financial accounting and Harbinger EDI
400 software packages. The Company has contacted the vendors of these systems
and obtained written certification that these IT systems are currently in
material Year 2000 compliance. The Company also has completed a pilot room
testing of these systems. In addition, the Company is in the process of testing
the Y2K readiness of its other IT applications. The Company, using an outside
consultant, also completed a focused status study on selected aspects of the Y2K
IT compliance testing program.
Embedded Systems
The Company is continuing with its assessment of its mission critical embedded
systems such as production equipment, facility control systems, and quality
control and research and development instrumentation. Specifically, working with
an outside consultant in the first quarter, the Company completed a pilot
program in which two products were selected for evaluation of the equipment and
instruments used in their processes. These pilot tests included inventory
assessment, compliance testing and, where indicated, remediation planning on
selected mission critical embedded systems. The Company is utilizing the pilot
design methodology to complete its Y2K compliance program on the remainder of
the Company's mission critical embedded systems. The Company expects to complete
this embedded systems testing phase by the end of the second quarter of 1999.
Remediation steps arising from the Y2K readiness testing program are being
initiated as appropriate. The Company's strategy is to continue to focus on
mission critical systems first. Beyond the embedded system Y2K testing pilot
program and the testing program modeled after these pilots, the Company has sent
Y2K compliance inquiries to the vendors of these embedded systems, is tracking
responses to its inquiries and, depending on vendor response, is securing
compliance information through direct contact with the manufacturer or through
research on the manufacturer's web page. The Company expects to have completed
its efforts to secure documented compliance information by the conclusion of its
testing program on mission critical systems by the end of the second quarter of
1999. After the Company has completed its critical embedded systems testing, it
plans to expand its inventory assessment and compliance testing to less critical
systems.
As a pharmaceutical manufacturer, the Company's research and development and
manufacturing operations are subject to government regulation. Replacement of
equipment for products subject to FDA approval and manufacturing standards
cannot be accomplished without filings and review by FDA. While the Company has
made significant progress in assessment and compliance testing of its critical
embedded systems, the Company cannot define the precise nature or extent of
remediation required at this time. The failure of the Company to properly and
timely identify equipment that will not function properly as a result of the Y2K
Issue could result in the Company's inability to repair or remediate that
equipment before December 31, 1999. In addition, equipment failures due to the
Y2K issue could result not only in significant replacement costs to the Company
but also in a significant delay in product shipments while the Company seeks to
validate replacement equipment, which could have a material adverse effect on
the Company.
Third-Party Suppliers, Vendors and Customers
The Company's Y2K Compliance Program also includes an investigation of the Y2K
compliance of its major suppliers, vendors, customers and business partners. For
example, third parties handle the payroll function for the Company, the vast
majority of the Company's product orders are received by computer over the
telecommunications systems, and the Company also relies on the services of
banks, utilities, and commercial airlines, among others. The Company continues
to seek and obtain assurances from key service providers that there will be no
interruption of service as a result of Y2K. While the Company has contacted its
supply chain business partners, not all third- party suppliers, vendors or
customers have responded. The Company will continue to make efforts to secure
Y2K compliance status from its supply chain, and is addressing contingency
planning in lieu of third party claimed compliance. There can be no assurances
that the contingency plans will adequately prevent a service interruption by one
or more of the Company's third-party suppliers from having a material adverse
effect on the Company.
-13-
<PAGE>
COPLEY PHARMACEUTICAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
CHANGES IN FINANCIAL CONDITION
The Company continues to contact its key bulk chemical and packaging suppliers
to determine their Y2K compliance status. As with certain of its equipment, the
Company cannot change suppliers of bulk active ingredients unless the
alternative supplier has been approved through the FDA regulatory process. Where
possible, the Company tries to qualify two or more sources of supply. However,
certain of the Company's current and future products will depend on a sole
source of raw material supply. Should one or more of these sole source suppliers
become unable to deliver product in a timely manner due to the Y2K Issue, the
Company would need to identify and qualify a new source of supply. This process
would likely involve significant delays and cost and could have a material
adverse effect on the Company. In addition, the Company continues to contact
significant customers to determine their progress towards Y2K compliance and to
identify issues, if any, which might develop because of customers' failure to be
prepared for Y2K. In the event issues are identified, the Company expects to try
to develop procedures to permit the Company to continue to supply the customer
despite Y2K. The Company has been assured by its key financial institutions that
they are currently Y2K compliant or will be Y2K compliant in early 1999.
Year 2000 Costs and Expenses
The Company's policy continues to be to expense all costs related to Y2K
compliance unless the useful life of the technological asset is extended or
increased, in which case the Company will capitalize that cost. For 1999 the
Company anticipates expenses relating to Y2K to include key personnel costs,
consultant engagements, software and hardware accommodations, data entry and
business partner communications. Based on currently available information, the
Company believes that these expenses will not exceed $500,000 and will be funded
through operations. Until the testing is completed on mission critical systems
in the Company's IT and Embedded Systems operations, the potential costs for any
associated remediation cannot be calculated and is not included in the $500,000.
If unforeseen compliance efforts are required or if present compliance efforts
are not completed on time, or if the cost of any required updating, modification
or replacement of the Company's systems or equipment exceeds the Company's
estimates, Y2K could result in material costs and have a material adverse effect
on the Company. For the quarter ended March 31, 1999, the expenses related to
Y2K were approximately $205,000 and consisted mainly of consulting fees and
internal payroll costs.
Contingency Plans and Worst Case Scenario
At the present time, the Company has formulated a draft contingency plan
addressing system failures in its business processes due to Y2K. The Company has
received written certifications confirming that its critical internal IT systems
are compliant, and the Company and its Y2K IT system audit supported these
findings. As the Company continues its IT and Embedded Systems compliance
testing on its mission critical operations, it is formulating appropriate
contingency planning. The integrated draft contingency plan encompasses all
functional areas within the Company, their business processes and the tasks
associated with each process. It addresses alternate strategies to support
critical business functions to prevent, wherever possible, business
interruptions. It is expected that this draft contingency plan will be revised
as the Company's testing program concludes and remediation initiatives are
completed. Moreover, it is anticipated that as the Company receives more
complete compliance information from its major suppliers, vendors, customers and
business partners, that additional efforts regarding business interruption
prevention and contingency planning can move forward. The Company expects that
its contingency plan will be completed by May 31, 1999, with certain business
interruption prevention initiatives underway before that date.
One possible worst case scenario for the Company resulting from Y2K would be
that one or more of the Company's sole source bulk chemical suppliers would
become temporarily unable to deliver raw materials to the Company as a result of
a system failure. If this were to happen, the Company would not be permitted to
substitute another manufacturer's raw material for that of its sole source
supplier. The Company would not be able immediately to continue to manufacture
product using that raw material once its inventories of the raw material were
expended. The Company's contingency planning with respect to an important
product might include pre-qualifying a second source for critical raw materials
when possible and/or might include building up key sole source raw material
inventories in advance of December 31, 1999.
-14-
<PAGE>
COPLEY PHARMACEUTICAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
CHANGES IN FINANCIAL CONDITION
Various statements in this discussion of Y2K are forward-looking statements
(statements which are not historical in fact) within the meaning of the Private
Securities Litigation Reform Act of 1995. These statements include statements of
the Company's expectations, anticipated schedules and expected completion dates,
estimated costs and statements regarding expected Y2K compliance. These
forward-looking statements are subject to various risks which may materially
affect the Company's efforts to achieve Y2K compliance to accomplish its goals
and to meet its expectations with respect to Y2K issues. These risks include the
possibility that the Company will not be able to complete the plans and
modifications that it has identified, on a timely basis, if at all, the
availability of skilled consultants, the difficulty of evaluating and testing
the wide variety of information systems and components, both hardware and
software, that must be evaluated, the variety, number and complexity of
equipment used in the Company's operations and the large number of vendors and
customers with which the Company interacts. The Company's assessment of the
effects of Y2K on the Company are based, in part, upon information received from
third parties and the Company's reasonable reliance on that information.
Therefore, the risk that inaccurate information is supplied by third parties
upon which the Company reasonably relied must be considered as a risk factor
that might affect the Company's Y2K efforts. Further, the delay or failure of
third parties to respond to inquiries will hinder the Company's ability to
evaluate and remediate the Year 2000 issue. The Company has not yet completed
evaluating certain aspects of Y2K and expects that its assessment of Y2K will
evolve as its Y2K compliance program progresses and the evolution and testing
process continues.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has three forms of debt which are subject to interest rate risk.
They are the industrial revenue bonds, the working capital line of credit and
the outstanding letters of credit. The rates on all three instruments are
variable and fluctuate with the prime rate of interest charged by the respective
bank. Carrying value of these instruments which approximates fair value is $4.8
million and principal is payable as follows; $300,000 for each of the next five
years and $3.3 million thereafter. Interest is payable monthly and interest
expense could be substantially higher if prime rate was to increase in future
periods. The bank's prime rate was 7.75% at March 31, 1999.
-15-
<PAGE>
PART II. OTHER INFORMATION (Continued)
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See descriptions of legal proceedings in Note C of Notes to Condensed
Consolidated Financial Statements in Part I of this Form 10-Q, which are hereby
incorporated by reference herein.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
Form 8-K dated February 3, 1999 - Item 5: Other Events.
The Company announced that Charles T.Lay joined its
Board of Directors on February 3, 1999.
No other reports on Form 8-K were filed during the three
months ended March 31, 1999.
-16-
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Signature Title Date
/s/ Daniel M.P. Caron Vice President-Finance, Chief May 17, 1999
- ------------------------- Financial Officer and Treasurer
Daniel M.P. Caron (principal financial and principal
accounting officer)
-17-
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONDENSED CONSOLIDATED BALANCE SHEETS, STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME AND STATEMENTS OF CASH FLOWS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<NAME> Copley Pharmaceutical, Inc.
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