<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 September 30, 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
<TABLE>CONSOLIDATED CONDENSED STATEMENTS OF ASSETS AND LIABILITIES Item 1
(LIQUIDATION BASIS) Page 2
(In thousands)
ASSETS (Note 1)
September 30, December 31,
1999 1998
(Unaudited)
<S> <C> <C>
Cash $ 62 $ 9
Accounts receivable 177 1,675
Inventories (Note 3) 485 756
Property, plant and equipment 4,568 4,568
Other assets 4 4
TOTAL ASSETS $ 5,296 $ 7,012
LIABILITIES AND CAPITAL DEFICIENCY
Collateralized obligations
Capitalized lease obligation $ 86 $ 21
Uncollateralized obligations
Payroll and related costs payable 43 42
Accounts payable 104 1,056
Accrued expenses and other liabilities 225 316
372 1,414
Other obligations
Amount due to Health-Chem Corporation
Subordinated promissory note 7,000 7,000
Note payable 3,899 3,435
Redeemable preferred stock 8,500 8,500
Preferred dividends payable 1,325 879
20,724 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 <15,926> <14,277>
Total Capital Deficiency <15,886> <14,237>
TOTAL LIABILITIES AND CAPITAL DEFICIENCY $ 5,296 $ 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 <446>
Net increase in assets and liabilities <1,203>
Capital deficiency at September 30, 1999 <15,886>
</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 Nine Months
Ended September 30, 1998
<S> <C> <C>
REVENUE:
Net sales $ 4,879
Cost of goods sold 2,986
Gross profit 1,893
OPERATING EXPENSES:
Selling, general and administrative expense 1,006
Legal expense 262
Research and development expense 598
Net interest expense 610
Total operating expenses 2,476
LOSS FROM OPERATIONS/BEFORE OTHER INCOME <583>
Other income - net 188
LOSS FROM OPERATIONS BEFORE TAXES: <395>
Income tax <benefit> provision (Note 3) 25
NET LOSS <370>
PREFERRED DIVIDENDS 446
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS $ <816>
Earnings per Common Share (basic & diluted)
(Note 5):
NET LOSS PER COMMON SHARE $ <0.02>
Average number of common shares outstanding
(basic and diluted) (Note 5) 40,000
</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 4
(Unaudited)
For the Three Months
<S> Ended September 30, 1998
REVENUE: <C> <C>
Net sales $ 1,430
Cost of goods sold 1,305
Gross profit 125
OPERATING EXPENSES:
Selling, general and administrative expense 270
Legal expense 42
Research and development expense 226
Net interest expense 213
Total operating expenses 751
LOSS FROM OPERATIONS/BEFORE OTHER INCOME <626>
Other income - net 94
LOSS FROM OPERATIONS BEFORE TAXES <532>
Income tax provision (Note 3) 0
NET LOSS <532>
PREFERRED DIVIDENDS 148
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS $ <680>
Earnings per Common Share (basic & diluted)
(Note 5):
NET LOSS PER COMMON SHARE $ <0.02>
Average number of common shares outstanding
(basic and diluted) (Note 5) 40,000
</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 5
(Unaudited)
For the Nine Months
Ended September 30, 1999
<S> <C> <C>
Cash was Provided by <Used for>:
Operating Activities:
Continuing operations:
Cash received from customers $ 5,109
Cash paid to suppliers and employees <4,770>
Interest paid - bank <673>
Cash provided by operating activities <334>
Financing activities:
Repayment of borrowings from
Health-Chem Corporation - net 464
Payment of capital lease <77>
Net cash used in financing activities 387
Net increase in cash 53
Cash at beginning of period 9
Cash at end of period $ 62
</TABLE>
[FN]
See Notes to Consolidated Financial Statements.
<PAGE>
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
CONSOLIDATED STATEMENT OF CASH FLOW Item 1
(In thousands) Page 6
(Unaudited)
For the Nine Months
<TABLE> Ended September 30, 1998
<S> <C> <C>
Cash was Provided by <Used for>:
Operating Activities:
Net loss $ <370>
Adjustments to reconcile net income <loss> to
net cash used for operations:
Depreciation and amortization 437
Loss on disposal of property, plant and equipment 0
Changes in:
Accounts receivable <328>
Inventories <202>
Other current assets <3>
Other non-current assets 1
Accounts payable 145
Accrued expenses and other current liabilities <112>
Net cash used for operating activities <432>
Investing Activities:
Additions to property, plant and equipment <453>
Disposal of property, plant and equipment 0
Net cash used for investing activities <453>
Financing Activities:
Borrowings from affiliates, net 1,054
Other long-term debt payments <9>
Preferred dividends paid <162>
Net cash provided by financing activities 883
Net Decrease in Cash <2>
Cash at beginning of period 18
Cash at end of period $ 16
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest $ 767
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 7
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 September 30, 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 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.
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
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.
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
<TABLE> NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 8
The Company has a new competitive design for its transdermal nitroglycerin
patch that was approved by the FDA in 1998, but it 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 Statement of Assets and Liabilities as of September 30, 1999
and the Consolidated Statements of Operations and of Cash Flow for the interim
periods ended September 30, 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
September 30, 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 September 30, 1999 and 1998 are not necessarily
indicative of the operating results for the full years.
2. Changes in Assets and Liabilities (in thousands):
The following represent changes in assets and liabilities (liquidation basis)
for activity through June 30, 1999. Management has estimated June 30, 2000 as
the date of dissolution unless the current status of the Company's financial
condition improves.
<S> <C> <C>
Net sales $ 3,611
Cost of goods sold 2,433
Gross profit 1,178
</TABLE>
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
<TABLE> NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 9
<S> <C> <C>
Expenses
Selling, general and administrative 982
Legal 96
Research and development 630
Net interest 673
2,381
Net decrease $ <1,203>
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.
For the Nine Months
Ended September 30,
<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>
A reconciliation of the provision for taxes on income to the tax computed at
the federal statutory rate follows:
For the Nine Months
Ended September 30,
1999 1998
<S> <C> <C>
Tax provision <benefit>
at statutory rate $ <530> $ <134>
Increase <decrease> resulting from:
State and local taxes, net of federal
tax benefit 0 <47>
Provision of valuation
allowance 530 <156>
Tax benefit $ 0 $ <25>
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.
September 30, 1999 December 31, 1998
<S> <C> <C>
Raw materials $ 303 $ 484
Finished goods and work in process 182 272
Total inventories $ 485 $ 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 11.45 million shares of common stock were
outstanding at September 30, 1999 and 1998. No options were included in the
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
<TABLE> NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 10
computation of diluted earnings per common share because losses from
operations were reported for all periods presented.
The dilutive effect of such options on the earnings per common share
computations for the periods ended September 30, 1999 and 1998 is presented
below (in thousands, except per share amounts):
For the Nine Months For the Three Months
Ended September 30, Ended September 30,
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Net Income <Loss>
Applicable to Common
Stockholders:
Net income <loss> $ 0 $ 370 $ 0 $ <532>
Preferred stock
dividends 0 446 0 148
Income <loss>
applicable to common
stockholders $ 0 $ <816> $ 0 $ <680>
Basic Earnings <Loss>
Per Common Share:
Weighted average number
of common shares
outstanding 40,000 40,000 40,000 40,000
Earnings <loss>
per common share $ 0.00 $ <0.02> 0.00 $ <0.02>
Diluted Earnings <Loss>
Per Common Share:
Weighted average
number of common
shares outstanding 40,000 40,000 40,000 40,000
Weighted average of
stocks options
outstanding 0 0 0 0
Weighted average
number of common
shares outstanding
- diluted 40,000 40,000 40,000 40,000
Diluted earnings <loss>
per common share $ 0.00 $ <0.02> 0.00 $ <0.02>
</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
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
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 1
(Unaudited) Page 11
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
$379,000 and $101,000 in the quarters ended September 30, 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.
Hercon is currently reviewing its options with respect to the manufacture and
marketing of its improved nitroglycerin patches.
Part I
Item 2
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
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Page 12
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
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 September 30, 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.
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Page 13
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 a
financial institution regarding a $1.5 million mortgage on its building.
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 $3.6 million for the nine months ended September 30, 1999 were
$1,268,000 lower than net sales in the same period in 1998, due primarily to
lower domestic sales volumes of transdermal nitroglycerin patches. During the
second quarter of 1998, the Company commenced production of over-the-counter
pharmaceutical and cosmetic products, with initial shipments occurring in
July. Lower demand for the Company's principal product was also responsible
for the $798,000 decrease in net sales for the third quarter of 1999 compared
to the same period of 1998.
Gross profit for the nine months ended September 30, 1999 was $715,000 lower
than gross profit in the same period in 1998. Gross profit as a percentage of
new sales declined to 32.6% for 1999 from 38.8% for 1998. In addition to the
decline in net sales for the nine months ended September 30, 1999, increased
overhead costs were incurred due to lower inventory levels. Payroll-related
expenses decreased $28,000 as compared to the same period in 1998.
For the quarter ended September 30, 1999, gross profit decreased $26,000
compared to the same period in 1998. Lower net sales were due primarily to
reduced demand for the Company's nitroglycerin patches.
Selling, general and administrative expenses, excluding legal expenses,
increased $270,000 for the third quarter of 1999 and $317,000 for the nine
months ended September 30, 1999 as compared to the same periods in 1998. The
1999 increase has been adjusted for depreciation of approximately $353,000
which will not be recorded in 1999 only according to the liquidation basis
presentation. This increase is due primarily to higher cost charges from
Health-Chem under the Corporate Services Agreement discussed in Note 7 to the
Consolidated Financial statement, partially offset by lower payroll-related
costs. Health-Chem charges are allocated based upon net sales percentages.
Charges from Health-Chem were $379,000 in the third quarter and $855,000 for
the nine months ended September 30, 1999 compared to $101,000 and $429,000 in
the corresponding periods of 1998. The higher charges from Health-Chem are
the result of a higher percentage of Health-Chem's consolidated net sales. The
decrease in payroll-related expenses at the Company reflects, the
organizational restructuring begun in 1997.
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Page 14
Legal expense for the nine months and quarter ended September 30, 1999
declined $166,000 and $36,000, respectively, as compared to the same periods
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 for the nine months and quarter ended
September 30, 1999 increased $32,000 and decreased $20,000, respectively, as
compared to the same periods in 1998. Higher research and development
expenses for the nine months ended September 30, 1999 resulted from reducing
1998 expenses with clinical testing and material vendor credits that did not
occur in 1999. Lower research and development expenditures during the quarter
reflect decreased activity relating to clinical testing and clinical material.
The Company expects total research and development expenses related to
pharmaceutical products in 1999 to be lower than 1998 levels.
Net interest expense increased $63,000 for the nine months ended September 30,
1999 and $12,000 in the September quarter compared to the same periods in
1998, due primarily to higher average outstanding balances on borrowings from
Health-Chem.
The $188,000 of other income for the nine months and quarter ended September
30, 1998 resulted from development work performed for a third party. In the
third quarter of 1999 no third party development work was done, however, a
sale of a die cutter machine resulted in a $14,000 loss.
Preferred dividends of $446,000 and $149,000 for the nine months and quarters
ended September 30, 1999 and 1998, respectively, reflect accrued dividends
accumulated on the Company's Redeemable Preferred Stock, $10.00 par value.
Semi-annual dividend payments are required to be made at the annual rate of
$.70 per outstanding share. Such payments were not made because of the lack
of legally available funds.
The results of operations for the periods ended September 30, 1999 and 1998
are not necessarily indicative of the operating results for the full years.
Liquidity and Capital Resources
Accounts receivable and inventory for September 30, 1999 as compared to December
30, 1999 decreased $1.4 million and $.3 million, respectively, reflecting the
lower level of business. Cash used for operating activities for in the nine
month period ended September 30, 1999 was $334,000 compared to $432,000 used for
operating activities in the same period of 1998. Cash of $1.5 million was
provided by the collection of accounts receivable and cash of $271,000 was
provided by the reduction of inventories. This was offset by the loss from
operations of $1.2 million (see Note 2 of the Consolidated Financial Statements)
and the payment of accounts payable of $952,000.
The Company has not paid cash dividends on its Common Stock and does not
anticipate doing so in the foreseeable future.
The Company spent $170,000 in the first three quarters 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 $65,000 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 its 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
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
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Page 15
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 semi-annual preferred dividend payments out of
funds legally available therefor each March and September at the annual rate
of $.70 per share on the then-outstanding shares of its redeemable preferred
stock, $10.00 par value. As of June 30, 1998, $162,000 was available for the
payment of preferred dividends. 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. Legally available funds were not available to make the
1998 and 1999 preferred dividend payments, nor were they available to make the
required $1,000,000 redemption payments in March 1998 and 1999. Additional
required redemption payments are $1,000,000 annually in 1999 through 2004 and
$1,500,000 in 2005. Legally available funds were also not available to make
either the preferred dividend payment or the required redemption payment in
March 1999. The terms of the preferred stock provide that if either dividends
payable on the preferred stock shall be in default in an amount equal to two
full semi-annual dividend payments or a mandatory redemption payment is not
made, the holder of all of the outstanding shares of the preferred stock shall
be entitled to elect the smallest number of Directors necessary to constitute
a majority of the Company'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 provided by Health-Chem's corporate staff,
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 $379,000 and
$101,000 for the three months ended September 30, 1999 and 1998, respectively.
The agreement expired on December 31, 1998 and automatically renewed for a
one-year term. The agreement will continue to automatically renew for
successive one-year terms unless notice of non-renewal is given by either
party. 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
September 30, 1999, Health-Chem was paid in full for 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
or raise additional capital from third parties. The Company is currently
working on a business solution in regard to the manufacture of its new
<PAGE> TRANSDERM LABORATORIES CORPORATION AND SUBSIDIARY Part I
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Item 2
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Page 16
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 adverse
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 September 30, 1999.
<PAGE>
<PAGE>
Part II
Item 2
Page 17
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None.
(b) During the quarter ended September 30, 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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