1.	Business and Basis of Presentation

Nature of Business

Prestige Brands Holdings, Inc. (“the Company”) and its subsidiaries are engaged in the marketing, sales and distribution of over-the-counter drug, personal care and household cleaning brands to mass merchandisers, drug stores, supermarkets and club stores primarily in the United States. In February 2005, the Company completed an initial public offering.

Basis of Presentation

The unaudited consolidated financial statements presented herein have been prepared in accordance with generally accepted accounting principles for interim financial reporting and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the financial statements include all adjustments, consisting of normal recurring adjustments, that are considered necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods. Operating results for the three month period ended June 30, 2005 are not necessarily indicative of results that may be expected for the year ending March 31, 2006. This financial information should be read in conjunction with the Company’s audited financial statements and notes thereto included in Amendment No. 2 to the Company’s Annual Report on Form 10-K/A for the year ended March 31, 2005.

As more fully described in Note 2, the Company determined that the financial statements and the disclosures in the notes thereto for the three month periods ended June 30, 2005 and 2004 contained in the Quarterly Report on Form 10-Q filed on August 9, 2005, required restatement. All amounts disclosed in the footnotes to the financial statements have been appropriately restated.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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, as well as the reported amounts of revenues and expenses during the reporting period. Although these estimates are based on the Company’s knowledge of current events and actions that the Company may undertake in the future, actual results could differ from those estimates.

 

Cash and Cash Equivalents

The Company considers all short-term deposits and investments with original maturities of three months or less to be cash equivalents. Substantially all of the Company’s cash is held by one bank located in Wyoming. The Company does not believe that, as a result of this concentration, it is subject to any unusual financial risk beyond the normal risk associated with commercial banking relationships.

Accounts Receivable

The Company extends non-interest bearing trade credit to its customers in the ordinary course of business. To minimize credit risk, ongoing evaluations of customers’ financial condition are performed; however, collateral is not required. The Company maintains an allowance for doubtful accounts based on its historical collections experience, as well as its evaluation of current and expected conditions and trends affecting its customers.

 

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Sales Returns

The Company must make estimates of potential future product returns related to current period sales. In order to do this, the Company analyzes historical returns, current economic trends, changes in customer demand and acceptance of the Company’s products when evaluating the adequacy of the Company’s allowance for returns in any accounting period. If actual returns are greater than those estimated by management, the Company’s financial statements in future periods may be adversely affected.

Inventories

Inventories are stated at the lower of cost or fair value where cost is determined by using the first-in, first-out method. The Company provides an allowance for slow moving and obsolete inventory.

Property and Equipment

Property and equipment are stated at cost and are depreciated using the straight-line method based on the following estimated useful lives:

		Years
Machinery		5
Computer equipment		3
Furniture and fixtures		7

Expenditures for maintenance and repairs are charged to expense as incurred. When an asset is sold or otherwise disposed of, the cost and associated accumulated depreciation are removed from the accounts and the resulting gain or loss is recognized in the consolidated statement of operations.

 

Property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. An impairment loss is recognized if the carrying amount of the asset exceeds its fair value.

 

Goodwill

The excess of the purchase price over the fair market value of assets acquired and liabilities assumed in acquisition transactions is classified as goodwill. In accordance with Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” the Company does not amortize goodwill, but performs impairment tests of the carrying value at least annually.

Intangible Assets

Intangible assets are stated at the lesser of cost or fair value less accumulated amortization. For intangible assets with finite lives, amortization is computed on the straight-line method over estimated useful lives ranging from five to 30 years.

Indefinite lived intangible assets are tested for impairment at least annually, while intangible assets with finite lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. An impairment loss is recognized if the carrying amount of the asset exceeds its fair value.

Deferred Financing Costs

The Company has incurred debt issuance costs in connection with its long-term debt. These costs are capitalized as deferred financing costs and amortized using the effective interest method over the term of the related debt.

Revenue Recognition

Revenues are recognized when the following revenue recognition criteria are met: (1) persuasive evidence of an arrangement exists; (2) there is a fixed or determinable price; (3) the product has been shipped and the customer takes ownership and assumes risk of loss; and (4) collectibility of the resulting receivable is

 

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reasonably assured. The Company has determined that the risk of loss generally occurs when the product is received by the customer and, accordingly, recognizes revenue at that time. Provision is made for estimated customer discounts and returns at the time of sale based on the Company’s historical experience.

The Company frequently participates in the promotional programs of its customers, as is customary in this industry. The ultimate cost of these promotional programs varies based on the actual number of units sold during a finite period of time. These programs may include coupons, scan downs, temporary price reductions or other price guarantee vehicles. The Company estimates the cost of such promotional programs at their inception based on historical experience and current market conditions and reduces sales by such estimates. At the completion of the promotional program, the estimated amounts are adjusted to actual results.

Costs of Sales

Costs of sales include product costs, warehousing costs, inbound and outbound shipping costs, and handling and storage costs. Shipping, warehousing and handling costs were $5.5 million and $5.3 million for the periods ended June 30, 2005 and 2004, respectively.

Advertising and Promotion Costs

Advertising and promotion costs are expensed as incurred. Slotting fees associated with products are recognized as a reduction of sales. Under slotting arrangements, the retailers allow the Company’s products to be placed on the stores’ shelves in exchange for such fees. Direct reimbursements of advertising costs are reflected as a reduction of advertising costs in the period earned.

Stock-based Compensation

The Company accounts for employee stock-based compensation in accordance with the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and complies with the disclosure provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“Statement No. 123”) and FASB Statement No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123.” Under APB 25, compensation expense is based on the difference, if any, on the date of grant, between the fair value of the Company’s common stock and the exercise price of the equity instrument.

Income Taxes

Income taxes are recorded in accordance with the provisions of FASB Statement No. 109, “Accounting for Income Taxes” (“Statement No. 109”). Pursuant to Statement No. 109, deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is established when necessary to reduce deferred tax assets to the amounts expected to be realized.

Derivative Instruments

FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“Statement No. 133”), requires companies to recognize derivative instruments as either assets or liabilities in the balance sheet at fair value. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, a cash flow hedge or a hedge of a net investment in an international operation.

The Company has designated its derivative financial instruments as cash flow hedges because they hedge exposure to variability in expected future cash flows that is attributable to interest rate risk. For these hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income (loss) and reclassified into earnings in the same line item associated with the

 

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forecasted transaction in the same period or periods during which the hedged transaction affects earnings. Any ineffective portion of the gain or loss on the derivative instruments is recorded in results of operations immediately.

Earnings Per Share

Basic and diluted earnings per share are calculated based on income (loss) available to common shareholders and the weighted-average number of shares outstanding during the reported period. For the period ended June 30, 2004, the weighted average number of common shares outstanding includes the Company’s common units as if the common units had been converted to common stock using the February 2005 initial public offering conversion ratio of one common unit to 0.4589 shares of common stock.

Recently Issued Accounting Standards

In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”) which clarifies guidance provided by Statement No. 143, “Accounting for Asset Retirement Obligations.” FIN 47 is effective for the Company no later than March 31, 2006. The adoption of FIN 47 is not expected to have a significant impact on the Company’s financial position, results of operations or cash flows.

In April 2005, the Securities and Exchange Commission approved an amendment to Rule 4-01 of Regulations S-X that delays the effective date of Statement No. 123 (Revised 2004), “Shared-Based Payments” (“Statement No. 123R”), which requires companies to expense the value of employee and director stock options and similar awards. The results of operations for the period ended June 30, 2005 would not have been affected had the Company applied the fair value recognition provisions of Statement 123(R) during this period.

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections” (“Statement No. 154”) which replaces Accounting Principles Board Opinion No. 20, “Accounting Changes” (APB Opinion No. 20”) and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”. Statement No. 154 requires that voluntary changes in accounting principle be applied retrospectively to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustments be made to the opening balance of retained earnings. APB Opinion No. 20 had required that most voluntary changes in accounting principle be recognized by including in net income the cumulative effect of changing to the new principle. Statement No. 154 is effective for all accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.

2. Restatement of Financial Statements

On November 15, 2005 and November 30, 2005, the Company filed Current Reports on Form 8-K with the Securities and Exchange Commission (“SEC”) which announced that previously reported financial statements were being restated as a result of a review of certain accounting practices performed in conjunction with the Company's assessment of internal controls over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002 and the preparation of its financial statements for the quarter ended September 30, 2005. The Company determined it erroneously applied generally accepted accounting principles as they relate to the recognition of revenue, the classification of certain trade promotion allowances, the computation of deferred income taxes and the computation of earnings per share.

With respect to revenue recognition, Staff Accounting Bulletin No. 104 sets forth the criteria for revenue recognition, one of which is that risk of loss has passed to the customer. The Company, consistent with its published pricing and shipping terms, has historically recognized revenue upon shipment of product to the customer. Upon closer examination of its shipping practices and terms, the Company determined that it often was unclear when, from a legal standpoint, risk of loss of its products passed to its customers.

 

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Accordingly, the Company has concluded that revenue should not be recognized until product is received by its customers (referred to as “FOB destination point”), unless the risk of loss transfers to the customer at the point of shipment. These adjustments had no effect on net cash flows provided by or used in operating activities.

With respect to the classification of trade promotions and allowances, Emerging Issues Task Force Issue 01-09 sets forth the criteria for classifying such promotions and allowances as an expense or a reduction of revenue. Upon review, the Company determined that it had incorrectly classified certain promotion and allowance amounts as selling, general and administrative expenses rather than as a reduction of revenues. These adjustments do not affect the balance sheet, net income, operating income or cash flows from operations.

With respect to the provision for income taxes and related deferred taxes, Statement of Financial Accounting Standards No. 109 sets forth the criteria by which such amounts are to be recognized. The Company has determined that the increase in deferred income taxes related to the increase in graduated federal income tax rates from 34% to 35% should have been recognized in the period in which it filed its first consolidated federal income tax return. Consequently, the charge to earnings for the increase in deferred income taxes has been recognized in the fiscal year ended March 31, 2005. This charge was previously recognized in the quarter ended June 30, 2005. This change did not affect cash flows from operations.

With respect to earnings per share, Statement of Financial Accounting Standards No. 128 sets forth the criteria for computing basic and diluted earnings per share. Upon examination of its earnings per share calculations, the Company determined that certain issued and outstanding, but unvested, shares held by management were improperly reflected in the basic earnings per share computations.

The effects of the adjustments enumerated above for each fiscal period are reflected in the schedules that follow.

 

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Consolidated Statements of Operations

		Three Months Ended June 30, 2005
(In thousands, except per share data)		Previously Reported			Revenue Recognition			Cooperative Advertising			Income Taxes			As Restated
Revenues
Net sales		$	63,530		$	1,928		$	(2,030	)	$	--		$	63,428
Other revenues			25												25
Total revenues			63,555			1,928			(2,030	)		--			63,453
Cost of Sales
Costs of sales			28,339			610									28,949
Gross profit			35,216			1,318			(2,030	)		--			34,504
Operating Expenses
Advertising and promotion			10,714			21			(2,030	)					8,705
General and administrative			4,911												4,911
Depreciation			483												483
Amortization of intangible assets			2,148												2,148
Total operating expenses			18,256			21			(2,030	)		--			16,247
Operating income			16,960			1,297			--			--			18,257
Other income (expense)
Interest income			81												81
Interest expense			(8,591	)											(8,591	)
Total other income (expense)			(8,510	)		--			--			--			(8,510	)
Income before provision for income taxes			8,450			1,297			--			--			9,747
Provision for income taxes			4,443			522						(1,147	)		3,818
Net income		$	4,007		$	775		$	--		$	1,147		$	5,929
Basic earnings per share		$	0.08											$	0.12
Diluted earnings per share		$	0.08											$	0.12
Average shares outstanding: Basic			49,998												48,722
Diluted			49,998												49,998

 

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Consolidated Statements of Operations

		Three Months Ended June 30, 2004
(In thousands, except per share data)		Previously Reported			Revenue Recognition			Cooperative Advertising			As Restated
Revenues
Net sales		$	67,682		$	(6,142	)	$	(2,860	)	$	58,680
Other revenues			75									75
Total revenues			67,757			(6,142	)		(2,860	)		58,755
Cost of Sales
Costs of sales			36,123			(2,985	)					33,138
Gross profit			31,634			(3,157	)		(2,860	)		25,617
Operating Expenses
Advertising and promotion			13,771			(126	)		(2,860	)		10,785
General and administrative			4,921									4,921
Depreciation			486									486
Amortization of intangible assets			1,803									1,803
Total operating expenses			20,981			(126	)		(2,860	)		17,995
Operating income			10,653			(3,031	)		-			7,622
Other income (expense)
Interest income			28									28
Interest expense			(11,077	)								(11,077	)
Loss on extinguishment of debt			(7,567	)								(7,567	)
Total other income (expense)			(18,616	)		--			--			(18,616	)
Loss before benefit for income taxes			(7,963	)		(3,031	)					(10,994	)
Benefit for income taxes			2,826			1,076						3,902
Net loss			(5,137	)		(1,955	)		--			(7,092	)
Cumulative preferred dividend on Senior Preferred and Class B Preferred Units			(3,619	)								(3,619	)
Net loss available to common shareholders		$	(8,756	)	$	(1,955	)	$	--		$	(10,711	)
Basic earnings per share		$	(0.33	)							$	(0.44	)
Diluted earnings per share		$	(0.33	)							$	(0.44	)
Average shares outstanding: Basic			26,516									24,511
Diluted			26,516									24,511

 

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Consolidated Balance Sheet

(In thousands, except per share data)		June 30, 2005
Assets		As Previously Reported			As Restated
Current assets
Cash		$	13,945		$	13,945
Accounts receivable			32,489			26,442
Inventories			27,946			30,589
Deferred income tax assets			6,965			6,965
Prepaid expenses and other current assets			4,039			4,039
Total current assets			85,384			81,980
Property and equipment			2,043			2,043
Goodwill			294,544			294,731
Intangible assets			606,465			606,465
Other long-term assets			14,344			14,344
Total Assets		$	1,002,780		$	999,563
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable		$	18,626		$	18,626
Accrued liabilities			10,705			9,365
Current portion of long-term debt			3,730			3,730
Total current liabilities			33,061			31,721
Long-term debt			490,698			490,698
Deferred income tax liabilities			89,916			89,916
Total liabilities			613,675			612,335
Shareholders’ Equity
Preferred stock - $0.01 per share par value
Authorized - 5,000 shares
Issued and outstanding - None			--			--
Common stock - $.01 per share par value
Authorized - 250,000 shares
Issued and outstanding - 50,000 shares			500			500
Additional paid-in capital			378,188			378,188
Treasury stock - 2 shares at cost			(4	)		(4	)
Accumulated other comprehensive loss			(365	)		(365	)
Retained earnings			10,786			8,909
Total shareholders’ equity			389,105			387,228
Total Liabilities and Shareholders’ Equity		$	1,002,780		$	999,563

 

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Consolidated Balance Sheet

(In thousands, except per share data)		March 31, 2005
Assets			As Previously Reported			As Restated
Current assets
Cash		$	5,334		$	5,334
Accounts receivable			43,893			35,918
Inventories			21,580			24,833
Deferred income tax assets			5,699			5,699
Prepaid expenses and other current assets			3,152			3,152
Total current assets			79,658			74,936
Property and equipment			2,324			2,324
Goodwill			294,544			294,731
Intangible assets			608,613			608,613
Other long-term assets			15,996			15,996
Total Assets		$	1,001,135		$	996,600
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable		$	21,705		$	21,705
Accrued liabilities			13,472			11,589
Current portion of long-term debt			3,730			3,730
Total current liabilities			38,907			37,024
Long-term debt			491,630			491,630
Deferred income tax liabilities			84,752			85,899
Total liabilities			615,289			614,553
Shareholders’ Equity
Preferred stock - $0.01 per share par value
Authorized - 5,000 shares
Issued and outstanding - None			--			--
Common stock - $.01 per share par value
Authorized - 250,000 shares
Issued and outstanding - 50,000 shares			500			500
Additional paid-in capital			378,251			378,251
Treasury stock - 2 shares at cost			(4	)		(4	)
Accumulated other comprehensive income			320			320
Retained earnings			6,779			2,980
Total shareholders’ equity			385,846			382,047
Total Liabilities and Shareholders’ Equity		$	1,001,135		$	996,600

The restatements did not affect previously reported net cash flows from operating, investing or financing activities.

 

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