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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2006
Commission file number 1-9601
K-V PHARMACEUTICAL COMPANY
(Exact name of registrant as specified in its charter)
2503 South Hanley Road
St. Louis, Missouri 63144
(314) 645-6600
DELAWARE 43-0618919
(State of Incorporation) (IRS Employer Identification No.)
Securities Registered Pursuant to Section 12(b) of the Act:
Class A Common Stock, par value $.01 per share New York Stock Exchange
Class B Common Stock, par value $.01 per share New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act:
7% Cumulative Convertible Preferred, par value $.01 per share
Indicate by check mark whether the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes [ X ] No [ ]
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2
of the Act).
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Act). Yes [ ] No [ X ]
The aggregate market value of the shares of Class A and Class B Common Stock
held by non-affiliates of the registrant as of September 30, 2005, the last
business day of the registrant's most recently completed second fiscal
quarter, was $548,161,941 and $89,557,184, respectively. As of June 8,
2006, the registrant had outstanding 36,974,977 and 12,524,759 shares of
Class A and Class B Common Stock, respectively, exclusive of treasury shares.
DOCUMENTS INCORPORATED BY REFERENCE
Part III: Portions of the definitive proxy statement of the registrant (to
be filed pursuant to Regulation 14A for registrant's 2006 Annual Meeting of
Shareholders, which involves the election of directors), are incorporated by
reference into Items 10, 11, 12, 13 and 14 to the extent stated in such
items.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Form 10-K, including the documents that we incorporate herein by
reference, contains various forward-looking statements within the meaning of
the United States Private Securities Litigation Reform Act of 1995, and
which may be based on or include assumptions concerning our operations,
future results and prospects. Such statements may be identified by the use
of words like "plans," "expect," "aim," "believe," "projects," "anticipate,"
"commit," "intend," "estimate," "will," "should," "could," and other
expressions that indicate future events and trends.
All statements that address expectations or projections about the future,
including without limitation, statements about our strategy for growth,
product development, regulatory approvals, market position, expenditures and
financial results, are forward-looking statements.
All forward-looking statements are based on current expectations and are
subject to risk and uncertainties. In connection with the "safe harbor"
provisions, we provide the following cautionary statements identifying
important economic, political, regulatory and technological factors which,
among others, could cause the actual results or events to differ materially
from those set forth or implied by the forward-looking statements and
related assumptions.
Such factors include (but are not limited to) the following: (1) changes in
the current and future business environment, including interest rates and
capital and consumer spending; (2) the difficulty of predicting FDA
approvals, including the timing, and whether any period of exclusivity will
be realized; (3) acceptance and demand for new pharmaceutical products; (4)
the impact of competitive products and pricing; (5) new product development
and launch, including the possibility that any product launch may be delayed
or that product acceptance may be less than anticipated; (6) reliance on key
strategic alliances; (7) the availability of raw materials; (8) the
regulatory environment; (9) fluctuations in operating results; (10) the
difficulty of predicting international regulatory approval, including the
timing; (11) the difficulty of predicting the pattern of inventory movements
by our customers; (12) the impact of competitive response to our sales,
marketing and strategic efforts; (13) risks that we may not ultimately
prevail in our litigation; (14) risks that we may see increased spending as
we continue to ramp up our branded business; and (15) the risks detailed
from time to time in our filings with the Securities and Exchange
Commission.
This discussion is by no means exhaustive, but is designed to highlight
important factors that may impact the Company's outlook.
Because the factors referred to above, as well as the statements included
under the captions "Narrative Description of Business," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and elsewhere in this Form 10-K, could cause actual results or
outcomes to differ materially from those expressed in any forward-looking
statements made by us or on our behalf, you should not place undue reliance
on any forward-looking statements. Further, any forward-looking statement
speaks only as of the date on which it is made and, unless applicable law
requires to the contrary, we undertake no obligation to update any
forward-looking statement to reflect events or circumstances after the date
on which the statement is made or to reflect the occurrence of unanticipated
events. New factors emerge from time to time, and it is not possible for us
to predict which factors will arise, when they will arise and/or their
effects. In addition, we cannot assess the impact of each factor on our
business or financial condition or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from
those contained in any forward-looking statements.
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ITEM 1. BUSINESS
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(a) GENERAL DEVELOPMENT OF BUSINESS
-------------------------------
Unless the context otherwise indicates, when we use the words "we,"
"our," "us," "our company" or "KV" we are referring to K-V
Pharmaceutical Company and its wholly-owned subsidiaries, including
Ther-Rx Corporation, ETHEX Corporation and Particle Dynamics, Inc.
We were incorporated under the laws of Delaware in 1971 as a
successor to a business originally founded in 1942. Victor M.
Hermelin, our Chairman and founder, invented and obtained initial
patents for early controlled release and enteric coating which
became part of our core business and a platform for future drug
delivery emphasis.
We develop advanced drug delivery technologies which enhance the
effectiveness of new therapeutic agents, existing pharmaceutical
products and prescription nutritional products. We have developed
and patented a wide variety of drug delivery and formulation
technologies which are primarily focused in four principal areas:
SITE RELEASE(R) bioadhesives; tastemasking; oral controlled
release; and oral quick dissolving tablets. We incorporate these
technologies in the products we market to control and improve the
absorption and utilization of active pharmaceutical compounds. In
1990, we established a generic marketing capability through a
wholly-owned subsidiary, ETHEX Corporation ("ETHEX"), which we
believe makes us one of the only drug delivery research and
development companies that also markets "technologically
distinguished" generic products. In 1999, we established a
wholly-owned subsidiary, Ther-Rx Corporation ("Ther-Rx"), to market
branded pharmaceuticals directly to physician specialists.
Our wholly-owned subsidiary, Particle Dynamics, Inc. ("PDI"), was
acquired in 1972. Through PDI, we develop and market specialty
value-added raw materials, including drugs, directly compressible
and microencapsulated products, and other products used in the
pharmaceutical, nutritional, food, personal care and other markets.
(b) SIGNIFICANT BUSINESS DEVELOPMENTS
---------------------------------
In May 2005, we entered into a long-term product development and
marketing license agreement with Strides Arcolab Limited
("Strides"), an Indian generic pharmaceutical developer and
manufacturer, for exclusive marketing rights in the United States
and Canada for 10 new generic drugs. Under the agreement, Strides
is responsible for developing, submitting for regulatory approval
and manufacturing the 10 products and we are responsible for
exclusively marketing the products in the territories covered by
the agreement. Under a separate agreement, we invested $11.3
million in Strides redeemable preferred stock.
In May 2005, the Company and FemmePharma, Inc. ("FemmePharma")
mutually agreed to terminate the license agreement between them
entered into in April 2002. As part of this transaction, we
acquired all of the common stock of FemmePharma for $25.0 million
after certain assets of the entity had been distributed to
FemmePharma's other shareholders. Under a separate agreement, we
had previously invested $5.0 million in FemmePharma's convertible
preferred stock. Included in the acquisition of FemmePharma are the
worldwide marketing rights to an endometriosis product that has
successfully completed Phase II clinical trials. This product was
originally part of the licensing arrangement with FemmePharma that
provided us, among other things, marketing rights for the product
principally in the United States. In accordance with the new
agreement, we acquired worldwide licensing rights of the
endometriosis product, are no longer responsible for milestone
payments and royalties specified in the original licensing
agreement, and secured exclusive worldwide rights for use of the
FemmePharma technology for vaginal anti-infective products. During
the fiscal year ended March 31, 2006, the Company recorded expense
of $30.4 million in connection with the FemmePharma acquisition
that consisted of $29.6 million for acquired in-process research
and development and $0.9 million in direct expenses related to the
transaction. The acquired in-process research and development
charge represented the estimated fair value of the endometriosis
product being
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developed that, at the time of the acquisition, had no alternative
future use and for which technological feasibility had not been
established.
In December 2005, we entered into a financing arrangement with St.
Louis County, Missouri related to expansion of our operations in
St. Louis County. In total, up to $135.5 million of industrial
revenue bonds may be issued to us by St. Louis County relative to
capital improvements made through December 31, 2009. This agreement
provides that 50% of the real and personal property taxes on up to
$135.5 million of capital improvements will be abated for a period
of 10 years subsequent to the property being placed in service. The
industrial revenue bonds are issued by St. Louis County to us upon
our payment of qualifying costs of capital improvements and
transfer of such improvements to St. Louis County, which are then
leased by us for a period ending December 1, 2019, unless earlier
terminated. We have the option at any time to discontinue the
arrangement and regain full title to the abated property. The
industrial revenue bonds bear interest at 4.25% per annum and are
payable as to principal and interest concurrently with payments due
under the terms of the lease. Industrial revenue bonds totaling
$73.0 million were outstanding at March 31, 2006. We have
classified the leased assets as property and equipment and have
established a capital lease obligation equal to the outstanding
principal balance of the industrial revenue bonds. Lease payments
may be made by tendering an equivalent portion of the industrial
revenue bonds. As the capital lease payments to St. Louis County
may be satisfied by tendering industrial revenue bonds (which is
our intention), the capital lease obligation, industrial revenue
bonds and related interest expense and interest income,
respectively, have been offset for presentation purposes in the
Consolidated Financial Statements.
In March 2006, we entered into a $43.0 million mortgage loan
agreement with one of our primary lenders, in part, to refinance
$9.9 million of existing mortgages. The $32.8 million of net
proceeds we received from the new mortgage loan will be used for
working capital and general corporate purposes. The new mortgage
loan bears interest at a rate of 5.91% and matures on April 1,
2021.
In fiscal 2006, we expanded our branded prescription nutritional
franchise when Ther-Rx introduced Encora(TM), a twice-daily
prescription nutritional supplement designed to meet the key
nutritional and preventative health needs of women past their
childbearing years. Ther-Rx also introduced two new branded
hematinic products, Niferex(R) Gold and Repliva 21/7(TM) in fiscal
2006.
In February 2006, we entered into an exclusive arrangement with
Gedeon Richter, Ltd., a European pharmaceutical company, to market
a broad group of generic drug products to the U.S. marketplace. The
products will serve the cardiovascular, diabetic and central
nervous system markets. Subject to FDA approval and patent
expirations, we expect to introduce these products to the U.S.
market over the next several years through 2017.
During fiscal 2006, we entered into two additional licensing
arrangements - one to market both Gynazole-1(R) and Clindesse(TM)
in five Scandanavian countries, the other to market Clindesse(TM)
in 18 Eastern European countries. These arrangements expanded
Gynazole-1(R)'s future international presence beyond the over 50
markets in Europe, Latin America, the Middle East, Asia, Indonesia,
the People's Republic of China, Australia and New Zealand covered
in other previously signed licensing agreements. We have previously
entered into licensing agreements for the right to market
Clindesse(TM) in Spain, Portugal, Andorra, Brazil and Mexico.
During fiscal 2006, we also received regulatory approvals to market
Gynazole-1(R) in 15 Eastern European countries and our first
regulatory approval in an Asian market.
In fiscal 2006, we received a favorable court ruling in a Paragraph
IV patent infringement action filed against us by AstraZeneca based
on our ANDA submissions to market generic formulations of
Toprol-XL(R). We believe we were the first company to file with the
FDA for generic approval of the 100mg and 200mg dosage strengths, a
position that may, upon approval, afford us the opportunity for a
six-month exclusivity period for marketing these generic versions.
The total branded dollar volume of Toprol-XL(R) in 2005 was $1.3
billion, of which the 100mg and 200mg strengths represented nearly
half.
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On June 9, 2006, we replaced our $140.0 million credit line by
entering into a new credit agreement with ten banks that provides
for a revolving line of credit for borrowing up to $320.0 million.
The new credit agreement also includes a provision for increasing
the revolving commitment, at the lenders' sole discretion, by up to
an additional $50.0 million. The new credit facility is unsecured
unless we, under certain specified circumstances, utilize the
facility to redeem part or all of our outstanding Convertible
Subordinated Notes. Interest is charged under the facility at the
lower of the prime rate or one-month LIBOR plus 62.5 to 150 basis
points depending on the ratio of senior debt to EBITDA. The new
credit agreement contains financial covenants that impose limits on
dividend payments, require minimum equity, a maximum senior
leverage ratio and minimum fixed charge coverage ratio. The new
credit facility has a five-year term expiring in June 2011.
(c) INDUSTRY SEGMENTS
-----------------
We operate principally in three industry segments, consisting of
branded products marketing, specialty generics marketing and
specialty raw materials marketing. Revenues are derived primarily
from directly marketing our own technologically distinguished
generic/non-branded and brand-name products. Revenues may also be
received in the form of licensing revenues and/or royalty payments
based upon a percentage of the licensee's sales of the product, in
addition to manufacturing revenues, when marketing rights to
products using our advanced drug delivery technologies are
licensed. See Note 21 to our Consolidated Financial Statements.
(d) NARRATIVE DESCRIPTION OF BUSINESS
---------------------------------
OVERVIEW
We are a fully integrated specialty pharmaceutical company that
develops, acquires, manufactures and markets technologically
distinguished branded and generic/non-branded prescription
pharmaceutical products. We have a broad range of dosage form
capabilities including tablets, capsules, creams, liquids and
ointments. We conduct our branded pharmaceutical operations through
Ther-Rx and our generic/non-branded pharmaceutical operations
through ETHEX. Through PDI, we also develop, manufacture and market
technologically advanced, value-added raw material products for the
pharmaceutical, nutritional, personal care, food and other markets.
We have a broad portfolio of drug delivery technologies which we
leverage to create technologically distinguished brand name and
specialty generic/non-branded products. We have developed and
patented 15 drug delivery and formulation technologies primarily in
four principal areas: SITE RELEASE(R) bioadhesives, oral controlled
release, tastemasking and oral quick dissolving tablets. We
incorporate these technologies in the products we market to control
and improve the absorption and utilization of active pharmaceutical
compounds. These technologies provide a number of benefits,
including reduced frequency of administration, reduced side
effects, improved drug efficacy, enhanced patient compliance and
improved taste.
We have a long history of developing drug delivery technologies. In
the 1950's, we received what we believe to be the first patents for
sustained release delivery systems which enhance the convenience
and effectiveness of pharmaceutical products. In our early years,
we used our technologies to develop products for other drug
marketers. Our technologies have been used in several well known
products, including Actifed(R) 12-hour, Sudafed(R) SA, Centrum
Jr.(R) and Kaopectate(R) Chewable. Since the 1990's, we have chosen
to focus our drug development expertise on internally developed
products for our branded and generic/non-branded pharmaceutical
businesses.
For example, since its inception in March 1999, our Ther-Rx
business has successfully launched 11 internally developed branded
pharmaceutical products, all of which incorporate our drug delivery
technologies. We have also introduced several technology-improved
versions of the four product franchises acquired by us.
Furthermore, most of the internally developed generic/non-branded
products marketed by our ETHEX business incorporate one or more of
our drug delivery technologies.
Our drug delivery technology allows us to differentiate our
products in the marketplace, both in the branded and
generic/non-branded pharmaceutical areas. We believe that this
differentiation provides substantial competitive advantages for our
products, allowing us to establish a strong record of growth and
profitability and a leadership position in certain segments of our
industry. For the past five years, we have grown net revenues at a
compounded annual growth rate of 15.6%. Ther-Rx has grown
substantially since its inception in March 1999 and continues to
gain market share in its women's healthcare and hematinic family of
products. Also, by focusing on the development and marketing of
technology-distinguished, multisource drugs, ETHEX has been able to
identify and bring to market niche products that leverage our
portfolio of drug delivery technologies in a way that produces
relatively high gross margin generics/non branded products.
5
THER-RX -- OUR BRAND NAME PHARMACEUTICAL BUSINESS
We established Ther-Rx in 1999 to market brand name pharmaceutical
products which incorporate our proprietary technologies. Since its
inception, Ther-Rx has introduced 11 products into two principal
therapeutic categories - women's health and oral hematinics - where
physician specialists can be reached using a highly focused sales
force. By targeting physician specialists, we believe Ther-Rx can
compete successfully without the need for a sales force as large as
pharmaceutical companies with less specialized product lines.
Ther-Rx's net revenues grew from $90.1 million in fiscal 2005 to
$145.4 million in fiscal 2006 and represented 39.6% of our fiscal
2006 total net revenues.
Ther-Rx's cardiovascular product line consists of Micro-K(R), an
extended-release potassium supplement used to replenish
electrolytes, primarily in patients who are on medication which
depletes the levels of potassium in the body. We acquired
Micro-K(R) in fiscal 1999 from the pharmaceutical division of
Wyeth. Sales of Micro-K(R) increased 28.2% to $8.3 million in
fiscal 2006.
We established our women's healthcare franchise through the August
1999 acquisition of PreCare(R), a prescription prenatal vitamin,
from UCB Pharma, Inc. Since the acquisition, Ther-Rx has
reformulated the original product using proprietary technologies,
and subsequently has launched five internally developed products as
extensions to the PreCare(R) product line. Building upon the
PreCare(R) acquisition, we have developed a line of proprietary
products which makes Ther-Rx the leading provider of branded
prescription prenatal vitamins in the United States.
The first of our internally developed, patented line extensions to
PreCare(R) was PreCare(R) Chewables, the world's first prescription
chewable prenatal vitamin. PreCare(R) Chewables addressed a
longstanding challenge to improve pregnant women's compliance with
prenatal vitamin regimens by alleviating the difficulty that
patients experience in swallowing large prenatal pills. Ther-Rx's
second internally developed product, PremesisRx(TM), is an
innovative prenatal prescription product that incorporates our
controlled release Vitamin B6. This product is designed for use in
conjunction with a physician-supervised program to reduce
pregnancy-related nausea and vomiting, which is experienced by 50%
to 90% of women who become pregnant. The third product, PreCare(R)
Conceive(TM), is the first product designed as a prescription
nutritional pre-conception supplement. The fourth product,
PrimaCare(R), is the first prescription prenatal/postnatal
nutritional supplement with essential fatty acids specially
designed to help provide nutritional support for women during
pregnancy, postpartum recovery and throughout the childbearing
years. The fifth product, PrimaCare(R) ONE, was launched in fiscal
2005 as a proprietary line extension to PrimaCare(R) and is the
first prenatal product to contain essential fatty acids in a
one-dose-per-day dosage form. The PrimaCare(R) franchise has grown
to be the number one branded prenatal prescription vitamin in the
U.S. As a result of this, sales of our branded prescription
prenatal vitamins increased 56.0% in fiscal 2006 to $50.4 million.
In June 2000, Ther-Rx launched its first NDA approved product,
Gynazole-1(R), the only one-dose prescription cream treatment for
vaginal yeast infections. Gynazole-1(R) incorporates our patented
drug delivery technology, VagiSite(TM), the only clinically proven
and Federal Food and Drug Administration, or FDA, approved
controlled release bioadhesive system.
In addition, we have entered into licensing agreements for the
right to market Gynazole-1(R) in over 50 markets in Europe, Latin
America, the Middle East, Asia, Indonesia, the People's Republic of
China, Australia, New Zealand, Mexico and Scandanavia. We also
received, during fiscal 2006, regulatory approval to market
Gynazole-1(R) into 15 Eastern European markets and our first
regulatory approval in an Asian market.
We established our hematinic product line by acquiring two leading
hematinic brands, Chromagen(R) and Niferex(R), in March 2003. We
re-launched technology-improved versions of these products mid-way
through fiscal 2004. In fiscal 2006, we introduced two new
hematinic products - Niferex(R) Gold and Repliva 21/7(TM). As
6
a result of new prescription growth and the introduction of the two
new products, sales of our hematinic product line grew to $36.8
million in fiscal 2006, a 44.8% increase over fiscal 2005.
In January 2005, Ther-Rx introduced its second NDA approved
product, Clindesse(TM), the first approved single-dose therapy for
bacterial vaginosis. Similar to Gynazole-1(R), Clindesse(TM)
incorporates our proprietary VagiSite(TM) bioadhesive drug delivery
technology. Since its launch, Clindesse(TM) has gained 19.7% of the
intravaginal bacterial vaginosis market in the United States and
generated $22.0 million of sales for its first full year in the
market. We have also entered into licensing agreements for the
right to market Clindesse(TM) in Spain, Portugal, Andorra, Brazil,
Mexico, five Scandanavian markets, and 18 Eastern European
countries.
In fiscal 2006, we expanded our prescription nutritional franchise
when Ther-Rx introduced Encora(TM), a twice-daily prescription
nutritional supplement designed to meet the key nutritional and
preventative health needs of women past their childbearing years.
Based on the addition of new products and our expectation of
continued growth in our branded business, Ther-Rx has expanded its
branded sales force to approximately 285 specialty sales
representatives and sales management personnel. Ther-Rx's sales
force focuses on physician specialists who are identified through
available market research as frequent prescribers of our
prescription products. Ther-Rx also has a corporate sales and
marketing management team dedicated to planning and managing
Ther-Rx's sales and marketing efforts.
ETHEX -- OUR TECHNOLOGICALLY DISTINGUISHED GENERIC/NON-BRANDED DRUG
BUSINESS
We established ETHEX, currently our largest business segment, in
1990 to utilize our portfolio of drug delivery systems to develop
and market hard-to-copy generic/non-branded pharmaceuticals. We
believe many of our ETHEX products enjoy higher gross margins than
other generic pharmaceutical companies due to our approach of
selecting products that benefit from our proprietary drug delivery
systems and our specialty manufacturing capabilities. These
advantages can act as barriers to entry which may limit competition
and reduce the rate of price erosion typically experienced in the
generic market. ETHEX's net revenues were $203.8 million for fiscal
2006, which represented 55.4% of our total net revenues.
We have incorporated our proprietary drug delivery technology in
many of our generic/non-branded pharmaceutical products. For
example, we have included METER RELEASE(R), one of our proprietary
controlled release technologies, into the only generic equivalent
to Norpace(R) CR, an antiarrhythmic that is taken twice daily.
Further, we have used our KV/24(R) once daily technology in the
generic equivalent to IMDUR(R), a cardiovascular drug that is taken
once per day. In addition, utilizing our specialty manufacturing
expertise and a sublingual delivery system, we produced and
marketed the first non-branded alternative to Nitrostat(R)
sublingual, an anti-angina product which historically has been
difficult to manufacture.
To capitalize on ETHEX's unique product capabilities, we continue
to expand our ETHEX product portfolio. In fiscal 2006, we launched
a new InveAmp(TM) line extension to our pain management business.
InveAmp(TM), a unique one unit dose ampoule, was designed to make
dispensing of schedule II solutions more effective.
Over the past two years, we have introduced a number of new
generic/non-branded products and currently have more than 50 new
product opportunities in our generic/non-branded products pipeline.
Although specialty generic sales resulting from new product
introductions were limited during fiscal 2006, we did receive ANDA
approval for Prednisolone Sodium Phosphate Liquid 15 mg (base)/5 mL
in June 2005 and late in the 2006 fiscal year ANDA approvals for
five strengths of Oxycodone Hydrochloride tablets, three strengths
of Hydromorphone Hydrochloride tablets and the 30 mg strength of
Morphine Sulfate. We also anticipate ANDA approvals for Diltiazem,
Levothyroxine and Metoprolol, among other products, in fiscal 2007.
In addition to our internal marketing efforts, we have entered into
a long-term product development and marketing license agreement
with Strides, an Indian generic pharmaceutical developer and
manufacturer, for
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exclusive marketing rights in the United States and Canada for 10
new generic drugs. Under the agreement, Strides will be responsible
for developing, submitting for regulatory approval and
manufacturing the 10 products and we will be responsible for
exclusively marketing the products in the territories covered by
the agreement. Under a separate agreement, we invested $11.3
million in Strides redeemable preferred stock.
In February 2006, we entered into an exclusive arrangement with
Gedeon Richter, Ltd., a European pharmaceutical company, to market
a broad group of generic drug products to the U.S. marketplace. The
products will serve the cardiovascular, diabetic and central
nervous system markets. Subject to FDA approval and patent
expirations, we expect to introduce these products to the U.S.
market over the next several years through 2017.
Also, late in fiscal 2006, we received a favorable court ruling in
a Paragraph IV patent infringement action filed against us by
AstraZeneca based on our ANDA submissions to market generic
formulations of Toprol-XL(R). We believe we were the first company
to file with the FDA for generic approval of the 100 mg and 200 mg
dosage strengths, a position that may, upon approval, afford us the
opportunity for a six month exclusivity period for marketing these
generic versions. The total branded dollar volume of Toprol-XL(R)
in 2005 was $1.3 billion, of which the 100 mg and 200 mg strengths
represented nearly half.
ETHEX primarily focuses on the therapeutic categories of
cardiovascular, women's health, pain management and respiratory,
leveraging our expertise in developing and manufacturing products
in these areas. In addition, we pursue opportunities outside of
these categories where we also may differentiate our products based
upon our proprietary drug delivery systems and our specialty
manufacturing expertise.
CARDIOVASCULAR. ETHEX currently markets over 45 products in its
cardiovascular line, including products to treat angina, arrhythmia
and hypertension, as well as for potassium supplementation. The
cardiovascular line accounted for 41.9% of ETHEX's net revenues in
fiscal 2006.
PAIN MANAGEMENT. ETHEX currently markets over 20 products in its
pain management line. Included in this line are several controlled
substance drugs, such as morphine, hydromorphone and oxycodone.
Pain management products accounted for 18.4% of ETHEX's net
revenues in fiscal 2006.
RESPIRATORY. ETHEX currently markets over 35 products in its
respiratory line, which consists primarily of cough/cold products.
ETHEX is the leading provider on a unit basis of prescription
cough/cold products in the United States today. The cough/cold line
accounted for 17.7% of ETHEX's net revenues in fiscal 2006.
WOMEN'S HEALTH CARE. ETHEX currently markets over 20 products in
its women's healthcare line, all of which are prescription prenatal
vitamins. The women's healthcare line accounted for 8.3% of ETHEX's
net revenues in fiscal 2006.
OTHER THERAPEUTICS. In addition to our core therapeutic lines,
ETHEX markets over 40 products in the gastrointestinal,
dermatological, anti-anxiety, digestive enzyme and dental
categories.
ETHEX has a dedicated sales and marketing team, which includes an
outside sales team of regional managers and national account
managers and an inside sales team. The outside sales force calls on
wholesalers and distributors and national drugstore chains, as well
as hospitals, nursing homes, independent pharmacies and mail order
firms. The inside sales force makes calls to independent pharmacies
to create pull-through at the wholesale level.
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PDI - OUR VALUE-ADDED RAW MATERIAL BUSINESS
PDI develops and markets specialty raw material products for the
pharmaceutical, nutritional, food, personal care and other
industries. Its products include value-added active drug molecules,
vitamins, minerals and other raw material ingredients that provide
benefits such as improved taste, altered or controlled release
profiles, enhanced product stability or more efficient and other
manufacturing process advantages. PDI is also a significant
supplier of value-added raw materials for the development and
manufacture of both existing and new products at our Ther-Rx and
ETHEX businesses. Net revenues for PDI were $17.0 million in fiscal
2006, which represented 4.6% of our total net revenues. PDI
currently offers three distinct lines of specialty raw material
products:
o DESCOTE(R) is a family of microencapsulated tastemasked
vitamins and minerals for use in chewable nutritional
products, quick dissolve dosage forms, foods, children's
vitamins and other products.
o DESTAB(TM) is a family of direct compression products that
enables pharmaceutical manufacturers to produce tablets and
caplets more efficiently and economically.
o MicroMask(TM) is a family of products designed to alleviate
problems associated with swallowing tablets. This is
accomplished by offering superior tasting, chewable or quick
dissolving dosage forms of medication.
BUSINESS STRATEGY
Our goal is to enhance our position as a leading fully integrated
specialty pharmaceutical company that utilizes its expanding drug
delivery expertise to bring technologically distinguished brand
name and generic/non-branded products to market. Our strategies
incorporate the following key elements:
INTERNALLY DEVELOP BRAND NAME PRODUCTS. We apply our existing drug
delivery technologies, research and development and manufacturing
expertise to introduce new brand name products which can expand our
existing franchises. During the second quarter of fiscal 2006,
Ther-Rx introduced Encora(TM), a new prescription nutritional
supplement product, and two new hematinic products, Niferex(R) Gold
and Repliva 21/7(TM). We plan to continue to use our research and
development, manufacturing and marketing expertise to create unique
brand name products within our core therapeutic areas and we
currently have a number of new products in clinical development.
CAPITALIZE ON ACQUISITION OPPORTUNITIES. We actively seek
acquisition opportunities for both Ther-Rx and ETHEX. Ther-Rx
continually looks for platform acquisition opportunities similar to
PreCare(R) around which we can build franchises. We believe that
consolidation among large pharmaceutical companies, coupled with
cost-containment pressures, has increased the level of sales
necessary for an individual product to justify active marketing and
promotion. This has led large pharmaceutical companies to focus
their marketing efforts on drugs with higher volume sales, newer or
novel drugs which have the potential for high volume sales and
products which fit within core therapeutic or marketing priorities.
As a result, major pharmaceutical companies increasingly have
sought to divest small or non-strategic product lines, which can be
profitable for specialty pharmaceutical companies like us.
In making acquisitions, we apply several important criteria in our
decision-making process. We pursue products with the following
attributes:
o products which we believe have relevance for treatment of
significant clinical needs;
o promotionally sensitive maintenance drugs which require
continual use over a long period of time, as opposed to more
limited use products for acute indications;
o products that have strong patent protection or can be
protected;
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o products which are predominantly prescribed by physician
specialists, which can be cost-effectively marketed by our
focused sales force; and
o products which we believe have potential for technological
enhancements and line extensions based upon our drug delivery
technologies.
FOCUS SALES EFFORTS ON HIGH VALUE NICHE MARKETS. We focus our
Ther-Rx sales efforts on niche markets where we believe we can
target a relatively narrow physician audience. Because our products
are sold to specialty physician groups that tend to be relatively
concentrated, we believe that we can address these markets cost
effectively with a focused sales force. Based on the addition of
new products and our expectation of continued growth in our branded
business, Ther-Rx has expanded its branded sales force to
approximately 285 specialty sales representatives and sales
management personnel. We plan to continue to build our sales force
as necessary to accommodate current and future expansions of our
product lines.
PURSUE ATTRACTIVE GROWTH OPPORTUNITIES WITHIN THE GENERIC INDUSTRY.
We plan to continue introducing generic and non-branded
alternatives to select drugs whose patents have expired,
particularly where we can use our drug delivery technologies. Such
generic or off-patent pharmaceutical products are generally sold at
significantly lower prices than the branded product. Accordingly,
generic pharmaceuticals provide a cost-efficient alternative to
users of branded products. We believe the health care industry will
continue to support growth in the generic pharmaceutical market and
that industry trends favor generic product expansion into the
managed care, long-term care and government contract markets. We
further believe that we are uniquely positioned to capitalize on
this growing market given our large base of proprietary drug
delivery technologies and our proven ability to lead the
therapeutic categories we enter.
ADVANCE EXISTING AND DEVELOP NEW DRUG DELIVERY TECHNOLOGIES. We
believe our drug delivery platform of 15 distinguished technologies
has unique breadth and depth. These technologies have enabled us to
create innovative products, including Gynazole-1(R) and
Clindesse(TM), which incorporate VagiSite(TM), our proprietary
bioadhesive controlled release system. In addition, our
tastemasking and controlled release systems are incorporated into
our prenatal vitamins, providing them with differentiated benefits
over other products on the market.
We plan to continue to develop our drug delivery technologies and
have various technologies currently under development, such as:
TransCell(R) for oral esophageal delivery of bioactive peptides and
proteins that are normally degraded by stomach enzymes or
first-pass liver effects; PulmoSite(TM) which applies bioadhesive
and controlled release characteristics to drug agents that are
inhaled for either local action in the lung or for systemic
absorption; and Ocusite(TM) for the delivery of active agents by a
bioadhesive topical application to the eye.
OUR PROPRIETARY DRUG DELIVERY TECHNOLOGIES
We believe we are a leader in the development of proprietary drug
delivery systems and formulation technologies which enhance the
effectiveness of new therapeutic agents, existing pharmaceutical
products and nutritional supplements. We have used many of these
technologies to successfully commercialize technologically
distinguished branded and generic/non-branded products.
Additionally, we continue to invest our resources in the
development of new technologies. The following describes our
principal drug delivery technologies.
SITE RELEASE(R) TECHNOLOGIES. SITE RELEASE(R) is our largest family
of technologies and includes eight systems designed specifically
for oral, topical or interorificial use. These systems rely on
controlled bioadhesive properties to optimize the delivery of drugs
to either wet mucosal tissue or the skin and are the subject of
issued patents and pending patent applications. Of the technologies
developed, products using the VagiSite(TM) and DermaSite(TM)
technologies have been successfully commercialized. Our fully
developed technologies include the following:
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o VagiSite(TM) is a controlled release bioadhesive delivery
system that incorporates advanced polyphasic principles to
create a bioemulsion system delivering therapeutic agents to
the vagina. We have outlicensed VagiSite(TM) for sale in
international markets for the treatment of vaginal infections.
VagiSite(TM) technology is used in Gynazole-1(R), a one-dose
prescription cream treatment for vaginal yeast infections and
Clindesse(TM), a one-dose prescription cream treatment for
bacterial vaginosis.
o DermaSite(TM) is a semi-solid SITE RELEASE(R) configuration
for topical applications to the skin. The bioadhesive and
controlled release properties of the delivery platform have
made possible the development of products requiring a
significantly reduced frequency of application.
o OraSite(R) is a controlled release mucoadhesive delivery
system administered orally in a solid or liquid form. A drug
formulated with the OraSite(R) technology may be formulated as
a liquid or as a lozenge in which the dosage form liquefies
upon insertion and adheres to the mucosal surface of the
mouth, throat and esophagus. OraSite(R) possesses
characteristics particularly advantageous to therapeutic
categories such as oral hygiene, sore throat and periodontal
and upper gastrointestinal tract disorders.
o OraSert(TM) is a solid dosage-form application system
specifically designed for localized delivery of active agents
to the oral tissues. The product is formulated as a "cough
drop" type tablet, which immediately liquefies upon placement
in the mouth and bioadheres to mucosal tissue in the mouth,
throat and esophagus. OraSert(TM) possesses characteristics
particularly advantageous to therapeutic applications such as
periodontal disease, respiratory conditions, pharyngeal
conditions and upper gastrointestinal tract disorders.
o BioSert(TM) is a bioadhesive delivery system in a solid insert
formulation for vaginal or rectal administration, similar in
appearance to a vaginal or rectal suppository, which can be
used for both local and systemic delivery of drugs. The
BioSert(TM) dosage form liquefies and bioadheres to vaginal or
rectal tissues, which is of particular benefit when a patient
can no longer tolerate orally administered medications. We are
currently developing several drug products that utilize the
BioSert(TM) technology, including non-steroidal
anti-inflammatory drugs, or NSAIDs, and antifungals for a
local effect and opioids for a systemic effect.
In addition, the following SITE RELEASE(R) technologies are
currently under development:
o Trans-Cell(R) is a novel bioadhesive, controlled release
delivery system that may permit oral delivery of bioactive
peptides and proteins that are normally degraded by stomach
enzymes or first-pass liver effects. This technology was
specifically designed to provide an oral delivery alternative
to biotechnology and other compounds that currently are
delivered as injections or infused.
o OcuSite(TM) is a liquid, microemulsion delivery system
intended for topical applications in the eye. The
microemulsion formulation lends optical clarity to the
application and is particularly well suited for ophthalmic
use. The bioadhesive and controlled release properties of this
delivery system allow for reduced dosing regimentation.
o PulmoSite(TM) applies bioadhesive and controlled release
characteristics to drug agents that are to be inhaled for
either local action to the lung or for systemic absorption.
ORAL CONTROLLED RELEASE TECHNOLOGIES. The technological leadership
of our advanced drug delivery systems was established in the
development of our three oral controlled release technologies, all
of which have been commercialized. Our systems can be individually
designed to achieve the desired release profile for a given drug.
The release profile is dependent on many parameters, such as drug
solubility, protein binding and site of absorption. Some of the
products utilizing our oral controlled release systems in the
market include
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Isosorbide-5-Mononitrate (an AB rated generic equivalent to
IMDUR(R)) and Disopyramide Phosphate (an AB rated generic
equivalent of Norpace(R) CR). Our patented technologies include the
following:
o KV/24(R) is a multi-particulate drug delivery system that
encapsulates one or more drug compounds into spherical
particles which release the active drug or drugs systemically
over an 18- to 24-hour period, permitting the development of
once-a-day drug formulations. We believe that our KV/24(R)
oral dosing system is the only commercialized 24-hour oral
controlled release system that is successfully able to
incorporate more than one active compound.
o METER RELEASE(R) is a polymer-based drug delivery system that
offers different release characteristics than KV/24(R) and is
used for products that require drug release rates of between
eight and 12 hours. We have developed METER RELEASE(R) systems
in tablet, capsule and caplet form that have been
commercialized in ETHEX products in the cardiovascular,
gastrointestinal and upper respiratory product categories.
o MICRO RELEASE(R) is a microparticulate formulation that
encapsulates therapeutic agents, employing smaller particles
than KV/24(R) and METER RELEASE(R). This system is used to
extend the release of drugs in the body where precise release
profiles are less important. MICRO RELEASE(R) has been
commercialized in prescription products marketed by ETHEX and
Ther-Rx as well as over-the-counter nutritional products.
TASTEMASKING TECHNOLOGIES. Our tastemasking technologies improve
the taste of unpleasant drugs. Our three patented tastemasking
systems can be applied to liquids, chewables or dry powders. We
first introduced tastemasking technologies in 1991 and have
utilized them in a number of Ther-Rx and ETHEX products, including
PreCare(R) Chewables and most of the liquid products that are sold
in ETHEX's cough/cold line. Our patented technologies include the
following:
o LIQUETTE(R) is a tastemasking system that incorporates
unpleasant tasting drugs into a hydrophilic and lipophilic
polymer matrix to suppress the taste of a drug. This
technology is used for mildly to moderately distasteful drugs
where low manufacturing costs are particularly important.
o FlavorTech(R) is a liquid formulation technology designed to
reduce the objectionable taste of a wide variety of
therapeutic products. FlavorTech(R) technology has been used
in cough/cold syrup products sold by ETHEX and has special
application to other products, such as antibiotic, geriatric
and pediatric pharmaceuticals.
o MicroMask(TM) is a tastemasking technology that incorporates a
dry powder, microparticulate approach to reducing
objectionable tastes by sequestering the unpleasant drug agent
in a specialized matrix. This formulation technique has the
effect of "shielding" the drug from the taste receptors
without interfering with the dissolution and ultimate
absorption of the agent within the gastrointestinal tract.
MicroMask(TM) is a more potent tastemasking technology than
LIQUETTE(R) and has been used in connection with two Ther-Rx
products.
QUICK DISSOLVING TECHNOLOGY. Our quick dissolving oral tablet
technology provides the ability to tastemask, yet dissolves in the
mouth in a matter of seconds. Most other quick-dissolving
technologies offer either quickness at the expense of poor
tastemasking or excellent tastemasking at the expense of quickness.
While still under development, this system allows for a drug to be
quickly dissolved in the mouth, and can be combined with
tastemasking capabilities that offer a unique dosage form for the
most bitter tasting drug compounds. We have been issued patents and
have patents pending for this system with the U.S. Patent and
Trademark Office, or PTO.
SALES AND MARKETING
Ther-Rx has a national sales and marketing infrastructure which
includes approximately 285 sales representatives and sales
management personnel dedicated to promoting and marketing our
branded pharmaceutical products to
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targeted physician specialists. The Ther-Rx sales force focuses on
physician specialists who are identified through available market
research as frequent prescribers of products in our therapeutic
categories. Ther-Rx also has a corporate sales and marketing
management team dedicated to planning and managing Ther-Rx's sales
and marketing efforts.
We attempt to increase sales of our branded pharmaceutical products
through physician sales calls and promotional efforts, including
sampling, advertising and direct mail. For acquired branded
products, we generally increase the level of physician sales calls
and promotion relative to the previous owner. For example, with the
PreCare(R) prenatal sales efforts, we increased the level of
physician sales calls and sampling to the highest prescribers of
prenatal vitamins. We also have enhanced our PreCare(R) brand
franchise by launching five more line extensions to address unmet
needs, including the launch of PreCare(R) Chewables, Premesis
Rx(TM), PreCare(R) Conceive(TM), PrimaCare(R) and PrimaCare(R) ONE.
The PreCare(R) product line enables us to deliver a full range of
nutritional products for physicians to prescribe to women in their
childbearing years. In addition, we added to our women's health
care family of products in June 2000 with the introduction of our
first NDA approved product, Gynazole-1(R), the only one-dose
prescription cream treatment for vaginal yeast infections. In
fiscal 2004, we further expanded our branded product offerings when
we launched technology improved versions of the Chromagen(R) and
Niferex(R) oral hematinic product lines that were acquired at the
end of fiscal 2003. In January 2005, we introduced our second NDA
approved product, Clindesse(TM), the first approved single-dose
therapy for bacterial vaginosis. And in fiscal 2006, we introduced
Encora(TM), a new prescription nutritional supplement product, and
two new hematinic products, Niferex(R) Gold and Repliva 21/7(TM).
By offering multiple products to the same group of physician
specialists, we believe we are able to maximize the effectiveness
of our experienced sales force.
ETHEX has an experienced sales and marketing team, which includes
an outside sales team, regional account managers, national account
managers and an inside sales team. The outside sales force calls on
wholesalers, distributors and national drugstore chains, as well as
hospitals, nursing homes, mail order firms and independent
pharmacies. The inside sales team calls on independent pharmacies
to create pull-through at the wholesale level.
We believe that industry trends favor generic product expansion
into the managed care, long-term care and government contract
markets. Further, we believe that our competitively priced,
technology-distinguished generic/non-branded products can fulfill
the increasing need of these markets to contain costs and improve
patient compliance. Accordingly, we intend to continue to devote
significant marketing resources to the penetration of those
markets.
PDI has a specialized technical sales group that calls on the
leading companies in the pharmaceutical, nutritional, personal
care, food and other markets in the United States.
During fiscal 2006, our three largest customers accounted for 27%,
16% and 13% of gross revenues. These customers were McKesson Drug
Company, Cardinal Health and Amerisource Corporation, respectively.
In fiscal 2005 and 2004, these customers accounted for gross
revenues of 27%, 16% and 12% and 25%, 16% and 13%, respectively.
Although we sell internationally, we do not have material
operations or sales in foreign countries and our sales are not
subject to significant geographic concentration.
RESEARCH AND DEVELOPMENT
We have long recognized that development of successful new products
is critical to achieving our goal of sustainable growth over the
long term. As such, our investment in research and development,
which increased at a compounded annual growth rate of 28.2% over
the past four fiscal years, reflects our continued commitment to
develop new products and/or technologies through our internal
development programs, and with our external strategic partners.
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Our research and development activities include the development of
new and next generation drug delivery technologies, the formulation
of brand name proprietary products and the development of
technologically distinguished generic/non-branded versions of
previously approved brand name pharmaceutical products. In fiscal
2006, 2005 and 2004, total research and development expenses were
$28.9 million, $23.5 million and $20.7 million, respectively.
In January 2005, we introduced our second NDA approved product,
Clindesse(TM), the first approved single-dose therapy for bacterial
vaginosis. Similar to Gynazole-1(R), Clindesse(TM) incorporates our
proprietary VagiSite(TM) bioadhesive drug delivery technology. In
fiscal 2006, we introduced Encora(TM), a new prescription
nutritional supplement product, and two new hematinic products,
Niferex(R) Gold and Repliva 21/7(TM). Ther-Rx currently has a
number of products in its research and development pipeline at
various stages of development. We believe we have the technological
expertise required to develop unique products to meet currently
unmet needs in the area of women's health, as well as other
therapeutic areas.
As part of the May 2005 acquisition of FemmePharma, we assumed
development responsibility and secured full worldwide marketing
rights to an endometriosis product that had successfully completed
Phase II clinical trials. We believe that this transaction allows
us to best monitor the drug's continued development to ultimately
capitalize on an attractive opportunity in this therapeutic area.
The Phase III clinical studies began during the latter part of
fiscal 2006. In connection with the FemmePharma acquisition, the
Company recorded expense of $30.4 million that consisted of $29.6
million for acquired in-process research and development and $0.9
million in direct expenses related to the transaction.
To capitalize on ETHEX's unique product capabilities, we continue
to expand our ETHEX product portfolio. Over the past two fiscal
years, we have introduced a number of new generic/non-branded
products and currently have a large portfolio of opportunities in
our generic/non-branded products pipeline. Our development process
typically consists of formulation, development and laboratory
testing, and where required (1) preliminary bioequivalency studies
of pilot batches of the manufactured product, (2) full scale
bioequivalency studies using commercial quantities of the
manufactured product and (3) submission of an ANDA to the FDA. We
believe that, unlike many generic drug companies, we have the
technical expertise required to develop generic substitutes for
hard-to-copy branded pharmaceutical products. We received ANDA
approval for Prednisolone Sodium Phosphate Liquid 15 mg (base)/5 mL
in June 2005 and late in the 2006 fiscal year ANDA approvals for
five strengths of Oxycodone Hydrochloride tablets, three strengths
of Hydromorphone Hydrochloride tablets and the 30 mg. strength of
Morphine Sulfate. We anticipate receiving ANDA approvals for
Diltiazem, Levothyroxine and Metoprolol, among other products, in
fiscal 2007.
In addition to our internal marketing efforts, we have entered into
a long-term product development and marketing license agreement
with Strides, an Indian generic pharmaceutical developer and
manufacturer, for exclusive marketing rights in the United States
and Canada for 10 new generic drugs. Under the agreement, Strides
will be responsible for developing, submitting for regulatory
approval and manufacturing the 10 products and we will be
responsible for exclusively marketing the products in the
territories covered by the agreement.
In February 2006, we entered into an exclusive arrangement with
Gedeon Richter, Ltd., a European pharmaceutical company, to market
a broad group of generic drug products to the U.S. marketplace. The
products will serve the cardiovascular, diabetic and central
nervous system markets. Subject to FDA approval and patent
expirations, we expect to introduce these products to the U.S.
market over the next several years through 2017.
Also, late in fiscal 2006, we received a favorable court ruling in
a Paragraph IV patent infringement action filed against us by
AstraZeneca based on our ANDA submissions to market generic
formulations of Toprol-XL(R). We believe we were the first company
to file with the FDA for generic approval of the 100 mg and 200 mg
dosage strengths, a position that may, upon approval, afford us the
opportunity for a six-month exclusivity period for
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marketing these generic versions. The total branded dollar volume
of Toprol-XL(R) in 2005 was $1.3 billion, of which the 100 mg and
200 mg strengths represented nearly half.
PDI currently has a number of products in its research and
development pipeline at various stages of development. PDI applies
its technologies to a diverse number of active and inactive
chemicals for more efficient processing of materials to achieve
benefits such as prolonged action of release, manufacturing
efficiencies, taste-masking, making materials more site specific
and other benefits. Typically, the finished products into which the
specialty raw materials are incorporated do not require FDA
approval.
We continually apply our scientific and development expertise to
refine and enhance our existing drug delivery systems and
formulation technologies and to create new technologies that may be
used in our drug development programs. Certain of these
technologies currently under development include advanced oral
controlled release systems, quick dissolving oral delivery systems
(with and without tastemasking characteristics) and transesophageal
and intrapulmonary delivery technologies.
PATENTS AND OTHER PROPRIETARY RIGHTS
We actively seek, when appropriate and available, protection for
our products and proprietary information by means of U.S. and
foreign patents, trademarks, trade secrets, copyrights and
contractual arrangements. Patent protection in the pharmaceutical
field, however, can involve complex legal and factual issues.
Moreover, broad patent protection for new formulations or new
methods of use of existing chemical compounds is sometimes
difficult to obtain, primarily because the active ingredient and
many of the formulation techniques have been known for some time.
Consequently, some patents claiming new formulations or new methods
of use for old drugs may not provide meaningful protection against
competition. Nevertheless, we intend to continue to seek patent
protection when appropriate and available and otherwise to rely on
regulatory-related exclusivity and trade secrets to protect certain
of our products, technologies and other scientific information.
There can be no assurance, however, that any steps taken to protect
such proprietary information will be effective.
Our policy is to file patent applications in appropriate situations
to protect and preserve, for our own use, technology, inventions
and improvements that we consider important to the development of
our business. We currently hold domestic and foreign issued patents
the last of which expires in fiscal 2022 relating to our controlled
release, site-specific, quick dissolve and tastemasking
technologies. We have been granted 35 U.S. patents and have 50 U.S.
patent applications pending. In addition, we have 26 foreign issued
patents and a total of 131 patent applications pending primarily in
Canada, Europe, Australia, Japan, South America, Mexico and South
Korea (see Item 1A "Risk Factors - We depend on our patents and
other proprietary rights" for additional information).
We currently own more than 150 U.S. and foreign trademark
registrations and have also applied for trademark protection for
the names of our proprietary controlled-release, tastemasking,
site-specific and quick dissolve technologies. We intend to
continue to trademark new technology and product names as they are
developed.
To protect our trademark, domain name, and related rights, we
generally rely on trademark and unfair competition laws, which are
subject to change. Some, but not all, of our trademarks are
registered in the jurisdictions where they are used. Some of our
other trademarks are the subject of pending applications in the
jurisdictions where they are used or intended to be used and others
are not.
MANUFACTURING AND FACILITIES
We believe that our administrative, research, manufacturing and
distribution facilities are an important factor in achieving our
long-term growth objectives. All facilities at March 31, 2006,
aggregating approximately 1.2 million square feet, are located in
the St. Louis, Missouri area. We own facilities with approximately
1.0 million square feet, with the balance under various leases at
pre-determined annual rates under agreements expiring from
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fiscal 2007 through fiscal 2008, subject in most cases to renewal
at our option. The purchase option on a 129,000 square foot
building leased by us on March 31, 2006 was exercised by us in
accordance with the lease agreement and is scheduled to be acquired
for $4.9 million in June 2006.
We manufacture drug products in liquid, semi-solid, tablet, capsule
and caplet forms for distribution by Ther-Rx, ETHEX and our
corporate licensees and value-added specialty raw materials for
distribution by PDI. We believe that all of our facilities are in
material compliance with applicable regulatory requirements.
We seek to maintain inventories at sufficient levels to support
current production and sales levels. During fiscal 2006, we
encountered no serious shortage of any particular raw materials.
Although there can be no assurance that raw material supply will
not adversely affect our future operations, we do not believe that
any shortages will occur in the foreseeable future.
COMPETITION
Competition in the development and marketing of pharmaceutical
products is intense and characterized by extensive research efforts
and rapid technological progress. Many companies, including those
with financial and marketing resources and development capabilities
substantially greater than our own, are engaged in developing,
marketing and selling products that compete with those that we
offer. Our branded pharmaceutical products may also be subject to
competition from alternate therapies during the period of patent
protection and thereafter from generic equivalents. In addition,
our generic/non-branded pharmaceutical products may be subject to
competition from pharmaceutical companies engaged in the
development of alternatives to the generic/non-branded products we
offer or of which we undertake development. Our competitors may
develop generic products before we do or may have pricing
advantages over our products. In our specialty pharmaceutical
businesses, we compete primarily on the basis of product efficacy,
breadth of product line and price. We believe that our patents,
proprietary trade secrets, technological expertise, product
development and manufacturing capabilities will enable us to
maintain a leadership position in the field of advanced drug
delivery technologies and to continue to develop products to
compete effectively in the marketplace.
In addition, we compete for product acquisitions with other
pharmaceutical companies. These competitors may have substantially
greater financial and marketing resources than we do. Accordingly,
our competitors may succeed in product line acquisitions that we
seek to acquire.
We also compete with drug delivery companies engaged in the
development of alternative drug delivery systems. We are aware of a
number of companies currently seeking to develop new non-invasive
drug delivery systems, including oral delivery and transmucosal
systems. Many of these companies may have greater research and
development capabilities, experience, manufacturing, marketing,
financial and managerial resources than we do. Accordingly, our
competitors may succeed in developing competing technologies,
obtaining FDA approval for products or gaining market acceptance
more rapidly than we do.
GOVERNMENT REGULATION
All pharmaceutical manufacturers are subject to extensive
regulation by the federal government, principally the FDA, and, to
a lesser extent, by state, local and foreign governments. The
Federal Food, Drug and Cosmetic Act, or FDCA, and other federal
statutes and regulations govern or influence, among other things,
the development, testing, manufacture, safety, labeling, storage,
recordkeeping, approval, advertising, promotion, sale and
distribution of pharmaceutical products. Pharmaceutical
manufacturers are also subject to certain record-keeping and
reporting requirements, establishment registration and product
listing, and FDA inspections.
With respect to any non-biological "new drug" product with active
ingredients not previously approved by the FDA, a prospective
manufacturer must submit a full NDA, including complete reports of
preclinical, clinical and other studies to prove the product's
safety and efficacy. A full NDA may also need to be submitted for a
drug
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product with a previously approved active ingredient if, among
other things, the drug will be used to treat an indication for
which the drug was not previously approved, or if the abbreviated
procedure discussed below is otherwise not available. A
manufacturer intending to conduct clinical trials in humans for a
new drug may be required first to submit a Notice of Claimed
Investigational Exception for a New Drug, or IND, to the FDA
containing information relating to preclinical and clinical
studies. INDs and full NDAs may be required to be filed to obtain
approval of certain of our products, including those that do not
qualify for abbreviated application procedures. The full NDA
process, including clinical development and testing, is expensive,
time consuming and is subject to inherent uncertainties.
The Drug Price Competition and Patent Restoration Act of 1984,
known as the Hatch-Waxman Act, established ANDA procedures for
obtaining FDA approval for generic versions of many non-biological
drugs for which patent or marketing exclusivity rights have expired
and which are bioequivalent to previously approved drugs.
"Bioequivalence" for this purpose, with certain exceptions,
generally means that the proposed generic formulation is absorbed
by the body at the same rate and extent as a previously approved
"reference drug." Approval to manufacture these drugs is obtained
by filing abbreviated applications, such as ANDAs. As a substitute
for clinical studies, the FDA requires data indicating the ANDA
drug formulation is bio-equivalent to a previously approved
reference drug among other requirements. The same abbreviated
application procedures apply to antibiotic drug products that are
bio-equivalent to previously approved antibiotics, except that
products containing certain older antibiotic ingredients are not
subject to the special patent or marketing exclusivity protections
afforded by the Hatch-Waxman Act to other drug products. The
advantage of the ANDA approval mechanism, compared to an NDA, is
that an ANDA applicant is not required to conduct preclinical and
clinical studies to demonstrate that the product is safe and
effective for its intended use and may rely, instead, on studies
demonstrating bio-equivalence to a previously approved reference
drug.
In addition to establishing ANDA approval mechanisms, the
Hatch-Waxman Act fosters pharmaceutical innovation through such
incentives as non-patent exclusivity and patent restoration. The
Act provides two distinct exclusivity provisions that either
preclude the submission or delay the approval of an ANDA. A
five-year exclusivity period is provided for new chemical
compounds, and a three-year marketing exclusivity period is
provided for changes to previously approved drugs which are based
on new clinical investigations essential to the approval. The
three-year marketing exclusivity period may be applicable to the
approval of a novel drug delivery system. The marketing exclusivity
provisions apply equally to patented and non-patented drug
products, but do not apply to products containing antibiotic
ingredients first submitted for approval on or before November 20,
1997. These provisions do not delay or otherwise affect the
approvability of full NDAs even when effective ANDA approvals are
not available. For drugs covered by patents, patent extension may
be provided for up to five years as compensation for reduction of
the effective life of the patent resulting from time spent in
conducting clinical trials and in FDA review of a drug application.
There has been substantial litigation in the biomedical,
biotechnology and pharmaceutical industries with respect to the
manufacture, use and sale of new products that are alleged to
infringe outstanding patent rights. One or more patents cover most
of the proprietary products for which we are developing generic
versions. When we file an ANDA for such drug products, we will, in
most cases, be required to certify to the FDA that any patent which
has been listed with the FDA as covering the product is either
invalid or will not be infringed by the sale of our product.
Alternatively, we could certify that we would not market our
proposed product until the applicable patent expires. A patent
holder may challenge a notice of non-infringement or invalidity by
filing suit, which would in most cases, prevent FDA approval until
the suit is resolved or at least 30 months have elapsed (unless the
patent expires, whichever is earlier). Should any entity commence a
lawsuit with respect to any alleged patent infringement by us, the
uncertainties inherent in patent litigation would make the outcome
of such litigation difficult to predict.
In addition to marketing drugs which are subject to FDA review and
approval, we market certain drug products in the United States
without FDA approval under certain "grandfather" clauses and
statutory and regulatory exceptions to the pre-market approval
requirement for "new drugs" under the FDCA. A determination as to
17
whether a particular product does or does not require FDA
pre-market review and approval can involve consideration of
numerous complex and imprecise factors. If a determination is made
by the FDA that any product marketed without approval requires such
approval, the FDA may institute enforcement actions, including
product seizure, or an action seeking an injunction against further
marketing and may or may not allow sufficient time to obtain the
necessary approvals before it seeks to curtail further marketing.
We are not in a position to predict whether or when the FDA might
choose to raise similar objections to the marketing without NDA or
ANDA approval of another category or categories of drug products
represented in our product lines. In the event such objections are
raised, we could be required or could decide to cease distribution
of additional products until pre-market approval is obtained. In
addition, we may not be able to obtain any particular approval that
may be required or such approval may not be obtained on a timely
basis.
In addition to obtaining pre-market approval for certain of our
products, we are required to maintain all facilities in compliance
with the FDA's current Good Manufacturing Practice, or cGMP,
requirements. In addition to compliance with cGMP each
pharmaceutical manufacturer's facilities must be registered with
the FDA. Manufacturers must also be registered with the U.S. Drug
Enforcement Administration or DEA, and similar state and local
regulatory authorities if they handle controlled substances, and
with the EPA and similar state and local regulatory authorities if
they generate toxic or dangerous wastes, and must comply with other
applicable DEA and EPA requirements. Noncompliance with applicable
requirements can result in fines, recall or seizure of products,
total or partial suspension of production and distribution, refusal
of the government to enter into supply contracts or to approve
NDAs, ANDAs or other applications and criminal prosecution. The FDA
also has the authority to revoke for-cause drug approvals
previously granted.
The Prescription Drug Marketing Act, or PDMA, which amended various
sections of the FDCA, requires, among other things, state licensing
of wholesale distributors of prescription drugs under federal
guidelines that include minimum standards for storage, handling and
record keeping. All of our facilities are registered with the State
of Missouri, where they are located, as required by Federal and
Missouri law. The PDMA also imposes detailed requirements on the
distribution of prescription drug samples such as those distributed
by the Ther-Rx sales force. The PDMA sets forth substantial civil
and criminal penalties for violations of these and other
provisions. Many states also require registration of out-of-state
drug manufacturers and distributors who sell products in their
states, and may also impose additional requirements or restrictions
on out-of-state firms. These requirements vary widely from
state-to-state and are subject to change with little or no direct
notice to potentially affected firms. We believe that we are
currently in compliance in all material respects with applicable
state requirements. However, in the event that we are found to have
failed to comply with applicable state requirements, we may be
subject to sanctions, including monetary penalties and potential
restrictions on our sales or other activities within particular
states.
For international markets, a pharmaceutical company is subject to
regulatory requirements, inspections and product approvals
substantially the same as those in the United States. In connection
with any future marketing, distribution and license agreements that
we may enter into, our licensees may accept or assume
responsibility for such foreign regulatory approvals. The time and
cost required to obtain these international market approvals may be
greater or lesser than those required for FDA approval.
Product development and approval within this regulatory framework
take a number of years, involve the expenditure of substantial
resources and is uncertain. Many drug products ultimately do not
reach the market because they are not found to be safe or effective
or cannot meet the FDA's other regulatory requirements. In
addition, the current regulatory framework may change and
additional regulatory or approval requirements may arise at any
stage of our product development that may affect approval, delay
the submission or review of an application or require additional
expenditures by us. We may not be able to obtain necessary
regulatory clearances or approvals on a timely basis, if at all,
for any of our products under development, and delays in receipt or
failure to receive such clearances or approvals, the loss of
previously received clearances or approvals, or failure to comply
with existing or future regulatory requirements could have a
material adverse effect on our business.
18
EMPLOYEES
As of March 31, 2006, we employed a total of 1,145 employees. We
are party to a collective bargaining agreement covering 120
employees that will expire December 31, 2009. We believe that our
relations with our employees are good.
ENVIRONMENT
We do not expect that compliance with Federal, state or local
provisions regulating the discharge of materials into the
environment or otherwise relating to the protection of the
environment will have a material effect on our capital
expenditures, earnings or competitive position.
AVAILABLE INFORMATION
We make available, free of charge through our Internet website
(http://www.kvpharmaceutical.com), our Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and
amendments to these reports filed or furnished pursuant to Section
13(a) or 15(d) of the Securities Exchange Act of 1934, as amended,
as soon as reasonably practicable after we electronically file
these reports with, or furnish them to, the Securities and Exchange
Commission, or SEC. Also, copies of our Corporate Governance
Guidelines, Audit Committee Charter, Compensation Committee
Charter, Nominating and Corporate Governance Committee Charter,
Code of Ethics for Senior Executives and Standard of Business
Ethics for all Directors and employees are available on our
Internet website, and available in print to any stockholder who
requests them. The information posted on our website is not
incorporated into this annual report.
In addition, the SEC maintains an Internet website
(http://www.sec.gov) that contains reports, proxy and information
statements, and other information regarding issuers that file
electronically with the SEC.
ITEM 1A. RISK FACTORS
------------
We operate in a rapidly changing environment that involves a number
of risks, some of which are beyond our control. The following
discussion highlights some of these risks and others are discussed
elsewhere in this report. Additional risks presently unknown to us
or that we currently consider immaterial or unlikely to occur could
also impair our operations. These and other risks could materially
and adversely affect our business, financial condition, operating
results or cash flows.
RISKS RELATED TO OUR BUSINESS
OUR FUTURE GROWTH IS LARGELY DEPENDENT UPON OUR ABILITY TO DEVELOP
NEW PRODUCTS.
We need to continue to develop and commercialize new brand name
products and generic products utilizing our proprietary drug
delivery systems to maintain the growth of our business. To do this
we will need to identify, develop and commercialize technologically
enhanced branded products and identify, develop and commercialize
drugs that are off-patent and that can be produced and sold by us
as generic products using our drug delivery technologies. If we are
unable to identify, develop and commercialize new products, we may
need to obtain licenses to additional rights to branded or generic
products, assuming they would be available for licensing, which
could decrease our profitability. We cannot assure you that we will
be successful in pursuing this strategy.
19
IF WE ARE UNABLE TO COMMERCIALIZE PRODUCTS UNDER DEVELOPMENT, OUR
FUTURE OPERATING RESULTS MAY SUFFER.
Certain products we are developing will require significant
additional development and investment, including preclinical and
clinical testing, where required, prior to their commercialization.
We expect that many of these products will not be commercially
available for several years, if at all. We cannot assure you that
such products or future products will be successfully developed,
prove to be safe and effective in clinical trials (if required),
meet applicable regulatory standards, or be capable of being
manufactured in commercial quantities at reasonable cost.
OUR ACQUISITION STRATEGY MAY NOT BE SUCCESSFUL.
We intend to continue to acquire pharmaceutical products, novel
drug delivery technologies and/or companies that fit into our
research, manufacturing, distribution or sales and marketing
operations or that could provide us with additional products,
technologies or sales and marketing capabilities. We may not be
able to successfully identify, evaluate and acquire any such
products, technologies or companies or, if acquired, we may not be
able to successfully integrate such acquisitions into our business.
We compete with many specialty pharmaceutical companies for
products and product line acquisitions. These competitors may have
substantially greater financial and managerial resources than we
have.
WE DEPEND ON OUR PATENTS AND OTHER PROPRIETARY RIGHTS AND CANNOT BE
CERTAIN OF THEIR CONFIDENTIALITY AND PROTECTION.
Our success depends, in large part, on our ability to protect our
current and future technologies and products, to defend our
intellectual property rights and to avoid infringing on the
proprietary rights of others. We have been issued numerous patents
in the United States and in certain foreign countries, which cover
certain of our technologies, and have filed, and expect to continue
to file, patent applications seeking to protect newly developed
technologies and products. The pharmaceutical field is crowded and
a substantial number of patents have been issued. In addition, the
patent position of pharmaceutical companies can be highly uncertain
and frequently involves complex legal and factual questions. As a
result, the breadth of claims allowed in patents relating to
pharmaceutical applications or their validity and enforceability
cannot be predicted. Patents are examined for patentability at
patent offices against bodies of prior art which by their nature
may be incomplete and imperfectly categorized. Therefore, even
presuming that the examiner has been able to identify and cite the
best prior art available to him during the examination process, any
patent issued to us could later be found by a court or a patent
office during post issuance proceedings to be invalid in view of
newly-discovered prior art or already considered prior art or other
legal reasons. Furthermore, there are categories of "secret" prior
art unavailable to any examiner, such as the prior inventive
activities of others, which could form the basis for invalidating
any patent. In addition, there are other reasons why a patent may
be found to be invalid, such as an offer for sale or public use of
the patented invention in the United States more than one year
before the filing date of the patent application. Moreover, a
patent may be deemed unenforceable if, for example, the inventor or
the inventor's agents failed to disclose prior art to the PTO that
they knew was material to patentability.
The coverage claimed in a patent application can be significantly
reduced before a patent is issued, either in the United States or
abroad. Consequently, there can be no assurance that any of our
pending or future patent applications will result in the issuance
of patents. Patents issued to us may be subjected to further
proceedings limiting their scope and may not provide significant
proprietary protection or competitive advantage. Our patents also
may be challenged, circumvented, invalidated or deemed
unenforceable. Patent applications in the United States filed prior
to November 29, 2000 are currently maintained in secrecy until and
unless patents issue, and patent applications in certain other
countries generally are not published until more than 18 months
after they are first filed (which generally is the case in the
United States for applications filed on or after November 29,
2000). In addition, publication of discoveries in scientific or
patent literature often lags behind actual discoveries. As a
result, we cannot be certain that we or our licensors will be
entitled to any rights in purported inventions claimed in pending
or future patent applications or that we or our licensors were the
first to file patent applications on such
20
inventions. Furthermore, patents already issued to us or our
pending applications may become subject to dispute, and any dispute
could be resolved against us. For example, we may become involved
in re-examination, reissue or interference proceedings in the PTO,
or opposition proceedings in a foreign country. The result of these
proceedings can be the invalidation or substantial narrowing of our
patent claims. We also could be subject to court proceedings that
could find our patents invalid or unenforceable or could
substantially narrow the scope of our patent claims. In addition,
statutory differences in patentable subject matter may limit the
protection we can obtain on some of our inventions outside of the
United States. For example, methods of treating humans are not
patentable in many countries outside of the United States.
These and other issues may prevent us from obtaining patent
protection outside of the United States. Furthermore, once patented
in foreign countries, the inventions may be subjected to mandatory
working requirements and/or subject to compulsory licensing
regulations.
We also rely on trade secrets, unpatented proprietary know-how and
continuing technological innovation that we seek to protect, in
part by confidentiality agreements with licensees, suppliers,
employees and consultants. These agreements may be breached by the
other parties to these agreements. We may not have adequate
remedies for any breach. Disputes may arise concerning the
ownership of intellectual property or the applicability or
enforceability of our confidentiality agreements and there can be
no assurance that any such disputes would be resolved in our favor.
Furthermore, our trade secrets and proprietary technology may
become known or be independently developed by our competitors, or
patents may not be issued with respect to products or methods
arising from our research, and we may not be able to maintain the
confidentiality of information relating to those products or
methods. Furthermore, certain unpatented technology may be subject
to intervening rights.
WE DEPEND ON OUR TRADEMARKS AND RELATED RIGHTS.
To protect our trademarks and goodwill associated therewith, domain
name, and related rights, we generally rely on federal and state
trademark and unfair competition laws, which are subject to change.
Some, but not all, of our trademarks are registered in the
jurisdictions where they are used. Some of our other trademarks are
the subject of pending applications in the jurisdictions where they
are used or intended to be used, and others are not.
It is possible that third parties may own or could acquire rights
in trademarks or domain names in the United States or abroad that
are confusingly similar to or otherwise compete unfairly with our
marks and domain names, or that our use of trademarks or domain
names may infringe or otherwise violate the intellectual property
rights of third parties. The use of similar marks or domain names
by third parties could decrease the value of our trademarks or
domain names and hurt our business, for which there may be no
adequate remedy.
THIRD PARTIES MAY CLAIM THAT WE INFRINGE ON THEIR PROPRIETARY
RIGHTS, OR SEEK TO CIRCUMVENT OURS.
We may be required to defend against charges of infringement of
patents, trademarks or other proprietary rights of third parties.
This defense could require us to incur substantial expense and to
divert significant effort of our technical and management
personnel, and could result in our loss of rights to develop or
make certain products or require us to pay monetary damages or
royalties to license proprietary rights from third parties. If a
dispute is settled through licensing or similar arrangements, costs
associated with such arrangements may be substantial and could
include ongoing royalties. Furthermore, we cannot be certain that
the necessary licenses would be available to us on acceptable
terms, if at all. Accordingly, an adverse determination in a
judicial or administrative proceeding or failure to obtain
necessary licenses could prevent us from manufacturing, using,
selling and/or importing in to the United States certain of our
products. Litigation also may be necessary to enforce our patents
against others or to protect our know-how or trade secrets. That
litigation could result in substantial expense or put our
proprietary rights at risk of loss, and we cannot assure you that
any litigation will be resolved in our favor. There currently are
two patent infringement lawsuits pending against us. Although we do
not believe they will
21
have a material adverse effect on our future financial condition or
results of operations, we cannot assure you of that.
WE MAY BE UNABLE TO MANAGE OUR GROWTH.
Over the past ten years, our businesses and product offerings have
grown substantially. This growth and expansion has placed, and is
expected to continue to place, a significant strain on our
management and operational and financial resources. To manage our
growth, we must continue to (1) expand our operational, sales,
customer support and financial control systems and (2) hire, train
and retain qualified personnel. We cannot assure you that we will
be able to adequately manage our growth. If we are unable to manage
our growth effectively, our business, results of operations and
financial condition could be materially adversely affected.
WE MAY NOT OBTAIN REGULATORY APPROVAL FOR OUR NEW PRODUCTS ON A
TIMELY BASIS, OR AT ALL.
Many of our new products will require FDA approval. FDA approval
typically involves lengthy, detailed and costly laboratory and
clinical testing procedures, as well as the FDA's review and
approval of the information submitted. We cannot assure you that
the products we develop will be determined to be safe and effective
in these testing procedures, or that they will be approved by the
FDA. The FDA also has the authority to revoke for-cause drug
approvals previously granted.
WE MAY BE ADVERSELY AFFECTED BY THE CONTINUING CONSOLIDATION OF OUR
DISTRIBUTION NETWORK AND THE CONCENTRATION OF OUR CUSTOMER BASE.
Our principal customers are wholesale drug distributors, major
retail drug store chains, independent pharmacies and mail order
firms. These customers comprise a significant part of the
distribution network for pharmaceutical products in the United
States. This distribution network is continuing to undergo
significant consolidation marked by mergers and acquisitions among
wholesale distributors and the growth of large retail drug store
chains. As a result, a small number of large wholesale distributors
control a significant share of the market, and the number of
independent drug stores and small drug store chains has decreased.
We expect that consolidation of drug wholesalers and retailers will
increase pricing and other competitive pressures on drug
manufacturers. For the fiscal year ended March 31, 2006, our three
largest customers, which are wholesale distributors, accounted for
27%, 16% and 13% of our gross sales. The loss of any of these
customers could materially and adversely affect our results of
operations or financial condition.
THE REGULATORY STATUS OF CERTAIN OF OUR GENERIC PRODUCTS MAY MAKE
THEM SUBJECT TO INCREASED COMPETITION.
Many of our products are manufactured and marketed without FDA
approval. For example, our prenatal products, which contain folic
acid, are sold as prescription multiple vitamin supplements. These
types of prenatal vitamins are typically regulated by the FDA as
prescription drugs, but are not covered by an NDA or ANDA. As a
result, competitors may more easily and rapidly introduce products
competitive with our prenatal and other products that have a
similar regulatory status.
One of the key motivations for challenging patents is the reward of
a 180-day period of market exclusivity. Under the Hatch-Waxman Act,
the developer of a generic version of a product which is the first
to have its ANDA accepted for filing by the FDA, and whose filing
includes a certification that the patent is invalid, unenforceable
and/or not infringed (a so-called "Paragraph IV certification"),
may be eligible to receive a 180-day period of generic market
exclusivity. This period of market exclusivity provides the patent
challenger with the opportunity to earn a risk-adjusted return on
legal and development costs associated with bringing a product to
market. In cases such as these where suit is filed by the
manufacturer of the branded product, final FDA approval of an ANDA
generally requires a favorable disposition of the suit, either by
judgment that the patents at issue are invalid and/or not infringed
or by settlement. There can be no assurance that we will ultimately
prevail in these litigations, that we will receive final FDA
approval of our ANDAs, or that any expectation of a period of
generic
22
exclusivity for certain of these products will actually be realized
when and if resolution of the litigations and receipt of final
approvals from the FDA occur.
Since enactment of the Hatch-Waxman Act in 1984, the interpretation
and implementation of the statutory provisions relating to the
180-day period of generic market exclusively have been the subject
of controversy, court decisions, changes to FDA regulations and
guidelines, and other changes in FDA interpretation. In addition,
on December 8, 2003, significant changes were enacted in the
statutory provisions themselves, some of which were retroactive and
others of which apply only prospectively or to situations where the
first ANDA filing with a Paragraph IV certification occurs after
the date of enactment. These interpretations and changes, over
time, have had significant effects on the ability of sponsors of
particular generic drug products to qualify for or utilize fully
the 180-day generic marketing exclusivity period. These
interpretations and changes have, in turn, affected the ability of
sponsors of corresponding innovator drugs to market their branded
products without any generic competition and the ability of
sponsors of other generic versions of the same products to market
their products in competition with the first generic applicant.
Because application of these provisions, and any changes in them or
in the applicable interpretations of them, depends almost entirely
on the specific facts of the particular NDA and ANDA filings at
issue, many of which are not in our control, we cannot predict
whether any changes would, on balance, have a positive or negative
effect on our business as a whole, although particular changes may
have predictable, and potentially significant positive or negative
effects on particular pipeline products. In addition, continuing
uncertainty over the interpretation and implementation of the
original Hatch-Waxman provisions, as well as the December 8, 2003
statutory amendments, is likely to continue to impair our ability
to predict the likely exclusivity that we may be granted, or
blocked by, based on the outcome of particular patent challenges in
which we are involved.
COMMERCIALIZATION OF A GENERIC PRODUCT PRIOR TO THE FINAL
RESOLUTION OF PATENT INFRINGEMENT LITIGATION COULD EXPOSE US TO
SIGNIFICANT DAMAGES IF THE OUTCOME OF SUCH LITIGATION IS
UNFAVORABLE AND COULD IMPAIR OUR REPUTATION.
We could invest a significant amount of time and expense in the
development of our generic products only to be subject to
significant additional delay and changes in the economic prospects
for our products. If we receive FDA approval for our pending ANDAs,
particularly our generic version of Toprol-XL(R), we may consider
commercializing the product prior to the final resolution of any
related patent infringement litigation. The risk involved in
marketing a product prior to the final resolution of the litigation
may be substantial because the remedies available to the patent
holder could include, among other things, damages measured by the
profits lost by such patent holder and not by the profits earned by
us. Patent holders may also recover damages caused by the erosion
of prices for its patented drug as a result of the introduction of
our generic drug in the marketplace. Further, in the case of a
willful infringement, which requires a complex analysis of the
totality of the circumstances, such damages may be trebled.
However, in order to realize the economic benefits of some of our
products, we may decide to risk an amount that may exceed the
profit we anticipate making on our product. There are a number of
factors we would need to consider in order to decide whether to
launch our product prior to final resolution, including, (i)
outside legal advice, (ii) the status of a pending lawsuit, (iii)
interim court decisions, (iv) status and timing of the trial, (v)
legal decisions affecting other competitors for the same product,
(vi) market factors, (vii) liability sharing agreements, (viii)
internal capacity issues, (ix) expiration dates of patents, (x)
strength of lower court decisions and (xi) potential triggering or
forfeiture of exclusivity. An adverse determination in the
litigation relating to a product we launch at risk could have a
material adverse effect on our business and consolidated financial
statements.
WE FACE THE RISK OF PRODUCT LIABILITY CLAIMS, FOR WHICH WE MAY BE
INADEQUATELY INSURED.
Manufacturing, selling and testing pharmaceutical products involve
a risk of product liability. Even unsuccessful product liability
claims could require us to spend money on litigation, divert
management's time, damage our reputation and impair the
marketability of our products. A successful product liability claim
outside of or in
23
excess of our insurance coverage could require us to pay
substantial sums and adversely affect our results of operations and
financial condition.
We previously distributed several pharmaceutical products that
contained phenylpropanolamine, or PPA, and that were discontinued
in 2000 and 2001. We are presently named a defendant in a product
liability lawsuit in Federal District Court in Mississippi
involving PPA. The suit originated out of a case, Virginia Madison,
et al. v. Bayer Corporation, et al. The original suit was filed in
December 2002, but was not served on us until February 2003. The
case was originally filed in the Circuit Court of Hinds County,
Mississippi, and was removed to the Federal District Court for the
Southern District of Mississippi by then co-defendant Bayer
Corporation. The case has been transferred to a Judicial Panel on
Multi-District Litigation for PPA claims sitting in the Western
District of Washington. The claims against us have been segregated
into a lawsuit brought by Johnny Fulcher individually and on behalf
of the wrongful death beneficiaries of Linda Fulcher, deceased,
against the Company. It alleges bodily injury, wrongful death,
economic injury, punitive damages, loss of consortium and/or loss
of services from the use of our distributed pharmaceuticals
containing PPA that have since been discontinued and/or
reformulated to exclude PPA. In May 2004, the case was dismissed
with prejudice by the Federal District Court for the Western
District of Washington for a failure to timely file an individual
complaint as required by certain court orders. The plaintiff filed
a request for reconsideration which was opposed and subsequently
denied by the Court in June 2004. In July 2004, the plaintiff filed
a notice of appeal of the dismissal. We have opposed this appeal.
We intend to vigorously defend our interests; however, we cannot
give any assurance we will prevail.
We have also been advised that one of our former distributor
customers is being sued in Florida state court in a case captioned
Darrian Kelly v. K-Mart et. al. for personal injury allegedly
caused by ingestion of K-Mart diet caplets that are alleged to have
been manufactured by us and to contain PPA. The distributor has
tendered defense of the case to us and has asserted a right to
indemnification for any financial judgment it must pay. We
previously notified our product liability insurer of this claim in
1999, and we have demanded that the insurer assume the Company's
defense. The insurer has stated that it has retained counsel to
secure additional factual information and will defer its coverage
decision until that information is received. We intend to
vigorously defend our interests; however, we cannot give any
assurance that we will not be impleaded into the action, or that,
if we are impleaded, that we would prevail.
Our product liability coverage for PPA claims expired for claims
made after June 15, 2002. Although we renewed our product liability
coverage for coverage after June 15, 2002, that policy excludes
future PPA claims in accordance with the standard industry
exclusion. Consequently, as of June 15, 2002, we will provide for
legal defense costs and indemnity payments involving PPA claims on
a going forward basis as incurred, including the Mississippi
lawsuit that was filed after June 15, 2002. Moreover, we may not be
able to obtain product liability insurance in the future for PPA
claims with adequate coverage limits at commercially reasonable
prices for subsequent periods. From time to time in the future, we
may be subject to further litigation resulting from products
containing PPA that we formerly distributed. We intend to
vigorously defend our interests; however, we cannot give any
assurance we will prevail.
WE DEPEND ON LICENSES FROM OTHERS, AND ANY LOSS OF THESE LICENSES
COULD HARM OUR BUSINESS, MARKET SHARE AND PROFITABILITY.
We have acquired the rights to manufacture, use and/or market
certain products. We also expect to continue to obtain licenses for
other products and technologies in the future. Our license
agreements generally require us to develop the markets for the
licensed products. If we do not develop these markets, the
licensors may be entitled to terminate these license agreements.
We cannot be certain that we will fulfill all of our obligations
under any particular license agreement for any variety of reasons,
including insufficient resources to adequately develop and market a
product, lack of market development despite our efforts and lack of
product acceptance. Our failure to fulfill our obligations could
result in the loss of our rights under a license agreement.
24
Certain products we have the right to license are at certain stages
of clinical tests and FDA approval. Failure of any licensed product
to receive regulatory approval could result in the loss of our
rights under its license agreement.
OUR POLICIES REGARDING RETURNS, ALLOWANCES AND CHARGEBACKS, AND
MARKETING PROGRAMS ADOPTED BY WHOLESALERS, MAY REDUCE OUR REVENUES
IN FUTURE FISCAL PERIODS.
Based on industry practice, generic product manufacturers,
including us, have liberal return policies and have been willing to
give customers post-sale inventory allowances. Under these
arrangements, from time to time, we give our customers credits on
our generic products that our customers hold in inventory after we
have decreased the market prices of the same generic products.
Therefore, if additional competitors enter the marketplace and
significantly lower the prices of any of their competing products,
we would likely reduce the price of our comparable products. As a
result, we would be obligated to provide significant credits to our
customers who are then holding inventories of such products, which
could reduce sales revenue and gross margin for the period when the
credits are accrued. Like our competitors, we also give credits for
chargebacks to wholesale customers that have contracts with us for
their sales to hospitals, group purchasing organizations,
pharmacies or other retail customers. A chargeback is the
difference between the price the wholesale customer pays and the
price that the wholesale customer's end-customer pays for a
product. Although we establish allowances based on our prior
experience and our best estimates of the impact that these policies
may have in subsequent periods, we cannot assure you that our
allowancess are adequate or that actual product returns, allowances
and chargebacks will not exceed our estimates.
INVESTIGATIONS OF THE CALCULATION OF AVERAGE WHOLESALE PRICES MAY
ADVERSELY AFFECT OUR BUSINESS.
Many government and third-party payors, including Medicare,
Medicaid, health maintenance organizations, or HMOs, and managed
care organizations, or MCOs, reimburse doctors and others for the
purchase of certain prescription drugs based on a drug's average
wholesale price, or AWP. In the past several years, state and
federal government agencies have conducted ongoing investigations
of manufacturers' reporting practices with respect to AWP, in which
they have suggested that reporting of inflated AWP's have led to
excessive payments for prescription drugs.
KV and/or ETHEX have been named as defendants in certain
multi-defendant cases alleging that the defendants reported
improper or fraudulent pharmaceutical pricing information, i.e.,
AWP and/or Wholesale Acquisition Cost, or WAC, information, which
caused the governmental plaintiffs to incur excessive costs for
pharmaceutical products under the Medicaid program. Cases of this
type have been filed against KV and/or ETHEX and other
pharmaceutical manufacturer defendants by the State of
Massachusetts, the State of Alabama, the State of Mississippi, New
York City, and approximately 40 counties in New York State. The New
York City case and all New York County cases have been transferred
to the Federal District Court for the District of Massachusetts for
coordinated or consolidated pretrial proceedings under the Average
Wholesale Price Multidistrict Litigation. One of the counties, Erie
County, challenged the transfer and the Erie County Case has been
remanded to state court. Each of these actions is in the early
stages, with fact discovery at beginning phases in the Alabama,
Massachusetts and Mississippi cases, but has not yet commenced in
the New York City/Counties or the Erie County case. We intend to
vigorously defend our interests in the actions described above;
however, we cannot give any assurance we will prevail.
We believe that various other governmental entities have commenced
investigations into the generic and branded pharmaceutical industry
at large regarding pricing and price reporting practices. Although
we believe our pricing and reporting practices have complied in all
material respects with our legal obligations, we cannot give any
assurance that we would prevail if legal actions are instituted by
these governmental entities.
25
RISING INSURANCE COSTS COULD NEGATIVELY IMPACT PROFITABILITY.
The cost of insurance, including workers' compensation, product
liability and general liability insurance, has risen significantly
in the past few years and is expected to continue to increase. In
response, we may increase deductibles and/or decrease certain
coverages to mitigate these costs. These increases, and our
increased risk due to increased deductibles and reduced coverages,
could have a negative impact on our results of operations,
financial condition and cash flows.
OUR GROSS PROFIT MAY FLUCTUATE FROM PERIOD TO PERIOD DEPENDING UPON
OUR PRODUCT SALES MIX, OUR PRODUCT PRICING, AND OUR COSTS TO
MANUFACTURE OR PURCHASE PRODUCTS.
Our future results of operations, financial condition and cash
flows will depend to a significant extent upon our branded and
generic/non-branded product sales mix. Our sales of branded
products create higher gross margins than our sales of
generic/non-branded products. As a result, our sales mix (the
proportion of total sales between branded products and
generic/non-branded products) will significantly impact our gross
profit from period to period. During fiscal 2006, sales of our
branded products and generic/non-branded products accounted for
39.6% and 55.4%, respectively, of our net revenues. During that
same period, branded products and generic/non-branded products
contributed 52.7% and 45.9%, respectively, to our consolidated
gross profits. Factors that may cause our sales mix to vary
include:
o the amount of new product introductions;
o marketing exclusivity, if any, which may be obtained on
certain products;
o the level of competition in the marketplace for certain
products;
o the availability of raw materials and finished products from
our suppliers;
o the scope and outcome of governmental regulatory action that
may involve us; and
o periodic dependence on a small number of products for a
significant portion of net revenue or income.
The profitability of our product sales is also dependent upon the
prices we are able to charge for our products, the costs to
purchase products from third parties, and our ability to
manufacture our products in a cost effective manner.
INCREASED INDEBTEDNESS MAY IMPACT OUR FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
At March 31, 2006, we had $243.0 million of outstanding debt,
consisting of $200.0 million of 2.5% Contingent Convertible
Subordinated Notes (the "Notes") and a $43.0 million mortgage loan
entered into in March 2006. We also have credit agreements with two
banks that provide revolving lines of credit for borrowing up to
$140.0 million. The credit agreements provide for $80.0 million in
revolving lines of credit along with supplemental credit lines of
$60.0 million that are available for financing acquisitions. These
credit facilities expire in October 2006 and June 2006,
respectively. At March 31, 2006, we had no cash borrowings under
either credit facility. Our level of indebtedness may have several
important effects on our future operations, including:
o we will be required to use a portion of our cash flow
from operations for the payment of any principal or
interest due on our outstanding indebtedness;
o our outstanding indebtedness and leverage will
increase the impact of negative changes in general
economic and industry conditions, as well as
competitive pressures; and
o the level of our outstanding debt and the impact it
has on our ability to meet debt covenants associated
with our revolving line of credit arrangement may
affect our ability to obtain additional financing for
working capital, capital expenditures, acquisitions
or general corporate purposes.
26
General economic conditions, industry cycles and financial,
business and other factors affecting our operations, many of which
are beyond our control, may affect our future performance. As a
result, our business might not continue to generate cash flow at or
above current levels. If we cannot generate sufficient cash flow
from operations in the future to service our debt, we may, among
other things:
o seek additional financing in the debt or equity
markets;
o refinance or restructure all or a portion of our
indebtedness;
o sell selected assets;
o reduce or delay planned capital expenditures; or
o reduce or delay planned research and development
expenditures.
These measures might not be sufficient to enable us to service our
debt. In addition, any financing, refinancing or sale of assets
might not be available on economically favorable terms or at all.
We may also consider issuing additional debt or equity securities
in the future to fund potential acquisitions or investments, to
refinance existing debt, or for general corporate purposes. If a
material acquisition or investment is completed, our operating
results and financial condition could change materially in future
periods. However, no assurance can be given that additional funds
will be available on satisfactory terms, or at all, to fund such
activities.
Holders of the Notes may require us to offer to repurchase their
Notes for cash upon the occurrence of a change in control or on May
16, 2008, 2013, 2018, 2023 and 2028. The source of funds for any
repurchase required as a result of any such events will be our
available cash or cash generated from operating activities or other
sources, including borrowings, sales of assets, sales of equity or
funds provided by a new controlling entity. The use of available
cash to fund the repurchase of the Notes may impair our ability to
obtain additional financing in the future.
WE MAY HAVE FUTURE CAPITAL NEEDS AND FUTURE ISSUANCES OF EQUITY
SECURITIES WILL RESULT IN DILUTION.
We anticipate that funds generated internally, together with funds
available under our credit facility, and the proceeds received from
our Notes offering completed in May 2003, will be sufficient to
implement our business plan for the foreseeable future, subject to
additional needs that may arise if acquisition opportunities become
available. We also may need additional capital if unexpected events
occur or opportunities arise. Additional capital might be raised
through the public or private sale of debt or equity securities. If
we sell equity securities, holders of our common stock could
experience dilution. Furthermore, those securities could have
rights, preferences and privileges more favorable than those of the
Class A or Class B common stock. We cannot assure you that
additional funding will be accessible or available on terms
favorable to us. If the funding is not available, we may not be
able to fund our expansion, take advantage of acquisition
opportunities or respond to competitive pressures.
WE MAY INCUR CHARGES FOR INTANGIBLE ASSET IMPAIRMENT.
When we acquire the rights to manufacture and sell a product, we
record the aggregate purchase price, along with the value of the
product related liabilities we assume, as intangible assets. We use
the assistance of valuation experts to help us allocate the
purchase price to the fair value of the various intangible assets
we have acquired. Then, we must estimate the economic useful life
of each of these intangible assets in order to amortize their cost
as an expense in our consolidated statement of income over the
estimated economic useful life of the related asset. The factors
that drive the actual economic useful life of a pharmaceutical
product are inherently uncertain, and include patent protection,
physician loyalty and prescribing patterns, competition by products
prescribed for similar indications, future introductions of
competing products not yet FDA approved, the impact of promotional
27
efforts and many other issues. We use all of these factors in
initially estimating the economic useful lives of our products, and
we also continuously monitor these factors for indications of
appropriate revisions.
In assessing the recoverability of our intangible assets, we must
make assumptions regarding estimated undiscounted future cash flows
and other factors. If the estimated undiscounted future cash flows
do not exceed the carrying value of the intangible assets we must
determine the fair value of the intangible assets. If the fair
value of the intangible assets is less than its carrying value, an
impairment loss will be recognized in an amount equal to the
difference. If these estimates or their related assumptions change
in the future, we may be required to record impairment charges for
these assets. We review intangible assets for impairment at least
annually and whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. If we
determine that an intangible asset is impaired, a non-cash
impairment charge would be recognized.
As circumstances after an acquisition can change, the value of
intangible assets may not be realized by us. If we determine that
impairment has occurred, we would be required to write-off the
impaired portion of the unamortized intangible assets, which could
have a material adverse effect on our results of operations in the
period in which the write-off occurs. In addition, in the event of
a sale of any of our assets, we cannot be certain that our recorded
value of such intangible assets would be recovered.
THERE ARE INHERENT UNCERTAINTIES INVOLVED IN THE ESTIMATES,
JUDGMENTS AND ASSUMPTIONS USED IN THE PREPARATION OF OUR FINANCIAL
STATEMENTS, AND ANY CHANGES IN THOSE ESTIMATES, JUDGMENTS AND
ASSUMPTIONS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL
POSITION AND RESULTS OF OPERATIONS.
The consolidated and condensed consolidated financial statements
that we file with the SEC are prepared in accordance with U.S.
generally accepted accounting principles ("U.S. GAAP"). The
preparation of financial statements in accordance with U.S. GAAP
involves making estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and the
related disclosure of contingent assets and liabilities. The most
significant estimates we are required to make under U.S. GAAP
include, but are not limited to, those related to revenue
recognition, sales allowances, inventories and cost of goods sold,
determining the useful life or impairment of goodwill and other
long-lived assets, litigation outcomes and related liabilities,
income taxes and self-insurance programs. We periodically evaluate
estimates used in the preparation of the consolidated financial
statements for reasonableness, including estimates provided by
third parties. Appropriate adjustments to the estimates will be
made prospectively, as necessary, based on such periodic
evaluations. We base our estimates on, among other things,
currently available information, market conditions, historical
experience and various assumptions, which together form the basis
of making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources.
Although we believe that our assumptions are reasonable under the
circumstances, estimates would differ if different assumptions were
utilized and these estimates may prove in the future to have been
inaccurate.
OUR INTERNAL CONTROLS MAY NOT BE SUFFICIENT TO ENSURE TIMELY AND
RELIABLE FINANCIAL INFORMATION.
As reported under Item 9A of this Form 10-K, our management
completed its assessment of the effectiveness of our internal
control over financial reporting as of March 31, 2006, and based on
that assessment concluded that we maintained effective internal
control over financial reporting as of March 31, 2006. Our
independent registered public accounting firm, KPMG LLP, has issued
an attestation report on management's assessment that expresses
unqualified opinions on management's assessment and on the
effectiveness of our internal control over financial reporting.
However, our operations continue to place stress on our internal
controls, and there can be no assurance that our control procedures
will continue to be adequate. The effectiveness of our controls and
procedures may be limited by a variety of risks, including, among
other things, faulty human judgment, simple errors, omissions and
mistakes, collusion of two or more people or inappropriate override
of procedures. If we fail to have effective internal controls and
procedures for financial reporting in place, we may be unable to
provide timely, accurate and reliable financial information.
28
RISKS RELATED TO OUR INDUSTRY
LEGISLATIVE PROPOSALS, REIMBURSEMENT POLICIES OF THIRD PARTIES,
COST CONTAINMENT MEASURES AND HEALTH CARE REFORM COULD AFFECT THE
MARKETING, PRICING AND DEMAND FOR OUR PRODUCTS.
Various legislative proposals, including proposals relating to
prescription drug benefits, could materially impact the pricing and
sale of our products. Further, reimbursement policies of third
parties may affect the marketing of our products. Our ability to
market our products will depend in part on reimbursement levels for
the cost of the products and related treatment established by
health care providers, including government authorities, private
health insurers and other organizations, such as HMOs and MCOs.
Insurance companies, HMOs, MCOs, Medicaid and Medicare
administrators and others are increasingly challenging the pricing
of pharmaceutical products and reviewing their reimbursement
practices. In addition, the following factors could significantly
influence the purchase of pharmaceutical products, which could
result in lower prices and a reduced demand for our products:
o the trend toward managed health care in the United
States;
o the growth of organizations such as HMOs and MCOs;
o legislative proposals to reform health care and
government insurance programs; and
o price controls and non-reimbursement of new and
highly priced medicines for which the economic
therapeutic rationales are not established.
These cost-containment measures and health care reform proposals
could affect our ability to sell our products.
The reimbursement status of a newly approved pharmaceutical product
may be uncertain. Reimbursement policies may not include some of
our products. Even if reimbursement policies of third parties grant
reimbursement status for a product, we cannot be sure that these
reimbursement policies will remain in effect. Limits on
reimbursement could reduce the demand for our products. The
unavailability or inadequacy of third party reimbursement for our
products could reduce or possibly eliminate demand for our
products. We are unable to predict whether governmental authorities
will enact additional legislation or regulation which will affect
third party coverage and reimbursement that reduces demand for our
products.
Our ability to market generic pharmaceutical products successfully
depends, in part, on the acceptance of the products by independent
third parties, including pharmacies, government formularies and
other retailers, as well as patients. We manufacture a number of
prescription drugs which are used by patients who have severe
health conditions. Although the brand-name products generally have
been marketed safely for many years prior to our introduction of a
generic/non-branded alternative, there is a possibility that one of
these products could produce a side effect which could result in an
adverse effect on our ability to achieve acceptance by managed care
providers, pharmacies and other retailers, customers and patients.
If these independent third parties do not accept our products, it
could have a material adverse effect on our financial condition and
results of operations.
EXTENSIVE INDUSTRY REGULATION HAS HAD, AND WILL CONTINUE TO HAVE, A
SIGNIFICANT IMPACT ON OUR BUSINESS, ESPECIALLY OUR PRODUCT
DEVELOPMENT, MANUFACTURING AND DISTRIBUTION CAPABILITIES.
All pharmaceutical companies, including us, are subject to
extensive, complex, costly and evolving regulation by the federal
government, principally the FDA and, to a lesser extent, the DEA
and state government agencies. The Federal Food, Drug and Cosmetic
Act, the Controlled Substances Act and other federal statutes and
regulations govern or influence the testing, manufacturing,
packing, labeling, storing, record keeping, safety, approval,
advertising, promotion, sale and distribution of our products.
Failure to comply with applicable FDA or other regulatory
requirements may result in criminal prosecution, civil penalties,
injunctions, recall or seizure of
29
products and total or partial suspension of production, as well as
other regulatory actions against our products and us.
We market certain drug products in the United States without FDA
approval under certain "grandfather" clauses and statutory and
regulatory exceptions to the pre-market approval requirement for
"new drugs" under the Federal Food, Drug and Cosmetic Act, or the
FDCA. A determination as to whether a particular product does or
does not require FDA pre-market review and approval can involve
consideration of numerous complex and imprecise factors. If a
determination is made by the FDA that any product marketed without
approval requires such approval, the FDA may institute enforcement
actions, including product seizure, or an action seeking an
injunction against further marketing and may or may not allow
sufficient time to obtain the necessary approvals before it seeks
to curtail further marketing. For example, in October 2002, FDA
sent warning letters to us and other manufacturers and distributors
of unapproved prescription drug products containing the expectorant
guaifenesin as a single entity in a solid oral extended-release
dosage form. Citing the recent approval of one such product, the
FDA warning letters asserted that the marketing of all such
products without NDA or ANDA approval should stop. The FDA
subsequently agreed to allow continued manufacture through May 2003
and sale through November 2003 of the products, and we complied
with those deadlines. We are not in a position to predict whether
or when the FDA might choose to raise similar objections to the
marketing without NDA or ANDA approval of another category or
categories of drug products represented in our product lines. In
the event such objections are raised, we could be required or could
decide to cease distribution of additional products until
pre-market approval is obtained. In addition, we may not be able to
obtain any particular approval that may be required or such
approvals may not be obtained on a timely basis.
In addition to compliance with current Good Manufacturing Practice,
or cGMP, requirements, drug manufacturers must register each
manufacturing facility with the FDA. Manufacturers and distributors
of prescription drug products are also required to be registered in
the states where they are located and in certain states that
require registration by out-of-state manufacturers and
distributors. Manufacturers also must be registered with the Drug
Enforcement Administration, or DEA, and similar applicable state
and local regulatory authorities if they handle controlled
substances, and with the Environmental Protection Agency, or EPA,
and similar state and local regulatory authorities if they generate
toxic or dangerous wastes, and must also comply with other
applicable DEA and EPA requirements. We believe that we are
currently in material compliance with cGMP and are registered with
the appropriate state and federal agencies. Non-compliance with
applicable cGMP requirements or other rules and regulations of
these agencies can result in fines, recall or seizure of products,
total or partial suspension of production and/or distribution,
refusal of government agencies to grant pre-market approval or
other product applications and criminal prosecution. Despite our
ongoing efforts, cGMP requirements and other regulatory
requirements, and related enforcement priorities and policies may
evolve over time and we may not be able to remain continuously in
material compliance with all of these requirements.
From time to time, governmental agencies have conducted
investigations of pharmaceutical companies relating to the
distribution and sale of drug products to government purchasers or
subject to government or third party reimbursement. We believe that
we have marketed our products in compliance with applicable laws
and regulations. However, standards sought to be applied in the
course of governmental investigations can be complex and may not be
consistent with standards previously applied to our industry
generally or previously understood by us to be applicable to our
activities.
The process for obtaining governmental approval to manufacture and
market pharmaceutical products is rigorous, time-consuming and
costly, and we cannot predict the extent to which we may be
affected by legislative and regulatory developments. We are
dependent on receiving FDA and other governmental or third-party
approvals prior to manufacturing, marketing and shipping many of
our products. Consequently, there is always the chance that we will
not obtain FDA or other necessary approvals, or that the rate,
timing and cost of such approvals, will adversely affect our
product introduction plans or results of operations. In many
instances we carry inventories of products in anticipation of
launch, and if such products are not subsequently launched, we may
be required to write-off the related inventory.
30
OUR INDUSTRY IS HIGHLY COMPETITIVE.
Numerous pharmaceutical companies are involved or are becoming
involved in the development and commercialization of products
incorporating advanced drug delivery systems. Our business is
highly competitive, and we believe that competition will continue
to increase in the future. Many pharmaceutical companies have
invested, and are continuing to invest, significant resources in
the development of proprietary drug delivery systems. In addition,
several companies have been formed to develop specific advanced
drug delivery systems. Many of these pharmaceutical and other
companies who may develop drug delivery systems have greater
financial, research and development and other resources than we do,
as well as more experience in commercializing pharmaceutical and
drug delivery products. Those companies may develop products using
their drug delivery systems more rapidly than we do or develop drug
delivery systems that are more effective than ours and thus may
represent significant potential competitors.
Our branded pharmaceutical business is subject to competition from
larger companies with greater financial resources that can support
larger sales forces. The ability of a sales force to compete is
affected by the number of physician calls it can make, which is
directly related to its size, the brand name recognition it has in
the marketplace and its advertising and promotional efforts. We are
not as well established in our branded product sales initiative as
larger pharmaceutical companies and could be adversely affected by
competition from companies with larger, more established sales
forces and higher advertising and promotional expenditures.
Our generic pharmaceutical business is also subject to competitive
pressures from a number of companies, some of which have greater
financial resources and broader product lines. To the extent that
we succeed in being first to market with a generic/non-branded
version of a significant product, our sales and profitability can
be substantially increased in the period following the introduction
of such product and prior to additional competitors' introduction
of an equivalent product. Competition is generally on price, which
can have an adverse effect on profitability as falling prices erode
margins. In addition, the continuing consolidation of the customer
base (wholesale distributors and retail drug chains) and the impact
of managed care organizations will increase competition as
suppliers compete for fewer customers. Consolidation of competitors
will increase competitive pressures as larger suppliers are able to
offer a broader product line. Further, companies continually seek
new ways to defeat generic competition, such as filing applications
for new patents to cover drugs whose original patent protection is
about to expire, developing and marketing other dosage forms
including patented controlled-release products or developing and
marketing as over-the-counter products those branded products which
are about to lose exclusivity and face generic competition.
In addition to litigation over patent rights, pharmaceutical
companies are often the subject of objections by competing
manufacturers over the qualities of their branded or generic
products and/or their promotional activities. For example,
marketers of branded products have challenged the marketing of
certain of our non-branded products that do not require FDA
approval and are not rated for therapeutic equivalence.
Currently, KV and ETHEX are named as defendants in ongoing
litigation with Solvay Pharmaceuticals, Inc. regarding Solvay's
allegations that ETHEX's comparative promotion of its
Pangestyme(TM) CN 10 and Pangestyme(TM) CN 20 products to Solvay's
Creon(R) 10 and Creon(R) 20 products resulted in false advertising
and misleading statements under various Federal and state laws, and
constituted unfair and deceptive trade practices. Discovery has
concluded. The case is expected to be tried in calendar 2006, but
no trial date has been set. We intend to vigorously defend our
interests; however, we cannot give any assurance we will prevail.
Competitors' objections also may be pursued in complaints before
governmental agencies or courts. These objections can be very
expensive to pursue or to defend, and the outcome of agency or
court review of the issues raised is impossible to predict. In
these proceedings, companies can be subjected to restrictions on
their activities or to liability for alleged damages despite their
belief that their products and procedures are in full compliance
31
with appropriate standards. In addition, companies that pursue what
they believe are legitimate complaints about competing
manufacturers and/or their products may nevertheless be unable to
obtain any relief.
OUR INDUSTRY EXPERIENCES RAPID TECHNOLOGICAL CHANGE.
The drug delivery industry is a rapidly evolving field. A number of
companies, including major pharmaceutical companies, are developing
and marketing advanced delivery systems for the controlled delivery
of drugs. Products currently on the market or under development by
competitors may deliver the same drugs, or other drugs to treat the
same indications, as many of the products we market or are
developing. The first pharmaceutical branded or generic/non-branded
product to reach the market in a therapeutic area often obtains and
maintains significant market share relative to later entrants to
the market. Our products also compete with drugs marketed not only
in similar delivery systems but also in traditional dosage forms.
New drugs, new therapeutic approaches or future developments in
alternative drug delivery technologies may provide advantages over
the drug delivery systems and products that we are marketing, have
developed or are developing.
Changes in drug delivery technology may require substantial
investments by companies to maintain their competitive position and
may provide opportunities for new competitors to enter the
industry. Developments by others could render our drug delivery
products or other technologies uncompetitive or obsolete. If others
develop drugs which are cheaper or more effective or which are
first to market, sales or prices of our products could decline.
RISKS RELATED TO OUR COMMON STOCK
THE MARKET PRICE OF OUR STOCK HAS BEEN AND MAY CONTINUE TO BE
VOLATILE.
The market prices of securities of companies engaged in
pharmaceutical development and marketing activities historically
have been highly volatile. In addition, any or all of the following
may have a significant impact on the market price of our common
stock: announcements by us or our competitors of technological
innovations or new commercial products; delays in the development
or approval of products; developments or disputes concerning patent
or other proprietary rights; publicity regarding actual or
potential medical results relating to products marketed by us or
products under development; regulatory developments in both the
United States and foreign countries; publicity regarding actual or
potential acquisitions; public concern as to the safety of drug
technologies or products; financial results which are different
from securities analysts' forecasts; economic and other external
factors; and period-to-period fluctuations in our financial
results.
FUTURE SALES OF COMMON STOCK COULD ADVERSELY AFFECT THE MARKET
PRICE OF OUR CLASS A OR CLASS B COMMON STOCK.
As of March 31, 2006, an aggregate of 3,162,307 shares of our Class
A common stock and 356,849 shares of our Class B common stock were
issuable upon exercise of outstanding stock options under our stock
option plans, and an additional 611,494 shares of our Class A
common stock and 1,879,500 shares of Class B common stock were
reserved for the issuance of additional options and shares under
these plans. In addition, as of March 31, 2006, 8,691,880 shares of
Class A common stock were reserved for issuance upon conversion of
$200.0 million principal amount of convertible notes, and 337,500
shares of our Class A common stock were reserved for issuance upon
conversion of our outstanding 7% cumulative convertible preferred
stock.
MANAGEMENT STOCKHOLDERS CONTROL OUR COMPANY.
At March 31, 2006, our directors and executive officers
beneficially own approximately 13% of our Class A Common Stock and
approximately 62% of our Class B Common Stock. As a result, these
persons control approximately 55% of the combined voting power
represented by our outstanding securities. These persons will
retain effective voting control of our company and are expected to
continue to have the ability to effectively
32
determine the outcome of any matter being voted on by our
stockholders, including the election of directors and any merger,
sale of assets or other change in control of our company.
Future sales of our common stock and instruments convertible or
exchangeable into our common stock and transactions involving
equity derivatives relating to our common stock, or the perception
that such sales or transactions could occur, could adversely affect
the market price of our common stock. This could, in turn, have an
adverse effect on the trading price of the Notes resulting from,
among other things, a delay in the ability of holders to convert
their Notes into our Class A common stock.
OUR CHARTER PROVISIONS AND DELAWARE LAW MAY HAVE ANTI-TAKEOVER
EFFECTS.
Our Amended Certificate of Incorporation authorizes the issuance of
common stock in two classes, Class A common stock and Class B
common stock. Each share of Class A common stock entitles the
holder to one-twentieth of one vote on all matters to be voted upon
by stockholders, while each share of Class B common stock entitles
the holder to one full vote on each matter considered by the
stockholders. In addition, our directors have the authority to
issue additional shares of preferred stock and to determine the
price, rights, preferences, privileges and restrictions of those
shares without any further vote or action by the stockholders. The
rights of the holders of common stock will be subject to, and may
be adversely affected by, the rights of the holders of any
preferred stock that may be issued in the future. The existence of
two classes of common stock with different voting rights and the
ability of our directors to issue additional shares of preferred
stock could make it more difficult for a third party to acquire a
majority of our voting stock. Other provisions of our Amended
Certificate of Incorporation and Bylaws, such as a classified board
of directors, also may have the effect of discouraging, delaying or
preventing a merger, tender offer or proxy contest, which could
have an adverse effect on the market price of our Class A common
stock.
In addition, certain provisions of Delaware law applicable to our
company could also delay or make more difficult a merger, tender
offer or proxy contest involving our company, including Section 203
of the Delaware General Corporation Law, which prohibits a Delaware
corporation from engaging in any business combination with any
"interested stockholder" (as defined in the statute) for a period
of three years unless certain conditions are met. In addition, our
senior management is entitled to certain payments upon a change in
control and all of our stock option plans provide for the
acceleration of vesting in the event of a change in control of our
company.
ITEM 1B. UNRESOLVED STAFF COMMENTS
-------------------------
None.
33
ITEM 2. PROPERTIES
----------
Our corporate headquarters is located at 2503 South Hanley Road in
St. Louis County, Missouri, and contains approximately 40,000
square feet of floor space. We have a lease on the building for a
period of ten years expiring December 31, 2006, with one five-year
option to renew and a successive three-year renewal option. The
building is leased from an affiliated partnership of an officer and
director of the Company.
In addition, we lease or own the facilities shown in the following
table. All of these facilities are located in the St. Louis
metropolitan area.
SQUARE LEASE RENEWAL
FOOTAGE USAGE EXPIRES OPTIONS
-----------------------------------------------------------------------------------------------------
30,150 PDI Mfg./Whse. 11/30/07 5 Years(1)
10,000 PDI/KV Lab/Whse. 11/30/06 None
15,000 KV/PDI Office 02/29/08 2 Years(3)
23,000 KV Office/R&D/Mfg. 12/31/06 5 Years(2)
44,100 KV Warehouse 11/30/06 1 Year(4)
128,960 KV Office/Mfg(7) 06/14/11 N/A
121,500 KV Office/Whse./Lab(8) Owned N/A
87,250 KV Mfg. Owned N/A
86,800 KV Lab(5) Owned N/A
302,940 KV Mfg/Whse/ETHEX/Ther-Rx Office(6)(8) Owned N/A
260,160 ETHEX/Ther-Rx/PDI Distribution(8) Owned N/A
96,360 KV Warehouse Owned N/A
<FN>
----------------------------------------
(1) One five-year option.
(2) Two five-year options.
(3) Two two-year options.
(4) One one-year option.
(5) This facility was renovated into an additional research lab
facility.
(6) This facility was renovated into office space for ETHEX,
Ther-Rx and certain KV administrative functions and production
space for additional operations.
(7) The purchase option on this building, which was leased by the
Company on March 31, 2006, was exercised by the Company in
accordance with the lease agreement and is scheduled to be
acquired for $4.9 million in June 2006.
(8) In March 2006, we entered into a $43.0 million mortgage loan
agreement with one of our primary lenders secured, in part, by
this property. This loan bears interest at a rate of 5.91% and
matures on April 1, 2021.
Properties used in our operations are considered suitable for the
purposes for which they are used and are believed to be adequate to
meet our needs for the reasonably foreseeable future. However, we
will consider leasing or purchasing additional facilities from time
to time, when attractive facilities become available, to
accommodate the consolidation of certain operations and to meet
future expansion plans.
ITEM 3. LEGAL PROCEEDINGS
-----------------
The information set forth under Note 12 - Commitments and
Contingencies - to the Consolidated Financial Statements included
in Item 8 of this report is incorporated in this Item 3 by
reference.
34
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
No matters were submitted to a vote of security holders during the
fourth quarter of the Company's fiscal year ended March 31, 2006.
ITEM 4(A). EXECUTIVE OFFICERS OF THE REGISTRANT
------------------------------------
The following is a list of current executive officers of our
Company, their ages, their positions with our Company and their
principal occupations for at least the past five years.
NAME AGE POSITION HELD AND PAST EXPERIENCE
- -------------------------------------------------------------------------------------------------
Marc S. Hermelin 64 Vice Chairman of the Board of the Company since 1974; Vice Chairman and Chief
Executive Officer since 1975.
Gerald R. Mitchell 67 Director since March 2006, Vice President and Chief Financial Officer since
1981.
Richard H. Chibnall 50 Vice President, Finance since February 2000.
Michael S. Anderson 57 Vice President, Industry Presence and Development since March 2006;
Chief Executive Officer, Ther-Rx Corporation from February 2000 to February
2006.
Jerald J. Wenker 44 President, Ther-Rx Corporation since June 2004; Vice President, Licensing and
New Business Development, Abbott Corporation from January 2002 to April 2004;
Vice President and General Manager, Anti-Infective Franchise Abbott Corporation
from April 2000 to January 2002.
Patricia K. McCullough 54 Chief Executive Officer, ETHEX Corporation since January 30, 2006;
Group Vice President, Business Development and Strategic Planning, Taro
Pharmaceuticals from September 2003 to January 2006; Senior Vice President,
Account Development, Cardinal Health from June 2000 to July 2003.
Philip J. Vogt 49 President, ETHEX Corporation since February 2000.
Raymond F. Chiostri 72 Chairman and Chief Executive Officer of Particle Dynamics, Inc. since 1999.
Paul T. Brady 43 President, Particle Dynamics, Inc. since 2003; Senior Vice President and
General Manager, International Specialty Products Corporation from June 2002
to January 2003; Senior Vice President, Commercial Director, North and South
America International Specialty Products from 2000 to 2002.
Eric D. Moyermann 48 President, Pharmaceutical Manufacturing since February 2000.
<FN>
Executive officers of the Company serve at the pleasure of the Board of Directors.
- -------------------------------
(1) Marc S. Hermelin is the son of Victor M. Hermelin, Chairman of the Board
of Directors of the Company since 1971 and father of David S. Hermelin, a
member of the Board of Directors since 2004.
35
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
--------------------------------------------------------------------
MATTERS
-------
a) PRINCIPAL MARKET
----------------
Our Class A common stock and Class B common stock are traded on the
New York Stock Exchange under the symbols KV.A and KV.B,
respectively.
b) APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK
---------------------------------------------
The number of holders of record of Class A and Class B common stock
as of June 8, 2006 was 811 and 364, respectively (not separately
counting shareholders whose shares are held in "nominee" or "street"
names, which are estimated to represent approximately 5,000 additional
Class A common stock and Class B common stock shareholders combined).
c) STOCK PRICE AND DIVIDEND INFORMATION
------------------------------------
The high and low closing sales prices of our Class A and Class B
common stock during each quarter of fiscal 2006 and 2005, as
reported on the New York Stock Exchange were as follows:
CLASS A COMMON STOCK
--------------------
FISCAL 2006 FISCAL 2005
----------- -----------
QUARTER HIGH LOW HIGH LOW
------- ---------------------- -----------------------
First...................... $24.37 $16.75 $26.24 $22.25
Second..................... 18.27 15.53 23.11 15.31
Third...................... 21.50 16.79 22.14 18.18
Fourth..................... 24.22 20.60 23.20 19.78
CLASS B COMMON STOCK
--------------------
FISCAL 2006 FISCAL 2005
----------- -----------
QUARTER HIGH LOW HIGH LOW
------- ---------------------- -----------------------
First...................... $24.72 $16.79 $29.60 $25.00
Second..................... 18.24 15.53 25.05 16.35
Third...................... 21.57 16.83 22.77 18.65
Fourth..................... 24.13 21.27 23.49 20.42
Since 1980, we have not declared or paid any cash dividends on our
common stock and we do not plan to do so in the foreseeable future.
No dividends may be paid on Class A common stock or Class B common
stock unless all dividends on the Cumulative Convertible Preferred
Stock have been declared and paid. Dividends must be paid on Class
A common stock when, and if, we declare and distribute dividends on
the Class B common stock. Dividends of $70,000 were paid in fiscal
2006 and 2005 on 40,000 shares of outstanding Cumulative
Convertible Preferred Stock. There were no undeclared and unaccrued
cumulative preferred dividends at March 31, 2006.
Also, under the terms of our credit agreement, we may not pay cash
dividends in excess of 25% of the prior fiscal year's consolidated
net income. For the foreseeable future, we plan to use cash
generated from operations for
36
general corporate purposes, including funding potential
acquisitions, research and development and working capital. Our
board of directors reviews our dividend policy periodically. Any
payment of dividends in the future will depend upon our earnings,
capital requirements, financial condition and other factors
considered relevant by our board of directors. See also Note 16 of
Notes to Consolidated Financial Statements for information relating
to our equity compensation plans.
- ----------------------------------------------------------------------------------------------------------------------
Issuer Purchases of Equity Securities
- ----------------------------------------------------------------------------------------------------------------------
Period Total number of Average price paid Total number of Maximum number of
shares purchased per share shares purchased as shares (or units)
(a) part of publicly that may yet be
announced plans or purchased under the
programs plans or programs
- ----------------------------------------------------------------------------------------------------------------------
1/1/06 - 1/31/06 4,541 $21.88 - -
- ----------------------------------------------------------------------------------------------------------------------
2/1/06 - 2/28/06 600 $22.64 - -
- ----------------------------------------------------------------------------------------------------------------------
3/1/06 - 3/31/06 - - - -
- ----------------------------------------------------------------------------------------------------------------------
Total 5,141 $21.97 - -
- ----------------------------------------------------------------------------------------------------------------------
<FN>
(a) Shares were purchased from employees upon their termination
pursuant to the terms of the Company's stock option plan.
37
EQUITY COMPENSATION PLAN INFORMATION
The following information regarding compensation plans of the
Company is furnished as of March 31, 2006, the end of the Company's
most recently completed fiscal year.
EQUITY COMPENSATION PLAN INFORMATION
REGARDING CLASS A COMMON STOCK
- ----------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
FUTURE ISSUANCE UNDER
NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS
ISSUED UPON EXERCISE OF PRICE OF OUTSTANDING (EXCLUDING SECURITIES
OUTSTANDING OPTIONS, OPTIONS, WARRANTS REFLECTED IN
WARRANTS AND RIGHTS AND RIGHTS COLUMN (a))
------------------------- ------------------------ -------------------------
PLAN CATEGORY (a) (b) (c)
Equity compensation plans
approved by security holders(1) 3,155,557 $15.83 611,494
Equity compensation plans not
approved by security holders(2) 6,750 $3.22 N/A
---------
Total 3,162,307 $15.80
=========
<FN>
(1) Consists of the Company's 2001 Incentive Stock Option Plan. See Note 16 of Notes to Consolidated
Financial Statements.
(2) Consists of options granted to non-employee members of the Board of Directors.
38
EQUITY COMPENSATION PLAN INFORMATION
REGARDING CLASS B COMMON STOCK
- ----------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
FUTURE ISSUANCE UNDER
NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS
ISSUED UPON EXERCISE OF PRICE OF OUTSTANDING (EXCLUDING SECURITIES
OUTSTANDING OPTIONS, OPTIONS, WARRANTS REFLECTED IN
WARRANTS AND RIGHTS AND RIGHTS COLUMN (a))
------------------------- ------------------------ -------------------------
PLAN CATEGORY (a) (b) (c)
Equity compensation plans
approved by security holders(1) 328,724 $14.38 1,879,500
Equity compensation plans not
approved by security holders(2) 28,125 $4.82 N/A
-------
Total 356,849 $13.63
=======
<FN>
(1) Consists of the Company's 2001 Incentive Stock Option Plan. See Note 16 of Notes to Consolidated
Financial Statements.
(2) Consists of options granted to non-employee members of the Board of Directors.
39
ITEM 6. SELECTED FINANCIAL DATA
-----------------------
(in thousands, except per share data)
MARCH 31,
--------------------------------------------------------------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
BALANCE SHEET DATA:
Total assets $618,013 $558,317 $528,438 $352,668 $195,192
Long-term debt 241,319 209,767 210,741 10,106 4,387
Shareholders' equity 309,275 292,702 257,749 260,616 158,792
INCOME STATEMENT DATA:
YEARS ENDED MARCH 31,
--------------------------------------------------------------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
Net revenues $367,618 $303,493 $283,941 $244,996 $204,105
% Increase from prior year 21.1% 6.9% 15.9% 20.0% 14.8%
Operating income(a)(b)(c)(d) $ 39,218 $ 52,412 $ 73,771 $ 42,929 $ 49,294
Net income(a)(b)(c)(d) 15,787 33,269 45,848 28,110 31,464
Net income
per common
share-diluted(e) (f) $ 0.31 $ 0.63 $ 0.84 $ 0.55 $ 0.65
Preferred stock dividends $ 70 $ 70 $ 436 $ 70 $ 70
<FN>
(a) Operating income in fiscal 2006 included an expense of $30.4 million
recognized in connection with the FemmePharma acquisition that
consisted of $29.6 million for acquired in-process research and
development and $0.9 million for direct expenses related to the
transaction (see Note 3 in the accompanying Notes to Consolidated
Financial Statements). The impact of this item, which was determined by
the Company to not be deductible for tax purposes, was to reduce our
diluted earnings per share for fiscal 2006 by $0.60.
(b) Operating income in fiscal 2005 included a $0.6 million net payment
received by us in accordance with a legal settlement and additional
income of $0.8 million for the reversal of a portion of the
Healthpoint litigation reserve that remained after payment of the
$16.5 million settlement amount and related litigation costs. The
impact of these items, net of applicable income taxes, was to
increase net income by $1.0 million and diluted earnings per share
by $0.02 in fiscal 2005.
(c) Operating income in fiscal 2004 included a $3.5 million net payment
received by us in accordance with a legal settlement and an
additional reserve of $1.8 million for attorneys' fees associated
with a lawsuit. The impact of these items, net of applicable income
taxes, was to increase net income by $1.1 million and diluted
earnings per share by $0.02 in fiscal 2004.
(d) Operating income in fiscal 2003 included a provision of $16.5
million for potential damages associated with the Healthpoint
litigation. The impact of the litigation reserve, net of applicable
income taxes, was to reduce net income by $10.4 million and diluted
earnings per share by $0.20 in fiscal 2003.
(e) Previously reported amounts give effect to the three-for-two stock
split effected in the form of a 50% stock dividend that occurred on
September 29, 2003.
(f) Amounts for fiscal 2004 have been restated to report shares
issuable upon conversion of contingent convertible notes, which
were issued in May 2003, pursuant to Emerging Issues Task Force
(EITF) Issue No. 04-08, the Effect of Contingently Convertible Debt
on Diluted Earnings per Share.
40
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS, AND
------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Except for the historical information contained herein, the
following discussion contains forward-looking statements that are
subject to known and unknown risks, uncertainties, and other
factors that may cause our actual results to differ materially from
those expressed or implied by such forward-looking statements.
These risks, uncertainties and other factors are discussed
throughout this report and specifically under the captions
"Cautionary Statement Regarding Forward-Looking Information" and
"Risk Factors." In addition, the following discussion and analysis
of the financial condition and results of operations should be read
in conjunction with "Selected Financial Data" and our Consolidated
Financial Statements and the notes thereto appearing elsewhere in
this Form 10-K.
BACKGROUND
We are a fully integrated specialty pharmaceutical company that
develops, acquires, manufactures and markets technologically-
distinguished branded and generic/non-branded prescription
pharmaceutical products. We have a broad range of dosage form
capabilities, including tablets, capsules, creams, liquids and
ointments. We conduct our branded pharmaceutical operations through
Ther-Rx Corporation and our generic/non-branded pharmaceutical
operations through ETHEX Corporation, which focuses principally on
technologically-distinguished generic products. Through Particle
Dynamics, Inc., we develop, manufacture and market technologically
advanced, value-added raw material products for the pharmaceutical,
nutritional, personal care, food and other markets.
We have a broad portfolio of drug delivery technologies which we
leverage to create technologically-distinguished brand name and
specialty generic products. We have developed and patented 15 drug
delivery and formulation technologies primarily in four principal
areas: SITE RELEASE(R) bioadhesives, oral controlled release,
tastemasking and oral quick dissolving tablets. We incorporate
these technologies in the products we market to control and improve
the absorption and utilization of active pharmaceutical compounds.
These technologies provide a number of benefits, including reduced
frequency of administration, reduced side effects, improved drug
efficacy, enhanced patient compliance and improved taste.
Our drug delivery technologies allow us to differentiate our
products in the marketplace, both in the branded and
generic/non-branded pharmaceutical areas. We believe that this
differentiation provides substantial competitive advantages for our
products, allowing us to establish a strong record of growth and
profitability and a leadership position in certain segments of our
industry.
RESULTS OF OPERATIONS
During fiscal 2006, we recorded expense of $30.4 million in
connection with the FemmePharma acquisition (see Note 3 to
Consolidated Financial Statements) that consisted of $29.6 million
for acquired in-process research and development and $0.9 million
for direct expenses related to the transaction. The valuation of
acquired in-process research and development represented the
estimated fair value of the worldwide marketing rights to an
endometriosis product we acquired as part of the FemmePharma
acquisition that, at the time of the acquisition, had no
alternative future use and for which technological feasibility had
not been clinically proven. The FemmePharma acquisition expense of
$30.4 million reduced our fiscal 2006 diluted earnings per share by
$0.60 to $0.31 per diluted share and reduced our fiscal 2006 net
income to $15.8 million.
Net revenues for fiscal 2006 increased $64.1 million, or 21.1%,
from fiscal 2005 as we reported sales growth of 61.4% and 5.4% in
our branded products and specialty generics segments, respectively.
The resulting $47.9 million increase in gross profit was offset
in part by a $30.7 million increase in operating expenses before
taking into account the $30.4 million of expense associated with
the FemmePharma acquisition. This increase in operating expenses
was primarily due to increases in personnel costs, branded
marketing and promotions expense, legal and professional expenses,
and research and development expense.
41
FISCAL 2006 COMPARED TO FISCAL 2005
NET REVENUES BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2006 2005 $ %
---------- ---------- ---------- -------
Branded products $ 145,435 $ 90,085 $ 55,350 61.4%
as % of net revenues 39.6% 29.7%
Specialty generics 203,833 193,402 10,431 5.4%
as % of net revenues 55.4% 63.7%
Specialty materials 16,988 18,345 (1,357) (7.4)%
as % of net revenues 4.6% 6.0%
Other 1,362 1,661 (299) (18.0)%
---------- ---------- ----------
Total net revenues $ 367,618 $ 303,493 $ 64,125 21.1%
The growth in branded product sales was due primarily to increased
sales of our two anti-infective brands, Clindesse(TM) and
Gynazole-1(R), and continued sales growth from our hematinic and
prescription prenatal product lines. Clindesse(TM), a single-dose
prescription cream therapy indicated to treat bacterial vaginosis,
contributed $22.0 million of sales during fiscal 2006. Since its
launch in January 2005, Clindesse(TM) has gained 19.7% of the
intravaginal bacterial vaginosis market. Sales of Gynazole-1(R),
our vaginal antifungal cream product, increased $3.9 million, or
18.3%, to $25.2 million during fiscal 2006. This increase was due
primarily to higher pricing as our prescription volume declined
3.6% in fiscal 2006. Sales of our hematinic products in fiscal 2006
increased $11.4 million, or 44.8%, to $36.8 million. The growth in
hematinic sales resulted from a 13.8% increase in prescription
volume during fiscal 2006, higher pricing and $3.3 million of
incremental sales associated with the introduction of two new
products, Niferex(R) Gold and Repliva 21/7(TM). Also included in
branded product sales was our PreCare(R) product line which
continued as the leading branded line of prescription prenatal
nutritional supplements in the United States. Sales from our
PreCare(R) product line increased $18.1 million, or 56.0%, to $50.4
million in fiscal 2006. This increase was primarily due to sales
growth experienced by PrimaCare(R) ONE, our proprietary line
extension to PrimaCare(R), as its share of the branded prenatal
nutritional supplement market increased to 17.5% at the end of
fiscal 2006. The increase in PreCare(R) product sales was also
impacted by a temporary fourth quarter supply disruption of
PrimaCare(R) ONE in the prior year. The increase in branded product
sales was further supplemented by the introduction of Encora(TM), a
new prescription nutritional supplement with essential fatty acids,
which contributed $1.8 million of incremental revenue during fiscal
2006 and a $1.8 million increase in sales of our Micro-K(R) product
line.
The increase in specialty generic sales resulted from $16.0 million
of increased sales volume from existing products in our cough/cold,
pain management and digestive enzyme product lines coupled with
$1.5 million of incremental sales volume from new product
introductions primarily in our pain management product line. These
increases were offset in part by product price erosion of $7.1
million that resulted from pricing pressures on certain products.
Although specialty generic sales resulting from new product
introductions were limited during fiscal 2006, we did receive late
in the fiscal year ANDA approval for five strengths of Oxycodone
Hydrochloride tablets and three strengths of Hydromorphone
Hydrochloride tablets. Also, late in fiscal 2006, we received a
favorable court ruling in a Paragraph IV patent infringement action
filed against us by AstraZeneca based on our ANDA submissions to
market generic formulations of Toprol-XL(R). We believe we were the
first company to file with the FDA for generic approval of the
100 mg and 200 mg dosage strengths, a position that may, upon
approval, afford us the opportunity for a six-month exclusivity
period for marketing these generic versions. The
42
total branded dollar volume of Toprol-XL(R) in 2005 was $1.3 billion,
of which the 100 mg and 200 mg strengths represented nearly half.
The decrease in specialty material product sales was primarily due
to reduced sales on a product that is used by a customer in a
chewable vitamin that the customer was in the process of
reformulating, coupled with increased competition on our calcium
carbonate products.
GROSS PROFIT BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2006 2005 $ %
---------- ---------- ---------- -------
Branded products $ 128,516 $ 78,844 $ 49,672 63.0%
as % of net revenues 88.4% 87.5%
Specialty generics 111,982 114,616 (2,634) (2.3)%
as % of net revenues 54.9% 59.3%
Specialty materials 4,732 6,394 (1,662) (26.0)%
as % of net revenues 27.9% 34.9%
Other (1,506) (4,043) 2,537 62.8%
---------- ---------- ----------
Total gross profit $ 243,724 $ 195,811 $ 47,913 24.5%
as % of total net revenues 66.3% 64.5%
The increase in gross profit was primarily due to the significant
sales growth experienced by our branded products segment. The
higher gross profit percentage on a consolidated basis reflected
the impact of our higher margin branded products comprising a
larger percentage of net revenues. This effect was offset in part
by lower margins in the specialty generics segment due primarily to
the impact of price erosion on certain products in the
cardiovascular and pain management product lines coupled with a
shift in the mix of sales toward lower margin products,
particularly in the cough/cold category. The gross profit
percentage decrease experienced by specialty materials primarily
resulted from higher production costs associated with lower volume
and an unfavorable mix of products sold.
RESEARCH AND DEVELOPMENT
------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2006 2005 $ %
---------- ---------- ---------- -------
Research and development $ 28,886 $ 23,538 $ 5,348 22.7%
as % of net revenues 7.9% 7.8%
The increase in research and development expense was due to
increased spending on bioequivalency studies as we continued active
development of various branded and generic/non-brand products in
our internal and external pipelines and increased personnel
expenses related to the growth of our research and development
staff.
We anticipate that research and development costs for fiscal 2007
will continue to increase based on our growing product development
pipeline, the expected cost of the Phase III clinical study on the
endometriosis product acquired in the first quarter of fiscal 2006
and other branded and generic opportunities.
43
PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
---------------------------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2006 2005 $ %
---------- ---------- ---------- -------
Purchased in-process research
and development $ 30,441 $ - $ 30,441 NM
During fiscal 2006, we recorded expense of $30.4 million in
connection with the FemmePharma acquisition that consisted of $29.6
million for acquired in-process research and development and $0.9
million in direct expenses related to the transaction. The
valuation of acquired in-process research and development
represents the estimated fair value of the worldwide marketing
rights to an endometriosis product we acquired as part of the
FemmePharma acquisition that, at the time of the acquisition, had
no alternative future use and for which technological feasibility
had not been established. The FemmePharma acquisition expense of
$30.4 million reduced our diluted earnings per share for the year
ended March 31, 2006 by $0.60.
SELLING AND ADMINISTRATIVE
--------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2006 2005 $ %
---------- ---------- ---------- -------
Selling and administrative $ 140,395 $ 116,638 $ 23,757 20.4%
as % of net revenues 38.2% 38.4%
The increase in selling and administrative expense was primarily
due to:
o $9.8 million increase in personnel costs associated with
expansion of the branded sales force in fiscal 2005 and
2006 and increases in management and other personnel to
support the overall growth of the business;
o $7.3 million increase in branded marketing and promotions
expense for promotion of our existing brands, to further
promote the launch of Clindesse(TM) and to support the
introduction in fiscal 2006 of a new prescription
nutritional supplement product and two new hematinic
products; and
o $6.4 million increase in legal and professional expense
commensurate with an increase in litigation activity and
evaluation of potential acquisition opportunities. The
increase in litigation activity included ongoing costs
associated with certain patent infringement actions
brought against us on products we market or propose to
market.
44
AMORTIZATION OF INTANGIBLE ASSETS
---------------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2006 2005 $ %
---------- ---------- ---------- -------
Amortization of intangible assets $ 4,784 $ 4,653 $ 131 2.8%
as % of net revenues 1.3% 1.5%
The increase in amortization of intangible assets was due primarily
to a full year's amortization in fiscal 2006 of license costs
incurred for a product launched in fiscal 2005 under a
co-development arrangement, an increase in amortization of patent
and trademark costs, and amortization of the purchase price
allocated to the non-compete agreement obtained in the FemmePharma
acquisition.
LITIGATION
----------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2006 2005 $ %
---------- ---------- ---------- -------
Litigation $ - $ (1,430) $ 1,430 NM
The $1.4 million of income reflected in "Litigation" for fiscal
2005 consisted of a $0.6 million net payment received by us in
accordance with a favorable legal settlement of vitamin antitrust
litigation and $0.8 million associated with the reversal of excess
reserves that resulted from settlement of the Healthpoint
litigation in fiscal 2005.
OPERATING INCOME
----------------
YEARS ENDED MARCH 31,
-----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2006 2005 $ %
---------- ---------- ---------- -------
Operating income $ 39,218 $ 52,412 $ (13,194) (25.2)%
The decrease in operating income resulted from the $30.4 million
in-process research and development charge recorded in connection
with the FemmePharma acquisition.
45
INTEREST EXPENSE
----------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2006 2005 $ %
---------- ---------- ---------- -------
Interest expense $ 6,045 $ 5,432 $ 613 11.3%
The increase in interest expense was primarily due to the
completion of a number of capital projects during fiscal 2006 and
the related reduced level of capitalized interest thereon.
INTEREST AND OTHER INCOME
-------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2006 2005 $ %
---------- ---------- ---------- -------
Interest and other income $ 5,737 $ 3,048 $ 2,689 88.2%
The increase in interest and other income was primarily due to an
increase in interest income on short-term investments and dividends
earned on redeemable preferred stock. The increase in interest
income resulted from a full year's effect of investing excess cash
into short-term investments with higher yielding interest rates. The
higher weighted average interest rate earned on short-term
investments was offset in part by a decline in the average balance
of invested cash.
PROVISION FOR INCOME TAXES
--------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2006 2005 $ %
---------- ---------- ---------- -------
Provision for income taxes $ 23,123 $ 16,759 $ 6,364 38.0%
effective tax rate 59.4% 33.5%
The increase in the effective tax rate was attributable to the
non-deductibility for tax purposes of the $30.4 million of expense
we recorded for the FemmePharma acquisition. For fiscal 2006, the
provision for income taxes was based on an effective tax rate of
33.3 % which was applied to a pre-tax income amount that excluded
the FemmePharma acquisition expense of $30.4 million.
NET INCOME AND DILUTED EARNINGS PER SHARE
-----------------------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2006 2005 $ %
---------- ---------- ---------- -------
Net income $ 15,787 $ 33,269 $ (17,482) (52.6)%
Diluted earnings per share 0.31 0.63 (0.32) (50.8)%
46
The decrease in net income resulted from the $30.4 million
in-process research and development charge, or $0.60 per share, we
recorded in connection with the FemmePharma acquisition.
FISCAL 2005 COMPARED TO FISCAL 2004
NET REVENUES BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2005 2004 $ %
---------- ---------- ---------- -------
Branded products $ 90,085 $ 82,868 $ 7,217 8.7%
as % of net revenues 29.7% 29.2%
Specialty generics 193,402 182,825 10,577 5.8%
as % of net revenues 63.7% 64.4%
Specialty materials 18,345 16,550 1,795 10.8%
as % of net revenues 6.0% 5.8%
Other 1,661 1,698 (37) (2.2)%
----------- ------------- -----------
Total net revenues $ 303,493 $ 283,941 $ 19,552 6.9%
The increase in branded product sales was due primarily to the
introduction of Clindesse(TM) in the fourth quarter of fiscal 2005,
continued growth of Gynazole-1(R) and increased sales of our two
hematinic brands. The introduction of Clindesse(TM), a single-dose
prescription cream therapy indicated to treat bacterial vaginosis,
contributed $4.2 million of incremental sales during the fourth
quarter of fiscal 2005. Sales of Gynazole-1(R), our vaginal
antifungal cream product, increased $2.7 million, or 14.4%, to
$21.3 million during fiscal 2005 as our share of the prescription
vaginal antifungal cream market increased. Sales from our two
hematinic product lines, Chromagen(R) and Niferex(R), increased
22.6% to $25.4 million during fiscal 2005 as both product lines
experienced significant growth in new prescriptions filled. During
the year, new prescription growth for Chromagen(R) and Niferex(R)
was 74.7% and 52.7%, respectively, compared to the prior year. Also
included in branded product sales was the PreCare(R) product line
which contributed $31.7 million of sales during fiscal 2005.
Although sales of our PreCare(R) product line declined 2.7% during
the year, the PreCare(R) family of products continued to be the
leading branded line of prescription prenatal nutritional
supplements in the United States. The $0.9 million decrease in
sales of our PreCare(R) product line was partially the result of a
temporary fourth quarter supply disruption of PrimaCare(R) ONE, our
proprietary line extension to PrimaCare(R), that was launched in
the second quarter. Prior to the occurrence of this supply issue,
which has since been resolved, PrimaCare(R) ONE generated $4.1
million of incremental sales in fiscal 2005. The increase in
branded product sales for fiscal 2005 was partially offset by a
$2.2 million decline in sales of our Micro-K(R) product line.
The growth in specialty generic sales resulted from $15.9 million
of incremental sales volume from new product introductions,
principally in our lower margin cough/cold product line, coupled
with $9.0 million of increased sales volume from existing products
in our cardiovascular and pain management product lines. These
increases were offset in part by product price erosion of $14.3
million principally in the second half of the fiscal year, that
resulted from pricing pressures on certain products in the
cardiovascular, pain management and cough/cold product lines.
Although specialty generic sales increased in fiscal 2005, we
experienced an $8.6 million, or 17.6%, decline in sales for the
three months ended March 31, 2005. This decrease resulted from a
significant decline in cardiovascular products sales due in part to
the absence of trade shows that occurred in the fourth quarter of
the prior year and resulted in an unfavorable mix in product
categories in the fourth quarter of fiscal 2005. The anticipated
approval of Diltiazem and another product in the fourth quarter of
fiscal 2005, would have more than offset the above decrease, had
the approval been received.
47
The increase in specialty material product sales was primarily due
to renewed focus on expanding the specialty materials business, the
addition of a new major customer in fiscal 2005 that resulted in
$1.3 million of incremental sales and an increased emphasis on
international markets that provided additional sales of $1.0
million in fiscal 2005.
GROSS PROFIT BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2005 2004 $ %
---------- ---------- ---------- -------
Branded products $ 78,844 $ 72,008 $ 6,836 9.5%
as % of net revenues 87.5% 86.9%
Specialty generics 114,616 111,550 3,066 2.7%
as % of net revenues 59.3% 61.0%
Specialty materials 6,394 4,789 1,605 33.5%
as % of net revenues 34.9% 28.9%
Other (4,043) (2,833) (1,210) (42.7)%
----------- ------------ -----------
Total gross profit $ 195,811 $ 185,514 $ 10,297 5.6%
as % of total net revenues 64.5% 65.3%
The increase in gross profit was primarily attributable to the
sales growth experienced by all three of our segments: branded
products, specialty generics and specialty materials. The lower
gross profit percentage on a consolidated basis primarily reflected
the impact of price erosion on certain specialty generic products
beginning in the second quarter and extending through the balance
of fiscal 2005, offset in part by certain selective price increases
implemented near the end of the third quarter. The gross profit
percentage decline experienced by the specialty generics segment
was offset in part by a shift in the mix of branded product sales
toward higher margin products with the introduction of
Clindesse(TM) in the fourth quarter coupled with improved pricing
and lower raw material costs at our specialty materials business.
RESEARCH AND DEVELOPMENT
------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2005 2004 $ %
---------- ---------- ---------- -------
Research and development $ 23,538 $ 20,651 $ 2,887 14.0%
as % of net revenues 7.8% 7.3%
48
The increase in research and development expense primarily resulted
from increased spending on bioequivalency studies for products in
our internal development pipeline and higher personnel expenses
related to the growth of our research and development staff.
SELLING AND ADMINISTRATIVE
--------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2005 2004 $ %
---------- ---------- ---------- -------
Selling and administrative $ 116,638 $ 88,333 $ 28,305 32.0%
as % of net revenues 38.4% 31.1%
The increase in selling and administrative expense was due
primarily to: greater personnel expenses resulting from an increase
in management and other personnel ($4.3 million) and expansion of
the branded sales force ($5.1 million including approximately $1.1
million for sales representatives during the fourth quarter of
fiscal 2005); a $2.2 million increase in branded marketing and
promotions expense commensurate with the growth of the segment due
to the investment of hiring additional management and field
personnel to provide additional resources for future planned
product launches; a $2.9 million increase in rent, depreciation,
insurance and utilities expense associated with expansion of our
office facilities over the past two years; a $1.7 million increase
in professional fees associated primarily with implementation of
the internal control provisions of the Sarbanes-Oxley Act of 2002;
a $1.2 million increase in legal expense; and $3.0 million of costs
incurred in the fourth quarter to support the launch of
Clindesse(TM). The increase in legal expense was due to an increase
in litigation activity, which included various patent infringement
actions brought by potential competitors with respect to products
we propose to market and for which we have submitted ANDA filings
and provided notice of certification required under the provisions
of the Hatch-Waxman Act.
AMORTIZATION OF INTANGIBLE ASSETS
---------------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2005 2004 $ %
---------- ---------- ---------- -------
Amortization of intangible assets $ 4,653 $ 4,459 $ 194 4.4%
as % of net revenues 1.5% 1.6%
The increase in amortization of intangible assets was due primarily
to the amortization of license costs incurred for a product
launched under a co-development arrangement in fiscal 2005.
49
LITIGATION
----------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2005 2004 $ %
---------- ---------- ---------- -------
Litigation $ (1,430) $ (1,700) $ 270 (15.9)%
The $1.4 million of income reflected in "Litigation" in fiscal 2005
consisted of a $0.6 million net payment received by us in
accordance with a favorable legal settlement of vitamin antitrust
litigation and $0.8 million related to the reversal of excess
reserves related to the Healthpoint litigation.
In the second quarter of fiscal 2004, we received $3.5 million for
settlement with a branded company of our claim that the branded
company interfered with our right to a timely introduction of a
generic product in a previous fiscal year. The impact of this
payment was offset in part by an additional litigation reserve of
$1.8 million related to attorneys' fees awarded in the Healthpoint
matter, which subsequently was settled.
OPERATING INCOME
----------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2005 2004 $ %
---------- ---------- ---------- -------
Operating income $ 52,412 $ 73,771 $ (21,359) (29.0)%
The decrease in operating income resulted primarily from a $28.3
million, or 32.0%, increase in selling and administrative expense
coupled with a $2.9 million increase in research and development
expense, offset in part by a $10.3 million increase in gross
profit.
INTEREST EXPENSE
----------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2005 2004 $ %
---------- ---------- ---------- -------
Interest expense $ 5,432 $ 5,865 $ (433) (7.4)%
The decrease in interest expense was primarily due to an increase
in the level of capitalized interest recorded on capital projects
that we had in process.
50
INTEREST AND OTHER INCOME
-------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2005 2004 $ %
---------- ---------- ---------- -------
Interest and other income $ 3,048 $ 2,092 $ 956 45.7%
The increase in interest and other income was primarily due to an
increase in the weighted average interest rate earned on short-term
investments, offset in part by a decline in the average balance of
short-term investments.
PROVISION FOR INCOME TAXES
--------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2005 2004 $ %
---------- ---------- ---------- -------
Provision for income taxes $ 16,759 $ 24,150 $ (7,391) (30.6)%
effective tax rate 33.5% 34.5%
The decrease in the provision for income taxes resulted from a
corresponding decrease in income before taxes coupled with a
decline in the effective tax rate. The decline in the effective tax
rate primarily resulted from the implementation of various tax
planning initiatives, as well as the generation of income tax
credits at both the Federal and state levels.
NET INCOME AND DILUTED EARNINGS PER SHARE
-----------------------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
----------------------
($ IN THOUSANDS): 2005 2004 $ %
---------- ---------- ---------- -------
Net income $ 33,269 $ 45,848 $ (12,579) (27.4)%
Diluted earnings per share 0.63 0.84 (0.21) (25.0)%
The decrease in net income resulted primarily from a $28.3 million,
or 32.0%, increase in selling and administrative expense coupled
with a $2.9 million increase in research and development expense,
offset in part by a $10.3 million increase in gross profit.
51
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Cash and cash equivalents and working capital were $100.7 million
and $311.2 million, respectively, at March 31, 2006, compared to
$159.8 million and $302.5 million, respectively, at March 31, 2005.
The increase in working capital resulted primarily from a $16.8
million increase in inventories related primarily to new specialty
generic products we expect to launch in fiscal 2007, offset in part
by a $7.6 million decrease in receivables associated primarily with
a $5.2 million increase in the reserve for chargebacks and a $1.7
million increase in the reserve for Medicaid rebates. The increase
in the reserve for chargebacks at March 31, 2006 was primarily due
to our specialty generics segment experiencing continued price
erosion during fiscal 2006 coupled with higher customer inventory
levels of our specialty generic products at the end of the year.
The impact of increased utilization of our branded products by
state Medicaid programs during the past two years resulted in a
larger reserve for Medicaid rebates at March 31, 2006.
The primary source of operating cash flow used in the funding of
our businesses continues to be internally generated funds from
product sales. Net cash flow from operating activities was $64.6
million in fiscal 2006 compared to $49.0 in fiscal 2005. This
increase resulted primarily from the operating cash flows for
fiscal 2005 including an $18.3 million reduction in accrued
liabilities attributable to settlement of the Healthpoint
litigation which was resolved during fiscal 2005.
Net cash used in investing activities included capital expenditures
of $58.3 million in fiscal 2006 compared to $63.6 million for the
prior year. In April 2005, the Company completed the purchase of a
260,000 square foot building in the St. Louis metropolitan area for
$11.8 million. The property had been leased by the Company since
April 2000 and continues to function as the Company's main
distribution facility. The purchase price was paid with cash. The
remaining capital expenditures during fiscal 2006 were primarily
for building renovation projects and for purchasing machinery and
equipment to upgrade and expand our pharmaceutical manufacturing
and distribution capabilities. Other investing activities in fiscal
2006 consisted of $61.2 million in purchases of short-term
marketable securities that were classified as available for sale.
In addition, in May 2005, the Company and FemmePharma mutually
agreed to terminate the license agreement we entered into with them
in April 2002 (see Note 3 to Consolidated Financial Statements). As
part of this transaction, we acquired all of the common stock of
FemmePharma for a $25.0 million cash payment. In connection with
this transaction, we acquired the worldwide marketing rights to an
endometriosis product that we are now developing. Also, in May
2005, we entered into a long-term product development and marketing
license agreement with Strides, an Indian generic pharmaceutical
developer and manufacturer, for exclusive marketing rights in the
United States and Canada for 10 new generic drugs. Under a separate
agreement, the Company invested $11.3 million in Strides
redeemable preferred stock (see Note 3 to Consolidated Financial
Statements).
Our debt balance was $243.0 million at March 31, 2006 compared to
$210.7 million at March 31, 2005 (see Note 10 to Consolidated
Financial Statements). In March 2006, we entered into a $43.0
million mortgage loan agreement with one of our primary lenders, in
part, to refinance $9.9 million of existing mortgages. The $32.8
million of net proceeds we received from the new mortgage loan will
be used for working capital and general corporate purposes. The new
mortgage loan bears interest at a rate of 5.91% and matures on
April 1, 2021.
In May 2003, we issued $200.0 million principal amount of
Convertible Subordinated Notes that are convertible, under certain
circumstances, into shares of our Class A common stock at an
initial conversion price of $23.01 per share. The Convertible
Subordinated Notes bear interest at a rate of 2.50% and mature on
May 16, 2033. We are also obligated to pay contingent interest at a
rate equal to 0.5% per annum during any six-month period commencing
May 16, 2006, if the average trading price of the Notes per $1,000
principal amount for the five-trading day period ending on the
third trading day immediately preceding the first day of the
applicable six-month period equals $1,200 or more. We may redeem
some or all of the Convertible Subordinated Notes at any time on or
after May 21, 2006, at a redemption price, payable in cash, of 100%
of the principal amount of the Convertible Subordinated Notes, plus
accrued and unpaid interest (including contingent interest, if any)
to the date of redemption. Holders may require us to repurchase all
or a portion of their Convertible Subordinated Notes on
52
May 16, 2008, 2013, 2018, 2023 and 2028, or upon a change in
control, as defined in the indenture governing the Convertible
Subordinated Notes, at 100% of the principal amount of the
Convertible Subordinated Notes, plus accrued and unpaid interest
(including contingent interest, if any) to the date of repurchase,
payable in cash. The Convertible Subordinated Notes are subordinate
to all of our existing and future senior obligations.
At March 31, 2006, we had credit agreements with two banks that
provided revolving lines of credit for borrowing up to $140.0
million. The credit agreements provided for $80.0 million in
revolving lines of credit along with supplemental credit lines of
$60.0 million that were available for financing acquisitions. These
credit facilities were to expire in October 2006 and June 2006,
respectively. The revolving and supplemental credit lines were
unsecured and interest was charged at the lower of the prime rate
or the one-month LIBOR rate plus 175 basis points. At March 31,
2006, we had $3.9 million in an open letter of credit issued under
the revolving credit line and no cash borrowings under either
credit facility. The credit agreements contained financial
covenants that imposed minimum levels of earnings before interest,
taxes, depreciation and amortization, a maximum funded debt ratio,
a limit on capital expenditures and dividend payments, a minimum
fixed charge coverage ratio and a maximum senior leverage ratio. As
of March 31, 2006, we were in compliance with all of our covenants.
On June 9, 2006, we replaced our $140.0 million credit line by
entering into a new credit agreement with ten banks that provides
for a revolving line of credit for borrowing up to $320.0 million.
The new credit agreement also includes a provision for increasing
the revolving commitment, at the lenders' sole discretion, by up to
an additional $50.0 million. The new credit facility is unsecured
unless we, under certain specified circumstances, utilize the
facility to redeem part or all of our outstanding Convertible
Subordinated Notes. Interest is charged under the facility at the
lower of the prime rate or one-month LIBOR plus 62.5 to 150 basis
points depending on the ratio of senior debt to EBITDA. The new
credit agreement contains financial covenants that impose limits on
dividend payments, require minimum equity, a maximum senior
leverage ratio and minimum fixed charge coverage ratio. The new
credit facility has a five-year term expiring in June 2011.
In December 2005, we entered into a financing arrangement with St.
Louis County, Missouri related to expansion of our operations in
St. Louis County (see Note 11 to Consolidated Financial
Statements). Up to $135.5 million of industrial revenue bonds may
be issued to us by St. Louis County relative to capital
improvements made through December 31, 2009. This agreement
provides that 50% of the real and personal property taxes on up to
$135.5 million of capital improvements will be abated for a period
of 10 years subsequent to the property being placed in service.
Industrial revenue bonds totaling $73.0 million were outstanding at
March 31, 2006. The industrial revenue bonds are issued by St.
Louis County to us upon our payment of qualifying costs of capital
improvements, which are then leased by us for a period ending
December 1, 2019, unless earlier terminated. We have the option at
any time to discontinue the arrangement and regain full title to
the abated property. The industrial revenue bonds bear interest at
4.25% per annum and are payable as to principal and interest
concurrently with payments due under the terms of the lease. We
have classified the leased assets as property and equipment and
have established a capital lease obligation equal to the
outstanding principal balance of the industrial revenue bonds.
Lease payments may be made by tendering an equivalent portion of
the industrial revenue bonds. As the capital lease payments to St.
Louis County may be satisfied by tendering industrial revenue bonds
(which is our intention), the capital lease obligation, industrial
revenue bonds and related interest expense and interest income,
respectively, have been offset for presentation purposes in the
Consolidated Financial Statements.
The following table summarizes our contractual obligations (in
thousands):
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
----- ------ --------- --------- -------
OBLIGATIONS AT MARCH 31, 2006
-----------------------------
Long-term debt obligations(a) $ 243,000 $ 1,681 $ 3,998 $ 4,497 $ 232,824
Operating lease obligations(b) 1,693 1,186 502 5 -
Other long-term obligations 5,442 - - - 5,442
------------------------------------------------------------------
Total contractual cash obligations(c) $ 250,135 $ 2,867 $ 4,500 $ 4,502 $ 238,266
------------------------------------------------------------------
<FN>
(a) Holders of the $200.0 million aggregate principal amount of
Convertible Subordinated Notes may require the Company to
repurchase them for an amount equal to the unpaid principal
amount in May 2008.
(b) The purchase option on a 129,000 square foot building leased by
us on March 31, 2006 was exercised by us in accordance with the
lease agreement and is scheduled to be acquired for $4.9 million
in June 2006.
(c) The Company has licensed the exclusive rights to co-develop and
market various generic equivalent products with other drug
delivery companies. These collaboration agreements require the
Company to make up-front and ongoing payments as development
milestones are attained. If all milestones remaining under these
agreements were reached, payments by the Company could total up
to $42,138.
53
We believe our cash and cash equivalents balance, cash flows from
operations and funds available under our credit facilities, will be
adequate to fund operating activities for the presently foreseeable
future, including the payment of short-term and long-term debt
obligations, capital improvements, research and development
expenditures, product development activities and expansion of
marketing capabilities for the branded pharmaceutical business. In
addition, we continue to examine opportunities to expand our
business through the acquisition of or investment in companies,
technologies, product rights, research and development and other
investments that are compatible with our existing businesses. We
intend to use our available cash to help in funding any
acquisitions or investments. As such, cash has been invested in
short-term, highly liquid instruments. We also may use funds
available under our credit facilities, or financing sources that
subsequently become available, including the future issuances of
additional debt or equity securities, to fund these acquisitions or
investments. If we were to fund one or more such acquisitions or
investments, our capital resources, financial condition and results
of operations could be materially impacted in future periods.
INFLATION
Inflation may apply upward pressure on the cost of goods and
services used by us in the future. However, we believe that the net
effect of inflation on our operations during the past three years
has been minimal. In addition, changes in the mix of products sold
and the effect of competition has made a comparison of changes in
selling prices less meaningful relative to changes in the overall
rate of inflation over the past three fiscal years.
CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are presented on the basis of
U.S. generally accepted accounting principles. Our significant
accounting policies are described in Note 2 in the accompanying
notes to the Consolidated Financial Statements. Certain of our
accounting policies are particularly important to the portrayal of
our financial position and results of operations and require the
application of significant judgment by our management. As a result,
these policies are subject to an inherent degree of uncertainty. In
applying these policies, we make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and
expenses and related disclosures. We base our estimates and
judgments on historical experience, the terms of existing
contracts, observance of trends in the industry, information that
is obtained from customers and outside sources, and on various
other assumptions that are believed to be reasonable and
appropriate under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources.
Although we believe that our estimates and assumptions are
reasonable, actual results may differ significantly from our
estimates. Changes in estimates and assumptions based upon actual
results may have a material impact on our results of operations
and/or financial condition. Our critical accounting estimates are
described below.
REVENUE RECOGNITION AND PROVISIONS FOR ESTIMATED REDUCTIONS TO
--------------------------------------------------------------
GROSS REVENUES. Revenue is generally realized or realizable and
---------------
earned when persuasive evidence of an arrangement exists, the
seller's price to the buyer is fixed or determinable, the
customer's payment ability has been reasonably assured and title
and risk of ownership have been transferred to the customer, which
is typically upon shipment to the customer.
Simultaneously with the recognition of revenue, we reduce the
amount of gross revenues by recording estimated sales provisions
for chargebacks, sales rebates, sales returns, cash discounts and
other allowances, and Medicaid rebates. These sales provisions are
established based upon consideration of a variety of factors,
including but not limited to, historical relationship to revenues,
historical payment and return experience, estimated and actual
customer inventory levels, customer rebate arrangements, and
current contract sales terms with wholesale and indirect customers.
54
From time to time, we provide incentives to our wholesale
customers, such as trade show allowances or stocking allowances
that they in turn use to accelerate distribution to their end
customers. We believe that such incentives are normal and customary
in the industry. Sales allowances are accrued and revenue is
recognized as sales are made pursuant to the terms of the
allowances offered to the customer. Due to the nature of these
allowances, we are able to accurately calculate the required
provisions for the allowances based on the specific terms in each
agreement. Additionally, customers will normally purchase
additional product ahead of regular demand to take advantage of the
temporarily lower cost resulting from the sales allowances. This
practice has been customary in the industry and we believe would be
part of a customer's ordinary course of business inventory level.
We reserve the right, with our major wholesale customers, to limit
the amount of these forward buys. Sales made as a result of
allowances offered on our specialty generics product line in
conjunction with trade shows sponsored by our major wholesale
customers and for other promotional programs accounted for 11.8%
and 15.2% of total gross revenues for fiscal 2006 and fiscal 2005,
respectively.
In addition, we understand that certain of our wholesale customers
have anticipated the timing of price increases and have made, and
may continue to make, business decisions to buy additional product
in anticipation of future price increases. This practice has been
customary in the industry and we believe would be part of a
customer's ordinary course of business inventory level.
We evaluate inventory levels at our wholesale customers, which
accounted for approximately 59% of our unit sales in fiscal 2006,
through an internal analysis that considers, among other things,
wholesaler purchases, wholesaler contract sales, available end
consumer prescription information and inventory data received from
our three largest wholesale customers. We believe that our
evaluation of wholesaler inventory levels allows us to make
reasonable estimates of our reserve balances. Further, our products
are typically sold with adequate shelf life to permit sufficient
time for our wholesaler customers to sell our products in their
inventory through to the end consumer.
The following table reflects the fiscal 2006 activity for each
reserve that serves to reduce our receivables balance:
Current Provision Current Provision Actual Returns
Related to Sales Related to Sales or Credits
(in thousands) Beginning Made in the Made in in the Ending
Balance Current Period Prior Periods Current Period Balance
--------- ----------------- ----------------- -------------- -------
YEAR ENDED MARCH 31, 2006
Accounts Receivable Reserves:
Chargebacks $ 9,409 $ 97,605 $ - $ (92,393) $14,621
Sales Rebates 1,246 14,158 - (13,142) 2,262
Sales Returns 2,286 14,212 - (14,325) 2,173
Cash Discounts and Other Allowances 3,880 17,362 - (16,925) 4,317
Medicaid Rebates 4,235 11,031 - (9,322) 5,944
------- --------- ----- ---------- -------
TOTAL $21,056 $154,368 $ - $(146,107) $29,317
======= ========= ===== ========== =======
55
The increase in the reserve for chargebacks at March 31, 2006 was
primarily due to our specialty generics segment experiencing price
erosion during fiscal 2006 coupled with higher customer inventory
levels of our specialty generic products at the end of the year.
The reserve for sales returns at March 31, 2006 was relatively
consistent with the prior year-end balance as improvement in the
rate of product returns at our specialty generics segment was
offset by an increase in the product return rate at our branded
business. The impact of increased utilization of our branded
products by state Medicaid programs during the past two years
resulted in a larger reserve for Medicaid rebates at March 31,
2006. The increase in reserves for sales rebates and cash discounts
and other allowances at March 31, 2006 was primarily due to greater
fourth quarter sales in fiscal 2006 compared to the prior year's
fourth quarter.
The following table reflects the fiscal 2005 activity for each
reserve that serves to reduce our receivables balance:
Current Provision Current Provision Actual Returns
Related to Sales Related to Sales or Credits
(in thousands) Beginning Made in the Made in in the Ending
Balance Current Period Prior Periods Current Period Balance
--------- ----------------- ----------------- -------------- -------
YEAR ENDED MARCH 31, 2005
Accounts Receivable Reserves:
Chargebacks $ 7,475 $ 81,871 $ - $ (79,937) $ 9,409
Sales Rebates 1,815 17,479 - (18,048) 1,246
Sales Returns 4,035 10,505 - (12,254) 2,286
Cash Discounts and Other Allowances 4,261 14,361 - (14,742) 3,880
Medicaid Rebates 3,062 9,048 211 (8,086) 4,235
------- -------- ---- --------- -------
TOTAL $20,648 $133,264 $211 $(133,067) $21,056
======= ======== ==== ========= =======
The fiscal 2005 reserve for chargebacks increased primarily due to
continued price erosion in the specialty generics segment of our
business, which was reflected in an increase in the current
provision from 14.2% of sales in fiscal 2004 to 18.7% of sales in
fiscal 2005. A reduction in the rate of product returns experienced
during fiscal 2005 to 2.4% of sales from 2.8% of sales in fiscal
2004 resulted in the lower reserve for sales returns. Increased
utilization of products in our branded products segment by state
Medicaid programs during fiscal 2005 resulted in the increase in
the reserve for Medicaid rebates, which was reflected in an
increase in the related provision from 1.9% of sales in fiscal 2004
to 2.1% of sales in fiscal 2005. Reserves for sales rebates and
cash discounts and other allowances declined primarily due to lower
fourth quarter sales, in both the retail chain and wholesale
distribution channels, compared to the prior year's fourth quarter.
The reserves for sales rebates and cash discounts and other
allowances require a lower degree of subjectivity, are less complex
in nature and are more readily ascertainable due to specific
contract terms, rates and consistent historical performance. The
reserves for chargebacks, sales returns and Medicaid rebates,
however, are more complex and require management to make more
subjective judgments. These reserves and their respective
provisions are discussed in further detail below.
Chargebacks - We market and sell products directly to wholesalers,
-----------
distributors, warehousing pharmacy chains, mail order pharmacies
and other direct purchasing groups. We also market products
indirectly to independent pharmacies, non-warehousing chains,
managed care organizations, and group purchasing organizations,
collectively referred to as "indirect customers." We enter into
agreements with some indirect customers to establish contract
pricing for certain products. These indirect customers then
independently select a wholesaler from which to purchase the
products at these contracted prices. Alternatively, we may
pre-authorize wholesalers to offer specified contract pricing to
other indirect customers. Under either arrangement, we provide
credit to the wholesaler for any difference between the contracted
price with the indirect customer and the wholesaler's invoice
price. This credit is called a chargeback.
56
Chargeback transactions are almost exclusively related to our
specialty generics business segment. During fiscal 2006 and 2005,
the chargeback provision reduced the gross sales of our specialty
generics segment by $97.0 million and $80.6 million, respectively.
These amounts accounted for 99.4% and 98.5% of the total chargeback
provisions recorded in fiscal 2006 and 2005, respectively.
The provision for chargebacks is the most significant and complex
estimate used in the recognition of revenue. The primary factors we
consider in developing and evaluating the reserve for chargebacks
include:
|X| The amount of inventory in the wholesale distribution
channel. We receive actual inventory information from our
three major wholesale customers and estimate the inventory
position of the remaining wholesalers based on historical
buying patterns. During fiscal 2006, unit sales to our
three major wholesale customers accounted for 78% of our
total unit sales to all wholesalers, and the aggregate
inventory position of the three major wholesalers at March
31, 2006 was approximately equivalent to our last eight
weeks of shipments during the fiscal year. We currently
use the last six weeks of our shipments as an estimate of
the inventory held by the remaining wholesalers where we
do not receive actual inventory data, as our experience
and buying patterns indicate that our smaller wholesale
customers carry less inventory than our large wholesale
customers. As of March 31, 2006, each week of inventory
for those remaining wholesalers represented approximately
$0.2 million, or 1.6%, of the reported reserve for
chargebacks.
|X| The percentage of sales to our wholesale customers that
will result in chargebacks. Using our automated chargeback
system we track, at the product level, the percentage of
sales units shipped to our wholesale customers that
eventually result in chargebacks to us. The percentage for
each product, which is based on actual historical
experience, is applied to the respective inventory units
in the wholesale distribution channel. As of March 31,
2006, the aggregate weighted average percentage of sales
to wholesalers assumed to result in chargebacks was
approximately 95%, with each 1% representing approximately
$0.2 million, or 1.1%, of the reported reserve for
chargebacks.
|X| Contract pricing and the resulting chargeback per unit.
The chargeback provision is based on the difference
between our invoice price to the wholesaler (referred to
as wholesale acquisition cost, or "WAC") and the contract
price negotiated with either our indirect customer or with
the wholesaler for sales by the wholesaler to the indirect
customers. We calculate the price difference, or
chargeback per unit, for each product and for each major
wholesale customer using historical weighted average
pricing, based on actual chargeback experience. Use of
weighted average pricing over time compensates for changes
in the mix of indirect customers and products from period
to period. As of March 31, 2006, a 5% shift in the
calculated chargeback per unit in the same direction
across all products and customers would result in a $0.7
million, or 5.0%, impact on the reported reserve for
chargebacks.
Shelf-Stock Adjustments - These adjustments represent credits
-----------------------
issued to our wholesale customers that result from a decrease in
our WAC. Decreases in our invoice prices are discretionary
decisions we make to reflect market conditions. These credits are
customary in the industry and are intended to reduce a wholesale
customer's inventory cost to better reflect current market prices.
Generally, we provide credits to customers at the time the price
reduction occurs based on the inventory that is owned by them on
the effective date of the price reduction. Since a reduction in WAC
reduces the chargeback per unit, or the difference between WAC and
the contract price, shelf-stock adjustments are typically included
as part of the reserve for chargebacks because the price reduction
credits act essentially as accelerated chargebacks. Although we
have contractually agreed to provide price adjustment credits to
our major wholesale customers at the time they occur, the impact of
any such price reductions not included in the reserve for
chargebacks is immaterial to the amount of revenue recognized in
any given period.
Sales Returns - Consistent with industry practice, we maintain a
-------------
returns policy that allows our direct and indirect customers to
return product six months prior to expiration and within one year
after expiration. This policy is applicable to both our branded and
specialty generics business segments. Upon recognition of revenue
from
57
product sales to customers, we provide for an estimate of
product to be returned. This estimate is determined by applying a
historical relationship of customer returns to gross sales. We
evaluate the reserve for sales returns by calculating historical
return rates using data from the last 12 months on a product
specific basis and by class of trade (wholesale versus retail
chain). The calculated percentages are applied against estimates of
inventory in the distribution channel on a product specific basis.
To determine the inventory levels in the wholesale distribution
channel, we utilize actual inventory information from our major
wholesale customers and estimate the inventory positions of the
remaining wholesalers based on historical buying patterns. For
inventory held by our non-wholesale customers, we use the last two
months of sales to the direct buying chains and the indirect buying
retailers as an estimate. A 10% change in the product specific
historical return rates used in the reserve analysis would have
changed the reserve balance at March 31, 2006 by approximately $0.1
million, or 5.7%, of the reported reserve for sales returns. A 10%
change in the amount of estimated inventory in the distribution
channel would have changed the reserve balance at March 31, 2006 by
approximately $0.1 million, or 6.9%, of the reported reserve for
sales returns.
Medicaid Rebates - Established in 1990, the Medicaid Drug Rebate
----------------
Program requires a drug manufacturer to provide to each state a
rebate every calendar quarter for covered outpatient drugs
dispensed to Medicaid patients. Medicaid rebates apply to both our
branded and specialty generic segments. Individual states invoice
us for Medicaid rebates on a quarterly basis using statutorily
determined rates for generic (11%) and branded (15%) products,
which are applied to the Average Manufacturer's Price, or "AMP",
for a particular product to arrive at a Unit Rebate Amount, or
"URA". The amount owed is based on the number of units dispensed by
the pharmacy to Medicaid patients extended by the URA. The reserve
for Medicaid rebates is based on expected payments, which are
driven by patient usage and estimated inventory in the distribution
channel. We estimate patient usage by calculating a payment rate as
a percentage of net sales lagged six months, which is then applied
to an estimate of customer inventory. We currently use the last two
months of our shipments to wholesalers and direct buying chains as
an estimate of inventory in the wholesale and chain channels and an
additional month of wholesale sales as an estimate of inventory
held by the indirect buying retailer. A 10% change in the amount of
customer inventory subject to Medicaid rebates would have changed
the reserve at March 31, 2006 by $0.6 million, or 9.8% of the
reported reserve for Medicaid rebates. Similarly, a 10% change in
estimated patient usage would have changed the reserve by $0.6
million, or 9.8% of the reported reserve for Medicaid rebates.
INVENTORY VALUATION. Inventories consist of finished goods held for
-------------------
distribution, raw materials and work in process. Our inventories
are stated at the lower of cost or market, with cost determined on
the first-in, first-out basis. In evaluating whether inventory
should be stated at the lower of cost or market, we consider such
factors as the amount of inventory on hand and in the distribution
channel, estimated time required to sell existing inventory,
remaining shelf life and current and expected market conditions,
including levels of competition. We establish reserves, when
necessary, for slow-moving and obsolete inventories based upon our
historical experience and management's assessment of current
product demand.
INTANGIBLE ASSETS. Our intangible assets principally consist of
-----------------
product rights, license agreements and trademarks resulting from
product acquisitions and legal fees and similar costs relating to
the development of patents and trademarks. Intangible assets that
are acquired are stated at cost, less accumulated amortization, and
are amortized on a straight-line basis over their estimated useful
lives. Upon approval, costs associated with the development of
patents and trademarks are amortized on a straight-line basis over
estimated useful lives ranging from five to 17 years. We determine
amortization periods for intangible assets that are acquired based
on our assessment of various factors impacting estimated useful
lives and cash flows of the acquired products. Such factors include
the product's position in its life cycle, the existence or absence
of like products in the market, various other competitive and
regulatory issues, and contractual terms. Significant changes to
any of these factors may result in a reduction in the intangible
asset's useful life and an acceleration of related amortization
expense.
We assess the impairment of intangible assets whenever events or
changes in circumstances indicate that the carrying value may not
be recoverable. Some factors we consider important which could
trigger an impairment review include the following: (1) significant
underperformance relative to expected historical or projected
future
58
operating results; (2) significant changes in the manner of
our use of the acquired assets or the strategy for our overall
business; and (3) significant negative industry or economic trends.
When we determine that the carrying value of an intangible asset
may not be recoverable based upon the existence of one or more of
the above indicators of impairment, we first perform an assessment
of the asset's recoverability. Recoverability is determined by
comparing the carrying amount of an intangible asset against an
estimate of the undiscounted future cash flows expected to result
from its use and eventual disposition. If the sum of the expected
future undiscounted cash flows is less than the carrying amount of
the intangible asset, an impairment loss is recognized based on the
excess of the carrying amount over the estimated fair value of the
intangible asset.
CONTINGENCIES. We are involved in various legal proceedings, some
-------------
of which involve claims for substantial amounts. An estimate is
made to accrue for a loss contingency relating to any of these
legal proceedings if it is probable that a liability was incurred
as of the date of the financial statements and the amount of loss
can be reasonably estimated. Because of the subjective nature
inherent in assessing the outcome of litigation and because of the
potential that an adverse outcome in legal proceedings could have a
material impact on our financial position or results of operations,
such estimates are considered to be critical accounting estimates.
After review, it was determined at March 31, 2006 that for each of
the various legal proceedings in which we are involved, the
conditions mentioned above were not met. We will continue to
evaluate all legal matters as additional information becomes
available.
RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs,
an Amendment to ARB No. 43, Chapter 4" which requires that abnormal
amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage) costs be recognized as current period
charges. In addition, this statement requires that allocation of
fixed production overheads to the costs of conversion be based on
the normal capacity of the production facilities. This statement is
effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. We are currently determining the
impact, if any, the adoption of this statement will have on our
financial condition and results of operations.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment" ("SFAS 123R"), which replaces SFAS No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"), and
supersedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees." SFAS 123R requires all share-based payments to
employees, including grants of employee stock options, to be
recognized in the financial statements based on their fair values.
The pro forma disclosures previously permitted under SFAS 123 no
longer will be an alternative to financial statement recognition.
Under SFAS 123R, the Company must determine the appropriate fair
value model to be used for valuing share-based payments, the
amortization method for compensation cost and the transition method
to be used at date of adoption. The transition methods include
modified prospective and modified retrospective adoption options.
Under the modified retrospective option, prior periods may be
restated either as of the beginning of the year of adoption or for
all periods presented. The modified prospective method requires
that compensation expense be recorded for all unvested stock
options and restricted stock at the beginning of the first quarter
of adoption of SFAS 123R, while the modified retrospective method
would record compensation expense for all unvested stock options
and restricted stock beginning with the first period restated.
In April 2005, the Securities and Exchange Commission announced an
amendment to Regulation S-X to amend the date for compliance with
SFAS 123R. The amendment requires each registrant that is not a
small business issuer to adopt SFAS 123R in the first fiscal year
commencing after June 15, 2005. As a result, the Company adopted
SFAS 123R beginning April 1, 2006 using the modified prospective
method. Adoption of SFAS 123R will have a significant impact on the
Company's consolidated financial statements, as it will be required
to expense the fair value of employee stock option grants rather
than disclose the pro forma impact on its consolidated net income
within the footnotes to the Company's Consolidated Financial
Statements. Based on the unvested stock option grants at March 31,
2006, the Company estimates that the adoption of SFAS 123R will
59
reduce consolidated net income for fiscal 2007 between $0.05 and
$0.06 per diluted share. This estimate is based, in part, on a
projection of our common stock prices and other valuation
assumptions related to potential fiscal 2007 stock option grants
which are subject to various uncertainties, including our future
share-based compensation strategy, stock price volatility,
estimated forfeiture rate and employee stock option exercise
behavior. Changes in any of the Company's assumptions could cause
future expenses to vary significantly from the Company's current
estimates.
In March 2005, the SEC issued SEC Staff Accounting Bulletin No. 107
("SAB 107") which describes the SEC staff's position on the
application of SFAS 123R. SAB 107 contains interpretive and certain
transitional guidance relating to the interaction between SFAS 123R
and certain SEC rules and regulations including the SEC's views
regarding the valuation of share-based payment arrangements
including assumptions related to expected volatility and expected
term, first time adoption of SFAS 123R in an interim period, the
modification of certain terms of employee share options prior to
the adoption of SFAS 123R and disclosures within Management's
Discussion and Analysis subsequent to the adoption of SFAS 123R. We
are currently evaluating SAB 107 and its guidance and will be
adopting it as part of our adoption of SFAS 123R beginning April 1,
2006.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections" ("SFAS 154"), which replaces Accounting
Principles Board ("APB") Opinion No. 20, "Accounting Changes" ("APB
20") and SFAS No. 3, "Reporting Accounting Changes in Interim
Financial Statements" ("SFAS 3"). SFAS 154 applies to all voluntary
changes in accounting principle and changes the requirements for
the accounting for and reporting of a change in accounting
principle. SFAS 154 also requires retrospective application to
prior period financial statements involving changes in accounting
principle unless it is impracticable to determine either the
period-specific or cumulative effect of the change. This statement
also requires that a change in the method of depreciation,
amortization or depletion of long-lived assets be accounted for as
a change in accounting estimate that is accounted for
prospectively. SFAS 154 also retains many provisions of APB 20
including those related to reporting a change in accounting
estimate, a change in the reporting entity and a correction of an
error and also carries forward provisions of SFAS 3 governing the
reporting of accounting changes in interim financial statements.
SFAS 154 is effective for accounting changes and corrections of
errors made in fiscal years beginning after December 15, 2005. We
believe that the adoption of SFAS 154 will not have a material
effect on our Consolidated Financial Statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
Our exposure to market risk is limited to fluctuating interest
rates associated with variable rate indebtedness that is subject to
interest rate changes.
Advances to us under our credit facilities bear interest at a rate
that varies consistent with increases or decreases in the publicly
announced prime rate and/or the LIBOR rate with respect to
LIBOR-related loans, if any. A material increase in such rates
could significantly increase borrowing expenses. We did not have
any cash borrowings under our credit facilities at March 31, 2006.
In May 2003, we issued $200.0 million principal amount of
Convertible Subordinated Notes. The interest rate on the
Convertible Subordinated Notes is fixed at 2.50% per annum and not
subject to market interest rate changes. Beginning May 16, 2006, we
will become obligated to pay contingent interest at a rate equal to
0.5% per annum during any six-month period, if the average trading
price of the Convertible Subordinated Notes per $1,000 principal
amount for the five-trading day period ending on the third trading
day immediately preceding the first day of the applicable six-month
period equals $1,200 or more.
60
In March 2006, we entered into a $43.0 million mortgage loan
secured by three of our buildings that matures in April 2021. The
interest rate on this loan is fixed at 5.91% per annum and not
subject to market interest rate changes.
61
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors and Shareholders
K-V Pharmaceutical Company:
We have audited the accompanying consolidated balance sheets of K-V
Pharmaceutical Company and subsidiaries as of March 31, 2006 and 2005, and
the related consolidated statements of income, comprehensive income,
shareholders' equity, and cash flows for the years then ended. In connection
with our audits of the consolidated financial statements, we have also
audited the accompanying financial statement schedule. These consolidated
financial statements and financial statement schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements and financial statement schedule
based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of K-V
Pharmaceutical Company and subsidiaries as of March 31, 2006 and 2005, and
the results of their operations and their cash flows for the years then
ended, in conformity with U.S. generally accepted accounting principles.
Also in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken
as a whole, presents fairly, in all material respects, the information set
forth therein.
As discussed in Note 2 to the consolidated financial statements, during
fiscal 2005, the Company adopted EITF 03-6 Participating Securities and the
Two-Class Method under SFAS No. 128 and EITF 04-8 The Effect of Contingently
Convertible Instruments on Diluted Earnings per Share.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of internal
control over financial reporting of K-V Pharmaceutical Company as of March
31, 2006, based on the criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), and our report dated June 14, 2006 expressed an
unqualified opinion on management's assessment of, and the effective
operation of, internal control over financial reporting.
/s/ KPMG LLP
St. Louis, Missouri
June 14, 2006
62
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors
K-V Pharmaceutical Company
We have audited the accompanying consolidated statements of income,
shareholders' equity and cash flows of K-V Pharmaceutical Company and
Subsidiaries for the year ended March 31, 2004. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We
believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of K-V Pharmaceutical Company and Subsidiaries for the year ended
March 31, 2004 in conformity with accounting principles generally accepted
in the United States of America.
/s/ BDO Seidman, LLP
Chicago, Illinois
June 4, 2004
63
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
MARCH 31,
---------------------------
2006 2005
---- ----
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents............................................................ $ 100,706 $ 159,825
Marketable securities................................................................ 106,763 45,694
Receivables, less allowance for doubtful accounts of $397 and $461
in 2006 and 2005, respectively.................................................... 54,746 62,361
Inventories, net..................................................................... 70,778 53,945
Prepaid and other assets............................................................. 6,963 9,530
Deferred tax asset................................................................... 8,034 5,827
----------- -----------
Total Current Assets.............................................................. 347,990 337,182
Property and equipment, less accumulated depreciation................................ 178,042 131,624
Intangible assets and goodwill, net.................................................. 72,955 76,430
Other assets......................................................................... 19,026 13,081
----------- -----------
TOTAL ASSETS......................................................................... $ 618,013 $ 558,317
=========== ===========
LIABILITIES
-----------
CURRENT LIABILITIES:
Accounts payable..................................................................... $ 17,975 $ 18,011
Accrued liabilities.................................................................. 17,100 15,733
Current maturities of long-term debt................................................. 1,681 973
----------- -----------
Total Current Liabilities......................................................... 36,756 34,717
Long-term debt....................................................................... 241,319 209,767
Other long-term liabilities.......................................................... 5,442 4,477
Deferred tax liability............................................................... 25,221 16,654
----------- -----------
TOTAL LIABILITIES.................................................................... 308,738 265,615
----------- -----------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
--------------------
7% cumulative convertible Preferred Stock, $.01 par value; $25.00 stated and
liquidation value; 840,000 shares authorized; issued and outstanding --
40,000 shares at both March 31, 2006 and 2005 (convertible into Class A
shares at a ratio of 8.4375 to one).............................................. -- --
Class A and Class B Common Stock, $.01 par value; 150,000,000 and
75,000,000 shares authorized, respectively;
Class A - issued 39,984,919 and 39,059,428 at March 31, 2006
and 2005, respectively........................................................ 400 391
Class B - issued 12,695,561 and 13,422,101 at March 31, 2006 and
2005, respectively (convertible into Class A shares on a one-for-one basis)... 127 134
Additional paid-in capital........................................................... 129,367 128,182
Retained earnings.................................................................... 233,496 217,779
Accumulated other comprehensive loss................................................. (211) (133)
Less: Treasury stock, 3,123,975 shares of Class A and 92,902 shares of Class B
Common Stock at March 31, 2006, and 3,111,003 shares of Class A and 92,902 shares
of Class B Common Stock at March 31, 2005, at cost................................ (53,904) (53,651)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY........................................................... 309,275 292,702
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................................... $ 618,013 $ 558,317
=========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
64
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
YEARS ENDED MARCH 31,
-----------------------------------------------
2006 2005 2004
------------ ----------- ------------
Net revenues........................................................... $ 367,618 $ 303,493 $ 283,941
Cost of sales.......................................................... 123,894 107,682 98,427
------------ ----------- ------------
Gross profit........................................................... 243,724 195,811 185,514
------------ ----------- ------------
Operating expenses:
Research and development............................................ 28,886 23,538 20,651
Purchased in-process research and
development and transaction costs............................... 30,441 -- --
Selling and administrative.......................................... 140,395 116,638 88,333
Amortization of intangible assets................................... 4,784 4,653 4,459
Litigation.......................................................... -- (1,430) (1,700)
------------ ----------- ------------
Total operating expenses............................................... 204,506 143,399 111,743
------------ ----------- ------------
Operating income....................................................... 39,218 52,412 73,771
------------ ----------- ------------
Other expense (income):
Interest expense.................................................... 6,045 5,432 5,865
Interest and other income........................................... (5,737) (3,048) (2,092)
------------ ----------- ------------
Total other expense, net.............................................. 308 2,384 3,773
------------ ----------- ------------
Income before income taxes............................................. 38,910 50,028 69,998
Provision for income taxes............................................. 23,123 16,759 24,150
------------ ----------- ------------
Net income............................................................. $ 15,787 $ 33,269 $ 45,848
============ =========== ============
Earnings per common share:
Basic - Class A common.............................................. $ 0.33 $ 0.71 $ 0.98
Basic - Class B common.............................................. 0.28 0.59 0.82
Diluted............................................................. $ 0.31 $ 0.63 $ 0.84
============ =========== ============
Weighted Average Shares Outstanding:
Basic - Class A common.............................................. 36,277 34,228 33,046
Basic - Class B common.............................................. 13,065 15,005 15,941
Diluted............................................................. 50,729 59,468 58,708
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
65
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
YEARS ENDED MARCH 31,
-----------------------------------------------
2006 2005 2004
------------ ----------- ------------
Net income............................................................. $ 15,787 $ 33,269 $ 45,848
Other comprehensive income (loss):
Unrealized loss on available for sale securities.................... (118) (201) --
Less related taxes.................................................. 40 68 --
------------ ----------- ------------
Total unrealized loss on available for sale securities, net...... (78) (133) --
------------ ----------- ------------
Total comprehensive income............................................. $ 15,709 $ 33,136 $ 45,848
============ =========== ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
66
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED MARCH 31, 2006, 2005 AND 2004
-----------------------------------------------------
CLASS A CLASS B ADDITIONAL
PREFERRED COMMON COMMON PAID-IN
STOCK STOCK STOCK CAPITAL
----- ----- ----- -------
(Dollars in thousands)
BALANCE AT MARCH 31, 2003................................ $ -- $ 236 $ 106 $120,961
Net income............................................... -- -- -- --
Dividends paid on preferred stock........................ -- -- -- --
Conversion of 117,187 Class B shares to Class A shares... -- 1 (1) --
Issuance of 27,992 Class A shares
under product development agreement................... -- -- -- 505
Purchase of common stock for treasury.................... -- -- -- --
Three-for-two stock dividend............................. -- 120 53 --
Stock options exercised - 552,617 shares of Class A less
91,538 shares repurchased and 413,419 shares of
Class B less 15,625 shares repurchased................ -- 5 4 2,362
-----------------------------------------------------
BALANCE AT MARCH 31, 2004................................ -- 362 162 123,828
Net income............................................... -- -- -- --
Dividends paid on preferred stock........................ -- -- -- --
Conversion of 2,783,537 Class B shares to
Class A shares........................................ -- 28 (28) --
Issuance of 14,679 Class A shares
under product development agreement................... -- -- -- 237
Purchase of common stock for treasury.................... -- -- -- --
Stock options exercised - 180,629 shares of Class A
and 56,899 shares of Class B.......................... -- 1 -- 4,117
Unrealized loss on marketable securities available
for sale, net of related taxes of $68................. -- -- -- --
-----------------------------------------------------
BALANCE AT MARCH 31, 2005................................ -- 391 134 128,182
Net income............................................... -- -- -- --
Dividends paid on preferred stock........................ -- -- -- --
Conversion of 736,778 Class B shares to Class A shares -- 7 (7) --
Purchase of common stock for treasury.................... -- -- -- --
Stock options exercised - 188,713 shares of Class A
and 10,238 shares of Class B.......................... -- 2 -- 1,185
Unrealized loss on marketable securities available
for sale, net of related taxes of $40................. -- -- -- --
-----------------------------------------------------
BALANCE AT MARCH 31, 2006................................ $ -- $ 400 $ 127 $129,367
=================================================================================================================
YEARS ENDED MARCH 31, 2006, 2005 AND 2004
-----------------------------------------------------------------
ACCUMULATED OTHER TOTAL
TREASURY RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK EARNINGS LOSS EQUITY
----- -------- ---- ------
(Dollars in thousands)
BALANCE AT MARCH 31, 2003................................ $ (28) $139,341 $ -- $260,616
Net income............................................... -- 45,848 -- 45,848
Dividends paid on preferred stock........................ -- (436) -- (436)
Conversion of 117,187 Class B shares to Class A shares... -- -- -- --
Issuance of 27,992 Class A shares
under product development agreement................... -- -- -- 505
Purchase of common stock for treasury.................... (51,155) -- -- (51,155)
Three-for-two stock dividend............................. -- (173) -- --
Stock options exercised - 552,617 shares of Class A less
91,538 shares repurchased and 413,419 shares of
Class B less 15,625 shares repurchased................ -- -- -- 2,371
-----------------------------------------------------------------
BALANCE AT MARCH 31, 2004................................ (51,183) 184,580 -- 257,749
Net income............................................... -- 33,269 -- 33,269
Dividends paid on preferred stock........................ -- (70) -- (70)
Conversion of 2,783,537 Class B shares to
Class A shares........................................ -- -- -- --
Issuance of 14,679 Class A shares
under product development agreement................... -- -- -- 237
Purchase of common stock for treasury.................... (2,468) -- -- (2,468)
Stock options exercised - 180,629 shares of Class A
and 56,899 shares of Class B.......................... -- -- -- 4,118
Unrealized loss on marketable securities available
for sale, net of related taxes of $68................. -- -- (133) (133)
-----------------------------------------------------------------
BALANCE AT MARCH 31, 2005................................ (53,651) 217,779 (133) 292,702
Net income............................................... -- 15,787 -- 15,787
Dividends paid on preferred stock........................ -- (70) -- (70)
Conversion of 736,778 Class B shares to Class A shares -- -- -- --
Purchase of common stock for treasury.................... (253) -- -- (253)
Stock options exercised - 188,713 shares of Class A
and 10,238 shares of Class B.......................... -- -- -- 1,187
Unrealized loss on marketable securities available
for sale, net of related taxes of $40................. -- -- (78) (78)
-----------------------------------------------------------------
BALANCE AT MARCH 31, 2006................................ $(53,904) $233,496 $(211) $309,275
=============================================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
67
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
YEARS ENDED MARCH 31,
-----------------------------------------------
2006 2005 2004
------------- ------------ -----------
Operating Activities:
Net income............................................................. $ 15,787 $ 33,269 $ 45,848
Adjustments to reconcile net income to net cash provided by operating
activities:
Acquired in-process research and development........................ 29,570 -- --
Depreciation, amortization and other non-cash charges............... 18,002 13,904 12,663
Deferred income tax provision....................................... 6,707 13,582 8,691
Deferred compensation............................................... 965 1,355 209
Litigation.......................................................... -- (843) 1,825
Changes in operating assets and liabilities:
Decrease (increase) in receivables, net............................. 7,615 3,511 (8,487)
Increase in inventories............................................. (16,833) (3,248) (9,977)
Decrease (increase) in prepaid and other assets..................... 1,372 (3,520) (6,294)
Increase (decrease) in accounts payable and accrued.................
liabilities...................................................... 1,424 (8,980) (10,471)
------------- ------------ -----------
Net cash provided by operating activities.............................. 64,609 49,030 34,007
------------- ------------ -----------
Investing Activities:
Purchase of property and equipment.................................. (58,334) (63,622) (21,792)
Purchase of marketable securities................................... (61,187) (10,565) (278)
Purchase of stock and intangible assets............................. (11,300) -- (4,000)
Product acquisition................................................. (25,643) -- (14,300)
------------- ------------ -----------
Net cash used in investing activities.................................. (156,464) (74,187) (40,370)
------------- ------------ -----------
Financing Activities:
Principal payments on long-term debt................................ (892) (8,179) (8,237)
Proceeds from borrowing of long-term debt........................... 32,764 -- --
Dividends paid on preferred stock................................... (70) (70) (436)
Proceeds from issuance of convertible notes......................... -- -- 194,165
Purchase of common stock for treasury............................... (253) (2,468) (51,155)
Exercise of common stock options.................................... 1,187 4,118 2,371
------------- ------------ -----------
Net cash provided by (used in) financing activities................... 32,736 (6,599) 136,708
------------- ------------ -----------
(Decrease) increase in cash and cash equivalents....................... (59,119) (31,756) 130,345
Cash and cash equivalents:
Beginning of year................................................... 159,825 191,581 61,236
------------- ------------ -----------
End of year......................................................... $ 100,706 $ 159,825 $ 191,581
============= ============ ===========
Non-cash investing and financing activities:
Term loan to finance building purchase.............................. $ -- $ -- $ 8,800
Term loans refinanced............................................... 9,859 -- --
Issuance of common stock under product development
agreement........................................................ -- 237 505
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)
1. DESCRIPTION OF BUSINESS
-----------------------
K-V Pharmaceutical Company and its subsidiaries ("KV" or the
"Company") are primarily engaged in the development, acquisition,
manufacture, marketing and sale of technologically distinguished
branded and generic/non-branded prescription pharmaceutical
products. The Company was incorporated in 1971 and has become a
leader in the development of advanced drug delivery and formulation
technologies that are designed to enhance therapeutic benefits of
existing drug forms. Through internal product development and
synergistic acquisitions of products, KV has grown into a fully
integrated specialty pharmaceutical company. The Company also
develops, manufactures and markets technologically advanced,
value-added raw material products for the pharmaceutical,
nutritional, food and personal care industries.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
BASIS OF PRESENTATION
---------------------
The Company's consolidated financial statements are prepared in
accordance with U.S. generally accepted accounting principles. The
consolidated financial statements include the accounts of KV and
its wholly-owned subsidiaries. All material inter-company accounts
and transactions have been eliminated in consolidation. Certain
reclassifications, none of which affected net income or retained
earnings, have been made to prior year amounts to conform to the
current year presentation.
USE OF ESTIMATES
----------------
The preparation of financial statements in conformity with U.S.
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent liabilities at
the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting period. Actual results
in subsequent periods may differ from the estimates and assumptions
used in the preparation of the accompanying consolidated financial
statements.
The most significant estimates made by management include the
determination of sales allowances, valuation of inventory balances,
the determination of useful lives for intangible assets, and the
evaluation of intangible assets and goodwill for impairment.
Management periodically evaluates estimates used in the preparation
of the consolidated financial statements and makes changes on a
prospective basis when adjustments are necessary.
CASH EQUIVALENTS
----------------
Cash equivalents consist of interest-bearing deposits that can be
redeemed on demand and investments that have original maturities of
three months or less.
MARKETABLE SECURITIES
---------------------
The Company's marketable securities consist of mutual funds
comprised of U.S. government investments and auction rate
securities. The Company classifies its marketable securities as
available-for-sale securities with net unrealized gains or losses
recorded as a separate component of shareholders' equity, net of
any related tax effect. Auction rate securities generally have
long-term stated maturities of 20 to 30 years. However, these
69
securities have certain economic characteristics of short-term
investments due to a rate-setting mechanism and the ability to
liquidate them through a Dutch auction process that occurs on
pre-determined intervals of less than 90 days.
INVENTORIES
-----------
Inventories consist of finished goods held for distribution, raw
materials and work in process. Inventories are stated at the lower
of cost or market, with the cost determined on the first-in,
first-out (FIFO) basis. Reserves for obsolete, excess or slow
moving inventory are established by management based on evaluation
of inventory levels, forecasted demand and market conditions.
PROPERTY AND EQUIPMENT
----------------------
Property and equipment are stated at cost, less accumulated
depreciation. Major renewals and improvements are capitalized,
while routine maintenance and repairs are expensed as incurred. At
the time properties are retired from service, the cost and
accumulated depreciation are removed from the respective accounts
and the related gains or losses are reflected in earnings. The
Company capitalizes interest on qualified construction projects.
Depreciation expense is computed over the estimated useful lives of
the related assets using the straight-line method. The estimated
useful lives are principally 10 years for land improvements, 10 to
40 years for buildings and improvements, 3 to 15 years for
machinery and equipment, and 3 to 10 years for office furniture and
equipment. Leasehold improvements are amortized on a straight-line
basis over the shorter of the respective lease terms or the
estimated useful life of the assets.
The Company assesses property and equipment for impairment whenever
events or changes in circumstances indicate that an asset's
carrying amount may not be recoverable.
INTANGIBLE ASSETS AND GOODWILL
------------------------------
Intangible assets consist of product rights, license agreements and
trademarks resulting from product acquisitions and legal fees and
similar costs relating to the development of patents and
trademarks. Intangible assets that are acquired are stated at cost,
less accumulated amortization, and are amortized on a straight-line
basis over estimated useful lives of 20 years. Costs associated
with the development of patents and trademarks are amortized on a
straight-line basis over estimated useful lives ranging from 5 to
17 years. The Company evaluates its intangible assets for
impairment whenever events or changes in circumstances indicate
that an intangible asset's carrying amount may not be recoverable.
Recoverability is determined by comparing the carrying amount of an
intangible asset against an estimate of the undiscounted future
cash flows expected to result from its use and eventual
disposition. If the sum of the expected future undiscounted cash
flows is less than the carrying amount of the intangible asset, an
impairment loss is recognized based on the excess of the carrying
amount over the estimated fair value of the intangible asset.
Goodwill relates to the 1972 acquisition of the Company's specialty
materials segment and is recorded net of accumulated amortization
through March 31, 2002. In accordance with the Company's adoption
of Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Other Intangible Assets," on April 1, 2002,
amortization of goodwill was discontinued. Instead, goodwill is
subject to at least an annual assessment of impairment on a fair
value basis. If the Company determines through the assessment
process that goodwill has been impaired, the Company will record
the impairment charge in its results of operations. The Company's
test for goodwill impairment in fiscal 2006 determined there was no
goodwill impairment.
70
OTHER ASSETS
------------
Non-marketable equity investments for which the Company does not
have the ability to exercise significant influence over operating
and financial policies (generally less than 20% ownership) are
accounted for using the cost method. Such investments are included
in "Other assets" in the accompanying consolidated balance sheets
and relate to the Company's $11,052 investment in the preferred
stock of Strides Arcolab Limited (see Note 3).
This investment is periodically reviewed for other-than-temporary
declines in fair value. An other than temporary decline in fair
value is identified by evaluating market conditions, the entity's
ability to achieve forecast and regulatory submission guidelines,
as well as the entity's overall financial condition.
REVENUE RECOGNITION
-------------------
Revenue is generally realized or realizable and earned when
persuasive evidence of an arrangement exists, delivery has occurred
or services have been rendered, the seller's price to the buyer is
fixed or determinable, and the customer's payment ability has been
reasonably assured. Accordingly, the Company records revenue from
product sales when title and risk of ownership have been
transferred to the customer, which is typically upon shipment to
the customer. The Company also enters into long-term agreements
under which it assigns marketing rights for the products it has
developed to pharmaceutical marketers. Royalties under these
arrangements are earned based on the sale of products.
Concurrently with the recognition of revenue, the Company records
estimated sales provisions for product returns, sales rebates,
payment discounts, chargebacks and other sales allowances. Sales
provisions are established based upon consideration of a variety of
factors, including but not limited to, historical relationship to
revenues, historical payment and return experience, estimated and
actual customer inventory levels, customer rebate arrangements, and
current contract sales terms with wholesale and indirect customers.
The following briefly describes the nature of each provision and
how such provisions are estimated.
|X| Payment discounts are reductions to invoiced amounts offered to
customers for payment within a specified period and are estimated
utilizing historical customer payment experience.
|X| Sales rebates are offered to certain customers to promote
customer loyalty and encourage greater product sales. These rebate
programs provide that, upon the attainment of pre-established
volumes or the attainment of revenue milestones for a specified
period, the customer receives credit against purchases. Other
promotional programs are incentive programs periodically offered to
customers. Due to the nature of these programs, the Company is able
to estimate provisions for rebates and other promotional programs
based on the specific terms in each agreement.
|X| Consistent with common industry practices, the Company has
agreed to terms with its customers to allow them to return product
that is within a certain period of the expiration date. Upon
recognition of revenue from product sales to customers, the Company
provides for an estimate of product to be returned. This estimate
is determined by applying a historical relationship of customer
returns to amounts invoiced.
|X| The Company markets and sells products directly to wholesalers,
distributors, warehousing pharmacy chains, mail order pharmacies
and other direct purchasing groups. The Company also markets
products indirectly to independent pharmacies, non-warehousing
chains, managed care organizations, and group purchasing
organizations, collectively referred to as "indirect customers."
The Company enters into agreements with some indirect customers to
establish contract pricing for certain products. These indirect
customers then independently select a wholesaler from which to
purchase the products at these contracted
71
prices. Alternatively, the Company may pre-authorize wholesalers
to offer specified contract pricing to other indirect customers.
Under either arrangement, the Company provides credit to the
wholesaler for any difference between the contracted price with
the indirect customer and the wholesaler's invoice price. This
credit is called a chargeback. Provisions for estimated
chargebacks are calculated primarily using historical chargeback
experience, actual contract pricing and estimated and actual
wholesaler inventory levels.
|X| Generally, the Company provides credits to wholesale customers
for decreases that are made to selling prices for the value of
inventory that is owned by these customers at the date of the price
reduction. These credits are customary in the industry and are
intended to reduce a wholesale customer's inventory cost to better
reflect current market prices. Since a reduction in the
wholesaler's invoice price reduces the chargeback per unit, price
reduction credits are typically included as part of the reserve for
chargebacks because they act essentially as accelerated
chargebacks. Although the Company contractually agreed to provide
price adjustment credits to its major wholesale customers at the
time they occur, the impact of any such price reductions not
included in the reserve for chargebacks is immaterial to the amount
of revenue recognized in any given period.
Actual product returns, chargebacks and other sales allowances
incurred are dependent upon future events and may be different than
the Company's estimates. The Company continually monitors the
factors that influence sales allowance estimates and makes
adjustments to these provisions when management believes that
actual product returns, chargebacks and other sales allowances may
differ from established allowances.
Accruals for sales provisions are presented in the Consolidated
Financial Statements as reductions to net revenues and accounts
receivable. Sales provisions totaled $154,368, $133,475 and
$103,262 for the years ended March 31, 2006, 2005 and 2004,
respectively. The reserve balances related to the sales provisions
totaled $29,317 and $21,056 at March 31, 2006 and 2005,
respectively, and are included in "Receivables, less allowance for
doubtful accounts" in the accompanying consolidated balance sheets.
CONCENTRATION OF CREDIT RISK
----------------------------
The Company extends credit on an uncollateralized basis primarily
to wholesale drug distributors and retail pharmacy chains
throughout the United States. As a result, the Company is required
to estimate the level of receivables which ultimately will not be
paid. The Company calculates this estimate based on prior
experience supplemented by a customer specific review when it is
deemed necessary. On a periodic basis, the Company performs
evaluations of the financial condition of all customers to further
limit its credit risk exposure. Actual losses from uncollectible
accounts have historically been insignificant.
The Company's three largest customers accounted for approximately
31%, 19% and 14%, and 23%, 18% and 16% of gross receivables at
March 31, 2006 and 2005, respectively.
For the year ended March 31, 2006, KV's three largest customers
accounted for 27%, 16% and 13% of gross revenues. For the years
ended March 31, 2005 and 2004, the Company's three largest
customers accounted for gross revenues of 27%, 16% and 12% and 25%,
16% and 13%, respectively.
The Company maintains cash balances at certain financial
institutions that are greater than the FDIC insurable limit.
SHIPPING AND HANDLING COSTS
---------------------------
The Company classifies shipping and handling costs in cost of
sales. The Company does not derive revenue from shipping.
72
RESEARCH AND DEVELOPMENT
------------------------
Research and development costs, including licensing fees for early
stage development products, are expensed in the period incurred.
The Company has licensed the exclusive rights to co-develop and
market various products with other drug delivery companies. These
collaborative agreements usually require the Company to pay
up-front fees and ongoing milestone payments. When the Company
makes an up-front or milestone payment, management evaluates the
stage of the related product to determine the appropriate
accounting treatment. If the product is considered to be beyond the
early development stage but has not yet been approved by regulatory
authorities, the Company will evaluate the facts and circumstances
of each case to determine if a portion or all of the payment has
future economic benefit and should be capitalized. Payments made to
third parties subsequent to regulatory approval are capitalized
with that cost generally amortized over the shorter of the patented
life of the product or the term of the licensing agreement.
The Company accrues estimated costs associated with clinical
studies performed by contract research organizations based on the
total of costs incurred through the balance sheet date. The Company
monitors the progress of the trials and their related activities to
the extent possible, and adjusts the accruals accordingly. These
accrued costs are recorded as a component of research and
development expense.
ADVERTISING
-----------
Costs associated with advertising are expensed in the period in
which the advertising is used and these costs are included in
selling and administrative expense. Advertising expenses totaled
$18,366, $10,885 and $7,264 for the years ended March 31, 2006,
2005 and 2004, respectively. Advertising expense includes the cost
of product samples given to physicians for marketing to their
patients.
LITIGATION
----------
The Company is subject to litigation in the ordinary course of
business and to certain other contingencies (see Note 12). Legal
fees and other expenses related to litigation and contingencies are
recorded as incurred. The Company, in consultation with its legal
counsel, also assesses the need to record a liability for
litigation and contingencies on a case-by-case basis. Accruals are
recorded when the Company determines that a loss related to a
matter is both probable and reasonably estimable.
DEFERRED FINANCING COSTS
------------------------
Deferred financing costs of $5,835 were incurred in connection with
the issuance of the 2.5% Convertible Subordinated Notes due 2033.
These costs are being amortized into interest expense on a
straight-line basis over the five-year period that ends on the
first date the debt can be put by the holders to the Company.
Accumulated amortization totaled $3,307 and $2,143 at March 31,
2006 and 2005, respectively. Deferred financing costs, net of
accumulated amortization, are included in "Other Assets" in the
accompanying consolidated balance sheets.
EARNINGS PER SHARE
------------------
Basic earnings per share is calculated by dividing net income
available to common shareholders for the period by the weighted
average number of common shares outstanding during the period.
Diluted earnings per share is computed by dividing net income by
the weighted average common shares and common share equivalents
outstanding during the periods presented assuming the conversion of
preferred shares and the
73
Convertible Subordinated Notes and the exercise of all in-the-money
stock options based on the treasury stock method. Common share
equivalents have been excluded from the computation of diluted
earnings per share where their inclusion would be anti-dilutive.
In June 2004, the Company adopted the guidance in Emerging Issues
Task Force (EITF) Issue No. 03-06, "Participating Securities and
the Two-Class Method under FASB Statement No. 128." The
pronouncement required the use of the two-class method in the
calculation and disclosure of basic earnings per share and provided
guidance on the allocation of earnings and losses for purposes of
calculating basic earnings per share. Accordingly, all periods
presented have been retroactively adjusted to give effect to such
guidance. For purposes of calculating basic earnings per share,
undistributed earnings are allocated to each class of common stock
based on the contractual participation rights of each class of
security. Holders of Class A common stock are entitled to receive
dividends per share equal to 120% of the dividends per share paid
on the Class B common stock.
In December 2004, the Company adopted the guidance in EITF 04-08,
"The Effect of Contingently Convertible Debt on Diluted Earnings
per Share." The EITF consensus required that the impact of
contingently convertible debt instruments be included in diluted
earnings per share computations (if dilutive) regardless of whether
the market price trigger (or other contingent feature) had been
met. Additionally, the EITF stated that prior period earnings per
share amounts presented for comparative purposes should be restated
to conform to this consensus.
INCOME TAXES
------------
Income taxes are accounted for under the asset and liability method
where deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. A valuation
allowance is established when it is more likely than not that some
portion or all of the deferred tax assets will not be realized.
STOCK-BASED COMPENSATION
------------------------
The Company grants stock options for a fixed number of shares to
employees with an exercise price greater than or equal to the fair
value of the shares at the date of grant. As permissible under
Statement of Financial Accounting Standards (SFAS) No. 123,
"Accounting for Stock-Based Compensation," the Company elected to
continue to account for stock option grants to employees in
accordance with Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees" and related
interpretations. APB 25 requires that compensation cost related to
fixed stock option plans be recognized only to the extent that the
intrinsic value of the options at the grant date exceeds the
exercise price. Accordingly, no compensation expense is recognized
for stock option awards granted to employees with exercise prices
at or above the market price at date of grant. The table that
follows illustrates the effect on net income and earnings per share
if the Company had determined stock-based compensation using the
fair value method prescribed by SFAS 123. Certain revisions have
been made to the expense amounts reported under the pro-forma
disclosure provisions of SFAS 123 for fiscal 2005 and 2004. These
revisions were not material and did not impact the consolidated
financial statements. The table that follows reflects the Company's
revised pro-forma results.
74
YEARS ENDED MARCH 31,
------------------------------------------
2006 2005 2004
---- ---- ----
Net income, as reported........................ $15,787 $33,269 $45,848
Stock-based employee
compensation expense,
net of related tax effects................... (2,433) (2,463) (1,726)
------- ------- -------
Pro forma net income........................... $13,354 $30,806 $44,122
======= ======= =======
Earnings per share:
Basic Class A common - as reported.......... $ 0.33 $ 0.71 $ 0.98
Basic Class A common - pro forma............ 0.28 0.66 0.94
Basic Class B common - as reported.......... 0.28 0.59 0.82
Basic Class B common - pro forma............ 0.23 0.55 0.79
Diluted - as reported....................... 0.31 0.63 0.84
Diluted - pro forma......................... 0.26 0.59 0.81
The weighted average fair value of the options has been estimated
on the date of grant using the following weighted average
assumptions for grants issued during the years ended March 31,
2006, 2005 and 2004, respectively: no dividend yield; expected
volatility of 46%, 50% and 52% for Class A common stock; expected
volatility of 44%, 47% and 50% for Class B common stock; risk-free
interest rate of 4.21%, 3.65% and 3.00% per annum; and expected
option terms ranging from 3 to 10 years for all three periods.
Weighted averages are used because of varying assumed exercise
dates.
COMPREHENSIVE INCOME
--------------------
Comprehensive income includes all changes in equity during a period
except those that resulted from investments by or distributions to
the Company's shareholders. Other comprehensive income refers to
revenues, expenses, gains and losses that, under generally accepted
accounting principles, are included in comprehensive income, but
excluded from net income as these amounts are recorded directly as
an adjustment to shareholders' equity. For the Company, other
comprehensive income (loss) is comprised of the net changes in
unrealized gains and losses on available-for-sale securities, net
of applicable income taxes.
FAIR VALUE OF FINANCIAL INSTRUMENTS
-----------------------------------
The fair values of the Company's cash and cash equivalents,
receivables, accounts payable and accrued liabilities approximate
their carrying values due to the relatively short maturity of these
items. Except for the Convertible Subordinated Notes discussed
below, the carrying amount of all long-term financial obligations
approximates their fair value because their terms are similar to
those which can be obtained for similar financial instruments in
the current marketplace.
The Company's $11,052 investment in the preferred stock of Strides
Arcolab Limited had a fair value of $11,251 at March 31, 2006 based
on an annual independent valuation analysis. Based on quoted market
rates, the Company's $200,000 principal amount of Convertible
Subordinated Notes had a fair value of $214,860 and $217,620 at
March 31, 2006 and 2005, respectively.
DERIVATIVE FINANCIAL INSTRUMENTS
--------------------------------
The Company's derivative financial instruments consist of embedded
derivatives related to the 2.5% Convertible Subordinated Notes due
2033. These embedded derivatives include certain conversion
features and a contingent interest feature. Although the conversion
features represent embedded derivative financial
75
instruments, based on the de minimis value of these features at the
time of issuance and at March 31, 2006, no value has been assigned
to these embedded derivatives. The contingent interest feature
provides unique tax treatment under the Internal Revenue Service's
contingent debt regulations. In essence, interest accrues, for tax
purposes, on the basis of the instrument's comparable yield (the
yield at which the issuer would issue a fixed rate instrument with
similar terms).
NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs,
an Amendment to ARB No. 43, Chapter 4" which requires that abnormal
amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage) costs be recognized as current period
charges. In addition, this statement requires that allocation of
fixed production overheads to the costs of conversion be based on
the normal capacity of the production facilities. This statement is
effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. The Company is currently determining
the impact, if any, the adoption of this statement will have on its
financial condition and results of operations.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment" ("SFAS 123R"), which replaces SFAS No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"), and
supersedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees." SFAS 123R requires all share-based payments to
employees, including grants of employee stock options, to be
recognized in the financial statements based on their fair values.
The pro forma disclosures previously permitted under SFAS 123 no
longer will be an alternative to financial statement recognition.
Under SFAS 123R, the Company must determine the appropriate fair
value model to be used for valuing share-based payments, the
amortization method for compensation cost and the transition method
to be used at date of adoption. The transition methods include
modified prospective and modified retrospective adoption options.
Under the modified retrospective option, prior periods may be
restated either as of the beginning of the year of adoption or for
all periods presented. The modified prospective method requires
that compensation expense be recorded for all unvested stock
options and restricted stock at the beginning of the first quarter
of adoption of SFAS 123R, while the modified retrospective method
would record compensation expense for all unvested stock options
and restricted stock beginning with the first period restated.
In April 2005, the Securities and Exchange Commission announced an
amendment to Regulation S-X to amend the date for compliance with
SFAS 123R. The amendment requires each registrant that is not a
small business issuer to adopt SFAS 123R in the first fiscal year
commencing after June 15, 2005. As a result, the Company adopted
SFAS 123R beginning April 1, 2006 using the modified prospective
method. Adoption of SFAS 123R will have a significant impact on the
Company's consolidated financial statements, as it will be required
to expense the fair value of employee stock option grants rather
than disclose the pro forma impact on its consolidated net income
within the footnotes to the Company's Consolidated Financial
Statements.
In March 2005, the SEC issued SEC Staff Accounting Bulletin No. 107
("SAB 107") which describes the SEC staff position on the
application of SFAS 123R. SAB 107 contains interpretive and certain
transitional guidance relating to the interaction between SFAS 123R
and certain SEC rules and regulations including the SEC's views
regarding the valuation of share-based payment arrangements
including assumptions related to expected volatility and expected
term, first time adoption of SFAS 123R in an interim period, the
modification of certain terms of employee share options prior to
the adoption of SFAS 123R and disclosures within Management's
Discussion and Analysis subsequent to the adoption of SFAS 123R.
The Company is currently evaluating SAB 107 and its guidance and
will be adopting it as part of the adoption of SFAS 123R beginning
April 1, 2006.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections" ("SFAS 154"), which replaces Accounting
Principles Board ("APB") Opinion No. 20, "Accounting Changes"
("APB 20")
76
and SFAS No. 3, "Reporting Accounting Changes in Interim Financial
Statements" ("SFAS 3"). SFAS 154 applies to all voluntary changes
in accounting principle and changes the requirements for the
accounting for and reporting of a change in accounting principle.
SFAS 154 also requires retrospective application to prior period
financial statements involving changes in accounting principle
unless it is impracticable to determine either the period-specific
or cumulative effect of the change. This statement also requires
that a change in the method of depreciation, amortization or
depletion of long-lived assets be accounted for as a change in
accounting estimate that is accounted for prospectively. SFAS 154
also retains many provisions of APB 20 including those related to
reporting a change in accounting estimate, a change in the
reporting entity and a correction of an error and also carries
forward provisions of SFAS 3 governing the reporting of accounting
changes in interim financial statements. SFAS 154 is effective for
accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. The Company believes that the
adoption of SFAS 154 will not have a material effect on its
Consolidated Financial Statements.
3. ACQUISITIONS AND LICENSE AGREEMENT
----------------------------------
In May 2005, the Company and FemmePharma, Inc. ("FemmePharma")
mutually agreed to terminate the license agreement between them
entered into in April 2002. As part of this transaction, the
Company acquired all of the common stock of FemmePharma for $25,000
after certain assets of the entity had been distributed to
FemmePharma's other shareholders. Under a separate agreement, the
Company had previously invested $5,000 in FemmePharma's convertible
preferred stock. Included in the Company's acquisition of
FemmePharma are the worldwide marketing rights to an endometriosis
product that has successfully completed Phase II clinical trials.
This product was originally part of the licensing arrangement with
FemmePharma that provided the Company, among other things,
marketing rights for the product principally in the United States.
In accordance with the new agreement, the Company acquired
worldwide licensing rights of the endometriosis product, no longer
is responsible for milestone payments and royalties specified in
the original licensing agreement, and secured exclusive worldwide
rights for use of the FemmePharma technology for vaginal
anti-infective products. For the year ended March 31, 2006, the
Company recorded expense of $30,441 in connection with the
FemmePharma acquisition that consisted of $29,570 for acquired
in-process research and development and $871 in direct expenses
related to the transaction. The acquired in-process research and
development charge represented the estimated fair value of the
endometriosis product being developed that, at the time of the
acquisition, had no alternative future use and for which
technological feasibility had not been established. The FemmePharma
acquisition expense was determined by the Company to not be
deductible for tax purposes. The Company also allocated $375 of the
purchase price for a non-compete agreement and $300 of the purchase
price for the royalty-free worldwide license to use FemmePharma's
technology for vaginal anti-infective products acquired in the
transaction.
In May 2005, the Company entered into a long-term product
development and marketing license agreement with Strides Arcolab
Limited ("Strides"), an Indian generic pharmaceutical developer and
manufacturer, for exclusive marketing rights in the United States
and Canada for 10 new generic drugs. Under the agreement, Strides
will be responsible for developing, submitting for regulatory
approval and manufacturing the 10 products and the Company will be
responsible for exclusively marketing the products in the
territories covered by the agreement. Under a separate agreement,
the Company invested $11,300 in Strides redeemable preferred stock.
This investment is denominated in the Indian rupee and is subject
to foreign currency transaction gains or losses resulting from
exchange rate changes. As a result of a change in the exchange
rate, the carrying value of this investment was $11,052 at March
31, 2006. This investment has been accounted for using the cost
method and is included in "Other assets" in the accompanying
consolidated balance sheet at March 31, 2006.
77
4. MARKETABLE SECURITIES
---------------------
The carrying amount of available-for-sale securities and their
approximate fair values at March 31, 2006 and 2005 were as follows.
MARCH 31, 2006
----------------------------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ----- ------ -----
Auction rate securities......... $ 70,000 $ - $ - $ 70,000
Equity securities............... 37,082 - (319) 36,763
---------- ---------- ----------- ----------
Total....................... $ 107,082 $ - $ (319) $ 106,763
========== ========== =========== ==========
MARCH 31, 2005
----------------------------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ----- ------ -----
Auction rate securities......... $ 10,000 $ - $ - $ 10,000
Equity securities............... 35,895 - (201) 35,694
---------- ---------- ----------- ----------
Total....................... $ 45,895 $ - $ (201) $ 45,694
========== ========== =========== ==========
The Company's marketable securities are classified as
available-for-sale and are recorded at fair value based on quoted
market prices using the specific identification method. These
investments are classified as current assets as the Company has the
ability to use them for current operating and investing purposes.
There were no realized gains or losses for the years ended March
31, 2006, 2005 and 2004. At March 31, 2006, the Company has
determined that its unrealized losses are temporary based on the de
minimis amount of losses compared to cost and the duration of the
losses being less than 24 months. The Company expects that all
losses will be recovered, and intends to hold these marketable
securities to recovery. If market conditions deteriorate, we may
incur future impairments.
Included in the Company's marketable securities at March 31, 2006
and 2005 are $70,000 and $10,000, respectively of auction rate
securities. Auction rate securities are investments with an
underlying component of long-term debt or an equity instrument.
These auction rate securities trade or mature on a shorter term
than the underlying instrument based on an auction bid that resets
the interest rate of the security. The auction or reset dates occur
at intervals that are typically less than three months providing
high liquidity to otherwise longer term investments.
5. INVENTORIES
-----------
Inventories as of March 31, consist of:
2006 2005
---- ----
Finished goods..................... $ 28,977 $ 30,521
Work-in-process.................... 7,969 5,773
Raw materials...................... 33,832 17,651
--------- ---------
$ 70,778 $ 53,945
========= =========
78
6. PROPERTY AND EQUIPMENT
----------------------
Property and equipment as of March 31, consist of:
2006 2005
---- ----
Land and improvements................................. $ 5,763 $ 2,030
Building and building improvements.................... 101,135 19,984
Machinery and equipment............................... 57,021 41,399
Office furniture and equipment........................ 24,573 14,871
Leasehold improvements................................ 21,044 9,985
Construction-in-progress.............................. 10,265 74,394
---------- ----------
219,801 162,663
Less accumulated depreciation......................... (41,759) (31,039)
---------- ----------
Net property and equipment......................... $ 178,042 $ 131,624
========== ==========
Capital additions to property and equipment were $58,334, $63,622
and $30,592 for the years ended March 31, 2006, 2005 and 2004,
respectively. Depreciation of property and equipment was $11,916,
$7,775 and $6,718 for the years ended March 31, 2006, 2005 and
2004, respectively.
Property and equipment projects classified as
construction-in-progress at March 31, 2006 are projected to be
completed during the next 12 months at an estimated cost of $5,301.
During the years ended March 31, 2006, 2005 and 2004, the Company
recorded capitalized interest on qualifying construction projects
of $940, $1,511 and $577, respectively.
7. INTANGIBLE ASSETS AND GOODWILL
------------------------------
Intangible assets and goodwill as of March 31, consist of:
2006 2005
---------------------------------- --------------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
------ ------------ ------ ------------
Product rights - Micro-K(R)....... $ 36,140 $ (12,708) $ 36,140 $(10,904)
Product rights - PreCare(R)....... 8,433 (2,811) 8,433 (2,389)
Trademarks acquired:
Niferex(R)..................... 14,834 (2,225) 14,834 (1,484)
Chromagen(R)/StrongStart(R).... 27,642 (4,147) 27,642 (2,764)
License agreements................ 4,400 (300) 4,168 (120)
Covenant not to compete........... 375 (34) - -
Trademarks and patents............ 3,403 (604) 2,814 (497)
---------- --------- --------- --------
Total intangible assets....... 95,227 (22,829) 94,031 (18,158)
Goodwill.......................... 557 - 557 -
---------- --------- --------- --------
$ 95,784 $ (22,829) $ 94,588 $(18,158)
========== ========= ========= ========
As of March 31, 2006, the Company's intangible assets have a
weighted average useful life of approximately 19 years.
Amortization of intangible assets was $4,784, $4,653 and $4,459 for
the years ended March 31, 2006, 2005 and 2004, respectively.
Assuming no additions, disposals or adjustments are made to the
carrying values and/or useful lives of the
79
intangible assets, annual amortization expense on product rights,
trademarks acquired and other intangible assets is estimated to be
approximately $4,788 in each of the five succeeding fiscal years.
8. OTHER ASSETS
------------
Other assets as of March 31, consist of:
2006 2005
---- ----
Cash surrender value of life insurance............... $ 3,416 $ 2,822
Preferred stock investments.......................... 11,052 5,000
Accrued dividends on preferred stock ................ 509 -
Deferred financing costs, net........................ 2,879 3,852
Deposits............................................. 1,170 1,407
--------- ---------
$ 19,026 $ 13,081
========= =========
9. ACCRUED LIABILITIES
-------------------
Accrued liabilities as of March 31, consist of:
2006 2005
---- ----
Salaries, wages, incentives and benefits....... $ 11,312 $ 10,383
Income taxes - current......................... 584 --
Promotion expenses............................. 344 131
Accrued interest payable....................... 1,875 1,875
Other.......................................... 2,985 3,344
--------- ---------
$ 17,100 $ 15,733
========= =========
10. LONG-TERM DEBT
--------------
Long-term debt as of March 31, consists of:
2006 2005
---- ----
Building mortgages............................. $ 43,000 $ 10,740
Convertible notes.............................. 200,000 200,000
--------- ---------
243,000 210,740
Less current portion........................... (1,681) (973)
--------- ---------
$ 241,319 $ 209,767
========= =========
As of March 31, 2006, the Company has credit agreements with two
banks that provide revolving lines of credit for borrowing up to
$140,000. The credit agreements provide for $80,000 in revolving
lines of credit along with supplemental credit lines of $60,000
that are available for financing acquisitions. These credit
facilities expire in October 2006 and June 2006, respectively. The
revolving and supplemental credit lines are unsecured and interest
is charged at the lower of the prime rate or the one-month LIBOR
rate plus 175 basis points. At March 31, 2006, the Company had
$3,900 in an open letter of credit issued under the revolving
credit line and no cash borrowings under either credit facility.
The credit agreements contain financial covenants that impose
minimum levels of earnings before interest, taxes, depreciation and
amortization, a maximum funded debt ratio, a limit on capital
expenditures and dividend payments, a minimum fixed charge coverage
ratio and a maximum senior leverage ratio.
80
In March 2006, the Company entered into a $43,000 mortgage loan
agreement with one of its primary lenders, in part, to refinance
$9,859 of existing mortgages. The $32,764 of net proceeds the
Company received from the new mortgage loan will be used for
working capital and general corporate purposes. The new mortgage
loan, which is secured by three of the Company's buildings, bears
interest at a rate of 5.91% and matures on April 1, 2021.
On May 16, 2003, the Company issued $200,000 principal amount of
Convertible Subordinated Notes (the "Notes") that are convertible,
under certain circumstances, into shares of Class A common stock at
an initial conversion price of $23.01 per share. The Notes, which
are due May 16, 2033, bear interest that is payable on May 16 and
November 16 of each year at a rate of 2.50% per annum. The Company
also is obligated to pay contingent interest at a rate equal to
0.5% per annum during any six-month period from May 16 to November
15 and from November 16 to May 15, with the initial six-month
period commencing May 16, 2006, if the average trading price of the
Notes per $1,000 principal amount for the five trading day period
ending on the third trading day immediately preceding the first day
of the applicable six-month period equals $1,200 or more. As this
contingent interest feature is based on the underlying trading
price of the Notes, the contingent interest meets the criteria of
and qualifies as an embedded derivative. At the time of issuance
and at March 31, 2006, management determined that the fair value of
this contingent interest embedded derivative was de minimis and,
accordingly, no value has been assigned to this embedded
derivative.
The Company may redeem some or all of the Notes at any time on or
after May 21, 2006, at a redemption price, payable in cash, of 100%
of the principal amount of the Notes, plus accrued and unpaid
interest, including contingent interest, if any. Holders may
require the Company to repurchase all or a portion of their Notes
on May 16, 2008, 2013, 2018, 2023 and 2028 or upon a change in
control, as defined in the indenture governing the Notes, at a
purchase price, payable in cash, of 100% of the principal amount of
the Notes, plus accrued and unpaid interest, including contingent
interest, if any.
The Notes are subordinate to all of our existing and future senior
obligations. The net proceeds to the Company were approximately
$194,200, after deducting underwriting discounts, commissions and
offering expenses. The Notes are convertible, at the holders'
option, into shares of the Company's Class A common stock prior to
the maturity date under the following circumstances:
o during any quarter commencing after June 30, 2003,
if the closing sale price of the Company's Class A
common stock over a specified number of trading days
during the previous quarter is more than 120% of the
conversion price of the Notes on the last trading
day of the previous quarter. The Notes are initially
convertible at a conversion price of $23.01 per
share, which is equal to a conversion rate of
approximately 43.4594 shares per $1,000 principal
amount of Notes;
o if the Company has called the Notes for redemption;
o during the five trading day period immediately
following any nine consecutive day trading
period in which the trading price of the Notes
per $1,000 principal amount for each day of such
period was less than 95% of the product of the
closing sale price of our Class A common stock
on that day multiplied by the number of shares
of our Class A common stock issuable upon
conversion of $1,000 principal amount of the
Notes; or
o upon the occurrence of specified corporate transactions.
The Company has reserved 8,691,880 shares of Class A common stock
for issuance in the event the Notes are converted into the
Company's common shares.
The Notes, which are unsecured, do not contain any restrictions on
the payment of dividends, the incurrence of additional indebtedness
or the repurchase of the Company's securities, and do not contain
any financial covenants.
81
The aggregate maturities of long-term debt as of March 31, 2006 are
as follows:
Due in one year............... $ 1,681
Due in two years.............. 1,940
Due in three years............ 2,058
Due in four years............. 2,182
Due in five years............. 2,315
Thereafter.................... 232,824
---------
$ 243,000
=========
The Company paid interest, net of capitalized interest, of $4,692
and $4,156 during the years ended March 31, 2006 and 2005,
respectively. For the year ended March 31, 2004, the Company paid
interest of $3,215.
11. TAXABLE INDUSTRIAL REVENUE BONDS
--------------------------------
In December 2005, the Company entered into a financing arrangement
with St. Louis County, Missouri related to expansion of its
operations in St. Louis County. Up to $135,500 of industrial
revenue bonds may be issued to the Company by St. Louis County
relative to capital improvements made through December 31, 2009.
This agreement provides that 50% of the real and personal property
taxes on up to $135,500 of capital improvements will be abated for
a period of 10 years subsequent to the property being placed in
service. Industrial revenue bonds totaling $73,000 were outstanding
at March 31, 2006. The industrial revenue bonds are issued by St.
Louis County to the Company upon its payment of qualifying costs of
capital improvements, which are then leased by the Company for a
period ending December 1, 2019, unless earlier terminated. The
Company has the option at any time to discontinue the arrangement
and regain full title to the abated property. The industrial
revenue bonds bear interest at 4.25% per annum and are payable as
to principal and interest concurrently with payments due under the
terms of the lease. The Company has classified the leased assets as
property and equipment and has established a capital lease
obligation equal to the outstanding principal balance of the
industrial revenue bonds. Lease payments may be made by tendering
an equivalent portion of the industrial revenue bonds. As the
capital lease payments to St. Louis County may be satisfied by
tendering industrial revenue bonds (which is the Company's
intention), the capital lease obligation, industrial revenue bonds
and related interest expense and interest income, respectively,
have been offset for presentation purposes in the Consolidated
Financial Statements.
12. COMMITMENTS AND CONTINGENCIES
-----------------------------
LEASES
The Company leases manufacturing, office and warehouse facilities,
equipment and automobiles under operating leases expiring through
fiscal 2013. Total rent expense for the years ended March 31, 2006,
2005 and 2004 was $3,819, $5,734 and $5,246, respectively.
Future minimum lease commitments under non-cancelable leases are as
follows:
2007.......................... $ 1,186
2008.......................... 430
2009.......................... 72
2010.......................... 5
A purchase option on a building leased by the Company on March 31,
2006 was exercised by the Company in accordance with the lease
agreement and is scheduled to be acquired for $4,900 in June 2006.
The future
82
minimum lease payments under this lease were only included above
through the date of the scheduled purchase. Payments that would
have been due under this lease were $535 per year through June
2011.
CONTINGENCIES
The Company is currently subject to legal proceedings and claims
that have arisen in the ordinary course of business. While the
Company is not presently able to determine the potential liability,
if any, related to such matters, the Company believes none of the
matters it currently faces, individually or in the aggregate, will
have a material adverse effect on its financial position or
operations except for the specific cases described in "Litigation"
below.
The Company has licensed the exclusive rights to co-develop and
market various generic equivalent products with other drug delivery
companies. These collaboration agreements require the Company to
make up-front and ongoing payments as development milestones are
attained. If all milestones remaining under these agreements were
reached, payments by the Company could total up to $42,138.
LITIGATION
The Company and ETHEX are named as defendants in a case brought by
CIMA LABS, Inc. and Schwarz Pharma, Inc. and styled CIMA LABS, Inc.
et. al. v. KV Pharmaceutical Company et. al. filed in Federal
District Court in Minnesota. It is alleged that the Company and
ETHEX infringed on a CIMA patent in connection with the manufacture
and sale of Hyoscyamine Sulfate Orally Dissolvable Tablets, 0.125
mg. The court has entered a stay pending the outcome of the Patent
and Trademark Offices' reexamination of the patent in suit. ETHEX
will continue to market the product during the stay. The Company
intends to vigorously defend its interests when the stay is lifted;
however, it cannot give any assurance it will prevail.
The Company and ETHEX are named as defendants in a case brought by
Solvay Pharmaceuticals, Inc. and styled Solvay Pharmaceuticals,
Inc. v. ETHEX Corporation, filed in Federal District Court in
Minnesota. In general, Solvay alleges that ETHEX's comparative
promotion of its Pangestyme(TM) CN 10 and Pangestyme(TM) CN 20
products to Solvay's Creon(R) 10 and Creon(R) 20 products resulted
in false advertising and misleading statements under various
federal and state laws, and constituted unfair and deceptive trade
practices. Discovery has concluded. The Case is expected to be
tried in 2006, but no trial date has been set. The Company intends
to vigorously defend its interests; however, it cannot give any
assurance it will prevail.
KV previously distributed several pharmaceutical products that
contained phenylpropanolamine, or PPA, and that were discontinued
in 2000 and 2001. The Company is presently named a defendant in a
product liability lawsuit in Federal District Court in Mississippi
involving PPA. The suit originated out of a case, Virginia Madison,
et al. v. Bayer Corporation, et al. The original suit was filed in
December 2002, but was not served on KV until February 2003. The
case was originally filed in the Circuit Court of Hinds County,
Mississippi, and was removed to the Federal District Court for the
Southern District of Mississippi by then co-defendant Bayer
Corporation. The case has been transferred to a Judicial Panel on
Multi-District Litigation for PPA claims sitting in the Western
District of Washington. The claims against the Company have been
segregated into a lawsuit brought by Johnny Fulcher individually
and on behalf of the wrongful death beneficiaries of Linda Fulcher,
deceased, against the Company. It alleges bodily injury, wrongful
death, economic injury, punitive damages, loss of consortium and/or
loss of services from the use of the Company's distributed
pharmaceuticals containing PPA that have since been discontinued
and/or reformulated to exclude PPA. In May 2004, the case was
dismissed with prejudice by the Federal District Court for the
Western District of Washington for a failure to timely file an
individual complaint as required by certain court orders. The
plaintiff filed a request for reconsideration which was opposed and
subsequently denied by the Court in June 2004. In July 2004, the
plaintiff filed a notice of appeal of the dismissal. The Company
has opposed this appeal. The Company intends to vigorously defend
its interests; however, it cannot give any assurance it will
prevail.
83
The Company has also been advised that one of its former
distributor customers is being sued in Florida state court in a
case captioned Darrian Kelly v. K-Mart et. al. for personal injury
allegedly caused by ingestion of K-Mart diet caplets that are
alleged to have been manufactured by the Company and to contain
PPA. The distributor has tendered defense of the case to the
Company and has asserted a right to indemnification for any
financial judgment it must pay. The Company previously notified its
product liability insurer of this claim in 1999, and the Company
has demanded that the insurer assume the Company's defense. The
insurer has stated that it has retained counsel to secure
additional factual information and will defer its coverage decision
until that information is received. The Company intends to
vigorously defend its interests; however, it cannot give any
assurance that it will not be impleaded into the action, or that,
if it is impleaded, that it would prevail.
KV's product liability coverage for PPA claims expired for claims
made after June 15, 2002. Although the Company renewed its product
liability coverage for coverage after June 15, 2002, that policy
excludes future PPA claims in accordance with the standard industry
exclusion. Consequently, as of June 15, 2002, the Company will
provide for legal defense costs and indemnity payments involving
PPA claims on a going forward basis as incurred, including the
Madison/Fulcher lawsuit that was filed after June 15, 2002.
Moreover, the Company may not be able to obtain product liability
insurance in the future for PPA claims with adequate coverage
limits at commercially reasonable prices for subsequent periods.
From time to time in the future, KV may be subject to further
litigation resulting from products containing PPA that it formerly
distributed. The Company intends to vigorously defend its
interests; however, it cannot give any assurance it will prevail.
After the Company filed ANDAs with the FDA seeking permission to
market a generic version of the 25 mg, 50 mg, 100 mg, and 200 mg
strengths of Toprol-XL(R) in extended release capsule form,
AstraZeneca filed lawsuits against KV for patent infringement under
the provisions of the Hatch-Waxman Act. In the Company's Paragraph
IV certification, KV contended that its proposed generic versions
do not infringe AstraZeneca's patents. Pursuant to the Hatch-Waxman
Act, the filing date of the suit against the Company instituted an
automatic stay of FDA approval of the Company's ANDA until the
earlier of a judgment, or 30 months from the date of the suit. The
Company filed motions for summary judgment with the Federal
District Court in Missouri alleging, among other things, that
AstraZeneca's patent is invalid and unenforceable. These motions
have been granted. AstraZeneca has appealed. The Company intends to
vigorously defend its interests; however, it cannot give any
assurance it will prevail.
The Company and/or ETHEX have been named as defendants in certain
multi-defendant cases alleging that the defendants reported
improper or fraudulent pharmaceutical pricing information, i.e.,
Average Wholesale Price, or AWP, and/or Wholesale Acquisition Cost,
or WAC, information, which caused the governmental plaintiffs to
incur excessive costs for pharmaceutical products under the
Medicaid program. Cases of this type have been filed against the
Company and/or ETHEX and other pharmaceutical manufacturer
defendants by the State of Massachusetts, the State of Alabama, the
State of Mississippi, New York City, and approximately 40 counties
in New York State. The New York City case and all New York County
cases have been transferred to the Federal District Court for the
District of Massachusetts for coordinated or consolidated pretrial
proceedings under the Average Wholesale Price Multidistrict
Litigation (MDL No. 1456). One of the counties, Erie County,
challenged the transfer and the Erie County Case has been remanded
to state court. Each of these actions is in the early stages, with
fact discovery at beginning phases in the Alabama, Massachusetts
and Mississippi cases, but has not yet commenced in the New York
City/Counties or the Erie County case. The Company intends to
vigorously defend its interests in the actions described above;
however, it cannot give any assurance it will prevail.
The Company believes that various other governmental entities have
commenced investigations into the generic and branded
pharmaceutical industry at large regarding pricing and price
reporting practices. Although the Company believes its pricing and
reporting practices have complied in all material respects with its
legal obligations, it cannot give any assurance that it would
prevail if legal actions are instituted by these governmental
entities.
84
The Company and ETHEX are named as defendants in a case brought by
the Estate of Bertie Helen Dye and styled Hope Campbell and Charles
Lee Dye, Co-administrators of the Estate of Bertie Helen Dye filed
in Federal District court in Virginia. It is alleged that the
Company and ETHEX caused Ms. Dye's death in connection with their
manufacture and sale of Ethezyme 830, a topical wound debridement
ointment. The claims are for negligence, breach of warranty, fraud
and punitive damages. Discovery has begun and the trial is set for
October 16, 2006. The Company intends to vigorously defend its
interests; however; it cannot give any assurance it will prevail.
The Company and ETHEX are named as co-defendants in a suit in the
U.S. District Court for the Southern District of Florida filed by
the personal representative of the estate of Joyce Hoyle and her
children in connection with Ms. Hoyle's death in 2003, allegedly
from oxycodone toxicity styled Thomas Hoyle v. Purdue Pharma et al.
The suit alleges that between June 2001 and May 2003 Ms. Hoyle was
prescribed and took three different opiate pain medications
manufactured and sold by the defendants, including one product,
oxycodone, that was manufactured by the Company and marketed by
ETHEX, and that such medications were promoted without sufficient
warnings about the side effect of addiction. The causes of action
are strict liability for an inherently dangerous product,
negligence, breach of express and implied warranty and breach of
implied warranty of fitness for a particular purpose. The discovery
process has not yet begun, and the court has set the trial to
commence on July 16, 2007. The Company intends to vigorously defend
its interests; however, it cannot give any assurance that it will
prevail.
On May 20, 2005, the Company was notified by the SEC that a
non-public formal investigation was initiated that appears to
relate to the Form 8-K disclosures the Company made on July 13,
2004. The Company believes the matter will be satisfactorily
resolved.
From time to time, the Company is involved in various other legal
proceedings in the ordinary course of its business. While it is not
feasible to predict the ultimate outcome of such other proceedings,
the Company believes that the ultimate outcome of such other
proceedings will not have a material adverse effect on its results
of operations or financial position.
There are uncertainties and risks associated with all litigation
and there can be no assurance that the Company will prevail in any
particular litigation.
13. EMPLOYMENT AGREEMENTS
---------------------
The Company has employment agreements with certain officers and key
employees which extend for one to five years. These agreements
provide for base levels of compensation and, in certain instances,
also provide for incentive bonuses and separation benefits. Also,
the agreement with the Chief Executive Officer ("CEO") contains
provisions for partial salary continuation under certain
conditions, contingent upon noncompete restrictions and providing
consulting services to the Company as specified in the agreement.
In addition, the CEO is entitled to receive retirement compensation
paid in the form of a single annuity equal to 30% of the CEO's
final average compensation payable each year beginning at
retirement and continuing for the longer of 10 years or the life of
the CEO. In accordance with this agreement, the Company recognized
retirement expense of $965, $1,355 and $209 for the years ended
March 31, 2006, 2005 and 2004, respectively.
14. GAIN FROM LEGAL SETTLEMENT
--------------------------
In September 2003, the Company received a payment from a branded
pharmaceutical company in the amount of $4,000. The payment
received by the Company was made in response to the Company's claim
that the branded company violated federal antitrust laws and
interfered with the Company's right to a timely introduction of a
generic pharmaceutical product in a previous fiscal year. The
payment was reflected by the Company in the "Litigation" line item
of operating income and was recorded net of approximately $500 of
attorney-related fees.
85
15. INCOME TAXES
------------
The income tax provisions for the years ended March 31, 2006, 2005
and 2004 are based on estimated Federal and state taxable income
using the applicable statutory rates. The current and deferred
Federal and state income tax provisions for the years ended March
31, 2006, 2005 and 2004 are as follows:
2006 2005 2004
---- ---- ----
PROVISION
Current
Federal............................... $ 15,034 $ 2,982 $ 14,184
State................................. 1,382 195 1,275
--------- -------- ---------
16,416 3,177 15,459
--------- -------- ---------
Deferred
Federal............................... 6,320 12,473 7,792
State................................. 387 1,109 899
--------- -------- ---------
6,707 13,582 8,691
--------- -------- ---------
$ 23,123 $ 16,759 $ 24,150
========= ======== =========
The reasons for the differences between the provision for income
taxes and the expected Federal income taxes at the statutory rate
are as follows:
2006 2005 2004
---- ---- ----
Expected income tax expense................. $ 13,618 $ 17,510 $ 24,499
Purchased in-process research
and development.......................... 10,654 - -
State income taxes, less
Federal income tax benefit............... 1,150 847 1,413
Business credits............................ (831) (1,080) (1,240)
Other ...................................... (1,468) (518) (522)
--------- -------- ---------
$ 23,123 $ 16,759 $ 24,150
========= ======== =========
As of March 31, 2006 and 2005, the tax effect of temporary
differences between the tax basis of assets and liabilities and
their financial reporting amounts are as follows:
2006 2005
-------------------------- --------------------------
CURRENT NON-CURRENT CURRENT NON-CURRENT
------- ----------- ------- -----------
Fixed asset basis differences........ $ - $ (8,701) $ - $ (6,658)
Reserves for inventory and
receivables....................... 7,547 - 5,510 -
Vacation pay reserve................. 378 - 249 -
Deferred compensation................ - 1,973 - 1,620
Amortization......................... - (2,652) - (2,121)
Convertible notes interest........... - (15,699) - (9,495)
Other................................ 109 (142) 68 -
------- --------- ------- ---------
Net deferred tax asset (liability) $ 8,034 $ (25,221) $ 5,827 $ (16,654)
======= ========= ======= =========
The Company paid income taxes of $15,482, $8,769, and $22,201
during the years ended March 31, 2006, 2005 and 2004, respectively.
86
Included in "Prepaid and other assets" at March 31, 2005 in the
accompanying consolidated balance sheet was income tax refunds
receivable of $2,518.
16. EMPLOYEE BENEFITS
-----------------
STOCK OPTION PLAN AND AGREEMENTS
On August 30, 2002, the Company's shareholders approved KV's 2001
Incentive Stock Option Plan (the "2001 Plan"), which allows for the
issuance of up to 4,500,000 shares of common stock. Prior to the
approval of the 2001 Plan, the Company operated under the 1991
Incentive Stock Option Plan, as amended, which still allows for the
issuance of up to 1,125,000 shares of common stock. Under the
Company's stock option plans, options to acquire shares of common
stock have been made available for grant to certain employees. Each
option granted has an exercise price of not less than 100% of the
market value of the common stock on the date of grant. The
contractual life of each option is generally 10 years. The
exercisability of the grants varies according to the individual
options granted. In addition to these plans, the Company has issued
stock options periodically to executives with employment agreements
and to non-employee directors. At March 31, 2006, options to
purchase 34,875 shares of stock were outstanding pursuant to
employment agreements and grants to non-employee directors.
The following summary shows the transactions for the years ended
March 31, 2006, 2005 and 2004 under option arrangements:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------- -------------------
AVERAGE AVERAGE
NO. OF PRICE PER NO. OF PRICE PER
SHARES SHARE SHARES SHARE
------ ----- ------ -----
Balance, March 31, 2003........... 3,503,033 $ 8.81 1,790,839 $ 8.00
Options granted................... 677,313 19.56 - -
Options becoming exercisable...... - - 541,924 12.17
Options exercised................. (966,036) 7.80 (966,036) 7.80
Options canceled.................. (437,502) 11.72 (132,869) 10.37
--------- ---------
Balance March 31, 2004............ 2,776,808 11.33 1,233,858 9.71
Options granted................... 676,250 22.19 - -
Options becoming exercisable...... - - 431,164 14.42
Options exercised................. (220,743) 6.44 (220,743) 6.44
Options canceled.................. (129,517) 16.30 (34,285) 13.35
--------- ---------
Balance March 31, 2005............ 3,102,798 13.84 1,409,994 11.58
Options granted................... 964,706 18.80 - -
Options becoming exercisable...... - - 416,898 13.75
Options exercised................. (198,730) 5.28 (198,730) 5.28
Options canceled.................. (349,618) 14.74 (143,513) 13.09
--------- ---------
Balance March 31, 2006............ 3,519,156 $15.55 1,484,649 $12.82
========= =========
The weighted average fair value of options granted at market price
on the date of grant was $6.25, $7.26, and $7.34 per share for the
years ended March 31, 2006, 2005 and 2004, respectively. The
weighted average fair value of options granted with an exercise
price exceeding market price on the date of grant was $5.84 and
$4.15 per share for the years ended March 31, 2005 and 2004,
respectively. During the year ended March 31, 2006, there were no
options granted with an exercise price exceeding market price on
the date of grant.
87
The following table summarizes information about stock options
outstanding at March 31, 2006:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------------ -----------------------------------
RANGE OF NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED
EXERCISE OUTSTANDING LIFE AVERAGE EXERCISABLE AVERAGE
PRICES AT 3/31/06 REMAINING EXERCISE PRICE AT 3/31/06 EXERCISE PRICE
------ ---------- --------- -------------- ---------- --------------
$ 0.82 - $ 5.00 239,735 1 Year $ 3.26 236,518 $ 3.22
$ 5.01 - $ 9.00 514,174 3 Years $ 7.09 289,307 $ 7.12
$ 9.01 - $14.00 617,764 4 Years $11.61 364,576 $11.83
$14.01 - $20.00 1,204,963 8 Years $17.18 351,319 $17.77
$20.01 - $27.50 942,520 8 Years $23.63 242,929 $24.05
PROFIT SHARING PLAN
The Company has a qualified trustee profit sharing plan (the
"Plan") covering substantially all non-union employees. The
Company's annual contribution to the Plan, as determined by the
Board of Directors, is discretionary and was $400, $300 and $400
for the years ended March 31, 2006, 2005 and 2004, respectively.
The Plan includes features as described under Section 401(k) of the
Internal Revenue Code.
The Company's contributions to the 401(k) investment funds are 50%
of the first 7% of the salary contributed by each participant.
Contributions of $1,877, $1,547 and $1,286 were made to the 401(k)
investment funds during the years ended March 31, 2006, 2005 and
2004, respectively.
Contributions are also made to multi-employer defined benefit plans
administered by labor unions for certain union employees. Amounts
charged to pension expense and contributed to these plans were
$180, $200 and $202 for the years ended March 31, 2006, 2005 and
2004, respectively.
HEALTH AND MEDICAL INSURANCE PLAN
The Company contributes to health and medical insurance programs
for its non-union and union employees. For non-union employees, the
Company self-insures the first $150,000 of each employee's covered
medical claims. Included in accrued liabilities in the consolidated
balance sheets as of March 31, 2006 and 2005 were $292 and $20 of
accrued health insurance reserves, respectively, for claims
incurred but not reported. In fiscal 2005, the Company established
a Voluntary Employees' Beneficiary Association for its non-union
employees to fund payments made by the Company for covered medical
claims. As a result of funding this plan, the Company's liability
for claims incurred but not reported was reduced by $850 and $680
at March 31, 2006 and 2005, respectively. For union employees, the
Company participates in a fully funded insurance plan sponsored by
the union. Total health and medical insurance expense for the two
plans was $9,662, $9,431, and $7,331 for the years ended March 31,
2006, 2005 and 2004, respectively.
17. RELATED PARTY TRANSACTIONS
--------------------------
The Company currently leases certain real property from an
affiliated partnership of an officer and director of the Company.
Lease payments made for this property for the years ended March 31,
2006, 2005 and 2004 totaled $284, $277, and $271, respectively.
88
18. EQUITY TRANSACTIONS
-------------------
As of March 31, 2006 and 2005, the Company had 40,000 shares of 7%
Cumulative Convertible Preferred Stock (par value $.01 per share)
outstanding at a stated value of $25 per share. The preferred stock
is non-voting with dividends payable quarterly. The preferred stock
is redeemable by the Company at its stated value. Each share of
preferred stock is convertible into Class A common stock at a
conversion price of $2.96 per share. The preferred stock has a
liquidation preference of $25 per share plus all accrued but unpaid
dividends prior to any liquidation distributions to holders of
Class A or Class B common stock. No dividends may be paid on Class
A or Class B common stock unless all dividends on the Cumulative
Convertible Preferred Stock have been declared and paid. There were
no undeclared and unaccrued cumulative preferred dividends at March
31, 2006 and 2005. Also, under the terms of its credit agreement,
the Company may not pay cash dividends in excess of 25% of the
prior fiscal year's consolidated net income.
The Company has reserved 750,000 shares of Class A common stock for
issuance under KV's 2002 Consultants Plan. These shares may be
issued from time to time in consideration for consulting and other
services provided to the Company by independent consultants. Since
inception of this plan, the Company has issued 47,732 Class A
shares as payment for certain milestones under product development
agreements.
Holders of Class A common stock are entitled to receive dividends
per share equal to 120% of the dividends per share paid on the
Class B common stock and have one-twentieth vote per share in the
election of directors and on other matters.
Under the terms of the Company's current loan agreement (see Note
10), the Company has limitations on paying dividends, except in
stock, on its Class A and Class B common stock. Payment of
dividends may also be restricted under Delaware corporation law.
On September 8, 2003, the Company's Board of Directors declared a
three-for-two stock split in the form of a 50% stock dividend of
its common stock to shareholders of record on September 18, 2003,
payable on September 29, 2003. Common stock was credited and
retained earnings was charged for the aggregate par value of the
shares issued. The stated par value of each share was not changed
from $0.01.
All per share data in this report has been restated to reflect the
aforementioned three-for-two stock split in the form of a 50% stock
dividend.
In May 2003, the Company used $50,000 of the net proceeds from the
Convertible Subordinated Notes issuance (see Note 10) to fund the
repurchase of 2,000,000 shares of the Company's Class A common
stock.
89
19. EARNINGS PER SHARE
------------------
The following table sets forth the computation of basic and diluted
earnings per share (in thousands, except per share data):
2006 2005 2004
---- ---- ----
Undistributed earnings:
Net income ....................................... $ 15,787 $ 33,269 $ 45,848
Less - preferred stock dividends.................. (70) (70) (436)
--------- -------- ---------
Undistributed earnings - basic EPS................ 15,717 33,199 45,412
Add - preferred stock dividends................... 70 70 436
Add - interest expense on convertible
notes, net of tax.............................. - 4,099 3,507
--------- -------- ---------
Net income - diluted EPS.......................... $ 15,787 $ 37,368 $ 49,355
========= ======== =========
Allocation of undistributed earnings:
Class A common stock.............................. $ 12,089 $ 24,316 $ 32,391
Class B common stock.............................. 3,628 8,883 13,021
--------- -------- ---------
Total allocated earnings - basic EPS........... $ 15,717 $ 33,199 $ 45,412
========= ======== =========
Weighted average shares outstanding - basic:
Class A common stock.............................. 36,277 34,228 33,046
Class B common stock.............................. 13,065 15,005 15,941
--------- -------- ---------
Total weighted average shares
outstanding - basic......................... 49,342 49,233 48,987
--------- -------- ---------
Effect of dilutive securities:
Employee stock options............................ 1,049 1,205 1,760
Convertible preferred stock....................... 338 338 338
Convertible notes................................. - 8,692 7,623
--------- -------- ---------
Dilutive potential common shares............... 1,387 10,235 9,721
--------- -------- ---------
Total weighted average shares
outstanding - diluted....................... 50,729 59,468 58,708
========= ======== =========
Basic earnings per share:
Class A common stock.............................. $ 0.33 $ 0.71 $ 0.98
Class B common stock.............................. 0.28 0.59 0.82
Diluted earnings per share(1) (2).................... 0.31 0.63 0.84
========= ======== =========
<FN>
- -----------------------
(1) Excluded from the computation of diluted earnings per share were
outstanding stock options whose exercise prices were greater than
the average market price of the common shares for the period
reported. For the years ended March 31, 2006, 2005 and 2004,
excluded from the computation were options to purchase 942, 713 and
207 of Class A and Class B common shares, respectively.
(2) For the year ended March 31, 2006, $200,000 principal amount of
Convertible Subordinated Notes convertible into 8,692 shares of
Class A common stock were excluded from the computation of diluted
earnings per share because their effect would have been
anti-dilutive.
90
20. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
---------------------------------------
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- ----
YEAR ENDED MARCH 31, 2006
- -------------------------
Net revenues............................... $ 85,475 $96,321 $98,392 $87,430 $367,618
Gross profit............................... 59,273 62,277 64,651 57,523 243,724
Pretax income (loss)....................... (17,664) 17,316 20,923 18,335 38,910
Net income (loss).......................... (21,944) 11,515 14,414 11,802 15,787
Basic earnings (loss) per share:
Class A common stock.................... (0.45) 0.24 0.31 0.25 0.33
Class B common stock.................... (0.45) 0.20 0.25 0.21 0.28
Diluted earnings (loss) per share.......... (0.45) 0.21 0.26 0.21 0.31
YEAR ENDED MARCH 31, 2005
- -------------------------
Net revenues............................... $ 66,087 $79,322 $86,857 $71,227 $303,493
Gross profit............................... 42,353 52,466 56,922 44,070 195,811
Pretax income (loss)....................... 11,543 19,591 20,062 (1,168) 50,028
Net income (loss).......................... 7,561 12,676 13,552 (520) 33,269
Basic earnings (loss) per share:
Class A common stock.................... 0.16 0.27 0.29 (0.01) 0.71
Class B common stock.................... 0.14 0.23 0.24 (0.01) 0.59
Diluted earnings (loss) per share.......... 0.14 0.23 0.25 (0.01) 0.63
91
21. SEGMENT REPORTING
-----------------
The reportable operating segments of the Company are branded
products, specialty generics and specialty materials. The Company
has aggregated its branded product lines in a single segment
because of similarities in regulatory environment, manufacturing
processes, methods of distribution and types of customer. This
segment includes patent-protected products and certain trademarked
off-patent products that the Company sells and markets as brand
pharmaceutical products. The specialty generics business segment
includes off-patent pharmaceutical products that are
therapeutically equivalent to proprietary products. The Company
sells its brand and generic products primarily to pharmaceutical
wholesalers, drug distributors and chain drug stores. The specialty
materials segment is distinguished as a single segment because of
differences in products, marketing and regulatory approval when
compared to the other segments.
Accounting policies of the segments are the same as the Company's
consolidated accounting policies. Segment profits are measured
based on income before taxes and are determined based on each
segment's direct revenues and expenses. The majority of research
and development expense, corporate general and administrative
expenses, amortization and interest expense, as well as interest
and other income, are not allocated to segments, but included in
the "all other" classification. Identifiable assets for the three
reportable operating segments primarily include receivables,
inventory, and property and equipment. For the "all other"
classification, identifiable assets consist of cash and cash
equivalents, corporate property and equipment, intangible and other
assets and all income tax related assets.
The following represents information for the Company's reportable
operating segments for fiscal 2006, 2005 and 2004.
FISCAL YEAR
ENDED BRANDED SPECIALTY SPECIALTY ALL
MARCH 31, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED
--------- -------- -------- --------- ----- ------------ ------------
------------------------------------------------------------------------------------------------------------------------
NET REVENUES
2006 $145,435 $203,833 $16,988 $ 1,362 $ - $367,618
2005 90,085 193,402 18,345 1,661 - 303,493
2004 82,868 182,825 16,550 1,698 - 283,941
-----------------------------------------------------------------------------------------------------------------------
SEGMENT PROFIT (LOSS)
2006 58,648 100,806 1,082 (121,626) - 38,910
2005 24,307 104,469 3,043 (81,521) - 50,028
2004 31,661 102,533 1,365 (65,561) - 69,998
-----------------------------------------------------------------------------------------------------------------------
IDENTIFIABLE ASSETS
2006 23,891 63,431 7,353 524,496 (1,158) 618,013
2005 25,015 67,209 8,001 459,250 (1,158) 558,317
2004 24,585 70,966 8,343 425,702 (1,158) 528,438
-----------------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT ADDITIONS
2006 540 1,097 269 56,428 - 58,334
2005 2,463 - 318 60,841 - 63,622
2004 420 1,685 71 28,416 - 30,592
-----------------------------------------------------------------------------------------------------------------------
DEPRECIATION AND AMORTIZATION
2006 587 317 173 16,925 - 18,002
2005 217 235 140 13,312 - 13,904
2004 332 123 141 12,067 - 12,663
-----------------------------------------------------------------------------------------------------------------------
Consolidated revenues are principally derived from customers in North
America and substantially all property and equipment is located in St.
Louis, Missouri.
92
22. SUBSEQUENT EVENT
----------------
On June 9, 2006, the Company replaced its $140,000 credit line by
entering into a new credit agreement with ten banks that provides
for a revolving line of credit for borrowing up to $320,000. The
new credit agreement also includes a provision for increasing the
revolving commitment, at the lenders' sole discretion, by up to an
additional $50,000. The new credit facility is unsecured unless the
Company, under certain specified circumstances, utilizes the
facility to redeem part or all of its outstanding Convertible
Subordinated Notes. Interest is charged under the facility at the
lower of the prime rate or one-month LIBOR plus 62.5 to 150 basis
points depending on the ratio of senior debt to EBITDA. The new
credit agreement contains financial covenants that impose limits on
dividend payments, require minimum equity, a maximum senior
leverage ratio and minimum fixed charge coverage ratio. The new
credit facility has a five-year term expiring in June 2011.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
There have been no disagreements with accountants on accounting or
financial disclosure matters.
ITEM 9A. CONTROLS AND PROCEDURES
-----------------------
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in its
Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and
forms, and that such information is accumulated and communicated to
the Company's management, including its principal executive officer
and principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure. In designing and
evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management
necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
As of the end of the period covered by this report, the Company
carried out an evaluation, under the supervision and with the
participation of its management, including its principal executive
officer and principal financial officer, of the effectiveness of
the design and operation of its disclosure controls and procedures.
Based on the foregoing, the Company's principal executive officer
and principal financial officer concluded that the Company's
disclosure controls and procedures were effective as of the end of
the period covered by this report.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of the Company is responsible for establishing and
maintaining adequate internal control over financial reporting. The
Company's internal control over financial reporting is designed to
provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting
principles.
The Company's internal control over financial reporting includes
those policies and procedures that (i) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
Company; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements
in accordance with generally accepted accounting principles, and
that receipts and expenditures of the Company are being made only
in accordance with authorizations of management and directors of
the Company; and (iii) provide reasonable assurance regarding the
prevention or timely detection of unauthorized acquisition, use or
disposition of the Company's assets that could have a material
effect on the financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
Management performed an assessment of the effectiveness of the
Company's internal control over financial reporting as of March 31,
2006. Management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in
Internal Control - Integrated Framework. As a result of
93
this assessment and based on the criteria set forth in the COSO
framework, management has concluded that, as of March 31, 2006, the
Company's internal control over financial reporting was effective.
Management's assessment of the effectiveness of the Company's
internal control over financial reporting as of March 31, 2006 has
been audited by KPMG LLP, an independent registered public
accounting firm, as stated in their report appearing herein.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There have been no changes in the Company's internal control over
financial reporting, during the fiscal quarter ended March 31,
2006, that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial
reporting.
94
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors and Shareholders
K-V Pharmaceutical Company:
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that K-V
Pharmaceutical Company maintained effective internal control over financial
reporting as of March 31, 2006, based on the criteria established in
Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is
responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control
over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether effective internal control over financial reporting was maintained
in all material respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating management's
assessment, testing and evaluating the design and operating effectiveness of
internal control, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles. A company's
internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that K-V Pharmaceutical Company
maintained effective internal control over financial reporting as of March
31, 2006, is fairly stated, in all material respects, based on the criteria
established in Internal Control--Integrated Framework issued by COSO. Also,
in our opinion, K-V Pharmaceutical Company maintained, in all material
respects, effective internal control over financial reporting as of March
31, 2006, based on criteria established in Internal Control--Integrated
Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets
of K-V Pharmaceutical Company and subsidiaries as of March 31, 2006 and
2005, and the related consolidated statements of income, comprehensive
income, shareholders' equity, and cash flows for the years then ended, and
our report dated June 14, 2006 expressed an unqualified opinion on those
consolidated financial statements.
/S/ KPMG LLP
St. Louis, Missouri
June 14, 2006
95
ITEM 9B. OTHER INFORMATION
-----------------
ETHEX Corporation and Patricia McCullough entered into an Employment and
Confidential Information Agreement dated as of January 30, 2006. Under the
terms of the agreement, Ms. McCullough will serve as ETHEX's Chief Executive
Officer. Ms. McCullough will receive a base annual salary of $285,000 and
relocation and fringe benefits normally provided to other employees in
comparable positions, subject to normal compensation review. Ms. McCullough
will be eligible for an incentive bonus and will be granted options to
purchase 50,000 shares of KV Class A common stock. The term of the agreement
is through April 1, 2007, subject to successive automatic renewals of one
year unless earlier terminated. Either party may terminate the agreement
upon 120 days advance written notice to the other, provided ETHEX may
terminate the agreement at any time for what it believes to be cause. For
the 36 month period following termination of the agreement, Ms. McCullough
will be subject to certain non-competition and non-solicitation covenants.
Ms. McCullough also agrees to maintain the confidentiality of all
confidential information of ETHEX and its affiliates.
Effective February 20, 2006, the Company and Michael Anderson entered into
an amendment to Mr. Anderson's Employment and Confidential Information
Agreement. Under the amendment, Mr. Anderson's title is changed to Corporate
Vice President, Industry Presence and Development, and his base salary is
changed to $332,000. The term of the agreement is extended until March 31,
2011, subject to successive automatic renewals of one year unless earlier
terminated. The amendment also permits Mr. Anderson to terminate the
agreement upon six months notice due to health problems confirmed by a
physician.
Ther-Rx Corporation and Jerald J. Wenker entered into an Employment and
Confidential Information Agreement dated as of April 8, 2004. Under the
terms of the agreement, Mr. Wenker will serve as Ther-Rx's President. Mr.
Wenker will receive a base annual salary of $350,000 and relocation and
fringe benefits normally provided to other employees in comparable
positions, subject to normal compensation review. Mr. Wenker will be
eligible for an incentive bonus and will be granted options to purchase
shares of KV Class A common stock. The term of the agreement is through
March 31, 2005, subject to successive automatic renewals of one year unless
earlier terminated. Mr. Wenker may terminate the agreement upon 120 days
advance written notice to the Ther-Rx. Ther-Rx may terminate the agreement
upon 30 days advance written notice to the Mr. Wenker, provided Ther-Rx may
terminate the agreement at any time for what it believes to be cause. For
the 36 month period following termination of the agreement, Mr. Wenker will
be subject to certain non-competition and non-solicitation covenants. Mr.
Wenker also agrees to maintain the confidentiality of all confidential
information of Ther-Rx and its affiliates.
On June 9, 2006, the Company replaced its $140 million credit line by
entering into a credit agreement with LaSalle Bank National Association,
Citibank, F.S.B and the other lenders thereto. This new credit agreement
with ten banks provides the Company with a revolving line of credit for
borrowing up to $320 million. The new credit agreement also includes a
provision for increasing the revolving commitment, at the lenders' sole
discretion, by up to an additional $50 million. The credit facility is
unsecured unless the Company, under certain specified circumstances,
utilizes the facility to redeem part or all of its outstanding Convertible
Subordinated Notes. Interest is charged under the facility at the lower of
the prime rate or one-month LIBOR plus 62.5 to 150 basis points depending on
the ratio of the Company's senior debt to EBITDA. The new credit agreement
contains financial covenants that impose limits on dividend payments,
require minimum equity, a maximum senior leverage ratio and minimum fixed
charge coverage ratio. The new credit facility has a five-year term expiring
in June 2011.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
--------------------------------------------------
The information contained under the caption "INFORMATION CONCERNING
NOMINEES AND DIRECTORS CONTINUING IN OFFICE" in the Company's
definitive proxy statement to be filed pursuant to Regulation 14(a)
for its 2006 Annual Meeting of Shareholders, which involves the
election of directors, is incorporated herein by this reference.
Also see Item 4(a) of Part I hereof.
ITEM 11. EXECUTIVE COMPENSATION
----------------------
The information contained under the captions "EXECUTIVE
COMPENSATION" and "INFORMATION AS TO STOCK OPTIONS" in the
Company's definitive proxy statement to be filed pursuant to
Regulation 14(a) for its 2006 Annual Meeting of Shareholders is
incorporated herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
The information contained under the captions "SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS" and "SECURITY OWNERSHIP OF MANAGEMENT"
in the Company's definitive proxy statement to be filed pursuant to
Regulation 14(a) for its 2006 Annual Meeting of Shareholders is
incorporated herein by this reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------
The information contained under the caption "TRANSACTIONS WITH
DIRECTORS AND EXECUTIVE OFFICERS" in the Company's definitive proxy
statement to be filed pursuant to Regulation 14(a) for its 2006
Annual Meeting of Shareholders is incorporated herein by this
reference.
96
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
--------------------------------------
The information contained under the caption "FEES PAID TO
INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS" in the Company's
definitive proxy statement to be filed pursuant to Regulation 14(a)
for its 2006 Annual Meeting of Shareholders is incorporated herein
by this reference.
97
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
---------------------------------------
(a) 1. Financial Statements: Page
The following consolidated financial statements of the Company
are included in Part II, Item 8:
Report of Independent Registered Public Accounting Firm.......... 62
Report of Independent Registered Public Accounting Firm.......... 63
Consolidated Balance Sheets as of March 31, 2006 and 2005........ 64
Consolidated Statements of Income for the Years Ended March 31,
2006, 2005 and 2004.............................................. 65
Consolidated Statements of Comprehensive Income for the Years
Ended March 31, 2006, 2005 and 2004.............................. 66
Consolidated Statements of Shareholders' Equity for the Years
Ended March 31, 2006, 2005 and 2004.............................. 67
Consolidated Statements of Cash Flows for the Years Ended
March 31, 2006, 2005 and 2004.................................... 68
Notes to Financial Statements.................................... 69-93
Controls and Procedures.......................................... 93
Evaluation of Disclosure Controls and Procedures................. 93
Management's Report on Internal Control over Financial
Reporting........................................................ 93-94
Changes in Internal Control over Financial Reporting............. 94
Report of Independent Registered Public Accounting Firm.......... 95
2. Financial Statement Schedules:
Report of Independent Registered Public Accounting Firm regarding
Financial Statement Schedule..................................... 100
Schedule II - Valuation and Qualifying Accounts.................. 101
98
(b) Exhibits. See Exhibit Index on pages 104 through 108 of this Report.
Management contracts and compensatory plans are designated on the
Exhibit Index.
(c) Financial Statement Schedules.
99
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors
K-V Pharmaceutical Company
The audit referred to in our report dated June 4, 2004, relating to the
consolidated financial statements of K-V Pharmaceutical Company, which are
included in Item 8 of this Form 10-K, included the audit of the accompanying
financial statement schedule for the year ended March 31, 2004. This
financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion on this financial
statement schedule based upon our audit. In our opinion, the 2004 financial
statement schedule presents fairly, in all material respects, the
information set forth therein.
/s/ BDO SEIDMAN, LLP
Chicago, Illinois
June 4, 2004
100
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
BALANCE AT CHARGED TO AMOUNTS BALANCE
BEGINNING COSTS AND CHARGED TO AT END
OF YEAR EXPENSES RESERVES OF YEAR
------- -------- -------- -------
(in thousands)
Year Ended March 31, 2004:
Allowance for doubtful accounts............ $ 422 $ (20) $ - $ 402
Reserves for sales allowances.............. 29,658 103,262 112,272 20,648
Inventory obsolescence..................... 1,003 2,442 2,443 1,002
--------- --------- --------- --------
$ 31,083 $ 105,684 $ 114,715 $ 22,052
========= ========= ========= ========
Year Ended March 31, 2005:
Allowance for doubtful accounts............ $ 402 $ 235 $ 176 $ 461
Reserves for sales allowances.............. 20,648 133,475 133,067 21,056
Inventory obsolescence..................... 1,002 3,182 2,891 1,293
--------- --------- --------- --------
$ 22,052 $ 136,892 $ 136,134 $ 22,810
========= ========= ========= ========
Year Ended March 31, 2006:
Allowance for doubtful accounts............ $ 461 $ (49) $ 15 $ 397
Reserves for sales allowances.............. 21,056 154,368 146,107 29,317
Inventory obsolescence..................... 1,293 4,215 3,808 1,700
--------- --------- --------- --------
$ 22,810 $ 158,534 $ 149,930 $ 31,414
========= ========= ========= ========
Financial statements of K-V Pharmaceutical Company (separately) are omitted
because KV is primarily an operating company and its subsidiaries included
in the financial statements are wholly-owned and are not materially indebted
to any person other than through the ordinary course of business.
101
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
K-V PHARMACEUTICAL COMPANY
Date: June 14, 2006 By /s/ Marc S. Hermelin
----------------- ------------------------------------
Vice Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: June 14, 2006 By /s/ Gerald R. Mitchell
----------------- ------------------------------------
Vice President and Chief Financial
Officer
(Principal Financial Officer)
Date: June 14, 2006 By /s/ Richard H. Chibnall
----------------- -----------------------------------
Vice President, Finance
(Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on the dates indicated by the following persons
on behalf of the Company and in their capacities as members of the Board of
Directors of the Company:
Date: June 14, 2006 By /s/ Marc S. Hermelin
----------------- -----------------------------------
Marc S. Hermelin
Date: June 14, 2006 By /s/ Victor M. Hermelin
----------------- -----------------------------------
Victor M. Hermelin
Date: June 14, 2006 By /s/ Norman D. Schellenger
----------------- -----------------------------------
Norman D. Schellenger
Date: June 14, 2006 By /s/ Gerald R. Mitchell
----------------- -----------------------------------
Gerald R. Mitchell
Date: June 14, 2006 By /s/ Kevin S. Carlie
----------------- -----------------------------------
Kevin S. Carlie
Date: June 14, 2006 By /s/ David A. Van Vliet
----------------- -----------------------------------
David A. Van Vliet
Date: June 14, 2006 By /s/ Jean M. Bellin
----------------- -----------------------------------
Jean M. Bellin
102
Date: June 14, 2006 By /s/ Terry B. Hatfield
----------------- -----------------------------------
Terry B. Hatfield
Date: June 14, 2006 By /s/ David S. Hermelin
----------------- -----------------------------------
David S. Hermelin
103
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
3(a) The Company's Certificate of Incorporation, which was
filed as Exhibit 3(a) to the Company's Annual Report on
Form 10-K for the year ended March 31, 1981, is
incorporated herein by this reference.
3(b) Certificate of Amendment to Certificate of Incorporation
of the Company, effective March 7, 1983, which was filed
as Exhibit 3(c) to the Company's Annual Report on Form
10-K for the year ended March 31, 1983, is incorporated
herein by this reference.
3(c) Certificate of Amendment to Certificate of Incorporation
of the Company, effective June 9, 1987, which was filed as
Exhibit 3(d) to the Company's Annual Report on Form 10-K
for the year ended March 31, 1988, is incorporated herein
by this reference.
3(d) Certificate of Amendment to Certificate of Incorporation
of the Company, effective September 24, 1987, which was
filed as Exhibit 3(f) to the Company's Annual Report on
Form 10-K for the year ended March 31, 1988, is
incorporated herein by this reference.
3(e) Certificate of Amendment to Certificate of Incorporation
of the Company, effective July 17, 1986, which was filed
as Exhibit 3(e) to the Company's Annual Report on Form
10-K for the year ended March 31, 1996, is incorporated
herein by this reference.
3(f) Certificate of Amendment to Certificate of Incorporation
of the Company, effective December 23, 1991, which was
filed as Exhibit 3(f) to the Company's Annual Report on
Form 10-K for the year ended March 31, 1996, is
incorporated herein by this reference.
3(g) Certificate of Amendment to Certificate of Incorporation
of the Company, effective September 3, 1998, which was
filed as Exhibit 4(g) to the Company's Registration
Statement on Form S-3 (Registration Statement No.
333-87402), filed May 1, 2002, is incorporated herein by
this reference.
3(h) Bylaws of the Company, as amended through November 18,
1982, which was filed as Exhibit 3(e) to the Company's
Annual Report on Form 10-K for the year ended March 31,
1993, is incorporated herein by this reference.
3(i) Amendment to Bylaws of the Company, effective July 2,
1984, which was filed as Exhibit 4(i) to the Company's
Registration Statement on Form S-3 (Registration Statement
No. 333-87402), filed May 1, 2002, is incorporated herein
by this reference.
3(j) Amendment to Bylaws of the Company, effective December 4,
1986, which was filed as Exhibit 4(j) to the Company's
Registration Statement on Form S-3 (Registration Statement
No. 333-87402), filed May 1, 2002, is incorporated herein
by this reference.
3(k) Amendment to Bylaws of the Company effective March 17,
1992, which was filed as Exhibit 4(k) to the Company's
Registration Statement on Form S-3 (Registration Statement
No. 333-87402), filed May 1, 2002, is incorporated herein
by this reference.
3(l) Amendment to Bylaws of the Company effective November 18,
1992, which was filed as Exhibit 4(l) to the Company's
Registration Statement on Form S-3 (Registration Statement
No. 333-87402), filed May 1, 2002, is incorporated herein
by this reference.
104
3(m) Amendment to Bylaws of the Company, effective December 30,
1993, which was filed as Exhibit 3(h) to the Company's
Annual Report on Form 10-K for the year ended March 31,
1996, is incorporated herein by this reference.
3(n) Amendment to Bylaws of the Company, effective September
24, 2002, which was filed as Exhibit 4(n) to the Company's
Registration Statement on Form S-3 (Registration Statement
No. 333-106294), filed June 19, 2003, is incorporated
herein by this reference.
3(o) Amendment to Bylaws of the Company, effective June 28,
2004, which increased the size of the board of directors
from seven to ten, filed herewith.
3(p) Amendment to Bylaws of the Company, effective September 9,
2004, which decreased the size of the board of directors
from ten to nine, filed herewith.
4(a) Certificate of Designation of Rights and Preferences of 7%
Cumulative Convertible preferred stock of the Company,
effective June 9, 1987, and related Certificate of
Correction, dated June 17, 1987, which was filed as
Exhibit 4(f) to the Company's Annual Report on Form 10-K
for the year ended March 31, 1987, is incorporated herein
by this reference.
4(b) Indenture dated as of May 16, 2003, by and between the
Company and Deutsche Bank Trust Company Americas, filed on
May 21, 2003, as Exhibit 4.1 to the Company's Current
Report on Form 8-K, is incorporated herein by this
reference.
4(c) Registration Rights Agreement dated as of May 16, 2003, by
and between the Company and Deutsche Bank Securities,
Inc., as representative of the several Purchasers, filed
on May 21, 2003 as Exhibit 4.2 to the Company's Current
Report on Form 8-K, is incorporated herein by this
reference.
4(d) Amended and Restated Loan Agreement, dated December 31,
2004 between the Company and its subsidiaries, LaSalle
National Bank Association and Citibank, F.S.B., filed on
January 18, 2005, as Exhibit 10.2 to the Company's Current
Report on Form 8-K, is incorporated herein by this
reference.
4(e) Promissory Note, dated March 23, 2006 between MECW, LLC
and LaSalle National Bank Association, filed on March 29,
2006, as exhibit 99 to the Company's Current Report on
Form 8-K, is incorporated herein by this reference.
4(f) Second Amendment to Amended and Restated Loan Agreement,
dated March 20, 2006 between the Company and its
subsidiaries, LaSalle National Bank Association and
Citibank, F.S.B., filed herewith.
4(g) Credit Agreement, dated as of June 9, 2006, among the
Company and its subsidiaries, LaSalle Bank National
Association, Citibank, F.S.B. and the other lenders thereto,
filed herewith.
10(a)* Restated and Amended Employment Agreement between the
Company and Gerald R. Mitchell, Vice President, Finance,
dated as of March 31, 1994, is incorporated herein by this
reference.
10(b)* Employment Agreement between the Company and Raymond F.
Chiostri, Corporate Vice-President and
President-Pharmaceutical Division, which was filed as
Exhibit 10(l) to the Company's Annual Report on Form 10-K
for the year ended March 31, 1992, is incorporated herein
by this reference.
10(c) Lease of the Company's facility at 2503 South Hanley Road,
St. Louis, Missouri, and amendment thereto, between the
Company as Lessee and Marc S. Hermelin as Lessor, which
was filed as Exhibit 10(n) to the Company's Annual Report
on Form 10-K for the year ended March 31, 1983, is
incorporated herein by this reference.
105
10(d) Amendment to the Lease for the facility located at 2503
South Hanley Road, St. Louis, Missouri, between the
Company as Lessee and Marc S. Hermelin as Lessor, which
was filed as Exhibit 10(p) to the Company's Annual Report
on Form 10-K for the year ended March 31, 1992, is
incorporated herein by this reference.
10(e)* KV Pharmaceutical Company Fourth Restated Profit Sharing
Plan and Trust Agreement dated September 18, 1990, which
was filed as Exhibit 4.1 to the Company's Registration
Statement on Form S-8 No. 33-36400, is incorporated herein
by this reference.
10(f)* First Amendment to the KV Pharmaceutical Company Fourth
Restated Profit Sharing Plan and Trust dated September 18,
1990, is incorporated herein by this reference.
10(g)* Fourth Amendment to and Restatement, dated as of January
2, 1997, of the KV Pharmaceutical Company 1991 Incentive
Stock Option Plan, which was filed as Exhibit 10(y) to the
Company's Annual Report on Form 10-K for the year ended
March 31, 1997, is incorporated herein by this reference.
10(h)* Agreement between the Company and Marc S. Hermelin, Vice
Chairman, dated December 16, 1996, with supplemental
letter attached, which was filed as Exhibit 10(z) to the
Company's Annual Report on Form 10-K for the year ended
March 31, 1997, is incorporated herein by this reference.
10(i) Amendment to Lease dated February 17, 1997, for the
facility located at 2503 South Hanley Road, St. Louis,
Missouri, between the Company as Lessee and Marc S.
Hermelin as Lessor, which was filed as Exhibit 10(aa) to
the Company's Annual Report on Form 10-K for the year
ended March 31, 1997, is incorporated herein by this
reference.
10(j)* Amendment, dated as of October 30, 1998, to Employment
Agreement between the Company and Marc S. Hermelin, which
was filed as Exhibit 10(ee) to the Company's Annual Report
on Form 10-K for the year ended March 31, 1999, is
incorporated herein by this reference.
10(k) Exclusive License Agreement, dated as of April 1, 1999
between Victor M. Hermelin as licenser and the Company as
licensee, which was filed as Exhibit 10(ff) to the
Company's Annual Report on Form 10-K for the year ended
March 31, 1999 is incorporated herein by this reference.
10(l)* Amendment, dated December 2, 1999, to Employment Agreement
between the Company and Marc S. Hermelin, Vice-Chairman,
which was filed as Exhibit 10(ii) to the Company's Annual
Report on Form 10-K for the year ended March 31, 2000, is
incorporated by this reference.
10(n)* Consulting Agreement, dated as of May 1, 1999, between the
Company and Victor M. Hermelin, Chairman, which was filed
as Exhibit 10(kk) to the Company's Annual Report on Form
10-K for the year ended March 31, 2000, is incorporated by
this reference.
10(o)* Stock Option Agreement dated as of April 9, 2001, granting
a stock option to Kevin S. Carlie, which was filed as
Exhibit 10(ii) to the Company's Annual Report on Form 10-K
for the year ended March 31, 2002, is incorporated herein
by this reference.
10(p)* Stock Option Agreement dated as of July 26, 2002, granting
a stock option to Marc S. Hermelin, which was filed as
Exhibit 10(rr) to the Company's Annual Report on Form 10-K
for the year ended March 31, 2003, is incorporated herein
by this reference.
106
10(q) License Agreement by and between the Company and
FemmePharma, Inc., dated as of April 18, 2002, which was
filed as Exhibit 10(tt) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(r) Stock Purchase Agreement by and between the Company and
FemmePharma, Inc., dated as of April 18, 2002, which was
filed as Exhibit 10(uu) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(s) Product Acquisition Agreement by and between the Company
and Schwarz Pharma dated as of March 31, 2003, which was
filed as Exhibit 10(vv) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(t) Product Acquisition Agreement by and between the Company
and Altana Inc. dated as of March 31, 2003, which was
filed as Exhibit 10(ww) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(u) Stock Option Agreement dated as of May 30, 2003, granting
a stock option to Marc S. Hermelin, which was filed as
Exhibit 10(yy) to the Company's Annual Report on Form 10-K
for the year ended March 31, 2004, is incorporated herein
by this reference.
10(v)* Amendment, dated November 5, 2004, to Employment Agreement
between the Company and Marc S. Hermelin, Vice-Chairman,
which was filed as Exhibit 10(a) to the Company's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 2004, is incorporated herein by this
reference.
10(w) Agreement and Plan of Merger by and among K-V
Pharmaceutical Company, Kestrel-Falcon Acquisition
Corporation, FP1096, Inc., and FemmePharma Holding
Company, Inc., dated as of May 4, 2005, which was filed as
Exhibit 10(ww) to the Company's Annual Report on Form 10-K
for the year ended March 31, 2005, is incorporated herein
by this reference.
10(x)* K-V Pharmaceutical 2001 Incentive Stock Option Plan, which
was filed as Exibit 10.1 to the Company's Current report
on Form 8-K filed November 22, 2005, is incorporated by
this reference.
10(y)* Form of 2001 Incentive Stock Option Plan Award Agreement
for Employees, which was filed as Exhibit 10.2 to the
Company's Current Report on Form 8-K filed November 22,
2005, is incorporated by this reference.
10(z)* Form of 2001 Incentive Stock Option Plan Award Agreement
for Directors, which was filed as Exhibit 10.3 to the
Company's Current Report on Form 8-K filed November 22,
2005, is incorporated by this reference.
10(aa)* Employment Agreement between ETHEX and Patricia McCullough,
Chief Executive Officer of ETHEX, dated January 30, 2006,
filed herewith.
10(bb)* Employment Agreement between the Company and Michael S.
Anderson, Corporate Vice President, Industry Presence and
Development, dated May 23, 1994, and amendments thereto,
filed herewith.
10(cc)* Employment Agreement between Ther-Rx and Jerald J. Wenker,
President of Ther-Rx, dated April 8, 2004, filed herewith.
21 List of Subsidiaries, filed herewith.
23.1 Consent of KPMG LLP, filed herewith.
23.2 Consent of BDO Seidman, LLP, filed herewith.
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) or Rule 15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, is filed
herewith.
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) or Rule 15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, is filed
herewith.
107
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
filed herewith.
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
filed herewith.
<FN>
*Management contract or compensation plan.
108