ITEM 1 BUSINESS
GENERAL
Leiner Health Products Inc. ("Leiner" or the "Company") is one of the nation's leading manufacturers of vitamins, minerals, and nutritional supplements and distributes its products primarily through Mass Market retailers. The Company has approximately a 17.4% share of all Mass Market vitamin sales in the United States, and an over 50% share of the Mass Market private label segment. Leiner's U.S. vitamin sales have grown at a compound annual rate of approximately 18% per year over the last seven years, over one and a quarter times the industry growth rate in the U.S. Leiner is also one of the nation's largest private label over-the-counter ("OTC") pharmaceuticals manufacturers, with approximately 19.5% of its sales in OTC pharmaceutical and other products.
The Company is the ultimate successor to the vitamin product division of P. Leiner & Sons, America, Inc. The division, founded in 1973, was purchased in 1979 by management and Booker plc through Leiner, then named P. Leiner Nutritional Products Corp. (the "Predecessor Company"). On May 4, 1992, Leiner Health Products Group Inc. ("Leiner Group") acquired Leiner (the "LHP Acquisition") for a total purchase price of approximately $90.9 million. On May 22, 1992, Leiner Group acquired privately held XCEL Laboratories, Inc., a major U.S. private label OTC pharmaceuticals manufacturer for a total purchase price of approximately $24.7 million. On March 8, 1993, XCEL Laboratories, Inc. was merged into Leiner. Leiner subsequently changed its name to Leiner Health Products Inc. Leiner Group was incorporated under the laws of the State of Delaware in 1987 by AEA Investors Inc. and did not have any significant assets, liabilities or activities prior to the LHP Acquisition. Leiner Group is a holding company with no significant operations or assets other than the stock of Leiner, which it holds through its sole direct subsidiary, PLI Holdings Inc., itself a holding company ("PLI Holdings"). Leiner Group was recapitalized effective June 30, 1997. See "Recapitalization."
In January 1997, the Company acquired Vita Health Company (1985) Ltd., one of the leading manufacturers of private label and branded vitamins, minerals and OTC pharmaceuticals in Canada, for a total purchase price of approximately $16.0 million, including $1.1 million of direct acquisition costs. Vita Health Company (1985) Ltd. changed its name in 1998 to Vita Health Products Inc. ("Vita Health"). Vita Health is currently a wholly-owned indirect subsidiary of Leiner. Vita Health is headquartered in Winnipeg, Manitoba, Canada. This location serves as Vita Health's headquarters, manufacturing, tableting, packaging and distribution location.
On December 17, 1999, Leiner Health Products Inc. acquired substantially all of the assets of Granutec, Inc. ("Granutec"), a manufacturer and distributor of private label, over-the-counter pharmaceutical drugs in the United States, and Vita Health acquired substantially all of the assets of Stanley Pharmaceuticals Ltd. ("Stanley"), a manufacturer and distributor of private label, over-the-counter pharmaceutical drugs and vitamin supplement products in Canada, both of which were subsidiaries of Novopharm Limited of Ontario, Canada ("Novopharm"). The Company also acquired certain related assets of Novopharm (collectively, the "Acquisition"). See Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations--Acquisition"
The Company's fiscal year ends on March 31 of each year. References herein to a "fiscal year" refer to the Company's fiscal year ended March 31 in the calendar year indicated (e.g., references to fiscal year 2000 are references to the Company's fiscal year ended March 31, 2000).
RECAPITALIZATION
On June 30, 1997, Leiner Group completed a leveraged recapitalization transaction (the "Recapitalization"). The Recapitalization was effected pursuant to a Stock Purchase Agreement and Plan of Merger,
dated as of May 31, 1997 (the "Recapitalization Agreement") among Leiner Group, North Castle Partners I, L.L.C. ("North Castle"), and LHP Acquisition Corp., a wholly-owned subsidiary of North Castle (the "Merger Entity"). North Castle, a Delaware limited liability company, is an investment fund formed by Mr. Charles F. Baird, Jr., to effect the Recapitalization. Pursuant to the Recapitalization, Leiner Group repurchased common stock from its existing shareholders in an amount totaling (together with equity retained by such shareholders) $211.1 million, issued $80.4 million of new shares of the recapitalized Leiner Group to North Castle, issued $85 million of Senior Subordinated Notes (the "Notes"), and established a $210 million senior secured credit facility that provided for both term and revolving credit borrowings. Immediately upon consummation of the Recapitalization, the obligations of Leiner Group under the Notes and the $210 million senior credit facility were assigned to and assumed by the Company. The Recapitalization was accounted for as a recapitalization of Leiner Group which had no impact on the historical basis of assets and liabilities as reflected in the Company's consolidated financial statements.
Upon consummation of the Recapitalization, (i) current managers and employees of the Company who had been existing shareholders had some of their existing common stock exchanged for cash, but together with Mr. Baird, retained approximately 8.3% of Leiner Group equity (consisting of approximately 58.6% of the non-voting Leiner Group common stock and 5.6% of the voting Leiner Group common stock) and received rights under certain circumstances to receive Leiner Group common stock ("Equity Rights") equal to approximately 7.4% of Leiner Group equity, as well as certain warrants to acquire Leiner Group common stock ("Warrants"), (ii) AEA Investors Inc. and certain of its co-investors (the "AEA Group") and certain former managers of the Company, all of whom had been existing shareholders, had most of their common stock purchased for cash, but also retained Leiner Group common stock equal to approximately 10.1% of Leiner Group equity (consisting of approximately 41.4% of the non-voting Leiner Group common stock and 8.8% of the voting Leiner Group common stock), as well as Warrants, and (iii) North Castle acquired the remainder of Leiner Group equity, primarily through the purchase of newly issued voting Leiner Group common stock equal to approximately 73.8% of Leiner Group equity for a cash investment of $80.4 million. In connection with the Recapitalization, existing stock options held by management shareholders were cashed out, exercised for common stock, or converted into Equity Rights.
SEASONALITY
Leiner's business is seasonal, as increased vitamin usage corresponds with the cough, cold and flu season. A significant portion of the Company's sales and a more significant portion of the Company's operating income occurs in the second half of the fiscal year as shown below (in millions):
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(1) Net sales and operating income of $6.1 million and $1.1 million, respectively, in the third quarter of fiscal year 2000 and $33.0 million and $3.1 million, respectively, in the fourth quarter of fiscal year 2000, relate to the Acquisition. See Note 3 of Notes to Consolidated Financial Statements.
(2) Includes expenses of $15.6 million related to stock option compensation, $5.2 million of management bonuses and expenses incurred by Leiner Group in connection with its capital raising activities of $12.0 million, all of which were incurred in connection with the Recapitalization. Without these expenses, operating income would have been $4.1 million for the first quarter of fiscal 1998 and $37.2 million for fiscal 1998. See Note 4 of Notes to Consolidated Financial Statements.
PRODUCTS
The following table sets forth the net sales of the Company's vitamin, OTC pharmaceutical and other product lines for the periods indicated (in millions):
VITAMIN PRODUCTS. The Company sells a full line of vitamin products, including more than 500 products in more than 10,000 stock keeping units ("SKUs"). The Company's products are sold in tablet and capsule forms, and in varying sizes with different potencies, flavors and coatings. The Company's vitamin products include national brand equivalents which compare to the dietary ingredients contained in CENTRUM-REGISTERED TRADEMARK-, ONE-A-DAY-REGISTERED TRADEMARK- and GINSANA-REGISTERED TRADEMARK-, natural vitamin products such as vitamins C and E and folic acid, minerals such as calcium, supplements such as glucosamine and herbal products such as St. John's wort, ginseng and ginkgo biloba. In addition, Leiner's YOUR LIFE-REGISTERED TRADEMARK- brand is one of the nation's largest broadline vitamin product brands. Sales of vitamins C and E, in the aggregate, accounted for approximately 30.9% of the Company's sales in fiscal 2000.
The Company sells vitamin products under its customers' store names ("private label products"). The Company estimates that private label products accounted for approximately 80% of Leiner's total fiscal 2000 vitamin sales.
Vita Health produces approximately 350 different types of vitamins and minerals. However, the majority of Vita Health's sales in this segment are concentrated in a few core product categories. The top 5 product categories, which comprise over one-half of Vita Health's vitamin sales, are vitamin C products, vitamin E products, multivitamins, herbal products and supplements.
OTC PHARMACEUTICALS. The Company markets approximately 400 different OTC pharmaceutical products in approximately 3,700 SKUs, including products comparable to most major national brands in the analgesic, cough and cold remedy and digestive aid categories. The Company sells its OTC pharmaceuticals under its customers' private labels as well as its own broadline brand, PHARMACIST FORMULA-REGISTERED TRADEMARK-, first introduced in 1989.
Vita Health's OTC pharmaceutical sales are primarily analgesic products and cough and cold products. In Canada, there are two primary classes of analgesic products, those with codeine and those without. Vita Health produces both types of products.
In the Acquisition, the Company acquired rights from Novopharm to market and manufacture pharmaceutical products previously available only by prescription, but now sold over-the-counter, ("Rx--to--OTC switch products"), including Ranitidine and Naproxen Sodium. The Company intends to use the Chemistry, Manufacturing and Control ("CMC") experience, (also gained in the Acquisition), with these and other Rx-to-OTC switch products to further broaden its OTC product line. See "Government Regulation--OTC Pharmaceuticals."
SERVICES; OTHER PRODUCTS. The Company performs contract manufacturing services on a limited basis for selected consumer product companies. In order to leverage further its existing distribution system and marketing expertise, the Company markets certain niche products. For example, the Company developed and markets the BODYCOLOGY-REGISTERED TRADEMARK- line of hair, skin and bath care products.
CUSTOMERS
The Company's vitamin products are sold in all 50 states through more than 50,000 retail outlets, including drug store, supermarket, mass merchandising, and warehouse club chains, as well as in convenience stores and through the United States military outlets worldwide. Leiner is the vitamin category manager for many leading retailers. The Company's vitamin product customers include eight of the ten largest drug store chains (including CVS Corp., Walgreen Company, Rite Aid Corporation, Eckerd Corporation, and Longs Drug Stores), nine of the ten largest supermarket chains (including Kroger Co., Albertson's, Inc., Safeway, Ahold USA, and Winn-Dixie Stores), six of the ten largest mass merchandising chains (including Wal-Mart, Target and Kmart), and the two largest warehouse club chains (Sam's Club and Costco). The Company has approximately 210 active U.S. customers. In fiscal 2000, Wal-Mart Stores, Inc. and Costco accounted for approximately 31% and 9%, respectively, of the Company's sales. Each of the Company's other major customers accounted for less than 10% of the Company's sales for
fiscal 2000. The Company's top ten customers in the aggregate accounted for approximately 68% of the Company's sales for fiscal 2000.
BACKLOG ORDERS
The Company had approximately $20.5 million in backlog orders, believed to be firm, as of March 31, 2000. Substantially all of these orders are expected to be shipped in fiscal 2001. The Company had $16.1 million in backlog orders, believed to be firm, as of March 31, 1999.
PURCHASED MATERIALS
The Company purchases from third party suppliers raw materials and certain products that the Company does not manufacture. Although the Company currently has supply arrangements with several suppliers of these ingredients and products, and the Company's purchased materials are generally available from numerous sources, an unexpected interruption of supply could materially adversely affect the Company's results of operations. Two suppliers provided approximately 23% of the materials purchased during fiscal 2000 by the Company. No other single supplier accounted for more than 10% of the Company's material purchases.
COMPETITION
The markets for the Company's products are highly competitive. The Company competes on the basis of customer service, product quality, range of products offered, pricing and marketing support. In the Mass Market vitamin product business, the Company believes that its major U.S. competitors are Pharmavite, Royal Numico, and NBTY, Inc. (manufacturer of Nature's Bounty vitamin products). In the OTC pharmaceuticals business, the Company believes its major U.S. competitor is Perrigo Company.
In the United States, the Company sells approximately 90% of its vitamin products to Mass Market and warehouse club retailers. The Company does not currently participate significantly in other U.S. distribution channels such as health food stores, direct mail and direct sales, and, therefore, may face competition from such alternative channels as more customers utilize these channels of distribution to obtain vitamin products.
The Company competes with other major private label and broadline brand manufacturers, certain of which are larger and have access to greater resources than the Company. Among other factors, competition among private label manufacturers is based upon price. If one or more manufacturers significantly reduce their prices in an effort to gain market share, the Company's results of operations or market position could be adversely affected. However, the Company believes that it competes favorably with other companies because of its (i) low manufacturing costs, (ii) sales and marketing strategies (including the wide range of products offered), (iii) customer service (including adaptability to customer needs and speed of delivery), and (iv) reputation of supplying quality products.
The Company also competes with larger manufacturers of nationally advertised brand name products such as American Home Products Corp., Bayer Group and Bristol-Myers Squibb Co., which have resources substantially greater than those of the Company, and are substantially less leveraged than the Company. In the future, one or more of these companies could seek to compete more directly with the Company by manufacturing private label products or by significantly lowering the prices of their national brand products. The Company believes, however, that the mass-oriented manufacturing and marketing methods used by national brand manufacturers are less suited to the customized packaging and marketing requirements of private label customers, which the Company satisfies by utilizing its packaging and graphics facilities.
EMPLOYEES
As of March 31, 2000, the Company had 3,103 full-time employees; 947 employees were engaged in executive or administrative capacities and 2,156 employees were engaged in manufacturing, packaging or distribution. In addition, as of March 31, 2000, the Company employed approximately 1,388 temporary employees. The large number of temporary employees gives the Company significant flexibility to adjust staffing levels in response to seasonal fluctuations in demand. Certain of the Vita Health employees are represented by a collective bargaining unit. The Company considers its relations with its employees to be good.
GOVERNMENT REGULATION
The manufacturing, processing, formulation, packaging, labeling, advertising and sale of the Company's products are subject to regulation by one or more United States and Canadian federal agencies, including the United States Food and Drug Administration ("FDA"), the United States Federal Trade Commission ("FTC"), the United States Consumer Product Safety ("CPSC") and Health Canada. The activities are also regulated by various agencies of the states, provinces and localities in which the Company's products are sold. In addition, the Company manufactures and markets certain of its products in compliance with the guidelines promulgated by voluntary standard organizations, such as the United States Pharmacopoeia Convention, Inc. ("USP").
FDA. The United States Food and Drug Administration exercises authority over three aspects of the Company's business: (i) the labeling and marketing of dietary supplements, (ii) the labeling and marketing of monograph OTC, abbreviated New Drug Application ("ANDA") and OTC pharmaceutical drug products, and (iii) the operation of its manufacturing and packaging facilities.
DIETARY SUPPLEMENTS. The Dietary Supplement Health and Education Act of 1994 ("DSHEA") was enacted on October 25, 1994 and amends the Federal Food, Drug and Cosmetic Act to (i) define dietary supplements, (ii) expand with certain limitations the number of products that can be marketed as dietary supplements, (iii) permit "structure/function" statements for all vitamin products, including herbal products and other nutritional supplements, and (iv) permit the use of certain published literature in the sale of vitamin products. Dietary supplements are regulated as food products under DSHEA, and the FDA is prohibited from regulating the dietary ingredients in supplements as food additives, or the supplements as drugs, unless product claims trigger drug status.
DSHEA provides for specific nutritional labeling requirements for dietary supplements. The latest FDA labeling regulations were effective March 23, 1999. DSHEA permits substantiated, truthful and non-misleading statements of nutritional support to be made in labeling, including describing the positive effects on general well-being from consumption of a dietary ingredient or the role of a nutrient or dietary ingredient in affecting or maintaining structure or function of the body. In addition, DSHEA authorizes the FDA to promulgate current good manufacturing practices specific to the manufacture of dietary supplements, to be modeled after current good manufacturing practices for food. The Company currently manufactures its dietary supplement products pursuant to the more detailed OTC pharmaceutical "Current Good Manufacturing Practices for Finished Pharmaceuticals" ("cGMP").
On January 6, 2000, the FDA published a Final Rule regarding statements made in dietary supplement labeling. Such statements cannot state expressly or implicitly that a dietary supplement has any effect on a disease. Since the passage of DSHEA the FDA has wavered on its definition of disease. This Final Rule clarifies the FDA's definition of a disease. In addition, the Final Rule opens up statements from several OTC drug monographs for use on dietary supplements (e.g., relief of occasional sleeplessness). This gives the industry a new level of freedom in marketing dietary supplements and providing information to consumers about the use of dietary supplements. Effective January 31, 2000, the Center for Food Safety and Applied Nutrition ("CFSAN") combined the former Office of Food Labeling and the former Office of Special Nutritionals into a single entity now known as the Office of Nutritional Products, Labeling and
Dietary Supplements. The merger of the two offices will maximize the resources that, in many cases, were previously working on overlapping issues.
The Company cannot determine what effect the FDA's future regulations, when and if promulgated, would have on its business in the future. Such regulations could, however, among other things, require expanded documentation of the properties of certain products, or scientific substantiation regarding ingredients, product claims or safety. In addition, the Company cannot predict whether new legislation regulating the Company's activities will be enacted, or what effect any such legislation would have on the Company's business.
OTC PHARMACEUTICALS. FDA regulation of OTC pharmaceuticals takes two forms. Most of the Company's OTC pharmaceutical products are governed by FDA monographs covering well-known ingredients and specifying, among other things, permitted claims, required warnings and precautions, allowable combinations of ingredients and dosage levels. Marketing a product governed by a monograph or pending monograph requires no prior approval of the FDA, only compliance with the applicable monograph. Monographs may be changed from time to time, requiring formulation, packaging or labeling changes for an affected product. While such changes may cause the Company to incur costs to comply with such changes, disruption of distribution or material obsolescence of inventory due to any such changes is not likely.
The Company also markets Rx-to-OTC switch products, which have gone through an FDA review and approval process before the products can be distributed. The Company acquired from Novopharm, five Rx-to-OTC switch products (Naproxen Sodium Tablets USP, Ibuprofen Tablets USP, Cimetidine Tablets USP, Loperamide Tablets, USP, and Ranitidine Tablets, USP) that were approved through the ANDA review process by the Office of Generic Drugs, FDA. Based on current FDA regulations, all chemistry, manufacturing and control ("CMC") issues related to these products are controlled by the information included in the ANDAs. Changes to the approved ANDAs and, therefore, changes to these products, are governed by specific regulations and guidances that determine when changes, if approved by the FDA, can be implemented. The Drug Price Competition and Patent Term Restoration Act of 1984 (the Hatch-Waxman Amendments to the Federal Food, Drug and Cosmetic Act) can give a three-year period of marketing exclusivity to a company that obtains FDA approval of an Rx-to-OTC switch product. Unless Leiner establishes relationships with such companies having exclusive marketing rights, the Company's ability to market Rx-to-OTC switch products and offer its customers products comparable to the national brand products would be delayed until the expiration of the exclusivity granted to the company initiating such a switch. There can be no assurance that, in the event that the Company applies for FDA approvals, the Company would obtain such approvals to market Rx-to-OTC switch products or, alternatively, that the Company would be able to obtain such products from other manufacturers.
The Company is also subject to the requirements of the Comprehensive Methamphetamine Control Act of 1996, a law designed to allow the Drug Enforcement Administration (DEA) to monitor transactions involving chemicals that may be used illegally in the production of methamphetamine. The Comprehensive Methamphetamine Control Act of 1996 establishes certain registration and recordkeeping requirements for manufacturers of OTC cold, allergy, asthma and diet medicines that contain ephedrine, pseudoephedrine or phenylpropanolamine. While certain of the Company's OTC pharmaceutical products contain pseudoephedrine, none of the Company's products contain ephedrine, a chemical compound that is distinct from pseudoephedrine. Pseudoephedrine is a common ingredient in decongestant products manufactured by the Company and other pharmaceutical companies.
MANUFACTURING AND PACKAGING. All facilities where foods (including dietary supplements) and pharmaceuticals are manufactured, packed, warehoused, or sold must comply with the FDA manufacturing standards applicable to that type of product. All of the Company's products are manufactured, packaged and distributed according to the cGMP. The FDA performs periodic audits to ensure that the Company's facilities remain in compliance with the cGMP regulations. The failure of a facility to be in
compliance may lead to a breach of representations made to private label customers or to regulatory action against the products made in that facility, including seizure, injunction or recall. The Company believes that its facilities are in compliance in all material respects with the cGMPs and other applicable requirements for each facility.
CPSC. The United States Consumer Product Safety Commission has authority, under the Poison Prevention Packaging Act, to designate those products, including vitamin products and OTC pharmaceuticals, that require child resistant closures to help reduce the incidence of poisonings. The CPSC has adopted regulations requiring numerous OTC pharmaceuticals and iron-containing dietary supplements to have such closures, and has adopted rules on the testing of such closures by both children and adults. The Company, working with its packaging suppliers, believes that it is in compliance with all CPSC requirements.
FTC. The United States Federal Trade Commission exercises primary jurisdiction over the advertising and other promotional practices of food and OTC pharmaceuticals marketers, and has concurrent jurisdiction with the FDA over the advertising and promotional practices of marketers of dietary supplements. The FTC has historically applied a different standard to health-related claims than the FDA; the FTC has applied a "substantiation standard," which is less restrictive than the standard under the Nutritional Labeling Education Act ("NLEA"). The FTC NLEA enforcement policy uses FDA regulations as a baseline (and safe harbor) and permits (i) nutrient content descriptions that are reasonable synonyms of FDA-permitted terms, and (ii) qualified health claims not approved by FDA where adequate substantiation exists for the qualified or limited claims.
STATE REGULATION. All states regulate foods and drugs under local laws that parallel federal statutes. Because the NLEA gave the states the authority to enforce many labeling prohibitions of the Federal Food, Drug, and Cosmetic Act after notification to the FDA, the Company and other dietary supplement manufacturers may be subject to increasing state scrutiny for NLEA compliance, as well as increasing FDA review. The Company is also subject to California Proposition 65 and state consumer health and safety regulations which could have a potential impact on the Company's business if any of the Company's products were ever found not in compliance. The Company is not engaged in any enforcement or other regulatory actions and is not aware of any products which are not in compliance with California Proposition 65 and other similar state regulations.
USP. The United States Pharmacopoeia Convention, Inc. is a non-governmental, voluntary standard-setting organization. Its drug standards are incorporated by reference into the Federal Food, Drug, and Cosmetic Act as the standards that must be met for the listed drugs, unless compliance with those standards is specifically disclaimed. USP standards exist for most OTC pharmaceuticals. The FDA requires USP compliance as part of cGMP.
The USP began adopting standards for vitamin and mineral dietary supplements in 1994. These standards cover composition (nutrient ingredient potency and combinations), disintegration, dissolution, manufacturing practices and testing requirements. These standards are codified in the USP Monographs and the USP Manufacturing Practices. In 1995, USP compliance included the standards for disintegration and dissolution. While USP standards for vitamins are voluntary, and not incorporated into federal law, customers of the Company may demand that products they are supplied meet these standards. Label claims of compliance with the USP may expose a company to FDA scrutiny for such claims. In addition, the FDA may in the future require compliance, or such a requirement may be included in new dietary supplement legislation. All of the Company's vitamin products (excluding certain nutritional supplements products for which no USP standards have been adopted) are formulated to comply with existing USP standards and are so labeled.
CANADIAN REGULATION. In Canada, the Company's products are subject to federal and provincial law, particularly federal drug legislation. Government regulation under the Food and Drug Act and the
regulations thereunder (the "Canadian Act") require regulatory approvals of such products through a drug identification number ("DIN") by Health Canada--Health Protection Branch (the "HPB"). All substances sold for ingestion by humans are regulated either as a food or drug under the Canadian Act. In addition, certain of the Company's products are subject to government regulation under the Canadian Controlled Drugs and Substances Act and the regulations thereunder ("CDSA"). The Canadian Act and the CDSA are enforced by the HPB.
The Canadian Act governs the processing, formulation, packaging, labeling, advertising and sale of the Company's products and regulates what may be represented to the public on labels and in promotional material, in respect of the properties of the various products. The Canadian Act also provides that any drugs sold in Canada must have a label affixed thereto which shows certain information such as its proper scientific or common name, the name and address of the manufacturer, its lot number, adequate directions for use, a quantitative list of its medical ingredients and its expiration date. In addition, no person may sell a drug unless it has been assigned a DIN. DINs are obtained through an application to the HPB. Regulations under the Canadian Act require all manufacturers to pay annual fees for their DINs. HPB approval for the sale of the Company's products may be subject to significant delays despite the Company's best efforts.
The CDSA governs the manufacture and sale of controlled substances as defined in the CDSA. The CDSA contains requirements for licenses of the factory, approved security, a qualified person in charge of the factory and detailed record keeping in connection with the manufacturing of controlled substances.
Regulations under the Canadian Act set out mandatory and rigorous procedures, practices and standards for manufacturers. Health Canada performs inspections of companies in the industry to ensure compliance with the Canadian Act and the CDSA. For each of the Company's products, the development process, the manufacturing procedures, the use of equipment, and laboratory practices and premises must comply with Good Manufacturing Practices and Establishment Licensing regulations under the Canadian Act.
The Company's herbal products which are being marketed with drug claims or which contain drug substances require regulatory approval in the form of a DIN issued by Health Canada. Approvals are based on traditional references and are approved as Traditional Herbal Medicines. In addition, the Canadian government has established a panel to review the regulatory framework for natural products. If the Canadian government implements new or amended requirements for natural products it may result in additional costs to the Company for the requisite regulatory approval.
INTELLECTUAL PROPERTY
The Company regards its trademarks and other proprietary rights as valuable assets and believes they are important in the marketing of the Company's products. Among the Company's most significant trademarks are YOUR LIFE-REGISTERED TRADEMARK-, PHARMACIST FORMULA-REGISTERED TRADEMARK-, DAILY PAK-REGISTERED TRADEMARK-, CENTRAL-VITE-REGISTERED TRADEMARK- and BODYCOLOGY-REGISTERED TRADEMARK-. The Company has registered its marks in the United States and approximately 48 foreign countries. Leiner now owns 143 trademark registrations in the United States and 227 registrations abroad, as well as 69 pending applications for registration of trademarks in the United States and 47 pending applications in other countries. The Company intends to maintain the foreign and domestic registrations of its trademarks so long as they remain valuable to its business. The Company vigorously polices its marks and protects them from infringement.
The Company does not currently have any patents on its proprietary processes. The Company believes that it can better protect its trade secrets by maintaining the confidentiality of the relevant information.
ENVIRONMENTAL MATTERS
The Company is subject to various United States and Canadian federal, state, provincial and local environmental laws and regulations. The costs of complying with such laws and regulations have not had, and are not expected to have, a material adverse effect on the business of the Company.
RISK FACTORS
SUBSTANTIAL LEVERAGE; ABILITY TO SERVICE INDEBTEDNESS. As a result of the Recapitalization, the Company is highly leveraged. The Amended Credit Agreement (as defined in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources) and the indenture governing the Notes will permit the Company to incur or guarantee certain additional indebtedness, subject to certain limitations. The Company will be required to repay the $171.1 million in term loans outstanding as of March 31, 2000 under the Amended Credit Agreement by December 30, 2005, with scheduled principal payments of $1.7 million annually for fiscal 2001 and fiscal 2002, $1.8 million for fiscal year 2003, $37.1 million for fiscal 2004, $82.4 million for fiscal 2005, and $46.4 million in fiscal 2006. All outstanding revolving credit borrowings under the Amended Credit Agreement will become due on June 30, 2003. The Company expects that its working capital needs will require it to obtain replacement revolving credit facilities at that time. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources--Financing Arrangements."
The Company's high degree of leverage could have important consequences to holders of Notes, including, but not limited to the following: (i) the Company's ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes may be impaired in the future; (ii) a substantial portion of the Company's cash flow from operations must be dedicated to the payment of principal and interest on its indebtedness, thereby reducing the funds available to the Company for its operations and other purposes, including investments in research and development and capital spending; (iii) the Company may be substantially more leveraged than certain of its competitors, which may place the Company at a competitive disadvantage; (iv) the Company may be hindered in its ability to adjust rapidly to changing market conditions; and (v) the Company's substantial degree of leverage could make it more vulnerable in the event of a downturn in general economic conditions or its business or changing market conditions and regulations.
The Company's ability to repay or to refinance its obligations with respect to its indebtedness will depend on its future financial and operating performance, which, in turn, will be subject to prevailing economic and competitive conditions and to certain financial, business, legislative, regulatory and other factors, many of which are beyond the Company's control. These factors could include operating difficulties, increased operating costs, product pricing pressures, the response of competitors, regulatory developments, and delays in implementing strategic projects. The Company's ability to meet its debt service and other obligations may depend in significant part on the extent to which the Company can implement successfully its business strategy. There can be no assurance that the Company will be able to implement its strategy fully or that the anticipated results of its strategy will be realized.
If the Company's cash flow and capital resources are insufficient to fund its debt service obligations, the Company may be forced to reduce or delay capital expenditures, sell assets, or seek to obtain additional equity capital, or to refinance or restructure its debt. There can be no assurance that the Company's cash flow and capital resources will be sufficient for the payment of principal, premium, if any, and interest on, its indebtedness in the future, or that any such alternative measures would be successful or would permit the Company to meet its scheduled debt service obligations. In addition, because the Company's obligations under the Amended Credit Agreement will bear interest at floating rates, an increase in interest rates could adversely affect, among other things, the Company's ability to meet its debt service obligations. The Company entered into an interest protection arrangement effective July 30, 1997 for a period of three years with respect to $29.5 million of its indebtedness under the Amended Credit
Agreement that provides a fixed rate of 6.17% on the interest rates payable thereon. On October 8, 1999, the Company entered into an interest protection agreement with respect to $54.0 million of its indebtedness under the Amended Credit Agreement, whereby the Company will not pay any lower than 5.94% on LIBOR rates plus applicable margin. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources--Financing Arrangements."
In connection with the Acquisition, the Company assumed an industrial development revenue bond loan ("IRB Loan") with an outstanding principal amount of $7.1 million. The interest rate on the IRB Loan is variable (4.15% as of March 31, 2000), and fluctuates on a weekly basis. Principal is due and payable in annual installments of $0.5 million, with the remaining outstanding principal amount due and payable on May 1, 2014.
During fiscal 2000, the Company entered into a loan agreement with the Manitoba Industrial Opportunities Program to fund the expansion and upgrading of the Company's manufacturing facility in Canada. As of March 31, 2000, the Company received approximately $1.3 million in advances on the loan, which is not to exceed a total of approximately $1.9 million. Interest on the loan will be waived contingent upon the Company's compliance with certain obligations, including meeting certain financial ratios. Principal repayments are scheduled to be made in two equal payments of 50% of the final loan amount. The first payment is to be made on the last day of the 48(th) month and the second on the last day of the 60(th) month after the date of the final disbursement, which is to be made no later than September 30, 2000.
SUBORDINATION OF NOTES. The Notes are unsecured, senior subordinated obligations of Leiner, and as such, are subordinated in right of payment to all existing and future senior debt of Leiner, including indebtedness of Leiner under the Amended Credit Agreement and Leiner's guarantee of indebtedness of Vita Health under the Amended Credit Agreement. The Notes rank PARI PASSU with all senior subordinated indebtedness of Leiner, if any, and rank senior to all subordinated indebtedness of Leiner, if any. The Notes are also effectively subordinated to all secured indebtedness of Leiner to the extent of the value of the assets securing such indebtedness, and to all existing and future obligations and liabilities of Leiner's subsidiaries. The obligations of Leiner under the Amended Credit Agreement are secured by substantially all of the assets of Leiner and any future U.S. subsidiary of Leiner and a pledge of the capital stock of Leiner and any such subsidiary and 65% of the capital stock of any direct foreign subsidiary of Leiner. The obligations of Vita Health under the Amended Credit Agreement are additionally secured by substantially all of the assets of Vita Health and its Canadian parents and subsidiaries.
In the event of bankruptcy, liquidation, dissolution, reorganization or any similar proceeding regarding Leiner, or any default in payment or acceleration of any debt thereof, the assets of Leiner will be available to pay obligations on the Notes only after the senior debt of Leiner has been paid in full, and there may not be sufficient assets remaining to pay amounts due on all or any of such Notes.
RESTRICTIVE FINANCING COVENANTS. The Amended Credit Agreement contains a number of covenants that significantly restrict the operations of the Company. In addition, the Company is required to comply with specified financial ratios and tests, including minimum net worth requirements, maximum leverage ratios, minimum fixed charge coverage ratios and minimum EBITDA to cash interest expense ratios, and certain of these ratios and tests may be more restrictive in future years. There can be no assurance that the Company will be able to comply with such covenants or restrictions in the future. The Company's ability to comply with such covenants and other restrictions may be affected by events beyond its control, including prevailing economic, financial and industry conditions. The breach of any such covenants or restrictions could result in a default under the Amended Credit Agreement that would permit the lenders thereunder to declare all amounts outstanding thereunder to be immediately due and payable, together with accrued and unpaid interest, and terminate their commitments to make further extensions of credit thereunder, and the Company could be prohibited from making any payments on the Notes. In addition, the indenture governing the Notes contains a number of restrictive covenants relating to the Company. These covenants, however, are subject to a number of exceptions and limitations, and may not afford holders of the Notes
with protection in the event of a highly-leveraged transaction, reorganization, restructuring, merger or similar transaction involving the Company that may adversely affect holders of the Notes.
CHANGE OF CONTROL. Upon the occurrence of a Change of Control (as defined in the indenture governing the Notes), the Company will be required to make an offer to purchase all of the outstanding Notes at a price equal to 101% of the principal amount thereof at the date of purchase plus accrued and unpaid interest, if any, to the date of purchase. The occurrence of certain of the events that would constitute a Change of Control under the indenture governing the Notes would constitute a default under the Amended Credit Agreement and might constitute a default under other indebtedness of the Company. In addition, the Amended Credit Agreement prohibits the purchase of the Notes in the event of a Change of Control, unless and until such time as the indebtedness under the Amended Credit Agreement is repaid in full. The Company's failure to purchase the Notes in such instance would result in default under each of the indentures governing the Notes and the Amended Credit Agreement. The inability to repay the indebtedness under the Amended Credit Agreement, if accelerated, could have material adverse consequences to the Company and to the holders of the Notes. Future indebtedness of the Company may also contain prohibitions of certain events or transactions that could constitute a Change of Control or require such indebtedness to be repurchased upon a Change of Control. In the event of a Change of Control, there can be no assurance that the Company would have sufficient assets to satisfy all of its obligations under the Amended Credit Agreement and the Notes.
FRAUDULENT TRANSFER CONSIDERATIONS. The incurrence of the indebtedness evidenced by the Notes may be subject to review under federal bankruptcy law or relevant state fraudulent conveyance laws if a bankruptcy case or lawsuit is commenced by or on behalf of unpaid creditors of the Company.
CONTROL OF THE COMPANY. North Castle holds approximately 57.4% of the issued and outstanding Leiner Group voting common stock. Pursuant to the terms of the Leiner Group Stockholders Agreement, dated as of June 30, 1997, as amended (the "Stockholders Agreement"), and entered into in connection with the Recapitalization, North Castle controls the Company and has the power to appoint new management and approve any action requiring the approval of the holders of Group common stock, including adopting amendments to Leiner Group's certificate of incorporation and approving mergers or sales of substantially all of the Company's assets. There can be no assurance that the interests of North Castle will not conflict with the interests of the holders of the Notes. Under North Castle's operating agreement, Mr. Baird has authority and discretion over the business affairs and operations of North Castle. See "Item 10. Directors and Executive Officers" and "Item 13. Certain Relationships and Related Transactions."
EFFECT OF RESEARCH AND PUBLICITY ON VITAMIN PRODUCT BUSINESS. The Company believes the growth experienced in the last several years by the vitamin product business is based largely on national media attention regarding recent scientific research suggesting potential health benefits from regular consumption of certain vitamin products. Various studies published since 1992 by researchers at major universities have suggested an association between regular consumption of antioxidant supplements such as vitamins E and C and a reduced risk of certain diseases, including heart disease, cancer and Alzheimer's disease. In addition, certain other studies have reported that consumption of folic acid (a B vitamin) can aid prevention of heart disease and neural tube birth defects. Such research has been described in major medical journals, magazines, newspapers and television programs. However, some recent studies relating to certain antioxidants have produced results contrary to the favorable indications of other prior and subsequent studies. The scientific research to date with respect to antioxidants and certain other of the Company's products is not conclusive, and there can be no assurance of future favorable scientific results and media attention, or the absence of unfavorable or inconsistent findings. In the event of future unfavorable scientific results or media attention, the Company's sales of vitamin products could be materially adversely affected.
POTENTIAL FOR INCREASED GOVERNMENT REGULATION. The manufacturing, processing, formulation, packaging, labeling, advertising and sale of the Company's products are subject to regulation by one or more United States and Canadian federal agencies, including the FDA, the FTC, CPSC and Health Canada. The Company's activities are also regulated by various agencies of the states, provinces, localities and countries in which the Company's products are sold. In addition, the Company manufactures and markets certain of its products in compliance with the guidelines promulgated by voluntary standard organizations, such as the USP. See "Government Regulations."
RELIANCE ON CERTAIN CUSTOMERS AND CERTAIN PRODUCTS. The Company has approximately 210 active U.S. customers. In fiscal 2000, Wal-Mart Stores, Inc. and Costco accounted for approximately 31% and 9%, respectively, of the Company's sales. Each of the Company's other major customers accounted for less than 10% of the Company's sales for fiscal 2000. The Company's top ten customers, in the aggregate, accounted for approximately 68% of the Company's sales for fiscal 2000. Sales of vitamins C and E, in the aggregate, accounted for approximately 30.9% of the Company's sales in fiscal 2000. If one or more of the Company's major customers substantially reduced their volume of purchases from the Company, or if sales of vitamin C or E were substantially reduced, the Company's results of operations could be materially adversely affected.
POTENTIAL FOR INCREASED COMPETITION. The market for the Company's products is highly competitive. The Company competes with other vitamin product and OTC pharmaceuticals manufacturers. Among other factors, competition among these manufacturers is based upon price. If one or more manufacturers significantly reduce their prices in an effort to gain market share, the Company's results of operations or market position could be adversely affected. Certain of the Company's competitors, particularly manufacturers of nationally advertised brand name products, are larger and have resources substantially greater than those of the Company, and are less leveraged than the Company. In the future, one or more of these companies could seek to compete more directly with the Company by manufacturing private label products or by significantly lowering the prices of their national brand products.
The Company sells substantially all of its vitamin products to Mass Market and warehouse club retailers. The Company does not currently participate significantly in other channels such as health food stores, direct mail and direct sales. The Company's products may, therefore, face competition from such alternative channels as more customers utilize these channels of distribution to obtain vitamin products.
RELIANCE ON CERTAIN SUPPLIERS; AVAILABILITY AND COST OF PURCHASED MATERIALS. The Company purchases from third party suppliers raw materials and certain products that the Company does not manufacture. Although the Company currently has supply arrangements with several suppliers of these ingredients and products, and the Company's purchased materials are generally available from numerous sources, an unexpected interruption of supply could materially adversely affect the Company's results of operations. See "Purchased Materials."
POSSIBILITY OF TRADE DRESS CLAIMS. The Company's packaging of certain of its branded products identifies nationally branded products to which the Company's products are comparable. Although the Company designs its packaging to avoid infringing upon any proprietary rights of national brand marketers and is not currently the subject of any legal actions regarding infringement, there can be no assurance that the Company will not be subject to such legal actions in the future.
EXPOSURE TO PRODUCT LIABILITY CLAIMS. The Company, like other retailers, distributors and manufacturers of products that are ingested, faces a risk of exposure to product liability claims in the event that, among other things, the use of its products results in injury. With respect to product liability coverage, the Company currently has an aggregate of $81 million of insurance coverage, including primary product liability and excess liability coverage with deductibles of $.25 million per claim, subject to an annual aggregate deductible limit of $1 million. There can be no assurance that product liability insurance will continue to be available at an economically reasonable cost or that the Company's insurance will be
adequate to cover liability the Company incurs in respect to product liability claims. See also "Item 3. Legal Proceedings and Product Liability."
RELIANCE ON KEY MANAGEMENT. The operation of the Company requires managerial and operational expertise. Leiner does not have employment contracts with any of its executive officers. Leiner has entered into severance benefit agreements with certain members of Leiner senior management. See "Item 11. Executive Compensation--Severance Arrangements." If, for any reason, key personnel do not continue to be active in Leiner management, operations could be adversely affected.
ACQUISITION RELATED RISKS. Part of the Company's business strategy has been and will continue to be to acquire other businesses that will complement its existing business. Management is unable to predict whether or when any prospective acquisition candidates will become available or the likelihood of a material transaction being completed should any negotiations commence. The Company's ability to finance acquisitions may be constrained by, among other things, its high degree of leverage. The Amended Credit Agreement and the indenture which governs the Notes may significantly limit the Company's ability to make acquisitions and to incur indebtedness in connection with acquisitions. In addition, acquisitions that the Company may make or in which the Company may enter will involve risks, including the successful integration and management of acquired technology, operations and personnel. The integration of acquired businesses may also lead to the loss of key employees of the acquired companies and diversion of management attention from ongoing business concerns. There can be no assurance that any acquisitions will be made, that the Company will be able to obtain additional financing needed to finance such transactions and, if any acquisitions are made, that they will be successful.
RISKS ASSOCIATED WITH INTERNATIONAL MARKETS. The Company's continued growth is dependent in part upon its ability to expand its operations into new markets, including international markets. The Company may experience difficulty entering new international markets due to greater regulatory barriers, the necessity of adapting to new regulatory systems and problems related to entering new markets with different cultural bases and political systems. Operating in international markets exposes the Company to certain risks, including, among other things, (i) changes in or interpretations of foreign import, currency transfer and other restrictions and regulations that among other things may limit the Company's ability to sell certain products or repatriate profits to the United States, (ii) exposure to currency fluctuations, particularly in light of the Company's substantial interest payment obligations, which must be paid in United States and Canadian dollars, (iii) the potential imposition of trade or foreign exchange restrictions or increased tariffs, and (iv) economic and political instability. As the Company continues to expand its international operations, these and other risks associated with international operations are likely to increase.
ITEM 2
ITEM 2 PROPERTIES
The following table sets forth the location, type of facility, square footage and ownership interest in each of the Company's principal facilities. The Company also leases certain additional office space throughout the United States.
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(1) The Company has the option to extend by 10 years.
The Company believes that its facilities and equipment are generally well maintained and in good operating condition.
Leiner's active manufacturing and distribution facilities consist of approximately 2.0 million square feet of owned or leased plant and office facilities in nine locations, in five U.S. states and two Canadian Provinces. The Company is one of the largest manufacturers in the North American vitamin products industry and is capable of packaging over 25 billion doses each year. In April 1995, Leiner was the first major vitamin product manufacturer to be certified as being in compliance with USP's vitamin manufacturing standards, which became effective in January 1995. The Company's U.S. facilities were audited by an independent quality assurance laboratory and received the laboratory's highest categorical rating. All of the Company's U.S. manufacturing facilities also have been audited by the FDA and have been found to be in compliance with the FDA's cGMP.
Leiner has five U.S. manufacturing facilities, which are located in Garden Grove, California, Valencia, California, Kalamazoo, Michigan, Wilson, North Carolina and Fort Mill, South Carolina. The primary manufacturing facility for the Company's vitamin products is its 138,500 square foot Garden Grove plant. The primary manufacturing facilities for the Company's OTC pharmaceuticals are the Company's 51,250 square foot Kalamazoo plant, and its 125,000 square foot Wilson facility. In the event of a catastrophic
casualty to one of the Company's primary vitamin or OTC tableting facilities, the Company has the ability to shift production to other facilities. The Company operates 44 tableting machines in its Garden Grove, California facility and 15 tableting machines in its Kalamazoo, Michigan facility, 8 tableting machines in its Fort Mill, South Carolina facility and 7 tableting machines in its Wilson, North Carolina facility. In fiscal 2000, the Company operated three packaging and distribution facilities in the U.S., which are located in Carson, California, Fort Mill, South Carolina and Largo, Florida. These facilities are equipped with a total of 32 packaging lines, and, as with tableting, products can be shifted between facilities in the event such a need arises.
In fiscal 1999, the Company established the Fort Mill, South Carolina manufacturing, packaging and distribution center. The center serves the Company's retail customers throughout the eastern United States and operated at 70% capacity in fiscal 2000. The center will employ approximately 800 employees when it becomes fully operational. The majority of these employees will be recruited from the local labor force with a smaller percentage relocating from the Company's other facilities.
Vita Health currently tablets, bottles and packages its products in a modern, newly expanded 185,000 square foot facility in Manitoba of which approximately 20,000 square feet is office space. Vita Health also has a 123,000 square foot manufacturing and distribution center in British Columbia.
ITEM 3
ITEM 3 LEGAL PROCEEDINGS AND PRODUCT LIABILITY
On September 27, 1999, the Company filed a civil antitrust lawsuit (the "Antitrust Lawsuit") against certain of its raw material suppliers and other alleged co-conspirators. The complaint alleges that the defendants conspired to fix vitamin prices and allocate vitamin production volume and vitamin customers in the United States. The complaint seeks unspecified damages and injunctive relief. After the lawsuit was filed, it was consolidated, for pre-trial purposes, with other similar cases. Based on the pretrial schedule set forth by the court, the case will not be ready for trial until approximately April 2002. At the present time, management cannot predict the outcome of this lawsuit, nor the estimated damages and potential recovery, if any.
In March 2000, the Company entered into a settlement agreement with one of its suppliers named in the Antitrust Lawsuit (the "Settlement Agreement"). Pursuant to the terms of the Settlement Agreement, the Company agreed to release all claims it may have against the supplier based on the Company's purchases of various vitamins from the supplier and to opt out of any settlement in connection with a pending class action lawsuit in so far as it pertains to the supplier.
In exchange for the Company's release and agreement to opt out of any settlement in the pending class action lawsuit, the Company received a settlement payment of approximately $2.4 million on March 21, 2000 which is recorded in other operating (income) charges in the accompanying Statement of Operations for the fiscal year ended March 31, 2000. In connection with the settlement, the Company incurred direct expenses of approximately $0.2 million which are recorded in general and administrative expenses.
The Company is subject to other legal proceedings and claims which arise in the normal course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, management does not believe the outcome of any of these matters will have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows.
The Company, like other retailers, distributors and manufacturers of products that are ingested, faces a risk of exposure to product liability claims in the event that, among other things, the use of its products results in injury. With respect to product liability coverage, the Company currently has an aggregate of
$81 million of insurance coverage, including primary product liability and excess liability coverage with deductibles of $.25 million per claim, subject to an annual, aggregate deductible limit of $1 million.
ITEM 4
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth quarter of fiscal 2000.
PART II ITEM 5
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no trading market for the Company's Common Stock. All of the outstanding shares of the Company's Common Stock are held by PLI Holdings. The Company did not pay any dividends in fiscal 2000 or fiscal 1999.
ITEM 6
ITEM 6 SELECTED FINANCIAL DATA
The following table presents selected historical financial data derived from the consolidated financial statements of the Company. This data should be read in conjunction with "Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations," and "Item 8, Financial Statements and Supplementary Data."
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(1) On December 17, 1999, the Company acquired substantially all of the assets of Granutec and Stanley and certain related assets of Novopharm. The Acquisition was accounted for using the purchase method of accounting. Accordingly, the operating results of Granutec and Stanley since the date of acquisition to March 31, 2000 are included in the consolidated financial results of the Company.
(2) On January 30, 1997, the Company acquired Vita Health. The Vita Health acquisition was accounted for under the purchase method of accounting. Consequently, the results of operations of Vita Health were included in the consolidated financial results of the Company from the date of acquisition to March 31, 1997.
(3) During fiscal 2000, $1.1 million of costs were incurred in connection with the closure of the Company's Madison, Wisconsin and Sherburne, New York facilities, which were offset by the gain on the sale of the Madison facility in the amount of $0.2 million and the sale of the Chicago, Illinois facility of $0.3 million. During fiscal 1999, $0.4 million of additional costs related to the closure of the West Unity, Ohio facility were expensed as incurred. During fiscal 1998, the Company announced the closure of its West Unity, Ohio facility. Accordingly, the Company reserved $1.2 million for closure costs of which $0.7 million was related to severance costs and $0.5 million was related to other closure costs. During fiscal 1997, the Company closed its liquid OTC manufacturing facility and out-sourced the production to a third party. The related costs incurred of $1.4 million included the write-off of fixed assets of $0.8 million and closure costs including salaries in conjunction with the facility closing of $0.6 million. During fiscal 1996, the Company decided to significantly reduce the size of its OTC liquid pharmaceuticals manufacturing business. Accordingly, the Company determined that certain long-lived assets with a carrying amount of $8.3 million were impaired and wrote them down by $4.7 million to their estimated fair value.
(4) Represents non-recurring charges relating to the Recapitalization, consisting of (x) a compensation charge incurred by the Company for the in-the-money value of existing stock options of $15.6 million which were (i) converted into an equivalent value of Equity Rights at the date of the Recapitalization, (ii) paid out in cash, or (iii) exercised for common stock (or a combination thereof), (y) $5.2 million in transaction bonuses which were paid to members of the Company's management subsequent to the Recapitalization, and (z) expenses aggregating $12.0 million incurred by Leiner Group in connection with its capital raising activities. These non-recurring charges contributed significantly to the Company's net loss of $17.4 million for fiscal 1998. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Fiscal 1999 Compared to Fiscal 1998."
(5) During fiscal 1997, the Company reorganized the management team. Expenses of $1.0 million included severance expense for the previous Chief Financial Officer, Vice President of Product Development and Vice President of Corporate Development and included the hiring and relocation expenses for the new Chief Financial Officer and other corporate officers.
(6) Other operating income in fiscal year 2000 includes a settlement involving a dispute with a vitamin product supplier in the amount of approximately $2.4 million. See Item 3 "Legal Proceedings and Product Liability". Other operating charges include management fees paid to related parties in the amount of $1.5 million for fiscal year 2000, $1.7 million in fiscal year 1999, $1.3 million in fiscal year 1998 and $0.4 million for fiscal years 1997 and 1996. Other operating income in fiscal 1999 includes a nonrecurring settlement arising from a dispute involving a service provider and a former employee in the amount of approximately $2.0 million.
(7) "EBITDA," as presented, represents earnings before interest expense, income taxes, depreciation and amortization and other non-cash charges, consisting of (i) the write off of deferred financing charges, net of income taxes, included as an extraordinary item in the statements of operations for fiscal 1998 and fiscal 1997, (ii) non-cash stock compensation charges, including those recorded in
connection with the Recapitalization (see Note 4), (iii) expenses related to the closure of facilities (see Note 3), and (iv) other non-cash charges in fiscal 1997.
EBITDA is calculated as follows (in thousands):
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(a) Excluding the Recapitalization-related expenses, EBITDA would have been $51.8 million for fiscal 1998.
Although EBITDA (as well as related EBITDA ratios) is a non-GAAP measurement, EBITDA, EBITDA margin, the ratio of total debt to EBITDA and the ratio of EBITDA to interest expense are included because management understands that such information is considered by certain investors to be an additional basis for evaluating the Company's ability to pay interest, repay debt and make capital expenditures. EBITDA should not be considered an alternative to measures of operating performance as determined in accordance with generally accepted accounting principles, including net income as a measure of the Company's operating results and cash flows as a measure of the Company's liquidity. Because EBITDA is not calculated identically by all companies, the presentation herein may not be comparable to other similarly titled measures of other companies.
(8) Depreciation and amortization as presented here does not include the amortization of deferred financing fees. In the statement of cash flows in the consolidated financial statements, the amortization of deferred financing fees is included in depreciation and amortization.
(9) For purposes of calculating the ratio of EBITDA to interest expense, interest expense excludes the amortization of deferred financing fees, which is included in interest expense in the statement of operations in the consolidated financial statements.
(10) In calculating the ratio of earnings to fixed charges, earnings consist of income before taxes plus fixed charges. Fixed charges consist of interest expense and amortization of deferred financing fees, whether capitalized or expensed, plus one-third of rental expense under operating leases (the portion that has been deemed by the Company to be representative of an interest factor). Earnings were inadequate to cover fixed charges by $15.1 million for the year ended March 31, 1998.
ITEM 7
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the Company's financial condition and results of operations should be read in conjunction with the consolidated financial statements of the Company contained elsewhere in this report. The Company's fiscal year ends on March 31 of each year. References herein to a "fiscal year" refer to the Company's fiscal year ended March 31 in the calendar year indicated (e.g., references to fiscal 2000 are references to the Company's fiscal year ended March 31, 2000).
GENERAL
CURRENT TRENDS. The Company believes that overall trends in the vitamin industry are the most significant trends affecting the Company's financial performance. For the 52 week period ended March 26, 2000, vitamin sales for the U.S. Mass Market increased approximately 7% versus the comparable period in the prior year. In the recent 13 week period ended March 26, 2000, however, market growth versus the prior year has slowed to under 2% versus the high growth periods in the prior year. For the 52 week period ended March 28, 1999, vitamin sales for the U.S. Mass Market had increased more than 16% over the prior 52 week period. According to industry sources, between 1992 and 2000, vitamin sales for the Mass Market increased at a compound annual rate of approximately 14% to $3.4 billion, as the percentage of American adults regularly using vitamins increased from 35% to 48%.
Increasing vitamin usage among the general population is linked to three major factors. First, research expenditures devoted to the positive effects of vitamin products have increased dramatically. Such research has been described in major medical journals and reported in the popular media. Second, the national trend towards improved fitness, greater self-care and preventive medicine has increased the general population's focus on consumption of nutritional products. Finally, the more favorable regulatory environment resulting from the DSHEA has generated increased new product introductions and more effective point of sale communication of the health benefits of vitamins to consumers. However, as has been the case in the past, adverse scientific research or publicity concerning the health benefits of vitamin consumption could materially impact the growth of the vitamin market.
Beginning in fiscal 1996 and continuing through fiscal 2000, the retail drug store industry experienced several major consolidations. The Company provides private label vitamin products to 8 of the 10 largest drug store chains in the United States and believes it has strong relationships with the leading drug store chains. Consequently, management believes the Company is well positioned to benefit from this consolidation trend due to its strong relationships with the acquiring companies in the largest consolidations and the anticipated reduction in the number of vendors as the consolidated companies streamline their purchasing. The Company believes that the consolidation of major drug store chains has had a positive effect on its sales and that the increased purchasing scale of the consolidated retailers increases the relative importance of each of these customers to the Company's financial performance. However, there can be no assurance that in the future such consolidations will not have adverse impacts on the Company's sales and financial performance.
RECAPITALIZATION ACCOUNTING; FINANCIAL STATEMENT PRESENTATION; PARENT COMPANY. The Recapitalization was accounted for as a recapitalization of Leiner Group, which had no impact on the historical basis of assets and liabilities as reflected in the consolidated financial statements of Leiner Group or the Company. The Recapitalization involved significant changes to the Company's capital structure, which resulted in higher reported interest expense. As a result, operating results for the periods subsequent to the Recapitalization date of June 30, 1997 are not comparable in all material respects to earlier periods. Other than with respect to redeemable preferred stock of Leiner Group, which was redeemed in connection with the Recapitalization, the consolidated financial statements of Leiner Group and Leiner for the periods discussed in the following paragraphs are not materially different.
ACQUISITION. On December 17, 1999, Leiner Health Products Inc. acquired substantially all of the assets of Granutec, Inc. ("Granutec"), a manufacturer and distributor of private label, over-the-counter pharmaceutical drugs in the United States, and Vita Health acquired substantially all of the assets of Stanley Pharmaceuticals Ltd. ("Stanley"), a manufacturer and distributor of private label, over-the-counter pharmaceutical drugs and vitamin supplement products in Canada, both of which were subsidiaries of Novopharm Limited of Ontario, Canada ("Novopharm"). The Company also acquired certain related assets of Novopharm (collectively, the "Acquisition"). The purchase price of approximately $60.2 million was funded in part by a $20.0 million capital contribution from the Company's ultimate parent, Leiner Group, and borrowings on the Company's revolving credit facility. The Acquisition was accounted for as a purchase under Accounting Principles Board Opinion No. 16, Business Combinations ("APB 16"). In accordance with APB 16, the Company allocated the price based on the fair value of the assets acquired and liabilities assumed. Portions of the purchase price, including intangible assets, were identified by independent appraisers utilizing proven valuation procedures and techniques. Acquired intangibles totaling $10.2 million included the fair value of customer base, acquired workforce and accelerated new drug applications. These intangibles are being amortized over their estimated useful lives of three to five years. Goodwill resulting from the acquisition is being amortized over 15 years.
In connection with the Acquisition, the Company has recorded approximately $7.0 million for accrued restructuring charges. The restructuring plan includes initiatives to integrate the operations of the Company with those of Granutec and Stanley, and reduce overhead, primarily through the transfer of certain manufacturing activities to lower cost facilities. The Company expects these actions to result in a reduction in workforce. Management is in the process of finalizing its restructuring plans and, accordingly, the amounts recorded are based on management's current estimate of those costs. The Company will finalize these plans during fiscal year 2001, and expects the majority of the restructuring actions to occur in fiscal year 2001 and 2002.
The components of the purchase price and the preliminary allocation are as follows (in millions):
As previously indicated, some allocations are based on preliminary estimates that are still being finalized. In addition, certain adjustments to the final purchase price are currently being negotiated with Novopharm. While the ultimate resolution of these matters may result in adjustments to the purchase price allocation, management believes that such amounts will not be materially different from those reflected above.
The following unaudited pro forma financial information presents the consolidated results of operations as if the Acquisition had occurred at the beginning of the year presented, and does not purport to be
indicative of the results that would have occurred had the Acquisition occurred at such date or of results which may occur in the future (in millions).
RESULTS OF OPERATIONS
The following table summarizes the Company's historical results of operations as a percentage of net sales for fiscal 2000, 1999 and 1998.
FISCAL 2000 COMPARED TO FISCAL 1999
Net sales for fiscal 2000 increased by $35.4 million, or 5.6% over fiscal 1999, from $626.9 million to $662.3 million. This increase was due to the Acquisition, which provided an additional $39.1 million of sales from OTC pharmaceutical drugs. Excluding net sales from Granutec and Stanley, the Company's net sales decreased $3.7 million compared to the prior year. This decrease was primarily the result of an overall slowdown in the Food, Drug and Mass market. Management estimates that vitamin sales for the overall U.S. Mass Market only grew by approximately 7% during the 52 week period ended March 26, 2000 compared to the 16% growth during the 52 week period ended March 28, 1999. The market slowdown resulted in decreased sales as customers adjusted their inventory in response to the slower rate of growth.
Gross profit margin for fiscal 2000 was 25.2% versus 26.0% in fiscal 1999. Gross profit increased $3.3 million, or 2.0%, from $163.3 million in fiscal 1999 to $166.6 million in fiscal 2000. The increase in gross profit is a result of the Acquisition, which accounted for $8.8 million of the increase, which was offset by a decrease of $5.5 million attributable to lower sales, a shift in the product mix to lower margin products, and pricing pressures on vitamins C and E.
Marketing, selling and distribution expenses together with general and administrative expenses (collectively, "Operating Expenses") increased $10.7 million, or 9.3%, in fiscal 2000 when compared to fiscal 1999. Operating Expenses for fiscal 2000 totaled $125.0 million, representing 18.9% of net sales, showing an increase over the prior year in which Operating Expenses totaled $114.3 million or 18.2% of net sales. This increase in Operating Expenses for fiscal 2000 is primarily the result of higher fixed costs associated with infrastructure development in support of advanced science and product quality initiatives, increased spending on information systems projects, including those related to the year 2000 issue, and an increase in marketing expenditures related to the relaunch of the Your Life-Registered Trademark- Brand.
Amortization of goodwill and other intangibles increased to $2.7 million in fiscal 2000 versus $1.7 million in fiscal 1999, primarily as a result of the Acquisition.
During fiscal 2000, the Company closed its Madison, Wisconsin and Sherburne, New York facilities. As a result, the Company incurred $1.1 million of expenses primarily for severance and relocation costs related to the closures which were offset by a $0.3 million gain from the sale of the Company's Chicago, Illinois facility and $0.2 million from the sale of the Madison facility. In fiscal 1999, $0.4 million of additional expenses were incurred related to the West Unity, Ohio facility, which closed in fiscal 1998.
Other operating income for fiscal 2000 was $0.9 million versus other operating income of $0.1 million in fiscal 1999. The increase in other operating income was due to the settlement of a supplier dispute in the amount of $2.4 million which is offset by management fees paid in the amount of $1.5 million. In fiscal 1999, the Company received a non recurring settlement arising from a dispute involving a service provider and a former employee, which was partially offset by management fees in the amount of $1.7 million and other operating charges of $0.2 million.
The Company's operating income for fiscal 2000 was $39.2 million, representing a $7.8 million decrease from fiscal 1999, primarily due to higher operating expenses as described above.
Net interest expense increased by $2.4 million to $31.1 million during fiscal 2000, compared to $28.7 million for fiscal 1999. This was due to an increase in the indebtedness of the Company resulting from the Acquisition, and to a lesser degree, increased interest rates.
The provision for income taxes for fiscal 2000 was $3.1 million, which compares to $8.0 million for fiscal 1999. The Company's effective tax rate is 39% for fiscal 2000 which closely approximates the combined federal and state rate. The effect of non-deductible goodwill is offset by the benefit of certain tax credits.
Primarily as a result of the previously discussed factors, net income of $4.9 million was recorded in fiscal 2000 compared to a net income of $10.3 million recorded in fiscal 1999.
FISCAL 1999 COMPARED TO FISCAL 1998
Net sales for fiscal 1999 increased by $124.8 million, or 24.9%, over fiscal 1998, from $502.1 million to $626.9 million. This increase was due primarily to sales growth in the U.S. vitamin market. Vitamin product sales increased by $105.3 million, or 24.8%, compared to the prior year. Management estimates that vitamin sales for the overall U.S. Mass Market grew by over 16% during the 52 week period ended March 28, 1999 compared to the comparable prior year period. Sales of OTC pharmaceuticals increased by $4.5 million, or 7.4%, compared to the prior year. This increase in sales was due primarily to the introduction of new digestive aid products.
Gross profit margin for fiscal 1999 was 26.0% versus 26.6% in fiscal 1998. Gross profit increased $29.8 million, or 22.3%, from $133.5 million in fiscal 1998 to $163.3 million in fiscal 1999. The increase in gross profit is primarily attributed to the higher sales volume.
Marketing, selling and distribution expenses together with general and administrative expenses (collectively, "Operating Expenses") increased $22.2 million, or 24.1%, in fiscal 1999 when compared to fiscal 1998. Operating Expenses for fiscal 1999 totaled $114.3 million, representing 18.2% of net sales, showing a slight improvement over the prior year in which Operating Expenses totaled $92.1 million or 18.4% of net sales. This increase in Operating Expenses for fiscal 1999 is primarily the result of infrastructure development in support of new products and diversification strategies and increased costs associated with changing all the Company's product labels to comply with the new DSHEA regulations effective March 23, 1999. The improvement in Operating Expenses as a percentage of net sales is the result of a cost control strategy to maintain a lower percentage growth of Operating Expenses.
Goodwill amortization of $1.7 million in both fiscal 1999 and fiscal 1998 related to the goodwill arising from the acquisitions of Leiner, XCEL Laboratories, Inc. and Vita Health.
During fiscal 1998, the Company announced its plans to close its West Unity, Ohio facility in fiscal 1999. As a result, the Company incurred $1.2 million of expenses primarily for severance and relocation costs related to the closure in fiscal 1998. In fiscal 1999, an additional $0.4 million of expense was incurred related to the West Unity closure.
In fiscal 1998, the Company recorded compensation expenses related to the in-the-money value of stock options issued to certain management personnel of $15.6 million, management bonuses of $5.2 million, and expenses incurred by Leiner Group in connection with its capital raising activities of $12.0 million, all of which related to the Recapitalization.
Other operating income for fiscal 1999 was $0.1 million versus other charges of $1.3 million in fiscal 1998. The increase in other income was due primarily to a non-recurring settlement arising from a dispute involving a service provider and a former employee in fiscal 1999, partially offset by a full year of management fees as a result of a consulting agreement entered into in connection with the Recapitalization. Other charges in fiscal 1998 primarily represented the management fees incurred in connection with the same consulting agreement in effect in fiscal 1999. See "Item 13. Certain Relationships and Related Transactions."
The Company's operating income for fiscal 1999 was $47.1 million, representing a $42.7 million increase over fiscal 1998 primarily due to the $32.8 million of Recapitalization-related expenses recorded in fiscal 1998. The Company had operating income of only $4.4 million for fiscal 1998. Eliminating the effect of such recapitalization-related expenses, operating income increased $9.9 million or 26.6% from $37.2 million in fiscal 1998 to $47.1 million in fiscal 1999 primarily due to the higher sales volumes.
Net interest expense increased by $9.2 million to $28.7 million during fiscal 1999, compared to $19.5 million for fiscal 1998. This was due to an increase in the indebtedness of the Company, as well as changes in the debt structure and interest rates arising as a result of the Recapitalization taking effect at the end of the first quarter of fiscal 1998.
The provision for income taxes for fiscal 1999 was $8.0 million, which compares to $1.2 million for fiscal 1998. The Company's effective tax rate of 44% for fiscal 1999 was higher than the combined federal and state rate of 40% primarily because of the nondeductability of goodwill amortization and expenses recorded in connection with certain accrued liabilities.
The extraordinary loss recorded in fiscal 1998 represented the write-off of $1.9 million of deferred financing charges which had been incurred by the Company when it entered into a credit facility on January 30, 1997. The income tax effect of that charge was a benefit of $0.8 million.
Primarily as a result of the previously discussed factors, net income of $10.3 million was recorded in fiscal 1999 compared to a net loss of $17.4 million recorded in fiscal 1998.
LIQUIDITY AND CAPITAL RESOURCES
GENERAL. The Company's cash has historically been used to fund capital expenditures, working capital requirements and debt service. As a result of the Recapitalization effective at the end of the first quarter of fiscal 1998, the Company's liquidity requirements were significantly increased, primarily due to significantly increased interest expense obligations. Interest expense, excluding amortization of deferred financing fees, totaled $29.2 million in fiscal 2000. In addition, the Company is required to repay the $171.1 million in term loans outstanding as of March 31, 2000 under the Amended Credit Agreement by December 30, 2005, with scheduled principal payments of $1.7 million for fiscal 2001 and 2002, $1.8 million for fiscal 2003, $37.1 million for fiscal 2004, $82.4 million for fiscal 2005, and $46.4 million for fiscal 2006. The Company is also required to apply certain asset sale proceeds, as well as 50% of its excess cash flow (as defined in the Amended Credit Agreement) unless a leverage ratio test is met, to prepay the borrowings under the Amended Credit Agreement. All outstanding revolving credit borrowings under the Amended Credit Agreement will become due on June 30, 2003.
CASH FLOW. During fiscal 2000, net cash provided by operating activities totaled $48.9 million, comprised of net income of $4.9 million combined with non cash charges to operations aggregating $19.7 million and changes in operating assets and liabilities, net of the effects of the Acquisition, aggregating $24.3 million. Non cash charges consist of depreciation and amortization aggregating $21.6 million offset by deferred tax benefits and translation adjustments aggregating $1.9 million. Changes in operating assets and liabilities are comprised of collections on account receivables of $19.5 million and increases in accounts payables and accrued expenses aggregating $6.7 million, offset by an increase in inventories of $0.5 million and net changes in certain other operating assets and liabilities of $1.4 million. Accounts receivables were reduced due to increased focus on customer collections while accounts payable and accrued expenses increased primarily due to the timing of disbursements. Management focused on optimizing the Company's inventory levels throughout fiscal 2000 and has been successful at managing inventory levels at a minimal growth rate.
Net cash used in investing activities was $76.6 million in fiscal 2000. This was primarily due to the Acquisition. Upon closing of the Acquisition, the Company used approximately $32.7 million of funds available under its Revolving Facility and a $20.0 million capital contribution it received from its direct parent to fund the purchase price and related expenses. The Company also assumed approximately $7.5 million of debt and certain other liabilities in connection with the Acquisition. Net property, plant and equipment expenditures in fiscal 2000 totaled $15.6 million. Approximately $9.8 million of capital expenditures were related to the purchase of assets of the Valencia, California softgel manufacturing facility in the second quarter of fiscal 2000. An additional $6.4 million of investing activity related to the contractual payment of customer advances and the balance of approximately $1.9 million was related to other investing activities.
Net cash provided by financing activities was $30.7 million in fiscal 2000. This was primarily the result of increased net borrowings under the Credit Agreement and a $20.0 million capital contribution from Leiner Group, in connection with the Acquisition.
FINANCING ARRANGEMENTS. On May 15, 1998, the Company entered into an Amended and Restated Credit Agreement (the "Credit Agreement" and together with the amendments described below, the "Amended Credit Agreement"), which was amended (i) on June 30, 1999 to include an additional U.S. term loan in the amount of $30.0 million as described below, (ii) on December 16, 1999 to waive certain limitations that would have prohibited the Acquisition and to raise the applicable margins (as defined in the Amended Credit Agreement), and (iii) on February 11, 2000, effective December 16, 1999, principally to modify the calculations of the Company's covenant requirements to properly account for the financial
statement impact of the Acquisition. The Amended Credit Agreement provides for one U.S. term loan due December 30, 2004 in the amount of $68.0 million, two U.S. term loans due December 30, 2005 in the amounts of $65.0 million and $30.0 million, respectively, a Canadian dollar denominated term loan due December 30, 2004 in the amount of approximately U.S. $12.0 million (collectively, the "Term Facility"), and a revolving credit facility in the amount of U.S. $125.0 million (the "Revolving Facility"), a portion of which is made available to Vita Health in Canadian dollars. The unpaid principal amount outstanding on the Revolving Facility is due and payable on June 30, 2003. As of June 20, 2000, the Company's unused availability under the Amended Credit Agreement was approximately $29.3 million.
The Revolving Facility includes letter of credit and swingline facilities. Borrowings under the Amended Credit Agreement bear interest at floating rates that are based on LIBOR or on the applicable alternate base rate (as defined in the Amended Credit Agreement) plus defined margins, and accordingly the Company's financial condition and performance is and will continue to be affected by changes in interest rates. The Company entered into an interest protection arrangement effective July 30, 1997 with respect to $29.5 million of its indebtedness under the Amended Credit Agreement that provides a fixed rate of 6.17% on LIBOR rates plus applicable margin on the interest rates payable thereon. On October 8, 1999, the Company entered into an interest protection agreement, with respect to $54.0 million of its indebtedness under the Amended Credit Agreement, whereby the Company will not pay any lower than 5.94% on LIBOR rates plus applicable margin on the interest payable thereon. In connection with this transaction, the Company received approximately $0.2 million that is being recorded as a reduction of interest expense over the period of the agreement, which terminates October 8, 2001. The Amended Credit Agreement imposes certain restrictions on the Company, including restrictions on its ability to incur additional debt, enter into sale-leaseback transactions, incur contingent liabilities, pay dividends or make distributions, incur or grant liens, sell or otherwise dispose of assets, make investments or capital expenditures, repurchase or prepay the Notes or other subordinated debt, or engage in certain other activities. The Company must also comply with certain financial ratios and tests, including a minimum net worth requirement, a maximum leverage ratio, a minimum interest coverage ratio and a minimum cash flow coverage ratio.
A portion of the outstanding borrowings under the Amended Credit Agreement, amounting to approximately U.S. $27.0 million as of March 31, 2000, is denominated in Canadian dollars. All other outstanding borrowings under the Amended Credit Agreement, and all of the borrowings under the Notes, are denominated in U.S. dollars. At March 31, 2000, borrowings under the Amended Credit Agreement bore interest at a weighted average rate of 8.34% per annum.
In 1997, the Company assumed $85.0 million of Senior Subordinated Notes issued in connection with the Recapitalization. The Notes may be required to be purchased by the Company upon a Change of Control (as defined) and in certain circumstances with the proceeds of asset sales. The Notes are subordinated to the indebtedness under the Amended Credit Agreement. The indenture governing the Notes imposes certain restrictions on the Company and its subsidiaries, including restrictions on its ability to incur additional debt, make dividends, distributions or investments, sell or otherwise dispose of assets, or engage in certain other activities. The Notes bear interest at a fixed rate of 9.63% per annum and are due on June 30, 2007.
In connection with the Acquisition, the Company assumed an industrial development revenue bond loan ("IRB Loan") with an outstanding principal amount of $7.1 million. The IRB Loan bore interest at the rate of 4.15% as of March 31, 2000. The interest rate on the IRB Loan is variable and fluctuates on a weekly basis. The principal amount of the IRB Loan is due and payable in annual installments of $0.5 million, with the remaining outstanding principal amount due and payable on May 1, 2014.
During fiscal 2000, the Company entered into a loan agreement with the Manitoba Industrial Opportunities Program to fund the expansion and upgrading of the Company's manufacturing facility in Canada. As of March 31, 2000, the Company received approximately $1.3 million in advances on the loan
which is not to exceed a total of approximately $1.9 million. Interest on the loan will be waived contingent upon the Company's compliance with certain obligations, including meeting certain financial ratios. Principal repayments are scheduled to be made in two equal payments of 50% of the final loan amount. The first payment is to be made on the last day of the 48(th) month and the second on the last day of the 60(th) month after the date of the final disbursement, which is to be made no later than September 30, 2000.
The Company currently believes that cash flow from operating activities, together with revolving credit borrowings available under the Amended Credit Agreement, will be sufficient to fund the Company's currently anticipated working capital, capital spending and debt service requirements until the maturity of the Revolving Facility (June 30, 2003), but there can be no assurance in this regard. The Company expects that its working capital needs will require it to obtain new revolving credit facilities at the time that the Revolving Facility matures, whether by extending, renewing, replacing or otherwise refinancing the Revolving Facility. No assurance can be given that any such extension, renewal, replacement or refinancing can be successfully accomplished.
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
Certain of the statements contained in this report (other than the financial statements and other statements of historical fact) are forward-looking statements, including statements regarding, without limitation, (i) the Company's growth strategies, (ii) trends in the Company's business and (iii) the Company's future liquidity requirements and capital resources.
Forward-looking statements are made based upon management's current expectations and beliefs concerning future developments and their potential effects upon the Company. There can be no assurance that future developments will be in accordance with management's expectations or that the effect of future developments on the Company will be those anticipated by management. The important factors described elsewhere in this report (including, without limitation, those factors discussed in "Item 1. Business--Risk Factors") could affect (and in some cases have affected) the Company's actual results and could cause such results to differ materially from estimates or expectations reflected in such forward-looking statements. In light of these factors, there can be no assurance that events anticipated by the forward-looking statements contained in this report will in fact transpire.
While the Company periodically reassesses material trends and uncertainties affecting the Company's results of operations and financial condition in connection with its preparation of management's discussion and analysis of results of operations and financial condition contained in its periodic reports, the Company does not intend to review or revise any particular forward-looking statement referenced in this report in light of future events.
ITEM 7A
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not believe that it has material exposure to interest rate, foreign currency exchange rate or other relevant market risks.
INTEREST RATE RISK. The Company's exposure to market risk for changes in interest rates relates primarily to the Company's debt obligations. The table below provides information about the Company's debt obligations and interest rate swap agreements:
FOREIGN CURRENCY RISK. The Company transacts business in various foreign currencies, primarily in Canada. The Company does not have hedging or similar foreign currency contracts. Approximately 8.6% of the revenues are denominated in foreign currencies. Significant currency fluctuations could adversely impact foreign revenues; however, the Company does not expect any significant changes in foreign currency exposure in the near future.
ITEM 8
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company, including an index thereto and the report of Ernst & Young LLP, the Company's independent auditors, begin on page.
ITEM 9
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III ITEM 10
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS
Management of the business of Leiner is vested in its Board of Directors (the "Board"). Currently, Leiner does not pay any compensation for services as a director on its Board. The Board is currently comprised of Messrs. Baird, Kaminski, and Bensussen. The Board of Directors of Leiner Group, the Company's indirect corporate parent, is currently comprised of Mr. Baird, who serves as Chairman, Messrs. Kaminski and Bensussen, and Messrs. Bruce Gorchow and Alan Colner, who were appointed as members of such Board in September 1997, Mr. John Heine, who was appointed as a member of such Board in December 1997 and Mr. Peter Carnwath, who was appointed as a member of such Board in March 1999.
The following table sets forth with respect to each of the directors and executive officers of the Company, their respective years of employment with the Company, ages and positions.
Robert M. Kaminski has been the Chief Executive Officer of Leiner since May 1992, and a Director of Leiner since June 1992. He has been Chief Executive Officer of Leiner Group since March 1994 and Vice Chairman of Leiner Group since July 1996. From 1988 to 1992, Mr. Kaminski was Chief Operating Officer of the Predecessor Company and from 1982 to 1988, he was Vice President--Sales of the Predecessor Company. Mr. Kaminski joined the Predecessor Company in 1978.
Gale K. Bensussen has been a Director of Leiner since June 1992 and President of Leiner since May 1992. He has been a Director of Leiner Group since June 1992 and President of Leiner Group since March 1994. Mr. Bensussen was Senior Vice President--Marketing and Corporate Development of the Predecessor Company from May 1991 to May 1992. From July 1988 to May 1991, Mr. Bensussen was Senior Vice President--Sales and Marketing of the Predecessor Company. Mr. Bensussen joined the Predecessor Company in 1974.
Robert J. La Ferriere became Senior Vice President--Marketing of Leiner in February 1997 and was a consultant to Leiner from 1996 to 1997. From 1992 to 1996, Mr. La Ferriere was President and Chief
Executive Officer of Slim Fast Foods and was a Vice President, then Senior Vice President--Purchasing, at Thrifty Drug and Discount Stores from 1984 until 1990.
Kevin J. Lanigan became Corporate General Manager and Executive Vice President of Leiner in January 2000. Mr. Lanigan served as Executive Vice President and Chief Operations Officer of Leiner from 1992 to 1999, and of Leiner Group from 1994 to 1999. From 1986 to 1992, Mr. Lanigan was Senior Vice President--Operations Planning of the Predecessor Company, and from 1979 to 1986, was Vice President--Operations. Before joining the Predecessor Company in 1973, he held various engineering positions in the aerospace industry.
Eric P. Schick became Executive Vice President--Sales and Merchandising in January, 2000. Mr. Schick served as Executive Vice President--Sales from June 1999 to December 1999. From December 1997 to June 1999, Mr. Schick was Senior Vice President--Sales, and from April 1997 to December 1997, he was Vice President--Sales. From 1994 to 1997 Mr. Schick was National Sales Manager of the Predecessor Company. Mr. Schick joined the Predecessor Company in 1981.
Robert O. Cavenah became Senior Vice President--Strategic Cost Management in March 1999. From 1992 to 1999, Mr. Cavenah was Vice President--Supply Chain Management. From 1986 to 1992, Mr. Cavenah was Vice President--Operations for the Predecessor Company. Prior to joining the Predecessor Company in 1981, Mr. Cavenah held several operational positions within the pharmaceutical industry.
Juan A. Guerrero became Chief Operations Officer and Senior Vice President--Supply Chain Management in April 2000. Mr. Guerrero became Senior Vice President, Purchasing in July 1999 after joining Leiner in December 1998, as Vice President, Purchasing. From 1981 until November 1998, Mr. Guerrero held various engineering and purchasing positions with Merck & Co., Inc.
Robert A. Kay joined Leiner in 1996 as Director of Nutritional Research and was promoted to Vice President--Science Center in 1997. Mr. Kay became Senior Vice President and Chief Science Officer in July 1997. From 1995 to 1996, he served as Vice President for Metagenics, Inc. From 1992 to 1995, Mr. Kay served as Chief Operations and Senior Vice President--Research and Development for Earthrise Company.
John L. Kelly became Senior Vice President--Human Resources of Leiner in November 1998. Mr. Kelly joined Leiner in March 1997 from Eveready Battery Company. From 1990 to 1997, Mr. Kelly was Area Chairman for Eveready Battery Company, subsidiary of Ralston Purina, with responsibilities for the commercial and manufacturing, packaging and distribution operations in Latin America and the Caribbean. From 1969 to 1990, Mr. Kelly worked for Ralston Purina Company where he held key international positions in finance, operations, human resources and business development.
Stephen P. Miller became Senior Vice President and Chief Financial Officer in January 2000. Mr. Miller joined Leiner in 1997, as Vice President Finance--Planning. Prior to joining Leiner, Mr. Miller worked for PepsiCo from 1985 to 1997, where he held various key finance positions within its domestic and international divisions. Mr. Miller served as Director of Finance--Florida/South Georgia, Director of Planning--Pepsi Cola International, Austria, Area Finance Director--Pepsi Cola International, Chile and Area Chief Financial Officer, Indiana.
Michael S. Yusko became Vice President and Acting Chief Financial Officer in August 1999 after joining the Company in 1998 as Vice President--Treasurer. Mr. Yusko is no longer employed with the Company effective April 18, 2000.
Charles F. Baird, Jr. has been a Director of Leiner since October 1997 and was elected Chairman in June 1998. He is the managing member of Baird Investment Group, L.L.C., the managing member of North Castle. From 1989 until May 1997, Mr. Baird served as a Managing Director of AEA Investors Inc. From 1979 to 1989, Mr. Baird worked as a management consultant with Bain & Company.
ITEM 11
ITEM 11 EXECUTIVE COMPENSATION
The following table sets forth the compensation of each of the Company's chief executive officer and the four most highly paid executive officers (other than the chief executive officer) (collectively, the "named executive officers") for the fiscal year ended March 31, 2000.
SUMMARY COMPENSATION TABLE
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(1) The compensation described in this table does not include medical and group life insurance received by the named executive officers which are available generally to all salaried employees of the Company and certain perquisites and other personal benefits received by the named executive officers, the value of which does not exceed the lesser of $50,000 or 10% of any such officer's total salary and bonus disclosed in this table.
(2) All options are for Leiner Group common stock and they generally vest on a pro rata basis at a rate of 25% per year, with 25% immediate vesting on the date of grant.
(3) Represents Company contributions to its defined contribution retirement plans, the dollar value of term life and income replacement insurance premiums, and tax affected relocation expenses paid by the Company on behalf of the executive.
There were no stock options granted during fiscal year ended March 31, 2000.
The following table sets forth the stock option exercises for the fiscal year ended March 31, 2000 and the stock option values as of March 31, 2000, in each case, for each of the named executive officers.
AGGREGATED OPTION EXERCISE IN LAST FISCAL YEAR AND OPTION VALUES AS OF MARCH 31, 2000(1)
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(1) All options are for Leiner Group common stock.
(2) Sets forth values for "in-the-money" options that represent the positive spread between the respective exercise prices of outstanding stock options and the value of Leiner Group's common stock as of March 31, 2000.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Board of Directors of Leiner Group established a Compensation Committee to review all compensation arrangements for executive officers of Leiner Group and its subsidiaries. The individuals serving on the Leiner Group Compensation Committee during the fiscal year ended March 31, 2000 were Mr. Baird, Mr. Colner and Mr. Heine.
SEVERANCE ARRANGEMENTS
In November 1991, the Predecessor Company entered into certain severance agreements with certain members of Leiner's senior management, pursuant to which Leiner will pay severance benefits if the individual's employment is terminated by Leiner other than for cause or if the individual resigns his or her employment with Leiner for good reason.
The severance benefits that the Company has agreed to provide to each of Robert M. Kaminski and Gale K. Bensussen include (a) a lump-sum severance payment equal to the sum of (i) one year's base salary, plus (ii) any annual individual performance bonus or targeted commission, both as in effect at the time of the termination or resignation; (b) outplacement assistance at the Company's expense, up to a maximum cost to the Company of $20,000; and (c) any rights under applicable Company plans or programs, including but not limited to stock option and incentive plans, as may be determined pursuant to the terms of such plans or programs. The severance benefits provided to Kevin J. Lanigan include a lump-sum severance payment equal to three times the sum of one year's base salary plus any annual individual performance bonus or targeted commission, both as in effect at the time of termination or resignation, as well as the benefits described in clauses (b) and (c) above, subject to certain limitations to the extent that the Company determines that the foregoing benefits would not be deductible by the Company because such payments constitute an "excess parachute payment" (as defined in section 280G of the Internal Revenue Code of 1986, as amended, (the "Internal Revenue Code").
In March 1997, the Company entered into a non-competition and retirement agreement with Mr. David F. Brubaker, former Chairman of Leiner, pursuant to which, among other things, the Company has agreed to pay Mr. Brubaker an amount equal to approximately $1 million spread across several installments through February 2000. The agreement provides that under certain circumstances all of the Company's payment obligations to Mr. Brubaker would accelerate.
In August 1999, the Company entered into a non-competition and severance agreement with William B. Towne, former Executive Vice President and Chief Financial Officer, pursuant to which, among other things, the Company agreed to pay Mr. Towne: (a) salary and benefits through and including August 1, 2001; (b) bonus for the fiscal year 2000 in the amount of $125,000 to be paid on or about July 1, 2000; and (c) outplacement assistance up to a maximum cost to the company of $20,000.
STOCK OPTION PLAN
Leiner Group has authorized options for issuance to members of management and employees ("Management Options") representing the right to acquire an additional 10% of Leiner Group's common stock on a fully-diluted basis immediately after the Recapitalization (giving effect to the exercise of such options but without giving effect to the exercise of the Warrants referred to under "The Recapitalization" in Item 1. Business), exercisable at a price equal to the greater of the purchase price paid by North Castle in the Recapitalization or the fair market value of such shares at the time of grant. A total of 88,300 of these Management Options were granted as of June 30, 1997, 22,556 of these Management Options were granted as of November 1, 1997, 2,950 of these Management Options were granted as of December 31, 1997 and 9,666 of these Management Options were granted as of June 11, 1998. Generally, options vest on a pro rata basis at a rate of 25% per year, with 25% immediate vesting on the date of grant.
Additionally, Management Options totaling 1,400, 1,500, 1,000 and 500 were granted as of August 1, 1998, August 3, 1998, December 1, 1998 and January 4, 1999, respectively.
ITEM 12
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
All of the shares of common stock of Leiner are owned by PLI Holdings and all of the shares of common stock of PLI Holdings are owned by Leiner Group.
The following table sets forth information regarding beneficial ownership of common stock of Leiner Group as of June 16, 2000, by (i) each person who is known by the Company to beneficially own more than 5% of voting Group Common Stock, (ii) each director of Leiner Group, (iii) each named executive officer of the Company listed on the Summary Compensation Table previously, and (iv) by all directors and executive officers as a group.
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(1) The address for North Castle is 60 Arch Street, Suite 1A, Greenwich, Connecticut 06830.
(2) North Castle is an investment fund formed as a limited liability company. Baird Investment Group, L.L.C. ("Baird Investment") is the sole managing member of North Castle. Mr. Charles F. Baird, Jr. is the sole managing member of Baird Investment. The address for Baird Investment is 60 Arch Street, Suite 1A, Greenwich, Connecticut 06830.
(3) Includes 24,870 shares of voting Leiner Group common stock owned by Mr. Baird and the shares of Leiner Group common stock owned by North Castle which Mr. Baird may be deemed to have beneficial ownership of by virtue of his status as the managing member of Baird Investment. Mr. Baird expressly disclaims such beneficial ownership. Does not include 3,255 shares of voting Leiner Group common stock held by a trust in favor of Mr. Baird's children. Mr. Baird expressly disclaims beneficial ownership of such shares.
(4) Pursuant to an agreement between AEA and the other members of the AEA Group, AEA has voting power over the shares of Leiner Group common stock held by the members of the AEA Group, and accordingly may be deemed to beneficially own such shares.
(5) Does not reflect Equity Rights owned by Messrs. Kaminski, Bensussen, and Lanigan reflecting the right to receive 24,067 shares, 18,484 shares, and 4,938 shares of Leiner Group common stock, respectively, as such Equity Rights are not exercisable within 60 days of the date hereof.
ITEM 13
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
EXCHANGE AGREEMENT: In order to become eligible for pooling accounting treatment in merger and acquisition transactions, on November 13, 1998, Leiner Group entered into an Exchange Agreement with North Castle, pursuant to which North Castle exchanged 712,000 shares of voting Leiner Group common stock for an equal number of shares of non-voting Leiner Group class B common stock (the "Pooling Restructuring").
STOCKHOLDERS AGREEMENT. On June 30, 1997 (the "Recapitalization Closing Date"), Leiner Group and the stockholders of Leiner Group entered into the stockholders agreement, which was subsequently amended on September 28, 1998, and again on December 17, 1999 (the "Stockholders Agreement"), which contains, among other terms and conditions, provisions relating to corporate governance, certain restrictions with respect to transfers of Recapitalized Common Stock (as defined) by certain parties thereunder, certain rights and obligations with respect to transfers of Recapitalized Common Stock and certain registration rights granted by the Company with respect to shares of Recapitalized Common Stock. The Stockholders Agreement gives the AEA Group the power to elect one member of Leiner Group's Board of Directors, and for as long as North Castle, North Castle Partners I-A, L.P. ("NCP I-A") and North Castle Partners II, L.P. ("NCP-II") collectively own at least 40% of the common stock of Leiner Group, each of NCP I-A and NCP-II shall be entitled to nominate one person for election of the Board of Directors of Leiner Group and North Castle shall be entitled to nominate all other persons for election to the Board of Directors. If North Castle ownership of Leiner Group equity falls below 40%, it may elect the number of directors that is proportionate to its shareholdings. Accordingly, North Castle controls the Company and has the power to appoint new management and approve any action requiring the approval of the holders of Leiner Group common stock, including adopting amendments to Leiner Group's certificate of incorporation and approving mergers or sales of substantially all of the Company's assets.
The Stockholders Agreement also restricts the ability of existing shareholders to transfer their Leiner Group equity to third parties prior to June 30, 2002, and gives certain of these shareholders a right of first refusal after that date. These restrictions either do not apply or change if there is a public offering, or if North Castle sells more than 5% of all outstanding Leiner Group equity. If North Castle seeks to sell more than 5% of the outstanding Leiner Group equity, other existing shareholders have the right to sell their shares at the same time. The Agreement also gives North Castle rights to require Leiner Group to register Leiner Group equity under the Securities Act, subject to certain limitations and conditions.
MANAGEMENT AGREEMENTS. Following its acquisition of Leiner on May 4, 1992, AEA entered into a management agreement with Leiner Group, pursuant to which AEA provided management, consulting and financial services to the Company for an annual fee of $0.35 million plus expenses. In connection with the Vita Health Acquisition in fiscal 1997, the Company paid to AEA an additional transaction fee of $0.3 million for services in arranging, structuring, and negotiating the terms of the Vita Health Acquisition and related refinancing, and reimbursed it for certain related expenses. AEA received a transaction fee of $3.5 million for similar services rendered in connection with the Recapitalization.
Upon consummation of the Recapitalization, Leiner Group's management agreement with AEA was terminated, and Leiner Group and Leiner entered into a consulting agreement with North Castle Partners, L.L.C. (the "Sponsor"), an affiliate of North Castle, to provide the Company with certain business, financial and managerial advisory services. Mr. Baird acts as the managing member of the Sponsor through Baird Investment. In exchange for such services, Leiner Group and Leiner have agreed to pay the Sponsor an annual fee of $1.5 million, payable semi-annually in advance, plus the Sponsor's reasonable out-of-pocket expenses, and to indemnify the Sponsor and certain affiliates against certain liabilities. This fee may be reduced upon completion of an initial public offering of Leiner's shares. The agreement also terminates on June 30, 2007, unless Baird Investment Group ceases to be the managing member of North Castle or North Castle terminates before that date. Leiner Group and Leiner also paid the Sponsor a
transaction fee of $3.5 million for services relating to arranging, structuring and financing the Recapitalization in fiscal 1998.
MANAGEMENT. As part of the Recapitalization, the current managers and employees of the Company were afforded the opportunity to choose the amount of their existing equity they wished to retain in Leiner Group in the form of Leiner Group equity. Managers and employees who retained their equity in Leiner Group as a result of the increased leverage on the Company incurred as part of the Recapitalization, acquired a greater percentage equity ownership. Under the Stockholders Agreement, current managers have the right, upon their death or permanent disability, to require Leiner Group to purchase their Leiner Group common stock for its then fair market value.
In connection with the Recapitalization, the Company paid senior managers transaction bonuses of $5.2 million in the aggregate in fiscal 1998. In addition, Leiner Group amended the stock option plan which currently provides for the Board of Leiner Group to grant options to acquire 127,222 shares of Leiner Group common stock. A total of 65,023 of these options were granted to executive officers as of June 30, 1997 and an additional 11,456, 750 and 722 of these Management Options were granted to executive officers on November 1, 1997, December 31, 1997 and June 11, 1998, respectively, in each case subject to a vesting schedule.
The Board of Leiner Group and management of the Company instituted a stock purchase plan pursuant to which certain managers and employees of the Company were afforded the opportunity to purchase Leiner Group common stock. The gross proceeds of such offering were $1.9 million, recorded in fiscal 1998.
On June 25, 1997, Baird Investment, the managing member of North Castle, entered into separate agreements with three of the principal investors in North Castle, Electra Fleming Inc. ("Electra"), Moore Capital Management, Inc. ("Moore") and PPM America, Inc. ("PPM"). As part of these agreements, Baird Group caused North Castle to exercise its rights under the Stockholders Agreement to nominate one person designated by Electra, Moore and PPM to serve on the Board of Directors of Leiner Group. In connection with these agreements, Leiner Group paid Electra, Moore and PPM a one-time board representation fee of $100,000, $75,000 and $75,000, respectively, in fiscal 1998.
CAPITAL CONTRIBUTION. In connection with the Acquisition, as of December 17, 1999, the Company received $20.0 million, which was funded by a subscription by affiliates of certain shareholders to the capital of Leiner Group. Leiner Group made a capital contribution in the same amount to the Company through PLI Holdings. Leiner Group issued 111,112 shares of common stock to certain affiliates.
PART IV ITEM 14
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
1. FINANCIAL STATEMENTS. The following financial statements of the Company are included in a separate section of this Annual Report on Form 10-K commencing on the pages referenced below:
2. FINANCIAL STATEMENT SCHEDULES. The following financial statement schedule of the Company is included in a separate section of this Annual Report on Form 10-K commencing on the page referenced below. All other schedules have been omitted because they are not applicable, not required, or the information is included in the Consolidated Financial Statements or notes thereto.
3. LIST OF EXHIBITS.
(b) Reports on Form 8-K: None
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Leiner Health Products Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Carson, State of California, on the 29th day of June, 2000.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
LEINER HEALTH PRODUCTS INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholder Leiner Health Products Inc.
We have audited the accompanying consolidated balance sheets of Leiner Health Products Inc. as of March 31, 2000 and 1999, and the related consolidated statements of operations, shareholder's equity (deficit) and cash flows for each of the three years in the period ended March 31, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Leiner Health Products Inc. at March 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Orange County, California May 26, 2000
LEINER HEALTH PRODUCTS INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
See accompanying notes to consolidated financial statements.
LEINER HEALTH PRODUCTS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
See accompanying notes to consolidated financial statements.
LEINER HEALTH PRODUCTS INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS)
See accompanying notes to consolidated financial statements.
LEINER HEALTH PRODUCTS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
See accompanying notes to consolidated financial statements.
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. FORMATION AND OPERATIONS
Leiner Health Products Inc. (the "Company") is primarily involved in a single business segment, the manufacture and distribution of vitamins, over-the-counter drugs and other health and beauty aid products to mass market retailers and through other channels, primarily in the United States and Canada. The Company is a wholly owned subsidiary of PLI Holdings Inc. ("PLI Holdings"), which operates solely as a holding company and which is itself a wholly owned subsidiary of Leiner Health Products Group Inc. ("Leiner Group"). These consolidated financial statements include the accounts of the Company and its subsidiaries, including VH Holdings Inc., a holding company which owns Vita Health Products Inc. ("Vita Health").
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the Company and its direct and indirect subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates made in preparing the consolidated financial statements include the allowance for uncollectible accounts, product returns, sales allowances and inventory reserves.
CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair values of cash and cash equivalents, short-term borrowings and the current portion of long-term debt approximate cost due to the short period of time to maturity. Fair values of long-term debt, which have been determined based on borrowing rates currently available to the Company for loans with similar terms or maturity, approximate the carrying amounts in the consolidated financial statements.
REVENUE RECOGNITION
The Company recognizes revenue from product sales at the time of shipment. Provisions are made currently for estimated returns and allowances.
INVENTORIES
Inventories are stated at the lower of cost or market, with cost being determined by the first-in, first-out method.
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method, at rates designed to distribute the cost of assets over their estimated service lives or, for leasehold improvements, the shorter of their estimated service lives or their remaining lease terms. Amortization of assets recorded under capital leases is included in depreciation expense.
GOODWILL AND OTHER INTANGIBLES
Goodwill represents the excess of the purchase price over the fair values of the net assets of acquired entities. Other intangibles are comprised principally of the estimated fair value of the customer lists, assembled workforce and accelerated new drug applications acquired in December 1999 (Note 3). Goodwill and other intangibles are being amortized on the straight-line method at rates designed to distribute the cost of the assets over their estimated lives.
OTHER NONCURRENT ASSETS
Deferred financing charges are being amortized based on the principal balance outstanding using the effective interest method. Incentives provided to customers to secure long-term sales agreements (primarily cash advances and credit memos to be applied against purchases under the contract) are amortized over the terms of the agreements or as related sales are recognized. Amounts deferred under such agreements totaled $7,484,000 and $6,488,000 as of March 31, 2000 and 1999, respectively.
RECOVERABILITY OF LONG-LIVED ASSETS
The Company reviews for impairment of long-lived assets and certain intangibles held and used whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The recoverability test is performed at the lowest level at which undiscounted net cash flows can be directly attributable to long-lived assets. Goodwill that is not associated with specific assets that are impaired is assessed for impairment when impairment indicators are present and reduced to its estimated fair value if less than its carrying value.
INVESTMENT IN JOINT VENTURE
The Company owns a 40% interest in HerbaLife Leiner, LLC, a joint venture engaged in selling health products to the Chinese market. The Company's investment in the joint venture is accounted for using the equity method of accounting. At March 31, 2000, the amount at which the investment is carried on the books of the Company is equal to the Company's portion of the underlying equity in the net assets of the joint venture.
FOREIGN CURRENCY TRANSLATION
The Company translates the foreign currency financial statements of its Canadian subsidiary by translating balance sheet accounts at the year-end exchange rates and income statement accounts at the weighted monthly average exchange rate for the year. Translation gains and losses are recorded in shareholder's equity, and realized gains and losses are reflected in income. Transaction gains and losses were immaterial in the years ended March 31, 2000, 1999 and 1998.
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) STOCK-BASED COMPENSATION
The Company has elected to account for its stock-based compensation plans using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees", and related interpretations. Under the provisions of APB 25, compensation expense is measured at the grant date for the difference between the estimated fair value of the stock, less the exercise price of the option.
ADVERTISING COSTS
Advertising costs are expensed as incurred. Advertising expense for the years ended March 31, 2000, 1999 and 1998 was $13,566,000, $8,127,000 and $8,150,000, respectively.
COMPREHENSIVE INCOME
Total comprehensive income represents the net change in shareholder's equity during a period from sources other than transactions with shareholders and as such, includes net earnings. For the Company, the only other component of total comprehensive income is the change in the cumulative foreign currency translation adjustments recorded in shareholder's equity.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has issued Statement No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES ("Statement 133"), which is required to be adopted in years beginning after June 15, 2000 for all fiscal quarters of all fiscal years. The Company has not yet determined the impact of the adoption of the Statement 133 on its consolidated financial position or consolidated results of operations. The Company will adopt Statement 133 in its fiscal year beginning April 1, 2001.
In March 2000, the Financial Accounting Standards Board issued Interpretation No. 44, ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION--AN INTERPRETATION OF APB OPINION NO. 25 ("FIN 44"). FIN 44 clarifies the definition of employee for purposes of applying Accounting Practice Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, the criteria for determining whether a plan qualifies as a noncompensatory plan, the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and the accounting for an exchange of stock compensation awards in a business combination. FIN 44 is effective July 1, 2000, but certain conclusions cover specific events that occur after either December 15, 1998, or January 12, 2000. The Company believes that FIN 44 will not have a material effect on its consolidated financial position or results of operations.
RECLASSIFICATIONS
Certain reclassifications have been made to the fiscal 1999 and 1998 consolidated financial statements to conform with the fiscal 2000 presentation.
3. ACQUISITION
On December 17, 1999, Leiner Health Products Inc. acquired substantially all of the assets of Granutec, Inc. ("Granutec"), a manufacturer and distributor of private label, over-the-counter pharmaceutical drugs in the United States, and Vita Health acquired substantially all of the assets of Stanley
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITION (CONTINUED) Pharmaceuticals Ltd. ("Stanley"), a manufacturer and distributor of private label, over-the-counter pharmaceutical drugs and vitamin supplement products in Canada, both of which were subsidiaries of Novopharm Limited of Ontario, Canada ("Novopharm"). The Company also acquired certain related assets of Novopharm (collectively, the "Acquisition"). The purchase price of approximately $60,177,000 which included the assumption of debt of $7,496,000, was funded in part by a $20,000,000 capital contribution from the Company's ultimate parent, Leiner Group, and borrowings on the Company's revolving credit facility. The Acquisition was accounted for as a purchase under Accounting Principles Board Opinion No. 16, Business Combinations ("APB 16"). In accordance with APB 16, the Company allocated the price based on the fair value of the assets acquired and liabilities assumed. Portions of the purchase price, including intangible assets, were identified by independent appraisers utilizing proven valuation procedures and techniques. Acquired intangibles totaling $10,172,000 included the fair value of customer base, acquired workforce and accelerated new drug applications. These intangibles are being amortized over their estimated useful lives of three to five years. Goodwill resulting from the Acquisition is being amortized over 15 years.
In connection with the Acquisition, the Company has recorded approximately $7,015,000 for accrued restructuring charges. The restructuring plan includes initiatives to integrate the operations of the Company with those of Granutec and Stanley, and reduce overhead, primarily through the transfer of certain manufacturing activities to lower cost facilities. The Company expects these actions to result in a reduction in workforce. Management is in the process of finalizing its restructuring plans and, accordingly, the amounts recorded are based on management's current estimate of those costs. The Company will finalize these plans during fiscal year 2001, and expects the majority of the restructuring actions to occur in fiscal year 2001 and 2002.
The components of the purchase price and the preliminary allocation are as follows (in thousands):
As previously indicated, some allocations are based on preliminary estimates that are still being finalized. In addition, certain adjustments to the final purchase price are currently being negotiated with Novopharm. While the ultimate resolution of these matters may result in adjustments to the purchase price allocation, management believes that such amounts will not be materially different from those reflected above.
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITION (CONTINUED) The following unaudited pro forma financial information presents the consolidated results of operations as if the Acquisition had occurred at the beginning of the year presented, and does not purport to be indicative of the results that would have occurred had the Acquisition occurred at such date or of results which may occur in the future (in thousands).
4. RECAPITALIZATION
On June 30, 1997, Leiner Group completed a leveraged recapitalization transaction ("Recapitalization"). This transaction was effected through receipt of an equity investment from North Castle Partners I, L.L.C. ("North Castle"), an investment fund formed by Mr. Charles F. Baird, Jr. to effect the Recapitalization. Pursuant to the Recapitalization, Leiner Group repurchased common stock from its existing shareholders in an amount totaling (together with equity retained by such shareholders) $211,100,000, issued $80,400,000 of new shares of the recapitalized Leiner Group to North Castle, issued $85,000,000 of Senior Subordinated Notes (the "Notes"), and established a $210,000,000 senior secured credit facility (the "Credit Facility") that provided for both term and revolving credit borrowings. Immediately upon consummation of the Recapitalization, the obligations of Leiner Group under the Notes and the Credit Facility were assigned to and assumed by the Company. The Recapitalization was accounted for as a recapitalization of Leiner Group which had no impact on the historical basis of assets and liabilities as reflected in the Company's consolidated financial statements.
In connection with the Recapitalization, the Company wrote off $1,109,000 of deferred financing charges, net of income taxes of $761,000, as an extraordinary loss on the early extinguishment of debt in the year ended March 31, 1998. Additionally in connection with the Recapitalization, the Company incurred expenses of $32,808,000 consisting of $11,954,000 related to Leiner Group's capital raising activities, transaction bonuses granted to certain management personnel in the aggregate amount of approximately $5,199,000 and compensation expense related to the in-the-money value of stock options of approximately $15,655,000. The compensation expense represented the excess of the fair market value of the underlying common stock over the exercise price of the options canceled in connection with the Recapitalization.
The assumption of debt and the transfer of excess funds from Leiner Group related to the Recapitalization totaled approximately $102,809,000 and consisted of the following (in thousands):
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. RECAPITALIZATION (CONTINUED) Of this amount, $8,300,000 is reflected in expenses related to Recapitalization of parent in the accompanying consolidated statement of operations for fiscal 1998, with the remainder first applied against capital in excess of par value until that was exhausted and then against accumulated deficit.
5. CLOSURE OF FACILITIES, LONG-LIVED ASSET IMPAIRMENT
In the second and third quarters of fiscal 2000, the Company closed its Madison, Wisconsin and Sherburne, New York facilities, respectively. The Company incurred approximately $1,179,000 in fiscal year 2000 for severance and other costs related to the closures, which were offset by a gain of approximately $230,000 from the sale of the Madison facility. Additionally, the Company recorded a gain of approximately $341,000 from the sale of its Chicago facility, which the Company had previously closed and written down to estimated fair value in fiscal year 1999.
During the year ended March 31, 1998, the Company's Board of Directors approved a plan to close the West Unity, Ohio facility during the summer of 1998. Estimated closure costs of $1,221,000 were recorded in the year ended March 31, 1998, of which $754,000 related to severance costs and $467,000 related to other closure costs. Such costs were paid in fiscal year 1999 and additional related closure costs totaling $380,000 were expensed in fiscal year 1999 as incurred.
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. COMPOSITION OF CERTAIN BALANCE SHEET ITEMS
Property, plant and equipment:
7. SUPPLEMENTARY CASH FLOW INFORMATION
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. LONG-TERM DEBT
Long-term debt consists of (in thousands):
CREDIT FACILITY
On May 15, 1998, the Company entered into an Amended and Restated Credit Agreement ("Credit Agreement", and together with the amendments described below, the "Amended Credit Agreement"), which was amended, (i) on June 30, 1999, to include an additional U.S. term loan in the amount of $30,000,000 as described below, (ii) on December 16, 1999, to waive certain limitations that would have prohibited the Acquisition and to raise the applicable margins (as defined in the Amended Credit Agreement), and (iii) on February 11, 2000, effective December 16, 1999, principally to modify the Company's covenant requirements to reflect the financial statement impact of the Acquisition. The Amended Credit Agreement provides for one U.S. term loan due December 30, 2004 in the amount of $68,000,000, two U.S. term loans due December 30, 2005 in the amounts of $65,000,000 and $30,000,000, respectively, and a Canadian dollar denominated term loan due December 30, 2004 in the amount of approximately U.S. $12,000,000 (collectively, the "Term Facility"), and a revolving credit facility in the amount of U.S. $125,000,000 (the "Revolving Facility"), a portion of which is made available to Vita Health in Canadian dollars. The unpaid principal amount outstanding on the Revolving Facility is due and payable on June 30, 2003.
Borrowings under the Amended Credit Agreement bear interest at floating rates that are based on the lender's base rate (9.0% at March 31, 2000), the lender's Canadian prime rate (7.0% at March 31, 2000), LIBOR (6.29% at March 31, 2000) or the lender's banker's acceptance rate (5.46% at March 31, 2000), as the case may be, plus an applicable margin that is itself based on the Company's leverage ratio (as defined in the Amended Credit Agreement). The leverage ratio is defined generally as the ratio of total funded indebtedness to the consolidated earnings before interest, taxes, depreciation, amortization expense and other special charges and its effect on the applicable margin and varies as follows: (a) for U.S. and Canadian revolving credit borrowings, from 1.0% to 2.5% for LIBOR- or banker's acceptance-based loans, and from zero to 1.5% for alternate base rate- or Canadian prime rate-based loans, (b) for the loans under the Term Facility, from 2.625% to 3.25% for LIBOR-based loans, and from 1.625% to 2.25% for alternate-base rate loans. As of March 31, 2000, the Company's weighted average interest rates were 8.65% for U.S.
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. LONG-TERM DEBT (CONTINUED)
CREDIT FACILITY (CONTINUED) borrowings and 8.09% for Canadian borrowings. In addition to certain agent and up-front fees, the Amended Credit Agreement requires a commitment fee of up to 0.5% of the average daily unused portion of the revolving credit facility based on the Company's leverage ratio.
The obligations of the Company under the U.S. portion of the Revolving Facility and Term Facility are guaranteed by the direct parent of the Company, PLI Holdings, and by any direct or indirect U.S subsidiaries of the Company. The obligations of Vita Health under the Canadian portion of the Revolving Facility and Term Facility are guaranteed by the Company, PLI Holdings, the Company's direct or indirect U.S. subsidiaries and direct or indirect subsidiaries of Vita Health. The Amended Credit Agreement is also secured by substantially all the assets of the Company and any of its direct or indirect U.S. subsidiaries, all of the stock of the Company and any such direct or indirect U.S. subsidiaries, and 65% of the common stock of any direct non-U.S. subsidiaries of the Company and its U.S. subsidiaries. The Canadian portion of the Revolving Facility and Term Facility is also secured by substantially all the assets of Vita Health, its direct and indirect Canadian parents and any direct or indirect non-U.S. subsidiaries of the Company, and all of the common stock of any such direct or indirect non-U.S. subsidiaries. The Revolving Facility also allows the Company to issue up to $35,000,000 in letters of credit in lieu of borrowing on the Revolving Facility. As of March 31, 2000, the Company had $13,997,000 of letters of credit outstanding, and had $38,085,000 available for borrowing under the Revolving Facility.
In order to manage its interest rate risk under the Amended Credit Agreement, the Company has entered into two interest protection agreements. On July 30, 1997, the Company entered into an interest protection arrangement covering $29,460,000 of its borrowings under the Amended Credit Agreement. Under this arrangement, the Company obtained a fixed interest rate of 6.17% on LIBOR, instead of the fluctuating rate as described above and pays a fee of approximately $25,596 per annum. This agreement expires July 30, 2000. On October 8, 1999, the Company entered into an interest protection agreement with respect to $54,000,000 of its indebtedness under the Amended Credit Agreement, whereby the Company will not pay any lower than 5.94% on LIBOR rates plus applicable margin on the interest payable thereon. In connection with this agreement, which terminates October 8, 2001, the Company received $229,500. Amounts paid or received under these agreements are recorded as an adjustment of interest expense over the period of the agreement.
SENIOR SUBORDINATED NOTES
The Company assumed the Notes issued by Leiner Group upon the consummation of the Recapitalization. The Notes accrue interest at the rate of 9 5/8% per annum and are due on June 30, 2007. Interest on the Notes is payable semiannually on January 1 and July 1 of each year. Upon the occurrence of a Change of Control (as defined in the indenture governing the Notes), the Company will be required to make an offer to purchase all of the outstanding Notes at a price equal to 101% of the principal amount thereof at the date of purchase plus accrued and unpaid interest, if any, to the date of purchase.
CAPITAL LEASE OBLIGATIONS
The capital lease obligations are payable in variable monthly installments through November 2004, bear interest at effective rates ranging from 4.42% to 17.19% and are secured by equipment with a net book value of approximately $8,031,000 and $6,805,000 at March 31, 2000 and 1999, respectively.
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. LONG-TERM DEBT (CONTINUED) INDUSTRIAL DEVELOPMENT REVENUE BOND LOAN
In connection with the Acquisition, the Company assumed an industrial development revenue bond loan ("IRB Loan"), with an outstanding principal amount of $7,100,000. The interest on the IRB Loan is variable (4.15% as of March 31, 2000), and fluctuates on a weekly basis. Principal is due and payable in annual installments of $500,000, with the remaining outstanding principal amount due and payable on May 1, 2014.
INDUSTRIAL OPPORTUNITIES PROGRAM LOAN
During fiscal 2000, the Company entered into a loan agreement with the Manitoba Industrial Opportunities Program to fund the expansion and upgrading of the Company's manufacturing facility in Canada. As of March 31, 2000, the Company received approximately $1,340,000 in advances on the loan which is not to exceed a total of $1,863,000. Interest on the loan will be waived contingent upon the Company's compliance with certain obligations, including meeting certain financial ratios. Principal repayments are scheduled to be made in two equal payments of 50% of the final loan amount. The first payment is to be made on the last day of the 48(th) month and the second on the last day of the 60(th) month after the date of the final disbursement, which is to be made no later than September 30, 2000.
COVENANTS AND MINIMUM PAYMENTS
The Amended Credit Agreement imposes certain restrictions on the Company, including restrictions on its ability to incur additional debt, enter into sale-leaseback transactions, incur contingent liabilities, pay dividends or make distributions, incur or grant liens, sell or otherwise dispose of assets, make investments or capital expenditures, repurchase or prepay the Notes or other subordinated debt, or engage in certain other activities. The Company must also comply with certain financial ratios and tests, including a minimum net worth requirement, a maximum leverage ratio, a minimum interest coverage ratio and a minimum cash flow coverage ratio. As of March 31, 2000, the Company was in compliance with the covenants and conditions of the Amended Credit Agreement as well as its other long-term debt.
Principal payments on long-term debt through fiscal 2005 and thereafter are (in thousands):
RETIREMENT OF DEBT
In connection with the establishment of a new credit agreement on June 30, 1997, the previous borrowings were retired and unamortized debt issuance costs of $1,870,000 were written off and included in the consolidated statement of operations as an extraordinary loss on the early extinguishment of debt in the year ended March 31, 1998.
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. INCOME TAXES
The Company is included in the consolidated Federal income tax return of Leiner Group. Under a tax sharing agreement, the Federal income tax provision is computed on a consolidated return basis and provides that the Company, by participating in the consolidated filing, shall be liable and make payment to Leiner Group for its proportionate share of the total tax liability. The agreement also provides that the Company shall receive benefit to the extent that its losses and other credits result in a reduction of the consolidated tax liability. In the event that a combined or consolidated state, local or foreign tax return is filed, the tax sharing arrangement for the Federal provision shall apply in a similar manner in computing the state, local and foreign tax liability or benefit.
Deferred income taxes are computed using the liability method and reflect the effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Valuation allowances are established, when necessary, to reduce deferred tax assets to estimated realizable amounts. The provision for income taxes reflects the taxes to be paid for the period and the change during the period in the deferred tax assets and liabilities.
Significant components of the Company's deferred tax assets and liabilities are (in thousands):
At March 31, 2000 and 1999, prepaid expense and other current assets in the accompanying consolidated balance sheets include deferred tax assets of $8,841,000 and $7,988,000, respectively, and other noncurrent liabilities include deferred tax liabilities of $1,347,000 and $2,133,000, respectively.
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. INCOME TAXES (CONTINUED) The following is a reconciliation of the statutory Federal income tax rate to the Company's effective income tax rate before extraordinary item:
United States and foreign income (loss) before taxes and extraordinary item are as follows (in thousands):
Significant components of the provision for income taxes are (in thousands):
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. EMPLOYEE BENEFITS
STOCK OPTION PLAN
Leiner Group's Stock Option Plan, as amended in 1997, provides for the issuance of nonqualified stock options to certain key employees and directors to purchase up to 127,222 shares of Leiner Group's common stock. Options granted are at exercise prices as determined by Leiner Group's Board of Directors, but not less than $100 per share. Options generally vest on a pro rata basis at a rate of 25% per year, with 25% immediate vesting on the date of grant, and expire no later than ten years from the date of grant.
Pro forma information regarding net income (loss) is required by SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, which also requires that the information be determined as if Leiner Group accounted for its employee stock options granted subsequent to March 31, 1995 under the fair value method per that Statement. The fair value for these options was estimated at the date of grant using the Black-Scholes option-pricing model. The Black-Scholes model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Leiner Group's employee stock options have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate, therefore, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
In calculating pro forma information regarding net income (loss), the fair value of the stock options granted during the years presented was determined using the Black-Scholes option pricing model and the following weighted average assumptions:
The pro forma net income (loss) for the years ended March 31, 2000, 1999 and 1998 were $3,330,000, $9,734,000 and $(18,571,000), respectively.
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. EMPLOYEE BENEFITS (CONTINUED) STOCK OPTION PLAN (CONTINUED)
Activity under the Stock Option Plan for the years ended March 31, 2000, 1999 and 1998 is set forth below:
Options exercisable at March 31, 2000, 1999 and 1998 were 90,502, 58,352 and 27,992, respectively. The weighted-average fair values of options granted during the years ended March 31, 1999 and 1998 were $74 and $41, respectively. The weighted average remaining contractual life was 7.4 years as of March 31, 2000.
CONTRIBUTORY RETIREMENT PLANS
The Company has contributory retirement plans that cover substantially all of the Company's employees who meet minimum service requirements. The Company's contributions to the plans are discretionary and are determined and funded annually by Leiner Group's Board of Directors. The Company's contributions totaled $2,186,000, $1,541,000 and $1,304,000 for the plan years ended March 31, 2000, 1999 and 1998, respectively.
11. RELATED PARTY TRANSACTIONS
Upon consummation of the Recapitalization, Leiner Group and the Company entered into a consulting agreement with North Castle Partners, L.L.C. (the "Sponsor"), an affiliate of North Castle, to provide the Company with certain business, financial and managerial advisory services. Mr. Baird acts as the managing member of the Sponsor through Baird Investment Group, L.L.C. ("Baird Investment"). In exchange for such services, Leiner Group and the Company have agreed to pay the Sponsor an annual fee of $1,500,000, payable semi-annually in advance, plus the Sponsor's reasonable out-of-pocket expenses. This fee may be reduced upon completion of an initial public offering of Leiner Group's shares. The agreement also terminates on June 30, 2007, unless Baird Investment ceases to be the managing member of North Castle, or upon the earliest of June 30, 2007 or the date that North Castle terminates before that
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. RELATED PARTY TRANSACTIONS (CONTINUED) date. During each of the three years ended March 31, 2000, management fees and expenses paid to the Sponsor, totaled $1,500,000, $1,735,000 and $1,197,000, respectively, and are included in other charges in the accompanying consolidated statement of operations. Leiner Group and the Company also paid the Sponsor a transaction fee of $3,500,000 for services relating to arranging, structuring and financing the Recapitalization during the year ended March 31, 1998.
In connection with the Acquisition (Note 3), the Company received a capital contribution of approximately $20,000,000 from Leiner Group, through its direct parent, PLI Holdings Inc.
12. COMMITMENTS
The Company leases certain real estate for its manufacturing facilities, warehouses, corporate and sales offices, as well as certain equipment under operating leases (noncancelable) that expire at various dates through June 2013 and contain renewal options. Total rents charged to operations were $12,915,000, $9,212,000 and $5,244,000 for the years ended March 31, 2000, 1999 and 1998, respectively.
Minimum future obligations on noncancelable operating leases in effect at March 31, 2000 are (in thousands):
13. CONTINGENCIES
On September 27, 1999, the Company filed a civil antitrust lawsuit (the "Antitrust Lawsuit") against certain of its raw material suppliers and other alleged co-conspirators. The complaint alleges that the defendants conspired to fix vitamin prices and allocate vitamin production volume and vitamin customers in the United States. The complaint seeks unspecified damages and injunctive relief. After the lawsuit was filed, it was consolidated, for pre-trial purposes, with other similar cases. Based on the pretrial schedule set forth by the court, the case will not be ready for trial until approximately April 2002. At the present time, management cannot predict the outcome of this lawsuit, nor the estimated damages and potential recovery, if any.
In March 2000, the Company entered into a settlement agreement with one of its suppliers named in the Antitrust Lawsuit (the "Settlement Agreement"). Pursuant to the terms of the Settlement Agreement, the Company agreed to release all claims it may have against the supplier based on the Company's purchases of various vitamins from the supplier and to opt out of any settlement in connection with a pending class action lawsuit in so far as it pertains to the supplier.
In exchange for the Company's release and agreement to opt out of any settlement in the pending class action lawsuit, the Company received a settlement payment of approximately $2.4 million on
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. CONTINGENCIES (CONTINUED) March 21, 2000 which is recorded in other operating (income) charges in the accompanying Statement of Operations for the fiscal year ended March 31, 2000. In connection with the settlement, the Company incurred direct expenses of approximately $0.2 million which are recorded in general and administrative expenses.
The Company is subject to other legal proceedings and claims which arise in the normal course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, management does not believe the outcome of any of these matters will have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows.
14. CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS, SUPPLIERS AND PRODUCTS
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of trade receivables. The Company sells its products to a geographically diverse customer base in the drug store, supermarket and discount chain industries. The Company performs ongoing credit evaluations of its customers and maintains reserves for potential losses. For the years ended March 31, 2000, 1999 and 1998, two customers represented approximately 31% and 9%, 30% and 11%, and 26% and 10%, respectively, of net sales. The Company's top ten customers in the aggregate accounted for approximately 68%, 70% and 67% of the Company's net sales for fiscal 2000, 1999 and 1998, respectively. For the years ended March 31, 2000, 1999, and 1998, two suppliers provided approximately 23%, 25% and 27% respectively, of the materials purchased. No other supplier accounted for more than 10% of the Company's purchases. Sales of vitamins C and E, in the aggregate, accounted for approximately 31%, 31% and 36% of the Company's sales in fiscal 2000, 1999 and 1998, respectively. If one or more of the Company's major customers substantially reduced their volume of purchases from the Company, or if sales of vitamin C or E were substantially reduced, the Company's results of operations could be materially adversely affected.
15. BUSINESS SEGMENT INFORMATION
The Company operates in two reportable segments. One represents the Company's U.S. Operations ("Leiner U.S.") and the other represents the Company's Canadian operations ("Vita Health"). The Company's operating segments manufacture a range of vitamins, minerals and nutritional supplements and distribute their products primarily through mass-market retailers. The accounting policies between the reportable segments are the same as those described in the summary of significant accounting policies. The Company evaluates segment performance based on operating profit, before the effect of non-recurring charges and gains, and intersegment profit.
LEINER HEALTH PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. BUSINESS SEGMENT INFORMATION (CONTINUED) Selected financial information for the Company's reportable segments for the years ended March 31, 2000, 1999 and 1998 is as follows (in thousands):
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(1) Intersegment eliminations relate to the intersegment sales and profit.
(2) Leiner U.S. and Vita Health include the activity of Granutec and Stanley, respectively, from December 17, 1999 to March 31, 2000.
(3) Includes the effect of the Recapitalization-related expenses.
SCHEDULE II
LEINER HEALTH PRODUCTS INC.
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
S-1