<PAGE>
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 June 24, 2000
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
July 31, 2000 was 34,939,002.
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SCHEIN PHARMACEUTICAL, INC.
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
Part I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of June 24, 2000 and
December 25, 1999 3
Condensed Consolidated Statements of Operations for the three and
six months ended June 24, 2000 and June 26, 1999 4
Condensed Consolidated Statements of Cash Flows for the six months
ended June 24, 2000 and June 26, 1999 5
Consolidated Statements of Comprehensive Income for the three and
six months ended June 24, 2000 and June 26, 1999 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk 18
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 21
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SCHEIN PHARMACEUTICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE)
<TABLE>
<CAPTION>
JUNE 24, DECEMBER 25,
2000 1999
--------- ---------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................... $ 6,463 $ 3,821
Accounts receivable ..................................... 74,493 61,828
Inventories ............................................. 103,516 128,726
Deferred income taxes ................................... 15,513 9,253
Other current assets .................................... 11,345 20,567
--------- ---------
Total current assets ............................... 211,330 224,195
Property, plant and equipment, net ........................... 99,131 100,730
Product rights, licenses and regulatory approvals, net ....... 49,219 51,557
Other assets ................................................. 26,355 27,019
--------- ---------
$ 386,035 $ 403,501
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses ................... $ 80,053 $ 104,872
Income taxes payable .................................... 6,216 7,511
Revolving credit and current maturities of long-term debt 242,566 128,631
--------- ---------
Total current liabilities .......................... 328,835 241,014
Long-term debt, less current maturities ...................... - 92,738
Deferred income taxes ........................................ 5,385 6,780
Other non-current liabilities ................................ 4,840 5,851
Commitments and contingencies
Stockholders' equity:
Common stock, $.01 par value; 100,000 authorized shares;
Issued and outstanding 33,350 and 32,943 shares ...... 334 329
Additional paid-in capital .............................. 106,818 101,357
Accumulated deficit ..................................... (66,466) (52,931)
Accumulated other comprehensive income .................. 8,523 10,597
Subscription receivable ................................. (2,234) (2,234)
--------- ---------
Total stockholders' equity ......................... 46,975 57,118
--------- ---------
$ 386,035 $ 403,501
========= =========
</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 SIX MONTHS ENDED
----------------------------- -----------------------------
JUNE 24, JUNE 26, JUNE 24, JUNE 26,
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenues .................................... $ 105,177 $ 135,404 $ 193,075 $ 241,267
Cost of sales ................................... 83,920 82,295 152,702 151,875
--------- --------- --------- ---------
Gross profit ........................... 21,257 53,109 40,373 89,392
Costs and expenses:
Selling, general and administrative .... 16,888 23,254 33,724 44,159
Research and development ............... 7,370 6,039 15,436 11,207
Amortization of intangibles and goodwill 329 1,604 663 3,195
Restructuring charge ................... - 9,500 - 9,500
Severance charge ....................... - - 3,500 -
--------- --------- --------- ---------
Operating income (loss) ......................... (3,330) 12,712 (12,950) 21,331
Interest expense, net ........................... 5,632 4,822 10,170 9,474
Other expenses (income), net .................... (1,273) 344 (561) 665
--------- --------- --------- ---------
Income (loss) before provision for income taxes . (7,689) 7,546 (22,559) 11,192
Provision (benefit) for income taxes ............ (3,076) 2,719 (9,024) 4,141
--------- --------- --------- ---------
Net income (loss) ............................... $ (4,613) $ 4,827 $ (13,535) $ 7,051
========= ========= ========= =========
Basic and diluted earnings (loss) per share ..... $ (0.14) $ 0.15 $ (0.41) $ 0.22
========= ========= ========= =========
Weighted average common shares and equivalents .. 33,079 32,654 33,028 32,624
========= ========= ========= =========
</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>
SIX MONTHS ENDED
-----------------------------------
JUNE 24, JUNE 26,
2000 1999
--------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)............................................................ $ (13,535) $ 7,051
Adjustments to reconcile net income (loss) to net
cash flows from operating activities:
Depreciation and amortization............................................. 8,645 11,393
Deferred income tax benefit............................................... (6,260) (1,195)
Gain on sale of marketable securities..................................... (1,374) (356)
Other..................................................................... 1,397 1,821
Changes in assets and liabilities:
Accounts receivable....................................................... (12,224) 5,336
Inventories............................................................... 25,210 (11,427)
Other current assets...................................................... 9,222 16,108
Accounts payable, income taxes payable, accrued expenses
and other liabilities................................................... (27,125) 3,830
--------------- ---------------
Net cash provided by (used in) operating activities............................. (16,044) 32,561
--------------- ---------------
Cash flows from investing activities:
Capital expenditures.......................................................... (5,620) (3,405)
Product rights and licenses................................................... - (17,000)
International investments..................................................... - (2,456)
Proceeds from the sale of marketable securities............................... 2,590 986
Other, net.................................................................... (3,085) -
--------------- ---------------
Net cash used in investing activities........................................... (6,115) (21,875)
--------------- ---------------
Cash flows from financing activities:
Principal payments on, or repayments of, debt................................. (43,049) (92,441)
Proceeds from issuance of debt................................................ 64,246 81,479
Proceeds from exercise of stock options....................................... 4,490 11
Proceeds from employee stock purchase plan.................................... 769 899
Increase in other non-current assets.......................................... (1,655) -
--------------- ---------------
Net cash provided by (used in) financing activities............................. 24,801 (10,052)
--------------- ---------------
Net increase in cash and cash equivalents....................................... 2,642 634
Cash and cash equivalents, beginning of period.................................. 3,821 377
--------------- ---------------
Cash and cash equivalents, end of period........................................ $ 6,463 $ 1,011
=============== ===============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
SCHEIN PHARMACEUTICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------- -----------------------
JUNE 24, JUNE 26, JUNE 24, JUNE 26,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income (loss) ............................... $ (4,613) $ 4,827 $(13,535) $ 7,051
-------- -------- -------- --------
Other comprehensive income, net of tax:
Foreign currency translation adjustment .... 18 (232) 16 49
Unrealized holding gains (losses) arising
during period ................... 2,305 128 (1,266) 4,717
Less: reclassification adjustment for gains
included in net income (loss) ... (824) - (824) (212)
-------- -------- -------- --------
Other comprehensive income (loss) ............... 1,499 (104) (2,074) 4,554
-------- -------- -------- --------
Comprehensive income (loss) ..................... $ (3,114) $ 4,723 $(15,609) $ 11,605
======== ======== ======== ========
</TABLE>
Components of accumulated other comprehensive income (loss), included in the
Company's balance sheets, are as follows:
<TABLE>
<CAPTION>
JUNE 24, DECEMBER 25,
2000 1999
------------------ -----------------
<S> <C> <C>
Unrealized gains on marketable securities.............................. $ 9,137 $ 11,227
Cumulative foreign currency translation adjustment..................... (614) (630)
------------------ ------------------
$ 8,523 $ 10,597
================== ==================
</TABLE>
6
<PAGE>
SCHEIN PHARMACEUTICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 -- GENERAL, BASIS OF PRESENTATION AND MERGER
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. These financial statements do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. The accompanying December 25, 1999 condensed consolidated
balance sheet was derived from the audited consolidated balance sheet, which is
included in the Company's 1999 Annual Report on Form 10-K. In the opinion of
management, all adjustments (consisting of only normal recurring accruals and
the effects of the 1999 restructuring charge and the 2000 severance charge)
considered necessary for a fair presentation have been included. Operating
results and cash flows for the interim periods ended June 24, 2000 are not
necessarily indicative of the results that may be expected for the fiscal year
ending December 30, 2000. The interim financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's 1999 Annual Report on Form 10-K.
On May 25, 2000, Watson Pharmaceuticals, Inc. (Watson) and Schein
Pharmaceutical, Inc. (Schein) announced that the companies had entered into a
definitive merger agreement under which Watson would acquire all of the
outstanding stock of Schein through a two-step transaction comprised of a cash
tender offer followed by a taxable stock merger. Pursuant to the merger
agreement, WS Acquisition Corp., a wholly owned subsidiary of Watson, conducted
a tender offer to purchase all of the outstanding shares of Schein common stock
for $19.50 per share in cash. On July 3, 2000, the tender offer expired and
thereafter WS Acquisition Corp. purchased 26,068,469 shares of common stock of
Schein, constituting 77.8% of the then outstanding shares of Schein common
stock. Schein is now in the process of seeking stockholder approval of the
merger contemplated by the merger agreement and has set August 28, 2000 as the
date for a special meeting of stockholders to consider and vote upon a proposal
to approve and adopt the merger agreement. Upon completion of the merger, under
the terms and subject to the conditions set forth in the merger agreement, WS
Acquisition Corp. will be merged into Schein, the separate corporate existence
of WS Acquisition Corp. will cease and Schein will continue as the surviving
corporation and wholly owned subsidiary of Watson. WS Acquisition Corp. will
vote its shares of Schein common stock for approval and adoption of the merger
agreement.
NOTE 2 -- INVENTORIES
Inventories are summarized as follows:
<TABLE>
<CAPTION>
JUNE 24, DECEMBER 25,
2000 1999
------------------ ------------------
(In thousands)
<S> <C> <C>
Finished products............................................. $ 36,134 $ 46,421
Work-in-process............................................... 25,157 31,544
Raw materials and supplies.................................... 42,225 50,761
------------------ ------------------
$ 103,516 $128,726
================== ==================
</TABLE>
7
<PAGE>
NOTE 3 -- BORROWINGS
REVOLVING CREDIT AND LOAN AGREEMENT
In February and March 2000, the Company and the lenders agreed to various
amendments to the revolving credit and loan agreement which modified certain
financial covenants, including leverage, interest expense coverage, fixed charge
and working capital ratios through the end of 2000 and increased the interest
rate on the outstanding loans and fees payable as described below. Under the
amended agreement the applicable interest rate was LIBOR + 3.5% through April
30, 2000 and LIBOR + 4.0% from May 1, 2000 through August 31, 2000. A fee based
on the Company's outstanding borrowings under the term loan and the revolving
credit commitment of 0.25% is payable quarterly and a fee of 0.5% of the
Company's outstanding borrowings under the term loan and revolving credit
commitment was paid on May 1, 2000.
Under the terms of the merger agreement Watson entered into agreements with
Schein, Schein's current lenders and others, to make funds available or provide
such credit support or other financial accommodation, as necessary to provide
Schein with immediate borrowing availability in the amount of $40 million. On
June 2, 2000, Watson entered into certain agreements, including a guarantee,
with certain of Schein's existing lenders. In connection therewith, $40 million
was made available to Schein on terms and conditions substantially similar to
the terms and conditions of Schein's existing bank facility. On July 6, 2000,
the revolving credit and term loan agreement and the interim financing were paid
in full with financing provided by Watson under an intercompany note which is
payable on demand and due no later than December 31, 2001. Accordingly, the
revolving credit and term loan and interim financing has been classified as a
current liability on the Company's balance sheet.
SENIOR FLOATING RATE NOTES
The Company's senior floating rate notes (the 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 pushdown method of accounting) is as follows:
<TABLE>
<CAPTION>
JUNE 24, DECEMBER 25,
2000 1999
------------------ ------------------
(In thousands)
<S> <C> <C>
Current assets:
Inventories........................................................ $74,693 $82,306
Intercompany receivables........................................... 45,255 44,022
Other current assets............................................... 11,297 6,866
Property, plant and equipment, net.......................................... 94,481 96,851
Product rights, licenses and regulatory approvals
and other assets.................................................. 18,065 20,325
Current liabilities......................................................... 277,217 179,477
Deferred income taxes and other liabilities................................. 4,216 6,420
Long-term debt (pushed down)................................................ - 92,738
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-----------------------------------------
JUNE 24, JUNE 26,
2000 1999
------------------ -------------------
(In thousands)
<S> <C> <C>
Net revenues................................................................ $ 117,294 $190,173
Gross profit................................................................ 17,645 60,625
Operating income (loss)..................................................... (5,507) 15,066
Net income (loss)........................................................... (9,377) 3,966
</TABLE>
Under the terms of the Company's Notes agreement, the Company has notified the
holders of the above mentioned Notes that there has been a change in control of
Schein and the holders of the Notes have the option to require the Company to
purchase the Notes at 101% of the aggregate principal amount plus accrued and
unpaid interest by August 25, 2000 and the Company has elected to redeem all of
the remaining issued and outstanding securities on August 28, 2000. In
accordance with the terms of the agreement, the redemption price will be
100.75% of the aggregate principal amount, plus accrued and unpaid interest.
Accordingly, the Notes have been classified as a current liability on the
Company's balance sheet.
NOTE 4 -- CONSENT AGREEMENT AND RESTRUCTURING CHARGES
MARSAM FACILITY
On July 29, 1999, the FDA concluded an inspection of the Company's Marsam
sterile manufacturing facility, located in Cherry Hill, NJ. At the close of the
inspection, Marsam received a Form 483 detailing the FDA's inspectional
observations and noting a number of significant deficiencies in current good
manufacturing practices. During the inspection, Marsam initiated actions to
address a number of the FDA's inspectional observations by voluntarily recalling
all Marsam products within expiry and suspending manufacturing and testing
activities. In September 1999 Marsam submitted its response to the FDA's
inspectional observations, together with its proposed corrective action plan
(Marsam Corrective Action Plan). A corrective action plan is a systematic
approach to assure that processes, quality assurance and quality control
programs, validation programs, employee training, and management controls comply
with cGMP regulations. The Marsam Corrective Action Plan contemplates resumption
of manufacturing on a product-by-product basis. On March 3, 2000 Marsam received
a Warning Letter from the FDA relating to the observations made during the
inspection. This FDA Warning Letter also acknowledged the commitments the
Company made under the Marsam Corrective Action Plan. The Company has confirmed
with the FDA in meetings with FDA representatives its approach to addressing
current cGMP deficiencies at Marsam on a voluntary basis. The Company does not
expect Marsam will be subject to further regulatory enforcement action related
to the 1999 inspection. Marsam is currently ineligible to receive new product
approvals, and the Company cannot predict when Marsam will resume manufacturing
specific products.
Following its suspension of operations at the Marsam facility, the Company
re-evaluated its sterile business and its assessment of the time and costs
required to reintroduce products. As a result, the Company modified its overall
business plans to more aggressively reduce operating costs. These measures
included, among other things, a reduction in the Company's workforce, and
dividing Marsam's product line into products it will seek to manufacture upon
completion of the Marsam Corrective Action Plan, and those products it has
decided not to manufacture. Marsam contributed approximately seven percent of
the Company's revenues and a smaller percentage of the Company's gross profits
over the four quarters preceding the suspension of shipment of its products.
9
<PAGE>
The Company intends to reactivate its penicillin operations as part of the first
phase of a plan to bring its Marsam facility back to operation. Pending
resumption of manufacturing at Marsam, the Company reintroduced penicillin G
potassium during the second quarter of 2000 supplied by a third party.
As a result of the actions discussed above, in the year ended December 25, 1999,
the Company recorded a restructuring charge of approximately $87.0 million, or
$52.2 million net of tax benefit. Costs of restructuring consisted largely of
costs incurred at the Marsam facility and related to the impairment of
intangible assets, product recalls, inventory write-offs and severance.
Recall costs and inventory write-offs were those costs that the Company
incurred related to the Marsam Corrective Action Plan.
STERIS FACILITY
On September 10, 1998, the U.S., on behalf of the FDA, based on actions it filed
in federal court in the Southern District of New York on September 9, 1998 and
the District of Arizona on September 10, 1998, initiated seizures of drugs and
drug related products manufactured by the Company's Steris facility. The actions
alleged certain instances in which the Steris facility, located in Phoenix,
Arizona, was not operating in conformity with 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 manufactured products.
On 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 agreement with the FDA (the Consent
Agreement). Under the terms of the Consent Agreement, Steris is required, among
other things, to demonstrate through independent certification that Steris'
processes, quality assurance and quality control programs, and management
controls comply with cGMP regulations. The Consent Agreement 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. Steris has submitted to the FDA the corrective
action plan provided for under the Consent Agreement (Steris Corrective Action
Plan) and is implementing the Steris Corrective Action Plan.
As a result of the Consent Agreement, Steris has divided its product line into
three categories: products that it will seek to manufacture under expedited
certification procedures under the Consent Agreement, products that it will seek
to manufacture once it satisfies all conditions under the Consent Agreement and
products it has decided not to manufacture in the near term. 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.
In October 1998, the Company resumed commercial distribution of INFeD(R), its
branded injectable iron product, from existing inventory. In the second
quarter of 1999 the Company began distribution of newly manufactured lots of
INFeD under the Consent Agreement and in the fourth quarter of 1999, the
Company resumed the manufacture of one other product deemed medically
necessary under the expedited certification procedures in the Consent
Agreement. On February 11, 2000, the FDA concluded an inspection at Steris.
The Company believes that the results of that inspection confirm that the
Company is complying with the requirements of the Steris Corrective Action
Plan. In March 2000, the Company resumed the manufacture and commercial
distribution of vecuronium bromide under the expedited certification
procedures provided in the Consent Agreement. Newly manufactured products
must undergo certification by independent experts and review by the FDA prior
to commercial distribution. As of April 2000, the Company may distribute
newly manufactured lots of INFeD following certification by independent
experts but without prior review by the FDA. Steris is currently ineligible
to receive new product approvals, and the Company cannot predict when Steris
will resume manufacturing additional products.
10
<PAGE>
RESTRUCTURING RESERVES
As a result of the restructuring charges described above, the Company
established certain restructuring reserves. Current period activity is as
follows (in millions):
<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
DEC. 25, JUNE 24,
1999 ADDITIONS DEDUCTIONS 2000
----------------- ----------------- ------------------ ------------------
<S> <C> <C> <C> <C>
Inventory and other - Marsam.................. $10.5 - $5.8 $4.7
Inventory and other - Steris.................. 0.9 - 0.9 -
----------------- ----------------- ------------------ ------------------
$11.4 - $6.7 $4.7
================= ================= ================== ==================
</TABLE>
NOTE 5 -- LEGAL PROCEEDINGS
In September and October 1998, following the commencement of the seizure action
by the FDA against Steris on September 10, 1998, a number of substantially
similar class action complaints asserting claims under the federal securities
laws were filed in federal court in the District of New Jersey against the
Company and certain of its officers and directors. On December 21, 1998, the
court entered an order consolidating the actions, appointing lead plaintiffs and
approving selection of lead and liaison counsel. On or about March 29, 1999,
lead plaintiffs filed a consolidated and amended class action complaint (the
Complaint), naming as defendants the Company, its directors at the time of the
Company's April 9, 1998 initial public offering (the Offering), and three of the
underwriters of 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 during the period from April 9, 1998 through September 28, 1998.
They allege that defendants violated the Securities Exchange Act of 1934 and
Rule 10b-5 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 and in statements made immediately following the
FDA seizure action on September 10, 1998. 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 and the effect of the
FDA enforcement action on the Company's operations. Plaintiffs on behalf of the
purported class seek damages, recision and/or recisionary damages. In May 1999,
the Company and the other defendants in this action filed a motion to dismiss
the Complaint. In March 2000, and prior to any decision on the motion to
dismiss, plaintiffs and defendants entered into a Memorandum of Understanding
(MOU) to settle the actions. The MOU provides for, among other things, the
certification of the class, for purposes of the settlement, and the taking of
additional discovery by plaintiffs appropriate and necessary to confirm the
fairness and reasonableness of the contemplated settlement. The MOU also
contemplates the execution of an appropriate Stipulation of Settlement and other
related documentation. In addition, the settlement can become effective only
upon notice to the proposed class and a hearing and approval by the Court. The
Company does not believe that, if approved, the contemplated settlement, which
is expected to be funded through insurance proceeds, will have a material
adverse effect upon its results of operations or financial condition.
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, and on June
22, 1999 the court fixed the fees at $2.0 million. On July 28, 1999, the Company
filed an appeal of this matter, which is currently pending before the appeals
court.
11
<PAGE>
In March 1999, an action entitled MARVIN SAMSON V. SCHEIN PHARMACEUTICAL, INC.,
MARTIN SPERBER AND MARSAM PHARMACEUTICALS INC. was commenced in Superior Court
of New Jersey, Camden County, Law Division, alleging, among other things,
breaches of plaintiff's employment agreement with Marsam and misrepresentations
concerning responsibilities that would be given to plaintiff, and sought, among
other things, damages. In June 2000, the Company settled the action, and the
parties stipulated to the dismissal of the complaint. Under the settlement, the
parties exchanged general releases and Marsam agreed to continue to make certain
immaterial payments to the plaintiff through September 5, 2000.
In November 1999, the Company was informed by the U.S. Department of Justice
that it, along with several other pharmaceutical companies, is a defendant in a
QUI TAM action brought in 1995 under the U.S. False Claims Act currently pending
in the Federal District Court for the Southern District of Florida. As of July
31, 2000, the Company has not been served in this action. A QUI TAM action is a
lawsuit brought by an individual for an alleged violation of a federal statute,
in which the Department of Justice has the right to intervene and take over the
prosecution of the lawsuit at its option. The Department of Justice has not yet
decided whether to intervene in the matter. Pursuant to applicable federal law,
the QUI TAM action is under seal and no details are available concerning the
name of the plaintiff, the various theories of liability or the amount of
damages sought from any of the defendants. Based on industry information, the
Company believes that the matter relates to pharmaceutical pricing issues and
whether allegedly improper efforts by pharmaceutical manufacturers led to
increased payments by Medicare and/or Medicaid. Because detailed allegations
have not been revealed to the Company by the Justice Department, management does
not have any basis on which to determine the Company's liability, if any, in
connection with the lawsuit or the likely amount of any such liability, or
whether any resolution of the lawsuit would be likely to have a material adverse
affect on the Company's financial position, results of operations or liquidity.
If, however, the QUI TAM action seeks to recover damages from Schein based on
its pricing practices, such action, if successful, could adversely affect
Schein.
On April 25, 2000, the Company was served with a Civil Investigative Demand
(CID) from the Office of the Attorney General of Texas in connection with a
state investigation of possible false reporting of information regarding the
marketing of and prices for drugs used by the Vendor Drug Program administered
by the Texas Department of Health, which establishes the reimbursement rates for
pharmaceuticals dispensed to Texas Medicaid recipients. The CID seeks
information about a single drug included in the Vendor Drug Program. The Company
has not been provided any details concerning the conduct under investigation.
Additionally, Schein has received notices or subpoenas from the attorneys
general of various other states, including Florida, Nevada and New York. Other
state and federal inquiries regarding pricing and reimbursements issues are
anticipated. At the present time, management does not have any basis on which to
determine the Company's liability, if any, upon conclusion of these attorney
general investigations, or whether the resolution of the investigations is
likely to have a material adverse effect on the Company's financial position,
results of operations, or liquidity. Any actions which may be instituted to
recover damages from Schein based on its pricing practices, if successful, could
adversely affect Schein. Any significant limitation in government or third party
reimbursement practices could adversely affect Schein.
In addition, the Company is a defendant in several product liability cases.
These cases are typical for a company in the pharmaceutical industry. The
Company also is involved in other proceedings and claims of various types.
Management presently believes that the disposition of all such known product
liability and other proceedings and claims (except for the matters set forth
immediately above for which it is too early to assess liability), individually
or in the aggregate, will not have a material adverse effect on the Company's
financial position, results of operations or liquidity.
12
<PAGE>
NOTE 6 - SEVERANCE CHARGE
In February 2000, the Company reduced its workforce by approximately 16% as part
of an evaluation of its sterile business plan and to reduce operating costs. As
a result, the Company incurred a pre-tax severance charge of $3.5 million in the
first quarter of 2000.
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<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, intend, 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 uncertainty and the difficulty of
predicting the United States Food and Drug Administration (FDA) approvals,
uncertainties associated with the implementation of the terms and conditions of
the consent decree affecting the Steris facility, uncertainties associated with
regulatory matters affecting the Marsam 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 and regulatory matters, and fluctuations in operating results. For
further details and discussion of these risks and uncertainties see Schein
Pharmaceutical, Inc.'s SEC filings including, but not limited to, its Annual
Report on Form 10-K for the year ended December 25, 1999. For further details
and discussion of the merger discussed below, as well as risks and uncertainties
related to Watson and Schein, see Watson Pharmaceuticals, Inc. Form S-4 filed on
July 14, 2000, as amended. The Company does not undertake to publicly update or
revise any of its forward looking statements even if experience or future
changes show that the indicated results or events will not be realized.
GENERAL
The following provides information regarding the Company's merger with Watson
Pharmaceuticals, Inc., (Watson), regulatory matters, and results of operations
and liquidity and capital resources. The discussion of the Company's results of
operations for the three and six month periods ended June 24, 2000 and June 26,
1999, respectively, and its liquidity and capital resources should be read in
conjunction with the Company's condensed consolidated financial statements
included elsewhere herein.
WATSON - SCHEIN MERGER
On May 25, 2000, Watson and Schein Pharmaceutical, Inc. (Schein) announced that
the companies had entered into a definitive merger agreement under which Watson
would acquire all of the outstanding stock of Schein through a two-step
transaction comprised of a cash tender offer followed by a taxable stock merger.
Pursuant to the merger agreement, WS Acquisition Corp., a wholly owned
subsidiary of Watson, conducted a tender offer to purchase all of the
outstanding shares of Schein common stock for $19.50 per share in cash. On July
3, 2000, the tender offer expired and thereafter WS Acquisition Corp. purchased
26,068,469 shares of common stock of Schein, constituting 77.8% of the then
outstanding shares of Schein common stock. Schein is now in the process of
seeking stockholder approval of the merger contemplated by the merger agreement
and has set August 28, 2000 as the date for a special meeting of stockholders to
consider and vote upon a proposal to approve and adopt the merger agreement.
Upon completion of the merger, under the terms and subject to the conditions set
forth in the merger agreement, WS Acquisition Corp. will be merged into Schein,
the separate corporate existence of WS Acquisition Corp. will cease and Schein
will continue as the surviving corporation and wholly owned subsidiary of
Watson. WS Acquisition Corp. will vote its shares of Schein common stock for
approval and adoption of the merger agreement.
A number of contracts signed by Schein contain provisions permitting the other
parties to terminate these contracts in their entirety or with respect to
certain product relationships as a result of a change of control of Schein or a
breach by Schein of those contracts. Watson and Schein are currently in
discussions with certain third parties regarding these provisions. We cannot
assure you that these discussions will ultimately be successful. Although the
failure to
14
<PAGE>
maintain these contracts would not bar the completion of the merger,
such a failure could harm the business, results of operations and financial
condition of Watson and Schein.
REGULATORY MATTERS
MARSAM FACILITY
On July 29, 1999, the FDA concluded an inspection of the Company's Marsam
sterile manufacturing facility, located in Cherry Hill, NJ. At the close of the
inspection, Marsam received a Form 483 detailing the FDA's inspectional
observations and noting a number of significant deficiencies in current good
manufacturing practices. During the inspection, Marsam initiated actions to
address a number of the FDA's inspectional observations by voluntarily recalling
all Marsam products within expiry and suspending manufacturing and testing
activities. In September 1999 Marsam submitted its response to the FDA's
inspectional observations, together with its proposed corrective action plan
(Marsam Corrective Action Plan). A corrective action plan is a systematic
approach to assure that processes, quality assurance and quality control
programs, validation programs, employee training, and management controls comply
with cGMP regulations. The Marsam Corrective Action Plan contemplates resumption
of manufacturing on a product-by-product basis. On March 3, 2000 Marsam received
a Warning Letter from the FDA relating to the observations made during the
inspection. This FDA Warning Letter also acknowledged the commitments the
Company made under the Marsam Corrective Action Plan. The Company has confirmed
with the FDA in meetings with FDA representatives its approach to addressing
current cGMP deficiencies at Marsam on a voluntary basis. The Company does not
expect Marsam will be subject to further regulatory enforcement action related
to the 1999 inspection. Marsam is currently ineligible to receive new product
approvals, and the Company cannot predict when Marsam will resume manufacturing
specific products.
Following its suspension of operations at the Marsam facility, the Company
re-evaluated its sterile business and its assessment of the time and costs
required to reintroduce products. As a result, the Company modified its overall
business plans to more aggressively reduce operating costs. These measures
included, among other things, a reduction in the Company's workforce, and
dividing Marsam's product line into products it will seek to manufacture upon
completion of the Marsam Corrective Action Plan, and those products it has
decided not to manufacture. Marsam contributed approximately seven percent of
the Company's revenues and a smaller percentage of the Company's gross profits
over the four quarters preceding the suspension of shipment of its products.
The Company intends to reactivate its penicillin operations as part of the first
phase of a plan to bring its Marsam facility back to operation. Pending
resumption of manufacturing at Marsam, the Company reintroduced penicillin G
potassium during the second quarter of 2000 supplied by a third party.
As a result of the actions discussed above, in the year ended December 25, 1999
the Company recorded a restructuring charge of approximately $87.0 million, or
$52.2 million net of tax benefit. Costs of restructuring consisted largely of
costs incurred at the Marsam facility and related to the impairment of
intangible assets, product recalls, inventory write-offs and severance.
Recall costs and inventory write-offs were those costs that the Company
incurred related to the Marsam Corrective Action Plan.
STERIS FACILITY
On September 10, 1998, the U.S., on behalf of the FDA, based on actions it filed
in federal court in the Southern District of New York on September 9, 1998 and
the District of Arizona on September 10, 1998, initiated seizures of drugs and
drug related products manufactured by the Company's Steris facility. The actions
alleged certain instances in which the Steris facility, located in Phoenix,
Arizona, was not operating in conformity with 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 manufactured products.
On 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 agreement with the FDA (the Consent
Agreement). Under the terms of the Consent Agreement, Steris is required, among
other things, to demonstrate through independent certification that Steris'
processes, quality assurance and quality control programs, and
15
<PAGE>
management controls comply with cGMP regulations. The Consent Agreement 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. Steris has submitted to the
FDA the corrective action plan provided for under the Consent Agreement (Steris
Corrective Action Plan) and is implementing the Steris Corrective Action Plan.
As a result of the Consent Agreement, Steris has divided its product line into
three categories: products that it will seek to manufacture under expedited
certification procedures under the Consent Agreement, products that it will seek
to manufacture once it satisfies all conditions under the Consent Agreement and
products it has decided not to manufacture in the near term. 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.
In October 1998, the Company resumed commercial distribution of INFeD(R), its
branded injectable iron product, from existing inventory. In the second quarter
of 1999, the Company began distribution of newly manufactured lots of INFeD
under the Consent Agreement and in the fourth quarter of 1999, the Company
resumed the manufacture of one other product deemed medically necessary under
the expedited certification procedures in the Consent Agreement. On February 11,
2000, the FDA concluded an inspection at Steris. The Company believes that the
results of that inspection confirm that the Company is complying with the
requirements of the Steris Corrective Action Plan. In March 2000, the Company
resumed the manufacture and commercial distribution of vecuronium bromide under
the expedited certification procedures provided in the Consent Agreement. Newly
manufactured products must undergo certification by independent experts and
review by the FDA prior to commercial distribution. As of April 2000, the
Company may distribute newly manufactured lots of INFeD following certification
by independent experts but without prior review by the FDA. Steris is currently
ineligible to receive new product approvals, and the Company cannot predict when
Steris will resume manufacturing additional products.
There can be no assurance that the FDA will determine that the Company has
adequately corrected the deficiencies at its operating sites, that subsequent
inspectional observations will not result in additional deficiencies, that
approval of any of the pending or subsequently submitted ANDAs by the Company
will be granted or that the FDA will not seek to impose additional sanctions
against the Company or any of its subsidiaries. The range of possible sanctions
includes FDA issuance of adverse publicity, product recalls or seizures,
injunctions, and civil or criminal prosecution. Any such sanctions, if imposed,
could have a material adverse effect on the Company's business. Additionally,
significant delays in the review or approval of applications for new products or
in complying with the requirements of the Marsam Corrective Action Plan, the
Steris Corrective Action Plan or the Consent Agreement could have a material
adverse effect on the Company's business, results of operations and financial
condition.
RESULTS OF OPERATIONS
QUARTER ENDED JUNE 24, 2000 COMPARED TO QUARTER ENDED JUNE 26, 1999
<TABLE>
<CAPTION>
NET REVENUES AND GROSS PROFIT THREE MONTHS ENDED % OF REVENUES
--------------------------- --------------------------
(In millions) JUNE 24, JUNE 26, % JUNE 24, JUNE 26,
2000 1999 CHANGE 2000 1999
------------ ----------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
NET REVENUES
Generic product revenues.......................... $ 67.7 $ 90.3 -25.0% 64.4% 66.7%
Branded product revenues.......................... 37.5 45.1 -16.9% 35.6% 33.3%
------------ ----------- ------------ -----------
Total net revenues........................... $ 105.2 $ 135.4 -22.3% 100.0% 100.0%
============ =========== ============ ===========
GROSS PROFIT...................................... $ 21.3 $ 53.1 -59.9% 20.2% 39.2%
============ =========== ============ ===========
</TABLE>
16
<PAGE>
Net revenues for the second quarter of 2000 decreased by $30.2 million, or
22.3%, from $135.4 million in 1999 to $105.2 million in 2000 due to both
lower generic and branded product revenues.
Revenues from generic products decreased by $22.6 million, or 25.0%, from $90.3
million in 1999 to $67.7 million in 2000. Contributing to the decline in generic
product sales was the decline in sales of methylphenidate and ketoprofen of
$11.1 million due to generic competition that began in mid-1999, the absence of
products manufactured at the Marsam facility of $4.9 million, and price erosion
and unit volume declines on other selected generics, offset partially by
revenues from the reintroduction of injectable buffered penicillin G during the
second quarter of 2000.
Net revenues from branded products decreased by $7.6 million, or 16.9%, from
$45.1 million in 1999 to $37.5 million in 2000. The 1999 second quarter brand
product sales reflected the commencement of regular shipments of newly
manufactured INFeD and elimination of backorders following the Food and Drug
Administration action at the Company's Phoenix facility. Ferrlecit(R) positively
impacted brand product sales performance in the second quarter of 2000 as its
market share continued to increase, reflecting increasing acceptance by the
nephrology community and the Health Care Financing Administration Decision
Memorandum received in May 2000.
Gross profit decreased by $31.8 million, or 59.9%, from $53.1 million in 1999 to
$21.3 million in 2000. The gross margin decreased by 19.0 percentage points
in 2000 to 20.2% compared to 39.2% in 1999. The decrease in gross profit was
principally due to lower revenues from branded products, costs associated
with the suspension of manufacturing activities at Marsam and lower volumes
and price erosion on methylphenidate and ketoprofen and other selected
generic products.
<TABLE>
<CAPTION>
COSTS AND EXPENSES THREE MONTHS ENDED % OF REVENUES
--------------------------- --------------------------
(In millions) JUNE 24, JUNE 26, % JUNE 24, JUNE 26,
2000 1999 CHANGE 2000 1999
----------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Selling, general and administrative................ $ 16.9 $ 23.3 -27.4% 16.1% 17.2%
Research and development........................... 7.4 6.0 22.0% 7.0% 4.5%
Amortization of intangibles and goodwill........... 0.3 1.6 -79.5% 0.3% 1.2%
Restructuring charge............................... - 9.5 -100.0% - 7.0%
----------- ----------- ------------ -----------
Total costs and expenses.................. $ 24.6 $ 40.4 -39.1% 23.4% 29.8%
=========== =========== ============ ===========
</TABLE>
Selling, general and administrative expenses decreased in the second quarter by
$6.4 million, or 27.4%, from $23.3 million in 1999 to $16.9 million in 2000.
This decrease reflects reduced costs associated with corrective action plans and
the benefits of ongoing cost reduction efforts.
Research and development expenses increased in the second quarter by $1.4
million, or 22.0%, primarily due to continued expansion of both brand and
generic product development efforts.
Amortization of intangibles and goodwill decreased by $1.3 million in the second
quarter of 2000 compared to the second quarter in 1999 due to the write-off of
intangible assets included in the 1999 restructuring charge.
17
<PAGE>
<TABLE>
<CAPTION>
INTEREST EXPENSE, NET,
OTHER EXPENSES (INCOME),
NET AND PROVISION (BENEFIT)
FOR INCOME TAXES THREE MONTHS ENDED % OF REVENUES
-------------------------- ----------------------------------------
(In millions) JUNE 24, JUNE 26, % JUNE 24, JUNE 26,
2000 1999 CHANGE 2000 1999
----------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Interest expense, net............................. $ 5.6 $ 4.8 16.8% 5.4% 3.5%
Other expenses (income), net...................... (1.3) 0.3 n/m -1.2% 0.2%
Provision (benefit) for income taxes.............. (3.1) 2.7 n/m -2.9% 2.0%
</TABLE>
Interest expense increased by $0.8 million from $4.8 million to $5.6 million
principally due to higher interest rates under the Company's revolving credit
and term loan agreement and higher debt levels due to the interim financing
obtained in connection with the merger agreement.
Other expenses (income), net, was $1.3 million income in 2000 and $0.3 million
expense in 1999. The change in other expenses (income), net, was primarily due
to a $1.4 million gain on the sale of marketable securities in 2000.
SIX MONTHS ENDED JUNE 24, 2000 COMPARED TO SIX MONTHS ENDED JUNE 26, 1999
<TABLE>
<CAPTION>
NET REVENUES AND GROSS PROFIT SIX MONTHS ENDED % OF REVENUES
-------------------------- --------------------------
(In millions) JUNE 24, JUNE 26, % JUNE 24, JUNE 26,
2000 1999 CHANGE 2000 1999
----------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
NET REVENUES
Generic product revenues.......................... $ 128.1 $ 178.9 -28.4% 66.3% 74.2%
Branded product revenues.......................... 65.0 62.4 4.2% 33.7% 25.8%
------------ ----------- ----------- -----------
Total net revenues........................... $ 193.1 $ 241.3 -20.0% 100.0% 100.0%
=========== =========== ============ ===========
GROSS PROFIT...................................... $ 40.4 $ 89.4 -54.8% 20.9% 37.1%
=========== =========== ============ ===========
</TABLE>
Net revenues for the six months of 2000 decreased by $48.2 million, or 20.0%,
from $241.3 million in 1999 to $193.1 million in 2000. This was primarily due to
the absence of revenues from Marsam manufactured products and lower revenues of
solid dosage generic products, partially offset by higher branded product
revenues.
Revenues from generic products decreased by $50.8 million, or 28.4%, from $178.9
million in 1999 to $128.1 million in 2000. This decrease was due to the absence
of revenues from Marsam manufactured products of $18.5 million, a decline in
sales of methylphenidate and ketoprofen of $22.3 million due to additional
generic competition that began in mid-1999 and decreases in selected other
generic products.
Net revenues from branded products increased $2.6 million or 4.2% from $62.4
million in 1999 to $65.0 million in 2000 largely due to increased revenues from
Ferrlecit, Schein's next generation iron product, which was launched in June
1999, offset by decreased revenues from INFeD. The increase in Ferrlecit
revenues is due to increasing market share, which reflects increasing acceptance
by the nephrology community.
Gross profit decreased by $49.0 million, or 54.8%, from $89.4 million in 1999 to
$40.4 million in 2000. The gross margin decreased by 16.1 percentage points
in 2000 to 20.9% compared to 37.0% in 1999. The decrease in gross profit was
principally due to decreased unit volumes and price erosion on
methylphenidate and ketoprofen due to increased competition, lower gross
margins on other selected generics and other costs associated with the
suspension of manufacturing activities at Marsam, offset by higher gross
profit on branded products.
<TABLE>
<CAPTION>
COSTS AND EXPENSES SIX MONTHS ENDED % OF REVENUES
-------------------------- --------------------------
(In millions) JUNE 24, JUNE 26, % JUNE 24, JUNE 26,
2000 1999 CHANGE 2000 1999
----------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Selling, general and administrative................ $ 33.7 $ 44.2 -23.6% 17.5% 18.3%
Research and development........................... 15.4 11.2 37.7% 8.0% 4.6%
Amortization of intangibles and goodwill........... 0.7 3.2 -79.2% 0.3% 1.3%
Severance/restructuring charge..................... 3.5 9.5 -63.2% 1.8% 3.9%
----------- ----------- ------------ -----------
Total costs and expenses.................. $ 53.3 $ 68.1 -21.7% 27.6% 28.2%
=========== =========== ============ ===========
</TABLE>
Selling, general and administrative expenses decreased in the six months by
$10.5 million, or 23.6%, from $44.2 million in 1999 to $33.7 million in 2000.
This decrease reflects reduced costs associated with corrective action plans and
the benefits of ongoing cost reduction efforts.
Research and development expenses increased in the six months by $4.2 million,
or 37.7%, primarily due to continued expansion of both brand and generic product
development efforts.
Amortization of intangibles and goodwill decreased by $2.5 million in the six
months of 2000 compared to the first six months in 1999 due to the write-off of
intangible assets included in the 1999 restructuring charge.
INTEREST EXPENSE, NET, OTHER EXPENSES
(INCOME), NET, AND PROVISION (BENEFIT) FOR
INCOME TAXES
<TABLE>
<CAPTION>
SIX MONTHS ENDED % OF REVENUES
-------------------------- --------------------------
(In millions) JUNE 24, JUNE 26, % JUNE 24, JUNE 26,
2000 1999 CHANGE 2000 1999
----------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Interest expense, net............................. $ 10.2 $ 9.5 7.3% 5.3% 3.9%
Other expenses (income), net...................... (0.6) 0.7 n/m -0.3% 0.3%
Provision (benefit) for income taxes.............. (9.0) 4.1 n/m -4.7% 1.7%
</TABLE>
Interest expense increased by $0.7 million, or 7.3%, from $9.5 million in 1999
to $10.2 million in 2000. The increase in interest expense was principally due
to higher interest rates under the Company's revolving credit and term loan
agreement.
Other expenses (income), net, was $0.6 million income in 2000 and $0.7 million
expense in 1999. The change in other expenses (income), net, was primarily due
to gains on the sale of marketable securities increasing from $0.3 million in
1999 to $1.4 million in 2000.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $16.0 million for the six months ended
June 24, 2000. The net cash used in operating activities was attributable to net
loss of $13.5 million as adjusted for non-cash items and changes in operating
assets and liabilities totaling $2.5 million. The increase in accounts
receivable of $12.2 million was primarily the result of the Company reducing its
effort to accelerate customer collections as it had in prior periods.
Inventories decreased $25.2 million from relatively high year-end levels.
Prepaid expenses and other assets decreased by $9.2 million primarily due to the
receipt of a litigation settlement of $7.5 million. Accounts payable, income
taxes, accrued expenses and other liabilities decreased by $27.1 million
primarily due to a decrease in accounts payable and accrued expenses being
partially offset by higher profit sharing accruals. The decrease in accounts
payable was largely due to proceeds from the $40 million interim financing
(described below) being used to reduce delayed payments to certain vendors.
Net cash used in investing activities for the six months ended June 24, 2000 was
$6.1 million which consisted primarily of capital expenditures of $5.6 million,
the majority of which related to the Company's Marsam and Puerto Rico
facilities.
The Company's cash flow continued to be affected in 2000 by the cash costs and
loss of revenues related to manufacturing disruptions at its Marsam and Steris
facilities, capital expenditures and principal payment obligations under the
revolving credit and loan agreement. The Marsam and Steris costs include
severance expenses, costs associated with maintaining and staffing idle or
underutilized manufacturing operations and the associated corrective action
plans.
Under the terms of the merger agreement Watson entered into agreements with
Schein, Schein's current lenders and others, to make funds available or provide
such credit support or other financial accommodation, as necessary to provide
Schein with immediate borrowing availability in the amount of $40 million. On
June 2, 2000, Watson entered into certain agreements, including a guarantee,
with certain of Schein's existing lenders. In connection therewith, $40 million
was made available to Schein on terms and conditions substantially similar to
the terms and conditions of Schein's existing bank facility. On July 6, 2000,
the revolving credit and term loan agreement and the interim financing were paid
in full with financing provided by Watson under an intercompany note which is
payable on demand and due no later than December 31, 2001.
Under the terms of the Company's Notes agreement, the Company has notified the
holders of the above mentioned Notes that there has been a change in control of
Schein and the holders of the Notes have the option to require the Company to
purchase the Notes at 101% of the aggregate principal amount plus accrued and
unpaid interest by August 25, 2000 and the Company has elected to redeem all of
the remaining issued and outstanding securities on August 28, 2000. In
accordance with the terms of the agreement, the redemption price will be
100.75% of the aggregate principal amount, plus accrued and unpaid interest.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The carrying amounts of financial instruments, including cash and cash
equivalents, accounts receivable, accounts payable and accrued liabilities,
approximate fair value because of the current nature of these instruments. The
carrying amounts reported for revolving credit and long-term debt approximate
fair value because the interest rates on these instruments are subject to
changes with market interest rates.
18
<PAGE>
PART II. OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
In September and October 1998, following the commencement of the seizure action
by the FDA against Steris on September 10, 1998, a number of substantially
similar class action complaints asserting claims under the federal securities
laws were filed in federal court in the District of New Jersey against the
Company and certain of its officers and directors. On December 21, 1998, the
court entered an order consolidating the actions, appointing lead plaintiffs and
approving selection of lead and liaison counsel. On or about March 29, 1999,
lead plaintiffs filed a consolidated and amended class action complaint (the
Complaint), naming as defendants the Company, its directors at the time of the
Company's April 9, 1998 initial public offering (the Offering), and three of the
underwriters of 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 during the period from April 9, 1998 through September 28, 1998.
They allege that defendants violated the Securities Exchange Act of 1934 and
Rule 10b-5 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 and in statements made immediately following the
FDA seizure action on September 10, 1998. 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 and the effect of the
FDA enforcement action on the Company's operations. Plaintiffs on behalf of the
purported class seek damages, recision and/or recisionary damages. In May 1999,
the Company and the other defendants in this action filed a motion to dismiss
the Complaint. In March 2000, and prior to any decision on the motion to
dismiss, plaintiffs and defendants entered into a Memorandum of Understanding
(MOU) to settle the actions. The MOU provides for, among other things, the
certification of the class, for purposes of the settlement, and the taking of
additional discovery by plaintiffs appropriate and necessary to confirm the
fairness and reasonableness of the contemplated settlement. The MOU also
contemplates the execution of an appropriate Stipulation of Settlement and other
related documentation. In addition, the settlement can become effective only
upon notice to the proposed class and a hearing and approval by the Court. The
Company does not believe that, if approved, the contemplated settlement, which
is expected to be funded through insurance proceeds, will have a material
adverse effect upon its results of operations or financial condition.
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, and on June
22, 1999 the court fixed the fees at $2.0 million. On July 28, 1999, the Company
filed an appeal of this matter, which is currently pending before the appeals
court.
In March 1999, an action entitled MARVIN SAMSON V. SCHEIN PHARMACEUTICAL, INC.,
MARTIN SPERBER AND MARSAM PHARMACEUTICALS INC. was commenced in Superior Court
of New Jersey, Camden County, Law Division, alleging, among other things,
breaches of plaintiff's employment agreement with Marsam and misrepresentations
concerning responsibilities that would be given to plaintiff, and sought, among
other things, damages. In June 2000, the Company settled the action, and the
parties stipulated to the dismissal of the complaint. Under the settlement, the
parties exchanged general releases and Marsam agreed to continue to make certain
immaterial payments to the plaintiff through September 5, 2000.
In November 1999, the Company was informed by the U.S. Department of Justice
that it, along with several other pharmaceutical companies, is a defendant in a
QUI TAM action brought in 1995 under the U.S. False Claims Act currently pending
in the Federal District Court for the Southern District of Florida. As of July
31, 2000, the Company has not been served in this action. A QUI TAM action is a
lawsuit brought by an individual for an alleged violation of a federal statute,
in which the Department of Justice has the right to intervene and take over the
prosecution of the lawsuit at its option. The Department of Justice has not yet
decided whether to intervene in the matter. Pursuant to applicable federal law,
the QUI TAM action is under seal and no details are available concerning the
name of the plaintiff, the various theories of liability or the amount of
damages sought from any of the defendants. Based on industry information, the
Company believes that the matter relates to pharmaceutical pricing issues and
whether
19
<PAGE>
allegedly improper efforts by pharmaceutical manufacturers led to increased
payments by Medicare and/or Medicaid. Because detailed allegations have not been
revealed to the Company by the Justice Department, management does not have any
basis on which to determine the Company's liability, if any, in connection with
the lawsuit or the likely amount of any such liability, or whether any
resolution of the lawsuit would be likely to have a material adverse affect on
the Company's financial position, results of operations or liquidity. If,
however, the QUI TAM action seeks to recover damages from Schein based on its
pricing practices, such action, if successful, could adversely affect Schein.
On April 25, 2000, the Company was served with a Civil Investigative Demand
(CID) from the Office of the Attorney General of Texas in connection with a
state investigation of possible false reporting of information regarding the
marketing of and prices for drugs used by the Vendor Drug Program administered
by the Texas Department of Health, which establishes the reimbursement rates for
pharmaceuticals dispensed to Texas Medicaid recipients. The CID seeks
information about a single drug included in the Vendor Drug Program. The Company
has not been provided any details concerning the conduct under investigation.
Additionally, Schein has received notices or subpoenas from the attorneys
general of various other states, including Florida, Nevada and New York. Other
state and federal inquiries regarding pricing and reimbursements issues are
anticipated. At the present time, management does not have any basis on which to
determine the Company's liability, if any, upon conclusion of these attorney
general investigations, or whether the resolution of the investigations is
likely to have a material adverse effect on the Company's financial position,
results of operations, or liquidity. Any actions which may be instituted to
recover damages from Schein based on its pricing practices, if successful, could
adversely affect Schein. Any significant limitation in government or third party
reimbursement practices could adversely affect Schein.
In addition, the Company is a defendant in several product liability cases.
These cases are typical for a company in the pharmaceutical industry. The
Company also is involved in other proceedings and claims of various types.
Management presently believes that the disposition of all such known product
liability and other proceedings and claims (except for the matters set forth
immediately above for which it is too early to assess liability), individually
or in the aggregate, will not have a material adverse effect on the Company's
financial position, results of operations or liquidity.
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 Watson Pharmaceuticals, Inc. and Schein
Pharmaceutical, Inc. announce
definitive merger agreement; dated
May 25, 2000
(ii) Form 8-K Change in control of registrant; Watson
Pharmaceuticals, Inc. completed
tender offer and acquired 77.8% of
Schein Pharmaceutical, Inc.; dated
July 6, 2000
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<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 _______________________________________
Whitney K. Stearns, Jr.
Senior Vice President and
Chief Financial Officer
Dated: August 4, 2000
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