HerbalEGram: Volume 5, Number 8, August 2008

NBTY Pays $371 Million for Troubled Leiner Health

Purchase gives NBTY more power over ingredient suppliers, while Leiner’s fall increases quality calls from industry

Back in 1982, when poisoned Tylenol capsules killed seven people, drug maker Johnson & Johnson earned praise for its swift actions to protect consumers. The company’s strong, proactive response made the incident a textbook case for business school students on how to turn potentially devastating news into a public relations win. By contrast, the recent handling of manufacturing problems by Leiner Health Products Inc.—which filed for bankruptcy earlier this year and closed one of its plants in response to an investigation by the U.S. Food and Drug Administration (FDA)—may go down in history as a textbook example of what not to do when quality troubles arise for a company.

Leiner’s recent inability to pass FDA muster for its over-the counter (OTC) products opened the door for the company to be snatched up by the largest U.S. supplement company, NBTY Inc., in June. Although the quality issues that resulted in the shuttering of its OTC operations did not involve the company’s supplement business and involved stability testing standards that are not required of supplement companies, some in the supplement industry believe they have exposed the industry to potentially damaging questions over the quality and safety of dietary supplements.

Founded in 1973, Leiner was a leading U.S. supplier of private-label supplements and over-the-counter (OTC) drugs—including private-label versions of acetaminophen, the active ingredient in Tylenol—for major food, drug, mass market and club warehouse retailers. In 2007, Leiner generated net sales of more than $735 million, including $400 million in supplement sales. In 2006, Nutrition Business Journal ranked Leiner as the second largest supplement company in the United States behind NBTY.

Leiner Caught on OTC Violations

Leiner’s recent problems began in January 2007, when an employee at the company’s OTC manufacturing plant in Fort Mill, South Carolina, blew the whistle on alleged quality concerns, prompting an investigation by the FDA. In a warning letter sent to Leiner in August 2007, the agency revealed that it had found “many serious deviations, some of which involved data manipulation and testing procedures” for OTC drug products manufactured under “violative conditions,” which “put consumers at significant risk.”

Court documents showed that interviews with employees led the FDA to charge Leiner with falsifying purity tests, failing to obtain data supporting expiration dates, failing to provide data to support the quality and safety of the company’s products, and failing to recall drugs on store shelves. In affidavits, Leiner employees accused management of pressuring employees to “use any means necessary to get the product released quickly,” including ignoring impurities and changing testing parameters to produce more desirable results. 

The FDA probe prompted Leiner to voluntarily recall all of its OTC products from its warehouses in April 2007 and shutter its Fort Mill plant in June 2007. In January of this year, Leiner closed its other OTC plant in Wilson, North Carolina, and outsourced its remaining OTC orders, documents filed with the U.S. Securities and Exchange Commission (SEC) show. Although Leiner’s supplement business was not part of the FDA probe, the company reported losing $10 million in supplement sale profits because of the negative publicity created by its OTC crackdown, according to court documents.

Leiner Health Products filed for chapter 11 bankruptcy in March of this year. In May, the company pled guilty to one count of mail fraud and agreed to a $10 million fine to settle a criminal investigation by the U.S. Department of Justice (DOJ), which agreed to drop other charges. In pleading guilty, Leiner acknowledged that, in 2006, quality-control officials at the company’s Fort Mill plant “gave the false appearance” that a drug batch had passed quality tests and “allowed the nonconforming drugs to be shipped to a customer,” according to a document filed in U.S. bankruptcy court in Delaware.

Leiner was purchased at auction in June by NBTY Inc. for $371 million. The sale is pending approval of the bankruptcy court and is expected to close no later than September of this year. NBTY initially bid $230 million for Leiner, but upped its offer to outbid private-label OTC leader Perrigo Co. for the troubled manufacturer.

The Rise…

Putting Leiner’s recent problems into context requires understanding the company’s past. Leiner Health Products, which was the largest supplement company in the United States in the mid to late 1990s, was founded in 1973, when P. Leiner & Sons, America formed a new vitamins division that gave birth to the Your Life vitamin brand. In 1979, Michael Leiner, David Brubaker and other executives led a management buyout of the division from its parent company in the United Kingdom. The new standalone company was named P. Leiner Nutritional Products Inc.

At the time it was purchased, Leiner was generating less than $10 million in sales and losing money, Michael Leiner told NBJ in June. But the new owners were able to successfully grow the supplement company, and in 1984, they took Leiner public. “We built up the company, both organically and through a series of acquisitions,” which included Vita-Fresh Vitamin Co. and FreshLabs Inc., Leiner said. Michael Leiner ran the company for more than 13 years, and under his leadership, Leiner’s revenues grew to $200 million and the company masterfully handled an L-tryptophan recall that had the potential to damage the U.S. supplement industry.

Ready to retire in 1992, Leiner and Brubaker sold the company to AEA Investors Inc., which took the company private through a leveraged buyout. Later that same year, the company purchased XCEL Laboratories, which gave the company a foothold in the private-label OTC arena. In June 1997, AEA sold Leiner to North Castle Partners, a private-equity firm started by AEA’s managing director Chip Baird. In 2004, as part of a recapitalization of the company, Leiner was sold once again, this time to Golden Gate Capital and a new investment fund managed by North Capital Partners.

Throughout the late 1990s, Leiner grew its business dramatically through a number of high-profile acquisitions. By 1998, Leiner’s supplement revenues had grown to $580 million and the company had established itself as a private-label leader and the largest supplement firm in the United States.

…And Fall of an Industry Leader

Leiner had a troubled history well before the company’s recent OTC problems surfaced. “The FDA event was the straw that broke the camel’s back, but it was a very sick camel to begin with,” Michael Leiner told NBJ.

In 2001, prior to Leiner’s recapitalization, the company underwent a restructuring and bankruptcy, paying out 25 cents on the dollar on an $80 million debt. North Castle Partners attributed the 2001 bankruptcy to a plunge in raw material prices following a DOJ settlement against 27 vitamin suppliers that were accused of price-fixing in violation of antitrust laws.

In November 2001, Leiner settled a complaint filed by the Federal Trade Commission (FTC) for reportedly labeling acetaminophen products as “made in the U.S.” when the products actually contained foreign ingredients. In 2002 and 2005, the company recalled iron-containing vitamin products that were packaged without child-proof lids. In 2006, a fire at an acetaminophen facility injured workers. 

Hoping to get Leiner’s side of the story, NBJ began working to schedule an interview with the company’s CEO, Robert Reynolds, in May. But Reynolds declined to speak to NBJ on the record because of the DOJ proceedings.  

In a Leiner press release issued on May 9, Reynolds said that his company’s May 2008 DOJ settlement resolved the government investigation of Leiner. “In addition to the closure of the affected facility, we also restructured our quality-control systems, including top-to-bottom personnel changes and implementation of strengthened compliance programs to ensure that all products conform to Leiner’s rigorous standards,” the release stated. Those changes included the resignation of former CEO Bob Kaminski, who remained on the board, and termination of CFO Kevin McDonnell.

In a June 10 press release, Reynolds praised the purchase agreement with NBTY. “We are very encouraged to have an agreement that contemplates that substantially all of our employees will receive employment offers from NBTY,” he said in the statement.

Leiner’s media spokesperson, Jen Brown, told NBJ in May that the company’s OTC business in Canada remained in operation. Asked if Leiner was still providing OTC private-label products for Costco and Wal-Mart, she replied, “Those are still [Leiner’s] largest customers.” Initially, NBTY announced that it would not pursue reviving Leiner’s OTC operations in the United States. However, the company now says it is considering what to do with Leiner’s OTC business.

As for Leiner’s supplement business, Brown told NBJ in May that the company’s “VMS [vitamins/minerals/supplements] products were completely unrelated to the investigation, so they are fine…Those are in separate facilities.” Brown added that no consumers had reported adverse health effects associated with any of Leiner’s products, despite the FDA complaints. “That’s part of the silver lining,” she added.

Vitamin Recall Latest Woe

But on June 6, another cloud passed over Leiner—this time casting a shadow on its supplement business—when the company issued an allergy alert and product recall of its Liquimax Complete Nutrition Multivitamin Formula, a supplement sold nationwide in retail stores. According to a Leiner press release, the company was made aware of the problem after receiving consumer reports that the product caused allergic reactions. Testing showed the multivitamin formula—which was manufactured by another company—to contain undeclared fish, tree nuts and wheat, which could trigger a “serious or life-threatening reaction” if consumed by consumers who are allergic to these substances.

Scott Van Winkle, managing director of equity research at Canaccord Adams in Boston, spoke with NBJ shortly after learning of the Leiner sale (but before the supplement recall was announced). “The regulatory issue had nothing to do with supplements,” Van Winkle said. “It was acetaminophen.” Still, as Van Winkle also noted, the scandal has implications for the supplement industry and should serve to teach supplement companies to be as careful as possible about ensuring the purity of their products and meeting label claims. “With GMPs coming into place, this shows you the detriment of not following good manufacturing practices.”

NBTY: More Powerful Than Ever

NBTY—which acquired all of Leiner’s assets in the June 9 auction, including Vita Health Products Inc. (a Canadian OTC drug manufacturing facility) and Leiner’s supplement manufacturing plant in Carson, California—stands to gain much from its recent purchase. 

“It certainly looks like [NBTY got] a good price, and this should be nicely accreted into wise earnings,” said Van Winkle, adding that the acquisition is expected to add 5%-10% to NBTY’s earnings. Although Leiner is a lower-margin business than what NBTY customarily operates, Van Winkle added that the purchase provides two key benefits for NBTY. “One, [NBTY] takes out a very large competitor on the private-label side, and two, [it] picks up … manufacturing facilities that allow [it] to further optimize [its] manufacturing capabilities.”

The purchase also makes NBTY a much stronger force to be reckoned with in the dietary supplement industry—one that will be able to dictate where ingredient directions go and further exert pressure on the raw material price front. “NBTY will become much more powerful than they already are,” said Dan
Lifton, director of business development at Maypro Inc., a global ingredients supplier.

NBTY’s stock [NYSE:NTY] jumped 7% on the news that it placed a bid for Leiner. After the bidding price rose to $371 million, the stock fell somewhat but has since rebounded to close at $33.98 a share on June 20, 9% higher than what it was on May 30.

NBTY President and Chief Financial Officer Harvey Kamil called the purchase a “great acquisition” and praised Leiner’s employees as “terrific people.” He added, “I’m sorry they went into bankruptcy, but at the same time, it was good for us.”

Kamil said he views the deal as an acquisition of a complementary, rather than competitive, business because NBTY is primarily a branded manufacturer (the company does do some private-label manufacturing). Leiner, on the other hand, was best known for its private-label products, as well as for its Your Life vitamin brand.

The addition of Leiner’s large supplement manufacturing operation will be another plus for NBTY, Kamil said. “We think we can give spectacular service to our customers. The exciting part is we can do private label and brands, and we have a high capacity to do that.”

NBTY’s purchase is structured under Section 363 of the U.S. Bankruptcy Code, which means NBTY will not assume any liability for products manufactured by Leiner prior to the acquisition—including Leiner’s recently recalled Liquimax multivitamin, Kamil said. 

Despite problems at the closed Fort Mill drug plant (a leased facility that NBTY did not acquire) and the recent allergen-related supplement recall, Kamil expressed confidence in the quality of the Leiner operations acquired. “They are USP certified,” Kamil said. “Their quality is extremely high. We have no issues with the quality of Leiner Health Products.”

Investors, Suppliers Suffer

Others in the industry do have questions about the quality of Leiner’s operations—and many have suffered financially as a result of the company’s bankruptcy proceedings. “Investors, financers lost money on this,” Van Winkle confirmed.  

“I know some suppliers who are trying to get their money,” said a key industry supplier who asked that his name not be published.

Although Leiner’s previous bankruptcy was structured in such a way that no vendors lost money, “this time suppliers are going to lose money,” said Scott Steinford, president of ZMC-USA and a supplier for Leiner. “The industry and the organization are definitely being impacted by this.” 

Bankruptcy court documents obtained by NBJ list Leiner’s 30 largest unsecured creditors who have claims ranging from $520,000 to $150 million. According to bankruptcy records, the U.S. Bank National Association filed a $150 million bond claim against Leiner, while Wells Fargo National Bank Association filed a $3.1 million claim against the company.

Among those suppliers that filed claims against Leiner, BASF tops the list with a trade claim in excess of $5 million. Dr. Reddy’s Laboratories and Vita Tech International Inc. each issued claim trades of more than $4 million, records show. Other creditors include Naturegen Inc., Lachman Consultants, Robinson Pharman Inc., Setco LLC, DSM Nutritional Products, Swiss Caps USA Inc., Sinochem Quindao Co. Ltd., Colorcon, Latham & Watkins, Watson Inc., A to Z Nutrition, Nutra Manufacturing Inc., Natoli Engineering Co. Inc., China Vitamins LLC, Jrs. Pharma LP, Richards Packaging Inc., United Pharma, Ocean Blue Inc., American Vitamins International, TRC Nutritional Laboratories, The Quantic Group Ltd., Primrose Candy Corp., Aetna Inc., Volt Temporary Service and Marlyn Nutraceuticals.

Steinford, who is a member of NBJ’s editorial advisory board, suggested Leiner’s woes may be attributed to “mismanagement to a degree.” Others in the industry said the company’s quality problems were, in part, the result of the company trying to meet the aggressive price and volume requirements set by the large mass market retailers.

“Everyone is trying to service that [large retail] segment, which is the largest segment of our business,” said one supplier, who asked to remain anonymous. “A lot of companies are trying to cut corners.”

“Maybe this was a deliberate situation or something attributed to sloppiness that Leiner got caught up in; I don’t know,” the source added. “But the fact is that Leiner got pushed and did not meet quality requirements to pass muster with the FDA, therefore they are done.”

Asked whether the implementation of new Good Manufacturing Practices (GMPs) for companies with 500 or more employees will resolve the problem, the source replied, “No. Because of all the pressures imposed on the industry, a lot of ingredients out there are suspect still. I do not see any changes in the supply channel.” Regulation and active enforcement, the source added, are what will be required to ensure product quality.

Silver Lining for Industry

Steinford said Leiner’s quality problems are certainly impacting suppliers and others in the nutrition industry, but he added that he doesn’t believe the event will cause “a black eye for the industry.”

The good news for supplement manufacturers and suppliers, Steinford said, is that this was “not a witch hunt” on the part of the FDA. Rather, Leiner’s downfall was brought on by one employee who questioned what was happening at the company’s OTC plant and became a whistle-blower, Steinford said. “It was not the FDA that instigated this.” The fact that Leiner pleaded guilty was a “smart move” that facilitated the sale to NBTY, Steinford added. “The Department of Justice investigation could have been very costly, as far as the fine [went].”

Industry consultant Jay Jacobowitz, president of Retail Insights in Brattleboro, Vermont, is less sanguine about the possible impact of Leiner’s downfall. “[This industry] has to be about quality, and now there is a nagging question in the back of your mind as you go to [large retailers] and look at the low-priced end caps and palette deals of supplements,” Jacobowitz observed. “You scratch your head and say, ‘Is the quality really there?’”

Jacobowitz also said Leiner’s quality troubles could produce potentially harmful collateral effects for the industry. “DSHEA [Dietary Supplements Health & Education Act] is not a God-given entitlement,” he said. “It exists because of a couple of dedicated people in Congress and some lucky timing. There are people with long memories on the other side who still want to take it out.”

Tighter industry self-regulation will be essential to avoiding such actions, Jacobowitz said. “The elephant in the room is China,” he added, noting that a high percentage of supplement ingredients are imported. “Were it widely known by the consuming public that a good portion of what’s in the [supplement] bottle comes from China, would they be comfortable?”

Others in the industry argue that the majority of supplement companies are doing the right things to ensure the quality of their products and that the rollout of the FDA’s new GMPs will only help to further prove the safety and efficacy of dietary supplements.

There is a “silver lining” to this event, said Bob Burke, founder and principal of the Natural Products Consulting Institute (NPCI). “This kind of unwelcome attention will cause more companies to clean up their acts internally, put more controls in place and perhaps [bring] greater ultimate credibility [to the industry].”

The NBJ Bottom Line

NBJ believes that the unfortunate fall of Leiner—a company once known for the quality of its products—was the result of several factors. The first was the company’s strategy to focus on the private-label supplement and OTC drug businesses, which have seen declining gross margins over the years and which grew at the expense of efforts to create value and raise margins through new product development or support of the company’s existing brands. In addition, we feel the excessive leveraging of the company has added to its financial pressures by increasing its debt and debt-service costs. Also, it appears that pressures to get products out the door quickly and as cost effectively as possible at Leiner created an environment where quality came second to company deadlines and where employees had to resort to whistle-blowing to bring attention to problems within the system.

In the end, however, NBJ believes that what happened at Leiner’s Fort Mill plant is a painful example of the industry policing itself—which is essential to maintaining product quality. Furthermore, Leiner’s OTC problems should serve as a cautionary tale to others in the supplement industry: Be very careful about protecting the quality of your products throughout the supply chain or risk the consequences, which could become much more severe and quick to come in the age of the new GMPs.

Ultimately, Leiner’s sale to NBTY could be positive for the industry because it gives the Leiner supplement business and its employees a second chance, and it opens up opportunities for high-quality manufacturers to win business that was once in Leiner hands.