UNITED STATES
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 September 26, 1998
Commission file number 1-14019
SCHEIN PHARMACEUTICAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 11-2726505
- ------------------------------------------------ -----------------------------
(State or other jurisdiction of incorporation or (I.R.S. Employer
organization) Identification No.)
100 Campus Drive, Florham Park, NJ 07932
- ------------------------------------------------ -----------------------------
(Address of principal executive offices) (Zip Code)
973-593-5500
----------------------------------------
(Registrant's telephone number)
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 common stock as of
October 30, 1998 was 32,429,888.
<PAGE>
SCHEIN PHARMACEUTICAL, INC.
INDEX
Part I. FINANCIAL INFORMATION PAGE
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of
September 26, 1998 and December 27, 1997 3
Condensed Consolidated Statements of Operations
for the three and nine months ended September 26,
1998 and September 27, 1997 4
Condensed Consolidated Statements of Cash Flows
for the nine months ended September 26, 1998 and
September 27, 1997 5
Notes to Condensed Consolidated Financial
Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
SCHEIN PHARMACEUTICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
September 26, December 27,
1998 1997
------------------- -------------------
Assets (unaudited)
------
<S> <C> <C>
Current assets:
Cash and cash equivalents.................................................. $ 10,512 $ 804
Accounts receivable, less allowance for possible losses of
$2,491 and $2,260....................................................... 79,796 88,781
Inventories................................................................ 115,543 119,142
Income taxes receivable, net............................................... 12,329 --
Other current assets....................................................... 13,125 14,035
------------------ -----------------
Total current assets.................................................. 231,305 222,762
Property, plant and equipment, net.............................................. 111,711 110,432
Product rights, licenses and regulatory approvals, net.......................... 104,284 86,564
Goodwill, net................................................................... 388 98,366
Other assets.................................................................... 16,922 16,002
------------------ -----------------
$ 464,610 $ 534,126
================== ================
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities:
Accounts payable and accrued expenses...................................... $ 100,141 $ 81,478
Income taxes payable....................................................... -- 11,595
Revolving credit and current maturities of long-term debt.................. 106,095 56,440
------------------ -----------------
Total current liabilities............................................. 206,236 149,513
Long-term debt, less current maturities......................................... 134,160 198,705
Other non-current liabilities................................................... 45,077 46,193
Commitments and contingencies
Stockholders' equity:
Common stock, $.01 par value; 100,000 authorized shares; issued and
outstanding 32,430 shares at September 26, 1998
and 28,693 shares at December 27, 1997.................................. 324 287
Additional paid-in capital................................................. 96,662 38,494
Retained earnings (accumulated deficit).................................... (17,432) 99,483
Accumulated other comprehensive income (loss).............................. (417) 1,502
Other -- (51)
------------------ -----------------
Total stockholders' equity............................................ 79,137 139,715
------------------ ----------------
$ 464,610 $ 534,126
================== =================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
SCHEIN PHARMACEUTICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except earnings per share)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------- ------------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
1998 1997 1998 1997
--------------- --------------- --------------- --------------
<S> <C> <C> <C> <C>
Net revenues.................................................. $ 116,922 $107,549 $ 401,574 $ 353,829
Cost of sales................................................. 78,069 75,572 264,683 240,562
--------------- -------------- --------------- --------------
Gross profit......................................... 38,853 31,977 136,891 113,267
Costs and expenses:
Selling, general and administrative.................. 22,575 20,885 66,394 59,956
Research and development............................. 7,571 8,676 21,772 22,854
Amortization of goodwill and other intangibles....... 2,139 2,574 7,287 7,722
Restructuring charge................................. 156,600 -- 156,600 --
--------------- -------------- --------------- --------------
Operating income (loss)....................................... (150,032) (158) (115,162) 22,735
Interest expense, net................................ 4,777 6,722 15,824 20,456
Other income, net.................................... (351) (6,559) (2,493) (6,542)
--------------- -------------- --------------- --------------
Income (loss) before provision for income taxes and
extraordinary item.................................. (154,458) (321) (128,493) 8,821
Provision (benefit) for income taxes.......................... (23,638) 155 (13,238) 5,095
--------------- -------------- --------------- --------------
Income (loss) before extraordinary item....................... (130,820) (476) (115,255) 3,726
Extraordinary item: loss on early extinguishment of
debt, net of income tax.............................. -- -- (1,660) --
--------------- -------------- --------------- --------------
Net income (loss)............................................. $ (130,820) $ (476) $ (116,915) $ 3,726
=============== ============== =============== ==============
Earnings (loss) per share, basic and diluted:
Income (loss) before extraordinary item.............. $ (4.04) $ (0.02) $ (3.72) $ 0.13
Extraordinary item................................... -- -- (0.06) --
--------------- -------------- --------------- --------------
Net income (loss).................................... $ (4.04) $ (0.02) $ (3.78) $ 0.13
=============== ============== =============== ==============
Weighted average common shares and equivalents: 32,401 28,693 30,954 28,755
=============== ============== =============== ==============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
SCHEIN PHARMACEUTICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
------------------------------------------
September 26, September 27,
1998 1997
------------------ -------------------
<S> <C>
Cash flows from operating activities:
Net income (loss)............................................................ $ (116,915) $ 3,726
Adjustments to reconcile net income (loss) to net
cash flows from operating activities:
Depreciation and amortization............................................. 19,105 19,749
Impairment of long lived assets, due to restructuring..................... 102,280 --
Inventory write-off, due to restructuring................................. 30,500 --
Deferred income taxes..................................................... 1,349 (1,237)
Gain on sale of marketable securities..................................... (4,551) (9,883)
Extraordinary item: loss on early extinguishment of debt, non-cash........ 1,160 --
Other..................................................................... 3,743 3,530
Changes in operating assets and liabilities:
Accounts receivable....................................................... 8,754 4,167
Inventories............................................................... (26,901) 7,254
Prepaid expenses and other assets......................................... (415) 278
Income taxes.............................................................. (22,780) (1,410)
Accounts payable, accrued expenses and other liabilities.................. 8,690 897
------------------ -------------------
Net cash provided by operating activities....................................... 4,019 27,071
------------------ -------------------
Cash flows from investing activities:
Capital expenditures.......................................................... (19,612) (8,992)
Product rights and licenses................................................... (15,811) --
International investments..................................................... (6,838) (150)
Proceeds from the sale of marketable securities............................... 6,607 11,575
Other, net.................................................................... (950) (1,188)
------------------- -------------------
Net cash provided by (used in) investing activities............................. (36,604) 1,245
------------------ -------------------
Cash flows from financing activities:
Principal payments on, or repayments of, debt................................. (169,890) (143,067)
Proceeds from issuance of debt................................................ 155,000 113,000
Net proceeds from initial public offering..................................... 52,450 --
Proceeds from stock purchase plan and exercise of stock options............... 4,850 --
Increase in other non-current assets.......................................... (117) --
------------------- -------------------
Net cash provided by (used in) financing activities............................. 42,293 (30,067)
------------------ -------------------
Net increase (decrease) in cash and cash equivalents............................ 9,708 (1,751)
Cash and cash equivalents, beginning of period.................................. 804 2,139
------------------- -------------------
Cash and cash equivalents, end of period........................................ $ 10,512 $ 388
================== ===================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
NOTE 1--SUMMARY OF ACCOUNTING POLICIES
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of only normal recurring accruals and the restructuring charge described in Note
7) considered necessary for a fair presentation have been included. Operating
results and cash flows for the interim periods ended September 26, 1998 are not
necessarily indicative of the results that may be expected for the year ending
December 26, 1998. For further information refer to the consolidated financial
statements and footnotes thereto for the 1997 fiscal year included in the
Company's Registration Statement on Form S-1 dated April 8, 1998.
Basic earnings per share has been computed using the weighted average number of
shares of common stock outstanding. Diluted earnings per share includes the
assumed exercise of stock options using the treasury stock method that could
potentially dilute earnings per share. In the three month and nine month periods
ended September 26, 1998, and in the quarter ended September 27, 1997, there
were no differences between basic and diluted loss per common share because the
assumed exercise of stock options was anti-dilutive.
NOTE 2--INVENTORIES
Inventories are summarized as follows:
<TABLE>
<CAPTION>
September 26, December 27,
1998 1997
------------------ -----------------
(In thousands)
<S> <C> <C>
Finished products............................................. $ $ 45,568
42,299
Work-in-process............................................... 29,562 33,160
Raw materials and supplies.................................... 43,682 40,414
------------------ ------------------
$ 115,543 $ 119,142
================== ==================
</TABLE>
NOTE 3--STRATEGIC ALLIANCES
On March 31, 1998, the Company entered into an agreement with Elan Corporation
plc covering several products in various stages of development in the areas of
oral sustained-release and transdermal products. Under the agreement, the
Company is obligated to pay $14 million in license fees through March 1999, of
which $7 million was paid in the third quarter of 1998, and $7 million was
included in accounts payable and accrued expenses at September 1998.
Additionally, the Company may be obligated to pay approximately $3.5 million in
additional fees as and when certain milestones are achieved. Certain of these
fees may be increased by up to $2 million or decreased by up to $0.5 million
depending on whether certain other milestones are achieved.
6
<PAGE>
SCHEIN PHARMACEUTICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 4-- BORROWINGS
The Company's senior floating rate notes are fully and unconditionally
guaranteed jointly and severally by each of the Company's domestic subsidiaries,
each of which is wholly-owned by the Company. These subsidiaries sell all of
their products to Schein Pharmaceutical, Inc., the parent company. Summarized
financial information for these wholly-owned subsidiary guarantors (using the
push-down method of accounting) is as follows:
<TABLE>
<CAPTION>
September 26, December 27,
1998 1997
------------------ ------------------
(In thousands)
<S> <C> <C>
Current assets:
Inventory.......................................................... $ 68,323 $ 74,924
Intercompany receivables........................................... 85,383 119,191
Other current assets............................................... 16,663 4,197
Property, plant and equipment, net.......................................... 106,668 104,807
Product rights, licenses and regulatory approvals, goodwill,
net and other assets.............................................. 70,822 178,548
Current liabilities......................................................... 163,166 109,800
Deferred income taxes and other liabilities................................. 44,331 44,921
Long-term debt (pushed down)................................................ 125,000 186,000
Nine Months Ended
------------------------------------------
September 26, September 27,
1998 1997
------------------ -------------------
(In thousands)
Net revenues................................................................ $ 339,452 $ 269,764
Gross profit................................................................ 102,121 70,718
Operating income (loss)..................................................... (131,605) 15,845
Net income (loss)........................................................... (123,314) 2,478
</TABLE>
The Company has amended its revolving credit and term loan agreements with its
bank group. This amendment provides for an increase in permissible investments
and certain indebtedness. Additionally, it modified the minimum net worth
requirement and adjusted certain required ratios (as defined therein) including
leverage, fixed charge coverage and interest expense coverage. The amendment
increased the future interest rate spread the Company will pay under the
revolving credit and term loan agreements depending upon the Company's
performance against leverage and interest expense ratios.
7
<PAGE>
NOTE 5--INITIAL PUBLIC OFFERING
On April 9, 1998, the Company consummated an initial public offering of 3.45
million shares of common stock which generated net proceeds of $52.5 million.
The majority of the proceeds of the offering were used to retire $50 million of
the Company's senior floating rate notes. This resulted in an extraordinary
charge of $1.7 million, net of taxes, related to the early extinguishment of
debt in the second quarter of 1998. This extraordinary item is comprised of a
write-off of non-cash deferred financing fees as well as costs associated with
the reacquisition of the notes.
NOTE 6-- COMPREHENSIVE INCOME
Effective in fiscal 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income." The Company's total
comprehensive income (loss) for the periods indicated were as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
----------------------------- -----------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
1998 1997 1998 1997
------------ ------------ ------------- ------------
(In thousands) (In thousands)
<S> <C> <C> <C>
Net income (loss).................................... $ (130,820) $ (476) $ (116,915) $ 3,726
------------- ------------- -------------- -------------
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment......... 534 -- 127 27
Unrealized holding gains arising during 114 4,126 662 7,323
period.................................
Less: reclassification adjustment for gains
included in net income................. (806) (5,880) (2,708) (5,880)
------------- ------------- -------------- -------------
Other comprehensive income (loss).................... (158) (1,754) (1,919) 1,470
------------- ------------- -------------- -------------
Comprehensive income (loss).......................... $ (130,978) $ (2,230) $ (118,834) $ 5,196
============= ============= ============== =============
</TABLE>
Components of accumulated other comprehensive income (loss), included in the
Company's balance sheets, are as follows:
<TABLE>
<CAPTION>
September 26, December 27, 1997
1998
------------------ ------------------
(In thousands)
<S> <C> <C>
Unrealized gains on marketable securities..................... $ 240 $ 2,286
Cumulative foreign currency translation adjustment............ (657) (784)
----------------- ------------------
$ (417) $ 1,502
================= ==================
</TABLE>
8
<PAGE>
SCHEIN PHARMACEUTICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 7-- CONSENT DECREE AND RESTRUCTURING CHARGE
Food and Drug Administration Consent Decree
On September 10, 1998, the United States, on behalf of the Food and Drug
Administration ("FDA"), based on actions it filed in federal court in the
Southern District of New York on September 9 and in the District of Arizona on
September 10, initiated seizures of drugs and drug related products manufactured
by the Company's Steris Laboratories, Inc. ("Steris") subsidiary. The actions
alleged certain instances in which the Steris facility was not operating in
conformity with current Good Manufacturing Practices (known as "cGMP")
regulations. The actions resulted in the seizure of all drugs and drug related
products in the Company's possession manufactured at the Steris facility and
halted the manufacture and distribution of Steris products.
On or about October 16, 1998, Steris and certain of its officers, without
admitting any allegations of the complaints and disclaiming any liability in
connection therewith, entered into a consent decree filed in the District of
Arizona (to which the New York action had been transferred). Under the terms of
the consent decree, Steris is required, among other things, to demonstrate
through independent certification that Steris' processes, programs, and controls
comply with cGMP regulations. The consent decree also provides for independent
certification of Steris' management controls, quality assurance and quality
control programs, and employee cGMP training. It further requires that Steris
develop a timeline and Corrective Action Plan for implementing these actions and
for expert certification with respect to matters covered in previous FDA
inspections of the facility. In addition, Steris will be destroying certain
inventory valued at $30.5 million. Steris posted a bond in the amount of $6
million to secure certain obligations under the consent order.
As a result of the consent decree, Steris has divided its product line into
three categories: products that it will seek to manufacture under expedited
certification procedures under the consent decree, products that it will seek to
manufacture once it satisfies all conditions under the consent decree, and
products it currently has decided not to manufacture. Expedited certification
procedures apply for certain products that are particularly important to the
medical community because they are primarily or exclusively available from the
Company or that are particularly significant to the Company.
The Steris facility accounted for approximately 40% of the Company's net sales
and 50% of gross profits for the first six months of 1998. The Company resumed
shipments of INFeD(R), its branded injectable iron product, from existing
inventory on October 30, 1998. Steris intends to resume production of INFeD(R)
in the coming weeks and other products starting in the first quarter of 1999.
The Steris products the Company has decided not to manufacture in the near term
contributed approximately $65 million in revenue in the 12-month period ended
June 1998.
During the 30 days following the signing of the consent agreement, Steris will
continue and expand the records review and product-testing program it initiated
earlier in 1998, which includes oversight by independent expert consultants.
Based on the findings of this program to date and other commitments under the
consent agreement, Steris has initiated a number of recalls and will institute
other recalls, if warranted.
The consent decree has been filed as an exhibit to the Company's report on Form
8-K, dated October 27, 1998, and the foregoing description of the consent decree
is qualified in its entirety by reference to the full and complete terms of the
consent decree.
9
<PAGE>
Restructuring Charge
As a result of the actions taken by the FDA and the consent agreement reached,
the Company recorded a restructuring charge of $132.4 million, net of tax
benefit, in the third quarter. The detail of this restructuring charge is as
follows (in millions):
<TABLE>
<CAPTION>
<S> <C>
Asset impairments:
Goodwill write-off............................................ $ 95.5
Inventory write-off........................................... 30.5
Fixed asset impairment........................................ 6.8
---------------
132.8
---------------
Restructuring costs:
Regulatory and compliance related costs....................... 10.1
Temporary manufacturing shutdown costs........................ 5.3
Severance and consolidation of distribution operations........ 4.4
Recalls and related expenses.................................. 2.0
Other costs and expenses...................................... 2.0
---------------
23.8
---------------
Total write-offs and charges....................... 156.6
Income tax benefit................................. (24.2)
---------------
$ 132.4
===============
</TABLE>
The long-term asset write-offs were recorded in accordance with Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". As a result of
the FDA consent agreement and the Company's decision not to manufacture certain
Steris products, the Company's approach to manufacturing and marketing products
for the institutional market required reevaluation. As a part of its evaluation,
management reviewed the carrying value of the goodwill associated with Marsam,
which like Steris, manufactures and markets generic injectable prescription
drugs for the institutional market. Based on an analysis of projected discounted
cash flows from operating income, management determined the amount of the
write-off of goodwill.
Regulatory and compliance related costs consist primarily of costs related to
products the Company will no longer manufacture and validation testing of
products in the market. Severance costs relate primarily to the reduction in
work force of approximately 350 employees at the Company's Steris facility. As
of September 26, 1998, $7.3 million has been charged against the restructuring
reserve of $23.8 million established in the third quarter of 1998. The Company
expects to record an additional restructuring charge of approximately $3
million, net of tax benefit, in the fourth quarter.
10
<PAGE>
NOTE 8--LEGAL PROCEEDINGS
In September and October 1998, following the commencement of the seizure action
by the FDA, six substantially similar complaints were filed in federal court in
the District of New Jersey against the Company, its Chairman and Chief Executive
Officer, its Chief Financial Officer and, in certain actions, one or more of the
following: the Company's Senior Vice President of Technical Operations, General
Counsel and three underwriters of the Company's April 9, 1998 initial public
offering (the "Offering"). Plaintiffs purport to sue on behalf of a class of
persons who purchased shares of the Company's common stock pursuant or traceable
to the Offering and allege that defendants violated the Securities Act of 1933
by making misrepresentations and omissions of material facts in connection with
the Offering and in the registration statement and prospectus issued pursuant to
the Offering. Plaintiffs allege, among other things, that defendants failed to
disclose or misrepresented facts concerning the status of the Company's internal
controls and ability to comply with government regulations relating to its
manufacturing activities, including the status of the Company's corrective
actions at the Steris facility. Plaintiffs on behalf of the purported class seek
damages, recission and/or recissionary damages under the provisions of the
Securities Act of 1933. The Company's time to move or answer with respect to the
complaints has in general been extended until after the appointment of lead
plaintiff and lead counsel and the filing by plaintiffs of any amended pleading.
The Company intends to defend itself vigorously against these actions.
As reflected in the Company's Registration Statement dated April 8, 1998, in one
of the Company's patent challenge litigations filed in the U.S. District Court
for the Southern District of New York, the trial judge ruled against the Company
and upheld the validity of the patent at issue. On October 1, 1998, the Court
awarded attorneys fees to the patent holder and its licensee. The Company has
been informed that the fees sought will be approximately $3 million, subject to
final determination by the Court. The Company intends to appeal this decision.
11
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
Certain statements in this Form 10-Q constitute "forward looking statements"
within the meaning of The Private Securities Litigation Reform Act of 1995,
including those concerning management's expectations with respect to future
events or results. Such forward looking statements may be identified by such
forward looking terms as expect, believe, may, anticipate, will or similar terms
or variations thereof. These forward looking statements involve certain
significant risks and uncertainties, and actual results may differ materially
from the forward looking statements. Some important factors which may cause
results to differ include: the difficulty of predicting Food and Drug
Administration ("FDA") approvals, uncertainties associated with implementation
of the terms and conditions of the consent decree affecting the Company's Steris
Laboratories, Inc. ("Steris") facility, the uncertainty of acceptance and demand
for the Company's new products, the impact of competitive products and pricing,
the availability of raw materials, uncertainties associated with litigation
(including without limitation patent challenges) and regulatory matters, and
fluctuations in operating results. Other important factors that may cause actual
results to differ materially from the forward looking statements are discussed
in the "Risk Factors" and "Management's Discussion & Analysis of Financial
Condition and Results of Operations" sections of the Company's prospectus dated
April 8, 1998, which is on file with the Securities and Exchange Commission as
part of the Company's Registration Statement on Form S-1. The Company assumes no
duty to update any such forward looking statements, even if experience or future
changes indicate that any such events or results may not be realized.
Food and Drug Administration Consent Decree
On September 10, 1998, the United States, on behalf of the FDA, based on actions
it filed in federal court in the Southern District of New York on September 9
and in the District of Arizona on September 10, initiated seizures of drugs and
drug related products manufactured by Steris. The actions alleged certain
instances in which the Steris facility was not operating in conformity with
current Good Manufacturing Practices (known as "cGMP") regulations. The actions
resulted in the seizure of all drugs and drug related products in the Company's
possession manufactured at the Steris facility and halted the manufacture and
distribution of Steris products.
On or about October 16, 1998, Steris and certain of its officers, without
admitting any allegations of the complaints and disclaiming any liability in
connection therewith, entered into a consent decree filed in the District of
Arizona (to which the New York action had been transferred). Under the terms of
the consent decree, Steris is required, among other things, to demonstrate
through independent certification that Steris' processes, programs, and controls
comply with cGMP regulations. The consent decree also provides for independent
certification of Steris' management controls, quality assurance and quality
control programs, and employee cGMP training. It further requires that Steris
develop a timeline and Corrective Action Plan for implementing these actions and
for expert certification with respect to matters covered in previous FDA
inspections of the facility. In addition, Steris will be destroying certain
inventory valued at $30.5 million. Steris posted a bond in the amount of $6
million to secure certain obligations under the consent order.
As a result of the consent decree, Steris has divided its product line into
three categories: products that it will seek to manufacture under expedited
certification procedures under the consent decree, products that it will seek to
manufacture once it satisfies all conditions under the consent decree, and
products it currently has decided not to manufacture. Expedited certification
procedures apply for certain products that are particularly important to the
medical community because they are primarily or exclusively available from the
Company or that are particularly significant to the Company.
The Steris facility accounted for approximately 40% of the Company's net sales
and 50% of gross profits for the first six months of 1998. The Company resumed
shipments of INFeD(R), its branded injectable iron product, from existing
12
<PAGE>
inventory on October 30, 1998. Steris intends to resume production of INFeD(R)
in the coming weeks and other products starting in the first quarter of 1999.
The Steris products the Company has decided not to manufacture in the near term
contributed approximately $65 million in revenue in the 12-month period ended
June 1998.
During the 30 days following the signing of the consent agreement, Steris will
continue and expand the records review and product-testing program it initiated
earlier in 1998, which includes oversight by independent expert consultants.
Based on the findings of this program to date and other commitments under the
consent agreement, Steris has initiated a number of recalls and will institute
other recalls, if warranted.
The consent decree has been filed as an exhibit to the Company's report on Form
8-K, dated October 27, 1998, and the foregoing description of the consent decree
is qualified in its entirety by reference to the full and complete terms of the
consent decree.
Restructuring Charge
As a result of the actions taken by the FDA and the consent agreement reached,
the Company recorded a restructuring charge of $132.4 million, net of tax
benefit, in the third quarter. The detail of this restructuring charge is as
follows (in millions):
<TABLE>
<CAPTION>
<S> <C>
Asset impairments:
Goodwill write-off............................................ $ 95.5
Inventory write-off........................................... 30.5
Fixed asset impairment........................................ 6.8
---------------
132.8
---------------
Restructuring costs:
Regulatory and compliance related costs....................... 10.1
Temporary manufacturing shutdown costs........................ 5.3
Severance and consolidation of distribution operations........ 4.4
Recalls and related expenses.................................. 2.0
Other costs and expenses...................................... 2.0
---------------
23.8
---------------
Total write-offs and charges....................... 156.6
Income tax benefit................................. (24.2)
---------------
$ 132.4
===============
</TABLE>
The long-term asset write-offs were recorded in accordance with Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". As a result of
the FDA consent agreement and the Company's decision not to manufacture certain
Steris products, the Company's approach to manufacturing and marketing products
for the institutional market required reevaluation. As a part of the evaluation,
management reviewed the carrying value of the goodwill associated with Marsam,
which like Steris, manufactures and markets generic injectable prescription
drugs for the institutional market. Based on an analysis of projected discounted
cash flows from operating income, management determined the amount of the
write-off of goodwill.
13
<PAGE>
Regulatory and compliance related costs consist primarily of costs related to
products the Company will no longer manufacture and validation testing of
products in the market. Severance costs relate primarily to the reduction in
work force of approximately 350 employees at the Company's Steris facility. As
of September 26, 1998, $7.3 million has been charged against the restructuring
reserve of $23.8 million established in the third quarter of 1998. The Company
expects to record an additional restructuring charge of approximately $3
million, net of tax benefit, in the fourth quarter.
Steris expects to experience incremental operating costs due to ongoing
compliance requirements and quality assurance programs initiated in part as a
result of the FDA action. The Company will seek to mitigate the impact of these
costs through savings achieved by significantly streamlining operations.
Results of Operations
Results for the third quarter and nine months ended 1998 were impacted by the
FDA seizure and related restructuring charge described above.
The following table sets forth comparisons of product revenues and settlement
revenues for each of the periods shown:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------- ------------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
1998 1997 1998 1997
--------------- -------------- -------------- --------------
(In millions) (In millions)
<S> <C> <C> <C> <C>
Product revenues................................ $ 116.9 $ 107.5 $ 371.6 $ 328.8
Patent reviews: settlement revenues............ -- -- 30.0 25.0
--------------- -------------- -------------- --------------
Total net revenues......................... $ 116.9 $ 107.5 $ 401.6 $ 353.8
=============== ============== ============== ==============
</TABLE>
Net revenues for the third quarter of 1998 increased $9.4 million, or 8.7%, from
$107.5 million in 1997 to $116.9 million in 1998. Net revenues for the nine
months ended 1998 increased $47.8 million, or 13.5%, from $353.8 million in 1997
to $401.6 million in 1998.
Product revenues for the third quarter increased $9.4 million and for the nine
month period increased $42.8 million. The increase in product revenues in the
third quarter is attributable to volume increases of $16.7 million partially
offset by price erosion of $7.6 million. In the nine month period volume
increases were $62.4 million and were partially offset by price erosion of $19.8
million. New generic products launched in the past 12 months contributed
revenues of $31.2 million in the third quarter and $76.1 million in the nine
month period. Methylphenidate and ketoprofen ER (both launched in the fourth
quarter of 1997) represent the majority of these new product revenues.
Settlement revenues in 1997 and 1998 reflected in the nine month periods were
funds received from a pharmaceutical company pursuant to an agreement reached
with the company in 1994. Under the agreement the Company received a final
payment of $30 million in the first quarter of 1998, half of which was paid to
the Company's consultant. In addition to the amounts paid to the consultant, the
Company incurs substantial other costs related to its patent review activities
as part of its overall product development activities.
Gross profit for the third quarter increased $6.9 million, or 21.5%, from $32.0
million in 1997 to $38.9 million in 1998. Gross profit for the nine month period
increased $23.6 million, or 20.9%, from $113.3 million in 1997 to $136.9 million
in 1998. The gross margin improved 3.5% from 29.7% in the third quarter 1997 to
33.2% in 1998 and in the nine month period gross margin increased 2.1% from
32.0% in 1997 to 34.1% in 1998. The increase in gross profit was principally the
result of volume increases, improvement in the mix of products sold and an
increase in settlement revenues, partially offset by price erosion.
14
<PAGE>
Selling, general and administrative expenses for the third quarter increased
$1.7 million, or 8.1%, from $20.9 million in 1997 to $22.6 million in 1998.
Selling, general and administrative expenses for the nine month period increased
$6.4 million, or 10.7%, from $60.0 million in 1997 to $66.4 million in 1998. The
increase in selling, general and administrative expenses was primarily due to
higher brand selling and marketing expenses to support pre-launch activities for
Ferrlecit(R) and certain generic marketing programs associated with new product
launches.
Research and development expenses in the third quarter decreased $1.1 million,
or 12.7%, from $8.7 million in 1997 to $7.6 million in 1998. Research and
development expenses in the nine month period of $21.8 million are $1.1 million
lower than last year's $22.9 million. However, it is currently expected that
research and development expenses for the full year may exceed 1997 levels.
Amortization of goodwill and other intangibles was $0.4 million lower than the
comparable periods in 1997.
A restructuring charge totaling $156.6 million ($132.4 million net of tax
benefit) was recorded in the third quarter of 1998. This charge relates to
specific decisions by the Company to reduce its work force, consolidate
distribution operations and includes the non-cash write-off of goodwill,
inventory, and impaired fixed assets, (see Restructuring Charge). Additionally,
in connection with the restructuring, the Company expects to record a charge of
approximately $5.0 million ($3.0 million net of tax benefit) in the fourth
quarter of 1998. The work force reduction in non-manufacturing areas, the
consolidation of distribution operations and the write-off of goodwill is
expected to result in a reduction in operating expenses of approximately $10.0
million per year. However, this is expected to be partially offset by increased
levels of spending in connection with the anticipated launch of Ferrlecit(R) in
1999.
Operating loss for the third quarter increased $149.9 million, from an operating
loss of $0.1 million in 1997 to an operating loss of $150.0 million in 1998.
Operating loss for the nine month period increased $137.9 million from an
operating income of $22.7 million in 1997 to an operating loss of $115.2 million
in 1998. Excluding the impact of the restructuring charge, operating income
increased $6.7 million for the third quarter to $6.6 million and for the nine
months increased $18.7 million to $41.4 million.
Interest expense, net, in the third quarter decreased $1.9 million, or 28.9%,
from $6.7 million in 1997 to $4.8 million in 1998. Interest expense, net, in the
nine month period decreased $4.6 million, or 22.6%, from $20.5 million in 1997
to $15.9 million in 1998. In the second quarter the Company retired $50 million
of senior floating rate notes with proceeds from its April 1998 initial public
offering which resulted in interest expense savings of $1.2 million in the third
quarter. Additional factors contributing to lower interest expense in the third
quarter and nine month period were lower overall debt levels, lower borrowing
rates due to higher cost subordinated debt being exchanged for lower cost senior
floating rate notes in December 1997 and lower interest rate spreads under the
bank agreement.
Other income, net, in the third quarter changed by $6.2 million from an income
of $6.6 million in 1997 to income of $0.4 million in 1998. Other income, net, in
the nine month period was $2.5 million in 1998 and $6.5 million in 1997. The
change in other income, net, in the nine month period is due to lower gains on
the sales of marketable securities in the 1998 period, offset by a gain on the
divestiture of an international joint venture.
An extraordinary item of $1.7 million in the nine month period of 1998 related
to the write-off of deferred financing fees in connection with the retirement of
$50 million of the Company's senior floating rate notes with proceeds the
Company received from its April 1998 initial public offering.
The Company's effective tax rate is impacted by the effect of significant
non-deductible expenses, which are largely comprised of amortization of goodwill
and in 1998 the write-off of the goodwill included in the restructuring charge.
The effective tax rate was a 10% benefit for the nine month period of 1998,
while the effective tax rate was 58% in 1997. The 1997 and 1998 effective tax
rates reflect the amortization of goodwill and in 1998 the $95 million charge
for the goodwill write-off with no corresponding tax benefit. Excluding the
impact of the restructuring charge, the Company's 1998 effective tax rate was
26% for the third quarter and 39% for the nine month period.
15
<PAGE>
Liquidity and Capital Resources
As a result of the actions taken by the FDA and the consent agreement reached,
the Company recorded a restructuring charge of $156.6 million, which is
described above. Of this amount, approximately $132.8 million consisted of
non-cash write-offs. The remaining $23.8 million consisted of charges which have
resulted or will result in cash outlays by the Company. It is expected that the
cash outlays related to the restructuring charge will be disbursed by the end of
1999. The Company expects to realize tax benefits of $24.2 million as a result
of the restructuring charge primarily through the utilization of net operating
loss ("NOL") carrybacks. The benefits of the NOL carrybacks are largely expected
to be collected in 1999. Accordingly, the net cash impact of the charge is not
expected to be significant.
Net cash provided by operating activities was $4.0 million for the nine months
ended September 1998. The net cash provided by operating activities during 1998
was attributable net income as adjusted for the effects of non-cash items of
$36.7 million and changes in assets and liabilities totaling $32.7 million. The
decrease in accounts receivable of $8.7 million was primarily the result of the
absence of revenues from Steris manufactured products subsequent to the FDA
action. Inventories increased from a seasonally low December inventory level by
$26.9 million, as well as increases in work in process, offset by a non-cash
write-off of $30.5 million related to the restructuring. The decrease in income
taxes of $22.8 million reflects the effects of the income tax benefit related to
the restructuring, partially offset by higher accrued expenses of $8.7 million
also related to the restructuring.
Net cash used in investing activities was $36.6 million for the nine months
ended September 1998. The net cash used in investing activities consisted
primarily of capital expenditures of $19.6 million, the acquisition of product
rights and licenses of $15.8 million and international investments of $6.8
million. Product rights and licenses and international investments consisted
principally of $7.0 million paid in connection with a product development and
supply agreement with Elan Corporation plc, $5.0 million under the trademark and
distribution agreement related to Ferrlecit(R), and $10.0 million related to a
strategic alliance agreement with Cheminor Drugs Limited and its subsidiaries
and Dr. Reddy's Laboratories and its subsidiaries. These cash outlays were
partially offset by proceeds from the sale of marketable securities of $6.6
million. The Company expects its 1999 capital expenditures to decline from its
anticipated 1998 level.
Net cash of $42.3 million provided by financing activities for the nine months
ended September 1998 was derived primarily from net proceeds from the Company's
initial public offering of $52.5 million and proceeds from the stock purchase
plan and the exercise of stock options of $4.9 million, offset by net repayments
of debt of $14.9 million. At September 26, 1998, the Company had $10.5 million
of cash, of which $9.1 million was used to make principal payments under its
term loan agreement after the quarter end.
The Company has amended its revolving credit and term loan agreements with its
bank group. This amendment provides for an increase in permissible investments
and certain indebtedness. Additionally, it modified the minimum net worth
requirement and adjusted certain required ratios (as defined therein) including
leverage, fixed charge coverage and interest expense coverage. The amendment
increased the future interest rate spread the Company will pay under the
revolving credit and term loan agreements depending upon the Company's
performance against leverage and interest expense ratios.
16
<PAGE>
The Company believes that cash generated from its operations and the
availability of $22 million under its revolving credit agreement as of September
1998 are sufficient to finance its current level of operations and currently
contemplated capital expenditures through the next 12 months. In the event the
Company makes any significant acquisitions, it may be required to raise
additional funds, through the issuance of additional debt or equity securities.
There can be no assurance that such funds, if required, would be available or,
if available, would be on terms acceptable to the Company.
Year 2000 Compliance
Various organizations are anticipating that they may experience operational
difficulties as a result of automated systems that utilize two digits rather
than four digits to represent the applicable year. The Company's Year 2000
("Y2K") compliance plan includes compliance verification of vendor supplied
software used by the Company, modification and testing of internally supported
applications, and remediation of non-compliant embedded technology utilized in
computer, network, telecommunications, office and manufacturing equipment. The
Company's plan also includes communication with its trading partners (customers
and suppliers) to determine their readiness for Y2K compliance. The Company
currently plans to complete its Y2K compliance for computer transaction-based
applications in late 1998 or early 1999, and for equipment utilizing embedded
technology in 1999. A contingency plan to address Y2K related issues has not as
yet been prepared; however, requisite contingency plans will be developed in
1999 to address reasonably likely worst case scenarios. All costs associated
with Y2K compliance are being expensed as incurred and are not expected to have
a material adverse effect on the Company's business, financial condition and
results of operations. Nevertheless, there is uncertainty concerning the
potential costs and effects associated with Y2K compliance. Thus, if the Company
is unsuccessful in identifying or fixing all Y2K problems in its critical
operations, or if it is affected by the inability of suppliers or major
customers to continue operations due to such a problem, its results of
operations or financial condition could be materially impacted.
17
<PAGE>
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
(a) Securities Litigation
In September and October 1998, following the commencement of the seizure action
by the FDA, six substantially similar complaints were filed in federal court in
the District of New Jersey against the Company, its Chairman and Chief Executive
Officer, its Chief Financial Officer and, in certain actions, one or more of the
following: the Company's Senior Vice President of Technical Operations, General
Counsel and three underwriters of the Company's April 9, 1998 initial public
offering (the "Offering"). Plaintiffs purport to sue on behalf of a class of
persons who purchased shares of the Company's common stock pursuant or traceable
to the Offering and allege that defendants violated the Securities Act of 1933
by making misrepresentations and omissions of material facts in connection with
the Offering and in the registration statement and prospectus issued pursuant to
the Offering. Plaintiffs allege, among other things, that defendants failed to
disclose or misrepresented facts concerning the status of the Company's internal
controls and ability to comply with government regulations relating to its
manufacturing activities, including the status of the Company's corrective
actions at its Steris Laboratories, Inc. facility. Plaintiffs on behalf of the
purported class seek damages, recission and/or recissionary damages under the
provisions of the Securities Act of 1933. The Company's time to move or answer
with respect to the complaints has in general been extended until after the
appointment of lead plaintiff and lead counsel and the filing by plaintiffs of
any amended pleading. The Company intends to defend itself vigorously against
these actions.
(b) Food and Drug Administration Consent Decree
Reference is made to Note 7 of the notes to be condensed consolidated financial
statements of the Company and Management's Discussion and Analysis of Financial
Condition and Results of Operations included in this report on Form 10-Q for a
discussion of the consent decree entered into on or about October 16, 1998 by
and between Steris Laboratories, Inc. and certain of its officers and the United
States Food and Drug Administration. The consent decree has been filed as an
exhibit to the Company's report on Form 8-K, dated October 27, 1998.
(c) Patent Litigation
As reflected in the Company's Registration Statement dated April 8, 1998, in one
of the Company's patent challenge litigations filed in the U.S. District Court
for the Southern District of New York, the trial judge ruled against the Company
and upheld the validity of the patent at issue. On October 1, 1998, the Court
awarded attorneys fees to the patent holder and its licensee. The Company has
been informed that the fees sought will be approximately $3 million, subject to
final determination by the Court. The Company intends to appeal this decision.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 - Financial Data Schedule
(b) Reports on Form 8-K
i) Form 8-K Steris Laboratories, Inc. Seizure Action by the
FDA; Dated September 10, 1998
ii) Form 8-K Work Force Reduction at Steris Laboratories and
Class Action Securities Lawsuits; Dated September
25, 1998
iii) Form 8-K Steris Laboratories Consent Agreement with the
FDA and Approximately $135 Million
One-time After Tax Charge Expected in 1998; Dated
October 27, 1998
18
<PAGE>
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.
Schein Pharmaceutical, Inc.
(Registrant)
By: /s/ Martin Sperber
------------------------------------
Martin Sperber
Chairman of the Board,
Chief Executive Officer and
President
(Principal Executive Officer)
By: /s/ Dariush Ashrafi
-------------------------------------
Dariush Ashrafi
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
Dated: November 10, 1998
19
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000948929
<NAME> $rhnbiw9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-mos
<FISCAL-YEAR-END> DEC-26-1998
<PERIOD-START> DEC-28-1997
<PERIOD-END> SEP-26-1998
<CASH> 10,512
<SECURITIES> 0
<RECEIVABLES> 82,287
<ALLOWANCES> 2,491
<INVENTORY> 115,543
<CURRENT-ASSETS> 231,305
<PP&E> 184,884
<DEPRECIATION> 73,173
<TOTAL-ASSETS> 464,610
<CURRENT-LIABILITIES> 206,236
<BONDS> 134,160
0
0
<COMMON> 324
<OTHER-SE> 78,813
<TOTAL-LIABILITY-AND-EQUITY> 464,610
<SALES> 401,574
<TOTAL-REVENUES> 401,574
<CGS> 264,683
<TOTAL-COSTS> 264,683
<OTHER-EXPENSES> 249,560
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 15,824
<INCOME-PRETAX> (128,493)
<INCOME-TAX> (13,238)
<INCOME-CONTINUING> (115,255)
<DISCONTINUED> 0
<EXTRAORDINARY> (1,660)
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</TABLE>
