UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER 1-9601
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K-V PHARMACEUTICAL COMPANY
(Exact name of registrant as specified in its charter)
DELAWARE 43-0618919
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2503 SOUTH HANLEY ROAD, ST. LOUIS, MISSOURI 63144
(Address of principal executive offices, including ZIP code)
Registrant's telephone number, including area code: (314) 645-6600
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
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Indicate by check mark whether the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark whether the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [ X ]
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 [ ] No [ X ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (229.405 of this chapter) 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. (See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act). (Check
one):
Large accelerated filer [ X ] Accelerated filer [ ] 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, 2006, the last
business day of the registrant's most recently completed second fiscal
quarter, was $764,402,618 and $108,099,019, respectively. As of January 15,
2008, the registrant had outstanding 37,708,248 and 12,233,802 shares of Class
A Common Stock and Class B Common Stock, respectively. Documents incorporated
by reference: None
EXPLANATORY NOTE REGARDING RESTATEMENT OF OUR CONSOLIDATED FINANCIAL
STATEMENTS
This Annual Report on Form 10-K contains the restatement of our consolidated
statements of income, comprehensive income, shareholders' equity and cash
flows for the fiscal years ended March 31, 2006 and 2005, and our consolidated
balance sheet as of March 31, 2006. In addition, because the impacts of the
restatement adjustments extend back to the fiscal year ended March 31, 1996,
we have recognized the cumulative restatement adjustments through March 31,
2004 as a net decrease to beginning shareholders' equity as of April 1, 2004.
In addition, for purposes of Item 6, Selected Financial Data for the years
ended March 31, 2004 and 2003, the cumulative restatement adjustments through
March 31, 2002 have been recognized as a net decrease to beginning
shareholders' equity as of April, 1 2002 and the fiscal years 2003 and 2004
impacts associated with such items have been reflected in our consolidated
balance sheet and statement of income data set forth in Item 6, Selected
Financial Data in this Form 10-K. We have not amended, and we do not intend to
amend, our previously filed Annual Reports on Form 10-K or Quarterly Reports
on Form 10-Q for each of the fiscal years and fiscal quarters of 1996 through
2006. We have amended our Quarterly Report on Form 10-Q for the quarter ended
June 30, 2006, the first quarter of our fiscal 2007 year, and filed Quarterly
Reports on Form 10-Q for the quarters ended September 30, 2006 and December
31, 2006, that contain the restatement of our consolidated financial
statements for certain interim periods as discussed therein.
On October 31, 2006, we announced that we had been served with a derivative
lawsuit filed in St. Louis City Circuit Court alleging that certain stock
option grants to current or former directors and officers between 1995 and
2002 were dated improperly. In accordance with our established corporate
governance procedures, the Board of Directors referred this matter to the
independent members of its Audit Committee (the "Special Committee" or
"Committee").
Shortly thereafter, the Special Committee, assisted by independent legal
counsel and forensic accounting experts engaged by the Committee, commenced an
investigation of our stock option grant practices, with the objective of
evaluating our accounting for stock options for compliance with U.S. Generally
Accepted Accounting Principles ("GAAP") and with the terms of our related
stock option plans over the period January 1, 1995 through October 31, 2006
(the "relevant period").
The investigation has now been completed and our Board of Directors received a
final report on October 2, 2007 from the Special Committee based on facts
disclosed in the course of the investigation and the advice of its independent
legal counsel and forensic accounting experts. The Special Committee found
that our previous accounting for stock-based compensation was not in
accordance with GAAP and that corrections to our previous consolidated
financial statements were required. We agreed with the Committee's findings
and, as a result, our consolidated retained earnings as of March 31, 2006,
incorporate an additional $16.3 million of stock-based compensation expense,
including related payroll taxes, interest and penalties, net of $2.6 million
in income tax benefits. In the course of the Special Committee's
investigation, we were notified by the SEC staff that it had commenced an
investigation with respect to the Company's stock option program. We have
cooperated with the SEC staff and, among other things, provided them with
copies of the Special Committee's report and all documents collected by the
Committee in the course of its review. Recently, the SEC staff, pursuant to a
formal order of investigation, has issued subpoenas for documents, most of
which have already been produced to the SEC staff, and for testimony by
certain employees. The Company expects that the production of any additional
documents called for by the subpoena and the testimony of the employees will
be completed by April 2008.
In addition, and as a separate matter, our consolidated retained earnings as
of March 31, 2006, incorporate an additional $5.4 million of income tax
expense to record additional liabilities associated with tax positions claimed
on tax returns filed for fiscal years 2004, 2005 and 2006 that should have
been recorded in accordance with GAAP, partially offset by certain expected
tax refunds. This adjustment is not related to the accounting for stock-based
compensation expense discussed above.
In addition, our consolidated retained earnings as of March 31, 2006,
incorporate a $0.4 million reduction of net income primarily related to
misstatements of net revenues and cost of sales resulting from improperly
recognized revenue prior to when title and risk of ownership of the product
transferred to the customer.
2
Please see "Review of Stock Option Grant Practices," "Review of Tax Positions"
and "Other Adjustments" in Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and Note 3 "Restatement of
Consolidated Financial Statements" in our consolidated financial statements
for a more detailed discussion related to the investigation of our former
stock option grant practices, review of tax positions and other adjustments.
The effect of these restatements are reflected in our Consolidated Financial
Statements and other supplemental data, including the unaudited quarterly data
and selected financial data included in this Annual Report on Form 10-K.
Financial information included in reports previously filed or furnished by K-V
Pharmaceutical Company for the fiscal periods 1996 through 2006 should not be
relied upon and are superseded by the information in this Annual Report on
Form 10-K.
Management also has determined that as of March 31, 2007, we had material
weaknesses in our internal control over financial reporting related to the
accounting for stock-based compensation, the accounting for income taxes
(unrelated to stock-based compensation) and revenue recognition. As described
in more detail in Item 9A of this Annual Report on Form 10-K, the Company has
undertaken measures designed to remedy these material weaknesses.
3
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 U.S. 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, acquisitions,
revenues, expenditures and other 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 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 timing, and that any period of exclusivity may not be realized; (3)
acceptance and demand for new pharmaceutical products; (4) the impact of
competitive products and pricing, including as a result of so-called
authorized-generic drugs; (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 and/or products manufactured
for the Company under contract manufacturing arrangements with third parties;
(8) the regulatory environment, including regulatory agency and judicial
actions and changes in applicable law or regulations; (9) fluctuations in
revenues and operating results; (10) the difficulty of predicting
international regulatory approval, including 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 litigation; (14) the
restatement of our financial statements for fiscal periods 1996 through 2006
and for the quarter ended June 30, 2006, as well as completion of the
Company's financial statements for the first, second and third quarters of
fiscal 2008; (15) actions by the Securities and Exchange Commission and the
Internal Revenue Service with respect to the Company's stock option grant and
accounting practices; (16) the risks detailed from time to time in our filings
with the Securities and Exchange Commission; (17) actions by NYSE Regulation,
Inc. with respect to the continued listing of the Company's stock on the New
York Stock Exchange; and (18) the impact of credit market disruptions on the
fair value of auction rate securities that the Company has acquired as
short-term investments.
This discussion is not 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 future 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.
4
ITEM 1. BUSINESS
--------
(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 Founder and Chairman Emeritus, invented and obtained
initial patents for early controlled release and enteric coating
which became part of our core business in the 1950's to 1970's and a
platform for later drug delivery emphasis in the 1980's and 1990's.
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 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,
non-branded 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 its own "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. Today, we believe we are a leading, vertically
integrated specialty pharmaceutical marketer.
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 June 2006, we replaced our $140.0 million credit line by entering
into a new syndicated 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 $200.0 million principal amount
of Convertible Subordinated Notes due 2033. 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 credit agreement contains financial covenants that impose
limits on dividend payments, require minimum equity, and restrict our
maximum senior leverage ratio and minimum fixed charge coverage
ratio. The credit facility has a five-year term expiring in June
2011.
In September 2006, we expanded our generic/non-branded cardiovascular
product line when we received approval from the U.S. Food and Drug
Administration ("FDA") to market six strengths of diltiazem
hydrochloride extended-release capsules, the generic version of
Tiazac(R). Incremental sales volume from these new products was $11.5
million in fiscal 2007.
In May 2007, we acquired the U.S. marketing rights to Evamist(TM), a
new low-dose estrogen transdermal spray, from VIVUS, Inc. The product
was formulated with a patented metered-dose transdermal spray system
which is designed to provide an easy, once-daily dose of estrodial
via the skin. Evamist(TM) is the first transdermal spray estrogen
replacement therapy product approved for use in the United States.
Under the terms of the Asset Purchase Agreement, we paid $10.0
million in cash at closing and agreed to make an additional cash
payment of
5
$140.0 million upon final approval of the product by the FDA. Because
the product had not obtained FDA approval when the initial payment
was made at closing, we recorded $10.0 million of in-process research
and development expense during the three months ended June 30, 2007.
The agreement also provides for two future payments upon achievement
of certain net sales milestones. If Evamist(TM) achieves $100.0
million of net sales in a fiscal year, a one-time payment of $10.0
million will be made, and if net sales levels reach $200.0 million in
a fiscal year, a one-time payment of up to $20.0 million will be
made. In July 2007, FDA approval for Evamist(TM) was received and we
paid $140.0 million to VIVUS, Inc. We are in the process of
determining the allocation of the $140.0 million payment and we plan
to launch the product during the fourth quarter of fiscal 2008.
In May 2007, we received FDA approval to market the 100 mg and 200 mg
strengths of metoprolol succinate extended-release tablets, the
generic version of Toprol-XL(R) (marketed by AstraZeneca). 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 these generic formulations. Since we were the
first company to file with the FDA for generic approval of the 100 mg
and 200 mg dosage strengths, we were accorded the opportunity for a
180-day exclusivity period for marketing these two dosage strengths.
We began shipping these two products in July 2007. The total branded
sales volume in the U.S. of Toprol-XL(R) in calendar year 2006 was
$1.7 billion, of which the 100 mg and 200 mg strengths represented
nearly half. We expect to eventually offer all four dosage strengths
of metoprolol succinate extended-release tablets having received the
approval of the 25 mg strength on March 20, 2008 and the anticipated
approval of the 50 mg strength pending FDA approval of our ANDA
application.
In July 2007, we entered into an additional licensing arrangement to
market Clindesse(R) in the People's Republic of China. We have
previously entered into licensing arrangements for the right to
market Clindesse(R) in Spain, Portugal, Andorra, Brazil, Mexico, five
Scandinavian markets and 18 Eastern European countries.
In January 2008, the Company entered into a definitive asset purchase
agreement with CYTYC Prenatal Products and Hologic, Inc. ("CYTYC") to
acquire the U.S. and worldwide rights to Gestiva(TM) (17-alpha
hydroxyprogesterone caproate). The New Drug Application ("NDA") for
Gestiva(TM) is currently before the FDA, pending approval for use in
the prevention of preterm birth in certain categories of pregnant
women. The proposed indication is for women with a history of at
least one spontaneous preterm delivery (i.e., less than 37 weeks),
who are pregnant with a single fetus. Under the terms of the asset
purchase agreement, the Company agreed to pay $82.0 million for
Gestiva(TM), $7.5 million of which was paid at closing. The remainder
is payable on the completion of two milestones: (1) $2.0 million on
the earlier to occur of CYTYC's receipt of acknowledgement from the
FDA that their response to the FDA's October 20, 2006 "approvable"
letter is sufficient for the FDA to proceed with their review of the
NDA or the receipt of FDA's approval of the Gestiva(TM) NDA and (2)
$72.5 million on FDA approval of a Gestiva(TM) NDA, transfer of all
rights in the NDA to the Company and receipt by the Company of
defined launch quantities of finished Gestiva(TM) suitable for
commercial sale. Because the product is not expected to have received
FDA approval by the closing of the transaction, the Company expects
to record $7.5 million when the initial payment is made and $2.0
million when the subsequent milestone payment is made of in-process
research and development expenses.
(C) INDUSTRY SEGMENTS
-----------------
We operate principally in three industry segments, consisting of
branded products marketing, specialty generics marketing and
specialty raw materials marketing. We derive revenues primarily from
directly marketing our own technologically distinguished brand-name
and generic/non-branded 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 23 to our
Consolidated Financial Statements.
6
(D) NARRATIVE DESCRIPTION OF BUSINESS
---------------------------------
OVERVIEW
We are a fully integrated specialty pharmaceutical company that
develops, manufactures, acquires 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 developed a diverse portfolio of drug delivery technologies
which we leverage to create technologically distinguished brand name
and specialty generic/non-branded products. We have 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 1999, Ther-Rx 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 ETHEX incorporate
one or more of our drug delivery technologies.
Our drug delivery technologies play a vital role in our ability to
offer improved and differentiated products in our branded products
portfolio and allow us to develop hard to replicate products that are
marketed through our generic/non-branded products business. We
believe that this differentiation provides substantial competitive
advantages for our products, which has allowed us to establish a
strong record of growth and profitability and a leadership position
in certain segments of our industry. As a result, we have grown net
revenues at a compounded annual growth rate of 15.7% over the four
fiscal years in the period ended March 31, 2007. Ther-Rx has grown
substantially since its inception in 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 generic/non-branded products.
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
7
grew from $145.5 million in fiscal 2006 to $188.7 million in fiscal
2007 and represented 42.5% of our fiscal 2007 total net revenues.
Ther-Rx's cardiovascular product line consists of Micro-K(R), an
extended-release potassium supplement used to replenish electrolytes,
that is used primarily in patients who are on medication which
depletes the levels of potassium in the body. We acquired Micro-K(R)
in 1999 from the pharmaceutical division of Wyeth. Sales of
Micro-K(R) were $7.9 million in fiscal 2007.
We established our women's healthcare franchise through our 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 six 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
U.S.
The first of our internally developed, patented line extensions to
PreCare(R) was PreCare(R) Chewables, the world's first prescription
chewable prenatal vitamin. Ther-Rx's second internally developed
product, PremesisRx(R), 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.
Our sixth product line extension, PreCare Premier(R), provides a wide
range of vitamins and minerals, plus a stool softener, in a small,
easy-to-swallow, once-daily caplet. Sales of our branded prescription
prenatal vitamins increased 44.1% in fiscal 2007 to $72.5 million.
In 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), which we believe is the only
clinically proven and FDA approved controlled release bioadhesive
system. Sales of Gynazole-1(R) were $24.7 million in fiscal 2007. We
have also 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 Scandinavia.
We established our hematinic product line by acquiring two leading
hematinic brands, Chromagen(R) and Niferex(R), in 2003. We
re-launched technology-improved versions of these products mid-way
through fiscal 2004. In fiscal 2006, we introduced two new hematinic
products - Repliva 21/7(TM) and Niferex Gold(R). We believe Repliva
21/7(TM) is a product offering that represents a revolutionary
advancement in iron therapy. Repliva 21/7(TM) has been uniquely
formulated to promote maximum red blood cell regeneration while
minimizing uncomfortable side effects that patients have typically
endured with traditional iron supplements. With Repliva 21/7(TM)
becoming the number one branded oral iron product in the U.S., sales
of our hematinic product line grew to $48.2 million in fiscal 2007, a
31.0% increase over fiscal 2006.
In January 2005, Ther-Rx introduced its second NDA approved product,
Clindesse(R), the first approved single-dose therapy for bacterial
vaginosis. Similar to Gynazole-1(R), Clindesse(R) incorporates our
proprietary VagiSite(TM) bioadhesive drug delivery technology. Since
its launch, Clindesse(R) has gained 26.4% of the intravaginal
bacterial vaginosis market in the U.S. Clindesse(R) generated a 44.6%
increase in sales to $31.8 million in fiscal 2007. We have also
entered into licensing agreements for the right to market
Clindesse(R) in Spain, Portugal, Andorra, Brazil, Mexico, five
Scandinavian markets, 18 Eastern European countries and the People's
Republic of China.
8
In fiscal 2006, we expanded our prescription nutritional franchise
when Ther-Rx introduced Encora(R), a twice-daily prescription
nutritional supplement designed to meet the key nutritional and
preventative health needs of women past their childbearing years.
In May 2007, we acquired the U.S. marketing rights to Evamist(TM), a
new low-dose estrogen transdermal spray, from VIVUS, Inc. The product
was formulated with a patented metered-dose transdermal spray system
which is designed to provide an easy, once-daily dose of estrodial
via the skin. Evamist(TM) is the first transdermal spray estrogen
replacement therapy product approved for use in the United States.
Under the terms of the Asset Purchase Agreement, we paid $10.0
million in cash at closing and agreed to make an additional cash
payment of $140.0 million upon final approval of the product by the
FDA. Because the product had not obtained FDA approval when the
initial payment was made at closing, we recorded $10.0 million of
in-process research and development expense during the three months
ended June 30, 2007. The agreement also provides for two future
payments upon achievement of certain net sales milestones. In July
2007, FDA approval for Evamist(TM) was received and we paid $140.0
million to VIVUS, Inc. We are in the process of determining the
allocation of the $140.0 million payment and we plan to launch the
product during the fourth quarter of fiscal 2008. We believe
Evamist(TM) will significantly augment the women's health offerings
of our branded segment as we leverage the promotion of this product
through our expanded branded sales force.
Based on the addition and development of new products and our
expectation of continued growth in our branded business, Ther-Rx has
expanded its branded sales force to approximately 340 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
differentiate our products and reduce the rate of price erosion
typically experienced in the generic market. ETHEX's net revenues
were $235.6 million for fiscal 2007, which represented 53.1% of our
total net revenues.
We have used our proprietary drug delivery technologies in many of
our generic/non-branded pharmaceutical products. For example, we have
used METER RELEASE(R), one of our proprietary controlled release
technologies, in the only generic equivalent to Norpace(R) CR, an
antiarrhythmic that is taken twice daily. Further, we have used
KV/24(TM) once daily technology in the generic equivalent to
IMDUR(R), a cardiovascular drug that is taken once per day.
9
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 narcotic pain relievers more effective.
Over the past several years, we have introduced a number of new
generic/non-branded products. During the latter part of fiscal 2006,
we received ANDA approvals for five strengths of oxycodone
hydrochloride tablets, three strengths of hydromorphone hydrochloride
tablets and the 30 mg strength of morphine sulfate extended-release
tablets, while in fiscal 2007 we received ANDA approval for six
strengths of diltiazem hydrochloride extended-release capsules. These
generic products generated incremental net revenues of $19.3 million
in fiscal 2007.
In May 2007, we received FDA approval to market the 100 mg and 200 mg
strengths of metoprolol succinate extended-release tablets, the
generic version of Toprol-XL(R). 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 these generic formulations. Since we were the first company to
file with the FDA for generic approval of the 100 mg and 200 mg
dosage strengths, we were accorded the opportunity for a 180-day
exclusivity period for marketing these two dosage strengths. We began
shipping these two products in July 2007. The total branded sales
volume in the U.S. of Toprol-XL(R) in 2006 was $1.7 billion, of which
the 100 mg and 200 mg strengths represented nearly half. We expect to
eventually offer all four dosage strengths of metoprolol succinate
extended-release tablets having received the approval of the 25 mg
strength on March 20, 2008 and the anticipated approval of the 50 mg
strength pending FDA approval of our ANDA application.
In fiscal 2008, we have received ANDA approval for ondansetron 4 mg
and 8 mg orally disintegrating tablets, two new strengths of morphine
sulfate extended-release tablets, the generic equivalent of MS
Contin(R), and the 100 mg and 200 mg strengths of benzonatate USP
capsules, the generic equivalent to Tessalon(R).
In addition to our internal product development efforts, we have
entered into several long-term product development and marketing
license agreements with various generic pharmaceutical developers and
manufacturers. Under these arrangements, the other parties are
responsible for developing, submitting for regulatory approval and
manufacturing the products and we are responsible for exclusively
marketing these products in the territories covered by the
in-licensing agreements. We expect certain products under these
agreements to be filed and/or approved beginning in fiscal 2008.
With the majority of our internal generic/non-branded product
development efforts primarily focused on building our pipeline with
products that use one or more of our 15 drug delivery technologies,
we believe this additional product source will provide an opportunity
to grow our generic/non-branded business by participating in larger
market opportunities which we have not historically pursued. These
new product sources have increased the scope of our
generic/non-branded product pipeline to more than 50 product
opportunities.
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 60 products in its
cardiovascular line, including products to treat angina, arrhythmia
and hypertension, as well as for potassium supplementation. The
cardiovascular line accounted for $101.4 million, or 43.0% of ETHEX's
net revenues in fiscal 2007.
PAIN MANAGEMENT. ETHEX currently markets over 30 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 $46.8 million, or 19.9% of ETHEX's
net revenues in fiscal 2007.
RESPIRATORY. ETHEX currently markets approximately 30 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
10
products in the U.S. today. The cough/cold line accounted for $42.5
million, or 18.0% of ETHEX's net revenues in fiscal 2007.
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 $15.1 million, or
6.4% of ETHEX's net revenues in fiscal 2007.
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. These
categories accounted for $29.8 million, or 12.7% of ETHEX's net
revenues in fiscal 2007.
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, 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 demand at the wholesale level.
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 Ther-Rx and ETHEX. Net revenues for
PDI were $17.4 million in fiscal 2007, which represented 3.9% of our
total net revenues.
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 fiscal 2007, Ther-Rx introduced PreCare
Premier(R), a new prescription prenatal vitamin product. 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, possibly, new therapeutic areas. We have
in place a strong pipeline of potential new products, including our
unique new product for treating endometriosis which is expected to
begin new Phase III trials in fiscal 2008.
CAPITALIZE ON ACQUISITION OPPORTUNITIES. We actively seek acquisition
opportunities for both Ther-Rx and ETHEX. In May 2007, we completed
the acquisition of the U.S. marketing rights to Evamist(TM), a new
low-dose estrogen transdermal spray, from VIVUS, Inc. The NDA for
this product was approved by the FDA in July 2007 and we plan to
introduce Evamist(TM) during the fourth quarter of fiscal 2008.
In January 2008, we entered into a definitive purchase agreement that
gives us full U.S. and worldwide rights to Gestiva(TM) (17-alpha
hydroxyprogesterone caproate) upon approval of the pending
Gestiva(TM) NDA by FDA. Gestiva(TM) is seeking an indication for use
in the prevention of preterm birth in certain categories of pregnant
women. The FDA issued an "approvable" letter for Gestiva(TM) in
October 2006, and a final approval is anticipated in late 2008. The
FDA has granted an Orphan Drug Designation for Gestiva(TM).
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Ther-Rx is also continually looking for platform acquisition
opportunities similar to PreCare(R) around which it 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 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;
o products which are predominantly prescribed by physician
specialists, which can be cost-effectively marketed by a 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 specialist 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 and
development of new products and our expectation of continued growth
in our branded business, Ther-Rx has expanded its branded sales force
to approximately 340 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.
In May 2007, we received FDA approval to market the 100 mg and 200 mg
strengths of metoprolol succinate extended-release tablets, the
generic version of Toprol-XL(R). 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 these generic formulations. Since we were the first company to
file with the FDA for generic approval of the 100 mg and 200 mg
dosage strengths, we were accorded the opportunity for a 180-day
exclusivity period for marketing these two dosage strengths. We began
shipping these two products in July 2007. The total branded sales
volume in the U.S. of Toprol-XL(R) in 2006 was $1.7 billion, of which
the 100 mg and 200 mg strengths represented nearly half. We expect to
eventually offer all four dosage strengths of metoprolol succinate
extended-release tablets having received the approval of the 25 mg
strength on March 20, 2008 and the anticipated approval of the 50 mg
strength pending FDA approval of our ANDA application.
12
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(R),
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 are actively advancing our existing portfolio of drug delivery
technologies and developing or acquiring exciting new technologies
with substantial growth potential. In May 2007, we completed the
acquisition of the U.S. marketing rights to Evamist(TM), a new
low-dose estrogen transdermal spray, from VIVUS, Inc. The product was
formulated with a patented metered-dose transdermal spray system
which is designed to provide an easy, once-daily dose of estrodial
via the skin. Evamist(TM) is the first transdermal spray estrogen
replacement therapy product approved for use in the U.S. The NDA for
this product was approved by the FDA in July 2007 and we plan to
introduce Evamist(TM) during the fourth quarter of fiscal 2008.
In June 2007, we acquired Particle and Coating Technologies Inc.
("PCT"), a privately held, St. Louis-based company. PCT is a particle
coating company which uses its proprietary processes to develop
products for the pharmaceutical, nutritional, veterinary, industrial
and cosmetic markets. PCT's technologies include novel particle
coatings, controlled release, buccal release, fast dissolving
tablets, tastemasking, inhalable particle delivery and PLGA
(polylactic-co-glycolic acid)-based depot-type deliveries, among
others, and are applied to products developed and marketed
internally, as well as out-licensed.
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 or acquisition
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.
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
isosorbide-5-mononitrate (an AB rated generic equivalent to
IMDUR(R)), disopyramide phosphate (an AB rated generic equivalent of
Norpace(R) CR) diltiazem extended-release capsules (an AB rated
generic equivalent to Tiazac(R)) and metoprolol succinate
extended-release tablets (an AB rated generic equivalent to
Toprol-XL(R)).
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.
13
ORAL 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 340 sales representatives and sales management
personnel dedicated to promoting and marketing our branded
pharmaceutical products to 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 six additional line extensions to address
unmet needs, including the launch of PreCare(R) Chewables, Premesis
Rx(R), PreCare(R) Conceive(TM), PrimaCare(R), PrimaCare(R) ONE and
PreCare Premier(TM). 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(R), the first approved
single-dose therapy for bacterial vaginosis. In fiscal 2006, we
introduced Encora(R), a new prescription nutritional supplement
product, and two new hematinic products, Repliva 21/7(TM) and Niferex
Gold(R). In May 2007, we completed the acquisition of the U.S.
marketing rights to Evamist(TM), a new low-dose estrogen transdermal
spray, from VIVUS, Inc. The NDA for this product was approved by the
FDA in July 2007 and we plan to introduce Evamist(TM) during the
fourth quarter of fiscal 2008. 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 demand 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.
During fiscal 2007, our three largest customers accounted for 26%,
21% and 14% of gross revenues. These customers were McKesson Drug
Company, Cardinal Health and Amerisource Corporation, respectively.
In fiscal
14
2006 and 2005, these customers accounted for gross revenues of 27%,
16% and 13%, and 27%, 17% and 12%, 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 24.1% over the past
five fiscal years, reflects our continued commitment to develop new
products and/or technologies through our internal development
programs, and with our external strategic partners.
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
2007, 2006 and 2005, total research and development expenses were
$31.5 million, $28.9 million and $23.5 million, respectively.
All applications for FDA approval must contain information relating
to product formulation, raw material suppliers, stability,
manufacturing processes, packaging, labeling and quality control.
Information to support the bioequivalence of generic drug products or
the safety and effectiveness of new drug products for their intended
use is also required to be submitted. There are generally two types
of applications used for obtaining FDA approval of new products:
* New Drug Application ("NDA"). An NDA is filed when approval
is sought to market a drug with active ingredients that have
not been previously approved by the FDA. NDAs are filed for
newly developed brand products and, in certain instances,
for a new dosage form, a new delivery system or a new
indication for previously approved drugs.
* Abbreviated New Drug Application ("ANDA"). An ANDA is filed
when approval is sought to market a generic equivalent of a
drug product previously approved under an NDA and listed in
the FDA's "Orange Book" or for a new dosage strength or a
new delivery system for a drug previously approved under an
ANDA.
One requirement for FDA approval of NDAs and ANDAs is that our
manufacturing procedures and operations conform to FDA requirements
and guidelines, generally referred to as current Good Manufacturing
Practices ("cGMP"). The requirements for FDA approval encompass all
aspects of the production process, including validation and
recordkeeping, and involve changing and evolving standards.
BRANDED PRODUCT DEVELOPMENT. The process required by the FDA before a
pharmaceutical product, with active ingredients that have not been
previously approved, may be marketed in the United States generally
involves the following:
* laboratory and preclinical tests;
* submission of an Investigational New Drug ("IND")
application, which must become effective before clinical
studies may begin;
* adequate and well-controlled human clinical studies to
establish the safety and efficacy of the proposed product
for its intended use;
15
* submission of an NDA containing the results of the
preclinical tests and clinical studies establishing the
safety and efficacy of the proposed product for its intended
use, as well as extensive data addressing matters such as
manufacturing and quality assurance;
* scale-up to commercial manufacturing; and
* FDA approval of an NDA.
Preclinical tests include laboratory evaluation of the product, its
chemistry, formulation and stability, as well as toxicology and
pharmacology studies to help define the pharmacological profile of
the drug and assess the potential safety and efficacy of the product.
The results of these studies are submitted to the FDA as part of the
IND. They must demonstrate that the product delivers sufficient
quantities of the drug to the bloodstream or intended site of action
to produce the desired therapeutic results before human clinical
trials may begin. These studies must also provide the appropriate
supportive safety information necessary for the FDA to determine
whether the clinical studies proposed to be conducted under the IND
can safely proceed. The IND automatically becomes effective 30 days
after receipt by the FDA unless the FDA, during that 30-day period,
raises concerns or questions about the conduct of the proposed trials
as outlined in the IND. In such cases, the IND sponsor and the FDA
must resolve any outstanding concerns before clinical trials may
begin. In addition, an independent institutional review board must
review and approve any clinical study prior to initiation.
Human clinical studies are typically conducted in three sequential
phases, which may overlap:
* Phase I: The drug is initially introduced into a relatively
small number of healthy human subjects or patients and is
tested for safety, dosage tolerance, mechanism of action,
absorption, metabolism, distribution and excretion.
* Phase II: Studies are performed with a limited patient
population to identify possible adverse effects and safety
risks, to assess the efficacy of the product for specific
targeted diseases or conditions, and to determine dosage
tolerance and optimal dosage.
* Phase III: When Phase II evaluations demonstrate that a
dosage range of the product is effective and has an
acceptable safety profile, Phase III trials are undertaken
to evaluate further dosage and clinical efficacy and to test
further for safety in an expanded patient population at
geographically dispersed clinical study sites.
The results of the product development, preclinical studies and
clinical studies are then submitted to the FDA as part of the NDA.
The NDA drug development and approval process could take from three
to more than 10 years.
In January 2005, we introduced our second NDA approved product,
Clindesse(R), the first approved single-dose therapy for bacterial
vaginosis. Similar to Gynazole-1(R), Clindesse(R) incorporates our
proprietary VagiSite(TM) bioadhesive drug delivery technology. In
fiscal 2006, we introduced Encora(R), a new prescription nutritional
supplement product, and two new hematinic products, Niferex Gold(R)
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
initial Phase III clinical studies began during the latter part of
fiscal 2006. We are currently in the process of modifying and
redefining these protocols. We are negotiating final protocol details
under a Special Protocol Assessment ("SPA") with the FDA to ensure
alignment prior to restarting the new Phase III study. In the
meantime, the Company is testing a next generation formula in a Phase
II study. In connection with the FemmePharma acquisition, the Company
recorded expense in fiscal 2006
16
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.
In May 2007, we acquired the U.S. marketing rights to Evamist(TM), a
new low-dose estrogen transdermal spray, from VIVUS, Inc. The product
was formulated with a patented metered-dose transdermal spray system
which is designed to provide an easy, once-daily dose of estrodial
via the skin. Evamist(TM) is the first transdermal spray estrogen
replacement therapy product approved for use in the United States.
Under the terms of the Asset Purchase Agreement, we agreed to pay
$10.0 million in cash at closing and agreed to make an additional
cash payment of $140.0 million upon final approval of the product by
the FDA. Because the product had not obtained FDA approval when the
initial payment was made at closing, we recorded $10.0 million of
in-process research and development expense during the three months
ended June 30, 2007. The agreement also provides for two future
payments upon achievement of certain net sales milestones. In July
2007, FDA approval for Evamist(TM) was received and we paid $140.0
million to VIVUS, Inc. We are in the process of determining the
allocation of the $140.0 million payment and we plan to launch the
product during the fourth quarter of fiscal 2008.
GENERIC/NON-BRANDED PRODUCT DEVELOPMENT. FDA approval of an ANDA is
required before marketing a generic equivalent of a drug approved
under an NDA in the United States or for a previously unapproved
dosage strength or delivery system for a drug approved under an ANDA.
The ANDA development process is generally less time consuming and
complex than the NDA development process. It typically does not
require new preclinical and clinical studies because it relies on the
studies establishing safety and efficacy conducted for the drug
previously approved through the NDA process. The ANDA process,
however, does require one or more bioequivalency studies to show that
the ANDA drug is bioequivalent to the previously approved drug.
Bioequivalence compares the bioavailability of one drug product with
that of another formulation containing the same active ingredient.
When established, bioequivalence confirms that the rate of absorption
and levels of concentration in the bloodstream of a formulation of
the previously approved drug and the generic drug are equivalent.
Bioavailability indicates the rate and extent of absorption and
levels of concentration of a drug product in the bloodstream needed
to produce the same therapeutic effect.
Supplemental ANDAs are required for approval of various types of
changes to an approved application, and these supplements may be
under review for six months or more. In addition, certain types of
changes may be approved only once new bioequivalence studies are
conducted or other requirements are satisfied.
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 2023 relating to our
controlled-release, site-specific, quick dissolve and taste-masking
technologies. We have been granted 43 U.S. patents and have 39 U.S.
patent applications pending. In addition, we have 67 foreign issued
patents and a total of 203 patent applications pending primarily in
Canada, Europe, Australia, Japan, South America, Mexico and
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South Korea (see Item 1A "Risk Factors - We depend on our patents and
other proprietary rights and cannot be certain of their
confidentiality and protection" for additional information).
We currently own more than 200 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 research, manufacturing, distribution and
administrative facilities are an important factor in achieving our
long-term growth objectives. All facilities at March 31, 2007,
aggregating approximately 1.2 million square feet, are located in the
St. Louis, Missouri metropolitan area. We own facilities with
approximately 1.1 million square feet, with the balance under various
leases at pre-determined annual rates under agreements expiring from
fiscal 2008 through fiscal 2017, subject in most cases to renewal at
our option. In June 2006, we exercised the purchase option on a
126,168 square foot building in accordance with a previous lease
agreement and acquired it for $4.9 million.
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 2007, 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. Many of these competitors have
substantially greater financial and marketing resources than we do.
Accordingly, our competitors may succeed in product line acquisitions
that we seek to acquire.
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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
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 subject to inherent uncertainties (see
"Research and Development" above).
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
bioequivalent to a previously approved reference drug among other
requirements. The same abbreviated application procedures apply to
antibiotic drug products that are bioequivalent 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 the product
is safe and effective for its intended use and may rely, instead, on
studies demonstrating bioequivalence 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
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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 U.S. 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 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 action seeking an
injunction or hold 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 objections to the
marketing without NDA or ANDA approval of a 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 affected 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 this regard, in June 2006, May 2007 and September 2007, the FDA
issued Notices to the pharmaceutical industry stating that
manufacture of all unapproved drug products containing carbinoxamine,
carbinoxamine labeled for children under two, timed-released
guaifenesin, hydrocodone labeled for children under six and all other
unapproved products containing hydrocodone, respectively, cease by
September 6, 2006, July 9, 2006, August 26, 2007, October 31, 2007,
and December 31, 2007, respectively. These Notices affect the
continued manufacture and sale of ETHEX's Hydro-Tussin(TM) CBX Syrup,
Tri-Vent(TM) HC Liquid, Guaifenex(R) DM ER Tablets, Guaifenex(R) PSE
60 ER Tablets, PhenaVent(TM) D Capsules, Guaifenex(R) PSE 80 ER
Tablets, Pseudovent(TM) DM Tablets, Histinex(R) PV Syrup, Hydrocodone
Bitartrate & Guaifenesin Liquid, Hydro-Tussin(TM) HC Syrup,
Histinex(R) HC Syrup and Hydro-Tussin(TM) Syrup. On March 13, 2008,
certain of the Company's other unapproved products were placed on
hold by representatives of the Missouri Department of Health and
Senior Services. Please see "Government Regulation" in Item 7,
Management's Discussion and Analysis of Financial Condition and
Results of Operations, for a more detailed discussion related to the
product hold.
In October 2007, the FDA issued a Notice extending the period during
which the FDA will exercise its enforcement discretion not to
challenge continued marketing and distribution of pancreatic enzyme
products, such as ETHEX's Pangestyme(TM) product. Under the
extension, FDA will continue to exercise its enforcement discretion
with respect to unapproved pancreatic enzyme products that have an
active Investigational New Drug Application ("IND") on active status
on or before April 28, 2008 and have submitted an NDA on or before
April 28, 2009.
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.
20
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, 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 U.S. 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 less
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 are 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.
EMPLOYEES
As of March 31, 2007, we employed a total of 1,414 employees. We were
a party to a collective bargaining agreement with the Teamsters Union
covering 133 employees that would have expired on December 31, 2009.
However, on January 23, 2008, the employee members of the union voted
to decertify their union representation. The decertification became
effective February 7, 2008.
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.
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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. 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 Standards of Business Ethics for all Directors and
employees are available on our Internet website, and available in
print to any shareholder 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 registrants 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
THE MATTERS RELATING TO THE INVESTIGATION BY THE SPECIAL COMMITTEE
AND THE RESTATEMENT OF THE COMPANY'S CONSOLIDATED FINANCIAL
STATEMENTS MAY RESULT IN ADDITIONAL LITIGATION AND GOVERNMENT
ENFORCEMENT ACTIONS.
We announced at an earlier date that our Board of Directors had
formed a Special Committee of outside directors to conduct an
investigation, with the assistance of independent legal counsel and
forensic accounting experts, of our past stock option grant practices
over the period January 1, 1995 through October 31, 2006. The
investigation concluded that no employee, officer or director of the
Company engaged in any intentional wrongdoing or was aware that the
Company's policies and procedures for granting and accounting for
stock options were materially noncompliant with GAAP. The
investigation also found no intentional violation of law or
accounting rules with respect to the Company's historical stock
option grant practices.
However, as a result of the independent investigation, the Special
Committee concluded, and based on its internal review, management
agrees, that incorrect measurement dates were used for financial
accounting purposes for stock option grants made in certain prior
periods. Therefore, we have recorded additional non-cash stock-based
compensation expense, and related tax effects, with regard to certain
past stock option grants, and we have restated certain previously
filed financial statements included in this Form 10-K, as more fully
described in the Explanatory Note immediately preceding Part I, Item
1, in "Management's Discussion and Analysis of Financial Condition
and Results of Operation" in Item 7, and in Note 3 "Restatement of
Consolidated Financial Statements" in Notes to Consolidated Financial
Statements in this Form 10-K.
The independent investigation and management's internal review and
related activities have required us to incur substantial expenses for
legal, accounting, tax and other professional services, have diverted
some of our management's attention from the Company's business, and
could have a material adverse effect on our business, financial
condition, results of operations and cash flows.
While we believe we have made appropriate judgments in determining
the correct measurement dates for our stock option grants, based upon
the Special Committee's findings and in consultation with outside
experts and our
22
independent registered public accounting firm, the SEC may disagree
with the manner in which we have accounted for and reported the
financial impact in our consolidated financial statements.
Accordingly, there is a risk we may have to further restate our prior
financial statements, amend prior filings with the SEC, or take other
actions not currently contemplated by us.
Our past stock option grant practices and the restatement of prior
financial statements have exposed the Company to risks associated
with litigation, regulatory proceedings and government enforcement
actions. As described in Note 13 to our Consolidated Financial
Statements, "Commitments and Contingencies," derivative lawsuits have
been filed in state and federal courts against certain current and
former directors and executive officers pertaining to allegations
relating to stock option grants. Also, the Company was notified by
the SEC in December 2007 that it had issued a formal order of
investigation with respect to the Company's stock option plans,
grants, exercises and accounting practices. Outcomes of litigation or
regulatory proceedings relating to the Company's past stock option
practices could have a material adverse effect on our financial
condition, results of operations or cash flows. The resolution of
these matters will continue to be time-consuming, expensive, and a
distraction to some of our management from the conduct of the
Company's business. Furthermore, if we are subject to adverse
findings in litigation or regulatory proceedings we could be required
to pay damages or penalties or have other remedies imposed.
WE HAVE MATERIAL WEAKNESSES IN INTERNAL CONTROL OVER FINANCIAL
REPORTING AND CANNOT ASSURE YOU THAT ADDITIONAL MATERIAL WEAKNESSES
WILL NOT BE IDENTIFIED IN THE FUTURE.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate
the effectiveness of our internal control over financial reporting as
of the end of each year, and to include a management report assessing
the effectiveness of our internal control over financial reporting in
each Annual Report on Form 10-K. Section 404 also requires our
independent registered public accounting firm to attest to, and
report on, management's assessment of the Company's internal control
over financial reporting.
In assessing the findings of the investigation as well as the
restatement, management concluded there were material weaknesses, as
defined in the Public Company Accounting Oversight Board's Auditing
Standard No. 2, in our internal control over financial reporting as
of March 31, 2007. Management is implementing steps to remediate
these material weaknesses by March 31, 2008, however, we cannot
assure you that such remediation will be effective. See the
discussion included in Item 9A of this Report for additional
information regarding our internal control over financial reporting.
Our internal control over financial reporting may not prevent all
errors and all fraud. A control system, no matter how well designed
and operated, can provide only reasonable, not absolute, assurance
that the control system's objectives will be met. Further, the design
of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative
to their costs. Controls can be circumvented by the individual acts
of some persons, by collusion of two or more people, or by management
override of the controls. Over time, controls may become inadequate
because changes in conditions or deterioration in the degree of
compliance with policies or procedures may occur. Because of the
inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.
As a result, significant deficiencies or material weaknesses in our
internal control over financial reporting may be identified in the
future. Any failure to maintain or implement required new or improved
controls, or any difficulties we encounter in their implementation,
could result in significant deficiencies or material weaknesses,
cause us to fail to timely meet our periodic reporting obligations,
or result in material misstatements in our financial statements. Any
such failure could also adversely affect the results of periodic
management evaluations and annual auditor attestation reports
regarding disclosure controls and the effectiveness of our internal
control over financial reporting required under Section 404 of the
Sarbanes-Oxley Act of 2002 and the rules promulgated there under. If
our internal control over financial reporting or disclosure controls
and procedures are not effective,
23
there may be errors in our financial statements that could require a
restatement or our filings may not be timely and investors may lose
confidence in our reported financial information, which could lead to
a decline in our stock price.
OUR FUTURE GROWTH WILL LARGELY DEPEND 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 may not be successful in pursuing this
strategy.
IF WE ARE UNABLE TO COMMERCIALIZE PRODUCTS UNDER DEVELOPMENT OR THAT
WE ACQUIRE, OUR FUTURE OPERATING RESULTS MAY SUFFER.
Certain products we develop or acquire 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 or at all.
OUR ACQUISITION STRATEGY MAY NOT BE SUCCESSFUL.
We intend to continue to pursue our efforts 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 and other types of pharmaceutical
companies for products and product line acquisitions. Many of these
competitors 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 U.S. 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
24
invention in the U.S. 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 U.S. or abroad.
Consequently, our pending or future patent applications may not
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 U.S. 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 U.S. 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 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
U.S. For example, methods of treating humans are not patentable in
many countries outside of the U.S.
These and other issues may prevent us from obtaining patent
protection outside of the U.S. 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 U.S. 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.
25
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 U.S.
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
four patent infringement lawsuits pending against us. They could have
a material adverse effect on our future business, financial
condition, results of operations or cash flows.
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 posed, and is
expected to continue to pose, significant challenges for our
management, 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. If we are unable to manage our growth
effectively, our business, financial condition, results of operations
or cash flows could be materially adversely affected.
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 U.S. 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, 2007, our
three largest customers, which are wholesale distributors, accounted
for 26%, 21% and 14% of our gross sales, respectively. The loss of
any of these customers could materially and adversely affect our
business, financial condition, results of operations or cash flows.
THE REGULATORY STATUS OF CERTAIN OF OUR GENERIC PRODUCTS MAY MAKE
THEM SUBJECT TO INCREASED COMPETITION OR TO REGULATORY DECISIONS TO
REQUIRE MARKET WITHDRAWAL OF ONE OR MORE OF OUR UNAPPROVED PRODUCTS.
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. In other cases, we sell unapproved products that
may become subject to FDA orders to the pharmaceutical industry to
remove one or more types of such products from the marketplace.
During the past year, such FDA orders have required manufacturers and
distributors of certain unapproved products containing guaifenesin
and hydrocodone to cease manufacture or distribution, including
certain ETHEX products. In the future, FDA may issue similar orders
affecting other of our products. In addition, in the event that FDA
concludes that we have failed to comply with a notice setting
deadlines for
26
discontinuation of the manufacture and sale of unapproved products,
or decides to take enforcement action against us on other grounds,
such as for alleged violations of current good manufacturing practice
requirements or for failure to obtain product approvals that FDA
deems to be necessary, FDA policies permit the agency to initiate
broad action against the marketing of additional categories of our
unapproved drug products, even if the agency has not instituted
similar actions against the marketing of such products by other
parties.
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. We may not ultimately prevail in these litigations,
we may not receive final FDA approval of our ANDAs, and we may not
achieve our expectation of a period of generic exclusivity for
certain of these products 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 exclusivity has been the subject of
controversy, court decisions, changes to FDA regulations and
guidelines, and other changes in FDA interpretation. In addition, in
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 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, 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
27
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 (1) outside legal
advice, (2) the status of a pending lawsuit, (3) interim court
decisions, (4) status and timing of a trial, (5) legal decisions
affecting other competitors for the same product, (6) market factors,
(7) liability sharing agreements, (8) internal capacity issues, (9)
expiration dates of patents, (10) strength of lower court decisions
and (11) 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,
financial condition, results of operations or cash flows.
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
excess of our insurance coverage could require us to pay substantial
sums and adversely affect our business, financial condition, results
of operations or cash flows.
We have 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 phenylpropanolamine, or 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
again in 2004, and we demanded that the insurer assume our 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 may be impleaded into the action, and, if
we are impleaded, we may not 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. 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 may not 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.
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.
28
WE EXPEND A SIGNIFICANT AMOUNT OF RESOURCES ON RESEARCH AND
DEVELOPMENT EFFORTS THAT MAY NOT LEAD TO SUCCESSFUL PRODUCT
INTRODUCTIONS.
We conduct research and development primarily to enable us to
manufacture and market FDA-approved pharmaceuticals in accordance
with FDA regulations. Typically, research costs related to the
development of innovative compounds and the filing of NDAs are
significantly greater than those expenses associated with ANDA
filings. As such, our investment in research and development, which
increased at a compounded annual growth rate of 24.1% over the five
fiscal year period ended March 31, 2007, reflects our ongoing
commitment to develop new products and/or technologies through our
internal development programs, and with our external strategic
partners. Because of the inherent risk associated with research and
development efforts in our industry, particularly with respect to new
drugs, our research and development expenditures may not result in
the successful introduction of FDA approved new pharmaceutical
products. Also, after we submit an ANDA, the FDA may request that we
conduct additional studies and as a result, we may be unable to
reasonably determine the total research and development costs to
develop a particular product. Finally, we cannot be certain that any
investment made in developing products will be recovered, even if we
are successful in commercialization. To the extent that we expend
significant resources on research and development efforts and are not
able, ultimately, to introduce successful new products as a result of
those efforts, our business, financial condition, results of
operations or cash flows may be materially adversely affected.
ANY SIGNIFICANT INTERRUPTION IN THE SUPPLY OF RAW MATERIALS AND/OR
CERTAIN FINISHED PRODUCTS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR
BUSINESS.
We typically purchase the active pharmaceutical ingredient (i.e., the
chemical compounds that produce the desired therapeutic effect in our
products) and other materials and supplies that we use in our
manufacturing operations, as well as certain finished products, from
many different domestic and foreign suppliers.
Additionally, we maintain safety stocks in our raw materials
inventory, and in certain cases where we have listed only one
supplier in our applications with the FDA, have received FDA approval
to use alternative suppliers should the need arise. However, there is
no guarantee that we will always have timely and sufficient access to
a critical raw material or finished product. A prolonged interruption
in the supply of a single-sourced raw material, including the active
ingredient, or finished product could cause our business, financial
condition, results of operations or cash flows to be materially
adversely affected. In addition, our manufacturing capabilities could
be impacted by quality deficiencies in the products which our
suppliers provide, which could have a material adverse effect on our
business.
We utilize controlled substances in certain of our current products
and products in development and therefore must meet the requirements
of the Controlled Substances Act of 1970 and the related regulations
administered by the Drug Enforcement Administration ("DEA"). These
regulations relate to the manufacture, shipment, storage, sale and
use of controlled substances. The DEA limits the availability of the
active ingredients used in certain of our current products and
products in development and, as a result, our procurement quota of
these active ingredients may not be sufficient to meet commercial
demand or complete clinical trials. We must annually apply to the DEA
for procurement quota in order to obtain these substances. Any delay
or refusal by the DEA in establishing our procurement quota for
controlled substances could delay or stop our clinical trials or
product launches, or could cause trade inventory disruptions for
those products that have already been launched, which could have a
material adverse effect on our business, financial condition, results
of operations or cash flows.
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
29
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 could 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, our allowances
may not be adequate or our actual product returns, allowances and
chargebacks may 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 asserted that reporting of inflated AWP's have led to excessive
payments for prescription drugs.
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
States of Massachusetts, Alabama, Mississippi, Utah and Iowa, New
York City, and approximately 45 counties in New York State. The State
of Mississippi effectively voluntarily dismissed the Company and
ETHEX without prejudice on October 5, 2006 by virtue of the State's
filing an Amended Complaint on such date that does not name either
the Company or ETHEX as a defendant. In the remaining cases, only
ETHEX is a named defendant. On August 13, 2007, ETHEX settled the
Massachusetts lawsuit for $0.58 million in cash and agreed to supply
$0.15 million in free pharmaceuticals over the next two years and
received a general release with no admission of liability. The New
York City case and all New York county cases (other than the Erie,
Oswego and Schenectady County cases) have been transferred to the
U.S. District Court for the District of Massachusetts for coordinated
or consolidated pretrial proceedings under the Average Wholesale
Price Multidistrict Litigation (MDL No. 1456). The cases pertaining
to the State of Alabama, Erie County, Oswego County, and Schenectady
County were removed to federal court by a co-defendant in October
2006, but all of these cases have since been remanded to the state
courts in which they originally were filed. Each of these actions is
in the early stages, with fact discovery commencing or ongoing. In
October 2007, ETHEX was served with a complaint naming ETHEX and nine
other pharmaceutical companies as defendants in a pricing suit filed
in state court in Utah by the State of Utah. The State of Utah filed
an amended complaint in November 2007. This suit has been removed to
federal court, where the State of Utah is seeking a remand to the
state courts. A decision is pending before the court. The time to
file an answer or other response in the Utah suit has not yet run. In
October 2007, the State of Iowa filed a complaint naming ETHEX and 77
other pharmaceutical companies as defendants in a pricing suit in
federal court in the State of Iowa. ETHEX and the other defendants
have moved to dismiss the Iowa complaint. The Company intends to
vigorously defend its interests in the actions described above;
however, the outcome may have a material adverse effect on our future
business, financial condition, results of operations or cash flows.
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 may not prevail if
legal actions are instituted by these governmental entities.
30
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 business, financial condition, results of
operations or cash flows.
OUR REVENUES, GROSS PROFIT AND OPERATING RESULTS 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 (the proportion of total sales
between branded products and generic/non-branded products). Our sales
of branded products generate higher gross margins than our sales of
generic/non-branded products. In addition, the introduction of new
generic products at any given time can involve significant initial
quantities being purchased by our wholesaler customers, as they
supply initial quantities to pharmacies and purchase product for
their own wholesaler inventories. As a result, our sales mix will
significantly impact our gross profit from period to period. During
fiscal 2007, sales of our branded products and generic/non-branded
products accounted for 42.5% and 53.1%, respectively, of our net
revenues. During that year, branded products and generic/non-branded
products contributed gross margins of 89.0% and 58.7%, respectively,
to our consolidated gross profit margin of 66.8% in fiscal 2007.
Factors that may cause our sales mix to vary include:
* the amount and timing of new product introductions;
* marketing exclusivity, if any, which may be obtained on certain
new products;
* the level of competition in the marketplace for certain products;
* the availability of raw materials and finished products from our
suppliers;
* the buying patterns of our three largest wholesaler customers;
* the scope and outcome of governmental regulatory action that may
involve us;
* periodic dependence on a relatively small number of products for a
significant portion of net revenue or income; and
* legal actions brought by our competitors.
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. If our revenues and gross profit
decline or do not grow as anticipated, we may not be able to
correspondingly reduce our operating expenses.
INCREASED INDEBTEDNESS MAY IMPACT OUR FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
At March 31, 2007, we had $241.3 million of outstanding debt,
consisting of $200.0 million principal amount of 2.5% Contingent
Convertible Subordinated Notes due 2033 (the "Notes") and the
remaining principal balance of a $43.0 million mortgage loan entered
into in March 2006. In June 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 Notes. The new credit facility has a term expiring in
June 2011. At March 31, 2007, we had no cash borrowings under our
credit facility, but $0.9 million of letters of credit were issued
under it. Our level of indebtedness may have several important
effects on our future operations, including:
31
* 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;
* our outstanding indebtedness and leverage will increase the impact
of negative changes in general economic and industry conditions,
as well as competitive pressures and increases in interest rates;
and
* 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.
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:
* seek additional financing in the debt or equity markets;
* refinance or restructure all or a portion of our indebtedness;
* sell selected assets;
* reduce or delay planned capital expenditures; or
* 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, and/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, additional funds may not 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. As a result of this, we
classified the Notes as a current liability as of June 30, 2007 due
to the right the holders have to require us to repurchase the Notes
on May 16, 2008. 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 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. We may raise additional capital 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. Additional funding may not be accessible or
available to us on favorable terms or at all. 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.
32
WE MAY BE ADVERSELY IMPACTED BY ECONOMIC FACTORS BEYOND OUR CONTROL
AND MAY INCUR IMPAIRMENT CHARGES TO OUR INVESTMENT PORTFOLIO.
The Company has funds invested in auction rate securities ("ARS").
Consistent with the Company's investment policy guidelines, the ARS
held by the Company are AAA rated securities with long-term nominal
maturities secured by student loans which are guaranteed by the U.S.
Government. The interest rates on these securities are reset through
an auction process at pre-determined intervals, up to 35 days. There
may be liquidity issues which arise in the credit and capital markets
and the ARS held by the Company may experience failed auctions as the
amount of securities submitted for sale may exceed the amount of
purchase orders. As a result, the Company may not be able to
liquidate some or all of its auction rate securities prior to their
maturities at prices approximating their face amounts.
During 2008, disruption in the credit and capital markets have
adversely affected the auction market for the type of securities held
by the Company and the ARS held by the Company have recently
experienced failed auctions as the amount of securities submitted for
sale has exceeded the amount of purchase orders. If uncertainties in
these credit and capital markets continue or these markets
deteriorate further the Company may incur impairments to the carrying
value of its investments in ARS, which could negatively affect the
Company's financial condition, cash flow and reported earnings. (See
Note 24 to the Consolidated Financial Statements for further
discussion of the Company's investment in ARS). However, the Company
believes that as of December 31, 2007, based on its current cash,
cash equivalents and marketable securities balances of $112 million
(exclusive of auction rate securities) and its current borrowing
capacity of $290 million under its credit facility, the current lack
of liquidity in the auction rate market will not have a material
impact on its ability to fund its operations or interfere with the
Company's external growth plans.
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 statements of income over the estimated economic
useful life of the related asset. The factors that affect 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 and the impact of promotional efforts, among many others. We
consider all of these factors in initially estimating the economic
useful lives of our products, and we also continuously monitor these
factors for indications of decline in carrying value.
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.
Because circumstances after an acquisition can change, the value of
intangible assets we record 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
33
operations in the period in which the write-off occurs. In addition,
in the event of a sale of any of our assets, we might not recover our
recorded value of associated intangible assets.
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 financial statements that we file with the SEC are
prepared in accordance with GAAP. The preparation of financial
statements in accordance with 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 GAAP include, but are not limited to, those
related to revenue recognition and reductions to gross revenues,
inventory valuation, intangible assets, stock-based compensation,
income taxes and loss contingencies related to legal proceedings. 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.
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 regularly challenge the pricing of pharmaceutical products and
review 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:
* the trend toward managed health care in the U.S.;
* the growth of organizations such as HMOs and MCOs;
* legislative proposals to reform health care and government
insurance programs; and
* 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
34
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 business, financial condition,
results of operations or cash flows.
EXTENSIVE INDUSTRY REGULATION HAS HAD, AND WILL CONTINUE TO HAVE, A
SIGNIFICANT IMPACT ON OUR INDUSTRY AND 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 or holds, recall
or seizure of products and total or partial suspension of production,
as well as other regulatory actions against our products and us.
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
35
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.
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:
developments regarding litigation and an investigation regarding our
former stock option grant practices; announcements by us or our
competitors of technological innovations or new commercial products;
delays in the development or approval of products; regulatory
withdrawals of our products from the market; 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
U.S. 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, 2007, an aggregate of 3,435,565 shares of our Class A
Common Stock and 230,842 shares of our Class B Common Stock were
issuable upon exercise of outstanding stock options under our stock
option plans, and an additional 563,750 shares of our Class A Common
Stock and 1,230,000 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, 2007, 8,691,880 shares of Class A Common
Stock were reserved for issuance upon conversion of $200.0 million
principal amount of 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.
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.
MANAGEMENT SHAREHOLDERS CONTROL OUR COMPANY.
At March 31, 2007, our directors and executive officers beneficially
own approximately 13% of our Class A Common Stock and approximately
66% of our Class B Common Stock. As a result, these persons control
approximately 59% 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 determine the outcome of any matter being
voted on by our shareholders, including the election of directors and
any merger, sale of assets or other change in control of our Company.
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
shareholders, while each share of Class B Common Stock entitles the
holder to one full vote on each matter considered by the
shareholders. In addition, our directors have the authority to issue
additional shares of preferred stock and to determine the price,
rights, preferences, privileges
36
and restrictions of those shares without any further vote or action
by the shareholders. 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 shareholder" (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.
37
ITEM 2. PROPERTIES
----------
Our corporate headquarters is located at 2503 South Hanley Road in
St. Louis County, Missouri, and contains approximately 35,000 square
feet of floor space. We have a lease on the building for a period of
five years expiring December 31, 2011, with one 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, Missouri
metropolitan area.
SQUARE LEASE RENEWAL
FOOTAGE USAGE EXPIRES OPTIONS
--------------------------------------------------------------------------------------
Leased Facilities
30,150 PDI Mfg./Whse. 11/30/12 5 Years(1)
10,000 PDI/KV Lab/Whse. 11/30/08 None
15,000 KV/PDI Office 02/29/08 2 Years(2)
23,000 KV Office/R&D/Mfg. 12/31/12 5 Years(1)
41,770 KV Warehouse 11/30/16 None
-------
119,920
Owned Facilities
126,168 KV Office/Mfg(3)
121,472 KV Office/Whse./Lab(4)
87,250 KV Mfg.
88,850 KV Lab
302,940 KV Mfg/Whse/ETHEX/Ther-Rx Office(4)
259,990 ETHEX/Ther-Rx/PDI Distribution(4)
96,360 KV Warehouse
---------
1,083,030
<FN>
----------------------------------------
(1) Two five-year options.
(2) Two two-year options.
(3) The purchase option on this building was exercised by the
Company in accordance with the lease agreement and was acquired
for $4.9 million in June 2006.
(4) 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 13 - Commitments and
Contingencies - to the Consolidated Financial Statements included in
Item 8 of this report is incorporated in this Item 3 by reference.
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, 2007.
38
ITEM 4A. 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(1) 66 Chairman of the Board and Chief Executive
Officer since August 2006; Vice Chairman
and Chief Executive Officer from 1975 to
August 2006; Vice Chairman of the Board
from 1974 to 1975.
Richard H. Chibnall 51 Vice President, Finance and Chief
Accounting Officer since June 2005; Vice
President, Finance from February 2000 to
June 2005.
David A. Van Vliet 52 Chief Administration Officer since
September 2006; Director from August 2004
to September 2006; President and Chief
Operating Officer of Angelica Corporation
from June 2005 to September 2006;
President and Chief Executive Officer of
Growing Family, Inc. from 1998 to June
2005.
Gregory S. Bentley 58 Senior Vice President and General Counsel
since April 2006; Executive Vice
President, General Counsel and Corporate
Compliance Officer, AAI Pharma, Inc. from
1999 to April 2006.
Michael S. Anderson 58 Corporate Vice President, Industry
Presence and Development since February
2006; Chief Executive Officer, Ther-Rx
Corporation from February 2000 to February
2006.
Patricia K. McCullough 55 Chief Executive Officer, ETHEX Corporation
since January 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.
Gregory J. Divis, Jr. 41 President, Ther-Rx Corporation since July
2007; Vice President, Business Development
and Life Cycle Management, Sanofi-aventis
U.S. from February 2006 to July 2007; Vice
President Sales, Respiratory East,
Sanofi-aventis U.S. from June 2004 to
February 2006; Executive Director, Sales
and Marketing National Accounts, Reliant
Pharmaceuticals from December 2003 to June
2004; Vice President and Country Manager
United Kingdom and Ireland,
Schering-Plough from May 2002 to December
2003; Vice President, Field Operations
Oncology-Biotech Division, Schering-Plough
from October 2000 to April 2002.
Raymond F. Chiostri 73 Corporate Vice President, KV
Pharmaceutical since September 2006;
Chairman and Chief Executive Officer of
Particle Dynamics, Inc. from 1999 to
September 2006.
Paul T. Brady 44 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.
Rita E. Bleser 52 President, Pharmaceutical Manufacturing
Division since April 2007; Vice President,
Technology, Tyco Healthcare from September
2001 to April 2007.
Ronald J. Kanterman 53 Vice President, Chief Financial Officer
and Assistant Secretary since March 2008;
Vice President, Strategic Financial
Management, Treasurer, and Assistant
Secretary from March 2006 to March
2008; Vice President, Treasury from
January 2004 to March 2006; Partner, Brown
Smith Wallace, LLP from 1993 to January
2004; Partner, Arthur Andersen & Co., from
1987 to 1993.
Executive officers of the Company serve at the pleasure of the Board of
Directors.
<FN>
- -------------------------------
(1) Marc S. Hermelin is the father of David S. Hermelin, Vice President,
Corporate Strategy & Operation Analysis, a member of the Board of Directors
since 2004.
39
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
----------------------------------------------------------------------
AND ISSUER PURCHASES OF EQUITY SECURITIES
-----------------------------------------
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 January 15, 2008, was 906 and 322, respectively (not separately
counting shareholders whose shares are held in "nominee" or "street"
names, which are estimated to represent approximately 5,000
additional holders of Class A Common Stock and Class B Common Stock
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 2007 and 2006, as reported
on the New York Stock Exchange were as follows:
CLASS A COMMON STOCK
--------------------
FISCAL 2007 FISCAL 2006
----------- -----------
QUARTER HIGH LOW HIGH LOW
------- ---------------------- -----------------------
First...................... $24.31 $17.50 $24.37 $16.75
Second..................... 23.94 16.90 18.27 15.53
Third...................... 24.91 21.74 21.50 16.79
Fourth..................... 26.28 22.83 24.22 20.60
CLASS B COMMON STOCK
--------------------
FISCAL 2007 FISCAL 2006
----------- -----------
QUARTER HIGH LOW HIGH LOW
------- ---------------------- -----------------------
First...................... $24.27 $17.48 $24.72 $16.79
Second..................... 23.92 16.92 18.24 15.53
Third...................... 24.86 21.78 21.57 16.83
Fourth..................... 26.21 22.71 24.13 21.27
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 2007
and 2006 on 40,000 shares of outstanding Cumulative Convertible
Preferred Stock. There were no undeclared and unaccrued cumulative
preferred dividends at March 31, 2007.
40
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 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 17 of
Notes to Consolidated Financial Statements for information relating
to our equity compensation plans.
- ----------------------------------------------------------------------------------------------------------------------
ISSUER PURCHASES OF EQUITY SECURITIES
- ----------------------------------------------------------------------------------------------------------------------
PERIOD TOTAL NUMBER OF WEIGHTED TOTAL NUMBER OF MAXIMUM NUMBER OF
SHARES PURCHASED AVERAGE PRICE PAID SHARES PURCHASED AS SHARES (OR UNITS)
(a) PER SHARE PART OF PUBLICLY THAT MAY YET BE
ANNOUNCED PLANS OR PURCHASED UNDER THE
PROGRAMS PLANS OR PROGRAMS
- ----------------------------------------------------------------------------------------------------------------------
1/1/07 - 1/31/07 552 $23.95 - -
- ----------------------------------------------------------------------------------------------------------------------
2/1/07 - 2/28/07 1,034 $25.71 - -
- ----------------------------------------------------------------------------------------------------------------------
3/1/07 - 3/31/07 174 $24.51 - -
- ----------------------------------------------------------------------------------------------------------------------
Total 1,760 $25.04 - -
- ----------------------------------------------------------------------------------------------------------------------
<FN>
(a) Shares were purchased from employees upon their termination pursuant to
the terms of the Company's Stock Option Plan.
41
EQUITY COMPENSATION PLAN INFORMATION
The following information regarding compensation plans of the Company
is furnished as of March 31, 2007, 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
NUMBER OF SECURITIES TO BE FUTURE ISSUANCE UNDER
ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS
OUTSTANDING OPTIONS, PRICE OF OUTSTANDING (EXCLUDING SECURITIES
WARRANTS AND RIGHTS OPTIONS, WARRANTS AND RIGHTS REFLECTED IN COLUMN (a))
------------------- ---------------------------- ------------------------
PLAN CATEGORY (a) (b) (c)
Equity compensation plans
approved by security holders(1) 3,435,565 $16.25 563,750
Equity compensation plans not
approved by security holders
-- -- --
--------- ------ -------
Total 3,435,565 $16.25 563,750
========= =======
<FN>
(1) Consists of the Company's 1991 and 2001 Incentive Stock Option Plans. See
Note 17 of Notes to Consolidated Financial Statements.
EQUITY COMPENSATION PLAN INFORMATION
REGARDING CLASS B COMMON STOCK
- --------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO BE FUTURE ISSUANCE UNDER
ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS
OUTSTANDING OPTIONS, PRICE OF OUTSTANDING (EXCLUDING SECURITIES
WARRANTS AND RIGHTS OPTIONS, WARRANTS AND RIGHTS REFLECTED IN COLUMN (a))
------------------- ---------------------------- ------------------------
PLAN CATEGORY (a) (b) (c)
Equity compensation plans
approved by security holders(1) 230,842 $13.92 1,230,000
Equity compensation plans not
approved by security holders
-- -- --
------- ------ ---------
Total 230,842 $13.92 1,230,000
======= =========
<FN>
(1) Consists of the Company's 1991 and 2001 Incentive Stock Option Plans. See Note 17 of Notes to Consolidated
Financial Statements.
42
STOCK PRICE PERFORMANCE GRAPH
Set forth below is a line-graph presentation comparing cumulative
shareholder returns for the last five fiscal years on an indexed
basis with the NYSE Composite Index and the S&P Pharmaceuticals
Index, a nationally recognized industry standard index. The graph
assumes the investment of $100 in Company Class A Common Stock and
$100 in Class B Common Stock, the NYSE Composite Index, and the S&P
Pharmaceuticals Index on March 31, 2002, and reinvestment of all
dividends. The Company's stock performance may not continue into the
future with the same or similar trends depicted in the graph below.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among KV Pharmaceutical Company, The NYSE Composite Index
And The S&P Pharmaceuticals Index
[GRAPH]
YEARS ENDED MARCH 31,
---------------------
2003 2004 2005 2006 2007
---- ---- ---- ---- ----
K-V PHARMACEUTICAL COMPANY 59.66 124.54 113.07 117.09 120.01
NYSE COMPOSITE 79.61 117.94 135.71 164.25 196.85
S&P PHARMACEUTICALS 80.68 84.81 80.98 81.91 91.33
43
ITEM 6. SELECTED FINANCIAL DATA
-----------------------
The following unaudited selected financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operation" and the Consolidated Financial Statements and the Notes thereto
included elsewhere in this Form 10-K to fully understand factors that may
affect the comparability of the information presented below. The information
presented in the following tables has been adjusted to reflect the restatement
of our consolidated financial results which is more fully described in the
"Explanatory Note" immediately preceding Part I, Item 1, in "Management's
Discussion and Analysis of Financial Condition and Results of Operation" in
Item 7, and in Note 3 "Restatement of Consolidated Financial Statements" in
the Notes to Consolidated Financial Statements in this Form 10-K. We derived
the selected consolidated financial data as of March 31, 2007 and 2006 and for
the fiscal years ended March 31, 2007, 2006 and 2005 from our audited
Consolidated Financial Statements, and accompanying notes, in this report on
Form 10-K. The income statement data for the fiscal years ended March 31, 2006
and 2005, and the balance sheet data as of March 31, 2006 have been restated
in connection with the restatements discussed in Note 3 of the Notes to
Consolidated Financial Statements. The income statement data for the years
ended March 31, 2004 and 2003, and the balance sheet data as of March 31,
2005, 2004 and 2003 have been restated as discussed in footnote (b) below.
We have not amended our previously filed Annual Reports on Form 10-K or
Quarterly Reports on Form 10-Q for the periods affected by the restatement,
except for the Quarterly Report on Form 10-Q for the quarter ended June 30,
2006. The financial information that has been previously filed or otherwise
reported for these periods is superseded by the information in this Annual
Report on Form 10-K, and the financial statements and related financial
information contained in those previously filed reports should no longer be
relied upon.
BALANCE SHEET DATA
(unaudited, in thousands) MARCH 31,
------------------------------------------------------------------------
2007 2006 (a) 2005 (b) 2004 (b) 2003 (b)
-------- -------- -------- -------- --------
(AS RESTATED) (AS RESTATED) (AS RESTATED) (AS RESTATED)
Cash, cash equivalents and
marketable securities $240,386 $207,469 $205,519 $226,911 $96,288
Working capital 372,291 304,958 296,240 301,604 136,696
Property and equipment, net 186,900 178,042 131,624 75,777 51,903
Total assets 707,783 619,313 558,952 527,679 352,310
Current liabilities 59,179 44,332 41,577 55,745 76,462
Long-term debt 239,451 241,319 209,767 210,741 10,106
Shareholders' equity 364,827 302,999 286,477 252,721 259,416
44
INCOME STATEMENT DATA
(unaudited; in thousands, except per share data) YEARS ENDED MARCH 31,
-------------------------------------------------------------------------
2007 2006 (a) 2005 (a) 2004 (b) 2003 (b)
-------- -------- -------- --------- ---------
(AS RESTATED) (AS RESTATED) (AS RESTATED) (AS RESTATED)
Net revenues $443,627 $367,640 $304,656 $ 282,994 $ 247,958
Operating income (c)(d) $ 88,156 $ 36,157 $ 51,684 $ 70,600 $ 43,352
Net income (c)(d) $ 58,090 $ 11,416 $ 31,217 $ 41,700 28,191
Earnings per share:
Diluted - Class A common (e) $ 1.05 $ 0.23 $ 0.60 $ 0.78 $ 0.55
Diluted - Class B common (f) $ 0.91 $ 0.20 $ 0.52 $ 0.68 $ 0.48
Shares used in per share calculation:
Diluted - Class A common (e) 58,953 49,997 58,633 57,792 51,155
Diluted - Class B common (f) 12,489 13,113 15,072 16,175 16,091
Preferred stock dividends $ 70 $ 70 $ 70 $ 436 $ 70
<FN>
(a) See Note 3 "Restatement of Consolidated Financial Statements" to the
Notes to Consolidated Financial Statements included in this Form 10-K for
additional information regarding the adjustments made to our restated
consolidated financial statements.
(b) The selected financial data as of March 31, 2005, 2004 and 2003 and for
the fiscal years ended March 31, 2004 and 2003 have been adjusted to
reflect the restatements described in Note 3, "Restatement of
Consolidated Financial Statements," of the Notes to Consolidated
Financial Statements. The cumulative after-tax impact of all restatement
adjustments related to years prior to fiscal 2003 totaled $11.6 million,
which is reflected as an adjustment to shareholders' equity as of April
1, 2002. See page 47 for table reconciling the Company's previously
reported results to the restated consolidated statements of income for
the fiscal years ended March 31, 2004 and 2003.
(c) 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 4
to the Notes to Consolidated Financial Statements). The impact of this
item, which is not deductible for tax purposes, was to decrease net
income by $30.4 million in fiscal 2006.
(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 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 in September
2003.
(f) In fiscal 2007, we began reporting diluted earnings per share for Class B
Common Stock under the two-class method which does not assume the
conversion of Class B Common Stock into Class A Common Stock. Previously,
we did not present diluted earnings per share for Class B Common Stock.
45
The tables below reflect the impact of the restatement adjustments on our
balance sheet data as of March 31, 2005, 2004 and 2003 and our income
statement data for the fiscal years ended March 31, 2004 and 2003.
BALANCE SHEET DATA
(unaudited, in thousands) MARCH 31, 2005
------------------------------------------------------
AS
PREVIOUSLY AS
REPORTED ADJUSTMENTS RESTATED
-------- ----------- --------
Cash, cash equivalents and
marketable securities $ 205,519 $ - $ 205,519
Working capital 302,465 (6,225) (a)(b)(c)(d)(e) 296,240
Property and equipment, net 131,624 - 131,624
Total assets 558,317 635 (a)(b)(e) 558,952
Current liabilities 34,717 6,860 (a)(b)(c)(d)(e) 41,577
Long-term debt 209,767 - 209,767
Shareholders' equity 292,702 (6,225) (a)(b)(c)(d)(e) 286,477
MARCH 31, 2004
------------------------------------------------------
AS
PREVIOUSLY AS
REPORTED ADJUSTMENTS RESTATED
-------- ----------- --------
Cash, cash equivalents and
marketable securities $ 226,911 $ - $ 226,911
Working capital 306,632 (5,028) (a)(b)(c)(d)(e) 301,604
Property and equipment, net 75,777 - 75,777
Total assets 528,438 (759) (a)(b)(e) 527,679
Current liabilities 51,476 4,269 (a)(b)(c)(d)(e) 55,745
Long-term debt 210,741 - 210,741
Shareholders' equity 257,749 (5,028) (a)(b)(c)(d)(e) 252,721
BALANCE SHEET DATA
(unaudited in thousands)
MARCH 31, 2003
------------------------------------------------------
AS
PREVIOUSLY AS
REPORTED ADJUSTMENTS RESTATED
-------- ----------- --------
Cash, cash equivalents and
marketable securities $ 96,288 $ - $ 96,288
Working capital 137,896 (1,200) (a)(c)(e) 136,696
Property and equipment, net 51,903 51,903
Total assets 352,668 (358) (a)(e) 352,310
Current liabilities 75,620 842 (c)(e) 76,462
Long-term debt 10,106 - 10,106
Shareholders' equity 260,616 (1,200) (a)(c)(e) 259,416
<FN>
(a) Adjustment for income tax impact associated with stock-based compensation
expense pursuant to APB 25 ($1,373, $1,050 and $717 in fiscal 2005, 2004
and 2003, respectively), partially offset by net effect of tax benefit
realized in accrued taxes ($723 and $319 in fiscal 2005 and 2004,
respectively) and excess tax benefit reflected in paid-in capital ($656
and $298 in 2005 and 2004, respectively).
(b) Adjustment for payroll taxes, interest and penalties associated with
stock-based compensation expense pursuant to APB 25 ($984 and $439 in
fiscal 2005 and 2004, respectively) and the related income tax impact
($273 and $123 in fiscal 2005 and 2004, respectively).
(c) Adjustment for exercise deposits received by the Company for stock
options in the two-year forfeiture period ($3,872, $3,288 and $1,321 in
fiscal 2005, 2004 and 2003, respectively).
(d) Adjustment for additional income tax liabilities associated with tax
positions taken on filed tax returns, partially offset by certain
expected tax refunds ($3,187 and $1,689 in fiscal 2005 and 2004,
respectively).
(e) Adjustment to record revenue and cost of sales when product is received
by the customer instead of shipping date for certain customers as
follows:
2005 2004 2003
---- ---- ----
Decrease in receivables $ 1,197 $ 2,360 $ 1,414
Increase in inventories 429 695 490
Decrease in deferred tax assets 187 245 151
Decrease in accrued liabilities 470 828 479
Decrease in retained earnings 485 1,082 596
46
INCOME STATEMENT DATA
(unaudited, in thousands, except per share data)
YEARS ENDED MARCH 31,
--------------------------------------------------------------------------------------------
2004 2003
--------------------------------------------- ---------------------------------------------
AS AS
PREVIOUSLY AS PREVIOUSLY AS
REPORTED ADJUSTMENTS RESTATED REPORTED ADJUSTMENTS RESTATED
-------- ----------- -------- -------- ----------- --------
Net revenues $ 283,941 $ (947) $ 282,994 $ 244,996 $ 2,962 $ 247,958
Cost of sales 98,427 (205) 98,222 94,527 1,352 95,879
--------------------------------------------- ---------------------------------------------
Gross profit 185,514 (742) 184,772 150,469 1,610 152,079
--------------------------------------------- ---------------------------------------------
Operating expenses:
Research and development 20,651 - 20,651 19,135 - 19,135
Selling and administrative 88,333 2,429 90,762 69,584 1,187 70,771
Amortization of intangibles 4,459 - 4,459 2,321 - 2,321
Litigation (1,700) - (1,700) 16,500 - 16,500
--------------------------------------------- ---------------------------------------------
Total operating expenses 111,743 2,429 114,172 107,540 1,187 108,727
--------------------------------------------- ---------------------------------------------
Operating income 73,771 (3,171) 70,600 42,929 423 43,352
--------------------------------------------- ---------------------------------------------
Other expense (income):
Interest expense 5,865 - 5,865 325 - 325
Interest and other income (2,092) - (2,092) (977) - (977)
--------------------------------------------- ---------------------------------------------
Total other expense (income) 3,773 - 3,773 (652) - (652)
--------------------------------------------- ---------------------------------------------
Income before income taxes 69,998 (3,171) 66,827 43,581 423 44,004
Provision for income taxes 24,150 977 25,127 15,471 342 15,813
--------------------------------------------- ---------------------------------------------
Net income $ 45,848 $ (4,148) $ 41,700 $ 28,110 $ 81 $ 28,191
============================================= =============================================
Earnings per share:
Basic - Class A common $ 0.98 $ (0.08) $ 0.90 $ 0.59 $ 0.01 $ 0.60
Basic - Class B common 0.82 (0.07) 0.75 0.50 - 0.50
Diluted - Class A common 0.84 (0.06) 0.78 0.55 - 0.55
Diluted - Class B common (a) 0.68 0.48
Shares used in per share calculation:
Basic - Class A common 33,046 (312) (b) 32,734 33,997 (253) (b) 33,744
Basic - Class B common 15,941 (96) (b) 15,845 15,803 (305) (b) 15,498
Diluted - Class A common 58,708 (916) (b) 57,792 51,561 (406) (b) 51,155
Diluted - Class B common (a) 16,175 16,091
<FN>
(a) In fiscal 2007, we began reporting diluted earnings per share for Class B
Common Stock under the two-class method which does not assume the
conversion of Class B Common Stock into Class A Common Stock. Previously,
we did not present diluted earnings per share for Class B Common Stock.
(b) Adjustment to reflect impact of unrecognized stock-based compensation and
excess tax benefits in applying the treasury stock method and unvested
stock options in the two-year forfeiture period.
47
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
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, which gives effect to the restatement
discussed in Note 3 to the Consolidated Financial Statements, 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.
REVIEW OF STOCK OPTION GRANT PRACTICES
BACKGROUND AND CONCLUSIONS
On October 31, 2006, we announced that we had been served with a
derivative lawsuit filed in St. Louis City Circuit Court alleging
that certain stock option grants to current or former officers and
directors between 1995 and 2002 were dated improperly. In accordance
with our established corporate governance procedures, the Board of
Directors referred this matter to the independent members of its
Audit Committee (the "Special Committee" or "Committee").
Shortly thereafter, the Special Committee commenced an investigation
of our stock option grant practices, assisted by independent legal
counsel and forensic accounting experts engaged by the Committee,
with the objectives of evaluating our accounting for stock options
for compliance with GAAP and for compliance with the terms of our
related stock option plans over the period January 1, 1995 through
October 31, 2006 (the "relevant period"). The Committee and its
advisors interviewed all available persons (45 in all) believed to be
relevant to the issues being investigated, including current and
former employees, current and former outside directors and our
current auditors and outside legal counsel. They reviewed nearly
300,000 electronic and hard copy documents relating to our stock
option grant practices. During the relevant period, we awarded 2,639
option grants covering 10.6 million shares of our Class A and Class B
Common Stock, which were reviewed by the Committee.
On October 11, 2007, we filed a Current Report on Form 8-K announcing
the Special Committee had completed its investigation. The
investigation concluded that there was no evidence that any employee,
officer or director of the Company engaged in any intentional
wrongdoing or was aware that the Company's policies and procedures
for granting and accounting for stock options were materially
non-compliant with GAAP. The investigation also found no intentional
violation of law or accounting rules with respect to our historical
stock option grant practices.
However, the Special Committee concluded that stock-based
compensation expense resulting from the stock option grant practices
followed by the Company prior to April 2, 2006 were not recorded in
accordance with GAAP because the expense computed for most of those
grants reflected incorrect measurement dates for financial accounting
purposes. The "measurement date" under applicable accounting
principles, namely Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, ("APB 25") and related
interpretations, is the first date on which all of the following are
known and not subject to change: (a) the individual who is entitled
to receive the option grant, (b) the number of options that an
individual is entitled to receive, and (c) the option's exercise
price.
48
FINDINGS AND ACCOUNTING CONSIDERATIONS
In general, stock options were granted to employees, executives and
non-employee members of the Board of Directors over the relevant
period under the terms of our 1991 and 2001 Incentive Stock Option
Plans (the "option plans"). The majority of our employees participate
in our stock option program. Approximately 78% of our employees as of
March 31, 2007, have been awarded grants under our option plans. In
addition to options granted to the CEO under those plans, "bonus
options" were awarded to him under the terms of his employment
agreement in lieu of, and in consideration for a reduction of, a
portion of the cash bonus provided for in that agreement.
The option plans required grants to be approved by the Compensation
Committee of the Board of Directors. Under the option plans, options
were to be granted with exercise prices set at no less than the fair
market value of the underlying common stock at the date of grant. The
1991 plan provided for the exclusive grant of Incentive Stock Options
("ISOs") as defined by Internal Revenue Code Section 422, while the
2001 plan provided for the grant of both ISOs and non-qualified stock
options ("NSOs"). Under the plans, options granted to employees other
than the CEO or directors are subject to a ten-year ratable vesting
period. Options granted to the CEO and directors generally vest
ratably over five years.
Both option plans require that shares received upon exercise of an
option cannot be sold for two years. If the employee terminates
employment voluntarily or involuntarily (other than by retirement,
death or disability) during the two-year period, the option plans
provide that the Company may elect to repurchase the shares at the
lower of the exercise price or the fair market value of the stock on
the date of termination. Based on management's analysis, we have
changed our accounting for stock-based compensation to consider this
provision of the option plans as a forfeiture provision to be
accounted for in accordance with the guidance provided in EITF No.
00-23, "Issues Related to the Accounting for Stock Compensation under
APB 25 and FIN 44", specifically Paragraph 78 and Issue 33 (a),
"Accounting for Early Exercise." In accordance with EITF No. 00-23,
cash paid by an employee for the exercise price is considered a
deposit or a prepayment of the exercise price that is recognized as a
current liability when received by the Company at the beginning of
the two-year forfeiture period. The receipt of the exercise price is
recognized as a current liability because the options are deemed not
exercised and the option shares are not considered issued until an
employee bears the risk and rewards of ownership. The options are
accounted for as exercised when the two-year forfeiture period
lapses. In addition, because the options are not considered exercised
for accounting purposes, the shares in the two-year forfeiture period
are not considered outstanding for purposes of computing basic EPS.
Prior to fiscal 2007, we had accounted for all option grants as fixed
in accordance with the provisions of APB 25 using the selected date
of grant as the measurement date. Because the exercise price of the
option was equal to or greater than the market price of the stock at
the measurement date, under our prior procedures, we did not
recognize any compensation expense since the option had no intrinsic
value (intrinsic value being the difference between the exercise
price and the market price of the underlying stock at the measurement
date).
As noted above, the Special Committee determined that our accounting
for most of the stock option grants was not in accordance with GAAP
because the date of grant, as defined by the Company, was not a
proper measurement date. To correct those errors, and consistent with
the accounting literature and guidance from the SEC, we organized the
grants into categories based on grant type and process by which the
grant was finalized. Based on the relevant facts and circumstances,
we applied the authoritative accounting standard (APB 25 and related
interpretations) to determine, for every grant within each category,
the proper measurement date. If the measurement date was not the
originally assigned grant date, accounting adjustments were made as
required, resulting in stock-based compensation expense and related
tax effects. The grants were classified as follows: (1)
promotion/retention grants to executives and employees and new hire
grants ("employee options"); (2) grants to persons elected or
appointed to the Board of Directors ("director options"); and (3)
bonus option grants to the CEO in lieu of cash bonus payments under
the terms of his employment agreement ("bonus options").
49
Employee Options. The evidence obtained through the Committee's
----------------
investigation indicated that employee options were granted based on
the lowest market price in the quarter of grant determined from an
effective date (as defined below) to the end of the quarter. The
exercise price and grant date of the options were determined by
looking back from the end of the quarter to the effective date and
choosing the lowest market price during that period. The date on
which the market price was lowest became the grant date. This
procedure to "look back" to the lowest market price in the preceding
quarter to set the exercise price was widely known and understood
within the Company. The effective date was either the date on which
the option recipients and the number of shares to be granted were
determined and approved by the CEO, the date of a promotion or the
date of hire. For new hires and promotions of existing employees
which represents substantially all of the award recipients, the terms
of the award except for the exercise price were communicated to the
recipients prior to the end of the quarter. At the end of the
quarter, when the exercise price was determined, written consents
were prepared and dated the date on which the stock price was lowest
during the quarter, to be approved by the members of the Compensation
Committee. The evidence obtained through the investigation indicated
the Compensation Committee never changed or denied approval of any
grants submitted to them and, as such, their approval was considered
a routine matter. Based on the evidence and findings of the Special
Committee, the results of management's analysis, the criteria
specified in APB 25 for determining measurement dates and guidance
from the staff of the SEC, we have concluded the measurement dates
for the employee options should not have been the originally assigned
grant dates, but instead, should have been the end of the quarter in
which awards were granted when the exercise price and number of
shares granted were fixed. Changing the measurement date from the
originally assigned grant date to the end of the quarter resulted in
recognition of additional stock-based compensation expense of $6.0
million, net of tax on 2,830 stock option grants, over the period
from fiscal 1996 through fiscal 2006.
Director Options. Director options were issued, prior to the
----------------
effective date of the Sarbanes-Oxley Act ("Sarbanes-Oxley") in August
2002, using the same "look back" process as described above for
employee options. This process was changed when the time for filing
Form 4's was shortened under the provisions of Sarbanes-Oxley, to
award options with exercise prices equal to the fair market value of
the stock on the date of grant. We concluded that the measurement
date for the director options granted prior to this change in grant
practice should be the end of the quarter. Changing the measurement
date from the originally assigned grant date to the end of the
quarter resulted in recognition of additional stock-based
compensation expense of $0.7 million, net of tax on 24 stock option
grants, over the period from fiscal 1996 through fiscal 2006.
Bonus Options. The terms of the CEO's employment agreement permitted
-------------
him the alternative of electing ISOs, restricted stock or discounted
stock options in lieu of the cash payment of part or all of the
annual incentive bonus due to him. In the event of an election to
receive options in lieu of the cash incentive due, those options were
to be valued using the Black-Scholes option pricing model, applying
the same assumptions as those used in the Company's most recent proxy
statement. The employment agreement provides that the CEO's annual
bonus is payable, based on the fiscal year net income, after the end
of the year. However, based on advice provided to us by our legal
counsel, and our longstanding interpretation, the Company believed
that it was permissible to make advance payments in the form of bonus
options during the year based on the anticipated annual bonus, and
did so.
Prior to fiscal 2005, the CEO received ten bonus option grants,
consisting of options to purchase 337,500 shares of Class A Common
Stock and 1,743,750 shares of Class B Common Stock under this
arrangement. The CEO and the Board's designated representative (our
Chief Financial Officer) negotiated the terms of the bonus options,
including the number of shares covered, the exercise price and the
grant date (the latter being selected using a "look back" process
similar to that followed in granting employee and director options).
We typically granted bonus options prior to fiscal year-end, shortly
after such agreement was reached. These bonus options were fully
vested at grant, had three-to-five year terms, were granted with a
10% or 25% premium to the market price of the stock on the selected
grant date and were subject to the approval of the Compensation
Committee. The CEO's cash bonus payable at the end of the fiscal year
in which the options were granted was reduced by the Black- Scholes
value of the options according to their terms.
50
Based on the facts and circumstances relative to the process for
granting the bonus options, the Special Committee determined, and
management has agreed that the measurement dates for these options
should be the end of the fiscal year in which they were granted. The
end of the fiscal year was used as the measurement date because that
is the date on which the amount of the annual bonus could be
determined and therefore the terms of the option could be fixed under
APB 25. This conclusion is predicated on the assumption that the
terms of the option were linked to the amount of the bonus earned.
While it was permissible to agree upon the number of shares that were
to be issued and would not be forfeitable prior to the end of the
year, under GAAP the exercise price is considered variable until the
amount of the bonus could be determined with finality. The
variability in the exercise price results from the premise that the
CEO would have been required to repay any shortfall in the bonus
earned from the value assigned to the option by the Black-Scholes
model. Although there was never an instance when the value of the
options as calculated exceeded the CEO's bonus, if that were to have
occurred, the amount repaid to cure the bonus shortfall would in
substance be an increase in the exercise price of the option. Since
the exercise price could not be determined with certainty until the
amount of the bonus was known, we have applied variable accounting to
the bonus options from the date of grant to the final fiscal year-end
measurement date. Variable accounting requires that compensation
expense is to be determined by comparing the quoted market value of
the shares covered by the option grant to the exercise price at each
intervening balance sheet date until the terms of the option become
fixed.
The compensation expense associated with the CEO's estimated bonus
was accrued throughout the fiscal year. When the value of a bonus
option was determined using the Black-Scholes model, previously
recorded compensation expense associated with the accrual of the
estimated bonus was reversed in the amount of the value assigned to
the bonus option. The previously recorded compensation expense should
not have been reversed. We developed a methodology in the restatement
process that considers both the intrinsic value of the option under
APB 25 and the Black-Scholes value assigned to the bonus option in
determining the amount of compensation expense to recognize once the
exercise price of the option becomes fixed and variable accounting
ends. Under this methodology, the intrinsic value of the option is
determined at the fiscal year-end measurement date under the
principles of APB 25. The intrinsic value is then compared to the
Black-Scholes value assigned to the option for compensation purposes
(the bonus value). The bonus value is the amount that would have been
accrued during the fiscal year through the grant date as part of the
total liability for the CEO's bonus. The greater of the intrinsic
value or bonus value is recorded as compensation expense. Using this
methodology and the fiscal year-end as the measurement dates resulted
in an increase in stock-based compensation expense of $6.9 million
over the period from fiscal 1996 through fiscal 2004. There was no
tax benefit associated with this expense, due to the tax years being
closed.
OTHER MODIFICATIONS OF OPTION TERMS
As described above, under the terms of our stock option plans, shares
received on exercise of an option are to be held for the employee for
two years during which time the shares cannot be sold. If the
employee terminates employment voluntarily or involuntarily (other
than by retirement, death or disability) during the two-year
forfeiture period, the plans provide the Company with the option of
repurchasing the shares at the lower of the exercise price or the
fair market value of the stock on the date of termination. In some
circumstances we elected not to repurchase the shares upon
termination of employment while the shares were in the two-year
forfeiture period, essentially waiving the remaining forfeiture
period requirement. We did not previously recognize this waiver as
requiring a new measurement date.
Based on management's analysis, we have concluded that a new
measurement date should have been recognized in two situations: (1)
where the employee terminated and the Company did not exercise its
right under the option plans to buy back the shares in the two-year
forfeiture period; and (2) where the forfeiture provision was waived
and the employee subsequently terminated within two years of the
exercise date. We now consider both of these situations to be an
acceleration of the vesting period because the forfeiture provision
was waived, i.e., the employee is no longer subject to a service
condition to earn the right to the shares and will benefit from the
modification. As such, a new measurement date is required. In this
case, the new measurement date is the date the
51
forfeiture provision was waived with additional stock-based
compensation expense being recognized at the date of termination.
Since the shares were fully vested, the intrinsic value of the option
at the new measurement date in excess of the intrinsic value at the
original measurement date should be expensed immediately. The new
measurement dates resulted in an increase in stock-based compensation
expense of $0.4 million, net of tax, on 27 stock option grants over
the period from fiscal 1996 through fiscal 2006.
STOCK OPTION ADJUSTMENTS
Stock-based Compensation Expense. Although the period for the Special
--------------------------------
Committee's investigation was January 1, 1995 to October 31, 2006,
management extended the period of review back to 1986 for purposes of
analyzing the aggregate impact of the measurement date changes
because the incorrect accounting for stock options extended that far
back in time. We have concluded that the measurement date changes
identified by the Special Committee's investigation and management's
analysis resulted in an understatement of stock-based compensation
expense arising from stock option grants since fiscal 1986, affecting
our consolidated financial statements for each fiscal year beginning
with our fiscal year ended March 31, 1986. The effect on the
consolidated financial statements for the fiscal years from 1986 to
1995 was not considered material, individually or in the aggregate.
Therefore, it was included as a cumulative adjustment to the
stock-based compensation expense for fiscal 1996. We have determined
the aggregate understatement of stock-based compensation expense for
the 11-year restatement period from 1996 through 2006 was $14.0
million, net of tax, on 2,891 stock option grants.
As previously discussed, we now consider the two-year repurchase
option specified in the option plans to be a forfeiture provision
that goes into effect when stock options are exercised. Therefore,
the service period necessary for an employee to earn an award varies
based on the timing of stock option exercises. We initially expense
each award (i.e., all tranches of an option award) on a straight-line
basis over ten years, which is the period that stock options become
exercisable. We ensure the cumulative compensation expense for an
award as of any date is at least equal to the measurement-date
intrinsic value of those options that have vested (i.e., when the
two-year forfeiture period has ended). If stock options expire
unexercised or an employee terminates employment after options become
exercisable, the compensation expense associated with the
exercisable, but unexercised options, is not reversed. In those
instances where an employee terminates employment before options
become exercisable or we repurchased the shares during the two-year
forfeiture period, all compensation expense for those options is
reversed as forfeiture.
Payroll Taxes, Interest and Penalties. In connection with the
-------------------------------------
stock-based compensation adjustments, we determined that certain
options previously classified as ISO grants were determined to have
been granted with an exercise price below the fair market value of
our stock on the revised measurement date. Under Internal Revenue
Code Section 422, ISOs may not be granted with an exercise price less
than the fair market value on the date of grant and, therefore, these
grants would not likely qualify for ISO tax treatment. The
disqualification of ISO classification exposes the Company and the
affected employees to payroll related withholding taxes once the
underlying shares are released from the post-exercise two-year
forfeiture period and the substantial risk of forfeiture has lapsed
(the "taxable event"). The Company and the affected employees may
also be subject to interest and penalties for failing to properly
withhold taxes and report the taxable event on their respective tax
returns. The Company is currently reviewing the potential
disqualification of ISO grants and the related withholding tax
implications with the Internal Revenue Service for calendar years
2004, 2005 and 2006 in an effort to reach agreement on the resulting
tax liability. In the meantime, the Company has recorded expenses
related to the withholding taxes, interest and penalties associated
with options which would have created a taxable event in calendar
years 2004, 2005 and 2006. The Company estimates that the payroll tax
liability at March 31, 2006 for the disqualification tax treatment
associated with ISO awards totaled $3.3 million. In addition, we
recorded an income tax benefit of $0.9 million related to this
liability.
Income Tax Benefit. We reviewed the income tax effect of the
------------------
stock-based compensation charges, and we believe the proper income
tax accounting for stock options under GAAP depends, in part, on the
tax designation of the stock options as either ISOs or NSOs. Because
of the potential impact of measurement date changes on the
52
qualified status of the options, we have determined that
substantially all of the options originally intended to be ISOs and
granted prior to April 2, 2006 might not be qualified under the tax
regulations and, therefore, should be accounted for as if they were
NSOs for financial accounting purposes. An income tax benefit has
resulted from the determination that certain NSOs for which
stock-based compensation expense was recorded will create an income
tax deduction. This tax benefit has resulted in an increase to our
deferred tax assets for stock options prior to the occurrence of a
taxable event or the forfeiture of the related options. Upon the
occurrence of a taxable event or forfeiture of the underlying
options, the corresponding deferred tax asset is reversed and the
excess or deficiency in the deferred tax assets is recorded to
paid-in capital in the period in which the taxable event or
forfeiture occurs. We have recorded a deferred tax asset of $1.3
million as of March 31, 2006, related to stock options.
The stock option adjustments and related income tax impacts discussed
above reduced net income by $16.3 million in the aggregate for the
fiscal years ended March 31, 1996 through 2006. We have restated pro
forma net income and earnings per share under Statement of Financial
Accounting Standards ("SFAS") No. 123 in Note 2 of the Notes to
Consolidated Financial Statements of this Form 10-K to reflect the
impact of these adjustments for the fiscal years ended March 31, 2006
and 2005.
REMEDIATION
The Special Committee recommended a remediation plan that included
the repricing of certain stock option grants awarded to officers and
directors and reimbursement by our CEO of $1.4 million. To reprice
the stock option grants awarded to certain senior officers and
directors, the original exercise prices have been increased to the
market prices of the stock on the new measurement date for all options
outstanding as of the beginning of the investigation.
As described above, the Special Committee concluded that the CEO's
bonus options awarded under his employment agreement should have been
issued at the end of the fiscal year rather than during the year as
had been our past practice. The Committee concluded that an
adjustment was appropriate to reflect that the bonus options should
not have been issued before fiscal year end and to remove any
benefits to the CEO from our past practice of looking back to select
grant dates and exercise prices. The Committee determined the
adjustment by calculating the Black-Scholes values of the bonus
options as if they had been issued at the end of the fiscal year and
then comparing those values to the amounts reported in our proxy
statements as the values of the bonus options based on the earlier
grant dates. The difference in the aggregate value of the bonus
options based on this methodology was $1.4 million. The Committee
considered several other alternative remediation calculations but
concluded, based on consideration of all of the facts and
circumstances, that the recommended amount was the appropriate
remediation. The CEO has made the recommended reimbursement of $1.4
million by delivery to the Company of 45,531 shares of Class A Common
Stock on November 1, 2007.
The Committee also recommended changes to our stock option grant
practices and additional training for employees involved in the
accounting for and administration of our stock option program. These
recommendations were accepted by the Board of Directors by unanimous
consent on October 11, 2007.
REVIEW OF TAX POSITIONS (UNRELATED TO STOCK OPTIONS)
In addition to the restatement adjustments associated with stock
options discussed above, our restated consolidated financial
statements include an adjustment for fiscal years 2004, 2005 and 2006
to reflect additional liabilities associated with tax positions taken
on filed tax returns for those years that should have been recorded
in accordance with GAAP, partially offset by certain expected tax
refunds. The aggregate impact of this adjustment was a $5.4 million
increase in income tax expense with a corresponding increase in taxes
payable. This adjustment is not related to the accounting for
stock-based compensation expense discussed above.
53
OTHER ADJUSTMENTS (UNRELATED TO STOCK OPTIONS)
In addition to the restatement adjustments associated with stock
options and income taxes discussed above, our restated Consolidated
Financial Statements include an adjustment for fiscal years 2002
through 2006 to reflect the correction of errors related to the
recognition of revenue associated with shipments to customers under
FOB destination terms and an adjustment to reduce the estimated
liability for employee medical claims incurred but not reported at
March 31, 2006. We improperly recognized revenue from certain
customers prior to when title and risk of ownership transferred to
the customer. The aggregate impact of these adjustments over the
periods affected was a decrease in net revenue of $1.2 million and a
decrease in net income of $0.4 million. The aggregate impact on net
income reflected a $0.5 million decrease associated with the net
revenue errors and a $0.1 million increase related to the adjustment
of the liability for medical claims.
RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS
We have restated our Consolidated Financial Statements for the fiscal
years ended March 31, 2006 and 2005. In addition, because the impacts
of the restatement adjustments extend back to the year ended March
31, 1996, we have recognized the cumulative restatement adjustments
through March 31, 2004 as a net decrease to beginning shareholders'
equity as of April 1, 2004. In addition, for purposes of Part II,
Item 6, Selected Financial Data, for the fiscal years ended March 31,
2004 and fiscal 2003, the cumulative stock-based compensation expense
and related income tax impact through March 31, 2002 has been
recognized as a net decrease to beginning shareholders' equity as of
April 1, 2002 and the 2003 and 2004 impacts associated with such
items have been reflected in our consolidated balance sheet and
statement of income data set forth in Part II, Item 6, Selected
Financial Data, in this Form 10-K.
The table below reflects the impact of the restatement adjustments
discussed above on our consolidated statements of income for the
periods presented below (in thousands):
YEARS ENDED MARCH 31, CUMULATIVE
----------------------------------------------------- 1996 THROUGH
CATEGORY OF ADJUSTMENT: 2006 (a) 2005 (a) 2004 (b) 2003 (b) 2002 (c)
- ----------------------- ----------- ----------- ----------- ------------- ----------------
Pretax income impact:
Stock-based compensation expense
related to measurement date changes (d) $ 927 $ 1,080 $ 1,990 $ 1,187 $ 10,449
Payroll taxes, interest and penalties (d) 2,294 545 439 - -
Other adjustments, net (160) (897) 742 (1,610) 2,534
----------- ----------- ----------- ------------- ----------------
Total pretax income reduction (increase) 3,061 728 3,171 (423) 12,983
----------- ----------- ----------- ------------- ----------------
Income tax expense (benefit)
Measurement date changes (286) (323) (333) (248) (469)
Payroll taxes and interest (635) (151) (123) - -
Other income tax adjustments (e) 2,171 1,498 1,689 - -
Other adjustments 60 300 (256) 590 (918)
----------- ----------- ----------- ------------- ----------------
Total income tax increase (reduction) 1,310 1,324 977 342 (1,387)
----------- ----------- ----------- ------------- ----------------
Total net reduction (increase) in net income $ 4,371 $ 2,052 $ 4,148 $ (81) $ 11,596
=========== =========== =========== ============= ================
<FN>
-----------------------
(a) See Note 3 "Restatement of Consolidated Financial Statements" of
the Notes to Consolidated Financial Statements included in this
Form 10-K for additional information regarding the adjustments
made to our restated consolidated financial statements.
(b) The impacts on fiscal 2004 and 2003 have been reflected in Part
II, Item 6, Selected Financial Data, in this Form 10-K.
(c) The cumulative effect of the restatement adjustments from fiscal
1996 through fiscal 2002 is reflected as an adjustment to
shareholders' equity as of April 1, 2002 in Item 6, Selected
Financial Data. The following is a summary of the pretax and
after-tax expense by fiscal year (in thousands):
54
STOCK OPTION ADJUSTMENTS OTHER ADJUSTMENTS
--------------------------------- -------------------------------- NET CHARGE
YEARS ENDED MARCH 31, PRETAX INCOME TAX PRETAX INCOME TAX TO NET INCOME
- --------------------- --------------- --------------- --------------- --------------- ----------------
1996 $ 829 (f) $ - $ - $ - $ 829
1997 657 (1) - - 656
1998 2,391 (19) - - 2,372
1999 535 (27) - - 508
2000 1,998 (62) - - 1,936
2001 1,722 (141) - - 1,581
2002 2,317 (219) 2,534 (918) 3,714
--------------- --------------- --------------- --------------- ----------------
Cumulative effect $ 10,449 $ (469) $ 2,534 $ (918) $ 11,596
=============== =============== =============== =============== ================
<FN>
(d) Stock-based compensation expenses, including related payroll
taxes, interest and penalties, have been recorded as adjustments
to the selling and administrative expense line item in our
consolidated statements of income for each period.
(e) This represents liabilities associated with tax positions taken
on filed tax returns for these years, partially offset by
certain expected tax refunds and is not related to accounting
for stock-based compensation.
(f) Includes additional expense from 1986 to 1995 totaling $0.6
million, the affect of which on the consolidated financial
statements for 1996 and for each year 1986 to 1995 was not
considered material.
As a result of our failure to file our Quarterly Report on Form 10-Q
for the quarter ended December 31, 2007, among others, on a timely
basis, we will not be eligible to use a short-form Form S-3
registration statement to offer or sell our securities in a public
offering until we have timely filed all required reports under the
Securities Exchange Act of 1934, as amended, for the 12 months prior
to our use of the registration statement.
BACKGROUND
We are a fully integrated specialty pharmaceutical company that
develops, manufactures, acquires 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 diverse 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.
55
GOVERNMENT REGULATION
In June 2006, May 2007 and September 2007, the FDA issued Notices to
the pharmaceutical industry stating that manufacture of all
unapproved drug products containing carbinoxamine, carbinoxamine
labeled for children under two, timed-released guaifenesin,
hydrocodone labeled for children under six and all other unapproved
products containing hydrocodone, respectively, cease by September 6,
2006, July 9, 2006, August 26, 2007, October 31, 2007, and December
31, 2007, respectively. These Notices affect the continued
manufacture and sale of ETHEX's Hydro-Tussin(TM) CBX Syrup,
Tri-Vent(TM) HC Liquid, Guaifenex(R) DM ER Tablets, Guaifenex(R) PSE
60 ER Tablets, PhenaVent(TM) D Capsules, Guaifenex(R) PSE 80 ER
Tablets, Pseudovent(TM) DM Tablets, Histinex(R) PV Syrup, Hydrocodone
Bitartrate & Guaifenesin Liquid, Hydro-Tussin(TM) HC Syrup,
Histinex(R) HC Syrup and Hydro-Tussin(TM) Syrup.
On March 13, 2008, representatives of the Missouri Department of
Health and Senior Services, accompanied by representatives of the
FDA, notified the Company of a hold on the Company's inventory of
certain unapproved drug products, restricting the Company's ability
to remove or dispose of those inventories without permission. KV
believes that the hold relates to a potential misunderstanding by KV
about the intended scope of recent FDA notices setting limits on the
marketing of unapproved guaifenesin products. In response to notices
issued by FDA in 2002 and 2003 with respect to single-entity
timed-release guaifenesin products, and a further notice issued in
2007 with respect to combination timed-released guaifenesin products,
KV timely discontinued a number of its guaifenesin products and
believed that, by doing so, it had complied with those notices. The
recent action to place a hold on certain KV products may indicate,
however, that additional guaifenesin products may have to be
discontinued. Pursuant to discussions with the Missouri Department,
and with the FDA, seeking to clarify the status of products that were
initially placed on hold, certain categories of those products were
released from the hold later in the day on March 13, 2008. These
discussions are continuing with respect to the status of the
remaining products subject to the hold. In fiscal 2007, ETHEX
reported net sales of $39.2 million from the products remaining
subject to the hold. Of this amount, approximately 84%, or $33.0
million, are cough/cold and allergy products sold by ETHEX as part of
its respiratory product line, 90% of which contain immediate-release
guaifenesin. We believe this hold will not materially affect our
results of operations for fiscal 2008. If the hold continues for an
extended period or if it becomes permanent, it would substantially
eliminate ETHEX's respiratory product line.The Company believes that
the potential loss of these revenues will be more than offset by
increases in revenues expected in our existing branded and generic
product lines and by anticipated new product approvals.
RESULTS OF OPERATIONS
We reported net income of $58.1 million in fiscal 2007 compared to
net income of $11.4 million in fiscal 2006. During fiscal 2006, we
recorded expense of $30.4 million in connection with the FemmePharma
acquisition (see Note 4 to the Consolidated Financial Statements)
that consisted of $29.6 million for acquired in-process research and
development and $0.9 million in direct expenses related to the
transaction. Excluding the $30.4 million of expense associated with
the prior year acquisition of FemmePharma, net income for fiscal 2007
would have increased $16.2 million, or 38.8%.
Net revenues for fiscal 2007 increased $76.0 million, or 20.7%, as we
experienced sales growth of $43.2 million, or 29.7%, in our branded
products segment and $31.8 million, or 15.6%, in our specialty
generics segment. The resulting $52.7 million increase in gross
profit was offset in part by a $31.1 million increase in operating
expenses before taking into account the $30.4 million of expense
associated with the prior year acquisition of FemmePharma. The
increase in operating expenses was primarily due to higher personnel
costs, an increase in branded marketing and promotions expense, the
incremental impact of stock-based compensation expense recorded in
conjunction with the adoption of SFAS 123R (see Note 17 to the
Consolidated Financial Statements), higher accrued payroll taxes,
interest and penalties on disqualified stock options, and additional
costs associated with the expansion of our facilities.
FISCAL 2007 COMPARED TO FISCAL 2006
NET REVENUES BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
--------------------------------------------------------
CHANGE
--------------------
2006
($ IN THOUSANDS): 2007 (AS RESTATED) $ %
-------------- ------------- ---------- -----
Branded products $ 188,681 $ 145,503 $ 43,178 29.7%
as % of net revenues 42.5% 39.6%
Specialty generics/non-branded 235,594 203,787 31,807 15.6%
as % of net revenues 53.1% 55.4%
Specialty materials 17,436 16,988 448 2.6%
as % of net revenues 3.9% 4.6%
Other 1,916 1,362 554 40.7%
------------- ------------ ----------
Total net revenues $ 443,627 $ 367,640 $ 75,987 20.7%
The increase in branded product sales was due primarily to continued
sales growth from our prescription prenatal and hematinic product
lines coupled with increased sales of our anti-infective brand,
Clindesse(R). Sales from our PreCare(R) product line increased 44.1%
to $72.5 million during fiscal 2007. This increase was primarily due
to sales growth experienced by PrimaCare(R) ONE, the introduction of
PreCare Premier(R) and product line price increases that occurred
over the past 12 months. Sales of PrimaCare(R) ONE in fiscal 2007
increased $22.3 million, or 104.2%, due primarily to market share
gains over the past two years. Specifically, PrimaCare(R) ONE
experienced an increase in prescription volume of 101.9% during
fiscal 2007. Sales from our hematinic products increased 31.0% to
$48.2 million in fiscal 2007. These increases primarily reflected
$8.3 million of incremental sales of Repliva 21/7(TM), a new
hematinic product introduced in the second quarter of fiscal 2006,
coupled with increased sales from our Niferex(R) products.
Clindesse(R), a single-dose prescription cream therapy indicated to
treat bacterial vaginosis, experienced sales growth of 44.6% to $31.8
million during fiscal 2007 as our share of the
56
prescription intravaginal bacterial vaginosis market increased to
26.4% at the end of fiscal 2007. Sales of Clindesse(R) in fiscal 2007
also reflected the impact of a price increase in September 2006.
The growth in specialty generic/non-branded sales resulted primarily
from increases experienced by our cardiovascular, cough/cold and pain
management product lines. The cardiovascular product line contributed
sales growth of $16.0 million, or 18.7%, in fiscal 2007 due to $11.5
million of incremental sales volume from new products with the
remaining increase attributable to higher prices. The reported new
products consisted of six strengths of diltiazem HCI ER Capsules (AB
rated to Tiazac(R)) that were approved by the FDA in September 2006.
In fiscal 2007, our cough/cold product line reported sales growth of
$8.1 million, or 23.5%, as sales volume grew $5.0 million and price
increases generated increased sales of $3.1 million. Sales from the
pain management product line in fiscal 2007 increased $9.1 million,
or 24.2%, due to incremental sales from three product approvals
received late in fiscal 2006 and increased prices on the other pain
management products.
The increase in specialty material product sales was primarily due to
the impact of price increases on certain products.
GROSS PROFIT BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
-------------------------------------------------------
CHANGE
---------------------
2006
($ IN THOUSANDS): 2007 (AS RESTATED) $ %
------------ ------------- ---------- --------
Branded products $ 167,864 $ 128,572 $ 39,292 30.6%
as % of net revenues 89.0% 88.4%
Specialty generics/non-branded 138,272 111,907 26,365 23.6%
as % of net revenues 58.7% 54.9%
Specialty materials 6,005 4,732 1,273 26.9%
as % of net revenues 34.4% 27.9%
Other (15,777) (1,506) (14,271) (947.6)%
------------ ------------- ----------
Total gross profit $ 296,364 $ 243,705 $ 52,659 21.6%
as % of total net revenues 66.8% 66.3%
The increase in gross profit was principally due to the sales growth
experienced by our branded products and specialty generic/non-branded
segments. The higher specialty generic gross profit percentage in
fiscal 2007 was primarily attributable to sales of new cardiovascular
products coupled with the impact of price increases on certain
cardiovascular, cough/cold and pain management products. Impacting
the Other category are contract manufacturing revenues, pricing and
production variances, and changes to inventory reserves associated
with production. Any inventory reserve changes associated with
finished goods are reflected in the applicable segment. The
fluctuation in the Other category was primarily due to the impact of
higher production costs during the first six months of the fiscal
year that resulted from lower-than-expected production volume,
coupled with an increase in provisions for obsolete inventory on
certain existing products in various stages of production. Also,
during the last three quarters of fiscal 2007, we recorded provisions
associated with certain new products where production occurred prior
to receiving FDA approval and the upcoming expiration dates made them
unsalable. The provision for obsolete inventory for fiscal 2007 and
2006 was $12.0 million and $4.2 million, respectively.
57
RESEARCH AND DEVELOPMENT
------------------------
YEARS ENDED MARCH 31,
---------------------------------------------------------
CHANGE
---------------------
($ IN THOUSANDS): 2007 2006 $ %
----------- ----------- ----------- ----
Research and development $ 31,462 $ 28,886 $ 2,576 8.9%
as % of net revenues 7.1% 7.9%
The increase in research and development expense was due to increased
spending on clinical efficacy and bioequivalence studies as we
continued active development of various brand and non-brand/generic
products in our internal and external pipelines, coupled with an
increase in research and development personnel.
PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
---------------------------------------------
YEARS ENDED MARCH 31,
-----------------------------------------------------
CHANGE
-----------------
($ IN THOUSANDS): 2007 2006 $ %
------- ----------- ---------- --
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 (see Note 4 to the
Consolidated Financial Statements) "Acquisitions and License
Agreement" that consisted of $29.6 million for acquired in-process
research and development and $0.9 million in direct expenses related
to the transaction. The valuation of acquired in-process research and
development represents the estimated fair value of the worldwide
marketing rights to an endometriosis product we acquired as part of
the FemmePharma acquisition that, at the time of the acquisition, had
no alternative future use and for which technological feasibility had
not been established.
SELLING AND ADMINISTRATIVE
--------------------------
YEARS ENDED MARCH 31,
------------------------------------------------------
2006 CHANGE
2007 (AS RESTATED) --------------
($ IN THOUSANDS): ----- ------------- $ %
--------- ----
Selling and administrative $ 174,344 $ 143,437 $ 30,907 21.6%
as % of net revenues 39.3% 39.0%
The increase in selling and administrative expense was primarily due
to:
* $14.8 million increase in personnel costs due to increases in
management and other personnel;
* $3.4 million increase in branded marketing and promotions expense;
* $2.5 million increase in legal and professional expense
commensurate with an increase in litigation activity and
evaluation of potential acquisition opportunities; and
* $2.2 million increase in expense resulting from facility
expansion.
The increase in personnel costs included $3.1 million of incremental
stock-based compensation expense resulting from the adoption of SFAS
123R, "Share-Based Payment," and an increase in accrued payroll
taxes, interest and penalties associated with the disqualification of
certain stock options. We adopted SFAS 123R using the
58
modified prospective method and, as a result, did not retroactively
adjust results from prior periods. Prior to the adoption of SFAS
123R, we accounted for stock-based compensation using the intrinsic
value method prescribed in APB 25 (see the "Explanatory Note"
immediately preceding Part I, Item 1, "Management's Discussion and
Analysis of Financial Condition and Results of Operation" in Part II,
Item 7, and Note 3 "Restatement of Consolidated Financial Statements"
in the Notes to Consolidated Financial Statements in this Form 10-K).
AMORTIZATION OF INTANGIBLE ASSETS
---------------------------------
YEARS ENDED MARCH 31,
-----------------------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2007 2006 $ %
------- ----------- ----- ----
Amortization of intangible assets $ 4,810 $ 4,784 $ 26 0.5%
as % of net revenues 1.1% 1.3%
The increase in amortization of intangible assets was due primarily
to an increase in amortization of patent and trademark costs.
LITIGATION
----------
YEARS ENDED MARCH 31,
--------------------------------------------------
CHANGE
-----------------
($ IN THOUSANDS): 2007 2006 $ %
------- ------ ---------- --
Litigation $(2,408) $ - $(2,408) NM
The $2.4 million of income reflected in "Litigation" consisted of a
net payment received by us in accordance with a settlement agreement
entered into with an insurance company for insurance coverage related
to the Healthpoint litigation.
OPERATING INCOME
----------------
YEARS ENDED MARCH 31,
-----------------------------------------------------
2006
2007 (AS RESTATED) CHANGE
-----------------
($ IN THOUSANDS): $ %
-------- -------- --------- ------
Operating income $ 88,156 $ 36,157 $ 51,999 143.8%
The improvement in operating income was partially due to the $30.4
million of expense we recorded during fiscal 2006 in connection with
the FemmePharma acquisition. Excluding the effect of this $30.4
million of expense, operating income for fiscal 2007 would have
increased $21.6 million, or 32.4%.
59
INTEREST EXPENSE
----------------
YEARS ENDED MARCH 31,
-----------------------------------------------------
CHANGE
-----------------
($ IN THOUSANDS): 2007 2006 $ %
------- ------- ------- -----
Interest expense $ 8,985 $ 6,045 $ 2,940 48.6%
The increase in interest expense resulted from interest incurred on
the $43.0 million mortgage loan we entered into in March 2006 coupled
with the completion of a number of sizable capital projects during
fiscal 2006 and the related reduced level of capitalized interest
recorded on those projects.
INTEREST AND OTHER INCOME
-------------------------
YEARS ENDED MARCH 31,
-----------------------------------------------------
CHANGE
-----------------
($ IN THOUSANDS): 2007 2006 $ %
------- ------- ------- -----
Interest and other income $ 9,901 $ 5,737 $ 4,164 72.6%
The increase in interest and other income resulted primarily from an
increase in the average balance of invested cash coupled with an
increase in the weighted average interest rate earned on short-term
investments. The increase in the weighted average interest rate was
due to higher short-term market interest rates.
PROVISION FOR INCOME TAXES
--------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
2007 2006 --------------
(AS RESTATED)
($ IN THOUSANDS): $ %
-------- ------- ------- -----
Provision for income taxes $ 32,958 $24,433 $ 8,525 34.9%
effective tax rate 37.0% 68.2%
The higher effective tax rate for fiscal 2006 was attributable to the
determination that $30.4 million of expense we recorded for the
FemmePharma acquisition was not deductible for tax purposes. The
effective tax rate would have been 36.9% for that year when applied
to a pre-tax income amount that excluded the FemmePharma acquisition
expense of $30.4 million. The effective tax rates in both fiscal 2007
and 2006 were adversely affected by the recording of additional
liabilities associated with tax positions claimed on filed tax
returns for those years.
60
NET INCOME AND DILUTED EARNINGS PER SHARE
-----------------------------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
2006 -------------------
2007 (AS RESTATED)
($ IN THOUSANDS): $ %
-------- -------- --------- ------
Net income $ 58,090 $ 11,416 $ 46,674 408.9%
Diluted earnings per Class A share 1.05 0.23 0.82 356.5%
Diluted earnings per Class B share 0.91 0.20 0.71 355.0%
The improvement in net income per share was partially due to the
$30.4 million of expense we recorded during fiscal 2006 in connection
with the FemmePharma acquisition. Net income was also favorably
impacted by a $52.7 million increase in gross profit, offset in part
by a $31.1 million increase in operating expenses before taking into
account the $30.4 million of expense associated with the prior year
acquisition of FemmePharma.
FISCAL 2006 COMPARED TO FISCAL 2005
NET REVENUES BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
------------------
2006 2005
($ IN THOUSANDS): (AS RESTATED) (AS RESTATED) $ %
------------- ------------ --------- -------
Branded products $ 145,503 $ 90,628 $ 54,875 60.6%
as % of net revenues 39.6% 29.7%
Specialty generics/non-branded 203,787 194,022 9,765 5.0%
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 $ 367,640 $ 304,656 $ 62,984 20.7%
The growth in branded product sales was due primarily to increased
sales of our two anti-infective brands, Clindesse(R) and
Gynazole-1(R), and continued sales growth from our hematinic and
prescription prenatal product lines. Clindesse(R), 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(R) 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 to pricing
increases 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, pricing increases and $3.3 million of incremental sales
associated with the introduction of two new products, Niferex Gold(R)
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 U.S. 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(R), a new prescription
nutritional supplement
61
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/non-branded sales resulted from
$15.3 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 $7.1
million that resulted from pricing pressures on certain products.
Although specialty generic sales resulting from new product
introductions were limited during fiscal 2006, we did receive late in
fiscal 2006 ANDA approval for five strengths of oxycodone
hydrochloride tablets and three strengths of hydromorphone
hydrochloride tablets.
The decrease in specialty material product sales was primarily due to
reduced sales on a product that is used by a customer in a chewable
vitamin that the customer was in the process of reformulating,
coupled with increased competition on our calcium carbonate products.
GROSS PROFIT BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
-----------------------------------------------------------
CHANGE
-----------------------
2006 2005
($ IN THOUSANDS): (AS RESTATED) (AS RESTATED) $ %
------------- ------------- ----------- -------
Branded products $ 128,572 $ 79,317 $ 49,255 62.1%
as % of net revenues 88.4% 87.5%
Specialty generics/non-branded 111,907 115,040 (3,133) (2.7)%
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 $ 243,705 $ 196,708 $ 46,997 23.9%
as % of total net revenues 66.3% 64.6%
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 generic/non-branded 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 change in 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% 7.7%
62
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.
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 $0.9
million in direct expenses related to the transaction. The valuation
of acquired in-process research and development represents the
estimated fair value of the worldwide marketing rights to an
endometriosis product we acquired as part of the FemmePharma
acquisition that, at the time of the acquisition, had no alternative
future use and for which technological feasibility had not been
established.
SELLING AND ADMINISTRATIVE
--------------------------
YEARS ENDED MARCH 31,
-----------------------------------------------------
CHANGE
2006 2005 ----------------
(AS RESTATED) (AS RESTATED)
($ IN THOUSANDS): $ %
--------- -------- --------- -----
Selling and administrative $ 143,437 $118,263 $ 25,174 21.3%
as % of net revenues 39.0% 38.8%
The increase in selling and administrative expense was primarily due
to:
* $11.2 million increase in personnel costs associated with
expansion of the branded sales force in fiscal 2005 and
2006, increases in management and other personnel to support
the overall growth of the business, and an increase in
accrued payroll taxes, interest and penalties associated
with the disqualification of certain stock options (see the
Explanatory Note beginning on page 2 of this Form 10-K and
Note 3 "Restatement of Consolidated Financial Statements" of
the Notes to Consolidated Financial Statements included in
this Form 10-K);
* $7.3 million increase in branded marketing and promotions
expense for promotion of our existing brands, to further
promote the launch of Clindesse(R) and to support the
introduction in fiscal 2006 of a new prescription
nutritional supplement product and two new hematinic
products; and
* $6.4 million increase in legal and professional expense
commensurate with an increase in litigation activity and
evaluation of potential acquisition opportunities. The
increase in litigation activity included ongoing costs
associated with certain patent infringement actions brought
against us on products we market or propose to market.
63
AMORTIZATION OF INTANGIBLE ASSETS
---------------------------------
YEARS ENDED MARCH 31,
-----------------------------------------------------
CHANGE
---------------------
($ 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 launch in fiscal 2005 under a co-development
arrangement completed in fiscal 2005, 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
$0.8 million associated with the reversal of excess reserves that
resulted from settlement of the Healthpoint litigation in fiscal
2005.
OPERATING INCOME
----------------
YEARS ENDED MARCH 31,
----------------------------------------------------------
CHANGE
2006 2005 ---------------------
(AS RESTATED) (AS RESTATED)
($ IN THOUSANDS): $ %
-------- -------- ---------- -------
Operating income $ 36,157 $ 51,684 $ (15,527) (30.0)%
The decrease in operating income resulted from the $30.4 million
in-process research and development charge recorded in connection
with the FemmePharma acquisition.
64
INTEREST EXPENSE
----------------
YEARS ENDED MARCH 31,
-------------------------------------------------------
CHANGE
---------------
($ 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 on those projects.
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 in
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
2006 2005 --------------
(AS RESTATED) (AS RESTATED)
($ IN THOUSANDS): $ %
---------- ---------- ------- -----
Provision for income taxes $ 24,433 $ 18,083 $ 6,350 35.1%
effective tax rate 68.2% 36.7%
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
effective tax rate would have been 36.9% when applied to a pre-tax
income amount that excluded the FemmePharma acquisition expense of
$30.4 million. The effective tax rates in both fiscal 2006 and 2005
were adversely affected by the recording of additional liabilities
associated with tax positions claimed on tax returns filed for those
fiscal years, partially offset by certain expected tax refunds.
65
NET INCOME AND DILUTED EARNINGS PER SHARE
-----------------------------------------
YEARS ENDED MARCH 31,
-----------------------------------------------------
CHANGE
2006 2005 -------------------
(AS RESTATED) (AS RESTATED)
($ IN THOUSANDS): $ %
--------- --------- --------- -------
Net income $ 11,416 $ 31,217 $ (19,801) (63.4)%
Diluted earnings per Class A share 0.23 0.60 (0.37) (61.7)%
Diluted earnings per Class B share 0.20 0.52 (0.32) (61.5)%
The decrease in net income per share resulted from the $30.4 million
in-process research and development charge we recorded in connection
with the FemmePharma acquisition.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Cash and cash equivalents and working capital were $82.6 million and
$372.3 million, respectively, at March 31, 2007, compared to $100.7
million and $305.0 million, respectively, at March 31, 2006. The
increase in working capital resulted primarily from a $25.1 million
increase in receivables, a $20.3 million increase in inventories and
an increase in net income adjusted for non-cash items. The increase
in receivables was primarily due to higher sales and the increase in
inventories related primarily to the new products we have recently
introduced or expect to launch in the few months following fiscal
year-end.
In addition, we had $119.2 million invested in auction rate
securities ("ARS") at March 31, 2007. The ARS held by the Company are
AAA rated securities with long-term nominal maturities secured by
student loans which are guaranteed by the U.S. Government. The
interest rates on these securities are reset through an auction
process that resets the applicable interest rate at pre-determined
intervals, up to 35 days. Subsequent to March 31, 2007, the ARS
market has experienced liquidity issues due to emerging instability
in the broader credit and capital markets. As a result, all of the
ARS held by the Company have recently experienced failed auctions as
the amount of securities submitted for sale has exceeded the amount
of purchase orders. Given the failed auctions, the Company's ARS are
illiquid until there is a successful auction for them. We cannot
predict how long the current imbalance in the auction rate market
will continue. We are currently evaluating the market for these
securities to determine if impairment of the carrying value of the
securities has occurred due to the loss of liquidity. However, the
Company believes that as of December 31, 2007, based on its current
cash, cash equivalents and marketable securities balances of $112
million (exclusive of ARS) and its current borrowing capacity under
its credit facility of $290 million, the current lack of liquidity in
the auction rate market will not have a material impact on its
ability to fund its operations or interfere with the Company's
external growth plans. (See Note 24 to the Notes to Consolidated
Financial Statements).
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 of $57.1 million was
favorably impacted by net income adjusted for non-cash items, offset
in part by the increases in receivables and inventories.
Net cash flow used in investing activities included capital
expenditures of $25.1 million in fiscal 2007 compared to $58.3
million for the prior year. In June 2006, the Company completed the
purchase of a 126,000 square foot building in the St. Louis
metropolitan area for $4.9 million. The property had been leased by
the Company since June 2001 and is used as a manufacturing facility
and office space. The purchase price was paid with cash on hand. The
remaining capital expenditures during fiscal 2007 were primarily for
purchasing machinery and equipment to upgrade and expand our
pharmaceutical manufacturing and distribution capabilities, and for
other building renovation projects. Other investing activities in
fiscal 2007 consisted of $50.9 million in purchases of
66
short-term marketable securities that were classified as available
for sale and a $0.4 million dividend payment for preferred stock. For
the prior year, other investing activities included the acquisition
of FemmePharma for a $25.6 million cash payment and the purchase of
Strides redeemable preferred stock for $11.3 million (see Note 4 to
the Consolidated Financial Statements).
Our debt balance, including current maturities, was $241.3 million at
March 31, 2007 compared to $243.0 million at March 31, 2006. 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 mortgage loan was used for working capital and general
corporate purposes. The 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 due 2033 ("the Notes") that are convertible, under
certain circumstances, into shares of our Class A Common Stock at a
conversion price of $23.01 per share, subject to possible adjustment.
The 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. As of May 16, 2007, the
average trading price over this period did not equal or exceed
$1,200. We 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) to the date of
redemption. Holders may require us 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 100% of the principal amount of the Notes, plus accrued and unpaid
interest (including contingent interest, if any) to the date of
repurchase, payable in cash. We classified the Notes as a current
liability as of June 30, 2007 and thereafter through March 31, 2008,
due to the right the holders have to require us to repurchase the
Notes on May 16, 2008. The Notes are subordinate to all of our
existing and future senior obligations.
In June 2006, we replaced our $140.0 million credit line by entering
into a new syndicated 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 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 our senior
debt to EBITDA. This agreement contains financial covenants that
impose limits on dividend payments, require minimum equity, a maximum
senior leverage ratio and minimum fixed charge coverage ratio. As of
March 31, 2007, we were in compliance with all of our financial
covenants. In addition, the agreement requires that we submit annual
audited financial statements to the lenders within 90 days of the
close of the fiscal year and quarterly financial statements within 45
days of the close of each fiscal quarter. The Company has obtained
the consent of the lenders to extend the period for submission of the
audited financial statements for the fiscal year ended March 31, 2007
to March 31, 2008 and for the submission of the quarterly financial
statements for the quarters ended June 30, 2007, September 30, 2007
and December 31, 2007 to May 31, 2008.
The new credit facility has a five-year term expiring in June 2011.
As of March 31, 2007, there were no borrowings outstanding under the
facility, but there were letters of credit of $0.9 million issued
under the agreement.
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 12 to the Notes 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 ten years
subsequent
67
to the property being placed in service. Industrial revenue bonds
totaling $109.4 million were outstanding at March 31, 2007. 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, 2007
-----------------------------
Long-term debt obligations(1) $ 241,348 $ 1,897 $ 204,164 $ 4,687 $ 30,600
Operating lease obligations 7,722 3,668 1,662 1,281 1,111
Other long-term obligations(2) 6,319 - - - 6,319
------------------------------------------------------------------
Total contractual cash obligations(3) $ 255,389 $ 5,565 $ 205,826 $ 5,968 $ 38,030
------------------------------------------------------------------
<FN>
(1) 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. If the market price of our Class A Common
Stock exceeds $23.01, we do not expect the Note holders will
exercise their repurchase rights.
(2) Represents the accrual of retirement compensation the Company
is obligated to pay its CEO beginning at retirement for the
longer of ten years or the life of the CEO.
(3) 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 $35.8 million as of March 31, 2007.
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,
68
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
GAAP. Our significant accounting policies are described in Note 2 to
the Notes to Consolidated Financial Statements. Certain of our
accounting policies are particularly important to the presentation of
our financial position and results of operations and require the
application of significant judgment by our management. As a result,
amounts determined under 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 we believe 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.
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 among other factors, 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.
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 these incentives are normal and customary in the
industry. Sales allowances are accrued and revenue is recognized as
sales are made in accordance with 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
non-branded/generics product line in conjunction with trade shows
sponsored by our major wholesale customers and for other promotional
programs accounted for 11.6% and 13.9% of total gross revenues for
fiscal 2007 and fiscal 2006, 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 60% of our unit sales in fiscal 2007,
through an internal analysis that considers, among other things,
wholesaler purchases,
69
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 2007 activity for each
accounts receivable reserve:
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
-------------- ------------------- ------------------- ---------------- ---------
(as restated)
YEAR ENDED MARCH 31, 2007
Accounts Receivable Reserves:
Chargebacks $ 14,312 $ 94,716 $ - $ (96,023) $ 13,005
Sales rebates 2,214 17,155 - (13,983) 5,386
Sales returns 2,127 12,591 - (11,845) 2,873
Cash discounts and other allowances 4,226 17,541 - (18,256) 3,511
Medicaid rebates 5,818 6,819 - (6,131) 6,506
-------------- ------------------- ------------------- ---------------- ----------
Total $ 28,697 $ $ 148,822 $ - $ (146,238) $ 31,281
============== =================== =================== ================ ==========
The decrease in the reserve for chargebacks at March 31, 2007 was
primarily due to a decline in customer inventory levels of our
specialty generic/non-branded products at the end of the year. The
higher reserve for sales rebates at March 31, 2007 resulted from
increased reserves on rebates associated with branded product sales
to managed care organizations that began late in the fiscal 2006 year
and ongoing sales promotions on new specialty generic/non-branded
products introduced in fiscal 2007. The increase in the reserve for
sales returns at March 31, 2007 was primarily due to an increase in
branded product sales coupled with reserves established on certain
new specialty generic/non-branded products where inventory with short
shelf lives was sold.
The following table reflects the fiscal 2006 activity for each
accounts receivable reserve:
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 (as restated) (as restated) (as restated) (as restated) (as restated)
Accounts Receivable Reserves:
Chargebacks $ 9,000 $ 97,791 $ - $ (92,479) $ 14,312
Sales rebates 1,192 14,185 - (13,163) 2,214
Sales returns 2,187 14,239 - (14,299) 2,127
Cash discounts and other allowances 3,712 17,395 - (16,881) 4,226
Medicaid rebates 4,051 11,052 - (9,285) 5,818
------------- ----------------- ------------------ ---------------- ------------
Total $ 20,142 $ 154,662 $ - $ (146,107) $ 28,697
============= ================= ================== ================ ============
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/non-branded 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
70
specialty generic/non-branded segment was offset by an increase in
the product return rate in 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 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.
Chargeback transactions are almost exclusively related to our
specialty generics business segment. During fiscal 2007 and 2006, the
chargeback provision reduced the gross sales of our specialty
generics segment by $93.9 million and $97.0 million, respectively.
These amounts accounted for 99.2% and 99.4% of the total chargeback
provisions recorded in fiscal 2007 and 2006, 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:
* 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 wholesaler customers based on historical buying
patterns. During fiscal 2007, unit sales to our three major
wholesale customers accounted for 83% of our total unit sales to
all wholesalers, and the aggregate inventory position of the three
major wholesalers at March 31, 2007 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 wholesale customers for
which we do not receive actual inventory data, as our experience
and customer buying patterns indicate that our smaller wholesale
customers carry less inventory than our large wholesale customers.
As of March 31, 2007, each week of inventory for those remaining
wholesalers represented approximately $0.2 million, or 1.4%, of
the reported reserve for chargebacks.
* 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, 2007,
the aggregate weighted average percentage of sales to wholesalers
assumed to result in chargebacks was approximately 97%, with each
1% representing approximately $0.1 million, or 1.1%, of the
reported reserve for chargebacks.
* 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
71
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, 2007, 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 5.1%,
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. As a result of WAC
decreases to certain specialty non-branded/generic products, we paid
shelf-stock adjustments of $8.7 million to our wholesale customers
during fiscal 2007.
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 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, 2007 by approximately $0.2 million, or 7.2%, 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, 2007 by approximately $0.3 million,
or 9.6%, 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 non-branded/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 affected 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, 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, 2007 by
$0.5
72
million, or 7.0% of the reported reserve for Medicaid rebates.
Similarly, a 10% change in estimated patient usage would have changed
the reserve by $0.5 million, or 7.0% 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,
which range from nine to 20 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 the carrying value may not be
recoverable. Factors we consider important which could trigger an
impairment review include: (1) significant underperformance relative
to expected historical or projected future 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.
STOCK-BASED COMPENSATION As discussed in Note 2 to the Consolidated
------------------------
Financial Statements, effective April 1, 2006, we adopted SFAS 123R,
which requires the measurement and recognition of compensation
expense, based on estimated fair values, for all share-based
compensation awards made to employees and directors over the vesting
period of the awards. The Company adopted SFAS 123R using the
modified prospective method and, as a result, did not retroactively
adjust results from prior periods due to the adoption. Under the
modified prospective method, stock-based compensation was recognized
(1) for the unvested portion of previously issued awards that were
outstanding at the initial date of adoption based on the grant date
fair value estimated in accordance with the pro forma provisions of
SFAS 123 and (2) for any awards granted or modified on or subsequent
to the effective date of SFAS 123R based on the grant date fair value
estimated in accordance with the provisions of the statement. Prior
to the adoption of SFAS 123R, the Company measured compensation
expense for its employee stock-based compensation plans using the
intrinsic value method prescribed by APB 25. The Company also applied
the disclosure provisions of SFAS 123, as amended by SFAS 148, as if
the fair-value-based method had been applied in measuring
compensation expense. Determining the fair value of share-based
awards at the grant date requires judgment to identify the
appropriate valuation model and estimate the assumptions, including
the expected term of the stock options and expected stock-price
volatility, to be used in the calculation. Judgment is also required
in estimating the percentage of share-based awards that are expected
to be forfeited. We estimated the fair value of stock options granted
using the Black-Scholes option-pricing model with
73
assumptions based primarily on historical data. If actual results
differ significantly from these estimates, stock-based compensation
expense and our results of operations could be materially impacted.
INCOME TAXES Our deferred tax assets and liabilities are determined
------------
based on temporary differences between financial reporting and tax
bases of assets and liabilities, applying enacted tax rates expected
to be in effect for the year in which the differences are expected to
reverse. Deferred tax assets and liabilities are measured using the
currently enacted tax rates that apply to taxable income in effect
for the years in which those tax assets are expected to be realized
or settled. We record a valuation allowance to reduce deferred tax
assets to the amount that is believed more likely than not to be
realized. Management believes it is more likely than not that
forecasted income, including income that may be generated as a result
of certain tax planning strategies, together with the tax effects of
the deferred tax liabilities, will be sufficient to fully recover the
remaining deferred tax assets. In the event that all or part of the
net deferred tax assets are determined not to be realizable in the
future, an adjustment to the valuation allowance would be charged to
earnings in the period such determination is made. Similarly, if we
subsequently realize deferred tax assets that were previously
determined to be unrealizable, the respective valuation allowance
would be reversed, resulting in a positive adjustment to earnings in
the period such determination is made.
Management regularly reevaluates the Company's tax positions taken on
filed tax returns using information about recent court decisions and
legislative activities. Many factors are considered in making these
evaluations, including past history, recent interpretations of tax
law, and the specific facts and circumstances of each matter. Because
tax laws and regulations are subject to interpretation and tax
litigation is inherently uncertain, these evaluations can involve a
series of complex judgments about future events and may rely heavily
on estimates and assumptions. The recorded tax liabilities are based
on estimates and assumptions that have been deemed reasonable by
management. However, if our estimates are not representative of
actual outcomes, recorded tax liabilities could be materially
impacted.
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 we determine 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 future 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, 2007 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 June 2006, the FASB issued FIN 48, which prescribes accounting for
and disclosure of uncertainty in tax positions. This interpretation
addresses the determination of whether tax benefits claimed or
expected to be claimed on a tax return should be recorded in the
financial statements. Under FIN 48, we may recognize the tax benefit
from an uncertain tax position only if it is more likely than not
that the tax position will be sustained on examination by the taxing
authorities, based on the technical merits of the position. The tax
benefits recognized in the financial statements from such a position
should be measured based on the largest benefit that has a greater
than 50% likelihood of being realized upon ultimate settlement. FIN
48 also provides guidance on derecognizing tax positions, financial
statement classification, recognition of interest and penalties,
accounting in interim periods, and disclosure and transition
requirements. FIN 48 is effective for fiscal years beginning after
December 15, 2006. We adopted FIN 48 on April 1, 2007 and do not
believe it will have a material effect on our Consolidated Financial
Statements.
In May 2007, the FASB issued FASB Staff Position No. FIN 48-1,
"Definition of "Settlement" in FASB Interpretation No. 48" ("FSP FIN
48-1"), which provides guidance on how a company should determine
whether
74
a tax position is effectively settled for the purpose of recognizing
previously unrecognized tax benefits. FSP FIN 48-1 should be applied
upon initial adoption of FIN 48, which we adopted on April 1, 2007,
as indicated above. We do not believe the adoption of FSP FIN 48-1
will have a material effect on our Consolidated Financial Statements.
In September 2006, FASB issued SFAS 157, "Fair Value Measurements"
("SFAS 157") which provides enhanced guidance for using fair value to
measure assets and liabilities. SFAS 157 clarifies the principle that
fair value should be based on the assumptions that market
participants would use when pricing an asset or liability, provides a
framework for measuring fair value under GAAP and expands disclosure
requirements about fair value measurements. SFAS 157 is effective for
financial statements issued in fiscal years beginning after November
15, 2007, and interim periods within those fiscal years. The Company
plans to adopt SFAS 157 at the beginning of fiscal 2009 and is
evaluating the impact, if any, the adoption of SFAS 157 will have on
its financial condition and results of operations.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value
Option for Financial Assets and Financial Liabilities" ("SFAS 159"),
which permits companies to choose to measure many financial
instruments and certain other items at fair value. The objective is
to improve financial reporting by providing companies with the
opportunity to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having
to apply complex hedge accounting provisions. SFAS 159 is effective
for fiscal years beginning after November 15, 2007. Companies are not
allowed to adopt SFAS 159 on a retrospective basis unless they choose
early adoption. The Company plans to adopt SFAS 159 at the beginning
of fiscal 2009 and is evaluating the impact, if any, the adoption of
SFAS 159 will have on its financial condition and results of
operations.
In March 2007, the FASB ratified the consensus reached by the
Emerging Issues Task Force ("EITF") in Issue No. 06-10, "Accounting
for Collateral Assignment Split-Dollar Life Insurance Arrangements,"
("Issue 06-10"). Issue 06-10 requires companies with collateral
assignment split-dollar life insurance policies that provide a
benefit to an employee that extends to postretirement periods to
recognize a liability for future benefits based on the substantive
agreement with the employee. Recognition should be in accordance with
FASB Statement No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions," or APB Opinion No. 12, "Omnibus
Opinion - 1967," depending on whether a substantive plan is deemed to
exist. Companies are permitted to recognize the effects of applying
the consensus through either (1) a change in accounting principle
through a cumulative-effect adjustment to retained earnings or to
other components of equity or net assets as of the beginning of the
year of adoption or (2) a change in accounting principle through
retrospective application to all prior periods. Issue 06-10 is
effective for fiscal years beginning after December 15, 2007, with
early adoption permitted. The Company plans to adopt Issue 06-10 at
the beginning of fiscal 2009 and is evaluating the impact of the
adoption of Issue 06-10 on its financial condition and results of
operations.
In September 2007, the EITF reached a consensus on Issue No. 07-1
("Issue 07-1"), "Accounting for Collaborative Arrangements." The
scope of Issue 07-1 is limited to collaborative arrangements where no
separate legal entity exists and in which the parties are active
participants and are exposed to significant risks and rewards that
depend on the success of the activity. The EITF concluded that
revenue transactions with third parties and associated costs incurred
should be reported in the appropriate line item in each company's
financial statements pursuant to the guidance in Issue 99-19,
"Reporting Revenue Gross as a Principal versus Net as an Agent." The
EITF also concluded that the equity method of accounting under
Accounting Principles Board Opinion 18, "The Equity Method of
Accounting for Investments in Common Stock," should not be applied to
arrangements that are not conducted through a separate legal entity.
The EITF also concluded that the income statement classification of
payments made between the parties in an arrangement should be based
on a consideration of the following factors: the nature and terms of
the arrangement; the nature of the entities' operations; and whether
the partners' payments are within the scope of existing GAAP. To the
extent such costs are not within the scope of other authoritative
accounting literature, the income statement characterization for the
payments should be based on an analogy to authoritative accounting
literature or a reasonable, rational, and consistently applied
accounting policy election. The provisions of Issue 07-1 are
effective for fiscal years beginning on or after December 15, 2008,
and
75
companies will be required to apply the provisions through
retrospective application. The Company plans to adopt Issue 07-1 at
the beginning of fiscal 2010 and is evaluating the impact of the
adoption of Issue 07-1 on its financial condition and results of
operations.
In June 2007, the FASB ratified the consensus reached by the EITF on
Issue No. 07-3, Accounting for Advance Payments for Goods or Services
Received for Use in Future Research and Development Activities
("Issue 07-3"), which is effective December 15, 2007 and is applied
prospectively for new contracts entered into on or after the
effective date. Issue 07-3 addresses nonrefundable advance payments
for goods or services for use in future research and development
activities. Issue 07-3 will require that these payments that will be
used or rendered for future research and development activities be
deferred and capitalized and recognized as an expense as the related
goods are delivered or the related services are performed. If an
entity does not expect the goods to be delivered or the services to
be rendered the capitalized advance payments should be expensed. The
Company is assessing the effects of adoption of Issue 07-3 on its
financial condition and results of operations.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),
"Business Combinations," ("SFAS 141 (R)") which replaces SFAS 141 but
retains the fundamental concept of purchase method of accounting in a
business combination and improves reporting by creating greater
consistency in the accounting and financial reporting of business
combinations, resulting in more complete, comparable, and relevant
information for investors and other users of financial statements. To
achieve this goal, the new standard requires the acquiring entity in
a business combination to recognize all the assets acquired and
liabilities assumed in the transaction and any non-controlling
interest at the acquisition date measured at their fair value as of
that date. This statement requires measuring a non-controlling
interest in the acquiree at fair value which will result in
recognizing the goodwill attributable to the non-controlling interest
in addition to that attributable to the acquirer. This statement also
requires the recognition of assets acquired and liabilities assumed
arising from contractual contingencies as of the acquisition date,
measured at their acquisition fair values. SFAS 141(R) is effective
for fiscal years beginning after December 15, 2008. The Company plans
to adopt SFAS 141(R) at the beginning of fiscal 2010 and is
evaluating the impact of SFAS 141(R) on its financial condition and
results of operations.
In December 2007, the FASB issued SFAS No. 160, "Non-controlling
Interests in Consolidated Financial Statements" ("SFAS 160") an
amendment of ARB No. 51, which will affect only those entities that
have an outstanding non-controlling interest in one or more
subsidiaries or that deconsolidate a subsidiary by requiring all
entities to report non-controlling (minority) interests in
subsidiaries in the same way as equity in the consolidated financial
statements. In addition, SFAS 160 eliminates the diversity that
currently exists in accounting for transactions between an entity and
non-controlling interests by requiring they be treated as equity
transactions. SFAS 160 is effective for fiscal years beginning after
December 15, 2008. The Company plans to adopt SFAS 160 at the
beginning of fiscal 2010 and is evaluating the impact of SFAS 160 on
its financial condition and results of operations.
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.
The majority of our investments in marketable securities are taxable
auction rate securities. The rates on these securities reset at
pre-determined interval up to 35 days. As of March 31, 2007, we had
invested $119.2 million in auction rate securities, primarily in high
quality (AAA rated) bonds secured by student loans which are
guaranteed by the U.S. Government. Recent developments in the
capital and credit markets subsequent to March 31, 2007 have
adversely affected the market for auction rate securities, which has
resulted in a loss of liquidity for these investments. We are
currently evaluating these securities to determine if impairment of
the carrying value of the securities has occurred due to the loss of
liquidity. (See Note 24 to the Consolidated Financial Statements for
further discussion of our investment in auction rate securities).
However, the Company believes that as of December 31, 2007, based on
its current cash, cash equivalents and marketable securities balances
of $112
76
million (exclusive of auction rate securities) and its current
borrowing capacity of $290 million under its credit facility, the
current lack of liquidity in the auction rate market will not have a
material impact on its ability to fund its operations or interfere
with the Company's external growth plans.
The annual favorable impact on our net income as a result of a 25, 50
or 100 basis point (where 100 basis points equals 1%) increase in
short-term interest rates would be approximately $0.6 million, $1.1
million or $2.2 million, respectively, based on our average cash, cash
equivalents and short-term marketable investment balances during the
fiscal year ended March 31, 2007.
Advances to us under our credit facility 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 facility at March 31, 2007.
In May 2003, we issued Notes with a principal amount of $200.0
million. The interest rate on the Notes is fixed at 2.50% and
therefore not subject to interest rate changes. Beginning May 16,
2006, we became 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 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.
Holders may require us 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 100% of
the principal amount of the Notes, plus accrued and unpaid interest
(including contingent interest, if any) to the date of repurchase,
payable in cash. As a result, we have classified the Notes as a
current liability as of June 30, 2007 due to the right the holders
have to require us to repurchase the Notes on May 16, 2008.
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.
77
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 (the Company) as of March 31, 2007 and
2006, and the related consolidated statements of income, comprehensive income,
shareholders' equity, and cash flows for each of the years in the three-year
period ended March 31, 2007. 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, 2007 and 2006, and the
results of their operations and their cash flows for each of the years in the
three-year period ended March 31, 2007 in conformity with U.S. generally
accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, the Company
adopted the provisions of Statement of Financial Accounting Standards No. 123
(Revised 2004), "Share-Based Payment", effective April 1, 2006.
As discussed in Note 3 to the consolidated financial statements, the Company's
consolidated balance sheet as of March 31, 2006, and the related consolidated
statements of income, comprehensive income, shareholders' equity, and cash
flows for the years ended March 31, 2006 and 2005, have been restated.
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,
2007 based on criteria established in Internal Control--Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO), and our report dated March 25, 2008 expressed an unqualified opinion
on management's assessment of, and an adverse opinion on the effective
operation of, internal control over financial reporting.
/s/ KPMG LLP
St. Louis, Missouri
March 25, 2008
78
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
MARCH 31,
------------------
2007 2006
---- ----
ASSETS (AS RESTATED)
------ -------------
CURRENT ASSETS:
Cash and cash equivalents............................................................ $ 82,574 $ 100,706
Marketable securities................................................................ 157,812 106,763
Receivables, less allowance for doubtful accounts of $716 and $397
in 2007 and 2006, respectively.................................................... 78,634 53,571
Inventories, net..................................................................... 91,515 71,166
Prepaid and other assets............................................................. 6,571 7,012
Deferred tax asset................................................................... 14,364 10,072
----------- -----------
Total Current Assets.............................................................. 431,470 349,290
Property and equipment, less accumulated depreciation................................ 186,900 178,042
Intangible assets and goodwill, net.................................................. 69,010 72,955
Other assets......................................................................... 20,403 19,026
----------- -----------
TOTAL ASSETS......................................................................... $ 707,783 $ 619,313
=========== ===========
LIABILITIES
-----------
CURRENT LIABILITIES:
Accounts payable..................................................................... $ 18,506 $ 17,975
Accrued liabilities.................................................................. 38,776 24,676
Current maturities of long-term debt................................................. 1,897 1,681
----------- -----------
Total Current Liabilities......................................................... 59,179 44,332
Long-term debt....................................................................... 239,451 241,319
Other long-term liabilities.......................................................... 6,319 5,442
Deferred tax liability............................................................... 38,007 25,221
----------- -----------
TOTAL LIABILITIES.................................................................... 342,956 316,314
----------- -----------
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, 2007 and 2006 (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 40,316,426 and 39,660,637 at March 31, 2007
and 2006, respectively........................................................ 403 397
Class B - issued 12,393,982 and 12,679,986 at March 31, 2007 and
2006, respectively (convertible into Class A shares on a one-for-one basis)... 124 127
Additional paid-in capital........................................................... 150,818 145,180
Retained earnings.................................................................... 269,430 211,410
Accumulated other comprehensive income (loss)........................................ 33 (211)
Less: Treasury stock, 3,237,023 shares of Class A and 92,902 shares of Class B Common
Stock at March 31, 2007, and 3,123,975 shares of Class A and 92,902 shares
of Class B Common Stock at March 31, 2006, at cost................................ (55,981) (53,904)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY........................................................... 364,827 302,999
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................................... $ 707,783 $ 619,313
=========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
79
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
YEARS ENDED MARCH 31,
----------------------------------------------------------------
2007 2006 2005
-------------------- -------------------- --------------------
(AS RESTATED) (AS RESTATED)
Net revenues.................................................... $ 443,627 $ 367,640 $ 304,656
Cost of sales................................................... 147,263 123,935 107,948
-------------------- -------------------- --------------------
Gross profit.................................................... 296,364 243,705 196,708
-------------------- -------------------- --------------------
Operating expenses:
Research and development.................................... 31,462 28,886 23,538
Purchased in-process research and
development and transaction costs....................... -- 30,441 --
Selling and administrative.................................. 174,344 143,437 118,263
Amortization of intangibles................................. 4,810 4,784 4,653
Litigation.................................................. (2,408) -- (1,430)
-------------------- -------------------- --------------------
Total operating expenses........................................ 208,208 207,548 145,024
-------------------- -------------------- --------------------
Operating income................................................ 88,156 36,157 51,684
-------------------- -------------------- --------------------
Other expense (income):
Interest expense............................................ 8,985 6,045 5,432
Interest and other income................................... (9,901) (5,737) (3,048)
-------------------- -------------------- --------------------
Total other expense (income), net............................... (916) 308 2,384
-------------------- -------------------- --------------------
Income before income taxes and cumulative effect
of change in accounting principle........................... 89,072 35,849 49,300
Provision for income taxes...................................... 32,958 24,433 18,083
-------------------- -------------------- --------------------
Income before cumulative effect of change
in accounting principle..................................... 56,114 11,416 31,217
Cumulative effect of change in accounting
principle (net of $670 in taxes)............................ 1,976 -- --
-------------------- -------------------- --------------------
Net income...................................................... $ 58,090 $ 11,416 $ 31,217
==================== ==================== ====================
(CONTINUED)
80
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME - (CONTINUED)
(In thousands, except per share data)
YEARS ENDED MARCH 31,
----------------------------------------------------------------
2007 2006 2005
-------------------- -------------------- --------------------
(AS RESTATED) (AS RESTATED)
Earnings per share before cumulative effect of change in
accounting principle:
Basic - Class A common.................................... $ $ 1.19 $ 0.24 $ 0.68
Basic - Class B common.................................... 0.99 0.20 0.56
Diluted - Class A common.................................. 1.02 0.23 0.60
Diluted - Class B common.................................. 0.88 0.20 0.52
Per share effect of cumulative effect of change in
accounting principle:
Basic - Class A common.................................... $ 0.04 $ - $ -
Basic - Class B common.................................... 0.04 - -
Diluted - Class A common.................................. 0.03 - -
Diluted - Class B common.................................. 0.03 - -
Earnings per share:
Basic - Class A common.................................... $ 1.23 $ 0.24 $ 0.68
Basic - Class B common.................................... 1.03 0.20 0.56
Diluted - Class A common.................................. 1.05 0.23 0.60
Diluted - Class B common.................................. 0.91 0.20 0.52
Shares used in per share calculation:
Basic - Class A common.................................... 36,813 35,842 33,734
Basic - Class B common.................................... 12,390 12,918 14,833
Diluted - Class A common.................................. 58,953 49,997 58,633
Diluted - Class B common.................................. 12,489 13,113 15,072
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
81
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
YEARS ENDED MARCH 31,
----------------------------------------------
2007 2006 2005
----------- ----------- -----------
(AS RESTATED) (AS RESTATED)
Net income............................................................. $ 58,090 $ 11,416 $ 31,217
Unrealized gain (loss) on available for sale securities:
Unrealized holding gain (loss) during the period.................... 100 (118) (201)
Reclassification of losses included in net income................... 270 -- --
Tax impact related to other comprehensive income (loss)............. (126) 40 68
----------- ----------- -----------
Total other comprehensive income (loss).......................... 244 (78) (133)
----------- ----------- -----------
Total comprehensive income............................................. $ 58,334 $ 11,338 $ 31,084
=========== =========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
82
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED MARCH 31, 2007, 2006 AND 2005
--------------------------------------------------------------------------------
ACCU-
MULATED
OTHER
COMPRE- TOTAL
CLASS A CLASS B ADDITIONAL HENSIVE SHARE-
PREFERRED COMMON COMMON PAID-IN TREASURY RETAINED INCOME HOLDERS'
STOCK STOCK STOCK CAPITAL STOCK EARNINGS (LOSS) EQUITY
----- ----- ----- ------- ----- -------- ------ ------
(Dollars in thousands)
BALANCE AT MARCH 31, 2004, AS PREVIOUSLY REPORTED.. $ -- $ 362 $ 162 $ 123,828 $ (51,183) $ 184,580 $ -- $ 257,749
Cumulative effect of restatement................... -- (5) (1) 10,641(a) -- (15,663) -- (5,028)
-------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2004, AS RESTATED............. -- 357 161 134,469 (51,183) 168,917 -- 252,721
Net income, as restated............................ -- -- -- -- -- 31,217 -- 31,217
Dividends paid on preferred stock.................. -- -- -- -- -- (70) -- (70)
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 -- -- -- 237
Stock-based compensation, as restated.............. -- -- -- 1,080 -- -- -- 1,080
Purchase of common stock for treasury.............. -- -- -- -- (2,468) -- -- (2,468)
Stock options exercised - 76,310 shares of Class
A and 12,101 shares of Class B, as restated..... -- 1 -- 3,533 -- -- -- 3,534
Excess income tax benefits from stock option
exercises, as restated.......................... -- -- -- 359 -- -- -- 359
Other comprehensive loss........................... -- -- -- -- -- -- (133) (133)
-------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2005, AS RESTATED............. -- 386 133 139,678 (53,651) 200,064 (133) 286,477
Net income, as restated............................ -- -- -- -- -- 11,416 -- 11,416
Dividends paid on preferred stock.................. -- -- -- -- -- (70) -- (70)
Conversion of 736,778 Class B shares to
Class A shares................................... -- 7 (7) -- -- -- -- --
Stock-based compensation, as restated.............. -- -- -- 927 -- -- -- 927
Purchase of common stock for treasury.............. -- -- -- -- (253) -- -- (253)
Stock options exercised - 353,355 shares of Class
A and 127,519 shares of Class B, as restated.... -- 4 1 3,138 -- -- -- 3,143
Excess income tax benefits from stock option
exercises, as restated.......................... -- -- -- 1,437 -- -- -- 1,437
Other comprehensive loss........................... -- -- -- -- -- -- (78) (78)
-------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2006, AS RESTATED............. -- 397 127 145,180 (53,904) 211,410 (211) 302,999
Net income......................................... -- -- -- -- -- 58,090 -- 58,090
Dividends paid on preferred stock.................. -- -- -- -- -- (70) -- (70)
Conversion of 441,341 Class B shares to
Class A shares................................... -- 4 (4) -- -- -- -- --
Stock-based compensation........................... -- -- -- 3,984 -- -- -- 3,984
Purchase of common stock for treasury.............. -- -- -- -- (2,077) -- -- (2,077)
Stock options exercised - 166,169 shares of Class A
and 193,899 shares of Class B................... -- 2 1 3,617 -- -- -- 3,620
Excess income tax benefits from stock option
exercises........................................ -- -- -- 683 -- -- -- 683
Cumulative effect of change in accounting
principle........................................ -- -- -- (2,646) -- -- -- (2,646)
Other comprehensive income ........................ -- -- -- -- -- -- 244 244
-------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2007.......................... $ -- $ 403 $ 124 $ 150,818 $ (55,981) $ 269,430 $ 33 $ 364,827
===============================================================================
<FN>
(a) Adjustment for stock-based compensation expense pursuant to APB 25
($13,626) and excess tax benefit associated with income tax impact of
stock-based compensation expense pursuant to APB 25 ($298), partially
offset by exercise deposits received by the Company for stock options in
the two-year forfeiture period ($3,283) - see Note 3.
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
83
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
YEARS ENDED MARCH 31,
------------------------------------------------
2007 2006 2005
------------- ------------ -----------
(AS RESTATED) (AS RESTATED)
Operating Activities:
Net income............................................................. $ 58,090 $ 11,416 $ 31,217
Adjustments to reconcile net income to net cash provided by operating
activities:
Acquired in-process research and development........................ -- 29,570 --
Cumulative effect of change in accounting principle................. (1,976) -- --
Depreciation and amortization ..................................... 22,388 18,002 13,904
Deferred income tax provision....................................... 7,698 6,062 13,095
Deferred compensation............................................... 877 965 1,355
Stock-based compensation............................................ 3,984 927 1,080
Litigation.......................................................... -- -- (843)
Excess tax benefits associated with stock options................... (683) -- --
Other............................................................... 270 -- --
Changes in operating assets and liabilities:
Decrease (increase) in receivables, net............................. (25,063) 7,593 2,348
Increase in inventories............................................. (20,349) (16,792) (2,982)
(Increase) decrease in prepaid and other assets..................... (2,771) 1,333 (3,530)
Increase (decrease) in accounts payable and accrued
liabilities...................................................... 14,670 5,533 (6,614)
------------- ------------ -----------
Net cash provided by operating activities.............................. 57,135 64,609 49,030
------------- ------------ -----------
Investing Activities:
Purchase of property and equipment.................................. (25,066) (58,334) (63,622)
Purchase of marketable securities................................... (50,949) (61,187) (10,565)
Purchase of preferred stock......................................... (400) (11,300) --
Product acquisition................................................. -- (25,643) --
------------- ------------ -----------
Net cash used in investing activities.................................. (76,415) (156,464) (74,187)
------------- ------------ -----------
Financing Activities:
Principal payments on long-term debt................................ (1,652) (892) (8,179)
Proceeds from borrowing of long-term debt........................... -- 32,764 --
Dividends paid on preferred stock................................... (70) (70) (70)
Purchase of common stock for treasury............................... (2,077) (253) (2,468)
Excess tax benefits associated with stock options................... 683 -- --
Cash deposits received for stock options............................ 4,264 1,187 4,118
------------- ------------ -----------
Net cash provided by (used in) financing activities................... 1,148 32,736 (6,599)
------------- ------------ -----------
Decrease in cash and cash equivalents................................. (18,132) (59,119) (31,756)
Cash and cash equivalents:
Beginning of year................................................... 100,706 159,825 191,581
------------- ------------ -----------
End of year......................................................... $ 82,574 $ 100,706 $ 159,825
============= ============ ===========
Non-cash investing and financing activities:
Term loans refinanced............................................... $ -- $ 9,859 $ --
Issuance of common stock under product development
agreement........................................................ -- -- 237
Stock options exercised (at expiration of two-year forfeiture period) 3,620 3,143 3,534
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
84
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)
1. DESCRIPTION OF BUSINESS
-----------------------
K-V Pharmaceutical Company and its subsidiaries ("KV" or the
"Company") are primarily engaged in the development, manufacture,
acquisition, 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 ("GAAP"). 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.
USE OF ESTIMATES
----------------
The preparation of financial statements in conformity with
GAAP 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
revenue recognition and reductions to gross revenues,
inventory valuation, intangible assets, stock-based
compensation, income taxes, and loss contingencies related to
legal proceedings. 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 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 securities have certain economic characteristics of
short-term investments due to a rate-setting mechanism and
85
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 at least annually or 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.
In accordance with Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets,"
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 2007 determined there was no goodwill
impairment.
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
86
the cost method. Such investments are included in "Other
assets" in the accompanying consolidated balance sheets and
relate to the Company's $11,406 investment in the preferred
stock of Strides Arcolab Limited (see Note 4).
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. The Company
also enters into long-term agreements under which it assigns
marketing rights for 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.
* Payment discounts are reductions to invoiced amounts
offered to customers for payment within a specified
period and are estimated utilizing historical customer
payment experience.
* 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.
* 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.
* 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
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.
87
Provisions for estimated chargebacks are calculated
primarily using historical chargeback experience,
actual contract pricing and estimated and actual
wholesaler inventory levels.
* 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.
* 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. The provision
for Medicaid rebates is based upon historical
experience of claims submitted by the various states.
The Company also monitors Medicaid legislative changes
to determine what impact such legislation may have on
the provision for Medicaid rebates.
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
$148,822, $154,662 (as restated) and $133,751 (as restated)
for the years ended March 31, 2007, 2006 and 2005,
respectively. The reserve balances related to the sales
provisions totaled $31,281 and $28,697 (as restated) at
March 31, 2007 and 2006, 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 34%, 20% and 15%, and 32% (as restated), 20% (as
restated) and 14% of gross receivables at March 31, 2007 and
2006, respectively.
For the year ended March 31, 2007, KV's three largest
customers accounted for 26%, 21% and 14% of gross revenues.
For the years ended March 31, 2006 and 2005, the Company's
three largest customers accounted for gross revenues of 27%,
16% and 13% and 27%, 17% (as restated) and 12%, respectively.
The Company maintains cash balances at certain financial
institutions that are greater than the FDIC insurable limit.
88
SHIPPING AND HANDLING COSTS
---------------------------
The Company classifies shipping and handling costs in cost of
sales. The Company does not derive revenue from shipping.
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 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 $21,932, $18,366 and $10,885 for the years ended March
31, 2007, 2006 and 2005, 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 13).
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 estimatable.
DEFERRED FINANCING COSTS
------------------------
Deferred financing costs of $5,835 were incurred in connection
with the issuance of convertible debt (see Note 11). 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 $4,471 and $3,307 at March
31, 2007 and 2006, respectively. Deferred financing costs,
net of accumulated amortization, are included in "Other
Assets" in the accompanying consolidated balance sheets.
89
EARNINGS PER SHARE
------------------
The Company has two classes of common stock: Class A Common
Stock and Class B Common Stock that is convertible into Class
A Common Stock. With respect to dividend rights, holders of
Class A Common Stock are entitled to receive cash dividends
per share equal to 120% of the dividends per share paid on the
Class B Common Stock. 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. 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.
Beginning in fiscal 2007, the Company presented diluted
earnings per share for Class B Common Stock for all periods
using the two-class method which does not assume the
conversion of Class B Common Stock into Class A Common Stock.
Previously, diluted earnings per share for Class B Common
Stock was not presented. The Company continues to present
diluted earnings per share for Class A Common Stock using the
if-converted method which assumes the conversion of Class B
Common Stock into Class A Common Stock, if dilutive.
Basic earnings per share is computed using the weighted
average number of common shares outstanding during the period
except that it does not include unvested common shares subject
to repurchase. Diluted earnings per share is computed using
the weighted average number of common shares and, if dilutive,
potential common shares outstanding during the period.
Potential common shares consist of the incremental common
shares issuable upon the exercise of stock options, unvested
common shares subject to repurchase, convertible preferred
stock and the convertible debt. The dilutive effects of
outstanding stock options and unvested common shares subject
to repurchase are reflected in diluted earnings per share by
application of the treasury stock method. Convertible
preferred stock and the convertible debt are reflected on an
if-converted basis. The computation of diluted earnings per
share for Class A Common Stock assumes the conversion of the
Class B Common Stock, while the diluted earnings per share for
Class B Common Stock does not assume the conversion of those
shares.
In December 2004, the Company adopted the guidance in EITF No.
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.
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. The Company records liabilities for tax positions
claimed on filed tax returns when the liabilities are probable
and can be reasonably estimated. Accrued interest and
penalties relating to unrecognized tax benefits are recorded
as part of the income tax provision.
90
STOCK-BASED COMPENSATION
------------------------
Effective April 1, 2006, the Company adopted SFAS No. 123 (revised
2004), "Share-Based Payment" ("SFAS 123R"), which requires the
measurement and recognition of compensation expense, based on
estimated fair values, for all share-based compensation awards made
to employees and directors over the vesting period of the awards.
The Company adopted SFAS 123R using the modified prospective method
and, as a result, did not retroactively adjust results from prior
periods. Under the modified prospective method, stock-based
compensation expense was recognized (1) for the unvested portion of
previously issued awards that were outstanding at the initial date
of adoption based on the grant date fair value estimated in
accordance with the pro forma provisions of SFAS 123 "Accounting for
Stock-Based Compensation" and (2) for any awards granted or modified
on or subsequent to the effective date of SFAS 123R based on the
grant date fair value estimated in accordance with the provisions of
this statement. Prior to the adoption of SFAS 123R, the Company
measured compensation expense for its employee stock-based
compensation plans using the intrinsic value method prescribed by
Accounting Principles Board Opinion No. 25 ("APB 25"). The Company
also applied the disclosure provisions of SFAS 123, as amended by
SFAS 148, as if the fair value-based method had been applied in
measuring compensation expense. Under APB 25, compensation cost for
stock options was recognized based on the excess, if any, of the
quoted market price of the stock at the grant date of the award or
other measurement date over the amount an employee must pay to
acquire the stock.
The following table illustrates the effect of the restatement
adjustments (see Note 3) on the Company's pro forma net income
and pro forma earnings per share as if the Company had applied
the fair value recognition provisions of SFAS 123 to options
granted under the Company's stock option plans for fiscal 2006
and 2005:
YEARS ENDED MARCH 31,
------------------------------------------------------------------------------------------------
2006 2005
-------------------------------------------- ---------------------------------------------
AS AS
PREVIOUSLY AS PREVIOUSLY AS
REPORTED ADJUSTMENTS RESTATED(1) REPORTED ADJUSTMENTS RESTATED(1)
---------- ----------- ----------- ---------- ----------- -----------
Net income $ 15,787 $ (4,371) $ 11,416 $ 33,269 $(2,052) $ 31,217
Add: Stock-based compensation
expense included in reported
net income, net of tax - 641 641 - 757 757
Deduct: Stock-based compensation
using the fair value based
method for all awards (2,433) (236) (2,669) (2,463) (1,301) (3,764)
------------------------------------------- --------------------------------------------
Pro forma net income $ 13,354 $ (3,966) $ 9,388 $ 30,806 $(2,596) $ 28,210
=========================================== ============================================
Earnings per share:
Basic - Class A common $ 0.33 $ (0.09) $ 0.24 $ 0.71 $ (0.03) $ 0.68
Basic - Class B common 0.28 (0.08) 0.20 0.59 (0.03) 0.56
Diluted - Class A common 0.31 (0.08) 0.23 0.63 (0.03) 0.60
Diluted - Class B common 0.20 0.52
Earnings per share - pro forma:
Basic - Class A common $ 0.28 $ (0.08) $ 0.20 $ 0.66 $ (0.05) $ 0.61
Basic - Class B common 0.23 (0.06) 0.17 0.55 (0.04) 0.51
Diluted - Class A common 0.26 (0.07) 0.19 0.59 (0.04) 0.55
Diluted - Class B common 0.16 0.48
<FN>
------------
(1) See Note 3 "Restatement of Consolidated Financial Statements."
The restated stock-based compensation expense included in net
income, net of tax, was $1,657, $939, $2,098, $1,581, $1,936,
$508, $2,372, $656, and $829 for the years ended March 31,
2004, 2003, 2002, 2001, 2000, 1999, 1998, 1997 and 1996,
respectively.
91
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.
FAIR VALUE OF FINANCIAL INSTRUMENTS
-----------------------------------
The Company's financial instruments consist primarily of cash
and cash equivalents, marketable securities, receivables,
investments, trade accounts payable, the convertible debt,
embedded derivatives related to the issuance of the
convertible debt and a mortgage loan agreement entered into in
March 2006. The carrying amounts of cash and cash equivalents,
receivables and trade accounts payable are representative of
their respective fair values due to their relatively short
maturities. The fair values of marketable securities are based
on quoted market prices. The Company estimates the fair value
of its fixed rate long-term obligations based on quoted market
rates of interest and maturity schedules for similar issues.
The carrying value of these obligations approximates their
fair value.
The Company's $11,406 investment in the preferred stock of
Strides Arcolab Limited had a fair value of $12,600 at March
31, 2007, based on an annual independent valuation analysis.
Based on quoted market rates, the Company's convertible debt
had a fair value of $229,240 and $214,860 at March 31, 2007
and 2006, respectively. The carrying amount of the mortgage
loan agreement approximates its fair value because its terms
are similar to those which can be obtained for similar
financial instruments in the current marketplace.
DERIVATIVE FINANCIAL INSTRUMENTS
--------------------------------
The Company's derivative financial instruments consist of
embedded derivatives related to the convertible debt. These
embedded derivatives include certain conversion features and a
contingent interest feature. Although the conversion features
represent embedded derivative financial instruments, based on
the de minimis value of these features at the time of issuance
and at March 31, 2007, 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 June 2006, the FASB issued FASB Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes - an
interpretation of FASB Statement No. 109" ("FIN 48"), which
prescribes accounting for and disclosure of uncertainty in tax
positions. This interpretation addresses the determination of
whether tax benefits claimed or expected to be claimed on a
tax return should be recorded in the financial statements.
Under FIN 48, the Company may recognize the tax benefit from
an uncertain tax position only if it is more likely than not
that the tax position will be sustained on examination by the
taxing authorities, based on the technical merits of the
position. The tax benefits recognized in the financial
statements from such a position should be measured based on
the largest benefit that has a greater than fifty percent
likelihood of being realized upon ultimate settlement. FIN 48
also provides guidance on derecognition of tax positions,
financial statement classification, recognition of interest
and penalties, accounting in interim periods, and disclosure
and transition requirements. FIN 48 is effective for fiscal
years beginning after December 15, 2006. The Company expects
the adoption of FIN 48 on April 1, 2007, will not have a
material effect on its consolidated financial statements.
92
In May 2007, the FASB issued FASB Staff Position No. FIN 48-1,
"Definition of "Settlement" in FASB Interpretation No. 48"
("FSP FIN 48-1"), which provides guidance on how a company
should determine whether a tax position is effectively settled
for the purpose of recognizing previously unrecognized tax
benefits. FSP FIN 48-1 is effective upon initial adoption of
FIN 48, which the Company adopted on April 1, 2007, as
indicated above.
In September 2006, FASB issued SFAS No. 157, "Fair Value
Measurements" ("SFAS 157"), which provides enhanced guidance
for using fair value to measure assets and liabilities. SFAS
157 clarifies the principle that fair value should be based on
the assumptions that market participants would use when
pricing an asset or liability, provides a framework for
measuring fair value under GAAP and expands disclosure
requirements about fair value measurements. SFAS 157 is
effective for financial statements issued in fiscal years
beginning after November 15, 2007, and interim periods within
those fiscal years. The Company plans to adopt SFAS 157 at the
beginning of fiscal 2009, and is evaluating the impact, if any,
the adoption of SFAS 157 will have on its financial condition
and results of operations.
In February 2007, the FASB issued SFAS No. 159, "The Fair
Value Option for Financial Assets and Financial Liabilities"
("SFAS 159"), which permits companies to choose to measure
many financial instruments and certain other items at fair
value. The objective is to improve financial reporting by
providing companies with the opportunity to mitigate
volatility in reported earnings caused by measuring related
assets and liabilities differently without having to apply
complex hedge accounting provisions. SFAS 159 is effective for
fiscal years beginning after November 15, 2007. Companies are
not allowed to adopt SFAS 159 on a retrospective basis unless
they choose early adoption. The Company plans to adopt SFAS
159 at the beginning of fiscal 2009, and is evaluating the
impact, if any, the adoption of SFAS 159 will have on its
financial condition and results of operations.
In March 2007, the FASB ratified the consensus reached by the
EITF in Issue No. 06-10, "Accounting for Collateral Assignment
Split-Dollar Life Insurance Arrangements" ("Issue 06-10").
Issue 06-10 requires companies with collateral assignment
split-dollar life insurance policies that provide a benefit to
an employee that extends to postretirement periods to
recognize a liability for future benefits based on the
substantive agreement with the employee. Recognition should be
in accordance with FASB Statement No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions,"
or APB Opinion No. 12, "Omnibus Opinion - 1967," depending on
whether a substantive plan is deemed to exist. Companies are
permitted to recognize the effects of applying the consensus
through either (1) a change in accounting principle through a
cumulative-effect adjustment to retained earnings or to other
components of equity or net assets as of the beginning of the
year of adoption or (2) a change in accounting principle
through retrospective application to all prior periods. Issue
06-10 is effective for fiscal years beginning after December
15, 2007, with early adoption permitted. The Company plans to
adopt Issue 06-10 at the beginning of fiscal 2009, and is
evaluating the impact of the adoption of Issue 06-10 on its
financial condition and results of operations.
In September 2007, the EITF reached a consensus on Issue No.
07-1 ("Issue 07-1"), "Accounting for Collaborative
Arrangements." The scope of Issue 07-1 is limited to
collaborative arrangements where no separate legal entity
exists and in which the parties are active participants and
are exposed to significant risks and rewards that depend on
the success of the activity. The EITF concluded that revenue
transactions with third parties and associated costs incurred
should be reported in the appropriate line item in each
company's financial statements pursuant to the guidance in
Issue 99-19, "Reporting Revenue Gross as a Principal versus
Net as an Agent." The EITF also concluded that the equity
method of accounting under Accounting Principles Board Opinion
18, "The Equity Method of Accounting for Investments in Common
Stock," should not be applied to arrangements that are not
conducted through a separate legal entity. The EITF also
concluded that the income statement classification of payments
made between the parties in an arrangement should be based
93
on a consideration of the following factors: the nature and
terms of the arrangement; the nature of the entities'
operations; and whether the partners' payments are within the
scope of existing GAAP. To the extent such costs are not
within the scope of other authoritative accounting literature,
the income statement characterization for the payments should
be based on an analogy to authoritative accounting literature
or a reasonable, rational, and consistently applied accounting
policy election. The provisions of Issue 07-1 are effective
for fiscal years beginning on or after December 15, 2008, and
companies will be required to apply the provisions through
retrospective application. The Company plans to adopt Issue
07-1 at the beginning of fiscal 2010 and is evaluating the
impact of the adoption of Issue 07-1 on its financial
condition and results of operations.
In June 2007, the FASB ratified the consensus reached by the
EITF on Issue No. 07-3, "Accounting for Advance Payments for
Goods or Services Received for Use in Future Research and
Development Activities" ("Issue 07-3"), which is effective
December 15, 2007, and is applied prospectively for new
contracts entered into on or after the effective date. Issue
07-3 addresses nonrefundable advance payments for goods or
services for use in future research and development
activities. Issue 07-3 will require that these payments that
will be used or rendered for future research and development
activities be deferred and capitalized and recognized as an
expense as the related goods are delivered or the related
services are performed. If an entity does not expect the goods
to be delivered or the services to be rendered the capitalized
advance payments should be expensed. The Company is assessing
the effects of adoption of Issue 07-3 on its financial
condition and results of operations.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),
"Business Combinations" ("SFAS 141(R)") which replaces SFAS
141 but retains the fundamental concept of purchase method of
accounting in a business combination and improves reporting by
creating greater consistency in the accounting and financial
reporting of business combinations, resulting in more
complete, comparable, and relevant information for investors
and other users of financial statements. To achieve this goal,
the new standard requires the acquiring entity in a business
combination to recognize all the assets acquired and
liabilities assumed in the transaction and any non-controlling
interest at the acquisition date at their fair value as of
that date. This statement requires measuring a non-controlling
interest in the acquiree at fair value which will result in
recognizing the goodwill attributable to the non-controlling
interest in addition to that attributable to the acquirer.
This statement also requires the recognition of assets
acquired and liabilities assumed arising from contractual
contingencies as of the acquisition date, measured at their
acquisition fair values. SFAS 141(R) is effective for fiscal
years beginning after December 15, 2008. The Company plans to
adopt SFAS 141(R) at the beginning of fiscal 2010, and is
evaluating the impact of SFAS 141(R) on its financial
condition and results of operations.
In December 2007, the FASB issued SFAS No. 160,
"Non-controlling Interests in Consolidated Financial
Statements" ("SFAS 160") an amendment of ARB No. 51, which
will affect only those entities that have an outstanding
non-controlling interest in one or more subsidiaries or that
deconsolidate a subsidiary by requiring all entities to report
non-controlling (minority) interests in subsidiaries in the
same way as equity in the Consolidated Financial Statements.
In addition, SFAS 160 eliminates the diversity that currently
exists in accounting for transactions between an entity and
non-controlling interests by requiring they be treated as
equity transactions. SFAS 160 is effective for fiscal years
beginning after December 15, 2008. The Company plans to adopt
SFAS 160 at the beginning of fiscal 2010, and is evaluating the
impact of SFAS 160 on its financial condition and results of
operations.
94
3. RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------------
REVIEW OF STOCK OPTION GRANT PRACTICES
BACKGROUND AND CONCLUSIONS
The Company has restated its consolidated statements of income,
comprehensive income, shareholders' equity and cash flows for the
fiscal years ended March 31, 2006 and 2005, and its consolidated
balance sheet as of March 31, 2006. In addition, because the
impacts of the restatement adjustments extend back to the fiscal
year ended March 31, 1996, we have recognized the cumulative
restatement adjustments through March 31, 2004, as a net decrease
to beginning shareholders' equity as of April 1, 2004.
On October 31, 2006, the Company announced that it had been served
with a derivative lawsuit filed in St. Louis City Circuit Court
alleging that certain stock option grants to current or former
officers and directors between 1995 and 2002 were dated
improperly. In accordance with the Company's established
corporate governance procedures, the Board of Directors referred
this matter to the independent members of its Audit Committee (the
"Special Committee" or "Committee").
Shortly thereafter, the Special Committee commenced an
investigation of the Company's stock option grant practices,
assisted by independent legal counsel and forensic accounting
experts engaged by the Committee, with the objectives of
evaluating the Company's accounting for stock options for
compliance with GAAP and for compliance with the terms of its
related stock option plans over the period January 1, 1995, through
October 31, 2006 (the "relevant period").
On October 11, 2007, the Company filed a Current Report on Form 8-
K announcing the Special Committee had completed its
investigation. The investigation concluded that there was no
evidence that any employee, officer or director of the Company
engaged in any intentional wrongdoing or was aware the Company's
policies and procedures for granting and accounting for stock
options were materially non-compliant with GAAP. The investigation
also found no intentional violation of law or accounting rules
with respect to the Company's historical stock option grant
practices.
However, the Special Committee concluded that stock-based
compensation expense resulting from the stock option grant
practices followed by the Company were not recorded in accordance
with GAAP because the expense computed for most of the grants
reflected incorrect measurement dates for financial accounting
purposes. The "measurement date" under applicable accounting
principles, namely APB 25 and related interpretations, is the
first date on which all of the following are known and not subject
to change: (a) the individual who is entitled to receive the
option grant, (b) the number of options that an individual is
entitled to receive, and (c) the option's exercise price.
FINDINGS AND ACCOUNTING CONSIDERATIONS
In general, stock options were granted to employees, executives
and non-employee members of the Board of Directors over the
relevant period under the terms of the Company's 1991 and 2001
Incentive Stock Option Plans (the "option plans"). In addition to
options granted to the CEO under those plans, options were awarded
to him under the terms of his employment agreement in lieu of, and
in consideration for a reduction of, the cash bonus provided for
in that agreement.
The option plans required grants to be approved by the
Compensation Committee of the Board of Directors. Under the option
plans, options were to be granted with exercise prices set at no
less than the fair market value of the underlying common stock at
the date of grant. The 1991 plan provided for the exclusive grant
of Incentive Stock Options ("ISOs") as defined by Internal Revenue
Code Section 422, while the 2001 plan provided for the grant of
ISOs and non-qualified stock options ("NSOs"). Under the plans,
options granted to employees other than the CEO or directors are
subject to a ten-year ratable vesting period. Options granted to
the CEO and directors generally vest ratably over five years.
95
Both option plans require that shares received upon exercise of an
option cannot be sold for two years. If the employee terminates
employment voluntarily or involuntarily (other than by retirement,
death or disability) during the two-year period, the option plans
provide that the Company may elect to repurchase the shares at the
lower of the exercise price of the option or the fair market value
of the stock on the date of termination. The Company has changed
its accounting for stock-based compensation to consider this
provision of the option plans as a forfeiture provision to be
accounted for in accordance with the guidance provided in EITF No.
00-23, "Issues Related to Accounting for Stock Compensation under
APB 25 and FIN 44", specifically Paragraph 78 and Issue 33 (a),
"Accounting for Early Exercise". In accordance with EITF No. 00-
23, cash paid by an employee for the exercise price is considered
a deposit or a prepayment of the exercise price that is recognized
as a current liability when received by the Company at the
beginning of the two-year forfeiture period. The receipt of the
exercise price is recognized as a current liability because the
options are deemed not exercised and the option shares are not
considered issued until an employee bears the risk and rewards of
ownership. The options are accounted for as exercised when the
two-year forfeiture period lapses. In addition, because the
options are not considered exercised for accounting purposes, the
shares in the two-year forfeiture period are not considered
outstanding for purposes of computing basic EPS.
The Company had accounted for all option grants as fixed in
accordance with the provisions of APB 25, using the date of grant
as the measurement date. Because the exercise price of the option
was equal to or greater than the market price of the stock at the
measurement date fixed by the terms of the awards, under prior
procedures the Company did not recognize any compensation expense
since the option had no intrinsic value (intrinsic value being the
difference between the exercise price and the market price of the
underlying stock at the measurement date).
As noted above, the Special Committee determined that the
Company's accounting for most of the stock option grants during
the periods fiscal 1996 through fiscal 2006 was not in accordance
with GAAP because the date of grant, as defined by the Company,
was not a proper measurement date. To correct the errors, and be
consistent with the accounting literature and guidance from the
Securities and Exchange Commission ("SEC"), the Company organized
the grants into categories based on grant type and process by
which the grant was finalized. Based on the relevant facts and
circumstances, the Company applied the authoritative accounting
standard (APB 25 and related interpretations) to determine, for
every grant within each category, the proper measurement date. If
the measurement date was not the originally assigned grant date,
accounting adjustments were made as required, resulting in stock-
based compensation expense and related tax effects. The grants
were classified as follows: (1) promotion/retention grants to
executives and employees and new hire grants ("employee options");
(2) grants to persons elected or appointed to the Board of
Directors ("director options"); and (3) bonus option grants to the
CEO in lieu of cash bonus payments under the terms of his
employment agreement ("bonus options").
Employee Options. The evidence obtained through the investigation
----------------
indicates that employee options were granted based on the lowest
market price in the quarter of grant determined from an effective
date (as defined below) to the end of the quarter. The exercise
price and grant date of the options were determined by looking
back from the end of the quarter to the effective date and
choosing the lowest market price during that period. The date on
which the market price was lowest became the grant date. This
procedure to "look back" to the lowest market price in the
preceding quarter to set the exercise price was widely known and
understood within the Company. The effective date was either the
date on which the option recipients and the number of shares to be
granted were determined and approved by the CEO, the date of a
promotion or the date of hire. For new hires and promotions of
existing employees which represent substantially all of the award
recipients, the terms of the awards, except for the exercise
price, were communicated to the recipients prior to the end of the
quarter. At the end of the quarter, when the exercise price was
determined, board consents were prepared and dated the date on
which the stock price was lowest during the quarter, to be
approved by the members of the Compensation Committee. The
evidence obtained through the investigation indicated the
Compensation Committee never changed or denied approval of any
grants submitted to them and, as such, their approval was
considered a routine matter. Based on the evidence and findings of
the Special Committee, the results of management's analysis, the
criteria specified in
96
APB 25 for determining measurement dates and guidance from the
staff of the SEC, the Company has concluded the measurement dates
for the employee options should not have been the originally
assigned grant dates, but instead, should have been the end of the
quarter in which awards were granted when the exercise price and
number of shares granted were fixed. Changing the measurement
dates from the originally assigned grant date to the end of the
quarter resulted in recognition of additional stock-based
compensation expense, net of related tax effects, of $603 on 1,461
stock option grants for fiscal 2006, $614 on 1,422 stock option
grants for fiscal 2005 and $4,752 on 2,268 stock option grants as
a cumulative adjustment to beginning shareholders' equity as of
April 1, 2004.
Director Options. Director options were issued, prior to the
----------------
effective date of the Sarbanes-Oxley Act ("Sarbanes-Oxley") in
August 2002, using the same "look back" process as described above
for employee options. This process was changed when the time for
Form 4's was shortened under the provisions of Sarbanes-Oxley, to
award options with exercise prices equal to the fair market value
of the stock on the date of grant. Prior to this change in grant
practice, the Company concluded the measurement date for the
director options should be the end of the quarter. Changing the
measurement date from the originally assigned grant date to the
end of the quarter resulted in recognition of additional stock-
based compensation expense, net of related tax effects, of $34 on
19 stock option grants for fiscal 2006, $51 on 16 stock option
grants for fiscal 2005 and $606 on 11 stock option grants as a
cumulative adjustment to beginning shareholders' equity as of
April 1, 2004.
Bonus Options. Under the terms of the CEO's employment agreement,
-------------
he is permitted the alternative of electing incentive stock
options, restricted stock or discounted stock options in lieu of
the payment of part or all of the annual incentive bonus due to
him in cash. In the event of an election to receive options in
lieu of cash incentive, those options were to be valued using the
Black-Scholes option pricing model, applying the same assumptions
as those used in the Company's most recent proxy statement. The
employment agreement provides the CEO's annual bonus is based on
fiscal year net income.
Prior to fiscal 2005, the CEO received ten bonus option grants,
consisting of 337,500 shares of Class A Common Stock and 1,743,750
shares of Class B Common Stock under this arrangement. The CEO and
the Board's designated representative (the Company's Chief
Financial Officer) negotiated the terms of the bonus options,
including the number of shares covered, the exercise price and the
grant date (the latter being selected using a "look back" process
similar to that followed in granting employee and director
options). The Company typically granted bonus options prior to
fiscal year-end, shortly after such agreement was reached. These
bonus options were fully vested at grant, had three to five year
terms, were granted with a 10% or 25% premium to the market price
of the stock on the selected grant date and were subject to the
approval of the Compensation Committee. The CEO's cash bonus
payable at the end of the fiscal year in which the options were
granted was reduced by the Black-Scholes value of the options
according to their terms.
Based on the facts and circumstances relative to the process for
granting the bonus options, the Special Committee determined, and
the Company has agreed, that the measurement dates for these
options should be the end of the fiscal year in which they were
granted. The end of the fiscal year was used as the measurement
date because that is the date on which the amount of the annual
bonus could be determined and therefore the terms of the option
could be fixed under APB 25. This conclusion is predicated on the
assumption that the terms of the option were linked to the amount
of the bonus earned. While it was permissible to agree upon the
number of shares that were to be issued prior to the end of the
year and that would not be forfeitable prior to the end of the
year, under GAAP the exercise price is considered variable until
the amount of the bonus could be determined with finality. The
variability in the exercise price results from the premise that
the CEO would have been required to repay any shortfall in the
bonus earned from the value assigned to the option by the Black-
Scholes model. Any amount repaid to cure the bonus shortfall would
in substance be an increase in the exercise price of the option.
Since the exercise price could not be determined with certainty
until the amount of the bonus was known, the Company has applied
variable accounting to the bonus options from the date of grant to
the final fiscal year-end measurement date. Variable accounting
requires that compensation expense is to be determined by
comparing the
97
quoted market value of the shares covered by the option grant to
the exercise price at each intervening balance sheet date until
the terms of the option become fixed.
The compensation expense associated with the CEO's estimated bonus
was accrued throughout the fiscal year. When the value of a bonus
option was determined using the Black-Scholes model, previously
recorded compensation expense associated with the accrual of the
estimated bonus was reversed in the amount of the value assigned
to the bonus option. The previously recorded compensation expense
should not have been reversed. The Company developed a methodology
in the restatement process that considers both the intrinsic value
of the option under APB 25 and the Black-Scholes value assigned
to the bonus option in determining the amount of compensation
expense to recognize once the exercise price of the option becomes
fixed and variable accounting ends. Under this methodology, the
intrinsic value of the option is determined at the fiscal year-end
measurement date under the principles of APB 25. The intrinsic
value is then compared to the Black-Scholes value assigned to the
option for compensation purposes ("the bonus value"). The bonus
value is the amount that would have been accrued during the fiscal
year through the grant date as part of the total liability for the
CEO's bonus. The greater of the intrinsic value or bonus value is
recorded as compensation expense. Using this methodology and the
fiscal year-end as the measurement dates, resulted in an increase
in stock-based compensation expense of $6,944 over the period from
fiscal 1996 through fiscal 2004. There was no tax benefit
associated with this expense due to the tax years being closed.
OTHER MODIFICATIONS OF OPTION TERMS
As described above, under the terms of the option plans, shares
received on exercise of an option are to be held for the employee
for two years during which time the shares cannot be sold. If the
employee terminates employment voluntarily or involuntarily (other
than by retirement, death or disability) during the two-year
forfeiture period, the plans provide the Company with the option of
repurchasing the shares at the lower of the exercise price or the
fair market value of the stock on the date of termination. In some
circumstances, the Company elected not to repurchase the shares
upon termination of employment while the shares were in the two-
year forfeiture period, essentially waiving the remaining
forfeiture period requirement. The Company previously did not
recognize this waiver as requiring a new measurement date.
Based on management's analysis, the Company has concluded that a
new measurement date should have been recognized in two
situations: (1) the employee terminated and the Company did not
exercise its right under the option plans to buy back the shares
in the two-year forfeiture period, and (2) the forfeiture
provision was waived and the employee subsequently terminated
within two years of the exercise date. The Company now considers
both of these waivers to be an acceleration of the vesting period
because the forfeiture provision was waived (i.e., the employee
is no longer subject to a service condition to earn the right to
the shares and will benefit from the modification). As such, a
new measurement date is required. In this case, the new
measurement date is the date the forfeiture provision was waived
with additional stock-based compensation expense, being recognized
at the date of termination. Since the shares were fully vested,
the intrinsic value of the option at the new measurement date in
excess of the intrinsic value at the original measurement date
should be expensed immediately. The new measurement dates resulted
in an increase in stock-based compensation expense, net of related
tax effects, of $4 on two stock option grants for fiscal 2006, $92
on one stock option grant for fiscal 2005 and $274 on 24 stock
option grants as a cumulative adjustment to beginning
shareholders' equity as of April 1, 2004.
98
STOCK OPTION ADJUSTMENTS
A discussion of the stock option restatement adjustments and
tables reflecting the impact of these adjustments is presented
below beginning on page 101.
Stock-based Compensation Expense. Although the period for the
--------------------------------
Special Committee's investigation was January 1, 1995 to October
31, 2006, the Company extended the period of review back to 1986
in its analysis of the aggregate impact of the measurement date
changes because the incorrect accounting for stock options
extended that far back in time. The Company has concluded that
the measurement date changes identified by the Special Committee's
investigation and management's analysis resulted in an
understatement of stock-based compensation expense arising from
stock option grants since 1986, affecting the Company's
Consolidated Financial Statements for each year beginning with the
year ended March 31, 1986. The impact of the misstatements on the
Consolidated Financial Statements for the fiscal years from 1986
to 1995 was not considered material, individually or in the
aggregate. Therefore, it was included as a cumulative adjustment
to the stock-based compensation expense for fiscal 1996. The
aggregate understatement of pre-tax, stock-based compensation
expense for the eleven-year restatement period from 1996 through
2006 was $15,632 on 2,891 stock option grants.
As previously discussed, the Company now considers the two-year
repurchase option specified in the option plans to be a forfeiture
provision that goes into effect when stock options are exercised.
Therefore, the service period necessary for an employee to earn an
award varies based on the timing of stock option exercises. The
Company initially expenses each award (i.e., all tranches of an
option award) on a straight-line basis over ten years, which is
the period that stock options become exercisable. The Company
ensures the cumulative compensation expense for an award as of any
date is at least equal to the measurement-date intrinsic value of
those options that have vested (i.e., when the two-year forfeiture
period has ended). If stock options expire unexercised or an
employee terminates employment after options become exercisable,
no compensation expense associated with the exercisable, but
unexercised options, is reversed. In those instances where an
employee terminates employment before options become exercisable
or the Company repurchased the shares during the two-year
forfeiture period, compensation expense for those options is
reversed as a forfeiture.
Payroll Taxes, Interest and Penalties. In connection with the
-------------------------------------
stock-based compensation adjustments, the Company determined that
certain options previously classified as ISO grants were
determined to have been granted with an exercise price below the
fair market value of the Company's stock on the revised
measurement dates. Under Internal Revenue Code Section 422, ISOs
may not be granted with an exercise price less than the fair
market value on the date of grant, and therefore these grants
would not likely qualify for ISO tax treatment. The
disqualification of ISO classification exposes the Company and the
affected employees to payroll related withholding taxes once the
underlying shares are released from the post exercise two-year
forfeiture period and the substantial risk of forfeiture has
lapsed (the "taxable event"). The Company and the affected
employees may also be subject to interest and penalties for
failing to properly withhold taxes and report this taxable event
on their respective tax returns. The Company is currently
reviewing the potential disqualification of ISO grants and the
related withholding tax implications with the Internal Revenue
Service ("IRS") for calendar years 2004, 2005 and 2006 in an
effort to reach agreement on the resulting tax liability. In the
meantime, the Company has recorded expenses related to the
withholding taxes, interest and penalties associated with options
which would have created a taxable event in calendar years 2004,
2005 and 2006. The estimated payroll tax liability at March 31,
2006 for the disqualification of tax treatment associated with ISO
awards totaled $3,278. In addition, the Company recorded an
income tax benefit of $909 related to this liability.
Income Tax Benefit. The Company reviewed the income tax effect of
------------------
the stock-based compensation charges, and it believes the proper
income tax accounting for stock options under GAAP depends, in
part, on the tax distinction of the stock options as either ISOs
or NSOs. Because of the potential impact of the measurement date
changes on the qualified status of the options, the Company has
determined that substantially all of the options originally
intended to be ISOs and granted prior to April 2, 2006, might not
be qualified under the tax regulations, and
99
therefore should be accounted for as if they were NSOs for
financial accounting purposes. An income tax benefit has resulted
from the determination that certain NSOs for which stock-based
compensation expense was recorded will create an income tax
deduction. This tax benefit has resulted in an increase to the
Company's deferred tax assets for stock options prior to the
occurrence of a taxable event or the forfeiture of the related
options. Upon the occurrence of a taxable event or forfeiture of
the underlying options, the corresponding deferred tax asset is
reversed and the excess or deficiency in the deferred tax assets
is recorded to paid-in capital in the period in which the taxable
event or forfeiture occurs. The Company has recorded a deferred
tax asset of $1,320 as of March 31, 2006, related to stock options.
REVIEW OF TAX POSITIONS (UNRELATED TO STOCK OPTIONS)
In addition, the Company's restated Consolidated Financial
Statements include an adjustment to increase the provision for
income taxes and taxes payable to reflect additional liabilities
associated with tax positions claimed on filed tax returns for
fiscal years 2004, 2005 and 2006 that should have been recorded in
accordance with GAAP, partially offset by certain expected tax
refunds. As of March 31, 2006, the Company's liability for taxes
payable increased $5,407 as a result of these adjustments.
OTHER ADJUSTMENTS (UNRELATED TO STOCK OPTIONS)
In addition to the restatement adjustments associated with stock
options and income taxes discussed above, our restated
Consolidated Financial Statements include an adjustment for fiscal
years 2002 through 2006 to reflect the correction of errors
related to the recognition of revenue associated with shipments to
customers under FOB destination terms and an adjustment to reduce
the estimated liability for employee medical claims incurred but
not reported at March 31, 2006. We incorrectly recognized revenue
for certain customers prior to when title and risk of ownership
transferred to the customer. The aggregate impact of these
adjustments over the periods affected was a decrease in net
revenue of $1,175 and a decrease in net income of $385. The
aggregate impact on net income reflects a $498 decrease associated
with the net revenue errors and a $113 increase related to the
adjustment of the liability for medical claims.
100
The table below reflects the impact of the restatement adjustments
discussed above on the Company's Consolidated Statements of Income for
the periods presented below:
CUMULATIVE
YEARS ENDED MARCH 31, 1996
--------------------- THROUGH
CATEGORY OF ADJUSTMENTS: 2006 2005 2004 (a)
- ------------------------ ------ ------ --------
Pretax income impact:
Stock-based compensation expense
related to measurement date changes (b) $ 927 $1,080 $13,626
Payroll taxes, interest and penalties (b) 2,294 545 439
Other adjustments (160) (897) 1,666
------ ------ -------
Total pretax income reduction 3,061 728 15,731
------ ------ -------
Income tax expense (benefit):
Measurement date changes (286) (323) (1,050)
Payroll taxes and interest (635) (151) (123)
Other income tax adjustments (c) 2,171 1,498 1,689
Other adjustments 60 300 (584)
------ ------ -------
Total income tax increase (reduction) 1,310 1,324 (68)
------ ------ -------
Total net income reduction $4,371 $2,052 $15,663
------ ------ -------
<FN>
- ------------
(a) The cumulative effect of the restatement adjustments from fiscal
1996 through fiscal 2004 is summarized below:
DECREASE/
STOCK OPTION ADJUSTMENTS(e) OTHER ADJUSTMENTS (INCREASE)
YEAR ENDED --------------------------- OTHER INCOME ----------------------- TO NET
MARCH 31, PRETAX INCOME TAX TAX ADJUSTMENTS PRETAX INCOME TAX INCOME
- ---------- ------ ---------- --------------- ------ ---------- ---------
1996 $ 829(d) $ - $ - $ - $ - $ 829
1997 657 (1) - - - 656
1998 2,391 (19) - - - 2,372
1999 535 (27) - - - 508
2000 1,998 (62) - - - 1,936
2001 1,722 (141) - - - 1,581
2002 2,317 (219) - 2,534 (918) 3,714
2003 1,187 (248) - (1,610) 590 (81)
2004 2,429 (456) 1,689 742 (256) 4,148
------- -------- --------- --------- ------- -------
Cumulative effect $14,065 $ (1,173) $ 1,689 $ 1,666 $ (584) $15,663
======= ======== ========= ========= ======= =======
<FN>
(b) Stock-based compensation expenses, including related payroll taxes,
interest and penalties, have been recorded as adjustments to the
selling and administrative expense line item in the Company's
consolidated statements of income for each period.
(c) This represents liabilities associated with tax positions claimed on
filed tax returns for these years, partially offset by certain
expected tax refunds.
(d) Includes additional expense from 1986 to 1995 totaling $636, the
effect of which on the consolidated financial statements for 1996
and for each year 1986 to 1995 was not considered material.
(e) Includes adjustments for payroll taxes, interest and penalties.
101
Consolidated Balance Sheet Impact
The following table reconciles the consolidated balance sheet previously
reported to the restated amounts as of March 31, 2006:
MARCH 31, 2006
--------------------------------------------------------------------
AS PREVIOUSLY AS
REPORTED ADJUSTMENTS RESTATED
-------- ----------- --------
Current assets:
Cash and cash equivalents $ 100,706 $ - $ 100,706
Marketable securities 106,763 - 106,763
Receivables, net 54,746 (1,175)(f) 53,571
Inventories, net 70,778 388(f) 71,166
Prepaid and other assets 6,963 49(a) 7,012
Deferred tax asset 8,034 2,038(b)(c)(f)(g) 10,072
---------- -------- ----------
Total current assets 347,990 1,300 349,290
Property and equipment, net 178,042 - 178,042
Intangible assets and goodwill, net 72,955 - 72,955
Other assets 19,026 - 19,026
---------- -------- ----------
Total assets $ 618,013 $ 1,300 $ 619,313
========== ======== ==========
Current liabilities:
Accounts payable $ 17,975 $ - $ 17,975
Accrued liabilities 17,100 7,576(b)(c)(d)(e)(f)(g) 24,676
Current maturities of long-term debt 1,681 - 1,681
---------- -------- ----------
Total current liabilities 36,756 7,576 44,332
Long-term debt 241,319 - 241,319
Other long-term liabilities 5,442 - 5,442
Deferred tax liabilities 25,221 - 25,221
---------- -------- ----------
Total liabilities 308,738 7,576 316,314
---------- -------- ----------
Commitments and contingencies - - -
Shareholders' equity:
Preferred stock - - -
Class A common stock 400 (3)(d) 397
Class B common stock 127 - 127
Additional paid-in capital 129,367 15,813(b)(d) 145,180
Retained earnings 233,496 (22,086)(a)(b)(c)(e)(f)(g) 211,410
Accumulated other comprehensive loss (211) - (211)
Less: Treasury stock (53,904) - (53,904)
---------- -------- ----------
Total shareholders' equity 309,275 (6,276) 302,999
---------- -------- ----------
Total liabilities and shareholders'
equity $ 618,013 $ 1,300 $ 619,313
========== ======== ==========
<FN>
- -----------
(a) Adjustment for accrued interest associated with certain expected tax
refunds.
(b) Adjustment for stock-based compensation expense pursuant to APB 25
($15,632) and income tax impact associated with stock-based
compensation expense pursuant to APB 25 ($1,658), partially offset
by net effect of tax benefit realized in accrued taxes ($2,432) and
excess tax benefit reflected in paid-in capital ($2,094).
(c) Adjustment for payroll taxes, interest and penalties associated with
stock-based compensation expense ($3,278) and the related income tax
benefit ($909).
(d) Adjustment for exercise deposits received by the Company for stock
options in the two-year forfeiture period ($1,916).
(e) Adjustment for additional liabilities associated with tax positions
claimed, partially offset by certain expected tax refunds ($5,407).
(f) Adjustment to record revenue and cost of sales when product is
received by the customer instead of shipping date for certain
customers (decrease in receivables of $1,175; increase in
inventories of $388; decrease in deferred tax assets of $125;
decrease in accrued liabilities of $414; and decrease in retained
earnings of $498).
(g) Adjustment for reduction in estimated liability associated with
employee medical claims incurred but not reported (decrease in
deferred tax assets of $66; decrease in accrued liabilities of $179;
and increase in retained earnings of $113).
102
Consolidated Statements of Income Impact
The following table reconciles the Company's previously reported results
to the restated Consolidated Statements of Income for the years ended
March 31, 2006 and 2005:
YEARS ENDED MARCH 31,
-------------------------------------------------------------------------------------
2006 2005
--------------------------------------- -----------------------------------------
AS AS
PREVIOUSLY AS PREVIOUSLY AS
REPORTED ADJUSTMENTS RESTATED REPORTED ADJUSTMENTS RESTATED
-------- ----------- -------- ---------- ----------- --------
Net revenues $ 367,618 $ 22 $367,640 $303,493 $ 1,163 $ 304,656
Cost of sales 123,894 41 123,935 107,682 266 107,948
-------------------------------------- -------------------------------------
Gross profit 243,724 (19) 243,705 195,811 897 196,708
-------------------------------------- -------------------------------------
Operating expenses:
Research and development 28,886 - 28,886 23,538 - 23,538
Purchased in-process research and
development and transaction costs 30,441 - 30,441 - - -
Selling and administrative 140,395 3,042 143,437 116,638 1,625 118,263
Amortization of intangibles 4,784 - 4,784 4,653 - 4,653
Litigation - - - (1,430) - (1,430)
-------------------------------------- -------------------------------------
Total operating expenses 204,506 3,042 207,548 143,399 1,625 145,024
-------------------------------------- -------------------------------------
Operating income 39,218 (3,061) 36,157 52,412 (728) 51,684
-------------------------------------- -------------------------------------
Other expense (income):
Interest expense 6,045 - 6,045 5,432 - 5,432
Interest and other income (5,737) - (5,737) (3,048) - (3,048)
-------------------------------------- -------------------------------------
Total other expense (income) 308 - 308 2,384 - 2,384
-------------------------------------- -------------------------------------
Income before income taxes 38,910 (3,061) 35,849 50,028 (728) 49,300
Provision for income taxes 23,123 1,310 24,433 16,759 1,324 18,083
-------------------------------------- -------------------------------------
Net income $ 15,787 $ (4,371) $ 11,416 $ 33,269 $ (2,052) $ 31,217
====================================== =====================================
Earnings per share:
Basic - Class A common $ 0.33 $ (0.09) $ 0.24 $ 0.71 $ (0.03) $ 0.68
Basic - Class B common 0.28 (0.08) 0.20 0.59 (0.03) 0.56
Diluted - Class A common 0.31 (0.08) 0.23 0.63 (0.03) 0.60
Diluted - Class B common (a) 0.20 0.52
Shares used in per share calculation:
Basic - Class A common 36,277 (435)(b) 35,842 34,228 (494)(b) 33,734
Basic - Class B common 13,065 (147)(b) 12,918 15,005 (172)(b) 14,833
Diluted - Class A common 50,729 (732)(b) 49,997 59,468 (835)(b) 58,633
Diluted - Class B common (a) 13,113 15,072
<FN>
(a) In fiscal 2007, the Company began reporting diluted earnings per
share for Class B Common Stock under the two-class method which
does not assume the conversion of Class B Common Stock into Class A
Common Stock. Previously, the Company did not present diluted
earnings per share for Class B Common Stock.
(b) Adjustment to reflect impact of unrecognized stock-based
compensation and excess tax benefits in applying the treasury stock
method and unvested stock options in the two-year forfeiture
period.
103
CONSOLIDATED STATEMENTS OF CASH FLOWS IMPACT
The following table reconciles the Company's previously reported results
to the restated Consolidated Statements of Cash Flows for the years
ended March 31, 2006 and 2005:
YEARS ENDED MARCH 31,
----------------------------------------------------------
2006
----------------------------------------------------------
AS
PREVIOUSLY AS
REPORTED ADJUSTMENTS RESTATED
-------- ----------- --------
Operating Activities:
Net income $ 15,787 $ (4,371)(a)(b)(c)(d)(e) $ 11,416
Adjustments to reconcile
net income to net cash
provided by operating activities:
Acquired in-process research
and development 29,570 - 29,570
Depreciation, amortization and
other non-cash charges 18,002 - 18,002
Deferred income tax provision 6,707 (645)(a)(b)(d)(e) 6,062
Deferred compensation 965 - 965
Stock-based compensation - 927(a) 927
Litigation - - -
Changes in operating assets and liabilities:
Decrease in receivables, net 7,615 (22)(d) 7,593
Increase in inventories (16,833) 41(d) (16,792)
Decrease in prepaid and other
assets 1,372 (39)(c) 1,333
Increase in accounts payable and accrued
liabilities 1,424 4,109(b)(c)(d)(e) 5,533
---------------------------------------------------------
Net cash provided by operating activities 64,609 - 64,609
---------------------------------------------------------
Investing Activities:
Purchase of property and equipment (58,334) - (58,334)
Purchase of marketable securities (61,187) - (61,187)
Purchase of preferred stock (11,300) - (11,300)
Product acquisition (25,643) - (25,643)
---------------------------------------------------------
Net cash used in investing activities (156,464) - (156,464)
---------------------------------------------------------
Financing Activities:
Principal payments on long-term debt (892) - (892)
Proceeds from borrowing of long-term debt 32,764 - 32,764
Dividends paid on preferred stock (70) - (70)
Purchase of common stock for treasury (253) - (253)
Cash deposits received for stock options 1,187 - 1,187
---------------------------------------------------------
Net cash provided by
financing activities 32,736 - 32,736
---------------------------------------------------------
Decrease in cash and cash equivalents (59,119) - (59,119)
Cash and cash equivalents:
Beginning of year 159,825 - 159,825
---------------------------------------------------------
End of year $ 100,706 $ - $ 100,706
=========================================================
YEARS ENDED MARCH 31,
----------------------------------------------------------
2005
----------------------------------------------------------
AS
PREVIOUSLY AS
REPORTED ADJUSTMENTS RESTATED
-------- ----------- --------
Operating Activities:
Net income $ 33,269 $ (2,052)(a)(b)(c)(d) $ 31,217
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation, amortization and
other non-cash charges 13,904 - 13,904
Deferred income tax provision 13,582 (487)(a)(b)(d) 13,095
Deferred compensation 1,355 - 1,355
Stock-based compensation - 1,080(a) 1,080
Litigation (843) - (843)
Changes in operating assets and liabilities:
Decrease in receivables, net 3,511 (1,163)(d) 2,348
Increase in inventories (3,248) 266(d) (2,982)
Increase in prepaid and other
assets (3,520) (10)(c) (3,530)
Decrease in accounts payable and accrued
liabilities (8,980) 2,366(b)(c)(d)(e) (6,614)
---------------------------------------------------------
Net cash provided by operating activities 49,030 - 49,030
---------------------------------------------------------
Investing Activities:
Purchase of property and equipment (63,622) - (63,622)
Purchase of marketable securities (10,565) - (10,565)
---------------------------------------------------------
Net cash used in investing activities (74,187) - (74,187)
---------------------------------------------------------
Financing Activities:
Principal payments on long-term debt (8,179) - (8,179)
Dividends paid on preferred stock (70) - (70)
Purchase of common stock for treasury (2,468) - (2,468)
Cash deposits received for stock options 4,118 - 4,118
---------------------------------------------------------
Net cash used in financing activities (6,599) - (6,599)
---------------------------------------------------------
Decrease in cash and cash equivalents (31,756) - (31,756)
Cash and cash equivalents:
Beginning of year 191,581 - 191,581
---------------------------------------------------------
End of year $159,825 $ - $159,825
=========================================================
<FN>
(a) Adjustment for stock-based compensation expense pursuant to APB 25
and the related income tax impact.
(b) Adjustment for payroll taxes, interest and penalties associated
with stock-based compensation expense and the related income tax
impact.
(c) Adjustment for additional liabilities associated with tax
positions, partially offset by certain expected tax refunds.
(d) Adjustment for revenue recognition errors related to shipments made
to certain customers.
(e) Adjustment for reduction in estimated liability associated with
employee medical claims incurred but not reported.
104
4. 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 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 was 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 U.S. and Canada for ten new generic
drugs. Under the agreement, Strides is responsible for
developing, submitting for regulatory approval and
manufacturing the ten products and the Company is
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 changes in the exchange rate, the
carrying value of this investment was $11,406 at March 31,
2007. 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, 2007.
105
5. MARKETABLE SECURITIES
---------------------
The carrying amount of available-for-sale securities and
their approximate fair values at March 31, 2007 and 2006
were as follows.
MARCH 31, 2007
-------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ---------- ---------- ------
Auction rate securities... $119,150 $ - $ - $119,150
Equity securities......... 38,612 50 - 38,662
-------- --- ------ --------
Total................. $157,762 $50 $ - $157,812
======== === ====== ========
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
======== === ===== ========
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. For the year ended March
31, 2007, a realized loss of $270 was recognized when the
Company determined that its unrealized loss on equity
securities had become other-than-temporary as the duration
of the losses had surpassed 24 months and the Company no
longer intended to hold these securities to recovery. There
were no realized gains or losses for the years ended March
31, 2006 and 2005.
Included in the Company's marketable securities at March 31,
2007 and 2006 are $119,150 and $70,000, 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 (see Note
24, Subsequent Events, for further discussion of the
Company's investments in auction rate securities).
106
6. INVENTORIES
-----------
Inventories as of March 31, consist of:
2007 2006
---- ----
(as restated)
Finished goods...................................... $ 35,420 $ 29,365
Work-in-process..................................... 13,294 7,969
Raw materials....................................... 42,801 33,832
--------- ---------
$ 91,515 $ 71,166
========= =========
7. PROPERTY AND EQUIPMENT
----------------------
Property and equipment as of March 31, consist of:
2007 2006
---- ----
Land and improvements............................... $ 6,253 $ 5,763
Buildings and building improvements................. 108,631 101,135
Machinery and equipment............................. 73,461 57,021
Office furniture and equipment...................... 27,819 24,573
Leasehold improvements.............................. 21,057 21,044
Construction-in-progress............................ 5,865 10,265
--------- ---------
243,086 219,801
Less accumulated depreciation....................... (56,186) (41,759)
--------- ---------
Net property and equipment....................... $ 186,900 $ 178,042
========= =========
Capital additions to property and equipment were $25,066, $58,334
and $63,622 for the years ended March 31, 2007, 2006 and 2005,
respectively. Depreciation of property and equipment was $16,208,
$11,916 and $7,775 for the years ended March 31, 2007, 2006 and
2005, respectively.
Property and equipment projects classified as
construction-in-progress at March 31, 2007, are projected to be
completed during the next 12 months at an estimated cost of $2,832.
During the years ended March 31, 2006 and 2005, the Company
recorded capitalized interest on qualifying construction projects
of $940 and $1,511, respectively. In fiscal 2007, the Company did
not record any capitalized interest.
107
8. INTANGIBLE ASSETS AND GOODWILL
------------------------------
Intangible assets and goodwill as of March 31, consist of:
2007 2006
--------------------------- ------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
------ ------------ ------ ------------
Product rights - Micro-K(R)............. $ 36,140 $(14,513) $ 36,140 $(12,708)
Product rights - PreCare(R)............. 8,433 (3,233) 8,433 (2,811)
Trademarks acquired:
Niferex(R)........................... 14,834 (2,967) 14,834 (2,225)
Chromagen(R)/StrongStart(R).......... 27,642 (5,528) 27,642 (4,147)
License agreements...................... 4,400 (480) 4,400 (300)
Covenant not to compete................. 375 (72) 375 (34)
Trademarks and patents.................. 4,196 (774) 3,403 (604)
-------- -------- -------- --------
Total intangible assets.............. 96,020 (27,567) 95,227 (22,829)
Goodwill................................ 557 - 557 -
-------- -------- -------- --------
$ 96,577 $(27,567) $ 95,784 $(22,829)
======== ======== ======== ========
As of March 31, 2007, the Company's intangible assets have a
weighted average useful life of approximately 19 years.
Amortization of intangible assets was $4,809, $4,784 and $4,653 for
the years ended March 31, 2007, 2006 and 2005, respectively.
Assuming no additions, disposals or adjustments are made to the
carrying values and/or useful lives of the intangible assets,
annual amortization expense on product rights, trademarks acquired
and other intangible assets is estimated to be approximately $4,818
in each of the five succeeding fiscal years.
108
9. OTHER ASSETS
------------
Other assets as of March 31, consist of:
2007 2006
---- ----
Cash surrender value of life insurance.... $ 3,874 $ 3,416
Preferred stock investments............... 11,806 11,052
Accrued dividends on preferred stock...... 1,198 509
Deferred financing costs, net............. 2,159 2,879
Deposits.................................. 1,366 1,170
-------- --------
$ 20,403 $ 19,026
======== ========
10. ACCRUED LIABILITIES
Accrued liabilities as of March 31, consist of:
2007 2006
---- ----
(AS RESTATED)
Salaries, wages, incentives and benefits.. $ 20,669 $ 14,411
Income taxes - current.................... 5,558 3,145
Accrued interest payable.................. 2,192 1,875
Professional fees......................... 5,921 1,854
Stock option deposits..................... 2,560 1,916
Other..................................... 1,876 1,475
-------- --------
$ 38,776 $ 24,676
======== ========
11. LONG-TERM DEBT
Long-term debt as of March 31, consists of:
2007 2006
---- ----
Building mortgages........................ $ 41,348 $ 43,000
Convertible notes......................... 200,000 200,000
-------- --------
241,348 243,000
Less current portion...................... (1,897) (1,681)
-------- --------
$239,451 $241,319
======== ========
In June 2006, the Company replaced its $140,000 credit line by
entering into a new syndicated 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 debt. Interest is charged under the
facility at the lower of the prime rate or 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. At
March 31, 2007, the Company had $850 in open letters of credit
issued under the new revolving credit line and no cash borrowings
under the facility.
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
109
mortgage loan was used for working capital and general corporate
purposes. The 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.
In May 2003, the Company issued $200,000 principal amount of 2.5%
Contingent Convertible Subordinated Notes due 2033 (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.
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 Company classified the Notes as a current
liability as of June 30, 2007, due to the right the holders have to
require the Company to repurchase the Notes on May 16, 2008. The
Notes are subordinate to all of our existing and future senior
obligations.
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:
* 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;
* if the Company has called the Notes for redemption;
* 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
* 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.
The contingent interest feature of the Notes meets the criteria of
and qualifies as an embedded derivative. Although this feature
represents an embedded derivative financial instrument, based on
its de minimis value at the time of issuance and at March 31, 2007,
no value has been assigned to this embedded derivative.
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.
110
The aggregate maturities of long-term debt as of March 31, 2007 are
as follows:
Due in one year.......................... $ 1,897
Due in two years......................... 202,020
Due in three years....................... 2,144
Due in four years........................ 2,276
Due in five years........................ 2,411
Thereafter............................... 30,600
--------
$241,348
========
The Company paid interest of $7,316 for the year ended March 31,
2007. During the years ended March 31, 2006 and 2005, the Company
paid interest, net of capitalized interest, of $4,692 and $4,156,
respectively.
12. 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 ten years subsequent to the property being placed in
service. Industrial revenue bonds totaling $109,397 were
outstanding at March 31, 2007. 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.
13. 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,
2007, 2006 and 2005 was $4,132, $3,819 and $5,734, respectively.
Future minimum lease commitments under non-cancelable operating
leases are as follows:
2008................... $3,668
2009................... 938
2010................... 724
2011................... 697
2012................... 584
Thereafter............. 1,111
111
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 $35,800.
LITIGATION
The Company is named as a defendant in a patent infringement case
filed in the U.S. District Court for the District of New Jersey by
Janssen, L.P., Janssen Pharmaceutica N.V. and Ortho-McNeil
Neurologics, Inc. (collectively, "Janssen") on December 14, 2007
and styled Janssen, L.P. et al. v. KV Pharmaceutical Company.
After the Company filed an ANDA with the FDA seeking permission to
market a generic version of the 8 mg and 16 mg strengths of
Razadyne(R) ER (formerly Reminyl(R)) galantamine hydrobromide
extended-release capsules, Janssen filed these lawsuits for patent
infringement under a patent owned by Janssen. In the Company's
Paragraph IV certification, KV contended that its proposed generic
versions do not infringe Janssen's patent. 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 has filed an answer and counterclaim for
declaratory judgment of non-infringement and patent invalidity.
The case is just commencing and no trial date has yet been set.
The Company intends to vigorously defend its interests; however, it
cannot give any assurance that it will prevail.
The Company is named as a defendant in a patent infringement case filed
in the U.S. District Court for the District of New Jersey by Celgene
Corporation ("Celgene") and Novartis Pharmaceuticals Corporation and
Novartis Pharma AG (collectively, "Novartis") on October 4, 2007 and
styled Celgene Corporation et al. v. KV Pharmaceutical Company. After the
Company filed an ANDA with the FDA seeking permission to market a generic
version of the 10 mg, 20 mg, 30 mg, and 40 mg strengths of Ritalin LA(R)
methylphenidate hydrochloride extended-release capsules, Celgene and
Novartis filed this lawsuit for patent infringement under the provisions
of the Hatch-Waxman Act with respect to two patents owned by Celgene and
licensed to Novartis. In the Company's Paragraph IV certification, KV
contended that its proposed generic versions do not infringe Celgene'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 has been served with this complaint and has
filed its answer and a counterclaim in the case, seeking a declaratory
judgment of non-infringement, patent invalidity, and inequitable conduct
in obtaining the patents. The case is just commencing and no trial date
has yet been set. The Company intends to vigorously defend its interests;
however, it cannot give any assurance that it will prevail.
The Company is named as a defendant in a patent infringement case brought
by Purdue Pharma L.P., The P.F. Laboratories, Inc., and Purdue
Pharmaceuticals L.P. ("Purdue") on January 17, 2007 against it and an
unrelated third party and styled Purdue Pharma L.P. et al. v. KV
Pharmaceutical Company et al. filed in the U.S. District Court for the
District of Delaware. After the Company filed an ANDA with the FDA
seeking permission to market a generic version of the 10 mg, 20 mg, 40
mg, and 80 mg strengths of OxyContin(R) in extended-release tablet form,
Purdue filed a lawsuit against KV for patent infringement under the
provisions of the Hatch-Waxman Act with respect to three Purdue patents.
In the Company's Paragraph IV certification, KV contended that its
proposed generic versions do not infringe Purdue's patents. On February
12, 2007, a second patent infringement
112
lawsuit was filed in the same court against the Company by
Purdue, asserting patent infringement under the same
three patents with respect to the Company's filing of an amendment
to its ANDA with FDA to sell a generic equivalent of Purdue's
OxyContin(R), 30 mg and 60 mg strengths, products. On June 6,
2007, a third patent infringement lawsuit was filed against the
Company by Purdue in the U.S. District Court for the Southern
District of New York, asserting patent infringement under the same
three patents with respect to the Company's filing of an amendment
to its ANDA with FDA to sell a generic equivalent of Purdue's
OxyContin(R), 15 mg strength, product. The two lawsuits filed in
federal court in Delaware have been transferred to the federal
court in New York for multi-district litigation purposes together
with an additional lawsuit by Purdue against another unrelated
company, also in federal court in New York. Purdue currently has a
similar lawsuit pending against an additional unrelated company in
federal court in Delaware.
The Company filed answers and counterclaims against Purdue in all
three lawsuits, asserting various defenses to Purdue's claims;
seeking declaratory relief of the invalidity, unenforceability and
non-infringement of the Purdue patents; and asserting counterclaims
against Purdue for violations of federal antitrust law, including
Sherman Act Section 1 and Section 2 for monopolization, attempt to
monopolize, and conspiracy to monopolize with respect to the U.S.
market for controlled-release oxycodone, and agreements in
unreasonable restraint of competition, and for intentional
interference with valid business expectancy. Purdue has filed
replies to the Company's counterclaims.
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 court initially stayed all
proceedings pending determining whether Purdue committed
inequitable conduct in its dealings with the U.S. Patent and
Trademark Office with respect to the issuance of its patents, which
would render such patents unenforceable, and the court's subsequent
decision on the issue. On January 7, 2008, the court issued its
decision finding that Purdue had not committed inequitable conduct
with respect to the patents in suit. Discovery in the suit has not
yet commenced but is expected to commence shortly. No trial date
has yet been set. The Company intends to vigorously defend its
interests; however, it cannot give any assurance that it will
prevail.
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 U.S. District
Court for the District of Minnesota. CIMA 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 U.S. Patent and Trademark Office's reexamination of
a patent at issue in the suit. The Patent and Trademark Office
has, to date, issued a final office action rejecting all existing
and proposed new claims by CIMA with respect to this patent. CIMA
has certain rights of appeal of this rejection of its claims and
has exercised those rights. ETHEX will continue to market the
product during the stay. The Company intends to vigorously defend
its interests if and when the stay is lifted; however, it cannot
give any assurance it will prevail.
The Company and ETHEX were named as defendants in a case brought by
Solvay Pharmaceuticals, Inc. and styled Solvay Pharmaceuticals,
Inc. v. ETHEX Corporation, filed in U.S. District Court in
Minnesota. In general, Solvay alleged 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. The court has previously entered an order granting in
part, and denying in part, the Company's motion for partial summary
judgment on certain of plaintiff's allegations of violations of the
Lanham Act, and an order denying a second motion by the Company for
partial summary judgment on plaintiff's remaining allegations under
the Lanham Act and state law. Settlement discussions required by
federal court processes were not fruitful. Trial took place in
federal court in Minneapolis and on March 6, 2007, the jury held
for the Company and ETHEX on all counts and the complaint has been
dismissed. The time for appeal by Solvay has now passed.
The Company and ETHEX are named as defendants in a case brought by
Axcan ScandiPharm Inc. and styled
113
Axcan ScandiPharm Inc. v. ETHEX Corporation et. al., filed in
U.S. District Court in Minnesota on June 1, 2007. In general, Axcan
alleges that ETHEX's comparative promotion of its Pangestyme(TM)
UL12 and Pangestyme(TM) UL18 products to Axcan's Ultrase(R) MT12
and Ultrase(R) MT18 products resulted in false advertising and
misleading statements under various federal and state laws, and
constituted unfair and deceptive trade practices. The Company filed
a motion for judgment on the pleadings in its favor on several
grounds. The motion has been granted in part and denied in part by
the court on October 19, 2007, with the court applying the statute
of limitations to cut off Axcan's claims concerning conduct prior
to June 2001, determining that it was too early to determine
whether laches or res judicata barred the suit, and rejecting the
remaining bases for dismissal. Discovery has since commenced and a
trial date has been set for January 2010. The Company intends to
vigorously defend its interests; however, it cannot give any
assurance that it will prevail.
The Company has 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
phenylpropanolamine, or 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 again in 2004, 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. 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 in the event of such future litigation; 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 U.S. District Court in Missouri alleging, among other
things, that AstraZeneca's patent is invalid and unenforceable. These
motions were granted and AstraZeneca appealed. On July 23, 2007, the
Court of Appeals for the Federal Circuit affirmed the decision of the
District Court below with respect to the invalidity of AstraZeneca's
patent but reversed and remanded with respect to inequitable conduct by
AstraZeneca. AstraZeneca filed for rehearing by the Federal Circuit,
which was denied and the time has now run with respect to any petition
for certiorari to the U.S. Supreme Court. As a result, the Company no
longer faces the prospect of any liability to AstraZeneca in connection
with this lawsuit. KV is, however, proceeding with its counterclaim
against AstraZeneca for inequitable conduct in obtaining the patents that
have been ruled invalid, in order to recover the Company's defense costs,
including legal fees; 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
114
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 States of
Massachusetts, Alabama, Mississippi, Utah and Iowa, New York City,
and approximately 45 counties in New York State. The State of
Mississippi effectively voluntarily dismissed the Company and ETHEX
without prejudice on October 5, 2006 by virtue of the State's
filing an Amended Complaint on such date that does not name either
the Company or ETHEX as a defendant. In the remaining cases, only
ETHEX is a named defendant. On August 13, 2007, ETHEX settled the
Massachusetts lawsuit for $575 in cash and $150 in free
pharmaceuticals over the next two years and received a general
release; no admission of liability was made. The New York City case
and all New York county cases (other than the Erie, Oswego and
Schenectady County cases) have been transferred to the U.S.
District Court for the District of Massachusetts for coordinated or
consolidated pretrial proceedings under the Average Wholesale Price
Multidistrict Litigation (MDL No. 1456). The cases pertaining to
the State of Alabama, Erie County, Oswego County, and Schenectady
County were removed to federal court by a co-defendant in October
2006, but all of these cases have since been remanded to the state
courts in which they originally were filed. A motion is pending in
New York state courts to coordinate the Oswego, Erie and
Schenectady Counties cases. Each of these actions is in the early
stages, with fact discovery commencing or ongoing in the Alabama
case and the federal cases involving New York City and 42 New York
counties. On October 24, 2007, ETHEX was served with a complaint
filed in Utah state court by the State of Utah naming it and nine
other pharmaceutical companies as defendants in a pricing suit. On
November 19, 2007, the State of Utah filed an amended complaint.
The Utah suit has been removed to federal court and a motion has
been filed to transfer the case to the MDL litigation for pretrial
coordination. The State is seeking to remand the case to state
court, and the decision is pending before the court. The time for
ETHEX to answer or respond to the Utah complaint has not yet run.
On October 9, 2007, the State of Iowa filed a complaint in federal
court in Iowa naming ETHEX and 77 other pharmaceutical companies as
defendants in a pricing suit. ETHEX and the other defendants have
filed a motion to dismiss the Iowa complaint. 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.
The Company and ETHEX were 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 alleged 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
were 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 had not yet begun, and the court had set the
trial to commence in July 2007. The plaintiff and the Company
agreed, however, to a tolling agreement, under which the plaintiff
dismissed the case without prejudice in return for the Company's
agreement to toll the statute of limitations in the event the
plaintiff refiled its case in the future. The case was dismissed
without prejudice. On January 18, 2008, the Company and ETHEX were
served with a new complaint, substantially similar to the earlier
law suit. KV and ETHEX have filed an answer to the new complaint.
The Company intends to vigorously defend its interests; however, it
cannot give any assurance that it will prevail.
On September 15, 2006, a shareholder derivative suit, captioned
Fuhrman v. Hermelin et. al., was filed in state court in St. Louis,
Missouri against the Company, as nominal defendant, and seven
present or former officers and
115
directors, alleging that defendants had breached their fiduciary
duties and engaged in unjust enrichment in connection with the
granting, dating, expensing and accounting treatment of past grants
of stock options between 1995 and 2002 to six current or former
directors or officers. Relief sought included damages, disgorgement
of backdated stock options and their proceeds, attorneys' fees, and
equitable relief. On February 26, 2007, the Fuhrman lawsuit was
dismissed without prejudice by the plaintiff in state court, and a
lawsuit, captioned Krasick v. Hermelin et. al., was filed in the
U.S. District Court for the Eastern District of Missouri by the
same law firms as in the Fuhrman lawsuit, with a different
plaintiff. The Krasick lawsuit was also a shareholder derivative
suit filed against the Company, as nominal defendant, and 19
present or former officers and directors. The complaint asserted
within its fiduciary duties claims allegations that the officers
and/or directors of KV improperly (including through collusion and
aiding and abetting) backdated stock option grants in violation of
shareholder-approved plans, improperly recorded and accounted for
the allegedly backdated options in violation of GAAP, improperly
took tax deductions under the Internal Revenue Code, disseminated
and filed false financials and false SEC filings in violation of
federal securities laws and rules thereunder, and engaged in
insider trading and misappropriation of information. Relief sought
included damages, a demand for accounting and recovery of the
benefits allegedly improperly received, rescission of the allegedly
backdated stock options and disgorgement of their proceeds, and
reasonable attorneys' fees, in addition to equitable relief,
including an injunction to require the Company to change certain of
its corporate governance and internal control procedures. On May
11, 2007, the Company learned of the filing of another lawsuit,
captioned Gradwell v. Hermelin et. al., also in the U.S. District
Court for the Eastern District of Missouri. The complaint was
brought by the same law firms that brought the Krasick litigation
and was substantively the same as in the Krasick litigation, other
than being brought on behalf of a different plaintiff and
eliminating one individual defendant from the suit. On July 18,
2007, the Krasick and Gradwell suits were refiled as a consolidated
action in U.S. District Court for the Eastern District of Missouri,
styled In re K-V Pharmaceutical Company Derivative Litigation,
which was substantively the same as the Krasick and Gradwell suits.
The Company has moved to terminate the litigation based on a
determination by members of a Special Committee of the Board of
Directors, as described more fully in Note 3, that continuation of
the litigation was not in the best interest of KV and its
shareholders. All individual officer and director defendants have
joined in that motion. Plantiffs filed a motion for rule to show
cause why the defendants' motion to terminate the lawsuit should
not be stricken and dismissed. The Company has filed an opposition
and the matter is pending before the court. On February 15, 2008,
the court stayed proceedings in the case until April 9, 2008, to
permit mediation pursuant to the parties' stipulation. Mediation is
scheduled to occur April 2, 2008. No formal discovery has yet
commenced, and no trial date has been set.
In the course of the Special Committee's investigation, by letter
dated December 18, 2006, the Company was notified by the SEC staff
that it had commenced an investigation with respect to the
Company's stock option plans, grants, exercises, and accounting
treatment. The Company has cooperated with the SEC staff in its
investigation and, among other things, has provided them with
copies of the Special Committee's report and all documents
collected by the Special Committee in the course of its review.
Recently, the SEC staff, pursuant to a formal order of
investigation, has issued subpoenas for testimony by certain
employees and for documents, most of which have already been
produced to the SEC staff. The Company expects that the production
of any additional documents called for by the subpoena and the
testimony of the employees will be completed by April 2008.
Resolution of any of the matters discussed above could have a
material adverse effect on the Company's results of operations or
financial condition.
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 the ultimate outcome of such
other proceedings will not have a material adverse effect on its
results of operations or financial condition.
116
There are uncertainties and risks associated with all litigation
and there can be no assurance the Company will prevail in any
particular litigation.
14. 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 ten years or the life
of the CEO. In accordance with this agreement, the Company
recognized retirement expense of $877, $965 and $1,355 for the
years ended March 31, 2007, 2006 and 2005, respectively.
15. GAIN FROM LEGAL SETTLEMENT
--------------------------
In January 2007, the Company received a $3,600 payment from an
insurance company in accordance with a settlement agreement entered
into with the insurance company for insurance coverage associated
with the Healthpoint litigation. The payment was reflected by the
Company in the "Litigation" line item of operating income and was
recorded net of approximately $1,192 of attorney-related fees.
16. INCOME TAXES
------------
The income tax provisions for the years ended March 31, 2007, 2006
and 2005, are based on estimated federal and state taxable income
using the applicable statutory rates. The current and deferred
federal and state income tax provisions, excluding income taxes
related to the cumulative effect of a change in accounting, for the
years ended March 31, 2007, 2006 and 2005 are as follows:
2007 2006 2005
---- ---- ----
PROVISION (as restated) (as restated)
Current:
Federal........... $23,434 $17,035 $ 4,607
State............. 1,918 1,552 368
------- ------- -------
25,352 18,587 4,975
------- ------- -------
Deferred:
Federal........... 7,042 5,521 12,036
State............. 564 325 1,072
------- ------- -------
7,606 5,846 13,108
------- ------- -------
$32,958 $24,433 $18,083
======= ======= =======
117
The reasons for the differences between the provision for income
taxes and the expected federal income taxes at the U.S. statutory
rate are as follows:
2007 2006 2005
---- ---- ----
(as restated) (as restated)
Expected income tax expense......... $31,175 $12,547 $17,255
Purchased in-process research.......
and development................... -- 10,654 --
State income taxes, net of
federal income tax benefit........ 1,613 1,218 922
Business credits.................... (945) (831) (1,080)
Other............................... 1,115 845 986
------- ------- -------
Provision for income tax expense.... $32,958 $24,433 $18,083
======= ======= =======
Other includes additional tax liabilities associated with tax
positions claimed on filed tax returns (unrecognized tax benefits).
As of March 31, 2007 and 2006, the tax effect of temporary
differences between the tax basis of assets and liabilities and
their financial reporting amounts are as follows:
2007 2006
--------------------------- ---------------------
CURRENT NON-CURRENT CURRENT NON-CURRENT
------- ----------- ------- -----------
(as restated)
Fixed asset basis differences................ $ -- $(14,121) $ -- $ (8,701)
Reserves for inventory and
receivables............................... 10,307 -- 7,422 --
Vacation pay reserve......................... 336 -- 378 --
Deferred compensation........................ -- 2,320 -- 1,973
Amortization................................. -- (3,440) -- (2,884)
Convertible notes interest................... -- (22,766) -- (15,699)
Stock-based compensation..................... 1,525 -- 1,320 --
Payroll taxes................................ 2,196 -- 909 --
Other........................................ -- -- 43 90
------- -------- ------- --------
Net deferred tax asset (liability)........ $14,364 $(38,007) $10,072 $(25,221)
======= ======== ======= ========
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or
all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation
of future taxable income during the periods in which those
temporary differences become deductible. Management considers the
timing of deferred tax liability reversals and projected future
taxable income. Based upon the level of historical taxable income
and projections for future taxable income over the periods in which
the temporary differences are deductible, management believes it
more likely than not the Company will realize the benefits of these
deductible differences.
An income tax benefit has resulted from the determination that
certain NSOs for which stock-based compensation expense was
recorded will create an income tax deduction. This tax benefit has
resulted in an increase to the Company's deferred tax assets for
stock options prior to the occurrence of a taxable event or the
forfeiture of the related options. Upon the occurrence of a
taxable event or forfeiture of the underlying options, the
corresponding deferred tax asset is reversed and the excess or
deficiency in the deferred tax asset is recorded to paid-in capital
in the period in which the taxable event or forfeiture occurs.
118
The Company paid income taxes of $22,164, $15,482, and $8,769
during the years ended March 31, 2007, 2006 and 2005, respectively.
The Company currently is being audited by the IRS for its March 31,
2006 tax year. The IRS is also currently auditing the employment
tax returns of the Company for calendar years 2004, 2005, and 2006.
Various information requests with respect to the periods under
audit have been received and responded to. We expect the IRS to
issue additional information requests.
Management regularly reevaluates the Company's tax positions taken
on filed tax returns using information about recent court decisions
and legislative activities. Many factors are considered in making
these evaluations, including past history, recent interpretations
of tax law, and the specific facts and circumstances of each
matter. Because tax law and regulations are subject to
interpretation and tax litigation is inherently uncertain, these
evaluations can involve a series of complex judgments about future
events and can rely heavily on estimates and assumptions. The
recorded tax liabilities are based on estimates and assumptions
that have been deemed reasonable by management. However, if our
estimates are not representative of actual outcomes, recorded tax
liabilities could be materially impacted.
As previously discussed, the Company determined that certain
options previously classified as ISO grants were determined to have
been granted with an exercise price below the fair market value of
the Company's stock on the revised measurement dates. Under
Internal Revenue Code Section 422, ISOs may not be granted with an
exercise price less than the fair market value on the date of
grant, and therefore these grants would not likely qualify for ISO
tax treatment. The disqualification of ISO classification exposes
the Company and the affected employees to payroll related
withholding taxes once the underlying shares are released from the
post exercise two-year forfeiture period and the substantial risk
of forfeiture has lapsed, which creates a taxable event. The
Company and the affected employees may also be subject to interest
and penalties for failing to properly withhold taxes and report the
taxable event on their respective tax returns. The Company is
currently reviewing the potential disqualification of ISO grants
and the related withholding tax implications with the IRS in an
effort to reach agreement on the resulting tax liability. The
Company recorded liabilities related to this matter of $6,750 as of
March 31, 2007.
17. STOCK-BASED COMPENSATION
------------------------
In August 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 shares of common stock. Under the
Company's stock option plan, 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 ten years and the
options vest at the rate of 10% per year from the date of grant.
The Company estimates the fair value of stock options granted using
the Black-Scholes option pricing model (the "Option Model"). The
Option Model requires the use of subjective and complex
assumptions, including the option's expected term and the estimated
future price volatility of the underlying stock, which determine
the fair value of the share-based awards. The Company's estimate of
expected term was determined based on the average period of time
that options granted are expected to be outstanding considering
current vesting schedules and the historical exercise patterns of
existing option plans and the two-year forfeiture period. The
expected volatility assumption used in the Option Model is based on
historical volatility over a period commensurate with the expected
term of the related options. The risk-free interest rate used in
the Option Model is based on the yield of U.S. Treasuries with a
maturity closest to the expected term of the Company's stock
options.
119
The Company's stock option agreements include a post-exercise
service condition which provides that exercised options are to be
held by the Company for a two-year period during which time the
shares can not be sold by the employee. If the employee terminates
employment voluntarily or involuntarily (other than by retirement,
death or disability) during the two-year period the stock option
agreements provide the Company with the option of repurchasing the
shares at the lower of the exercise price or the fair market value
of the stock on the date of termination. This repurchase option is
considered a forfeiture provision and the two-year period is
included in determining the requisite service period over which
stock-based compensation expense is recognized. The requisite
service period initially is equal to the expected term (as
discussed above) and is revised when an option exercise occurs.
If stock options expire unexercised or an employee terminates
employment after options become exercisable, no compensation
expense associated with the exercisable, but unexercised options,
is reversed. In those instances where an employee terminates
employment before options become exercisable or the Company
repurchases the shares during the two-year forfeiture period,
compensation expense for these options is reversed as a forfeiture.
When an employee exercises stock options, the exercise proceeds
received by the Company are recorded as a deposit and classified as
a current liability for the two-year forfeiture period. These
options are accounted for as issued shares when the two-year
forfeiture period lapses. Until the two-year forfeiture
requirement is met, the underlying shares are not considered
outstanding and not included in calculating basic earnings per
share.
In accordance with the provisions of SFAS 123R, share-based
compensation expense recognized during a period is based on the
value of the portion of share-based awards that are expected to
vest with employees. Accordingly, the recognition of share-based
compensation expense beginning April 1, 2006 has been reduced for
estimated future forfeitures. SFAS 123R requires forfeitures to be
estimated at the time of grant with adjustments recorded in
subsequent period compensation expense if actual forfeitures differ
from those estimates. Prior to adoption, the Company accounted
for forfeitures as they occurred for the disclosure of pro forma
information presented in the Notes to Consolidated Financial
Statements for prior periods. Upon adoption of SFAS 123R on April
1, 2006, the Company recognized the cumulative effect of a change
in accounting principle to reflect the effect of estimated
forfeitures related to outstanding awards that are not expected to
vest as of the adoption date. The cumulative adjustment increased
net income by $1,976, net of tax, and increased diluted earnings
per share for Class A and Class B shares by $0.03 and $0.03,
respectively.
The Company recognized, in accordance with SFAS 123R, stock-based
compensation expense of $3,984 and a related tax benefit of $1,134
for the year ended March 31, 2007. As a result of the restatement
discussed in Note 3, stock-based compensation expense of $927 and
$1,080 and related tax benefits of $286 and $323 were recognized in
the years ended March 31, 2006 and 2005, respectively. There was
no stock-based employee compensation cost capitalized as of March
31, 2007. Cash received as deposits for option exercises was
$4,264, $1,187, and $4,118 and the actual tax benefit realized for
the tax deductions from option exercises (at expiration of two-year
forfeiture period) was $934, $1,709, and $403 for 2007, 2006 and
2005, respectively.
The following weighted average assumptions were used for stock
options granted during the years ended March 31, 2007, 2006 and
2005:
YEARS ENDED MARCH 31,
---------------------------------------------------
2007 2006 2005
---- ---- ----
(as restated) (as restated)
Dividend yield.................... None None None
Expected volatility............... 45% 48% 50%
Risk-free interest rate........... 4.93% 4.91% 4.88%
Expected term..................... 8.9 years 8.8 years 8.7 years
Weighted average fair value per
share at grant date............. $ 12.98 $ 12.74 $ 14.27
120
A summary of the changes in the Company's stock option plan for the
years ended March 31, 2007, 2006 and 2005 consisted of the
following:
WEIGHTED
WEIGHTED AVERAGE
AVERAGE REMAINING AGGREGATE
EXERCISE CONTRACTUAL INTRINSIC
SHARES PRICE TERM VALUE
------ ----- ---- ------
Balance, March 31, 2004 (as restated)........ 3,355 $10.44
Options granted.............................. 737 21.61
Options exercised............................ (88) 4.24 $ 1,443
Options canceled............................. (150) 14.24
------
Balance, March 31, 2005 (as restated)........ 3,853 12.53
Options granted.............................. 955 18.99
Options exercised............................ (481) 5.80 8,519
Options canceled............................. (401) 14.59
------
Balance, March 31, 2006 (as restated)........ 3,926 14.71
Options granted.............................. 555 21.64
Options exercised............................ (360) 8.80 5,631
Options canceled............................. (455) 16.62
------
Balance, March 31, 2007...................... 3,666 $16.11 5.2 $30,909
======
Expected to vest at
March 31, 2007......................... 2,841 $16.11 5.2 $23,954
Options exercisable at March 31, 2007
(excluding shares in the two-year
forfeiture period)...................... 1,310 $15.61 4.0 $12,022
As of March 31, 2007, the Company had $35,258 of total unrecognized
compensation expense, related to stock option grants, which will be
recognized over the remaining weighted average period of 4.8 years.
18. EMPLOYEE BENEFITS
-----------------
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 $500, $400 and $300
for the years ended March 31, 2007, 2006 and 2005, 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 $2,227, $1,877 and $1,547 were made to the 401(k)
investment funds for the years ended March 31, 2007, 2006 and 2005,
respectively.
121
PENSION PLANS
Contributions are made to a multi-employer defined benefit plan
administered by Teamsters Negotiated Pension Plan for certain union
employees. In the event of a withdrawal from the multi-employer
pension plan, the Company would incur an obligation to the plan for
the portion of the unfunded benefit obligation applicable to its
employees covered by the plan. (See Note 24, Subsequent Events, for
further discussion of the Company's obligation under the plan).
Amounts charged to pension expense and contributed to these plans
were $197, $180 and $200 for the years ended March 31, 2007, 2006
and 2005, 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. In fiscal 2005, the Company established a
Voluntary Employees' Beneficiary Association ("VEBA") 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 $935 and $850 at March 31, 2007 and 2006, 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 $12,029, $9,662 and $9,431
for the years ended March 31, 2007, 2006 and 2005, respectively.
19. RELATED PARTY TRANSACTIONS
--------------------------
The Company currently leases certain real property from an
affiliated partnership of the Chairman and CEO of the Company.
Lease payments made for this property for the years ended March 31,
2007, 2006 and 2005 totaled $296, $284, and $277, respectively.
20. EQUITY TRANSACTIONS
-------------------
As of March 31, 2007 and 2006, 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 accrued cumulative preferred dividends
at March 31, 2007 and 2006. 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
11), 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.
122
21. EARNINGS PER SHARE
------------------
The following table sets forth the computation of basic and diluted
earnings per share:
2007 2006 2005
--------------------- ------------------- -------------------
CLASS A CLASS B CLASS A CLASS B CLASS A CLASS B
------- ------- ------- -------- ------- -------
(AS RESTATED) (AS RESTATED)
Basic earnings per share:
Numerator:
Allocation of undistributed earnings
before cumulative effect of change
in accounting principle $ 43,768 $ 12,276 $ 8,725 $ 2,621 $ 22,795 $ 8,352
Allocation of cumulative effect of
change in accounting principle 1,543 433 - - - -
-------- -------- -------- ------- -------- -------
Allocation of undistributed earnings $ 45,311 $ 12,709 $ 8,725 $ 2,621 $ 22,795 $ 8,352
======== ======== ======== ======= ======== =======
Denominator:
Weighted average shares outstanding 37,180 12,455 36,277 13,065 34,228 15,005
Less - weighted average unvested
common shares subject to repurchase (367) (65) (435) (147) (494) (172)
-------- -------- -------- ------- -------- -------
Number of shares used in per
share computations 36,813 12,390 35,842 12,918 33,734 14,833
======== ======== ======== ======= ======== =======
Basic earnings per share before cumulative
effect of change in accounting principle $ 1.19 $ 0.99 $ 0.24 $ 0.20 $ 0.68 $ 0.56
Per share effect of cumulative effect of
change in accounting principle 0.04 0.04 - - - -
-------- -------- -------- ------- -------- -------
Basic earnings per share $ 1.23 $ 1.03 $ 0.24 $ 0.20 $ 0.68 $ 0.56
======== ======== ======== ======= ======== =======
Diluted earnings per share:
Numerator:
Allocation of undistributed earnings
for basic computation before
cumulative effect of change in
accounting principle $ 43,768 $ 12,276 $ 8,725 $ 2,621 $ 22,795 $ 8,352
Reallocation of undistributed earnings
as a result of conversion of Class B
to Class A shares 12,276 - 2,621 - 8,352 -
Reallocation of undistributed earnings to
Class B shares - (1,297) - (12) - (492)
Add - preferred stock dividends 70 - 70 - 70 -
Add - interest expense convertible notes 3,883 - - - 3,903 -
-------- -------- -------- ------- -------- -------
Allocation of undistributed earnings
for diluted computation before cumulative
effect of change in accounting principle 59,997 10,979 11,416 2,609 35,120 7,860
Allocation of cumulative effect of
change in accounting principle 1,976 362 - - - -
-------- -------- -------- ------- -------- -------
Allocation of undistributed earnings $ 61,973 $ 11,341 $ 11,416 $ 2,609 $ 35,120 $ 7,860
======== ======== ======== ======= ======== =======
(CONTINUED)
123
2007 2006 2005
--------------------- ------------------- -------------------
CLASS A CLASS B CLASS A CLASS B CLASS A CLASS B
------- ------- ------- ------- ------- -------
(AS RESTATED) (AS RESTATED)
Diluted earnings per share (continued):
Denominator:
Number of shares used in basic computation 36,813 12,390 35,842 12,918 33,734 14,833
Weighted average effect of dilutive securities:
Conversion of Class B to Class A shares 12,390 - 12,918 - 14,833 -
Employee stock options 720 99 899 195 1,036 239
Convertible preferred stock 338 - 338 - 338 -
Convertible notes 8,692 - - - 8,692 -
-------- -------- -------- ------- -------- -------
Number of shares used in per share
computations 58,953 12,489 49,997 13,113 58,633 15,072
======== ======== ======== ======= ======== =======
Diluted earnings per share before cumulative
effect of change in accounting principle $ 1.02 $ 0.88 $ 0.23 $ 0.20 $ 0.60 $ 0.52
Per share effect of cumulative effect of
change in accounting principle 0.03 0.03 - - - -
-------- -------- -------- ------- -------- -------
Diluted earnings per share (1) (2) $ 1.05 $ 0.91 $ 0.23 $ 0.20 $ 0.60 $ 0.52
======== ======== ======== ======= ======== =======
- ---------
<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, 2007, 2006
and 2005, excluded from the computation were options to
purchase 216, 291 and 616 of Class A and Class B common
shares, respectively.
(2) For the year ended March 31, 2006, the $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.
124
22. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
---------------------------------------
The following table sets forth selected unaudited consolidated
quarterly financial information for the years ended March 31, 2007
and 2006. The Company amended its Quarterly Report on Form 10-Q for
the quarter ended June 30, 2006, and filed Quarterly Reports on Form
10-Q for the quarters ended September 30, 2006 and December 31, 2006,
that include the restatement of the consolidated statements of
operations for the quarters ended June 30, 2006, December 31, 2005,
September 30, 2005 and June 30, 2005. Information for the quarter
ended March 31, 2006 has been restated from previously reported
information filed in the Company's 2006 Form 10-K, as a result of the
restatement of its consolidated financial statements discussed in
Note 3 "Restatement of Consolidated Financial Statements."
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER YEAR
-------------------------------------------------------------------------
YEAR ENDED MARCH 31, 2007
-------------------------
Net revenues.......................................... $ 96,200 $ 108,983 $ 117,949 $ 120,495 $ 443,627
Gross profit.......................................... 62,738 70,104 79,510 84,012 296,364
Income before income taxes and cumulative
effect of change in accounting principle......... 13,335 19,655 28,048 28,034 89,072
Income before cumulative effect of change
in accounting principle.......................... 8,122 12,085 18,462 17,445 56,114
Cumulative effect of change in accounting
principle........................................ 1,976 - - - 1,976
Net income............................................ 10,098 12,085 18,462 17,445 58,090
Earnings per share before effect of change
in accounting principle:
Basic - Class A common......................... $0.17 $0.26 $0.39 $0.37 $1.19
Basic - Class B common......................... 0.14 0.21 0.33 0.31 0.99
Diluted - Class A common....................... 0.15 0.22 0.33 0.31 1.02
Diluted - Class B common....................... 0.13 0.19 0.29 0.27 0.88
Per share effect of cumulative effect of
change in accounting principle:
Basic - Class A common......................... 0.04 - - - 0.04
Basic - Class B common......................... 0.04 - - - 0.04
Diluted - Class A common....................... 0.04 - - - 0.03
Diluted - Class B common....................... 0.03 - - - 0.03
Earnings per share:
Basic - Class A common......................... 0.21 0.26 0.39 0.37 1.23
Basic - Class B common......................... 0.18 0.21 0.33 0.31 1.03
Diluted - Class A common....................... 0.19 0.22 0.33 0.31 1.05
Diluted - Class B common....................... 0.16 0.19 0.29 0.27 0.91
1ST 2ND 3RD 4TH FULL
QUARTER QUARTER QUARTER QUARTER YEAR
----------------------------------------------------------------------------
YEAR ENDED MARCH 31, 2006 (AS RESTATED) (AS RESTATED)
- ---------------------------
Net revenues $ 85,043 $ 92,322 $101,752 $ 88,523 $367,640
Gross profit 59,008 59,682 66,763 58,252 243,705
Income (loss) before income taxes (18,322) 13,814 22,190 18,167 35,849
Net income (loss) (22,888) 8,590 14,706 11,008 11,416
Earnings (loss) per share:
Basic - Class A common (0.47) 0.18 0.31 0.23 0.24
Basic - Class B common (0.47) 0.15 0.26 0.20 0.20
Diluted - Class A common (0.47) 0.16 0.27 0.20 0.23
Diluted - Class B common (0.47) 0.14 0.23 0.18 0.20
125
The following table presents the effect of the financial statement
restatement adjustments on the Company's previously reported
consolidated statement of income for the three months ended March 31,
2006.
THREE MONTHS ENDED MARCH 31, 2006
-------------------------------------------------------------------
AS
PREVIOUSLY AS
REPORTED ADJUSTMENTS RESTATED
-------- ----------- --------
Net revenues $ 87,430 $ 1,093 (d) $ 88,523
Cost of sales 29,907 364 (d) 30,271
---------------- ----------------- -------------
Gross profit 57,523 729 58,252
---------------- ----------------- -------------
Operating expenses:
Research and development 8,017 - 8,017
Selling and administrative 30,648 897 (a)(b)(e) 31,545
Amortization of intangibles 1,195 - 1,195
---------------- ----------------- -------------
Total operating expenses 39,860 897 40,757
---------------- ----------------- -------------
Operating income 17,663 (168) 17,495
---------------- ----------------- -------------
Other expense (income):
Interest expense 1,663 - 1,663
Interest and other income (2,335) - (2,335)
---------------- ----------------- -------------
Total other expense (income) (672) - (672)
---------------- ----------------- -------------
Income before income taxes 18,335 (168) 18,167
Provision for income taxes 6,533 626 (a)(b)(c)(d)(e) 7,159
---------------- ----------------- -------------
Net income $ 11,802 $ (794) $ 11,008
================ ================= =============
Earnings per share:
Basic - Class A common $ 0.25 $ (0.02) $ 0.23
Basic - Class B common 0.21 (0.01) 0.20
Diluted - Class A common 0.21 (0.01) 0.20
Diluted - Class B common (f) 0.18
Shares used in per share calculation:
Basic - Class A common 36,647 (339) (g) 36,308
Basic - Class B common 12,774 (105) (g) 12,669
Diluted - Class A common 59,693 (778) (g) 58,915
Diluted - Class B common (f) 12,865
<FN>
(a) Adjustment for stock-based compensation expense pursuant to APB 25 ($240)
and the related income tax impact ($75).
(b) Adjustment for payroll taxes, interest and penalties associated with
stock-based compensation expense pursuant to APB 25 ($836) and the
related income tax impact ($231).
(c) Adjustment for additional liabilities associated with tax positions
claimed on filed tax returns, partially offset by certain expected tax
refunds ($571).
(d) Adjustment for revenue recognition errors related to shipments made to
certain customers.
(e) Adjustment for reduction in estimated liability associated with employee
medical claims incurred but not reported ($179) and the related income
tax impact ($66).
(f) In fiscal 2007, the Company began reporting diluted earnings per share
for Class B Common Stock under the two-class method which does not assume
the conversion of Class B Common Stock into Class A Common Stock.
Previously, the Company did not present diluted earnings per share for
Class B Common Stock.
(g) Adjustment to reflect impact of unrecognized stock-based compensation and
excess tax benefits in applying the treasury stock method and unvested
stock options in the two-year forfeiture period.
126
23. SEGMENT REPORTING
-----------------
The reportable operating segments of the Company are branded
products, specialty generic/non-branded and specialty materials. The
branded products segment includes patent-protected products and
certain trademarked off-patent products that the Company sells and
markets as brand pharmaceutical products. The specialty generics
segment includes off-patent pharmaceutical products that are
therapeutically equivalent to proprietary products. The Company sells
its branded and generic/non-branded 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 2007, 2006 and 2005.
FISCAL YEAR
ENDED BRANDED SPECIALTY SPECIALTY ALL
MARCH 31, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED
--------- -------- -------- --------- ----- ------------ ------------
- ------------------------------------------------------------------------------------------------------------------------------
NET REVENUES
2007 $188,681 $235,594 $17,436 $1,916 $ - $443,627
2006 (AS RESTATED)(1) 145,503 203,787 16,988 1,362 - 367,640
2005 (AS RESTATED)(1) 90,628 194,022 18,345 1,661 - 304,656
- ------------------------------------------------------------------------------------------------------------------------------
SEGMENT PROFIT (LOSS)
2007 87,346 125,596 2,799 (126,669) - 89,072
2006 (AS RESTATED)(1) 58,704 100,731 1,082 (124,668) - 35,849
2005 (AS RESTATED)(1) 24,510 104,893 3,043 (83,146) - 49,300
- ------------------------------------------------------------------------------------------------------------------------------
IDENTIFIABLE ASSETS
2007 32,995 84,581 8,410 582,955 (1,158) 707,783
2006 (AS RESTATED)(1) 23,582 62,953 7,353 526,583 (1,158) 619,313
2005 (AS RESTATED)(1) 24,650 66,806 8,001 460,653 (1,158) 558,952
- ------------------------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT ADDITIONS
2007 96 - 108 24,862 - 25,066
2006 540 1,097 269 56,428 - 58,334
2005 2,463 - 318 60,841 - 63,622
- ------------------------------------------------------------------------------------------------------------------------------
DEPRECIATION AND AMORTIZATION
2007 709 338 163 21,178 - 22,388
2006 587 317 173 16,925 - 18,002
2005 217 235 140 13,312 - 13,904
- ------------------------------------------------------------------------------------------------------------------------------
<FN>
(1) See Note 3 "Restatement of Consolidated Financial Statements."
127
Consolidated revenues are principally derived from customers in North
America and substantially all property and equipment is located in
the St. Louis, Missouri Metropolitan area.
24. SUBSEQUENT EVENTS
-----------------
In May 2007, the Company acquired the U.S. marketing rights to
Evamist(TM), a new estrogen replacement therapy product delivered
with a patented metered-dose transdermal spray system, from VIVUS,
Inc. Under terms of the Asset Purchase Agreement, the Company paid
$10,000 in cash at closing and agreed to make an additional cash
payment of $140,000 upon final approval of the product by the U.S.
Food and Drug Administration ("FDA"). Because the product had not
obtained FDA approval when the initial payment was made at closing,
the Company recorded $10,000 of in-process research and development
expense during the three months ended June 30, 2007. The agreement
also provides for two future payments upon achievement of certain net
sales milestones. If Evamist(TM) achieves $100,000 of net sales in a
fiscal year, a one-time payment of $10,000 will be made, and if net
sales levels reach $200,000 in a fiscal year, a one-time payment of
$20,000 will be made. In July 2007, FDA approval for Evamist(TM) was
received and a payment of $140,000 was subsequently made to VIVUS,
Inc. The Company is in the process of determining the appropriate
allocation of the $140,000 payment.
In May 2007, the Company received FDA approval to market the 100 mg
and 200 mg strengths of metoprolol succinate extended-release
tablets, the generic version of Toprol-XL(R) (marketed by
AstraZeneca). In fiscal 2006, the Company had received a favorable
court ruling in a Paragraph IV patent infringement action filed
against the Company by AstraZeneca based on the Company's ANDA
submissions to market these generic formulations. Since KV was the
first company to file with the FDA for generic approval of the 100 mg
and 200 mg dosage strengths, the Company was accorded the opportunity
for a 180-day exclusivity period for marketing these two dosage
strengths.
In January 2008, the Company entered into a definitive asset purchase
agreement with CYTYC Prenatal Products and Hologic, Inc. ("CYTYC") to
acquire the U.S. and worldwide rights to Gestiva(TM) (17-alpha
hydroxyprogesterone caproate). The NDA for Gestiva(TM) is currently
before the FDA, pending approval for use in the prevention of preterm
birth in certain categories of pregnant women. The proposed
indication is for women with a history of at least one spontaneous
preterm delivery (i.e., less than 37 weeks), who are pregnant with a
single fetus. Under the terms of the asset purchase agreement, the
Company agreed to pay a total of $82,000 for Gestiva(TM), $7,500 of
which is payable at closing. The remainder is payable on the
completion of two milestones: (1) $2,000 on the earlier to occur of
CYTYC's receipt of acknowledgement from the FDA that their response
to the FDA's October 20, 2006 "approvable" letter is sufficient for
the FDA to proceed with their review of the NDA or the receipt of
FDA's approval of the Gestiva(TM) NDA and (2) $72,500 on FDA approval
of a Gestiva(TM) NDA, transfer of all rights in the NDA to the
Company and receipt by the Company of defined launch quantities of
finished Gestiva(TM) suitable for commercial sale. Because the
product is not expected to have received FDA approval by the closing
of the transaction, the Company expects to record $7,500 when the
initial payment is made and $2,000 when the subsequent milestone
payment is made of in-process research and development expenses.
128
On January 9, 2008 the Company has received a subpoena from the
Office of Inspector General of HHS, seeking documents with respect to
two of ETHEX's nitroglycerin products. The subpoena states that it is
in connection with an investigation into potential false claims under
Title 42 of the U.S. Code. The Company is in the process of gathering
the relevant documents in response to the subpoena.
On January 23, 2008, the 133 employees represented by the Teamsters
Union voted to decertify union representation effective February 7,
2008. As a result of the decertification, the Company incurred a
withdrawal liability for the portion of the unfunded benefit
obligation associated with the multi-employer pension plan
administered by the union applicable to its employees covered by the
plan. The withdrawal liability of $923 will be recorded as an expense
in fiscal year 2008.
As of February 24, 2008, the Company held auction rate debt
securities in the aggregate principal amount of $83,900. The
auction rate securities are AAA rated, long-term debt obligations
secured by student loans, which are guaranteed by the U.S.
Government. Liquidity for these securities has been provided by an
auction process that resets the applicable interest rate at
pre-determined intervals, up to 35 days. In the past, the auction
process has allowed investors to obtain immediate liquidity by
selling the securities at their face amounts. The value of these
securities was not impaired as of March 31, 2007. Disruptions in
credit markets, subsequent to March 31, 2007, however, have adversely
affected the auction market for these types of securities. During the
period from February 11, 2008 to March 6, 2008 auctions for all of
the auction rate securities held by the Company failed to produce
sufficient bidders to allow for successful auctions. The Company
cannot predict how long the current imbalance in the auction market
will continue. As a result, for a period of time, the Company may or
may not be able to liquidate any of its auction rate securities prior
to their maturities at prices approximating their face amounts. The
Company is currently evaluating the market for these securities to
determine if impairment of the carrying value of the securities has
occurred due to the loss of liquidity. If such impairment has
occurred and is not temporary, the Company would recognize an
impairment loss in the statement of income for fiscal year 2008.
129
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 (Item 9A(a)),
that K-V Pharmaceutical Company (the Company) did not maintain effective
internal control over financial reporting as of March 31, 2007, because of the
effect of material weaknesses identified in management's assessment, based on
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.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be
prevented or detected. The following material weaknesses have been identified
and included in management's assessment:
* Stock-Based Compensation--The design of the Company's policies and
procedures did not adequately address the financial reporting risks
associated with stock options. Specifically, these deficiencies in the
design of the Company's controls resulted in a more than remote
130
likelihood of a material misstatement in the Company's financial
statements in each of the following areas:
* Determining measurement dates,
* Determining forfeiture provisions,
* Determining the tax treatment of stock option awards.
Additionally, the Company's policies and procedures to ensure that the
necessary information was captured and communicated to those responsible
for stock option accounting were inadequate, and the Company's finance
and accounting personnel involved in the stock option granting and
administration process were inadequately trained. These deficiencies each
result in a more than remote likelihood of a material misstatement in the
Company's financial statements.
* Income Taxes--The design of the Company's policies and procedures did not
adequately address the financial reporting risks associated with
uncertain tax positions. Additionally, the Company's policies and
procedures to ensure that the necessary information was captured and
communicated to those responsible for accounting for uncertain tax
positions were inadequate. These deficiencies each result in a more than
remote likelihood of a material misstatement in the Company's financial
statements.
* Revenue Recognition--The design of the Company's policies and procedures
did not adequately address the financial reporting risks associated with
customer shipping terms. This deficiency results in a more than remote
likelihood of a material misstatement in the Company's financial
statements.
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, 2007 and 2006, and
the related consolidated statements of income, comprehensive income,
shareholders' equity, and cash flows for each of the years in the three-year
period ended March 31, 2007. These material weaknesses were considered in
determining the nature, timing, and extent of audit tests applied in our audit
of the March 31, 2007 consolidated financial statements, and this report does
not affect our report dated March 25, 2008, which expressed an unqualified
opinion on those consolidated financial statements.
In our opinion, management's assessment that the Company did not maintain
effective internal control over financial reporting as of March 31, 2007, is
fairly stated, in all material respects, based on criteria established in
Internal Control--Integrated Framework issued by COSO. Also, in our opinion,
because of the effect of the material weaknesses described above on the
achievement of the objectives of the control criteria, the Company has not
maintained effective internal control over financial reporting as of March 31,
2007, based on criteria established in Internal Control--Integrated Framework
issued by COSO.
/s/ KPMG LLP
St. Louis, Missouri
March 25, 2008
131
ITEM 9A. CONTROLS AND PROCEDURES
-----------------------
(a) MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining
adequate internal control over financial reporting, as defined in
Exchange Act Rule 13a-15(f) under the Securities Exchange Act of
1934, as amended (the "Exchange Act"). Our management, including our
Chief Executive Officer and Chief Accounting Officer, conducted an
evaluation of the effectiveness of our internal control over
financial reporting as of March 31, 2007. In making this assessment,
our management used the criteria established in Internal Control --
Integrated Framework, issued by the Committee of Sponsoring
Organizations of the Treadway Commission ("COSO").
Internal Control Over Financial Reporting is a process designed by,
or under the supervision of, the company's principal executive and
principal financial officers, or persons performing similar
functions, and effected by the company's board of directors,
management, and other personnel, 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 and 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 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.
The Public Company Accounting Oversight Board's Auditing Standard No.
2 defines a material weakness as a significant deficiency, or a
combination of significant deficiencies, that results in there being
a more than remote likelihood that a material misstatement of the
financial statements will not be prevented or detected. A significant
deficiency is a control deficiency, or combination of control
deficiencies, that adversely affects the Company's ability to
initiate, authorize, record, process or report external financial
data reliably in accordance with U.S. Generally Accepted Accounting
Principles ("GAAP") such that there is more than a remote likelihood
that a misstatement of the Company's annual or interim financial
statements that is more than inconsequential will not be prevented or
detected.
Based on our evaluation of internal control over financial reporting
as of March 31, 2007, management has determined that the following
material weaknesses existed in our internal control over financial
reporting.
Stock-Based Compensation
The design of the Company's policies and procedures did not
adequately address the financial reporting risks associated with
stock options. Specifically, these deficiencies in the design of the
Company's controls resulted in a more than remote likelihood of a
material misstatement in the Company's
132
financial statements in each of the following areas:
o Determining measurement dates,
o Determining forfeiture provisions,
o Determining the tax treatment of stock option awards.
Additionally, the Company's policies and procedures to ensure that
the necessary information was captured and communicated to those
responsible for stock option accounting were inadequate, and the
Company's finance and accounting personnel involved in the stock
option granting and administration process were inadequately trained.
These deficiencies each result in a more than remote likelihood of a
material misstatement in the Company's financial statements.
Income Taxes
The design of the Company's policies and procedures did not
adequately address the financial reporting risks associated with
uncertain tax positions. Additionally, the Company's policies and
procedures to ensure that the necessary information was captured and
communicated to those responsible for accounting for uncertain tax
positions were inadequate. These deficiencies each result in a more
than remote likelihood of a material misstatement in the Company's
financial statements.
Revenue Recognition
The design of the Company's policies and procedures did not
adequately address the financial reporting risks associated with
customer shipping terms. This deficiency results in a more than
remote likelihood of a material misstatement in the Company's
financial statements.
The aforementioned material weaknesses resulted in material errors in
the accounting for stock-based compensation, income taxes, and
revenue recognition, and in the restatement of our historical
consolidated financial statements. As a result of the material
weaknesses described above, management has concluded that the Company
did not maintain effective internal control over financial reporting
as of March 31, 2007 based on the criteria established in COSO's
Internal Control - Integrated Framework.
KPMG LLP, our independent registered public accounting firm, who
audited the consolidated financial statements of the Company included
in this annual report has issued an unqualified opinion on
management's assessment of our internal control over financial
reporting, and expressed an adverse opinion on the effectiveness of
our internal control over financial reporting as of March 31, 2007.
This report appears on pages 130-131 of this annual report.
(b) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
No changes in our internal control over financial reporting occurred
during the quarter ended March 31, 2007 that have materially
affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
(c) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Accounting Officer,
we conducted an evaluation of the effectiveness of our disclosure
controls and procedures, as such terms are defined in Rules 13a-15(e)
and 15d-15(e) promulgated under the Exchange Act, as of March 31,
2007, the end of the period covered by this Annual Report on Form
10-K.
Disclosure controls and procedures are controls and procedures
designed to ensure that information required to be disclosed in the
Company's reports filed under the Exchange Act, such as this Report,
is recorded, processed,
133
summarized and reported within the time periods specified in the
SEC's rules and forms. Disclosure controls are also designed to
ensure that such information is accumulated and communicated to the
Company's management, including the Chief Executive Officer and Chief
Financial Officer, as appropriate to allow timely decisions regarding
required disclosure.
As a result of the material weaknesses in our internal control over
financial reporting described above, our management, including our
Chief Executive Officer and our Chief Financial Officer concluded
that our disclosure controls and procedures were not effective as of
March 31, 2007. Notwithstanding the material weaknesses described
above, our management, based upon the substantial work performed
during the restatement process have concluded that our consolidated
financial statements for the periods covered by and included in this
Annual Report on Form 10-K are fairly stated in all material respects
in accordance with U.S. generally accepted accounting principles for
each of the periods presented herein.
(d) REMEDIATION ACTIVITIES
Subsequent to March 31, 2007, we have taken several steps to
remediate the material weaknesses related to accounting for
stock-based compensation, income taxes and revenue recognition
described in (a) above. We have implemented or are in the process of
implementing internal control improvements as follows:
Stock-Based Compensation
* Expanding the General Counsel's role to include oversight of the
process of documenting stock option grants.
* Engaging an outside professional services firm to advise us on
improving the design of the internal controls over our stock
option processes and controls over the preparation and review of
stock-based compensation information in the Company's financial
reports.
* Establishing an Employee Compensation Reporting Committee
comprised of senior tax, legal, human resource, and
accounting/finance personnel, to review stock option grants and
the reasonableness of the key assumptions used in the valuation
of stock options and any variances (e.g. modifications or
deviations) from the Company's standard stock option awards
granted to employees.
* Establishing a procedure whereby senior financial management
will review employment agreements, employment offers, and other
agreements with employees to ensure proper accounting based upon
the terms and conditions of such agreements.
* Enhancing training and education to ensure that all relevant
personnel involved in the administration of and accounting for
stock option grants, including tax personnel, understand the
terms of the Company's stock option plans and the relevant
accounting guidance under U.S. generally accepted accounting
principles.
* Utilizing the Company's internal audit function to conduct
testing of controls relating to stock option activity and the
accuracy of the model used in valuing the Company's stock
options.
Income Taxes
* Enhancing training and education to ensure that personnel
reviewing tax provision calculations and disclosures understand
the relevant accounting guidance under U.S. generally accepted
accounting principles.
* Engaging a third party professional services firm, as necessary,
to review significant and/or unusual tax matters and obtain
guidance on the appropriate tax and accounting treatment.
* Enhancing communication of relevant business issues through
regular meetings between the tax department, operating division
executives and other management personnel.
* Implementing procedures to improve documentation and review of
tax liabilities.
Revenue Recognition
* Implementing a procedure to verify actual customer receipt dates
of shipments made during the last several days of a period end
for the FOB destination customers.
* Implementing a policy requiring that shipping terms for all
customers are properly documented and reviewed by
finance/accounting personnel.
134
ITEM 9B. OTHER INFORMATION
-----------------
On March 23, 2008, Gerald R. Mitchell, the Company's Chief Financial
Officer, retired and the Company appointed Ronald J. Kanterman, age
53, to succeed Mr. Mitchell as the Company's Chief Financial Officer.
Mr. Kanterman will continue to serve as the Company's Treasurer and
Assistant Secretary.
In connection with his retirement, the Company entered into a
consulting agreement with Mr. Mitchell with an initial term of 24
months from its effective date, and which renews for successive
12-month periods unless terminated by the Company or Mr. Mitchell,
provided, however, that the agreement may be terminated at any time
by either party on 60 days' notice.
Pursuant to the consulting agreement, Mr. Mitchell will provide up to
80 hours per month of consulting services at an hourly rate of $115
per hour. The consulting agreement provides for a guaranteed minimum
of 80 hours per month for the first year. Mr. Mitchell will also be
entitled to reimbursement of expenses incurred in providing services
to the Company under the consulting agreement. The consulting
agreement also provides that any stock options previously granted to
Mr. Mitchell will continue to be exercisable, and with respect to
unvested options vest and become exercisable, for so long as the
consulting agreement is in effect.
The consulting agreement also provides that the restrictive covenants
in Mr. Mitchell's employment agreement that prevent him from
competing against the Company or soliciting customers or employees of
the Company for a period of three years after the end of his
employment with the Company will remain in force and will be
unaffected by the consulting agreement.
Mr. Kanterman previously served as the Company's Vice President,
Strategic Financial Management, Treasurer and Assistant Secretary
since March 2006, and as Vice President, Treasury from January 2004
to March 2006. Mr. Kanterman's prior responsibilities included
significant roles in financial planning, investor relations and
project management. Prior to joining the Company, Mr. Kanterman
served as a partner at Brown Smith Wallace, LLP from 1993 to 2004.
Previously, Mr. Kanterman was a partner at Arthur Andersen & Co.,
from 1987 to 1993.
In connection with his appointment as Chief Financial Officer, the
Company and Mr. Kanterman entered into an amendment to his employment
agreement effective March 23, 2008. The employment agreement, as
amended, continues until March 31, 2013, and renews for successive
12-month periods unless terminated by the Company or Mr. Kanterman,
provided, however, that the agreement may be terminated at any time
after the initial term by Mr. Kanterman on 120 days' notice. The
employment agreement, as amended, provides for a base salary of
$330,000.
In addition, Mr. Kanterman is also entitled to receive an incentive
bonus based on his participation in an Incentive Plan, which gives
Mr. Kanterman the opportunity to earn up to a percentage of his base
salary, based upon certain performance criteria.
Mr. Kanterman is also eligible to receive stock-based awards under
the Company's Incentive Stock Option Plan and to participate in the
Company's profit Sharing and 401(k) Plans. In connection with his
appointment as Chief Financial Officer, Mr. Kanterman was awarded
options to acquire 25,000 shares of the Company's Class A Common
Stock.
Under the terms of his employment agreement, if he is terminated by
the Company without cause, Mr. Kanterman is entitled to severance
payments equal to 50% of his base compensation paid over a six-month
period and continuation of his Company provided medical, disability
and life insurance benefits for six months.
The employment agreement also contains restrictive covenants
preventing Mr. Kanterman from competing against the Company or
soliciting customers or employees of the Company for a period of 36
months after the end of his employment with the Company.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
--------------------------------------------------
The Company's Certificate of Incorporation, as amended, and Bylaws,
as amended, provide for a division of the Board of Directors into
three classes. One of the classes is elected each year to serve a
three-year term. The terms of the current Class C Directors expire at
the 2007 Annual Meeting. The Company's Bylaws, as amended, specify
that the number of directors shall be determined by the Board of
Directors from time to time. The Board of Directors currently has set
the number of directors at seven. There are currently seven directors
and no vacancies on the Board of Directors.
The following sets forth certain information about our current
Directors.
CLASS C DIRECTORS: TO SERVE AS DIRECTORS UNTIL OUR NEXT ANNUAL MEETING
Jean M. Bellin (age 57). Mr. Bellin has served as a Director since
2003. Mr. Bellin has been the President of Metagenics, Inc., a life
sciences company and distributor of science-based medical foods and
nutraceuticals since September 2006. He was previously the CEO of
Mountain View Pharmaceuticals, Inc., a biopharmaceutical company
focused on the development of long-acting therapeutic proteins. Prior
to that he was a Vice President at Osteohealth Company and Luitpold
Animal Health from 2003 to 2004 and from 1997 to 2001 he was the CEO
and a Director of New Medical Concepts.
Terry B. Hatfield (age 59). Mr. Hatfield has served as a Director
since 2004. He has been President of ZeaVision, a company focused on
zeaxanthin and its benefits to those suffering (or at risk of)
age-related vision loss since 2003. From 2001 to 2003 he was a
consultant for merger and acquisition transactions.
135
Norman D. Schellenger (age 75). Mr. Schellenger has served as a
Director since 1998. He has also been a Director of ProEthics
Pharmaceuticals, Inc. since 2004. He retired from UCB Pharma in 1996
where he served as Vice President Sales and Marketing from 1995 to
1996. Prior to that he was President of Whitby Pharmaceuticals from
1992 to 1994.
CLASS A DIRECTORS: TO CONTINUE TO SERVE AS DIRECTORS UNTIL 2008
Kevin S. Carlie (age 52). Mr. Carlie has served as a Director since
2001. He has been a member or partner since 1984 in the Certified
Public Accounting Firm of Stone Carlie & Company, LLC, and its
predecessors.
Marc S. Hermelin (age 66). Mr. Hermelin has been the Chairman of the
Board and Chief Executive Officer of the Company since August 2006.
From 1974 to August 2006 he was the Vice Chairman of the Board and
Chief Executive Officer of the Company. He is the father of David S.
Hermelin.
CLASS B DIRECTORS: TO CONTINUE TO SERVE AS DIRECTORS UNTIL 2009
David S. Hermelin (age 41). Mr. Hermelin has served as a Director
since 2004. He has been the Vice President of Corporate Strategy and
Operations Analysis of the Company since 2002. From 1995 to 2002 he
was Vice President of Corporate Planning and Administration for the
Company. He is the son of Marc S. Hermelin, the Chairman and Chief
Executive Officer of the Company.
Jonathon E. Killmer (age 66). Mr. Killmer has served as a Director
since 2006. He retired in 2004. From 2002 to 2004 he provided
consulting services to Hypercom Corporation, an electronic payment
products and services company. He was the Chief Operating Officer and
Chief Financial Officer of Hypercom from 1999 to 2002. He has been a
director of Blue Cross Blue Shield of Minnesota since 1999. He is
presently Chairman of the Board of Blue Plus, a Minnesota domiciled
HMO.
Gerald R. Mitchell (age 68). Mr. Mitchell has been Vice President and
Chief Financial Officer of the Company since 1981.
Gerald R. Mitchell was a Class B Director at March 31, 2007. Mr.
Mitchell has retired from the Company and resigned from the Board of
Directors effective March 23, 2008.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires the Company's executive officers, the Company's directors
and persons who own more than 10% of a registered class of the
Company's equity securities to file periodic reports of ownership and
changes in ownership with the Securities and Exchange Commission.
Such individuals are required by Securities and Exchange Commission
regulation to furnish the Company with copies of all such forms they
file. Based solely on a review of the copies of all such forms
furnished to the Company or written representations that no reports
were required to be filed, the Company believes that such persons
complied with all Section 16(a) filing requirements applicable to
them with respect to transactions during fiscal 2007 except that each
of Michael S. Anderson, David S. Hermelin, Marc S. Hermelin, Patricia
K. McCullough, and Jerald J. Wenker had a late filing for a Statement
of Change in Beneficial Ownership of Securities on Form 4.
136
AUDIT COMMITTEE
Structure and Responsibilities. The Company has a standing Audit
------------------------------
Committee of the Board of Directors consisting of Kevin S. Carlie,
CPA (Chairman), Jonathon E. Killmer and Terry B. Hatfield. The
Company's Board of Directors adopted the Audit Committee's written
charter. The Board of Directors has determined that each member of
the Audit Committee meets the standards of independence required by
the New York Stock Exchange, as well as the independence requirements
for audit committee members under Rule 10A-3 promulgated under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). In
addition, the Board of Directors has determined that each member is
financially literate and possesses sufficient accounting or related
financial management expertise within the meaning of the listing
standards of the New York Stock Exchange and that each of Mr. Carlie
and Mr. Killmer qualifies as an "audit committee financial expert"
under the definition set forth in Item 407(d)(5) of Regulation S-K.
The Audit Committee annually appoints the Company's independent
registered public accounting firm, reviews with the independent
registered public accounting firm a plan and scope of the audit and
audit fees, meets periodically with representatives of the
independent registered public accounting firm, the internal auditors,
the Board of Directors and management to monitor the adequacy of
reporting, internal controls and compliance with the Company's
policies, reviews its annual and interim consolidated financial
statements and performs the other functions or duties provided in the
Audit Committee Charter.
The Board of Directors has adopted a set of corporate governance
guidelines establishing general principles with respect to, among
other things, director qualifications and responsibility. These
Corporate Governance Guidelines establish certain criteria,
experience and skills requirements for potential candidates. There
are no established term limits for service as a director of the
Company. In general, it is expected that each director of the Company
will have the highest personal and professional ethics and integrity
and be devoted to representing the interests of the Company and its
stockholders. In addition, it is expected that the Board of Directors
as a whole will be made up of individuals with diverse experiences in
business, government, education and technology. The Company's
Corporate Governance Guidelines are available on its website at
http://www.kvph.com and can be obtained free of charge by written
request to the attention of the Assistant Secretary of the Company at
the address appearing on the first page of this Form 10-K or by
telephone at (314) 645-6600.
STANDARDS OF BUSINESS ETHICS POLICY
All directors and employees of the Company, including its Chief
Executive Officer, Chief Financial Officer, Chief Accounting Officer
and other principal finance and accounting officers, are required to
comply with the Company's Standards of Business Ethics Policy to
ensure that the Company's business is conducted in a legal and
ethical manner. The Company's Standards of Business Ethics Policy
covers all areas of professional conduct, including employment
policies and practices, conflicts of interest and the protection of
confidential information, as well as strict adherence to all laws and
regulations applicable to the conduct of our business. Employees and
directors are required to report any suspected violations of our
Standards of Business Ethics Policy. The Company, through the Audit
Committee, has procedures in place to receive, retain and treat
complaints received regarding accounting, internal accounting control
or auditing matters and to allow for the confidential and anonymous
submission by employees of concerns regarding questionable accounting
or auditing matters. The Company's Standards of Business Ethics
Policy can be reviewed on the Company's website, http://www.kvph.com,
or by contacting the Company at the address appearing on the first
page of this Form 10-K to the attention of the Assistant Secretary of
the Company, or by telephone at (314) 645-6600.
The Company has also established a Senior Executives Code of Ethics
as a supplement to the Standards of Business Ethics Policy. The
Senior Executives Code of Ethics applies to the Chief Executive
Officer, Chief Financial Officer, Chief Accounting Officer and any
other officer of the Company serving in a finance, accounting,
treasury, tax or investor relations role. The Senior Executives Code
of Ethics requires each of such officers to provide accurate and
timely information related to the Company's public disclosure
requirements. The
137
Company's Senior Executives Code of Ethics can be reviewed on the
Company's website, http://www.kvph.com, or by contacting the Company
at the address appearing on the first page of this Form 10-K to the
attention of the Assistant Secretary of the Company, or by telephone
at (314) 645-6600. The Company intends to post any amendment to, or
waiver of, the Senior Executives Code of Ethics on its website.
ITEM 11. EXECUTIVE COMPENSATION
----------------------
COMPENSATION OF DIRECTORS
-------------------------
The following table sets forth the annual compensation to
non-employee directors for the fiscal year ended March 31, 2007:
------------------------------------------------------------------------------------
FEES
EARNED OR OPTION
PAID IN STOCK AWARDS
CASH AWARDS ($) TOTAL
NAME ($) ($) (2) ($)
------------------------------------------------------------------------------------
Jean M. Bellin 23,750 - 15,187 38,937
------------------------------------------------------------------------------------
Kevin S. Carlie 41,650 - 40,279 81,929
------------------------------------------------------------------------------------
Terry B. Hatfield 33,650 - 13,733 47,383
------------------------------------------------------------------------------------
Jonathon E. Killmer 30,400 - 3,287 33,687
------------------------------------------------------------------------------------
Norman D. Schellenger 27,300 - 5,973 33,273
------------------------------------------------------------------------------------
David A. Van Vliet (1) 9,500 - 13,899 23,399
------------------------------------------------------------------------------------
<FN>
- -------------------------------
(1) David A. Van Vliet resigned as a Director in October 2006 to accept a
position as the Company's Chief Administration Officer.
(2) Option awards represent the compensation expense recognized for financial
statement reporting purposes for the fiscal year ended March 31, 2007 in
accordance with SFAS 123(R) for stock options granted in and prior to
fiscal 2007. Fair value is based on the Black-Scholes option pricing
model using the fair value of the underlying shares at the measurement
date. Stock option awards with a fair value of $25,302 (per share value
of $12.65) and $63,522 (per share value of $12.70) were granted to Mr.
Carlie and Mr. Killmer, respectively, during fiscal 2007. For additional
discussion on the valuation assumptions used in determining stock-based
compensation and the grant date fair value for stock options, see
Stock-Based Compensation in Note 17 to our Consolidated Financial
Statements. Effective as of March 31, 2007, the following Non-Officer
Directors had the following outstanding unexercised options (the amounts
in the table reflect the effect of repricing certain stock options as a
result of the Special Committee's investigation into the Company's stock
option grant practices):
138
---------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES
UNDERLYING OPTIONS (#)
---------------------------------------------------------------------------------------------------------
OPTION OPTION OPTION GRANT
CLASS A CLASS B EXERCISE EXPIRATION DATE FAIR
NAME COMMON STOCK COMMON STOCK PRICE ($) DATE VALUE ($)
---------------------------------------------------------------------------------------------------------
Jean M. Bellin 7,500 18.87 5/23/2008 85,225
2,500 18.42 9/10/2009 26,973
2,500 19.99 11/01/2010 30,067
---------------------------------------------------------------------------------------------------------
Kevin S. Carlie 450 19.37 4/01/2008 5,893
2,500 18.42 9/10/2009 26,973
7,500 19.70 11/01/2010 88,358
2,000 23.70 10/05/2011 25,302
---------------------------------------------------------------------------------------------------------
Terry B. Hatfield 5,000 25.25 6/29/2009 73,283
2,500 18.42 9/10/2009 26,973
2,500 19.26 11/01/2010 28,524
---------------------------------------------------------------------------------------------------------
Jonathon E. Killmer 5,000 23.80 10/05/2011 63,522
---------------------------------------------------------------------------------------------------------
Norman D. Schellenger 2,500 18.42 9/10/2009 25,903
2,500 19.99 11/01/2010 30,067
---------------------------------------------------------------------------------------------------------
Additional Information About Director Compensation
--------------------------------------------------
Director compensation is designed to attract individuals who have the required
background, experiences and functional expertise to provide strategic
direction and oversight to the Company. Only those directors who are not also
officers of the Company are compensated for their services as directors of the
Company ("Non-Officer Directors"). With respect to such Non-Officer Directors,
the Compensation Committee of the Board recommends the appropriate levels of
compensation to the Board, and the full Board of Directors approves the actual
compensation to be paid to the Non-Officer Directors.
The Company's director compensation program consists of a combination of cash
compensation and stock options in order to align the interest of the directors
with those of the Company's shareholders.
Basic Retainer - The cash compensation component for new Non-Officer Directors
consists of a base retainer of $15,000 per year ($20,000 for the Chairman of
the Audit Committee).
Meeting Fees - In addition, such directors also receive $1,000 per day for
in-person meetings of the Board of Directors or other Committees on which the
director serves. Fees for telephonic meetings are $500. Total annual
compensation received by the Non-Officer Directors, therefore, is determined
by the number of Committee and Board meetings attended each year.
Expense Reimbursement - The Company also pays for the ordinary and necessary
out-of-pocket expenses incurred by the Non-Officer Directors for attendance at
Board of Directors and Committee meetings.
Stock Options - As stated above, the stock option component of the director
compensation program is designed to align the interest of the directors with
those of the Company's shareholders. As such, upon appointment as a director,
each Non-Officer Director is currently granted options to acquire 7,500 shares
of Class B Common Stock. Subsequent grants for Non-Officer Directors who are
not members of the Compensation Committee are determined periodically by the
Board based on the recommendation of the Compensation Committee. Subsequent
grants for members of the Compensation Committee are determined periodically
by the Board. Such options are granted as non-qualified options under the
Company's Incentive Stock Option Plan and generally vest ratably over five
years. The shares acquired upon exercise are subject to a two-year forfeiture
period, during which time they cannot be sold.
139
COMPENSATION DISCUSSION AND ANALYSIS
------------------------------------
The Compensation Committee of the Company's Board of Directors is responsible
for establishing and periodically reviewing the Company's executive
compensation philosophy and guiding principles. No less frequently than
annually, the Compensation Committee evaluates its plans and policies against
current and emerging competitive practices, legal and regulatory developments
and corporate governance trends. The purpose of the review is to provide
assurance that in light of the changing corporate environment, the Company's
executive compensation program continues to help attract and retain the talent
necessary to foster strong sales growth, long-term financial performance and
shareholder returns.
Compensation and Benefits Philosophy
- ------------------------------------
The Company's executive compensation program is designed with the goal of
providing compensation that is fair, reasonable and competitive. The program
is intended to help the Company recruit and retain highly qualified and
experienced executives and to provide rewards that are linked to performance
while also aligning the interests of executives with those of the Company's
shareholders. The program is based on the following guiding principles:
Performance - The Company believes the best way to accomplish alignment of
compensation plans with the interest of its shareholders is to link executive
pay directly to the Company's performance.
Competitiveness - The Company's executive compensation and benefits program is
designed to be competitive with those provided at companies in the
pharmaceutical and drug delivery industries for similar talent. The benefits
component of the program is designed to provide competitive levels of
protection and financial security and is not based on individual performance.
Cost - The Company's total compensation and benefit program is designed to be
cost-effective and affordable, ensuring that the interests of the Company's
shareholders are considered in determining executive pay levels. The Company
seeks to adequately fund its executive compensation program while, at the same
time, ensuring that enough funding remains for its short-term and long-term
goals.
The Company believes that its philosophy of aligning management and
shareholder interests is an important element in creating an environment of
trust and teamwork that furthers the long-term interests of the organization.
Components of Total Compensation
- --------------------------------
The Company's total compensation program for executive officers has two main
components: direct compensation and benefit plans.
The key components of direct compensation for executive officers are:
Base salary - Base salary is designed to attract and retain highly experienced
executives who can manage the Company to achieve its short-term and long-term
strategic goals. Executive salaries are based on an individual's overall
experience, Company tenure, level and scope of responsibility and the general
and industry-specific business competitive environment.
Cash earned incentives - This component of direct compensation is designed to
place a significant portion of an executive's annual compensation at risk -
that is, linked to both the Company's and the individual's annual performance.
Cash earned incentives are based on individual performance, performance of the
Company and performance of the department or division under the responsibility
of the executive, measured in terms of the attainment of both defined and
general objectives.
140
Stock option grants - This component of direct compensation is designed to
strengthen the link between compensation and increased returns for
shareholders and, thereby, align management's interest in the Company's
long-term success with the interests of the Company's shareholders. Awards
granted to executive officers are discretionary under the Company's Incentive
Stock Option Plan. The size of individual awards is dependent upon the
executive's position, tenure and number of vested and previously exercised
options.
The above-described criteria are applied to each executive officer
subjectively, based upon the Compensation Committee's evaluation of each
executive officer's performance and value to the Company.
Benefit plans for executive officers include:
Insurance plans - The Company provides standard company-sponsored insurance
plans to its employees, including the executive officers. The core insurance
package includes health, dental, disability and basic group life insurance
coverage. In general, executives participate in these benefits on the same
basis as other Company employees.
401(k) Plan - Through the Company's 401(k) Plan the named executive officers
are provided an opportunity to save for retirement on a tax-favored basis.
Participation in the 401(k) Plan is generally available to all Company
employees the beginning of each pay period (except for union employees covered
by a collective bargaining agreement). The Company matches employee
contributions to the 401(k) Plan at 50% of the first 7% of the employee's
contributions.
Perquisites - Executives are generally provided a car allowance or company
car. The Chief Executive Officer is entitled to receive certain perquisites
under the terms of his employment agreement, which are more fully described in
the footnotes to the Summary Compensation Table under the heading "Other
Compensation."
Determining Benefit Levels. The Compensation Committee periodically reviews
the benefits offered to the executives to ensure that the benefits program
provided is competitive and cost-effective for the Company, and support its
need for a qualified and experienced executive team. The benefits component of
the executive compensation program is not tied to the Company's or individual
performance.
Establishing Overall Compensation Levels. The Company makes this decision
based on the competitive market value for the area of responsibility as well
as the education and experience of the executive.
Direct compensation levels (base salary, cash earned incentive and stock
option grant awards) are established based on performance. The performance
factor consists of how well the individual executive and her or his area of
responsibility performed against goals and objectives which were established
before the fiscal year commenced as well as how the executive promoted an
environment of results, teamwork and talent development in their areas of
responsibility.
Determining Incentive Compensation Allocation - Annual and Long-Term
Incentives. The amount allocated to annual versus long-term compensation is
determined based on the amount of available funding for the Company's overall
compensation programs, including executive compensation. The overall funding
levels are ultimately subject to the judgment and approval of the Compensation
Committee to ensure an appropriate alignment with the interests of the
Company's shareholders and the Company's ability to meet its long-term
strategic goals. In determining individual executive officer pay levels, the
Compensation Committee considers the total compensation to be delivered to
individual executives and, as such, may exercise discretion in determining the
portion allocated to annual versus long-term incentives. The Company believes
this "total compensation" approach - permitting flexibility to shift the mix
of annual and long-term compensation - provides the ability to align pay
decisions with the short- and long-term needs of the business. It also allows
for the flexibility needed to recognize differences in performance by
providing differentiated pay.
Each named executive officer is evaluated on an annual basis and, to the
extent the Compensation Committee determines to grant options to such named
executive officer, options are typically granted at the end of the review
period. The Company has not adopted any policy with respect to coordinating
option grant dates with the release of material
141
non-public information. Rather, the grant date with respect to any options
granted to a named executive officer generally is the date the Compensation
Committee determines to grant such options. In general, stock options are
granted on a company-wide basis on the last trading day of each fiscal
quarter. As such, there may be times when the Compensation Committee grants
options when the Board or Compensation Committee is in possession of material
non-public information. The Compensation Committee typically does not take
such information into account when determining whether and in what amount to
make option grants.
Determining Individual Compensation Levels
Named Executive Officers Other than the Chief Executive Officer. Compensation
levels for named executive officers are determined based on the overall
performance of the Company and individual performance, as well as the
executive's experience and tenure at the Company.
Individual performance objectives target specific areas for improvement or set
specific goals against key performance indicators within an executive's area
of responsibility. The objectives are proposed by the executive and approved
by a committee that includes the Chief Executive Officer.
(1) Base Salary. The Company grants regular, annual base salary increases to
-----------
executives who are performing at or above expectations at the beginning of
each fiscal year. Among other factors, annual increases seek to achieve an
appropriate competitive level to account for increases in the cost of living
and similar factors and/or to address changes in the external competitive
market for a given position.
(2) Cash Earned Incentives and Stock Option Awards. Cash earned incentives for
----------------------------------------------
executive officers are generally determined based on the terms of their
individual Incentive Plans. These plans typically provide for a range of
pay-outs expressed as a percentage of annual salary that are tied to the
successful completion of the executive's individual and department performance
objectives. At the end of the fiscal year, each executive's performance
against his or her objectives is evaluated by a committee that includes the
Chief Executive Officer to determine the incentive pay-out level per the
Incentive Plan. These evaluations are submitted to the Compensation Committee
for approval along with the Incentive Plan for review after the end of the
fiscal year when incentive compensation decisions are made.
The Company has entered into Incentive Compensation Plans with certain
executive officers, for the fiscal year ended March 31, 2007, to reward
achievement of certain corporate objectives, as determined at fiscal year end.
The officer is entitled to receive a percentage of his/her base salary as
determined by the percentage of goals achieved. If the employee is actively
employed at fiscal year end, incentives are payable in one lump sum within 90
days. If the participant is promoted or transferred within the Company to a
position of greater or equal authority, all eligibilities under the plan
terminate unless otherwise stipulated.
The Company entered into Incentive Compensation Plans with Michael Anderson,
currently Vice President of Industry Presence and Development, Jerald Wenker,
formerly President of Ther-Rx Corporation and Patricia McCullough, Chief
Executive Officer of the ETHEX Corporation, rewarding each for achieving
specific objectives.
Under the terms of his Incentive Compensation Plan, Mr. Wenker was entitled to
receive up to 60% of his base salary for achieving corporate and management
objectives and meeting revenue goals. Mr. Wenker could earn up to 20% of his
base salary for achieving 100% of Ther-Rx operating income, net revenues and
corporate objectives. The fiscal 2007 operating income objectives for Mr.
Wenker included achieving gross sales targets for Ther-Rx, maintaining Ther-Rx
expenses at specific levels, and achieving net income targets for Ther-Rx. The
corporate objectives for Mr. Wenker related to achieving prescription volume
and sales targets for each Ther-Rx product for fiscal 2007. Mr. Wenker could
also earn up to 15% of his base salary for achieving net revenues targets for
all products, excluding acquisitions. In addition, Mr. Wenker could earn up to
15% of his base salary for identifying, acquiring and launching new products
that achieve certain revenue and margin targets. Finally, Mr. Wenker could
earn up to 10% of his base salary for meeting management objectives related to
the development and expansion of Ther-Rx. Mr. Wenker left the Company in
January
142
2007. Mr. Wenker was not awarded any compensation pursuant to his Incentive
Compensation Plan for fiscal 2007 because he was no longer with the Company.
Under the terms of her Incentive Compensation Plan, Ms. McCullough was
entitled to receive up to 55% of her base salary for achieving corporate and
management objectives and meeting certain revenue goals. Ms. McCullough could
earn up to 20% of her base salary for achieving 100% of ETHEX corporate
objectives, which for fiscal 2007, included financial objectives and
objectives related to corporate culture, corporate environment, performance
and productivity. Ms. McCullough could also earn up to 10% of her base salary
for identifying and launching new products that achieve certain revenue and
margin targets, and identifying and pursuing strategic opportunities to
acquire products and submit FDA approval applications for such products. In
addition, Ms. McCullough could earn up to 20% of her base salary for achieving
net revenue targets for all products and for existing products. Finally, Ms.
McCullough could earn up to 5% of her base salary for meeting objectives
related to expanding the use of innovative marketing concepts, managing
marketing expenses so that they do not exceed budgeted amounts, increasing
product profitability and reducing cost of goods sold. Based on her
achievement of objectives under her Incentive Compensation Plan, Ms.
McCullough was awarded compensation of $57,000 for the 2007 fiscal year.
Under the terms of his employment arrangement, Mr. Anderson was guaranteed,
and was paid, incentive compensation of $166,000 for the 2007 fiscal year.
In determining the amount of an executive's variable compensation - the cash
earned incentive and stock option awards - the Compensation Committee
generally considers the executive's performance and the desired mix between
the annual and long-term awards. The Compensation Committee exercises its
discretion to determine the overall total compensation to be awarded to each
executive, and the amount of that total that will be paid in the form of an
annual cash earned incentive and stock option awards. As a result, the amounts
paid in the form of annual cash earned incentive and in the form of stock
option awards are designed to work together in conjunction with base salary to
deliver a total compensation package to the executive believed to be
appropriate.
The Company believes that the design of its variable compensation program
supports its overall compensation objectives by: allowing for significant
differentiation of pay based on performance; providing the flexibility
necessary to ensure that pay packages for the executive officers are
competitive relative to the external market; and providing the Committee with
the ability to deliver compensation in a manner that is linked to results that
benefit the Company's shareholders, and appropriately reflects the
contributions of each executive to the short- and long-term success of the
Company.
Chief Executive Officer. The Chief Executive Officer's compensation is based
upon an evaluation of the compensation received by chief executive officers at
similarly situated companies, historical performance of the Chief Executive
Officer and the terms of his Employment Agreement. For a description of the
compensatory elements of the Employment Agreement please refer to the
information under "-Employment Arrangements with Named Executive Officers"
below.
143
COMPENSATION IN THE LAST FISCAL YEAR
------------------------------------
SUMMARY COMPENSATION TABLE
The following table sets forth certain information regarding the annual and
long-term compensation for services rendered to us in all capacities for the
fiscal year ended March 31, 2007 of those persons who were (1) our principal
executive officer, (2) our principal financial officer, (3) the three most
highly compensated executive officers other than the principal executive
officer and principal financial officer who were serving as executive officers
at fiscal year end, and (4) one individual, Jerald J. Wenker, who was not
serving as an executive officer at fiscal year end (each, a "named executive
officer" and collectively, the "named executive officers").
- -----------------------------------------------------------------------------------------------------------------------------------
Change in
Pension Value
and
Non-Equity Nonqualified
Incentive Deferred All
Name and Plan Compensation Other
Principal Fiscal Salary Bonus Option Compensation Earnings Compensation Total
Position Year ($) ($) Awards ($) (6) ($) (7) ($) (8) ($) (9) ($)
- -----------------------------------------------------------------------------------------------------------------------------------
Marc S. 2007 1,281,764 - - 2,545,857 877,000 602,652 5,307,273
Hermelin,
Chairman of the
Board and Chief
Executive
Officer
- -----------------------------------------------------------------------------------------------------------------------------------
Gerald R. 2007 208,526 50,000 16,213 - - 12,511 287,250
Mitchell, (3)
Vice President
and Chief
Financial
Officer
- -----------------------------------------------------------------------------------------------------------------------------------
Michael S. 2007 332,000 166,000 113,028 - - 13,582 624,610
Anderson Vice (4)
President,
Industry
Presence and
Development
- -----------------------------------------------------------------------------------------------------------------------------------
Patricia K. 2007 285,607 - 65,197 57,000 - 15,194 422,998
McCullough,
Chief Executive
Officer ETHEX
Corporation
- -----------------------------------------------------------------------------------------------------------------------------------
David A. Van 2007 176,641 72,916 74,914 - - 3,170 327,641
Vliet (5) (5)
Chief
Administration
Officer (1)
- -----------------------------------------------------------------------------------------------------------------------------------
Jerald J. 2007 302,990 - 130,812 - - 15,659 449,461
Wenker
Former
President,
Ther-Rx
Corporation (2)
- -----------------------------------------------------------------------------------------------------------------------------------
144
<FN>
(1) Mr. Van Vliet joined the Company in October 2006. His salary covers the
period October 1, 2006 through March 31, 2007.
(2) Mr. Wenker left the Company in January 2007. In connection with his
departure, all vested and non-vested stock options were forfeited.
(3) Mr. Mitchell received a discretionary bonus for his individual
performance as recommended at the end of the fiscal year by the Chairman
and CEO and subsequently approved by the Compensation Committee.
(4) Mr. Anderson was guaranteed a one-time bonus of $166,000 per the terms of
his Fiscal 2007 Incentive Compensation Plan.
(5) Mr. Van Vliet was guaranteed a bonus of $72,916 per the terms of his
employment offer. In addition, he received a stock option grant of
100,000 Class A shares under the terms of our 2001 Incentive Stock Option
Plan.
(6) Option awards represent the compensation expense recognized by us for
financial statement reporting purposes for the fiscal year ended March
31, 2007 in accordance with SFAS 123(R). Grant date fair value is based
on the Black-Scholes option pricing model on the date of grant. For
additional discussion on the valuation assumptions used in determining
the compensation expense, see "Stock-Based Compensation" in Note 17 to
our Consolidated Financial Statements.
(7) Non-equity incentive plan compensation represents payment for fiscal year
2007 under our annual cash incentive award programs. For additional
discussion on our annual cash incentive award programs, see "Cash Earned
Incentives and Stock Option Awards" above under the heading "Compensation
Discussion and Analysis".
(8) Per the terms of his Employment Agreement, Mr. Hermelin is entitled to
receive retirement compensation paid in the form of a single life annuity
equal to 30% of his final average compensation payable each year
beginning at retirement and continuing for the longer of ten years or
life. Based on this agreement, we recognized expense of $877,000 in
accordance with APB Opinion No. 12, Omnibus Opinion, as amended by SFAS
106, Employers' Accounting for Postretirement Benefits Other than
Pensions, ("APB 12") based on an annual actuarial valuation of the
liability assuming retirement at age 75.
(9) All other compensation includes the following:
Car 401(k) Split Dollar Group Term Other Total Other
Allowance Match Life Insurance Life Insurance Perquisites Compensation
Name ($) ($) ($) ($) ($) ($)
- ------- ------------ ------ ---------------- -------------- ------------ --------------
Marc S. Hermelin 2,072 7,765 508,794 495 83,526 602,652
Gerald R. Mitchell 4,147 7,602 - 762 - 12,511
Michael S. Anderson 4,297 8,968 - 317 - 13,582
Patricia K. McCullough 8,400 6,536 - 258 - 15,194
David A. Van Vliet - 3,096 - 74 - 3,170
Jerald J. Wenker 11,400 2,947 - 69 1,243 15,659
Other compensation for Mr. Hermelin includes $508,794 of premiums paid by us
under split dollar life insurance agreements with Mr. Hermelin dated July 1,
1990, November 8, 1991 and June 9, 1999. Under the terms of the agreements,
the policies are collaterally assigned to us to secure repayment of the
premiums paid by us, which are to be paid out of the cash surrender value of
the policies if the policies are terminated or canceled, or from the death
benefit proceeds if Mr. Hermelin should die while the agreements and policies
remain in force. The policies have a total death benefit of $19.5 million.
Cumulative premiums paid since the date of the agreements total $4,120,391. We
have recorded the cash surrender value of the policies as an asset, the value
of which was $3,736,494 as of March 31, 2007. During fiscal 2007, the cash
surrender value of the
145
policies increased by $446,742, which when compared to the premiums paid of
$508,794 resulted in a net cost to the Company of $62,052.
Other perquisites for Mr. Hermelin include the following:
Disability Insurance - Under the terms of his employment agreement, we are
required to provide disability insurance for Mr. Hermelin equal to 60% of his
base salary. The value of the disability protection is imputed to Mr. Hermelin
currently in order for the ultimate disability benefits to be tax free. The
amount of compensation relative to this perquisite for fiscal 2007 was
$13,934.
Tax Gross-up - Represents the taxes due on the imputed value of life and
disability insurance. The amount of tax gross-up was $59,592 for fiscal 2007.
Financial Services - Under the terms of his employment agreement, Mr. Hermelin
is entitled to an annual allowance of up to $10,000 to be used for tax
preparation, estate planning and similar financial services. The amount of
compensation relative to this perquisite for fiscal 2007 was $10,000.
GRANTS OF PLAN-BASED AWARDS
The following table provides information about equity and non-equity awards
granted to named executive officers for fiscal 2007:
All Other
Option
Estimated Possible Payouts Awards: Grant Date
Under Non-Equity Number of Exercise or Fair Value
Incentive Plan Awards(1) Securities Base Price of Stock
-------------------------------- Underlying of Option and Option
Threshold Target Maximum Options Awards Awards
Name Grant Date ($) ($) ($) (#) ($/Sh) ($)(2)
- ---- ---------- --------- --------- ----------- ------------ ----------- ------------
Marc S. Hermelin (3) N/A 0 2,545,857 0 0 0 0
Gerald R. Mitchell (4) N/A 0 0 0 0 0 0
Michael S. Anderson (5) N/A 0 0 0 0 0 0
Patricia K.
McCullough (6) N/A 0 57,000 157,000 0 0 0
David A. Van Vliet (7) N/A 0 0 0
10/5/2006 100,000 23.70 1,420,320
Jerald J. Wenker (8) N/A 0 0 0
6/30/2006 10,000 18.66 113,376
<FN>
(1) We provide performance-based annual cash incentive awards to our chief
executive officer under the terms of his employment agreement and for
certain of our executive officers under individual fiscal 2007 Incentive
Compensation Plans. These columns indicate the ranges of possible payouts
targeted for fiscal 2007 performance under the applicable annual cash
incentive award plan for each named executive officer. Actual cash
incentive awards for fiscal year 2007 performance are set forth in the
"Summary Compensation Table". For additional discussion on our annual
cash incentive award programs, see "Cash Earned Incentives and Stock
Option Awards" above under the heading "Compensation Discussion and
Analysis".
(2) The grant date fair value of stock option awards is based on the
Black-Scholes option pricing model using the fair value of the underlying
shares at the measurement date, in accordance with SFAS 123(R). For
additional discussion on the valuation assumptions used in determining
the grant date fair value and the accounting for stock options, see
Share-Based Compensation in Note 17 to our consolidated financial
statements included in the Company's Annual Report on Form 10-K for the
fiscal year ended March 31, 2007.
146
(3) The target amount is the result of applying the bonus formula in Mr.
Hermelin's Employment Agreement (See Employment Agreements with named
executive officers below for a description of the formula) to the
Company's net income for the 2007 fiscal year. There are no threshold,
target or maximum amounts established for Mr. Hermelin's non-equity
incentive compensation. The terms of his Employment Agreement determine
the amount earned.
(4) Mr. Mitchell did not receive non-equity incentive compensation but did
receive a discretionary bonus for fiscal 2007 as described in the Summary
Compensation Table.
(5) Mr. Anderson did not receive non-equity incentive compensation but was
entitled to a guaranteed bonus for fiscal year 2007 as described in the
Summary Compensation Table.
(6) The target amount represents the actual non-equity incentive plan pay-out
to Ms. McCullough for fiscal 2007 under the terms of her incentive plan.
Under the plan she has the ability to earn up to 55% of her base salary
in incentive pay, which is shown as the maximum pay-out. There are no
threshold or target amounts established for Ms. McCullough's non-equity
incentive compensation.
(7) Mr. Van Vliet did not receive non-equity incentive compensation but was
entitled to a guaranteed bonus for fiscal year 2007 as described in the
Summary Compensation Table. The stock option award granted to Mr. Van
Vliet on October 5, 2006 was authorized in connection with the terms of
his offer of employment as an executive officer of the Company. The
option grant has a ten-year term and becomes exercisable in ten equal
annual installments commencing October 5, 2006. Once exercised, the
shares are subject to a two-year forfeiture period during which they are
restricted from sale.
(8) The stock option award granted to Mr. Wenker was authorized in connection
with his performance during fiscal 2006. The award which was unvested was
forfeited upon his departure from the Company in January 2007.
EMPLOYMENT ARRANGEMENTS WITH NAMED EXECUTIVE OFFICERS
-----------------------------------------------------
Chief Executive Officer
The Company has an employment agreement with Marc S. Hermelin, Chairman and
Chief Executive Officer, that commenced in 1996 and was extended in November
2004 through March 2010, and automatically renews for successive 12-month
periods thereafter unless terminated by Mr. Hermelin or the Company. Pursuant
to the terms of his employment agreement, Mr. Hermelin's base compensation
increases annually by the greater of the consumer price index (CPI) or 8%. Mr.
Hermelin's base salary for fiscal 2007 was $1,281,764. In addition, Mr.
Hermelin is entitled to receive an incentive bonus based on the Company's net
income for each fiscal year. The annual bonus is to be calculated on and
payable with respect to each incremental level of net income as follows: for
net income of $200,000 and below, the bonus percentage is zero; for net income
between $200,000 and $600,000, the bonus percentage is 5%; for net income
between $600,000 and $3,000,000 the bonus percentage is 7%; for net income
between $3,000,000 and $5,000,000, the bonus percentage is 6%; for net income
between $5,000,000 and $10,000,000, the bonus percentage is 5%; and for net
income in excess of $10,000,000, the bonus percentage is 4%.
The bonus is payable in one or more of the following forms: stock options,
shares of restricted stock, discounted stock options or cash, as agreed upon
by the Company and Mr. Hermelin. Mr. Hermelin is also provided a Company
vehicle and an annual allowance up to $10,000 for personal financial planning
services. Mr. Hermelin is provided the opportunity to defer up to 50% of his
base salary and up to 100% of any bonus during his employment pursuant to the
terms of a Deferred Compensation Plan effective January 1,1997. As of March
31, 2007, Mr. Hermelin has not elected to defer any compensation.
Mr. Hermelin is also insured under life insurance policies for which the
premium is to be repaid to the Company out of policy proceeds, in accordance
with split dollar agreements between the Company and Mr. Hermelin dated July
1, 1990,
147
November 8, 1991 and June 9, 1999. Mr. Hermelin is entitled to participate in
the Company's group life and health insurance programs or other comparable
coverage at the Company's expense for the duration of his life.
Upon his retirement, Mr. Hermelin is entitled to receive compensation for
consulting services and consideration for complying with certain restrictive
covenants, paid in the form of a single life annuity equal to 15% of final
average base salary/bonus for each, and retirement benefits in the form of
single life annuity payments equal to 30% of final average base salary/bonus.
Such payments would be adjusted annually by the greater of CPI or 8% for the
longer of 10 years or life, and continue the longer of 10 years or life,
payable to his beneficiaries upon his death. Final average base salary/bonus
is the average of total salary/bonus paid for the three highest consecutive
years in the five-year period ending coincident with the retirement date.
Under the terms of his employment agreement, Mr. Hermelin is entitled to
benefits in the event of his termination other than voluntary termination,
retirement or termination as a result of death or disability, or if his
employment is terminated following a change in control of the Company. Please
see "Potential Payments Upon Termination or Change-in-Control" for a
description of these benefits.
Based on a recommendation from the Compensation Committee, in 2004 the Board
of Directors approved an amendment to the Chief Executive Officer's Employment
Agreement extending it to March 31, 2010. The recommendation to extend the
agreement was based on the Chief Executive Officer's performance.
In 2004, the Compensation Committee engaged Watson Wyatt, a compensation,
employee benefit and human resources consulting firm, to review the terms of
Mr. Hermelin's employment agreement to determine if his compensation package
and contract terms were fair and reasonable relative to industry standards and
comparable peer groups. Watson Wyatt concluded that the sum of the financial
components in the employment contract was competitive with the median total
direct compensation of comparable peer group companies. While Mr. Hermelin's
salary and bonus were high within the group, long-term incentives were low
resulting in total compensation below the peer group's median.
In reaching its conclusion, Watson Wyatt compared Mr. Hermelin's compensation
to a peer group of 13 companies in the pharmaceutical industry similar in size
to the Company. Mr. Hermelin's total direct compensation (base salary, bonus
and stock option grants) was between the 25th percentile and median of the
peer group. Mr. Hermelin's base salary and bonus were in the top quartile of
the peer group, whereas his long-term incentives were below the 25th
percentile of the peer group. Watson Wyatt noted that Mr. Hermelin had 31
years experience at the Company and 29 years as the Company's chief executive
officer, where the tenures of chief executives in the peer group ranged from
one to 21 years with an average of 9.7 years.
Watson Wyatt also concluded that the provisions of Mr. Hermelin's employment
contract were within the range of market practices. It pointed out that all
provisions were within the market range, such as annual salary increase, the
bonus formula, continued medical coverage and certain charitable
contributions. Although Watson Wyatt noted that terms providing for retirement
consulting arrangements and payments for non-compete covenants were not
typical in employment agreements, it pointed out that Mr. Hermelin's tenure
was significantly longer than the chief executive officers of the peer
companies.
The Compensation Committee also reviewed a Bank of America report on chief
executive officers' compensation in the specialty pharmaceutical industry. The
Bank of America report reviewed compensation practices of 21 specialty
pharmaceutical companies. Based on the report, Mr. Hermelin's then total
compensation package of $2.6 million was less than both the median and average
total compensation packages of $3.6 million and $4.5 million paid to chief
executive officers in the specialty pharmaceutical sector. The study also
provided, and the Compensation Committee considered, the mix of cash and
non-cash (such as stock options) in chief executive officers' compensation
packages, the dilutive effect of stock options granted to chief executive
officers, and stock option compensation paid to the peer group chief executive
officers.
148
Other Named Executive Officers
Consistent with the Company's executive compensation program, the other named
executive officers have employment agreements (extending from year to year)
establishing base levels of compensation, subject to normal compensation
reviews and an incentive bonus based on performance.
Chief Financial Officer
The Company has an employment agreement with Gerald R. Mitchell, Vice
President and Chief Financial Officer, which was restated and amended in 1994,
and which renews for successive 12-month periods unless terminated by the
Company or Mr. Mitchell. Mr. Mitchell initially received base compensation of
$130,400 in 1994, subject to the Company's normal compensation review. Mr.
Mitchell also receives a company vehicle. Mr. Mitchell may be entitled to
stock options as provided in a separate stock option agreement.
Under the terms of his employment agreement, Mr. Mitchell was entitled to
benefits if his employment was terminated following a change in control of the
Company. Please see "Potential Payments Upon Termination or Change-in-Control"
for a description of these benefits.
The employment agreement also contains restrictive covenants preventing Mr.
Mitchell from competing against the Company or soliciting customers or
employees of the Company for a period of 36 months after the end of his
employment with the Company.
Mr. Mitchell notified the Company of his intention to retire approximately
three years ago in order to allow the Company sufficient time to identify and
hire a successor. Effective March 23, 2008, Mr. Mitchell retired from the
Company and resigned from the Company's Board of Directors.
Chief Administration Officer
The Company has an employment agreement with David A. Van Vliet, Chief
Administration Officer, that commenced on September 29, 2006, continued until
March 31, 2007, and automatically renews for successive 12-month periods
unless terminated by the Company or Mr. Van Vliet. Mr. Van Vliet received a
base salary of $350,000 during fiscal 2007. In addition, Mr. Van Vliet is also
entitled to receive an incentive bonus based on his participation in an
Incentive Plan, which gives Mr. Van Vliet the opportunity to earn up to 50% of
his base salary, based upon certain performance criteria. Mr. Van Vliet had a
guaranteed incentive of $72,916 for his first five months of employment. Mr.
Van Vliet is also provided with a company vehicle.
Mr. Van Vliet is also eligible to receive stock-based awards under the
Company's Incentive Stock Option Plan. He has received a grant of stock
options with respect to 100,000 shares of KV Class A Common Stock. Mr. Van
Vliet is also eligible to participate in the Company's Profit Sharing and
401(k) Plans.
Under the terms of his employment agreement, Mr. Van Vliet is entitled to
benefits if his employment is terminated by the Company without cause or if
his employment is terminated following a change of control of the Company.
Please see "Potential Payments Upon Termination or Change-in-Control" for a
description of these benefits.
The employment agreement also contains restrictive covenants preventing Mr.
Van Vliet from competing against the Company or soliciting customers or
employees of the Company for a period of 36 months after the end of his
employment with the Company.
149
Vice President, Industry Presence and Development
The Company has an employment agreement with Michael S. Anderson, Vice
President, Industry Presence and Development, that commenced on May 23, 1994
and was subsequently amended on May 5, 1997, February 16, 2000, and February
20, 2006 and continues through March 31, 2011, and automatically renews for
successive 12-month periods until terminated by the Company or Mr. Anderson.
Mr. Anderson's base salary was $332,000 effective February 20, 2006.
Under the terms of his employment agreement, Mr. Anderson is entitled to
benefits if his employment is terminated by the Company without cause or if
his employment is terminated following a change of control of the Company.
Please see "Potential Payments Upon Termination or Change-in-Control" for a
description of these benefits.
The employment agreement also contains restrictive covenants preventing Mr.
Anderson from competing against the Company or soliciting customers or
employees of the Company for a period of 36 months after the end of his
employment with the Company.
Chief Executive Officer of ETHEX Corporation
The Company has an employment agreement with Patricia K. McCullough, Chief
Executive Officer of ETHEX Corporation, that commenced on January 30, 2006 and
continued through April 1, 2007, and automatically renews for successive
12-month periods until terminated by the Company or Ms. McCullough. Ms.
McCullough's base salary in fiscal 2007 was $285,000 effective January 30,
2006.
Under the terms of her employment agreement, Ms. McCullough is entitled to
benefits if her employment is terminated by the Company. Please see "Potential
Payments Upon Termination or Change-in-Control" for a description of these
benefits.
The employment agreement also contains restrictive covenants preventing Ms.
McCullough from competing against the Company or soliciting customers or
employees of the Company for a period of 36 months after the end of her
employment with the Company.
The Impact of Accounting and Tax Treatments on Forms of Compensation Paid
Based on regulations issued by the Internal Revenue Service, the Company has
taken the necessary actions to ensure deductibility of performance-based
compensation paid to named executive officers. Section 162(m) of the Internal
Revenue Code generally disallows a tax deduction to public companies for
compensation exceeding $1 million paid to the Chief Executive Officer and any
one of the four other most highly compensated executive officers for any
fiscal year. Qualifying performance-based compensation is not subject to the
limitation if certain requirements are met.
150
INFORMATION AS TO STOCK OPTIONS
-------------------------------
The following tables list certain information concerning option exercises and
option holdings as of the end of fiscal 2007 of options held by the named
executive officers to acquire shares of Class A Common Stock and Class B
Common Stock.
Outstanding Equity Awards At Fiscal Year-End
------------------------------------------------------------------------------------------------------------------
NUMBER OF NUMBER
SECURITIES OF SECURITIES
UNDERLYING UNDERLYING
UNEXERCISED UNEXERCISED OPTION OPTION OPTION GRANT
OPTIONS (#) OPTIONS (#) EXERCISE EXPIRATION DATE FAIR
NAME EXERCISABLE UNEXERCISABLE PRICE ($) DATE VALUE $
------------------------------------------------------------------------------------------------------------------
Marc S. Hermelin 100,000 0 25.04 5/10/2008 1,061,334
------------------------------------------------------------------------------------------------------------------
Gerald R. Mitchell 2,000 8,000 (1) 19.99 11/01/2015 131,477
5,530 0 6.70 8/15/2007 28,342
4,705 0 6.81 8/15/2007 24,610
------------------------------------------------------------------------------------------------------------------
Michael S. Anderson 30,000 45,000 (2) 24.12 3/31/2011 992,977
2,000 3,000 (3) 23.09 5/21/2014 74,824
------------------------------------------------------------------------------------------------------------------
Patricia K. McCullough 10,000 40,000 (4) 24.12 3/31/2016 737,562
------------------------------------------------------------------------------------------------------------------
David A. Van Vliet 10,000 90,000 (5) 23.70 10/05/2016 1,420,320
------------------------------------------------------------------------------------------------------------------
<FN>
(1) Option granted on 11/01/2005 and vests ratably as to 10% per year from
date of grant.
(2) Option granted on 3/31/2006 and vests ratably as to 20% per year from
date of grant.
(3) Option granted on 5/21/2004 and vests ratably as to 10% per year from
date of grant.
(4) Option granted on 3/31/2006 and vests ratably as to 10% per year from
date of grant.
(5) Option granted on 10/05/2006 and vests ratably as to 10% per year from
date of grant.
151
Option Exercises and Stock Vested
------------------------------------------------------------------------------------
NUMBER OF VALUE
SHARES REALIZED
ACQUIRED ON ON
NAME EXERCISE EXERCISE
(#) (a)
------------------------------------------------------------------------------------
Marc S. Hermelin 96,450 $561,050
------------------------------------------------------------------------------------
Michael S. Anderson 3,375 63,754
------------------------------------------------------------------------------------
<FN>
---------------------
(a) Value realized on exercise is determined based on the difference
between the market price of the stock on the date of exercise and
the exercise price. Shares acquired on exercise of stock options
are subject to a two-year forfeiture period, during which time
they cannot be sold.
PENSION PLANS
-------------
Present Value of Payments During
Name Plan Name Accumulated Benefit Last Fiscal Year
---- --------- ------------------- ----------------
MARC S. HERMELIN K-V PHARMACEUTICAL COMPANY $6,318,529 $0
NON-QUALIFIED RETIREMENT PLAN
Under the terms of his Employment Agreement, Mr. Hermelin is entitled to
receive retirement compensation paid in the form of a single life annuity
equal to 30% of his final average compensation payable each year at the
beginning of retirement and continuing for the longer of ten years or life.
Final average compensation is based on the highest compensation (including
bonuses) earned during the three consecutive years of the five year period
ending immediately prior to the retirement date. The present value of the
accumulated benefit assumes retirement at age 75, a 10% annual increase in the
Company's net income for purposes of estimating future non-equity incentive
payments, and a 6% discount rate. If Mr. Hermelin were to retire at age 65
(his age at the end of fiscal year 2007) the present value of the accumulated
benefit would increase to $14,408,000.
In addition, the Employment Agreement entitles Mr. Hermelin to consulting
compensation for up to 300 hours annually and additional compensation in
consideration for complying with certain restrictive covenants each equal to
15% of final average compensation payable in the form of a single life annuity
for the longer of ten years or life.
Retirement expense is recognized under the requirements of APB 12. Under APB
12, to the extent the terms of the contract attribute all or a portion of the
expected future benefits to a period of service greater than one year, the
cost of those benefits are accrued over that period of the employee's service
in a systematic and rational manner. The method used for this calculation
allocates expense to each year as the difference between the present value of
accrued benefits (based upon updated compensation and discount rates) at the
end of the fiscal year and the beginning of the fiscal year. The present value
of the accumulated benefit is unfunded.
There are no defined benefit arrangements for the other named executive
officers.
152
Potential Payments upon Termination or Change-in-Control
- --------------------------------------------------------
Certain of the Company's named executive officers are entitled, pursuant to
employment agreements, to benefits upon termination of employment or
termination of employment after a change of control of the Company. The
following discussion provides information with respect to payments to which
named executive officers are entitled upon termination of employment or
following termination resulting from a change in control of the Company. The
dollar amounts described below assume that the triggering event for each named
executive officer occurred at March 31, 2007, the last day of the Company's
last completed fiscal year. For additional discussion regarding employment
agreements with named executive officers, including discussion of conditions
and obligations applicable to the receipt of the payments described below, see
"Employment Arrangements with Named Executive Officers" above under the
heading "Compensation Discussion and Analysis."
Under the terms of his employment agreement, Mr. Hermelin is entitled to
benefits if his employment with the Company is terminated other than as a
result of a voluntary termination, his retirement or his termination as a
result of death or disability or if his employment is terminated following a
change of control of the Company.
In the event of his termination other than voluntary termination, retirement
or termination as a result of death or disability, Mr. Hermelin is entitled to
receive an amount equal to his then base salary and 36 monthly payments equal
to 75% of his last monthly base salary. In addition, all stock options would
become immediately vested and available for exercise up to two years following
termination. Assuming that Mr. Hermelin's employment was terminated as of
March 31, 2007, the value of these benefits would be:
Base salary $1,281,764
Undiscounted value of 36 monthly payments 2,883,969
----------
Total value $4,165,733
==========
In the event of a termination following a change of control of the Company,
Mr. Hermelin has the right to elect to receive either the payments described
above or a lump sum cash payment equal to 2.5 times his base salary, bonus
payments over the 30 months following termination as if he had continued in
his position, acceleration of stock options, employee benefits for 30 months
following termination and unconditional retirement compensation equal to 60%
of his final average compensation payable in the form of a single life
annuity. In addition, Mr. Hermelin is entitled to a gross-up payment for any
payments made for a termination following a change of control that would be
considered excess parachute payments under Section 280G(b) and subject to the
excise tax imposed by Section 4999 of the Internal Revenue Code. Assuming that
Mr. Hermelin's employment was terminated as of March 31, 2007 following a
change of control, the value of these benefits to Mr. Hermelin would be
approximately $33,302,935 calculated as follows:
2.5x BASE SALARY $ 3,204,410
BONUS (a) 5,830,682
ACCELERATION OF STOCK OPTIONS (b) -
RETIREMENT COMPENSATION (c) 21,371,000
EMPLOYEE BENEFITS (d) 235,793
TAX GROSS-UP FOR SECTION 280G
PAYMENTS (e) 2,661,050
-----------
TOTAL VALUE $33,302,935
===========
153
<FN>
(a) Represents the total amount of estimated bonuses to be paid
over the 30 months following termination assuming a 10%
annual increase in net income for each of the fiscal years
2008 and 2009, which are the years included in the 30 month
period following the triggering event. The bonus for the
fiscal year ended March 31, 2007 is excluded from the table
as the triggering event is assumed to have occured on the
last day of the performance period and thus the pay out would
be the same as if the termination had not occurred.
(b) Mr. Hermelin currently has no unvested stock options.
(c) Represents the present value of the accumulated benefit
assuming Mr. Hermelin retired on March 31, 2007.
(d) Represents the benefits to be paid to Mr. Hermelin including
car allowance, 401(k) match, group term insurance,
disability insurance, medical benefits and financial
services allowance, over the 30 months following termination
assuming no increase in cost over the cost incurred for the
12 months ended March 31, 2007.
(e) Represents the tax reimbursement needed to provide the
benefit outlined in the employment agreement related to the
excise tax imposed by Internal Revenue Code Section 4999 with
respect to excess parachute payments computed under Internal
Revenue Code Section 280 G(b).
Under the terms of his employment agreement, Mr. Mitchell is entitled to
benefits if his employment is terminated following a change of control of the
Company. In this situation, Mr. Mitchell would receive one and one-half times
his base salary, bonus payments over the next 18 months as if he had continued
in his position, acceleration of stock options and employee benefits for 24
months. Assuming that Mr. Mitchell's employment was terminated as of March 31,
2007 following a change of control, the value of these benefits to Mr.
Mitchell would be approximately $425,383 calculated as follows:
1.5x BASE SALARY $312,789
BONUS (a) 75,000
ACCELERATION OF STOCK OPTIONS (b) 11,060
EMPLOYEE BENEFITS (c) 26,534
--------
TOTAL VALUE $425,383
========
<FN>
(a) Represents estimated bonus to be paid assuming an annual
bonus continuing at $50,000 prorated over 18 months.
(b) Represents the aggregate value of the acceleration of
unvested stock options based on the spread between the
closing price of our Class A Common Stock on March 31, 2007
of $24.73 and the exercise price of the option.
(c) Represents the benefits to be paid to Mr. Mitchell including
car allowance, 401(k) match, group term insurance and medical
benefits, over the next 24 months assuming no increase in
cost over the cost incurred for the 12 months ended March 31,
2007.
Under the terms of his employment agreement, Mr. Anderson is entitled to
benefits if his employment is terminated by the Company without cause or if
his employment is terminated following a change of control of the Company.
In the event of involuntary termination, except for cause, Mr. Anderson is
entitled to receive severance pay equal to one half of his annual salary
payable in 12 equal installments, 12 months of continued medical, disability
and term life insurance coverage and acceleration of unvested stock options to
be immediately exercisable. Assuming that Mr. Anderson's employment was
terminated as of March 31, 2007, the value of these benefits would be
approximately $200,465 calculated as follows:
154
0.5x BASE SALARY $166,000
ACCELERATION OF STOCK OPTIONS (a) 32,370
EMPLOYEE BENEFITS (b) 2,095
--------
TOTAL VALUE $200,465
========
<FN>
(a) Represents the aggregate value of the acceleration of
unvested stock options based on the spread between the
closing price of our Class A Common Stock on March 31, 2007
of $24.73 and the exercise price of the option.
(b) Represents the benefits paid for Mr. Anderson including group
term insurance, disability insurance and medical benefits.
In the event of a termination following a change of control of the Company,
Mr. Anderson is entitled to receive severance pay equal to 1.5 times base
compensation plus any bonus that would be payable to him for 18 months
following termination, and continued medical benefits for 24 months. In
addition, any outstanding stock options will fully vest and remain exercisable
for 90 days following termination. Assuming that Mr. Anderson's employment was
terminated as of March 31, 2007 following a change of control, the value of
these benefits to Mr. Anderson would be approximately $691,434 calculated as
follows:
1.5x BASE SALARY $498,000
BONUS (a) 149,400
ACCELERATION OF STOCK OPTIONS (b) 32,370
EMPLOYEE BENEFITS (c) 11,664
--------
TOTAL VALUE $691,434
========
<FN>
(a) Represent estimated bonus to be paid assuming an annual bonus
of 30% of his base salary prorated over 18 months.
(b) Represents the aggregate value of the acceleration of
unvested stock options based on the spread between the
closing price of our Class A Common Stock on March 31, 2007
of $24.73 and the exercise price of the option.
(c) Represents the benefits to be paid to Mr. Anderson including
group term life insurance and medical benefits over the next
24 months assuming no increase in cost over the cost incurred
for the 12 months ended March 31, 2007.
Under the terms of his employment agreement, Mr. Van Vliet is entitled to
benefits if his employment is terminated by the Company without cause or if
his employment is terminated following a change of control of the Company. In
either case, Mr. Van Vliet is entitled to receive severance pay equal to his
annual base salary in effect at the date of termination, continued benefits
over the 12 month period and acceleration of unvested stock options to become
immediately exercisable. Assuming that Mr. Van Vliet's employment was
terminated as of March 31, 2007 either by the Company without cause or
following a change of control of the Company, the value of these benefits
would be approximately $433,692 calculated as follows:
ANNUAL BASE SALARY $350,000
ACCELERATION OF STOCK OPTIONS (a) 82,400
EMPLOYEE BENEFITS (b) 1,292
--------
TOTAL VALUE $433,692
========
<FN>
(a) Represents the aggregate value of the acceleration of
unvested stock options based on the spread between the
closing price of our Class A Common Stock on March 31, 2007
of $24.73 and the exercise price of the option.
155
(b) Represents the benefits to be paid to Mr. Van Vliet including
401(k) match, group term life insurance and medical benefits
over the next 12 months assuming no increase in cost over the
cost incurred for the 12 months ended March 31, 2007.
Patricia K. McCullough's employment agreement with the Company does not
contain provisions related to severance or change of control. Ms. McCullough
is entitled to 120 days' notice of termination and is entitled to receive her
normal compensation for such period, even if the Company exercises its option
to request that Ms. McCullough not work during the notice period. Except for
this situation, Ms. McCullough is only entitled to benefits upon termination
or upon a change of control of the Company that are generally available to the
Company's salaried employees.
COMPENSATION COMMITTEE INTERLOCKS
AND INSIDER PARTICIPATION;
TRANSACTIONS WITH DIRECTORS AND EXECUTIVE OFFICERS
Since June 2004, the Compensation Committee of the Board of Directors has
deliberated and taken any required actions regarding the compensation of the
Company's executive officers and reviewed the compensation process for the
entire Company.
Victor M. Hermelin, the founder and Chairman Emeritus of the Company and
father of Marc S. Hermelin, received a salary, consulting fees, royalties and
other compensation of $133,904, $145,566, $189,699 and $8,896, respectively.
Marc S. Hermelin, the Chairman and Chief Executive Officer of the Company, is
a partner in a partnership that leases certain real property to the Company.
Lease payments made by the Company to the partnership for this property during
fiscal year 2007 totaled $295,734.
David S. Hermelin, the son of Marc S. Hermelin and grandson of Victor M.
Hermelin, is a director and is employed by the Company as Vice President,
Corporate Strategy and Operations Analysis. Pursuant to the terms of his
employment agreement with the Company, for fiscal year 2007, David S. Hermelin
received a salary, earned incentive and other compensation of $254,610,
$88,900 and $2,795, respectively, from the Company. In addition, Mr. Hermelin
exercised options during the fiscal year with a realized value of $61,478.
Realized value is based on the difference between the market price of the
stock on the date of exercise and the exercise price.
Sarah R. Weltscheff is employed by the Company as Senior Vice President, Human
Resource Management and Corporate Communications. Ms. Weltscheff and Marc S.
Hermelin are married under religious law. For fiscal 2007, Ms. Weltscheff
received a salary, earned incentive and other compensation of $293,808,
$115,000, and $8,087, respectively, from the Company. In addition, Ms.
Weltscheff exercised options during the fiscal year with a realized value of
$1,309,515. Realized value is based on the difference between the market price
of the stock on the date of exercise and the exercise price.
156
COMPENSATION COMMITTEE REPORT
- -----------------------------
In fulfilling its oversight responsibilities with respect to the Compensation
Disclosure and Analysis included in this Proxy Statement the Compensation
Committee, among other things, has:
* reviewed and discussed the Compensation Disclosure and Analysis with
management; and
* following such review, the Compensation Committee approved the
inclusion of such Compensation Disclosure and Analysis in this proxy
statement.
Respectfully submitted,
THE COMPENSATION COMMITTEE OF THE BOARD OF
DIRECTORS OF K-V PHARMACEUTICAL COMPANY
Jonathon E. Killmer, Chairman
Norman D. Schellenger, Member
NOTWITHSTANDING ANYTHING SET FORTH IN ANY OF OUR PREVIOUS FILINGS UNDER THE
SECURITIES ACT OF 1933 OR THE SECURITIES EXCHANGE ACT OF 1934 THAT MIGHT
INCORPORATE FUTURE FILINGS, INCLUDING THIS PROXY STATEMENT, IN WHOLE OR IN
PART, THE PRECEDING REPORT SHALL NOT BE DEEMED INCORPORATED BY REFERENCE IN
ANY SUCH FILINGS.
157
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
-----------------------------------------------
The following table sets forth information as of January 15, 2008, with
respect to each person known by the Company to be the beneficial owner of more
than 5% of the outstanding shares of our Class A or Class B Common Stock in
addition to those holders listed under "Security Ownership of Management."
NAME AND ADDRESS AMOUNT AND NATURE PERCENT OF PERCENT OF
OF BENEFICIAL OWNER TITLE OF CLASS OF BENEFICIAL OWNER CLASS A CLASS B
------------------- -------------- ------------------- -------- -------
Neuberger Berman, Inc. (1) Class A
605 Third Avenue Common Stock 4,884,241 13.9% --%
New York, NY 10158
Lord, Abbett & Co. LLC (2) Class A
90 Hudson Street Common Stock 2,659,888 7.18% --%
11th Floor
Jersey City, NJ 07302
<FN>
- ----------------------------
(1) As reflected on the Schedule 13G dated February 12, 2008, filed by
Neuberger Berman, Inc. ("NBI"). Shares reported by NBI were reported as
being beneficially owned by its subsidiaries, Neuberger Berman, LLC,
Neuberger Berman Management Inc., and Neuberger Berman Equity Funds of
which Neuberger Berman, LLC serves as sub advisor and Neuberger Berman
Management Inc. serves as investment manager. NBI reported sole voting
power of 255,647 Class A shares; shared voting power of 3,474,643 Class A
shares; no sole dispositive power; and shared dispositive power of
4,884,241 Class A shares.
(2) As reflected on the Schedule 13G dated February 14, 2008, filed by Lord,
Abbett & Co. LLC ("Lord Abbett"). Lord Abbett reported sole voting power
of 2,487,176 Class A shares, no shared voting power, sole dispositive
power of 2,659,888 Class A shares, and no shared dispositive power.
158
SECURITY OWNERSHIP OF MANAGEMENT
--------------------------------
Under regulations of the Securities and Exchange Commission, persons who have
power to vote or to dispose of our shares, either alone or jointly with
others, are deemed to be beneficial owners of those shares. The following
table shows, as of January 15, 2008, the beneficial ownership of (1) each of
the executive officers named in the Summary Compensation Table, (2) each
present director and nominee for director of the Company and (3) all present
directors and executive officers as a group of all of our shares of Class A
Common Stock and Class B Common Stock. Unless otherwise noted, voting and
dispositive power relating to the shares described below is exercised solely
by the listed beneficial owner. The individuals named have furnished this
information to us.
AMOUNT OF AMOUNT OF
BENEFICIAL BENEFICIAL
OWNERSHIP- PERCENT OF OWNERSHIP- PERCENT OF
NAME AND ADDRESS CLASS A STOCK (a) CLASS A (b) CLASS B STOCK (a) CLASS B (b)
---------------- ----------------- ----------- ----------------- -----------
Shares beneficially attributed to
Marc S. Hermelin pursuant to trusts:
Lawrence Brody and Marc S. 1,270,560 (c) 3.4% 2,077,312 (c) 17.0%
Hermelin, Trustees
One Metropolitan Square
St. Louis, MO 63101
Lawrence Brody, Arnold L. 1,212,284 (d) 3.2% 2,082,375 (d) 17.0%
Hermelin and Marc S.
Hermelin, Trustees
One Metropolitan Square
St. Louis, MO 63101
Lawrence Brody, Marc S. 1,647,994 (e) 4.4% 2,637,085 (e) 21.6%
Hermelin and David S.
Hermelin, Trustees
One Metropolitan Square
St. Louis, MO 63101
Marc S. Hermelin, individually owned 218,677 0.6% 1,316,613 (h) 10.8%
Total shares attributable 4,349,515 11.6% 8,113,385 66.4%
to Marc S. Hermelin
Shares beneficially attributed to
David S. Hermelin pursuant to a trust:
Lawrence Brody, Marc S. 1,647,994 (e) 4.4% 2,637,085 (e) 21.6%
Hermelin and David S.
Hermelin, Trustees
One Metropolitan Square
St. Louis, MO 63101
159
AMOUNT OF AMOUNT OF
BENEFICIAL BENEFICIAL
OWNERSHIP- PERCENT OF OWNERSHIP- PERCENT OF
NAME AND ADDRESS CLASS A STOCK (a) CLASS A (b) CLASS B STOCK (a) CLASS B (b)
---------------- ----------------- ----------- ----------------- -----------
David S. Hermelin, individually owned 15,375 * 92,875 *
Total shares attributable 1,663,369 4.4% 2,709,960 22.1%
to David S. Hermelin
Gerald R. Mitchell 58,125 (g) * 77,625 *
Jean M. Bellin 1,500 * 9,500 *
Norman D. Schellenger 1,500 * 2,000 *
Kevin S. Carlie 5,300 * 15,500 *
Terry B. Hatfield 1,500 * 6,000 *
David A. Van Vliet 21,500 * 6,000 *
Jonathon E. Killmer 1,000 --- 2,000 *
Patricia K. McCullough 10,000 * --- ---
Michael S. Anderson 80,100 * --- ---
Jerald J. Wenker --- --- --- ---
All current directors and executive 6,193,409 (f) 16.4% 10,941,970 (f) 89.4%
officers as a group (18 individuals)
<FN>
- ---------------------
* Less than one percent
(a) Includes the following shares that were not owned by the persons listed
but which could be purchased from the Company under options exercisable
currently or within 60 days after January 15, 2008.
SHARES OF CLASS A SHARES OF CLASS B
COMMON STOCK COMMON STOCK
------------ ------------
Marc S. Hermelin ................... 100,000 ---
David S. Hermelin................... --- 40,000
Gerald R. Mitchell.................. 3,000 ---
Jean M. Bellin...................... 1,500 9,500
Norman D. Schellenger............... 1,500 2,000
Kevin S. Carlie..................... 5,300 2,450
Terry B. Hatfield................... 1,500 6,000
David A. Van Vliet.................. 20,000 6,000
Jonathon E. Killmer................. --- 2,000
Patricia K. McCullough.............. 10,000 ---
Michael S. Anderson................. 32,001 ---
160
<FN>
(b) In determining the percentages of shares deemed beneficially owned by
each director and officer listed herein, the exercise of all options held
by each person that are currently exercisable or will become exercisable
within 60 days of January 15, 2008, is assumed.
(c) These shares are held in an irrevocable trust created by another party,
the beneficiary of which is Anne S. Kirschner.
(d) These shares are held in an irrevocable trust created by another party,
the beneficiary of which is Arnold L. Hermelin.
(e) These shares are held in two irrevocable trusts created by another party,
the beneficiaries of which are Marc S. Hermelin (as to 1,112,869 shares
of Class A Common Stock, of which 189,716 shares are held as security for
a loan and 1,614,460 shares of Class B Common Stock) and Minnette
Hermelin, the mother of Marc S. Hermelin (as to 535,125 shares of Class A
Common Stock, of which 56,250 shares are held as security for a loan and
1,022,625 shares of Class B Common Stock). Mrs. Hermelin passed away on
December 31, 2007.
(f) All of such shares are owned, or represented by shares purchasable as set
forth in footnote (a). In determining the percentage of shares deemed
beneficially owned by all directors and executive officers as a group,
the exercise of all options held by each person which are currently
exercisable or exercisable within 60 days of January 15, 2008, is
assumed. For such purposes, 37,708,248 shares of Class A Common Stock and
12,233,802 shares of Class B Common Stock are assumed to be outstanding.
(g) These shares include 22,635 shares beneficially owned by the officer
listed herein, but constructively owned by relatives residing in his
home. In addition, includes 11,475 shares held as security for a loan.
(h) Includes 464,891 shares which are held as security for a loan.
In addition to the 37,708,248 shares of Class A Common Stock
outstanding as of January 15, 2008, 40,000 shares of the 7% Preferred
Stock are issued and outstanding. Each share of 7% Preferred Stock is
convertible into Class A Common Stock at a ratio of 8.4375 shares of
Class A Common Stock for each share of 7% Preferred Stock. Other than
as required by law, the 7% Preferred Stock has no voting rights. If
all shares of the 7% Preferred Stock were converted, the aggregate
voting power thereof would be equivalent to the voting power of
16,875 shares of Class B Common Stock.
In addition, all holders of Class B Common Stock have the right, at
any time, to convert their Class B Common Stock into Class A Common
Stock on a share-for-share basis. If all shares of Preferred Stock
and all shares of Class B Common Stock were converted into Class A
Common Stock, 50,279,550 shares of Class A Common Stock would be
outstanding, and each person included in the previous table would
hold the number of shares of Class A Common Stock equal to the number
of shares of Class B Common Stock listed in the table plus the number
of shares of Class A Common Stock listed in the table, which includes
options exercisable by all directors and executive officers currently
or within 60 days after January 15, 2008.
In addition, the Company issued $200.0 million principal amount of
Convertible Subordinated Notes due 2033 ("the Notes") that are
convertible, under certain circumstances, into shares of our Class A
Common Stock at a conversion price of $23.01 per share, subject to
possible adjustment. At the current conversion price, the Notes are
convertible into 8,691,880 shares of Class A Common Stock.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
-----------------------------------------------------------
INDEPENDENCE
------------
DETERMINATION OF DIRECTOR INDEPENDENCE
--------------------------------------
Under the rules of the New York Stock Exchange ("NYSE"), a director
of the Company only qualifies as "independent" if our Board of
Directors affirmatively determines that the director has no material
relationship with the Company (either directly or as a partner,
shareholder or officer of an organization that has a relationship
161
with the Company). Our Board of Directors has established guidelines
to assist it in determining whether a director has a material
relationship with the Company. Under these guidelines, a director is
not considered to have a material relationship with the Company if he
or she does not meet any of the exceptions for determining
independence under Section 303A.02 of the NYSE Listed Company Manual.
Our Board of Directors has determined that Messrs. Schellenger,
Killmer, Carlie, Bellin and Hatfield are "independent" as determined
under Section 303A.02 of the NYSE Listed Company Manual.
Since June 2004, the Compensation Committee of the Board of Directors
has deliberated and taken any required actions regarding the
compensation of the Company's executive officers and reviewed the
compensation process for the entire Company.
Victor M. Hermelin, the founder and Chairman Emeritus of the Company
and father of Marc S. Hermelin, received a salary, consulting fees,
royalties and other compensation of $133,904, $145,566, $189,699 and
$8,896, respectively.
Marc S. Hermelin, the Chairman and Chief Executive Officer of the
Company, is a partner in a partnership that leases certain real
property to the Company. Lease payments made by the Company to the
partnership for this property during fiscal year 2007 totaled
$295,734.
David S. Hermelin, the son of Marc S. Hermelin and grandson of Victor
M. Hermelin, is a director and is employed by the Company as Vice
President, Corporate Strategy and Operations Analysis. Pursuant to
the terms of his employment agreement with the Company, for fiscal
year 2007, David S. Hermelin received a salary, earned incentive and
other compensation of $254,610, $88,900 and $2,795, respectively,
from the Company. In addition, Mr. Hermelin exercised options during
the fiscal year with a realized value of $61,478. Realized value is
based on the difference between the market price of the stock on the
date of exercise and the exercise price.
Sarah R. Weltscheff is employed by the Company as Senior Vice
President, Human Resource Management and Corporate Communications.
Ms. Weltscheff and Marc S. Hermelin are married under religious law.
For fiscal 2007, Ms. Weltscheff received a salary, earned incentive
and other compensation of $293,808, $115,000, and $8,087,
respectively, from the Company. In addition, Ms. Weltscheff exercised
options during the fiscal year with a realized value of $1,309,515.
Realized value is based on the difference between the market price of
the stock on the date of exercise and the exercise price.
PROCEDURES FOR APPROVING RELATED PARTY TRANSACTIONS
---------------------------------------------------
Pursuant to the written policies and procedures adopted by the Board
of Directors of the Company (the "Related Party Transaction
Guidelines"), the Nominating and Corporate Governance Committee is
responsible for reviewing, approving and ratifying all related party
transactions. A related party transaction is any transaction in which
the Company is a party, and in which an executive officer, director,
nominee for director, a shareholder owning 5% or more of the
Company's securities or any of such person's immediate family
members, is a party or is known by the Company to have a direct or
indirect material benefit. In cases where a member of the Nominating
and Corporate Governance Committee is a party to the related party
transaction, such member shall not participate in approving the
transaction. Compensation paid to related parties or their immediate
family members need not be approved if (1) the total compensation
amount is less than $120,000 a year, or (2) the compensation has
otherwise been approved by the Compensation Committee or the Board of
Directors.
In determining whether a related party transaction is in, or not
opposed to, the Company's best interest, the Nominating and Corporate
Governance Committee may consider any factors deemed relevant or
appropriate, including (but not be limited to):
162
* whether there are any actual or apparent conflicts of interest;
* the nature, size or degree of those conflicts;
* whether such conflicts may be mitigated;
* the potential benefits and detriments to the Company of such
related party transaction;
* whether the nature or terms of the related party transaction are
unusual; and
* whether steps have been taken to ensure fairness to the Company.
In making its decision, the Nominating and Corporate Governance
Committee may consider the Company's compliance officer's written
recommendation as to issues raised under the Company's Standard of
Business Ethics Policy. In addition, the Nominating and Corporate
Governance Committee may seek such additional information as it deems
necessary, including, without limitation, any other legal or expert
advice considered appropriate. All transactions above were approved
under the Company's related party transfer guidelines.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
--------------------------------------
The following table sets forth the amount of audit fees,
audit-related fees, tax fees and all other fees billed or expected to
be billed by KPMG LLP, the Company's current independent registered
public accounting firm, for the fiscal years ended March 31, 2007 and
March 31, 2006, respectively:
MARCH 31, 2007 MARCH 31, 2006
-------------- --------------
Audit Fees (1) $1,995,000 $ 600,000
Audit-Related Fees - -
---------- ------------
Total Fees $1,995,000 $ 600,000
========== ============
<FN>
---------------
(1) Includes fees for professional services rendered in connection
with the audit of our consolidated financial statements and
internal control over financial reporting and the review of
consolidated financial statements included in our Forms 10-Q for
the related annual period.
PRE-APPROVAL POLICIES AND PROCEDURES
The Audit Committee has adopted a policy that requires advance
approval of all audit, audit-related, tax services, and other
services provided to the Company by the independent registered public
accounting firm. The policy provides for pre-approval by the Audit
Committee of specifically defined audit and non-audit services.
Unless the specific service has been previously pre-approved with
respect to that year, the Audit Committee must approve the permitted
service before the independent registered public accounting firm is
engaged to perform it. The Audit Committee has delegated to the Chair
of the Audit Committee authority to approve permitted services
provided that the Chair reports any decisions to the Committee at its
next scheduled meeting. The Audit Committee approved all audit and
non-audit services provided by the independent registered public
accounting firm for fiscal 2007. The Audit Committee, after review
and discussion with KPMG LLP of the Company's pre-approval policies
and procedures, determined that the provision of these services in
accordance with such policies and procedures was compatible with
maintaining KPMG LLP's independence.
163
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........................ 78
Consolidated Balance Sheets as of March 31, 2007 and 2006 ..................... 79
Consolidated Statements of Income for the Years Ended
March 31, 2007, 2006 and 2005.................................................. 80-81
Consolidated Statements of Comprehensive Income for
the Years Ended March 31, 2007, 2006 and 2005.................................. 82
Consolidated Statements of Shareholders' Equity for
the Years Ended March 31, 2007, 2006 and 2005.................................. 83
Consolidated Statements of Cash Flows for the Years
Ended March 31, 2007, 2006 and 2005............................................ 84
Notes to Financial Statements.................................................. 85-129
Report of Independent Registered Public Accounting Firm........................ 130-131
Controls and Procedures........................................................ 132
Management's Report on Internal Control over
Financial Reporting............................................................ 132-134
Changes in Internal Control over Financial Reporting........................... 133
Evaluation of Disclosure Controls and Procedures............................... 133
Remediation Activities......................................................... 134
Other Information.............................................................. 135
2. Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts................................ 166
Exhibits. See Exhibit Index on pages 167 through 172 of this Report.
Management contracts and compensatory plans are designated on the
Exhibit Index.
Consent of Independent Registered Public Accounting Firm....................... 174
164
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: March 25, 2008 By /s/ Marc S. Hermelin
------------------------------ ------------------------------------------------
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: March 25, 2008 By /s/ Ronald J. Kanterman
------------------------------ ------------------------------------------------
Vice President and Chief Financial Officer
(Principal Financial Officer)
Date: March 25, 2008 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: March 25, 2008 By /s/ Marc S. Hermelin
------------------------------ ------------------------------------------------
Marc S. Hermelin
Date: March 25, 2008 By /s/ Norman D. Schellenger
------------------------------ ------------------------------------------------
Norman D. Schellenger
Date: March 25, 2008 By /s/ Kevin S. Carlie
------------------------------ ------------------------------------------------
Kevin S. Carlie
Date: March 25, 2008 By /s/ Jonathon E. Killmer
------------------------------ ------------------------------------------------
Jonathon E. Killmer
Date: March 25, 2008 By /s/ Jean M. Bellin
------------------------------ ------------------------------------------------
Jean M. Bellin
Date: March 25, 2008 By /s/ Terry B. Hatfield
------------------------------ ------------------------------------------------
Terry B. Hatfield
Date: March 25, 2008 By /s/ David S. Hermelin
------------------------------ ------------------------------------------------
David S. Hermelin
165
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, 2005:
Allowance for doubtful accounts............ $ 402 $ 235 $ 176 $ 461
Reserves for sales allowances (as restated) 19,458 133,751 133,067 20,142
Inventory obsolescence..................... 1,002 3,182 2,891 1,293
------------- ------------- ------------- --------------
$ 20,862 $ 137,168 $ 136,134 $ 21,896
============= ============= ============= ==============
Year Ended March 31, 2006:
Allowance for doubtful accounts............ $ 461 $ (49) $ 15 $ 397
Reserves for sales allowances (as restated) 20,142 154,662 146,107 28,697
Inventory obsolescence..................... 1,293 4,215 3,808 1,700
------------- ------------- ------------- --------------
$ 21,896 $ 158,828 $ 149,930 $ 30,794
============= ============= ============= ==============
Year Ended March 31, 2007:
Allowance for doubtful accounts............ $ 397 $ 320 $ 1 $ 716
Reserves for sales allowances.............. 28,697(1) 148,822 146,238 31,281
Inventory obsolescence..................... 1,700 11,979 4,650 9,029
------------- ------------- ------------- --------------
$ 30,794 $ 161,121 $ 150,889 $ 41,026
============= ============= ============= ==============
<FN>
(1) As restated.
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.
166
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.
167
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 was filed as Exhibit 3(o) to the Company's Annual
Report on Form 10-K for the year ended March 31, 2006, is
incorporated herein by this reference.
3(p) Amendment to Bylaws of the Company, effective June 28, 2004,
which was filed as Exhibit 3(p) to the Company's Annual
Report on Form 10-K for the year ended March 31, 2006, is
incorporated herein by this reference.
3(q) Amendment to Bylaws of the Company, effective November 30,
2007, which was filed as Exhibit 99 to the Company's Current
Report on Form 8-K, filed December 31, 2007, is incorporated
herein by this reference.
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., which was filed as Exhibit 4(f) to the
Company's Annual Report on Form 10-K for the year ended March
31, 2006, is incorporated herein by this reference.
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,
which was filed as Exhibit 4(g) to the Company's Annual
Report on Form 10-K for the year ended March 31, 2006, is
incorporated herein by this reference.
168
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.
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, 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, 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.
169
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.
10(q) 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(r)* Amendment, dated November 5, 2004, to Employment Agreement
between the Company and Marc S. Hermelin, 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(s)* K-V Pharmaceutical 2001 Incentive Stock Option Plan, which
was filed as Exhibit 10.1 to the Company's Current Report on
Form 8-K filed November 22, 2005, is incorporated by this
reference.
10(t)* 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(u)* 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(v)* Employment Agreement between ETHEX and Patricia McCullough,
Chief Executive Officer of ETHEX, dated January 30, 2006,
which was filed as Exhibit 10(aa) to the Company's Annual
Report on Form 10-K for the year ended March 31, 2006, is
incorporated herein by this reference.
10(w)* Employment Agreement between the Company and Michael S.
Anderson, Corporate Vice President, Industry Presence and
Development, dated May 23, 1994, and amendments thereto,
which was filed as Exhibit 10(bb) to the Company's Annual
Report on Form 10-K for the year ended March 31, 2006, is
incorporated herein by this reference.
10(x)* Employment Agreement between the Company and Ronald J.
Kanterman, Vice President, Treasurer dated January 26, 2004,
filed herewith.
10(y)* Employment Agreement between the Company and Gregory S.
Bentley, Senior Vice President and General Counsel, dated
April 24, 2006, filed herewith.
10(z)* Employment Agreement between the Company and David A. Van
Vliet, Chief Administration Officer, dated September 29,
2006, filed herewith.
10(aa)* Employment Agreement between the Company and Rita E. Bleser,
President, Pharmaceutical Division, dated April 30, 2007,
filed herewith.
170
10(bb)* Employment Agreement between Ther-Rx and Gregory J. Divis,
Jr., President, Ther-Rx Corporation, dated July 20, 2007,
filed herewith.
10(cc)* Employment Agreement by and between the Company and Richard
H. Chibnall, Vice President, Finance and Chief Accounting
Officer, dated December 22, 1995, as amended by amendment
dated April 1, 2005, filed herewith.
10(dd)* Employment Agreement by and between Particle Dynamics, Inc.
and Paul T. Brady, President, Particle Dynamics, Inc., dated
May 5, 2005, filed herewith.
10(ee)* Employment Agreement between the Company and David S.
Hermelin, Vice President, Corporate Strategy and Operations
Analysis, dated May 2, 1990, Employment Agreement between the
Company and David S. Hermelin, dated November 18, 1996,
Amendment, dated April 8, 1998 and Amendment dated August 16,
2004, filed herewith.
171
21 List of Subsidiaries, filed herewith.
23.1 Consent of KPMG 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.
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.
172
APPENDIX
Page 43 of the printed Form 10-K contains a Comparison of 5 Year Cumulative
Total Return graph. The information contained in the graph is depicted in
the table immediately following the graph.