U.S.
SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-QSB
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
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SECURITIES
EXCHANGE ACT OF 1934
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For
the quarterly period ended: June 30, 2007
|
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|
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
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SECURITIES
EXCHANGE ACT OF 1934
|
For
the
transition period from ________ to _________
Commission
file number 000-27642
TRANSDERM
LABORATORIES CORPORATION
(Exact
name of small business issuer
as
specified in its charter)
Delaware
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|
13-3518345
|
(State
or other jurisdiction of
incorporation
or organization)
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(I.R.S.
Employer Identification No.)
|
101
Sinking Springs Lane, Emigsville, PA 17318
(Address
of principal executive offices)
(717)
764-1191
(Issuer's
telephone number)
(Former
name, former address and former
fiscal
year, if changed since last report)
APPLICABLE
ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS
DURING THE PRECEDING FIVE YEARS
Check
whether the registrant filed all documents and reports required to be filed
by
Section l2, 13 or 15(d) of the Exchange Act after the distribution of securities
under a plan confirmed by a court. Yes
o
No
o
APPLICABLE
ONLY TO CORPORATE ISSUERS
State
the
number of shares outstanding of each of the issuer's classes of common equity,
as of the latest practicable date: At June 2, 2008, there were 40,000,000 shares
of common stock outstanding.
Transitional
Small Business Disclosure Format (Check one): Yes
o
No
x
PART
I — FINANCIAL INFORMATION
Item
1. Financial Statements.
ITEM
1.
FINANCIAL
STATEMENTS
Index
to
Consolidated Financial Statements.
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PAGE
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Consolidated
Balance Sheets June 30, 2007 (Unaudited) and December 31, 2006
(Audited)
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F–2
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Consolidated
Statements of Operations Six Months Ended June 30, 2007 (Unaudited)
and
June 30, 2006 (Unaudited)
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F–3
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Consolidated
Statements of Operations Three Months Ended June 30, 2007 (Unaudited)
and
June 30, 2006 (Unaudited)
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F–4
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Consolidated
Cash Flow Statements Six Months Ended June 30, 2007 (Unaudited) and
June
30, 2006 (Unaudited)
|
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F–5
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Notes
to Consolidated Financial Statements (Unaudited)
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F–6
to F–15
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TRANSDERM
LABORATORIES CORPORATION
CONSOLIDATED
BALANCE SHEETS
(In
thousands, except per share amounts)
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|
June
30,
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December
31,
|
|
|
|
2007
|
|
2006
|
|
|
|
(Unaudited)
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
CURRENT
ASSETS
|
|
|
|
|
|
|
|
Cash
|
|
$
|
135
|
|
$
|
1,145
|
|
Accounts
receivable
|
|
|
1,065
|
|
|
1,885
|
|
Inventories
|
|
|
837
|
|
|
937
|
|
Other
current assets
|
|
|
150
|
|
|
20
|
|
Total
Current Assets
|
|
|
2,187
|
|
|
3,987
|
|
|
|
|
|
|
|
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PROPERTY,
PLANT AND EQUIPMENT, net
|
|
|
1,276
|
|
|
1,528
|
|
|
|
|
|
|
|
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MORTGAGE
ESCROW DEPOSIT
|
|
|
201
|
|
|
201
|
|
|
|
|
|
|
|
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TOTAL
ASSETS
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|
$
|
3,664
|
|
$
|
5,716
|
|
|
|
|
|
|
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LIABILITIES
AND STOCKHOLDERS’ DEFICIENCY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
85
|
|
$
|
147
|
|
Royalties
payable
|
|
|
7,072
|
|
|
7,321
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|
Other
liabilities
|
|
|
862
|
|
|
1,291
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|
Current
portion of long-term debt
|
|
|
41
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|
|
40
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|
Subordinated
promissory note
|
|
|
7,000
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|
|
7,000
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|
Redeemable
preferred stock
|
|
|
8,500
|
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|
8,500
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|
Preferred
stock dividends payable
|
|
|
5,937
|
|
|
5,639
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|
Total
Current Liabilities
|
|
|
29,497
|
|
|
29,938
|
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|
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LONG-TERM
LIABILITIES
|
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Long-term
payable - Health-Chem
|
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|
9,879
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|
9,231
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|
Mortgage
payable
|
|
|
1,299
|
|
|
1,318
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|
Payable
to affiliate
|
|
|
666
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|
|
666
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|
Note
payable
|
|
|
167
|
|
|
167
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|
Total
Long-Term Liabilities
|
|
|
12,011
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|
11,382
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|
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COMMITMENTS
|
|
|
|
|
|
|
|
|
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|
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PREFERRED
STOCK
|
|
|
0
|
|
|
0
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|
|
|
|
|
|
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STOCKHOLDERS’
DEFICIENCY
|
|
|
|
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Common
stock, par value $.001 per share; 60,000,000 shares authorized; 40,000,000
shares issued and outstanding
|
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|
40
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|
40
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Accumulated
deficit
|
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|
<37,884
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>
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|
<35,644
|
>
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Total
Stockholders’ Deficiency
|
|
|
<37,844
|
>
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|
<35,604
|
>
|
|
|
|
|
|
|
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TOTAL
LIABILITIES AND STOCKHOLDERS’ DEFICIENCY
|
|
$
|
3,664
|
|
$
|
5,716
|
|
See
Notes
to Consolidated Financial Statements.
TRANSDERM
LABORATORIES CORPORATION
CONSOLIDATED
STATEMENTS OF OPERATIONS (Unaudited)
(In
thousands, except per share amounts)
|
|
Six
Months Ended
|
|
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|
June
30,
|
|
|
|
2007
|
|
2006
|
|
REVENUES:
|
|
|
|
|
|
|
|
Product
sales
|
|
$
|
2,254
|
|
$
|
2,919
|
|
Product
development revenue
|
|
|
327
|
|
|
92
|
|
Total
revenues
|
|
|
2,581
|
|
|
3,011
|
|
|
|
|
|
|
|
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COSTS
AND EXPENSES:
|
|
|
|
|
|
|
|
Cost
of sales – royalties
|
|
|
840
|
|
|
536
|
|
Cost
of sales – other
|
|
|
1,909
|
|
|
1,695
|
|
Selling,
general and administrative
|
|
|
1,402
|
|
|
880
|
|
Research
and development
|
|
|
216
|
|
|
258
|
|
|
|
|
|
|
|
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|
LOSS
FROM OPERATIONS
|
|
|
<1,786
|
>
|
|
<358
|
>
|
Interest
income <expense>, net
|
|
|
<564
|
>
|
|
<511
|
>
|
Other
income <expense>, net
|
|
|
408
|
|
|
0
|
|
|
|
|
|
|
|
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|
LOSS
FROM OPERATIONS BEFORE TAXES
AND
MINORITY INTEREST
|
|
|
<1,942
|
>
|
|
<869
|
>
|
Minority
interest
|
|
|
0
|
|
|
0
|
|
Income
tax expense
|
|
|
0
|
|
|
0
|
|
NET
LOSS
|
|
|
<1,942
|
>
|
|
<869
|
>
|
|
|
|
|
|
|
|
|
PREFERRED
DIVIDENDS
|
|
|
298
|
|
|
298
|
|
|
|
|
|
|
|
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|
NET
LOSS APPLICABLE TO COMMON STOCKHOLDERS
|
|
$
|
<2,240
|
>
|
$
|
<1,167
|
>
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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NET
LOSS PER COMMON SHARE (BASIC & DILUTED)
|
|
$
|
<.06
|
>
|
$
|
<.03
|
>
|
|
|
|
|
|
|
|
|
Average
number of common shares outstanding: (in thousands)
|
|
|
|
|
|
|
|
Basic
|
|
|
40,000
|
|
|
40,000
|
|
Diluted
|
|
|
40,000
|
|
|
40,000
|
|
See
Notes
to Consolidated Financial Statements.
TRANSDERM
LABORATORIES CORPORATION
CONSOLIDATED
STATEMENTS OF OPERATIONS (Unaudited)
(In
thousands, except per share amounts)
|
|
Three
Months Ended
|
|
|
|
June
30,
|
|
|
|
2007
|
|
2006
|
|
REVENUES:
|
|
|
|
|
|
|
|
Product
sales
|
|
$
|
1,105
|
|
$
|
1,300
|
|
Product
development revenue
|
|
|
59
|
|
|
87
|
|
Total
revenues
|
|
|
1,164
|
|
|
1,387
|
|
|
|
|
|
|
|
|
|
COSTS
AND EXPENSES:
|
|
|
|
|
|
|
|
Cost
of sales – royalties
|
|
|
577
|
|
|
238
|
|
Cost
of sales – other
|
|
|
978
|
|
|
781
|
|
Selling,
general and administrative
|
|
|
953
|
|
|
412
|
|
Research
and development
|
|
|
98
|
|
|
138
|
|
|
|
|
|
|
|
|
|
LOSS
FROM OPERATIONS
|
|
|
<1,442
|
>
|
|
<182
|
>
|
Interest
income <expense>, net
|
|
|
<287
|
>
|
|
<253
|
>
|
Other
income <expense>, net
|
|
|
408
|
|
|
0
|
|
|
|
|
|
|
|
|
|
LOSS
FROM OPERATIONS BEFORE TAXES
AND
MINORITY INTEREST
|
|
|
<1,321
|
>
|
|
<435
|
>
|
Minority
interest
|
|
|
0
|
|
|
0
|
|
Income
tax expense
|
|
|
0
|
|
|
0
|
|
NET
LOSS
|
|
|
<1,321
|
>
|
|
<435
|
>
|
|
|
|
|
|
|
|
|
PREFERRED
DIVIDENDS
|
|
|
149
|
|
|
149
|
|
|
|
|
|
|
|
|
|
NET
LOSS APPLICABLE TO COMMON STOCKHOLDERS
|
|
$
|
<1,470
|
>
|
$
|
<584
|
>
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
LOSS PER COMMON SHARE (BASIC & DILUTED)
|
|
$
|
<.04
|
>
|
$
|
<.01
|
>
|
|
|
|
|
|
|
|
|
Average
number of common shares outstanding: (in thousands)
|
|
|
|
|
|
|
|
Basic
|
|
|
40,000
|
|
|
40,000
|
|
Diluted
|
|
|
40,000
|
|
|
40,000
|
|
See
Notes
to Consolidated Financial Statements.
TRANSDERM
LABORATORIES CORPORATION
CONSOLIDATED
CASH FLOW STATEMENTS (Unaudited)
(In
thousands)
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
|
|
2007
|
|
2006
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
Net
loss applicable to common stockholders
|
|
$
|
<2,240
|
>
|
$
|
<1,167
|
>
|
Adjustments
to reconcile net loss to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
160
|
|
|
158
|
|
Preferred
stock dividends payable
|
|
|
298
|
|
|
298
|
|
Write-off
of property, plant and equipment
|
|
|
92
|
|
|
0
|
|
Changes
in:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
820
|
|
|
2,045
|
|
Inventories
|
|
|
100
|
|
|
<276
|
>
|
Other
current assets
|
|
|
<130
|
>
|
|
23
|
|
Mortgage
escrow deposit
|
|
|
0
|
|
|
<5
|
>
|
Accounts
payable
|
|
|
<62
|
>
|
|
<125
|
>
|
Royalties
payable
|
|
|
<249
|
>
|
|
537
|
|
Other
liabilities
|
|
|
<429
|
>
|
|
<1,266
|
>
|
Net
cash <used for> provided by operating activities
|
|
|
<1,640
|
>
|
|
222
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
Additions
to property, plant and equipment
|
|
|
0
|
|
|
<105
|
>
|
Net
cash used for investing activities
|
|
|
0
|
|
|
<105
|
>
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Borrowings
from affiliates, net
|
|
|
648
|
|
|
267
|
|
Long-term
debt payments
|
|
|
<18
|
>
|
|
<24
|
>
|
Net
cash provided by financing activities
|
|
|
630
|
|
|
243
|
|
|
|
|
|
|
|
|
|
NET
<DECREASE> INCREASE IN CASH
|
|
|
<1,010
|
>
|
|
360
|
|
Cash
at beginning of period
|
|
|
1,145
|
|
|
759
|
|
Cash
at end of period
|
|
$
|
135
|
|
$
|
1,119
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
Disclosures of Cash Flow Information:
|
|
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
|
|
|
|
Interest
|
|
$
|
93
|
|
$
|
86
|
|
See
Notes
to Consolidated Financial Statements.
TRANSDERM
LABORATORIES CORPORATION
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1.
Basis
of Presentation
Transderm
Laboratories Corporation (“Transderm”) engages in the development, manufacture
and marketing of transdermal drug delivery systems. Transderm operates
principally through its 98.5% owned subsidiary, Hercon Laboratories Corporation
(“Hercon”, which together with Transderm is referred to collectively as the
“Company”). Transderm is 90% owned by Health-Chem Corporation (“Health-Chem” and
together with Transderm, Hercon and Health-Chem’s other subsidiaries, the
“Group”).
As
of
June 30, 2007, the Company’s sole product and continuing source of revenues were
transdermal nitroglycerin patches (the “Hercon products”) used for transdermal
relief of the vascular and cardiovascular symptoms related to angina pectoris
which it has manufactured and sold pursuant to the terms of a license agreement
between Key Pharmaceuticals, Inc. (“Key”) and Hercon entered into in March 2000
(the “Key License”).
On
April
26, 2007, Key terminated the Key License for failure to pay royalties and sued
the Company for accrued royalties owed. In May 2007, the Company and Key entered
into a
Final
Judgment On Consent which, among other things, granted the Company a limited
right to manufacture and sell the Hercon Products through August 16, 2007 and
outlined a financial settlement between Key and Hercon as to royalties owed
under the License Agreement
and that
contemplated that the Company would discontinue manufacturing and selling the
Hercon Products after August 16, 2007. Over the ensuing months, Key periodically
extended the time during which the Company could manufacture and sell the Hercon
Products under the Key License. On April 21, 2008, the Company and Key entered
into a Settlement Agreement
that
entitles the Company to manufacture and sell transdermal products under the
Key
License indefinitely, subject to the Company’s continued satisfaction of the
terms of such agreement, which consists principally of the payment of an
aggregate of
$425,000
in seven equal installments of $60,714.29, the first of which is due and owing
on or before July 21, 2008 and the remaining installments to be due and owing
on
or before October 21, 2008, January 21, 2009, April 21, 2009, July 21, 2009,
October 21, 2009 and December 21, 2009.
For all
periods presented in this report, 100% of the net product sales reported as
revenue in the consolidated statements of operations was generated by products
sold under the Key License and any loss of or inability to manufacture and
sell
products under
the Key
License would have a material negative impact on our operations.
The
Company also generates revenues from research and development activities it
undertakes for client companies and will be the contract manufacturer of these
products if United States Food and Drug Administration (“FDA”) approval is
obtained.
The
accompanying unaudited consolidated financial statements include the accounts
of
Transderm and Hercon. As of December 31, 2004, the consolidated financial
statements also include a Variable Interest Entity (“VIE”), York Realty Leasing
LLC, of which Transderm is the primary beneficiary as further described in
Note
7. All significant intercompany accounts and transactions, including those
involving the VIE, have been eliminated in consolidation. The Company is a
90%
owned subsidiary of Health-Chem Corporation (“Health-Chem”).
The
accompanying unaudited consolidated financial statements have been prepared
in
accordance with generally accepted accounting principles in the United States
of
America for interim financial information. Accordingly, they do not include
all
of the information and footnotes required by generally accepted accounting
principles in the United States for full year financial statements. In the
opinion of management, all adjustments considered necessary for a fair
presentation have been included and are of a normal, recurring nature. Operating
results for the six month period ended June 30, 2007 are not necessarily
indicative of the results that may be expected for the year ended December
31,
2007. These consolidated financial statements should be read in conjunction
with
the consolidated financial statements and notes thereto that are included in
the
Company’s Annual Report on Form 10-KSB for the fiscal period ended December 31,
2006.
2.
Cash
Management
The
Company participates in Health-Chem’s cash management practice, wherein all cash
requirements are borrowed from Health-Chem and all excess cash is advanced
to
Health-Chem. The intercompany balance was $9,879,000 at June 30, 2007. Interest
is charged based upon the average outstanding intercompany balance and interest
rate on Health-Chem’s debt. The average interest rate charged was 10.375% during
both the six months ended June 30, 2007 and 2006.
3.
Expenses
Charged by Health-Chem
Pursuant
to a Corporate Services Agreement between the Company and Health-Chem,
Health-Chem pays for certain administrative expenses on behalf of the Company
for which Health-Chem is reimbursed. These expenses are comprised primarily
of
an allocation of corporate services including executive, professional, legal
and
accounting. The allocation of these costs, approximately $428,000 and $176,000
for the six months ended June 30, 2007 and 2006, respectively, reflect
Health-Chem’s estimate of their cost for these services based upon a method
(allocation based upon the Company’s net sales as a percentage of Health-Chem’s
consolidated net sales) which is considered by the Company to be reasonable.
The
Company estimates that these expenses, on a stand-alone basis, would not have
been materially different from the costs allocated.
4.
Per
Share Information
Basic
and
diluted earnings per share are computed based upon the weighted average number
of common shares outstanding during each period after adjustment for any
dilutive effect of the Company's stock options.
5.
Stock
Options
In
accordance with SFAS No. 123,
Accounting
for Stock-Based Compensation
and SFAS
No. 148,
Accounting
for Stock-Based Compensation-Transition and Disclosure
,
the
Company accounts for its stock option plans under the intrinsic-value-based
method as defined in APB No. 25,
Accounting
for Stock Issued to Employees
.
The
following table illustrates the effect on net earnings and earnings per share
if
the Company had applied the fair value recognition provisions of SFAS No. 123
to
stock-based employee compensation (in thousands, except per share
amounts):
|
|
Six
Months Ended
|
|
Three
Months Ended
|
|
|
|
June
30,
|
|
June
30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss applicable to common stockholders, as reported:
|
|
$
|
<2,240
|
>
|
$
|
<1,167
|
>
|
$
|
<1,470
|
>
|
$
|
<584
|
>
|
Add:
Stock-based compensation expense recognized under the intrinsic value
method
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
Deduct:
Stock-based compensation expense determined under fair value based
method
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
Pro
forma net loss applicable to common stockholders
|
|
$
|
<2,240
|
>
|
$
|
<1,167
|
>
|
$
|
<1,470
|
>
|
$
|
<584
|
>
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
– as reported
|
|
$
|
<.06
|
>
|
$
|
<.03
|
>
|
$
|
<.04
|
>
|
$
|
<.01
|
>
|
Basic
– pro forma
|
|
$
|
<.06
|
>
|
$
|
<.03
|
>
|
$
|
<.04
|
>
|
$
|
<.01
|
>
|
Diluted
– as reported
|
|
$
|
<.06
|
>
|
$
|
<.03
|
>
|
$
|
<.04
|
>
|
$
|
<.01
|
>
|
Diluted
– pro forma
|
|
$
|
<.06
|
>
|
$
|
<.03
|
>
|
$
|
<.04
|
>
|
$
|
<.01
|
>
|
6.
Going
Concern
As
of
June 30, 2007, the Company’s financial and operating condition raised
significant doubt about its ability to continue as a going concern. At said
date, the Company
had
aggregate debts and liabilities of
$41,508,000
and had a working capital deficiency of $27,310,000. These debts and liabilities
include $7,072,000 of royalties due under the Key License and $31,473,000 to
Health-Chem.
T
he
Company has sustained operating losses in each of the last three years.
In
addition, at June 30, 2007 Health-Chem owes $11,779,000 under outstanding
debentures which became due in 1999 and under which it currently is in default,
which exerts pressure on the financial condition of the Group as a
whole.
The
Group
has been able to continue to operate over the last several years because it
has
not made any payments under the debentures since 1999 and because it did not
make any royalty payments under the Key License since its inception in March
2000 until May 2007. Apart from these obligations, the Group has been paying
its
other current debts and liabilities as they become due from cash flow generated
from operations. The Group does not have cash on hand to repay the amount due
under the debentures.
The
Company’s financial condition has prevented it from securing financing or
obtaining loans from which it could repay all or a portion of its
liabilities
.
Moreover, as previously noted, as of June 30, 2007, the Company’s sole product
and continuing source of revenues was a transdermal nitroglycerin patch and
the
Company does not have any business prospects for the foreseeable future. If
the
Company does not abide by the terms of the Settlement Agreement, including
its
obligations to make quarterly cash payments going forward, the Company could
lose its right to manufacture and sell transdermal products under the Key
License (until the expiration of the patent on February 16, 2010), and will
have
no other source of revenue.
In
light
of the uncertainty relating to the Company’s ability to continue operating
without the benefit of a license to utilize Key’s technology in its transdermal
patch products,
Transderm
and/or Hercon may have to seek protection under federal bankruptcy laws in
which
case it would not be able to continue as a going concern.
Management
has not developed a firm plan for addressing the conditions that give rise
to
its ability to continue operating as a going concern, but at a minimum
will:
|
·
|
seek
to develop other business opportunities for the Company, in the
pharmaceutical industry or otherwise;
|
|
·
|
investigate
the possibility of selling Hercon Laboratories Corporation;
|
|
·
|
seek
to raise working capital through borrowing or through issuing equity;
and
|
|
·
|
evaluate
new directions for the Company.
|
Management
will continue to develop and modify its plans to adapt to business and financial
conditions as they evolve. However, management can offer no assurance that
it
will be successful in developing a plan which permits the Company to continue
as
a going concern. The accompanying consolidated financial statements do not
include any adjustments that might result from the outcome of these
uncertainties.
7.
Property,
Plant and Equipment
In
December 2004, the Company sold its real property, buildings, improvements
and
equipment located in Emigsville, Pennsylvania to York Realty Leasing LLC, an
affiliated company, for a sale price of $1.9 million. Concurrent with the sale,
the Company entered into a 15-year net lease with York Realty Leasing LLC for
the property expiring in December 2019, which can be extended by the Company
for
an additional five years. The agreement provides for a Company repurchase option
at a price of $1,995,000. The base annual lease cost during the initial 15
year
term is $212,400, and the base lease expense for the remaining term of the
lease
is as follows: 2007 - $212,400; 2008 - $212,400; 2009 - $212,400; 2010 -
$212,400; 2011 - $212,400; and 2012 and thereafter - $1,699,200. In December
2002, the Company received an appraisal for the real property, including the
structures and appurtenances, which appraised the market value of the property
at $1,850,000. The proceeds from the sale were used to satisfy a $1.6 million
first mortgage associated with the property and to substantially pay off a
$367,500 second mortgage, a portion of which was held by related parties. Andy
Yurowitz, the Company’s Chairman of the Board, President, Chief Executive
Officer and a member of the Board of Directors, is a 50% owner of York Realty
Leasing LLC. As a result of Financial Interpretation 46(R), effective as of
December 31, 2004, the Company’s consolidated balance sheet includes the assets
and liabilities of York Realty Leasing LLC. In December 2005, York Realty
Leasing LLC obtained a $1.4 million mortgage on this property with a financial
institution.
I
n
September 2007, subsequent to the close of the period covered by this report,
Andy Yurowitz sold his 50% interest in York Realty Leasing LLC,
as
more
fully described in Note 12 - Subsequent Events.
8.
Settlement
Liability: Royalties
During
March 2006, the Company received notice from Key that it was in default under
the License Agreement for failing to make royalty payments due. The License
Agreement includes a provision affording Key the right to terminate the License
Agreement if a breach of the agreement was continuing for thirty days after
the
receipt from Key of notice of and a demand to cure the breach. Hercon did not
have the financial resources to pay the accrued royalties within the prescribed
time and, on April 26, 2007, Key terminated the License and Hercon’s right to
manufacture and sell products utilizing its technology.
On
April
27, 2007, Key filed a complaint against Hercon in the United States District
Court, District of New Jersey (the “Court”) demanding, among other things,
that
Hercon pay accrued royalties under the License Agreement (the
“Complaint”).
On
May
23, 2007, the Court entered a Final Judgment On Consent between Key and Hercon
(the “Consent Judgment”) which set aside the complaint filed by Key against the
Company on April 26, 2007 (the “Complaint”) and served as the basis for settling
the amount due by Hercon to Key under the License Agreement and governed the
relationship between the parties thereafter. The Consent Judgment was predicated
on Hercon’s intention to wind down and cease business operations by August 16,
2007 while remaining operational until such date in order to maximize the value
of its assets and inventory for the benefit of its creditors. Under the Consent
Judgment, the parties agreed, among other things, that (i) Hercon owed Key
accrued royalties in the amount of $8,000,000 (the “Judgment Amount”); (ii)
Hercon would have a limited right to operate under the License Agreement until
August 16, 2007, provided that Hercon paid to Key the sum of $500,000 upon
the
execution of the Consent Judgment, which sum Hercon paid as ordered on May
23,
2007, which, under the Consent Judgment, reduced the Judgment Amount to $7
million; and (iii) any additional payments made to Key to satisfy the Consent
Judgment would reduce the Judgment Amount by twice as much. Hercon’s payment of
$500,000 pursuant to the Consent Judgment resulted in a $1,000,000 reduction
in
the Judgment Amount, thus generating a forgiveness of debt of $500,000. Hercon
has recorded this $500,000 forgiveness of debt as other income. The $7 million
Judgment Amount is included in the June 30, 2007 royalties payable balance
of
$7,072,000. The Consent Judgment increased the amount due by $332,000 to a
total
of $8,000,000.
On
several occasions subsequent to June 30, 2007, Key periodically extended the
time during which the Company could manufacture and sell the Hercon Products
under the Key License. On April 21, 2008, the Company and Key entered into
a
Settlement Agreement
that
entitles the Company to manufacture and sell transdermal products under the
Key
License indefinitely, subject to the Company’s continued satisfaction of the
terms of such agreement
.
This
Settlement Agreement is
more
fully described in Note 12 - Subsequent Events
.
9.
Commitments
& Contingencies
Approximately
forty-five percent of the Company’s employees are covered by a collective
bargaining agreement with a local unit of the Retail Wholesale and Department
Store Union, AFL-CIO (“R.W.D.S.U.”). The R.W.D.S.U. agreement is for a three
year period ending December 10, 2007. The contract is subject to annual renewal
thereafter and acknowledges that the R.W.D.S.U. is the exclusive bargaining
agent for the Company’s regular production employees, excluding all other
employees including but not limited to supervisors, foremen, clerical employees,
time-keepers, watchmen, guards, maintenance personnel and part-time
employees.
Certain
raw materials and components used in the manufacture of our products are
available from limited sources, and, in some cases, a single source. Generally,
regulatory authorities must approve raw material sources for transdermal
products. Without adequate approved supplies of raw materials or packaging
supplies, our manufacturing operations could be interrupted until another
supplier is identified, our products approved and trading terms with it
negotiated. We may not be able to identify an alternative supplier and any
supplier that we do identify may not be able to obtain the requisite regulatory
approvals in a timely manner, or at all. Furthermore, we may not be able to
negotiate favorable terms with an alternative supplier. Any disruptions in
our
manufacturing operations from the loss of an approved supplier may cause us
to
incur increased costs and lose revenues and may have an adverse effect on our
relationships with our partners and customers, any of which could have adverse
effects on our business and results of operations. Our business also faces
the
risk that third party suppliers may supply us with raw materials that do not
meet required specifications, which, if undetected by us, could cause our
products to test out of specification and require us to recall the affected
product.
We
market
all of our products through a single marketing representative. If we were to
lose the services of such marketing agent for any reason or said entity does
not
maintain a steady demand for our product, and we are unable to identify an
adequate replacement, our business, results of operations and financial
condition would be materially adversely affected.
We
rely
on insurance to protect us from many business risks, including product
liability, business interruption, property and casualty loss and employment
practices liability. The cost of insurance has risen significantly in recent
years. In response, we may increase deductibles and/or decrease certain
coverages to mitigate these costs. There can be no assurance that the insurance
that we maintain and intend to maintain will be adequate, or that the cost
of
insurance and limitations in coverage will not adversely affect our business,
financial position or results of operations. Furthermore, it is possible that,
in some cases, coverage may not be available at any price.
10.
Litigation
On
January 4, 2008,
subsequent
to the close of the period covered by this report,
Transderm
filed a Complaint for Declaratory Relief, Breach of Contract and Monetary
Damages against York Realty Leasing LLC
,
as
more
fully described in Note 12 –
Subsequent
Events.
On
January 24, 2008,
subsequent
to the close of the period covered by this report,
the
Company filed a Motion to Vacate Consent Judgment
seeking
to vacate the Consent Judgment because, among other things, the Consent Judgment
was not properly authorized or consented to by the Company. On January 25,
2008,
also
subsequent
to the close of the period covered by this report,
the
Company
filed
an
Order
to Show Cause Seeking Temporary Restraints u
nder
which it sought injunctive relief to prevent Key from enforcing the Consent
Judgment based upon the likelihood that the Company would prevail on the Motion
to Vacate the Consent Judgment. See
Note 12
-
Subsequent
Events for a further discussion of these actions.
On
February 25, 2008,
subsequent
to the
close of the period covered by this report,
Andy
Yurowitz, a director and the former chief executive of Health-Chem and each
of
its subsidiaries, served each of Health-Chem and Hercon with a summons without
complaint which was filed in The Supreme Court of the State of New York, Kings
County on February 7, 2008
,
as
more
fully described in Note 12 -
Subsequent
Events.
11.
Other
Income <Expense>, Net
Other
income <expense>, net for the six months ended June 30, 2007 was $408,000.
This amount consists of income of $500,000 related to the execution of the
Consent Judgment, as more fully described in Note 8 - Settlement Liability:
Royalties, partially offset by a loss of $92,000 related to the write-off of
uncompleted construction.
12.
Subsequent
Events
On
July
23, 2007, Key and Hercon entered into a letter agreement whereby Key granted
Hercon’s request to extend its ability to operate under the Consent Judgment.
Key has agreed to extend Hercon’s limited right to operate under the Consent
Judgment through November 16, 2007 subject to Hercon’s payment of $150,000 in
three monthly installments of $50,000 in immediately available funds to be
received by Key by August 18, 2007, September 15, 2007 and October 13, 2007,
respectively. Such payments are to be deemed additional consideration and shall
not affect Hercon’s obligation to comply with all of its obligations under the
Consent Judgment, which remains in full force and effect. The payments required
by the letter agreement shall reduce the principle due under the Consent
Judgment by the amount of the actual payment. Additional payments against
principle made by Hercon and received by Key by November 16, 2007, excluding
the
$150,000 due under the letter agreement and any royalties that are otherwise
due
pursuant to the limited license granted under the Consent Judgment, shall reduce
the Consent Judgment by twice the amount of such additional payment. Hercon
has
made the required August 18, 2007, September 15, 2007 and October 13, 2007
installment payments. On November 8, 2007, prior to its termination by the
Company, McTevia & Associates entered into a letter of intent with a third
party that describes a transaction in which such party would acquire the Consent
Judgment from Key for the purposes of acquiring the assets of Hercon and its
existing business as a going concern through a consensual foreclosure under
the
Consent Judgment (the “Letter of Intent”). The transactions contemplated by the
Letter of Intent were subject to numerous conditions, including the third
party’s ability to enter into agreements and secure the required regulatory
approvals that would allow it seamlessly to continue the operation of Hercon’s
business at its current facilities. By letter dated December 3, 2007, the
Company notified the third party that McTevia did not have the power or
authority to enter into the Letter of Intent and that such document is not
a
binding and valid agreement of the Company or of any of its constituent
corporations.
On
November 21, 2007, Key advised the Company that it would continue to forebear
from enforcing its rights under the Consent Judgment solely to permit a third
party to complete due diligence relating to the Company in connection with
such
party’s proposed purchase of the Consent Judgment from Key. By letter dated
December 28, 2007, the Company (i) requested that Key agree to forebear from
executing on the Consent Judgment retroactive from November 16, 2007 and for
an
additional 90 days to commence on the date that such extension was to have
been
granted, if at all, and (ii) advised Key that it would submit a
proposal
to settle or satisfy the Consent Judgment in an economically feasible manner
and
continue operations
.
By
letter dated January 18, 2008, representatives of Key advised Hercon that it
had
rejected Hercon’s request for an extension of the
limited
right to operate under the Consent
Judgment
and that Hercon was required to immediately cease manufacturing and selling
transdermal nitroglycerin patch products which were the subject of the License
Agreement. The Company discontinued selling the transdermal nitroglycerin patch
products as of the close of business on January 18, 2008 and discontinued
manufacturing the transdermal nitroglycerin patch products as of the close
of
business on January 21, 2008. On January 24, 2008, the Company filed a Motion
to
Vacate Consent Judgment
seeking
to vacate the Consent Judgment because, among other things, the Consent Judgment
was not properly authorized or consented to by the Company. On January 25,
2008,
the Company filed
an
Order
to Show Cause Seeking Temporary Restraints u
nder
which it sought injunctive relief to prevent Key from enforcing the Consent
Judgment based upon the likelihood that the Company would prevail on the Motion
to Vacate the Consent Judgment.
On
January 25, 2008, counsel for Key informally notified the Company that it would
not seek sanctions against the Company for any resumption of operations pending
resolution of the Company’s motion for interim relief, and the Company
immediately resumed manufacturing and selling transdermal patches. On February
12, 2008, the Company and Key entered into a letter agreement whereby Key agreed
to extend the Company’s limited right to operate under the Consent Judgment
through March 10, 2008 in exchange for the Company’s immediate withdrawal, with
prejudice, of the Motion to Vacate Consent Judgment and Order to Show Cause
Seeking Temporary Restraints and the Company’s acknowledgment that the Consent
Judgment is legally valid and binding upon the Company. In connection with
the
negotiation of the February 12, 2008 letter, Key agreed to consider any proposal
made by the Company to settle or satisfy the Consent Judgment without
foreclosing its option to accept a third party offer to purchase the Consent
Judgment. Since the execution of the February 12, 2008 letter agreement, the
Company had been in negotiations with Key with respect to the Company’s possible
settlement of the Consent Judgment. On March 11, 2008, Key agreed to extend
the
Company’s limited right to operate under the Consent Judgment through March 24,
2008 to permit the parties to continue negotiating a resolution to Key’s claims,
including the possible settlement of the Consent Judgment by the Company from
Key
.
On
April
21, 2008, the Company and Key entered into a Settlement Agreement
that
entitles the Company to manufacture and sell transdermal products under the
Key
License indefinitely, subject to the Company’s continued satisfaction of the
terms of such agreement.
Under
the
Settlement Agreement, the Company agreed to pay Key an aggregate of $1,425,000,
of which the Company paid Key $1,000,000 upon the execution of the Settlement
Agreement and agreed to pay the balance of $425,000 in seven equal installments
of $60,714.29, the first of which is due and owing on or before July 21, 2008
and the remaining installments to be due and owing on or before October 21,
2008, January 21, 2009, April 21, 2009, July 21, 2009, October 21, 2009 and
December 21, 2009. The amount paid and payable under the Settlement Agreement
was allocated as follows: $650,000 was applied to the purchase of the Consent
Judgment; $350,000 was applied to the satisfaction of all royalties due for
the
period October 1, 2007 through the execution of the Settlement Agreement; and
payments aggregating $425,000 will be applied to the satisfaction of all
royalties that may become due under the License Agreement from the date of
the
Settlement Agreement through the termination of the License
Agreement.
The
Settlement Agreement further provides that:
|
·
|
The
License Agreement will continue in effect until it expires on February
16,
2010 as modified by the Settlement Agreement so that all royalties
which
become due after April 21, 2007 under the License Agreement would
be
satisfied by the additional payments to be made in the future totaling
$425,000, as described above, and that the Company would no longer
be
required to account to Key for royalties due after April 21,
2008;
|
|
·
|
The
Consent Judgment, including Key’s right to receive $8,000,000 in past due
royalty payments thereunder, reduced by a credit of $1,150,000 in
respect
of payments by Hercon prior to entering into the Settlement Agreement,
would remain in full force and effect until Key received payment
of all
amounts owed under the Settlement
Agreement;
|
|
·
|
The
Company may not assign, delegate or otherwise transfer the License
Agreement or any of its rights or obligations arising under the License
Agreement without the prior written consent of
Key;
|
|
·
|
All
agents, officers, directors and stockholders of all parties to the
Settlement Agreement were released and all such parties agreed to
hold the
others harmless from any and all claims that were or could have been
asserted in the action brought by Key or in the Action or in relation
to
the Consent Judgment or any claims which would or could have been
asserted
by or against the parties prior to the execution of the Settlement
Agreement, provided, however, that if at any time, any of the monies
paid
to Key were set aside as a preference under the bankruptcy laws,
or were
otherwise ordered to be disgorged from Key in connection with legal
proceedings that involve the Company or any of its affiliates, Key’s
release would be deemed null and void, if the Company was unable
to cure
the setting aside of the monies paid. In the event the disgorgement
is not
cured, avoided, or otherwise recovered in connection with a bankruptcy
case involving any corporate constituent of the Company, Key would
have an
allowed claim in such bankruptcy case for the full amount of the
Consent
Judgment less any amounts previously paid to and retained by
it;
|
|
·
|
Any
breaches by the Company of its obligations under the Settlement Agreement
which were not cured within 25 days after written notice requesting
cure
would entitle Key to enforce the Consent Judgment, and any payments
made
by the Company to Key pursuant to the Settlement Agreement would
be
applied towards the satisfaction of the Consent Judgment;
and
|
|
·
|
Andrew
Levinson and Manfred Mayerfeld, directors of each constituent corporation
of the Company, agreed that they would be jointly and severally liable
to
Key, if within 90 days of the date that Key received the first payment,
a
proceeding were commenced against Hercon or Key and Key was thereafter
ordered in such proceeding, pursuant to a final, non-appealable order,
to
return or disgorge all or any portion of the initial $1,000,000 payment
under the Settlement Agreement. The amount for which either or both
would
be liable would be the lesser of the amount ordered to be returned
or
disgorged or the amount of that initial payment. Any obligations
of Mr.
Levinson or Mr. Mayerfeld would be deemed to be extinguished if within
90
days of the date Key received the first payment, it did not receive
notice
of an action, potential action or other proceeding requiring it to
return
or disgorge such payment or any portion thereof and such action or
proceeding is not commenced. At a meeting of the Board of Directors
of the
Company (the “Board”) held on April 16, 2008, at which the Board approved
the terms of settlement described above, the Board agreed to defer
consideration of appropriate collateral to be provided to Messrs.
Levinson
and Mayerfeld for their guarantee and appropriate compensation to
them
therefor.
|
If
the
Company does not abide by the terms of the Settlement Agreement, including
its
obligations to make quarterly cash payments going forward, the Company could
lose its right to manufacture and sell transdermal products under the Key
License (until the expiration of the patent on February 16, 2010), and will
have
no other source of revenue.
The
note
payable of $167,000 at June 30, 2007 relates to the purchase of certain fixed
assets. The purchase of these fixed assets was pursuant to a development,
manufacturing and supply agreement that Hercon entered into with a client
company. Payment terms of the note are contingent upon certain performance
criteria under the agreement. One such performance criteria applicable to the
client company may result in the note being forgiven. On August 20, 2007, the
client company and Hercon entered into a letter amendment to the development,
manufacturing and supply agreement whereby the $167,000 note was immediately
forgiven.
On
September 25, 2007, Andy Yurowitz sold his 50% interest in York Realty Leasing
LLC at cost to William Robbins, an unrelated third party, making Mr. Robbins
the
100% owner of York Realty Leasing LLC. Prior to this sale, Mr. Robbins had
owned
the remaining 50% of York Realty Leasing LLC.
On
December 11, 2007, the Company entered into a new collective bargaining
agreement with the R.W.D.S.U. The new agreement is for a three year period
ending December 10, 2010 and is on substantially the same terms as the expiring
agreement.
On
January 4, 2008, Transderm filed a Complaint for Declaratory Relief, Breach
of
Contract and Monetary Damages against York Realty Leasing LLC (“York”) in the
Court of Common Pleas of York County, Pennsylvania (the “Complaint”). The action
arises out of York’s various correspondences to Transderm alleging that it is in
breach of and default under the lease between the parties dated December 7,
2004
for failure to pay rent as provided in the lease. In the Complaint, the Company
is seeking, among other things, a declaratory judgment to the effect that the
lease is in full force and effect, that the Company is not in default under
the
lease and that Transderm is owed an amount on account with York which York
has
refused to credit to Transderm. On January 23, 2008, the Company filed an
amended complaint in this matter seeking to clarify certain facts but otherwise
requesting the same relief. York did not file a timely answer to the Company’s
complaint and, upon further notice to York, the Court entered a default judgment
in favor of the Company on February 26, 2008. A hearing in this matter was
held
on April 25, 2008 whereby the Court ordered that the lease is in full force
and
effect, that the Company is not in default under the lease and that Transderm
is
entitled to a rental credit of $57,200.
On
February 25, 2008, Andy Yurowitz, a director and the former chief executive
of
Health-Chem and each of its subsidiaries, served each of Health-Chem and Hercon
with a summons without complaint which was filed in The Supreme Court of the
State of New York, Kings County on February 7, 2008. The summons also indicated
that Andrew Levinson and Manfred Mayerfeld, members of the Boards of Health-Chem
and Hercon, will be named in this action. The summons requires that each party
file a notice of appearance in the action within a specified time after being
served. The summons states that the nature of the action and the relief sought
is defendant’s breach of contract and failure to pay wages. Until the Company is
served with and reviews the complaint with counsel, it is unable to comment
upon
the allegations or any potential defenses.
Item
2. Management’s Discussion and Analysis or Plan of
Operation.
This
Management’s Discussion or Plan of Operation section contains a number of
forward-looking statements, all of which are based on current expectations.
Actual results may differ materially from the anticipated results discussed
herein.
The
Company
Transderm
Laboratories Corporation (“Transderm”) manufactures nitroglycerin transdermal
patches and conducts research and development activities for third parties
on a
contract basis. Transderm conducts the majority of its business and all of
its
manufacturing operations through Hercon Laboratories Corporation (“Hercon”), in
which it owns 98.5% of the outstanding shares of capital stock (Transderm and
Hercon may sometimes be referred to collectively as “we”, “us”, or the
“Company”).
Transderm
is a 90%-owned subsidiary of Health-Chem Corporation ("Health-Chem" which,
together with Transderm, Hercon and Health-Chem’s other subsidiaries, may be
referred to as the “Group”).
Until
April 25, 2007, the Company had manufactured and sold drug-in-adhesive
transdermal nitroglycerin patch products (the “Hercon Products”) under the terms
of a license agreement between Key Pharmaceuticals, Inc.,
a
division of Schering Plough
(“Key”),
and Hercon dated March 13, 2000 (the “License Agreement”). By letter dated April
26, 2007, Key notified Hercon that it terminated the License Agreement based
on
Hercon’s failure to pay royalties on sales of the Hercon Products or otherwise
account to Key for sales of the Hercon Products. On April 27, 2007, Key served
Hercon with a complaint filed in the United States District Court, District
of
New Jersey (the “Court”), demanding payment of all royalties due under the
License Agreement (the “Action”). Hercon did not have the means to repay the
accrued royalties under the License Agreement. The products covered by the
Key
License represented the Company’s only products and, upon termination of the
License Agreement, left it without any other meaningful source of continuing
revenue.
On
May
23, 2007, Key, on the one hand, and Hercon and McTevia & Associates, LLC, as
the purported trustee of the Company’s assets (“Trustee”) pursuant to a
so-called trust mortgage
under
which the Company purportedly granted to McTevia & Associates a security
interest in all of its real and personal property,
on the
other hand, executed a Final Judgment On Consent wherein, among other things,
(i) the parties stipulated that the amount of royalties owed to Key under the
License Agreement exceeded $8 million (though the parties settled on that
amount), (ii) the parties outlined a financial settlement with respect to
royalties owed to Key, (iii) the Company was required to pay Key the sum of
$500,000
(for which it would be credited the amount of $1 million and which would reduce
the aggregate royalties owed to Key by $1 million to $7 million)
and (iv)
Key granted the Company a limited right under the License Agreement to
manufacture and sell the Hercon Products through August 16, 2007, as more fully
described in Transderm’s quarterly report on Form 10-Q for the three months
ended March 31, 2007 (the “Consent Judgment”).
The
Consent Judgment was predicated on Hercon’s intention to wind down and cease
business operations by August 16, 2007 while remaining operational until such
date in order to maximize the value of its assets and inventory for the benefit
of its creditors.
Over
the
ensuing months, Key periodically extended the Company’s limited right to
manufacture and sell the Hercon Products under the Consent Judgment, in one
case
requiring the payment of $150,000 to extend such right to November 16,
2007.
On
November 12, 2007, the Group terminated the Trustee and began to negotiate
directly with Key.
On
April
21, 2008, after many months of negotiations, Key and Hercon entered into a
Settlement Agreement (“Settlement Agreement”) with respect to settling
outstanding controversies between the parties under the terms of the
Consent
Judgment, which will allow the Company to continue manufacturing and selling
the
Hercon Products indefinitely, subject to satisfying certain continuing financial
obligations.
Under
the
Settlement Agreement,
a copy
of which was annexed as an exhibit to Transderm’s Current Report on Form 8-K
filed with the SEC on April 29, 2008,
the
parties agreed that, among other material terms:
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·
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The
Company would pay to Key an aggregate of $1,425,000, of which the
Company
paid Key $1,000,000 upon the execution of the Settlement Agreement
and
agreed to pay the balance of $425,000 in seven equal installments
of
$60,714.29, payable as follows: by July 21, 2008, October 21, 2008,
January 21, 2009, April 21, 2009, July 21, 2009, October 21, 2009
and
December 21, 2009. The payments aggregating $425,000 will be applied
to
the satisfaction of all royalties that may become due under the License
Agreement from the date of the Settlement Agreement through the
termination of the License
Agreement.
|
|
·
|
The
License Agreement will continue in effect until it expires on February
16,
2010 as modified by the Settlement Agreement, in that all future
royalties
under the License Agreement would be satisfied by the additional
payments
to be made in the future totaling $425,000, as described above, and
that
the Company would no longer be required to account to Key for royalties
going forward;
|
|
·
|
The
Consent Judgment, including Key’s right to receive past due royalty
payments thereunder (aggregating $6,850,000 as of the date of the
Settlement Agreement), would remain in full force and effect until
Key
received payment of all amounts owed under the Settlement
Agreement;
|
|
·
|
All
parties to the Settlement Agreement and their respective affiliates
were
released from all claims that were or could have been asserted in
the
action brought by Key, that were subsumed within Key’s lawsuit against
Hercon or in relation to the Consent Judgment or otherwise, except
that if
Key was required to return any of the monies paid to it under a bankruptcy
or other disgorgement proceeding, which, if not cured by the Company,
then
Key’s release would be deemed void and Key would have a right to pursue
the full amount due to it under the Consent Judgment, as well as
any other
course of action it would be entitled to
take;
|
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·
|
The
Company would have the right to cure any breach of the Settlement
Agreement within 25 days after written notice requesting a
cure.
|
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·
|
Andrew
Levinson and Manfred Mayerfeld, directors of each of the constituent
corporations of the Company, agreed that they would be jointly and
severally liable to Key, if within 90 days of the date that Key received
the first payment, a proceeding were commenced against Hercon or
Key and
Key was thereafter ordered in such proceeding, pursuant to a final,
non-appealable order, to return or disgorge all or any portion of
the
initial $1,000,000 payment under the Settlement Agreement. The amount
for
which either or both would be liable would be the lesser of the amount
ordered to be returned or disgorged or the amount of that initial
payment.
Any obligations of Mr. Levinson or Mr. Mayerfeld would be deemed
to be
extinguished if within 90 days of the date Key received the first
payment,
it did not receive notice of an action, potential action or other
proceeding requiring it to return or disgorge such payment or any
portion
thereof and such action or proceeding is not commenced. At a meeting
of
the Board of Directors of the Company (the “Board”) held on April 16,
2008, at which the Board approved the terms of settlement described
above,
the Board agreed to defer consideration of appropriate collateral
to be
provided to Messrs. Levinson and Mayerfeld for their guarantee and
appropriate compensation to them
therefor.
|
In
order
to satisfy the initial payment to Key under the Settlement Agreement, Transderm
borrowed $1 million from its parent, Health-Chem Corporation, which owns 90%
of
Transderm’s outstanding common stock.
The
foregoing description of the contents of the Settlement Agreement is qualified
by the full text of the agreement on file with the SEC.
As
of
June 30, 2007, the Company had total liabilities of approximately $41.5 million,
which includes (i) $31.4 million owed to Health-Chem, (ii) $7.1 million of
royalties owed to Key
under
the Key License and (iii) other current trade payables and miscellaneous
liabilities aggregating $3.0 million. Also, at June 30, 2007, the Company had
a
working capital deficiency of $27.3 million and cash and other current assets
of
$2.2 million. The notes to our audited consolidated financial statements for
the
year ended December 31, 2006 and the auditor’s report accompanying said
financial statements indicate that these liabilities and the Company’s
working
capital deficiency raise substantial doubt about our ability to continue as
a
going concern.
Results
of Operations
.
Six
months ended June 30, 2007 versus the six months ended June 30,
2006
We
incurred a net loss during the six months ended June 30, 2007 of $2,240,000
as
compared to a net loss of $1,167,000 for the same period in 2006. The increase
in net loss was attributable primarily to a decline in product sales and to
additional selling, general and administrative expenses, as described in the
ensuing paragraphs.
For
the
six months ended June 30, 2007, product sales decreased by approximately 23%
from the corresponding 2006 period from $2,919,000 to $2,254,000, which, in
each
case, consisted exclusively of sales of transdermal nitroglycerin patches.
Management attributes the decrease to a 61% decline in product sales to one
of
our largest customers and at a lower average net selling price.
Product
development revenue for the six months ended June 30, 2007 was $327,000,
consisting of revenues generated from research and development projects we
are
undertaking for three customers. Product development revenue for the same period
in 2006 was $92,000, consisting of revenues from two research and development
projects. The $235,000 increase is due to the timing of milestone payments
received associated with the various projects.
Other
income for the six months ended June 30, 2007 was $408,000. This
amount
consists of income of $500,000 resulting from the forgiveness of debt under
the
Consent Judgment, as more fully explained below, which partially is offset
by a
loss of $92,000 related to the write-off of uncompleted construction
.
The
Company did not report any other income for the same period in 2006. The
$500,000 represents forgiveness of debt in that a $500,000 payment made to
Key
under the terms of the Consent Judgment resulted in a reduction of total
royalties owed to Key under the License Agreement by $1,000,000.
Gross
profit decreased by $948,000, or 122%, leading to a gross loss of $168,000
for
the six months ended June 30, 2007 as compared to a gross profit of $780,000
for
the same period in 2006. Gross profit as a percent of total revenues decreased
from 26% during the six months ended June 30, 2006 to a negative 7% during
the
same period in 2007.
The
decrease in gross profit was due primarily to decreased sales volumes of lower
margin products and to additional royalty expense of $332,000 recorded pursuant
to the Consent Judgment.
Selling,
general and administrative expenses increased by $522,000 for the six months
ended June 30, 2007 as compared to the corresponding period in 2006. The
increase is due primarily to increases in professional/consulting fees, legal
fees and corporate services expenses allocated from Health-Chem of $289,000,
$136,000 and $252,000, respectively, partially offset by decreases in wages
and
commission expense of $98,000 and $40,000, respectively. A significant portion
of the legal and professional/consulting fees incurred during 2007 were
attributable to the Key royalty negotiations and establishing the Trust
Mortgage
.
Research
and development expenses decreased by $42,000 to $216,000 for the six months
ended June 30, 2007 as compared to the corresponding period in 2006. The
decrease is due primarily to decreases in wages, lab supplies and repairs and
maintenance of $13,000, $14,000 and $16,000, respectively.
Net
interest expense increased by $53,000, or 10%, to $564,000 for the six months
ended June 30, 2007 as compared to $511,000 for the same period in 2006. The
increase consists of a $67,000 increase in interest expense, partially offset
by
a $14,000 increase in interest income. The interest expense increase is due
to
$62,000 of additional interest related to higher average outstanding balances
on
borrowings from Health-Chem and to $5,000 of additional interest due to higher
interest rates associated with the variable rate mortgage. The interest income
increase is due primarily to the Company adopting an investment policy in April
2006 whereby all excess cash is automatically invested in interest-bearing
instruments.
Three
months ended June 30, 2007 versus the three months ended June 30,
2006
We
incurred a net loss during the three months ended June 30, 2007 of $1,470,000
as
compared to a net loss of $584,000 for the same period in 2006. The increase
in
net loss was attributable primarily to a decline in product sales and to
additional selling, general and administrative expenses, as described in the
ensuing paragraphs.
For
the
three months ended June 30, 2007, product sales decreased by approximately
15%
from the corresponding 2006 period from $1,300,000 to $1,105,000, which, in
each
case, consisted exclusively of sales of transdermal nitroglycerin patches.
Management attributes the decrease to a lower average net selling
price.
Product
development revenue for the three months ended June 30, 2007 was $59,000,
consisting of revenues generated from research and development projects we
are
undertaking for one customer. Product development revenue for the same period
in
2006 was $87,000, consisting of revenues from two research and development
projects. The $28,000 decrease is due to the timing of milestone payments
received associated with the various projects.
Other
income for the three months ended June 30, 2007 was $408,000. This
amount
consists of income of $500,000 resulting from the forgiveness of debt under
the
Consent Judgment, as more fully explained below, which partially is offset
by a
loss of $92,000 related to the write-off of uncompleted construction
.
The
Company did not report any other income for the same period in 2006. The
$500,000 represents forgiveness of debt in that a $500,000 payment made to
Key
under the terms of the Consent Judgment resulted in a reduction of total
royalties owed to Key under the License Agreement by
$1,000,000.
Gross
profit decreased by $759,000, or 206%, leading to a gross loss of $391,000
for
the three months ended June 30, 2007 as compared to a gross profit of $368,000
for the same period in 2006. Gross profit as a percent of total revenues
decreased from 27% during the three months ended June 30, 2006 to a negative
34%
during the same period in 2007.
The
decrease in gross profit was due primarily to increased sales volumes of lower
margin products and to additional royalty expense of $332,000 recorded pursuant
to the Consent Judgment.
Selling,
general and administrative expenses increased by $541,000 for the three months
ended June 30, 2007 as compared to the corresponding period in 2006. The
increase is due primarily to increases in professional/consulting fees, legal
fees and corporate services expenses allocated from Health-Chem of $291,000,
$136,000 and $205,000, respectively, partially offset by decreases in wages
and
commission expense of $59,000 and $16,000, respectively. A significant portion
of the legal and professional/consulting fees incurred during 2007 were
attributable to the Key royalty negotiations and establishing the Trust
Mortgage
.
Research
and development expenses decreased by $40,000 for the three months ended June
30, 2007 as compared to the corresponding period in 2006. The decrease is due
primarily to decreases in wages, repairs and maintenance, lab supplies and
clinical materials/testing of $3,000, $16,000, $13,000 and $7,000,
respectively.
Net
interest expense increased by $34,000, or 13%, to $287,000 for the three months
ended June 30, 2007 as compared to $253,000 for the same period in 2006. The
increase consists of a $33,000 increase in interest expense and a $1,000
decrease in interest income. The interest expense increase is due to $32,000
of
additional interest related to higher average outstanding balances on borrowings
from Health-Chem and to $1,000 of additional interest due to higher interest
rates associated with the variable rate mortgage. The interest income decrease
is due primarily to lower interest rates associated with the mortgage escrow
deposit.
Liquidity
and Capital Resources
.
At
June
30, 2007, the Company had total current assets of $2.2 million, including
$135,000 in cash, and a working capital deficiency of $27.3 million, the
calculation of which includes current liabilities owed to Health-Chem
aggregating $21.6 million. Without giving effect to current liabilities in
favor
of Health-Chem, we had a working capital deficiency of $5.7 million. Our total
stockholders’ deficiency was $37.8 million at June 30, 2007, compared to $35.6
million at December 31, 2006. As of June 30, 2007, we had an accumulated
deficit of approximately $37,884,000. Our principal sources of liquidity have
been cash provided by loans from Health-Chem and cash generated by operations.
Our principal uses of cash have been for working capital, royalty fees and
the
payment of various professional, consulting and legal fees.
Our
working capital deficiency increased by $1,359,000 from December 31, 2006 to
June 30, 2007 due to a decrease of $1,800,000 in current assets, partially
offset by a decrease of $441,000 in current liabilities. The current assets
decrease consists of decreases in cash, accounts receivable and inventory of
$1,010,000, $820,000 and $100,000, respectively, partially offset by an increase
in other current assets of $130,000. The current liabilities decrease consists
primarily of decreases in accounts payable, royalties payable and other
liabilities of $62,000, $249,000 and $429,000, respectively, partially offset
by
an increase in preferred stock dividends payable of $298,000. The decrease
in
accounts receivable resulted from a decrease in sales in the second quarter
of
2007 as compared to the fourth quarter of 2006 and also reflects the timing
of
customer payments. The decrease in inventory reflects lower transdermal
nitroglycerin product sales and the timing of raw material purchases. The
increase in other current assets is due primarily to retainers paid to various
professional organizations. The royalties payable decrease is attributable
to
the Company commencing royalty payments to Key in May 2007. The other
liabilities decrease is due primarily to decreases in accrued chargebacks,
rebates and allowances, and audit fees. The increase in preferred stock
dividends payable is due to legally available funds not being available to
make
the required dividend payment.
Cash
used
for operating activities for the six months ended June 30, 2007 was $1,640,000,
as compared to cash provided by operating activities of $222,000 for the same
period in 2006. The decrease is due primarily to a $2,240,000 net loss in 2007
as compared to a $1,167,000 net loss in 2006 and to decreasing accounts
receivable, inventory, accounts payable, royalties payable and other liabilities
of $820,000, $100,000, $62,000, $249,000 and $429,000, respectively, and
increasing other current assets of $130,000 in 2007 as compared to decreasing
accounts receivable, other current assets, accounts payable and other
liabilities of $2,045,000, $23,000, $125,000 and $1,266,000, respectively,
and
increasing inventory and royalties payable of $276,000 and $537,000,
respectively, in 2006. The Company had no investing activities for the six
months ended June 30, 2007. Investing activities for the six months ended June
30, 2006 used cash of $105,000, consisting of additions made to property, plant
and equipment. Financing activities for the six months ended June 30, 2007
provided $630,000 of cash as compared to the same period in 2006 which provided
$243,000 of cash.
The
Company’s current financial and operating condition raises significant doubt
about our ability to continue as a going concern. We anticipate that, given
our
historical operating results, we may not generate sufficient revenues from
product sales to satisfy our ongoing obligations under the Settlement Agreement
until the amount due is paid in full. We are paying our current expenses,
obligations and liabilities to third parties as they become due from cash
generated from sales and from cash borrowed from Health-Chem, which received
a
$1.85 million payment from the State of Pennsylvania in May 2007, representing
amounts held by such agency on Health-Chem’s behalf. We would like to expand our
operations to add other transdermal products and enter into agreements with
third parties to conduct research and development activities on their behalf,
though we cannot say with certainty whether we will be presented with any such
opportunities or if we will have the capital resources to pursue such
activities. We do not have the capital to pursue such opportunities and we
cannot be certain that we will have access to capital on acceptable terms,
if at
all, should an opportunity presents itself. Accordingly, we cannot predict
our
future capital requirements at this time.
Off-Balance
Sheet Arrangements
.
We
have
not entered into any off-balance sheet arrangements.
Critical
Accounting Policies
.
Our
significant accounting policies are described in Note 2 of the Notes to
Consolidated Financial Statements of the Company’s Annual Report on Form 10-KSB
for the year ended December 31, 2006. Included within these policies are certain
policies which contain critical accounting estimates and, therefore, have been
deemed to be “critical accounting policies.” Critical accounting estimates are
those which require management to make assumptions about matters that were
uncertain at the time the estimate was made and for which the use of different
estimates, which reasonably could have been used, or changes in the accounting
estimates that are reasonably likely to occur from period to period, could
have
a material impact on the presentation of our financial condition, changes in
financial condition or results of operations.
Inflation
.
We
believe that our results of operations are not dependent upon moderate changes
in inflation rates.
FORWARD-LOOKING
STATEMENTS
The
Private Securities Litigation Reform Act of 1995 (the Act) provides a safe
harbor for forward-looking statements made by or on behalf of our company.
From
time to time, our representatives and we may make written or verbal
forward-looking statements, including statements contained in this report and
other company filings with the SEC and in our reports to stockholders.
Statements that relate to other than strictly historical facts, such as
statements about our plans and strategies, expectations for future financial
performance, new and existing products and technologies, and markets for our
products are forward-looking statements within the meaning of the Act.
Generally, the words "believe," "expect," "intend," "estimate," "anticipate,"
"will" and other similar expressions identify forward-looking statements. The
forward-looking statements are and will be based on our then-current views
and
assumptions regarding future events and operating performance, and speak only
as
of their dates. Investors are cautioned that such statements involve risks
and
uncertainties that could cause actual results to differ materially from
historical or anticipated results due to many factors including, but not limited
to, our limited revenues, our future capital needs, uncertainty of capital
funding, acceptance of our product offerings, the effects of government
regulations on our business, competition, and other risks. We undertake no
obligation to publicly update or revise any forward-looking
statements.
Item
3. Controls and Procedures.
(a)
Disclosure Controls and Procedures. Our management, with the participation
of
our chief executive officer and chief financial officer, has evaluated the
effectiveness of our disclosure controls and procedures (as such term is defined
in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the
period covered by this report. Based on such evaluation, our chief executive
officer and chief financial officer have concluded that, as of the end of such
period, our disclosure controls and procedures are effective in recording,
processing, summarizing and reporting, on a timely basis, information required
to be disclosed by us in the reports that we file or submit under the Exchange
Act.
(b)
Internal Control Over Financial Reporting. There have not been any changes
in
our internal control over financial reporting (as such term is defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to
which this report relates that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.
PART
II — OTHER INFORMATION
Item
1. Legal Proceedings.
As
of the
date hereof, the Company is party to three legal proceedings, as
follows:
Key:
See
Part
I, Item 2. Management’s Discussion and Analysis or Plan of Operation for a
discussion of the action by Key against Hercon in the Federal District Court
for
the District of New Jersey.
York
Realty LLC:
On
January 4, 2008, Transderm filed a Complaint for Declaratory Relief, Breach
of
Contract and Monetary Damages against York Realty Leasing, LLC (“York”) in the
Court of Common Pleas of York County, Pennsylvania (the “Complaint”). The action
arises out of York’s various correspondences to Transderm alleging that it is in
breach of and default under the lease between the parties dated December 7,
2004
for failure to pay rent as provided in the lease. In the Complaint, the Company
is seeking, among other things, a declaratory judgment to the effect that the
lease is in full force and effect, that the Company is not in default under
the
lease and that Transderm is owed an amount on account with York which York
has
refused to credit to Transderm. On January 23, 2008, the Company filed an
amended complaint in this matter seeking to clarify certain facts but otherwise
requesting the same relief. York did not file a timely answer to the Company’s
complaint and, upon further notice to York, the Court entered a default judgment
in favor of the Company on February 26, 2008. A hearing in this matter was
held
on April 25, 2008 whereby the Court ordered that the lease is in full force
and
effect, that the Company is not in default under the lease and that Transderm
is
entitled to a rental credit of $57,200.
Yurowitz
Action:
On
February 25, 2008, Andy Yurowitz, a director and the former chief executive
of
Transderm, Hercon and Health-Chem, served each of Health-Chem and Hercon with
a
summons without complaint which was filed in The Supreme Court of the State
of
New York, Kings County on February 7, 2008. The summons also indicated that
Andrew Levinson and Manfred Mayerfeld, members of the Boards of Health-Chem
and
Hercon, will be named in this action. The summons requires that each party
file
a notice of appearance in the action within a specified time after being
served.
The
summons states that the nature of the action and the relief sought is
defendant’s breach of contract and failure to pay wages. Until the Company is
served with and reviews the complaint with counsel, it is unable to comment
upon
the allegations or any potential defenses.
Item
2. Changes in Securities and Small Business Issuer Purchase of Equity
Securities.
(a) None.
(b) None.
(c)
During the three months ended June 30, 2007, the Company did not issue any
securities.
(d) None.
(e) None.
Item
3. Defaults Upon Senior Securities.
On
August
31, 1995, Hercon issued to Health-Chem a $7,000,000, 9% Subordinated Promissory
Note in exchange for the then outstanding borrowings from affiliates. The
Company has been required to make semi-annual interest payments each March
and
September on this note. The principal amount of $7,000,000 was due on March
31,
2002. In March, 2002 the Company defaulted on its obligation to repay the
principal amount of $7,000,000. Interest on the principal amount of this
promissory note, which accrues at the rate of $630,000 per annum, is transferred
semi-annually each March and September into the Group’s intercompany
account.
Item
4. Submission of Matters to a Vote of Security Holders.
None.
Item
5. Other Information.
(a)
Cancellation
of Note Payable.
On
August
20, 2007, a note payable by Hercon in the amount of $167,000 at June 30, 2007
was cancelled under the terms of an agreement between Hercon and a client that
had retained Hercon to undertake research and development activities on its
behalf. The agreement provided that in the event that the client did not file
certain documents with the United States Food and Drug Administration by May
30,
2006, the note was cancelable by Hercon and all amounts due thereunder would
be
forgiven by the note holder.
(b)
Termination
of Andy Yurowitz as Chief Executive Officer and President.
On
May
14, 2007, James McTevia, in his capacity as Chief Restructuring Officer of
the
Company, terminated Andy Yurowitz as a paid employee of Transderm, Hercon and
Health-Chem. Mr. Yurowitz’s status as an officer of each of these companies was
not affected by such termination. On November
22,
2007,
the Board ratified the prior termination of Andy Yurowitz as a paid employee
and
terminated him as the Chief Executive Officer and President, for cause. Mr.
Yurowitz continues to serve as a member of the board of Transderm, Hercon and
Health-Chem.
(c)
Appointment
of Acting Chief Executive Officer.
On
November 22, 2007, the board of directors appointed Ron Burghauser, the chief
financial officer of Transderm and Hercon, as the acting chief executive officer
of each company.
Item
6. Exhibits.
(a)
Exhibits.
Exhibit
No.
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Description
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10.1
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Consent
Judgment dated May 23, 2007, by the United States District Court,
District
of New Jersey entered a Final Judgment On Consent between Key
Pharmaceuticals, Inc. and Hercon Laboratories
Corporation.
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31.1
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Certification
of Principal Executive Officer and Principal Financial Officer pursuant
to
Rule 13a-14 and Rule 15d 14(a), promulgated under the Securities
and
Exchange Act of 1934, as Amended.
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|
|
|
32.1
|
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906
of the Sarbanes-Oxley Act of
2002.
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SIGNATURES
In
accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
TRANSDERM
LABORATORIES CORPORATION
Name
and Capacity
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Date
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/s/
Ronald J. Burghauser
|
|
June
3, 2008
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By:
Ronald J. Burghauser
Acting
Chief Operating Officer,
Chief
Financial Officer,
Treasurer
and Secretary
(Principal
Financial Officer)
(Principal
Accounting Officer)
|
|
|
Grafico Azioni Twinlab Consolidated (PK) (USOTC:TLCC)
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