AT BOOTH #4274

Word from Wall Street: The Leiner Bankruptcy

By Adam Ismail | 05.01.08

Could this be a sign of troublesome times for the supplement industry?

The Leiner Bankruptcy

Could this be a sign of troublesome times for the supplement industry?

ByAdam Ismail

Leiner Health Products is one of the largest supplement manufacturers in the industry. It not only produces the Your Life brand of supplements, but it also has a significant share of the private label supplement brands sold in the U.S. today. So when the company announced that it was filing for bankruptcy at the end of March, it understandably shocked the industry. Given the credit crunch, the falling dollar, and what appears to be a shrinking global economy, does the Leiner bankruptcy foreshadow things to come in our industry? Fortunately, things are not as bad as they seem.

Leiner was also a large contract manufacturer of over-the-counter (OTC) pharmaceutical products. The problems Leiner is experiencing appear to stem from troubles it had during an audit of its OTC facility in South Carolina in April of 2007. The FDA inspected the plant and found that the company was not in compliance with all of the required good manufacturing practices (GMPs) at the facility. This led to a product recall, and eventually the decision to cease manufacturing of OTC products.

Recalls alone can be expensive and crippling to a company. (Fortunately there do not seem to be any consumer injuries due to the product made at the facility, significantly reducing the costs of the recall.) First, there’s the cost of getting inventory back from retail shelves. At the time of the FDA inspection, Leiner said there was $184 million in affected product on store shelves, and another $19 million that it held in inventory. The company had a little more than $600 million in annual sales at the time, so the costs of getting this product back and destroying it were significant.

The next impact they faced was the loss of sales. OTC revenues accounted for 25% of its sales alone, or about $150 million. According to the LA Times, it has been one year since the company essentially ceased all production of OTC products and it likely won’t resume it in the near future. These quality control and quality assurance problems may have resulted in more than just lost OTC business, some of its more conservative customers or customers that required both OTC and supplement manufacturing may have moved their supplement business elsewhere as well. Indeed, Perrigo, one of Leiner’s main competitors, said it alone had picked up about $100 million in sales as a result of the problems at Leiner, and it was more than just OTC business. In addition, there are reports on the Internet that retailers like CVS and Rite-Aid moved to other manufacturers.

So, if you put yourself in Leiner’s shoes, you have capitalized the company with a debt level appropriate for a $600 million business, but suddenly you just had to pay out $200 million for a product recall, have lost $150 million in sales, and have a fairly expensive manufacturing facility sitting idle that you are paying the mortgage on. Obviously this is not a good situation, but you have to give Leiner some credit—they worked for another year to resolve the situation before filing for Chapter 11 bankruptcy protection.

The bankruptcy protection allowed the company to obtain debtor-in-possession financing, which it can use as working capital to finance its ongoing operations. However, these loans do come at a cost. Some of Leiner’s suppliers, who are now creditors in the bankruptcy, said the banks offering the financing are charging up to 50% in annual interest. The other way the bankruptcy filing helps Leiner is that it allows the company to operate without making further payments on the debt until the bankruptcy plan is approved by the courts.

Leiner’s desired outcome from the bankruptcy is to sell the business as an ongoing concern and use most of the proceeds to pay off the debt. The unsecured creditors in the bankruptcy are voicing their concerns over this and have asked the court to halt the sale of the company until the auction process is changed. They claim that the way the auction process is set up, large banks and executives with bonus plans will receive the bulk of the proceeds, leaving little for the suppliers and other unsecured creditors. The U.S. bankruptcy Trustee in the case has expressed similar reservations over the bonus plans.

So the saga continues, but at the end of the day it is important to note that the Leiner bankruptcy was driven by problems at its OTC facility and not its supplement business. These problems may have resulted in a shift of supplement business to other contract manufacturers, but it affected only Leiner and was not representative of softness in the supplement sector. Indeed, after bankruptcy Leiner will be well positioned with a solid remaining base of supplement customersNW