<PAGE>
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 0-27642
TRANSDERM LABORATORIES CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 13-3518345
(State of Incorporation) (I.R.S. Employer Identification No.)
460 Park Avenue, Suite 1300, New York, NY 10022
(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, 40,000,000 shares of Common Stock, $.001 Par Value,
were outstanding.
Page 1
<PAGE>
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
CONSOLIDATED CONDENSED STATEMENTS OF ASSETS AND LIABILITIES Item 1
<TABLE> (LIQUIDATION BASIS) Page 2
(In thousands)
ASSETS (Note 1)
March 31, December 31,
1999 1998
(Unaudited)
<S> <C> <C>
Cash $ 16 $ 9
Accounts receivable 859 1,675
Inventories (Note 3) 606 756
Property, plant and equipment 4,568 4,568
Other assets 4 4
TOTAL ASSETS $ 6,053 $ 7,012
LIABILITIES AND CAPITAL DEFICIENCY
Collateralized obligations
Capitalized lease obligation $ 123 $ 21
Uncollateralized obligations
Payroll and related costs payable 38 42
Accounts payable 710 1,056
Accrued expenses and other liabilities 161 316
909 1,414
Other obligations
Amount due to Health-Chem Corporation
Subordinated promissory note 7,000 7,000
Note payable 2,854 3,435
Redeemable preferred stock 8,500 8,500
Preferred dividends payable 1,028 879
19,382 19,814
Capital deficiency
Common stock, par value $.001 per share; 60,000,000 share authorized;
40,000,000 shares issued and outstanding 40 40
Accumulated deficit <14,401> <14,277>
Total Capital Deficiency <14,361> <14,237>
TOTAL LIABILITIES AND CAPITAL DEFICIENCY $ 6,053 $ 7,012
CONSOLIDATED STATEMENT OF CHANGES IN ASSETS AND LIABILITIES
(LIQUIDATION BASIS)
(In thousands)
(Unaudited)
<S> <C> <C>
Capital deficiency at January 1, 1999 <14,237>
Changes or adjustments:
Preferred dividend <149>
Net increase in assets and liabilities 25
Capital deficiency at March 31, 1999 <14,361>
</TABLE>
[FN]
See Notes to Consolidated Financial Statements
<PAGE>
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
<TABLE> CONSOLIDATED STATEMENT OF OPERATIONS Item 1
(In thousands, except per share data) Page 3
(Unaudited)
For the Three Months
Ended March 31,
<S> 1998
REVENUE: <C> <C>
Net sales $ 2,139
Cost of goods sold 990
Gross profit 1,149
OPERATING EXPENSES:
Selling, general and administrative expense 372
Legal expense 135
Research and development expense 190
Net interest expense 204
Total operating expenses 901
INCOME FROM OPERATIONS BEFORE TAXES 248
Income tax benefit (Note 3) 25
NET INCOME 273
PREFERRED DIVIDENDS 149
NET INCOME <LOSS> APPLICABLE TO COMMON STOCKHOLDERS $ 124
Earnings per Common Share (basic & diluted)
(Note 5):
NET INCOME <LOSS> PER COMMON SHARE $ 0.00
Average number of common shares
outstanding (Note 5)
Basic 40,000
Diluted 43,067
</TABLE>
[FN]
See Notes to Consolidated Financial Statements.
<PAGE>
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY 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 $ 2,776
Cash paid to suppliers and employees <1,944>
Interest paid <223>
Cash provided by operating activities 609
Financing activities:
Repayment of borrowings from
Health-Chem Corporation - net <581>
Payment of capital lease <21>
Net cash used in financing activities <602>
Net increase in cash 7
Cash at beginning of period 9
Cash at end of period $ 16
</TABLE>
[FN]
See Notes to Consolidated Financial Statements.
<PAGE>
<PAGE>
<TABLE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
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 income $ 273
Adjustments to reconcile net income to
net cash used for operations:
Depreciation and amortization 142
Changes in:
Accounts receivable <363>
Inventories 219
Accounts payable <192>
Accrued expenses and other current liabilities <248>
Net cash used for operating activities <169>
Investing Activities:
Additions to property, plant and equipment <8>
Disposal of property, plant and equipment 0
Net cash used for investing activities <8>
Financing Activities:
Borrowings from affiliates, net 170
Other long-term debt payments <2>
Net cash provided by financing activities 168
Net Decrease in Cash <9>
Cash at beginning of period 18
Cash at end of period $ 9
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest $ 361
Income taxes 1
</TABLE>
[FN]
See Notes to Consolidated Financial Statements.
<PAGE>
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 6
1. Basis of Presentation and Nature of Operations
The consolidated financial statements include the accounts of Transderm
Laboratories Corporation and its subsidiary, Hercon Laboratories Corporation
("Hercon"). Transderm Laboratories Corporation and Hercon Laboratories
Corporation are sometimes hereinafter referred to collectively as the
"Company". The Company is an indirect 90% owned subsidiary of Health-Chem
Corporation ("Health-Chem").
Health-Chem failed to repay $8 million in principal as well as the accrued
interest of $.4 million due on its 10.375% convertible subordinated debentures
at maturity, on April 15, 1999. In January 1997, Health-Chem and its
subsidiaries, including 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 Health-Chem's Herculite Products, Inc. and Hercon Environmental Corporation
subsidiaries aggregating $14.2 million. Out of such proceeds, Health-Chem
made a $1.9 million partial payment on its debt obligation in respect of the
Debentures in September 1999. Health-Chem's ability to repay the balance of
the obligations on the Debentures is contingent, among other things, upon the
Company's effecting a business solution with regard to the manufacture of its
new nitroglycerin products and Health-Chem's ability to secure financing from
a financial institution. There can be no assurance that Health-Chem or the
Company will be successful in such efforts. The terms of the related
debenture indenture between Health-Chem and Bankers Trust Company as trustee
for the debentureholders, empower the trustee to institute an action or
proceeding at law or in equity for the collection of the sums due and unpaid.
The trustee has not indicated any forbearance specifically that it will
abstain from exercising such rights and to ensure compliance with generally
accepted accounting principles, the Company's Statements of Assets and
Liabilities as of December 31, 1998 and March 31, 1999 have been presented on
a liquidation basis. Accordingly, the net assets of the Company as of these
dates are stated at liquidation value whereby assets are stated at their
estimated net realizable values and liabilities are stated at their
anticipated settlement amounts.
The valuation of assets and liabilities necessarily requires estimate and
assumptions. The actual value of any liquidating distributions would depend
on a variety of factors including among others, the proceeds from the sale of
any of the Company's assets and the timing of actual distributions. The
valuations presented in the accompanying Consolidated Statements 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.
The Company is engaged in the development, manufacture and marketing of
transdermal drug delivery systems and over-the-counter pharmaceutical and
cosmetic products. The Company manufactures and markets a transdermal
nitroglycerin patch which it has sold 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 manufactures and markets 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.
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
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 7
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.
The Company has a new competitive design for its transdermal nitroglycerin
patch that was approved by the FDA in 1998, but has not sold such patches due
to the unfavorable resolution of litigation with Key Pharmaceuticals, Inc.
discussed in Note 9. 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.
The viability of the Company is dependent upon its ability to generate cash
flow sufficient to sustain operations by increasing sales of existing products
or introducing commercially viable new products based on similar technology.
In addition to its transdermal nitroglycerin products, the Company is also
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 FDA filing for any
additional products will be effected or that FDA approval for any additional
products will be obtained.
The Company is dependent upon its parent company, Health-Chem. Health-Chem is
the Company's principal source of funds not generated by operations. Cash
requirements are borrowed from Health-Chem and any cash generated from
operations is used to repay borrowings from Health-Chem. The Company's
subordinated promissory note was given to Health-Chem in exchange for the then
outstanding borrowings from Health-Chem. Health-Chem also holds the Company's
outstanding redeemable preferred stock. The Company is included in the
consolidated federal income tax return of Health-Chem. Health-Chem also
provides most of the administrative services required by the Company. To
satisfy pressing financial obligations, the assets of two of Health-Chem's
subsidiaries were sold in the third quarter of 1999 and the outstanding
balances of the companies' primary source of third-party funding were paid off
and the relationship was terminated. Health-Chem remains in default of
payment of its debt obligations in respect of its convertible subordinated
debentures. Health-Chem is currently in discussions with a financial
institution regarding a $1.5 million credit facility. There can be no
assurance that Health-Chem will be able to continue to fund the Company's
operations, nor that the Company will be able to secure adequate funding from
other sources.
The Consolidated Statements of Assets and Liabilities as of March 31, 1999,
the Consolidated Statements of Operations and of Cash Flow for the interim
periods ended March 31, 1999 and 1998 have been prepared by the Company and
have not been audited in accordance with General Accepted Accounting
Principles ("GAAP"). In management's opinion, all necessary adjustments,
consisting of normal recurring items, have been made to present fairly the
financial position, results of operations and cash flows of the Company 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 note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. It is suggested that these
consolidated financial statements be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's 1998 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> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 8
2. Changes in Assets and Liabilities (in thousands):
The following represent changes in assets and liabilities (liquidation basis)
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.
<TABLE>
<S> <C> <C>
Net sales $ 1,960
Cost of goods sold 1,106
Gross profit 854
Expenses
Selling, general and administrative 355
Legal 38
Research and development 213
Net interest 223
829
Net increase $ 25
</TABLE>
3. Taxes on Income
The Company is included in the consolidated federal income tax return of its
parent, Health-Chem, and is party to a Tax Sharing Agreement with Health-Chem.
Deferred tax assets and liabilities reflect differences between the financial
statement and tax bases of assets and liabilities that will result in future
taxable or deductible amounts. Deferred tax assets are reduced by a valuation
allowance when, in the opinion of management, it is more likely than not that
some or all of the deferred assets will not be realized. The deferred tax
assets and liabilities are measured using the enacted tax laws and rates
applicable to the periods in which the differences are expected to affect
taxable income.
<TABLE>
For the Three Months
Ended March 31,
<S> 1999 1998
Taxes on income include <C> <C>
<benefit> provision for:
Federal income taxes $ 0 $ <0>
State and local income taxes 0 <25>
Total $ 0 $ <25>
Taxes on income comprise:
Current $ 0 $ <25>
Deferred 0 0
Total $ 0 $ <25>
</TABLE>
A reconciliation of the provision for taxes on income to the tax computed at
the federal statutory rate follows:
<TABLE> For the Three Months
Ended March 31,
1999 1998
<S> <C> <C>
Tax provision at statutory rate $ 9 $ 84
Increase <decrease> resulting from:
State and local taxes, net of federal
tax benefit 0 <6>
Reversal of valuation allowance <9> <103>
Tax benefit $ 0 $ <25>
</TABLE>
<PAGE>
TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 9
4. Inventories (In thousands)
Inventories are stated at lower of cost (first-in, first-out basis) or market.
The Company's ability to recover the cost of inventory is dependent upon,
among other things, the demand for its products.
<TABLE>
March 31, 1999 December 31, 1998
<S> <C> <C>
Raw materials $ 377 $ 484
Finished goods and work in process 229 272
Total inventories $ 606 $ 756
</TABLE>
5. Earnings Per Share
Basic and diluted earnings per share are computed based upon the weighted
average number of common shares outstanding, after adjustment for any dilutive
effect of the Company's stock options. Throughout the periods presented in
these financial statements, there were 40 million shares of common stock
outstanding. Options to purchase 11.4 million shares of common stock were
outstanding at both March 31, 1999 and 1998.
The dilutive effect of such options on the earnings per common share
computations for the periods ended March 31, 1999 and 1998 is presented below
(in thousands, except per share amounts):
<TABLE> For the Three Months
Ended March 31,
1999 1998
<S> <C> <C>
Net Income <Loss> Applicable to Common
Stockholders:
Net income <loss> $ 0 $ 273
Preferred stock dividends 0 149
Income <loss> applicable to common
stockholders $ <0> $ 124
Basic Earnings <Loss> Per Common Share:
Weighted average number of common
shares outstanding 40,000 40,000
Earnings <loss> per common share $ 0.00 $ 0.00
Diluted Earnings <Loss> Per Common Share:
Weighted average number of common
shares outstanding 40,000 40,000
Weighted average of stocks options
outstanding 00 3,067
Weighted average number of common
shares outstanding - diluted 40,000 43,067
Diluted earnings <loss> per common share $ 0.00 $ 0.00
</TABLE>
6. Cash Management
The Company participates in Health-Chem's cash management practice, wherein
all cash requirements are borrowed from Health-Chem and all excess cash is
advanced to Health-Chem. The intercompany balance is expected to be paid out
of future cash flow and is therefore considered to be long-term. Interest is
charged based upon the average outstanding intercompany balance and Health-
Chem's cost of funds. On August 31, 1995, Hercon issued to Health-Chem a
$7,000,000, 9% subordinated promissory note in exchange for the then
outstanding borrowings from Health-Chem. The Company is required to make
semi-annual interest payments each March and September on this note, with the
principal amount of $7,000,000 payable on March 31, 2002. The Company and
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 10
Health-Chem are currently reconsidering the method of allocation in light of
the sale of assets of Health-Chem's Herculite and Hercon Environmental
subsidiaries in August 1999.
7. Expenses Charged by Health-Chem
Pursuant to a Corporate Services Agreement between the Company and Health-
Chem, Health-Chem pays certain expenses on behalf of the Company for which
Health-Chem is reimbursed, including all the costs related to the building in
which the Company operates. The Company is also charged by Health-Chem for
certain administrative services, including executive, legal, accounting, human
resources, public relations, and office rent. Health-Chem charged the Company
$189,000 and $149,000 in the quarters ended March 31, 1999 and 1998,
respectively. Management believes that these expenses, on a stand-alone
basis, would not have been materially different than the amounts charged by
Health-Chem.
8. Redeemable Preferred Stock
The Company is required to make semi-annual preferred dividend payments to
Health-Chem, the holder of the Company's outstanding redeemable preferred
stock, $10.00 par value, in March and September of each year at an annual rate
of $.70 per share on the then-outstanding shares. In August 1998 the Company
declared and paid a dividend of $162,000 in respect of dividends in arrears
that were due on September 30, 1997. The Company has been unable to make the
required dividend payments for 1998 and 1999. Further, the required $1.0
million annual redemptions of outstanding preferred stock have not been made
for 1998 nor 1999. Additional required redemptions are $1 million annually in
2000 through 2004 and $1.5 million in 2005. If the Company is in default on
dividends payable on the preferred stock in an amount equal to two full semi-
annual payments, or if a mandatory redemption payment is not made Health-Chem,
the holder of all the outstanding shares of the preferred stock, is entitled
to elect the smallest number of Directors necessary to constitute a majority
of Transderm's Board of Directors until such time as the default is cured.
Health-Chem has waived this right since, because it controls 90% of the
Company, it already possesses such power.
9. Litigation
In August 1995, Key Pharmaceuticals, Inc., a subsidiary of Schering-Plough
Corporation ("Key"), commenced an action against Hercon in the United States
District Court for the District of Delaware ("Delaware District Court")
alleging that Hercon's submission to the FDA of three Abbreviated New Drug
Applications ("ANDAs") relating to some of Hercon's transdermal nitroglycerin
products, for which the Company 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 denied the material allegations of the
complaint, asserting, among other things, that the Key patent is invalid and
unenforceable and that Hercon had not infringed and did not infringe any claim
of the patent. Hercon 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's claim that Key's patent is invalid and unenforceable.
On December 17, 1997, the Delaware District Court issued an injunction,
enjoining Hercon, 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 rulings in favor of Key. In
January 1999, the CAFC denied Hercon's petition for rehearing of its appeal.
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Page 11
Hercon is currently reviewing its options with respect to the manufacture and
marketing of its improved nitroglycerin patches.
Management's Discussion and Analysis of Financial Condition 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.
The Company 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 has sold 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 9 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,
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.
On April 15, 1999, the Company's parent company, Health-Chem defaulted on its
obligation to repay $8 million in principal as well as the accrued interest of
$.4 million due on it 10.375% convertible subordinated debentures at maturity.
Effective August 1999, besides the operations of the Company, Health-Chem does
not have any other operating activities. Health-Chem and its subsidiaries,
including 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 Health-
Chem's Herculite Products, Inc. and Hercon Environmental Corporation
subsidiaries. Out of such proceeds, Health-Chem made a $1.9 million partial
repayment of its debt obligations in respect of the debentures in September
1999. Health-Chem's ability to repay the balance of the obligations on the
debentures is contingent, among other things, 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 financing from a financial
institution. There can be no assurance that Health-Chem or the Company will
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Page 12
be successful in their efforts toward that end. Under the terms of the
subordinated debentures between Health-Chem 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.
No concessions have been offered by the Trustee that it will continue to
abstain from exercising such rights. In the circumstances, Health-Chem 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 principles, the Company's Statements of Assets and Liabilities as of
December 31, 1998 and March 31, 1999 have 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 realizable
values and liabilities 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 and there are a number of important factors that could cause actual results
to differ from these estimates.
The viability of the Company is dependent upon its ability to generate cash
flow sufficient to sustain operations by increasing sales of existing products
or introducing commercially viable new products based on similar technology,
to more fully utilize its existing manufacturing capacity. Arrangements that
would allow for the production and sale of the improved nitroglycerin patch
are being pursued, but there can be no assurance that such efforts will be
successful. In addition to its transdermal nitroglycerin products, the
Company is also 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 FDA
filings for any additional products will be effected or that FDA approval for
any additional products will obtained.
In the short term, the Company must rely on sales of existing products to
continue operations, which are declining, and borrowings from Health-Chem to
provide funds to continue operating. The sale of the assets of two of Health-
Chem's subsidiaries was recently completed to provide funds to satisfy
pressing financial obligations. At this time, Health-Chem has no external
source of financing for its business, although it is in discussions with
financial institutions regarding a $1.5 million credit facility. There can be
no assurance that Health-Chem will be able to continue to fund the Company's
operations, nor that the Company will be able to secure adequate funding from
other sources.
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.
Results of operations are recorded in the Consolidated Statement of Changes in
Assets and Liabilities and in Note 2 of the Consolidated Financial Statements.
This method of reporting results of operations will continue until the financial
status of the Company improves or the dissolution of the Company occurs.
Net sales of $1.96 million in the first quarter of 1999 were $179,000 below
net sales in the first quarter of 1998. The sales decrease is due primarily to
lower sales volumes of transdermal nitroglycerin patches. Sales of pore
strips, which were nonexistent in the first quarter of 1998, accounted for
$291,000 of the $1.96 million sales in the first quarter of 1999.
Cost of goods sold in the 1999 quarter were $116,000 higher than in the
comparable quarter of 1998, principally due to costs associated with the
addition of production facilities for pore strip products. Overall, gross
profit of $854,000 in 1999 as a percentage of net sales dropped to 43.6% from
53.7% in the first quarter of 1998. Plant operating expenses increased $40,000
in the first quarter of 1999 as compared to the same period in 1998, including
a $36,000 increase in payroll-related expenses associated with the pore strip
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Page 13
products.
Selling, general and administrative expenses decreased $18,000 for the three
months ended March 31, 1999 as compared to the same period in 1998. This
decrease is due primarily to lower payroll-related costs offset by a $40,000
increase in charges from Health-Chem. Pursuant to a Corporate Services
Agreement between the Company and Health-Chem, selling, general and
administrative expenses incurred by Health-Chem which cannot be directly
attributed to a specific subsidiary are allocated to the Company based upon
its net sales as a percentage of Health-Chem's consolidated net sales. The
Company's allocation of Health-Chem's total expenses for the three months
ended March 31, 1999 was higher than the comparable period in 1998, increasing
from 15% in 1998 to 20% in 1999, partially offset by Health-Chem's total
expenses being lower.
Legal expenses decreased $97,000 for the three months ended March 31, 1999 as
compared to the same period in 1998, reflecting the resolution early in 1999
of the Company's appeal of the lower court decision in the Key Litigation.
Research and development expenses of $213,000 were $23,000 higher in the three
months ended March 31, 1999 than in the same period in 1998. The increase was
due primarily to higher outside testing and payroll related expenses. The
Company expects total research and development expenses related to
pharmaceutical products in 1999 to be lower than 1998 levels.
Net interest expense increased $19,000 for the three months ended March 31,
1999 as compared to the same period in 1998 due primarily to increases in
interest rates on outstanding balances on borrowings from Health-Chem.
Preferred dividends of $149,000 on the Company's redeemable preferred stock,
$10.00 par value, were accrued in the first quarter of both 1999 and 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.
Liquidity and Capital Resources
Accounts receivable and inventory for March 31, 1999 as compared to December 31,
1998 decreased $.8 million and $.2 million, respectively, reflecting the lower
level of business. Cash provided by operating activities for the three months
ended March 31, 1999 was $609,000 compared to $169,000 used for operating
activities in the same period of 1998. Cash from operating activities was
primarily generated from the collection of accounts receivable.
The Company has not paid cash dividends on its Common Stock and does not
anticipate doing so in the foreseeable future.
The Company spent $134,000 in the first quarter of 1999 on equipment needed to
produce, assemble and package over-the-counter pharmaceutical and cosmetic
products and the improved nitroglycerin patch. The Company anticipates
further capital expenditures of $100,000 in 1999 for additional equipment
needed to produce these products. Capital expenditures in 1998 and 1999 have
been funded by borrowings from Health-Chem, but there can no assurance that
Health-Chem will be able to fund the additional capital expenditures that are
anticipated in 1999.
The Company has financed its capital requirements primarily from borrowings
from Health-Chem.
Health-Chem was a borrower along with its affiliates, including the Company,
under the terms of a secured financing agreement with IBJ Whitehall Business
Credit Corporation (as successor in interest to IBJ Schroder Business Credit
Corporation) ("IBJ"). Outstanding borrowings under this agreement were paid
off in August, 1999 with the proceeds from the sale of assets of Health-Chem's
Herculite Products, Inc. ("Herculite") and Hercon Environmental Corporation
("Hercon Environmental") subsidiaries. The Company is currently working on a
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Page 14
business solution with regard to the manufacture of its new nitroglycerin
products. The Company is also working 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 condition of the Company and its
ability to continue operations.
The Company is required to make semi-annual interest payments each March and
September on its $7,000,000, 9% Subordinated Promissory Note. The Company
made the required 1998 and 1999 semi-annual interest payments in March and
September. On May 12, 1998, Hercon and Health-Chem entered into an amendment
to the Subordinated Promissory Note, whereby the maturity date of the note and
corresponding $7,000,000 principal payment were extended from March 31, 1999
to March 31, 2002.
The Company is required to make a semi-annual preferred dividend payment to
Health-Chem, the holder of the Company's outstanding redeemable preferred
stock, $10.00 per value, each March and September at the annual rate of $.70
per share on the then-outstanding shares. In August 1998 the Company declared
and paid a dividend of $162,000 in respect of dividends in arrears that were
due on September 30, 1997. The Company has been unable to make the required
dividend payments for 1998 and 1999. Further, the Company was required to
redeem $1.0 million of outstanding preferred stock in each year 1998 and 1999,
but was unable to do so. Additional required redemptions are $1,000,000
annually in 2000 through 2004 and $1,500,000 in 2005. If dividends payable on
the preferred stock are in default in an amount equal to two full semi-annual
payments, or if a mandatory redemption payment is not made, the holder of all
the outstanding shares of the preferred stock, Health-Chem, is entitled to
elect the smallest number of Directors necessary to constitute a majority of
Transderm's Board of Directors until such time as the default is cured.
Health-Chem waived this right since, as a practical matter, it already
possessed such power.
Pursuant to a Corporate Services Agreement between the Company and Health-
Chem, Health-Chem provides or otherwise makes available to the Company certain
general corporate services including, but not limited to, accounting, tax,
corporate communications, legal, data processing, purchasing, human resources,
financial and other administrative staff functions, and arranges for
administration of insurance and employee benefit programs. The Company
reimburses Health-Chem for the actual out-of-pocket cost to Health-Chem, or
for those services not directly attributable to the Company, reimburses them
based upon a method (allocation based upon the Company's net sales as a
percentage of Health-Chem's consolidated net sales) which is considered by the
Company to be reasonable. The amount of such costs billed to the Company by
Health-Chem was $189,000 and $149,000 for the three months ended March 31,
1999 and 1998, respectively. The Agreement expired on December 31, 1998 and
automatically renewed for a one-year term. The Company and Health-Chem are
currently reconsidering the method of allocation in light of the sale of
assets of Health-Chem's Herculite and Hercon Environmental subsidiaries in
August 1999.
Pursuant to a tax sharing agreement between the Company and Health-Chem, the
Company is required to pay Health-Chem as the Company uses its net operating
loss and tax credit carryforwards to offset future taxable income. At March
31, 1999, Health-Chem had been paid in full such amounts.
The semi-annual interest payment on the subordinated promissory note is
$315,000 and the semi-annual dividend on the preferred stock currently
outstanding is $297,500. In addition to the cumulative dividends and
interest payments, the Company is obligated to redeem the preferred stock and
repay the promissory note as described above. Internally generated funds are
not currently sufficient to provide the Company with cash to meet all of these
retirement and redemption obligations and thus the Company will need to either
continue to obtain waivers and amendments of some of these payment obligations
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Page 15
or raise additional capital from third parties. The Company is currently
working on a business solution in regard to the manufacture of its new
nitroglycerin products, along with securing 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 condition of the Company and its
ability to continue operations.
Inflation
Management does not believe that inflation has had a material effect upon its
results of operations, liquidity or capital resources.
Update on the 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,
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 there will be no 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.
<PAGE>
<PAGE> Part II
Item 1
Page 16
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.
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 be signed on its behalf by the
undersigned thereunto duly authorized.
TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY
November 24, 1999 /s/ Robert D. Speiser
By: Robert D. Speiser
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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