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, 2008
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 [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [X] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [ ]
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 28, 2007, the last
business day of the registrant's most recently completed second fiscal
quarter, was $887,560,274 and $37,278,549, respectively. As of June 6, 2008,
the registrant had outstanding 37,755,099 and 12,256,159 shares of Class A
Common Stock and Class B Common Stock, respectively. Documents incorporated by
reference: Portions of the Company's Definitive Proxy Statement for its 2008
Annual Meeting of Shareholders are incorporated by reference in Part III of
this Annual Report on Form 10-K.
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,"
"expects," "aims," "believes," "projects," "anticipates," "commits,"
"intends," "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, product launches, regulatory approvals, governmental and
regulatory actions and proceedings, market position, market share increases,
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, competitive, 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 us 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 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 our litigation; (14) actions by the Securities and Exchange
Commission and the Internal Revenue Service with respect to our stock option
grants and accounting practices; (15) the impact of credit market disruptions
on the fair value of auction rate securities that we acquired as
short-term investments and have now become illiquid; (16) whether any recalled
products will have any material financial impact or result in litigation,
agency actions or material damages; and (17) the risks detailed from time to
time in our filings with the Securities and Exchange Commission.
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.
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ITEM 1. BUSINESS
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(a) GENERAL DEVELOPMENT OF BUSINESS
-------------------------------
Unless the context otherwise indicates, when we use the words "we,"
"our," "us," "our company" or "KV" we are referring to K-V
Pharmaceutical Company and its wholly-owned subsidiaries, including
Ther-Rx Corporation, ETHEX Corporation and Particle Dynamics, Inc.
We were incorporated under the laws of Delaware in 1971 as a
successor to a business originally founded in 1942. Victor M.
Hermelin, our 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 to the
present.
Today, 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);
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 May 2007, we 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 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 $141.5
million upon final approval of the product by the U.S. Food and Drug
Administration ("FDA"). 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. Because the product had not
obtained FDA approval when the initial payment was made at closing,
we recorded the $10.0 million payment made during the first quarter
of fiscal 2008 as in-process research and development expense. In
July 2007, FDA approval for Evamist(TM) was received and a payment of
$141.5 million was made to VIVUS, Inc. The preliminary purchase price
allocation, which is subject to change based on the final fair value
assessment, resulted in estimated identifiable intangible assets of
$52.4 million to product rights; $15.2 million to trademark rights;
$66.4 million to rights under a sublicense agreement; and, $7.5
million to a covenant not to compete. This product was purchased
using $91.5 million in cash and $50 million of our revolving line of
credit. Upon FDA approval in July 2007, we began amortizing the
product rights, trademark rights and rights under the sublicense
agreement over 15 years and the covenant not to compete over nine
years.
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.
The 180-day exclusivity period has allowed us to realize higher
margins on these products compared to our other generic/non-branded
products. We
3
began shipping these two products in July 2007, and along with the 25
mg strength approved in March 2008, they generated net revenues in
fiscal 2008 of $120.0 million.
We received FDA approval to market the 25 mg and 50 mg strengths of
metoprolol succinate extended-release tablets in March 2008 and May
2008, respectively. As a result of the recent 50 mg approval, KV now
offers the complete line of all four dosage strengths of metoprolol
succinate extended-release tablets - 200 mg, 100 mg, 50 mg and 25 mg.
As of March 31, 2008, KV had a 69.1% and 72.5% share of the generic
market place according to IMS Inc. for the 200 mg and 100 mg
strengths, respectively.
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, we 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, we agreed to pay $82.0 million for Gestiva(TM),
$7.5 million of which was paid at closing. Because the product had
not obtained FDA approval when the initial payment was made at
closing, we recorded the $7.5 million payment as in-process research
and development expense in the fourth quarter of fiscal 2008. The
remainder of the purchase price 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 us and
receipt by us of defined launch quantities of finished Gestiva(TM)
suitable for commercial sale.
(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 and products marketed under joint
development agreement with other companies. Revenues may also be
received in the form of licensing revenues and/or royalty payments
based upon a percentage of the licensee's sales of the product, in
addition to manufacturing revenues, when marketing rights to products
using our advanced drug delivery technologies are licensed. See Note
21 of the Notes to the Consolidated Financial Statements.
(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), 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
4
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
consolidated net revenues at a compounded annual growth rate of 19.4%
over the five fiscal years in the period ended March 31, 2008 marking
the Company's 13th consecutive year of record revenues. 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 grew from $188.7 million in fiscal 2007 to
$214.9 million in fiscal 2008 and represented 35.7% of our fiscal
2008 total net revenues.
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
United States.
The first of our internally developed, patented line extensions to
PreCare(R) was PreCare(R) Chewables, the world's first prescription
chewable prenatal vitamin. 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 Conceive(R), 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 ONE(R), was launched
in fiscal 2005 as a
5
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. During June 2008, a third party company introduced a product
purporting to be a substitute for PrimaCare ONE(R), and we are
currently engaged in litigation with this company with respect to
patent and trademark infringement and other claims. See Note 12 of
the Notes to Consolidated Financial Statements. 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
13.7% in fiscal 2008 to $82.5 million. 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. Sales of Encora(R) increased 45.0% in
fiscal 2008 to $4.5 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 $24.0 million in fiscal 2008. 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.
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 28.0% of the intravaginal
bacterial vaginosis market in the United States. Clindesse(R)
generated a 27.4% increase in sales to $40.5 million in fiscal 2008.
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.
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(R) and Niferex Gold(R). We believe Repliva
21/7(R) is a product offering that represents a revolutionary
advancement in iron therapy. Repliva 21/7(R) 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(R)
becoming the number one branded oral iron product in the United
States and Ther-Rx being the number one provider of branded
prescription oral iron supplements in the United States, sales of our
hematinic product line grew to $53.8 million in fiscal 2008, an 11.6%
increase over fiscal 2007.
In May 2007, we acquired from VIVUS, Inc. the U.S. marketing rights
to Evamist(TM), a unique transdermal estrogen therapy delivering a
low dose of estradiol in a once-daily spray. Under terms of the asset
purchase agreement, we paid $10.0 million in cash at closing and made
an additional cash payment of $141.5 million upon final approval of
the product by the FDA in July 2007. Evamist(TM) is indicated for the
treatment of moderate-to-severe vasomotor symptoms due to menopause
and targets the estrogen replacement market where physicians and
patients are seeking an effective and safe, low-dose estrogen
product. 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.
We began shipping this product at the end of fiscal 2008.
In January 2008, we entered into a definitive asset purchase
agreement with CYTYC to acquire the U.S. and worldwide rights to
Gestiva(TM) (17-alpha hydroxyprogesterone caproate). Under the terms
of the asset purchase agreement, we agreed to pay $82.0 million for
Gestiva(TM), $7.5 million of which was paid at closing. 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. The FDA issued an "approvable"
letter for Gestiva(TM) in October 2006, and a final approval is
anticipated in fiscal 2009. The FDA has granted an Orphan Drug
Designation for Gestiva(TM). The acquisition of Gestiva(TM) is
intended to allow Ther-
6
Rx to capitalize on the already strong relationships built over the
past seven years between Ther-Rx's 330-member sales force and
Obstetrician/Gynecologists.
To capitalize on Ther-Rx's success in marketing women's health
products, we continue to look for opportunities to expand our Ther-Rx
product portfolio. 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 are now testing
an alternative formula in a Phase II study to determine which
alternative to take into Phase III clinicals. The Company expects to
start Phase III clinicals in fiscal 2010.
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 330 specialty sales
representatives. 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
increased 56.1% to $367.9 million for fiscal 2008, which represented
61.1% of our total net revenues.
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.
The 180-day exclusivity period has allowed us to realize higher
margins on these products compared to our other generic/non-branded
products. We began shipping these two products in July 2007 and along
with the 25 mg approved and launched in March 2008 generated net
revenues in fiscal 2008 of $120.0 million.
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 a variety of products including 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, among others.
To capitalize on ETHEX's unique product capabilities, we continue to
expand our ETHEX product portfolio. In fiscal 2006, we launched a new
InveAmp(R) line extension to our pain management business.
InveAmp(R), a unique one unit dose ampoule, was designed to make
dispensing of narcotic pain relievers more effective. In fiscal 2007,
we received ANDA approval for six strengths of diltiazem
hydrochloride extended-release capsules. As noted above, in fiscal
2008, 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). We also received in fiscal 2008 ANDA
approval for ondansetron 4 mg and 8 mg orally disintegrating tablets,
the 100 mg and 200 mg 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, we received FDA approval to market the
25 mg and 50 mg strengths of metoprolol succinate extended-release
tablets in March 2008 and May 2008, respectively. As a result of the
recent 50 mg approval, KV now offers the complete line of all four
dosage strengths of metoprolol succinate extended-release tablets -
200 mg, 100 mg, 50 mg and 25 mg.
7
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 most of 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 2009. 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
these development agreements with existing parties will further
provide an opportunity to grow our generic/non-branded business.
These new product sources have increased the scope of our
generic/non-branded product pipeline to more than 50 product
opportunities.
The Company seeks to pursue an approach of developing generic
products that are more difficult to develop or manufacture and that
will therefore have significant barriers to entry by other generic
companies, such as metoprolol succinate extended-release tablets. The
Company has a rich generic pipeline. In fiscal year 2008, between the
Company's own internal development activities and its external
development partners, the Company filed 16 ANDAs and received 5
generic product approvals from the FDA. In fiscal year 2009, the
Company anticipates that, between its external development partners
and its own internal development activities, it will file
approximately 16 generic ANDA filings and receive six product
approvals from the FDA.
On February 14, 2006, the Company announced it had entered into an
agreement with Gedeon Richter under which the Company had acquired
exclusive rights to market a group of generic products in the United
States. However, due to changes in the generic drug marketplace, the
Company and Gedeon Richter have agreed the current portfolio of
products covered by the agreement, which has now been terminated, no
longer represent market opportunities that are worth pursuing. The
two companies remain committed partners in other endeavors and are
keeping options open to explore other more meaningful joint
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 70 products in its
cardiovascular line, including products to treat angina, arrhythmia
and hypertension, as well as for potassium supplementation. The
cardiovascular line accounted for $237.2 million, or 64.5%, of
ETHEX's net revenues in fiscal 2008.
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 $45.7 million, or 12.4%, of ETHEX's
net revenues in fiscal 2008.
RESPIRATORY. During most of fiscal 2008, ETHEX marketed approximately
30 products in its respiratory line, which consisted primarily of
cough/cold products. The cough/cold line accounted for $38.5 million,
or 10.5% of ETHEX's net revenues in fiscal 2008. In March 2008,
representatives of the Missouri Department of Health and Senior
Services and the FDA notified us of a hold on our inventory of
certain unapproved products. Previously, we had received notices that
required us to cease the manufacture and sale of unapproved products
containing timed-release guaifenesin. As a result of these notices,
we are currently marketing one cough/cold product. We will
discontinue manufacturing and marketing all unapproved cough/cold
products subject to the hold. See Part I, Item 1A "Risk Factors" for
additional information. The regulatory status of certain of our
generic products may make them subject to increased competition or to
regulatory decisions that may require market withdrawal of one or
more of our unapproved products.
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 $14.1 million, or
3.8%, of ETHEX's net revenues in fiscal 2008.
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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 $32.2 million, or 8.8%, of ETHEX's net
revenues in fiscal 2008.
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 $18.0 million in fiscal 2008, up 3.3% over net revenues of
$17.4 for fiscal 2007, which represented 3.0% 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. 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 believe we have in place a strong pipeline
of potential new products.
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 began
shipping 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).
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;
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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 330 specialty sales representatives. We plan to
continue to build our sales force over time 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. 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. Almost two-thirds of ETHEX'S
generic/non-branded products use the Company's proprietary drug
delivery technologies, and approximately 80% rank either first or
second in their respective generic categories by volume.
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.
The 180-day exclusivity period has allowed us to realize higher
margins on these products compared to our other generic/non-branded
products. We began shipping these two products in July 2007 and with
the approval and launch in March 2008 of the 25 mg strength they
generated net revenues in fiscal 2008 of $120.0 million. We received
FDA approval to market the 25 mg and 50 mg strengths of metoprolol
succinate extended-release tablets in March 2008 and May 2008,
respectively. As a result of the recent 50 mg approval, KV now offers
the complete line of all four dosage strengths of metoprolol
succinate extended-release tablets - 200 mg, 100 mg, 50 mg and 25 mg.
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
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product approved for use in the U.S. The NDA for this product was
approved by the FDA in July 2007 and we began shipping Evamist(TM)
during the fourth quarter of fiscal 2008.
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
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.
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.
Our unique quick dissolving tablet can be taken without water. Its
durability avoids the need for special packaging and it supports the
incorporation of our tastemasking technologies. Our oral dissolving
tablet technology is commercialized in our hyoscyamine sulfate orally
disintegrating tablets, as well as the ondansetron orally
disintegrating tablets approved by the FDA in fiscal 2008.
SALES AND MARKETING
Ther-Rx has a national sales and marketing infrastructure which
includes approximately 330 sales representatives 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.
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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 Conceive(R), PrimaCare(R), PrimaCare ONE(R) and
PreCare Premier(R). 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(R) 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 began shipping Evamist(TM) during March 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 primarily 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 2008, our three largest customers accounted for 24.6%,
23.9% and 9.8% of gross revenues. These customers were Cardinal
Health, McKesson Drug Company and Amerisource Corporation,
respectively. In fiscal 2007 and 2006, these customers accounted for
gross revenues of 21.1%, 25.7% and 14.4%, and 15.7%, 26.9% and 12.7%,
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 19.5% 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
2008, 2007 and 2006, total research and development expenses were
$46.6 million, $31.5 million and $28.9 million, respectively,
excluding acquired in-process research and development.
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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:
o 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.
o 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:
o laboratory and preclinical tests;
o submission of an Investigational New Drug ("IND")
application, which must become effective before clinical
studies may begin;
o adequate and well-controlled human clinical studies to
establish the safety and efficacy of the proposed product
for its intended use;
o 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;
o scale-up to commercial manufacturing; and
o 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:
o 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.
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o 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.
o 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 fiscal 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(R). 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 are now testing an alternative formula
in a Phase II study to determine which alternative to take into Phase
III clinicals. The Company expects to start Phase III clinicals in
fiscal 2010.
In May 2007, we acquired from VIVUS, Inc. the U.S. marketing rights
to Evamist(TM), a unique transdermal estrogen therapy delivering a
low dose of estradiol in a once-daily spray. Under terms of the asset
purchase agreement, we paid $10.0 million in cash at closing and made
an additional cash payment of $141.5 million upon final approval of
the product by the FDA in July 2007. Evamist(TM) is indicated for the
treatment of moderate-to-severe vasomotor symptoms due to menopause
and targets the estrogen replacement market where physicians and
patients are seeking an effective and safe, low-dose estrogen
product. We began shipping this product at the end of fiscal 2008.
In January 2008, we entered into a definitive asset purchase
agreement with CYTYC to acquire the U.S. and worldwide rights to
Gestiva(TM) (17-alpha hydroxyprogesterone caproate). Under the terms
of the asset purchase agreement, we agreed to pay $82.0 million for
Gestiva(TM), $7.5 million of which was paid at closing. 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. The FDA issued an "approvable"
letter for Gestiva(TM) in October 2006, and a final approval is
anticipated in fiscal 2009. The FDA has granted an Orphan Drug
Designation for Gestiva(TM).
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.
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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
When appropriate and available, we actively seek 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 42 U.S. patents and have 37 U.S.
patent applications pending. In addition, we have 71 foreign issued
patents and a total of 204 patent applications pending primarily in
Canada, Europe, Australia, Japan, South America, Mexico and South
Korea (see Part I, Item 1A "Risk Factors for additional information).
We depend on our patents and other proprietary rights and cannot be
certain of their confidentiality and protection.
We currently own more than 224 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, 2008,
aggregating approximately 1.3 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 2009 through fiscal 2021, subject in most cases to renewal at
our option.
We manufacture drug products in liquid, cream, 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 2008, 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.
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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.
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. (See "-Research and Development").
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.
In addition to establishing ANDA approval mechanisms, the
Hatch-Waxman Act fosters pharmaceutical innovation through such
incentives as non-patent exclusivity and patent restoration. The Act
provides two distinct exclusivity provisions that either preclude the
submission or delay the approval of an ANDA. A five-year exclusivity
period is provided for new chemical compounds, and a three-year
marketing exclusivity period is provided for changes to previously
approved drugs which are based on new clinical investigations
essential to the approval. The three-year marketing exclusivity
period may be applicable to the approval of a novel drug delivery
system. The marketing exclusivity provisions apply equally to
patented and non-patented drug products, but do not apply to products
containing antibiotic ingredients first submitted for approval on or
before November 20, 1997. These provisions do not delay or otherwise
affect the approvability of full NDAs even when effective ANDA
approvals are not available. For drugs covered by patents, patent
extension may be provided for up to five
16
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. We are involved in various
lawsuits resulting from ANDA filings. See Note 12 of the Notes to
Consolidated Financial Statements.
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.
In March 2008, representatives of the Missouri Department of Health
and Senior Services, accompanied by representatives of the FDA,
notified us of a hold on our inventory of certain unapproved drug
products, restricting our ability to remove or dispose of those
inventories without permission.
The hold relates to a misinterpretation about the intended scope of
recent FDA notices setting limits on the marketing of unapproved
guaifenesin products. In response to notices issued by the 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, we timely
discontinued a number of our guaifenesin products and believed that,
by doing so, had complied with those notices. The recent action to
place a hold on certain of our products indicates that additional
guaifenesin products should also have been discontinued. In addition,
the FDA expanded the hold to include other products that did not
contain guaifenesin but were being marketed without FDA approval
under certain "grandfather clauses" and statutory and regulatory
exceptions to the pre-market approval requirement for "new drugs"
under the FDCA. FDA policies permit the agency to initiate broad
action against the marketing of additional categories of our
unapproved products, if the FDA deems approval necessary, even if the
agency has not instituted similar actions against the marketing of
such products by other
17
parties. Pursuant to discussions with the Missouri Department of
Health and Senior Services and with the FDA, the affected Morphine
and Oxycodone products have been released from the hold. We will
discontinue manufacturing and marketing all of the other unapproved
products subject to the hold.
The FDA has not proposed, nor do we expect them to propose, that the
products subject to the hold be recalled from the distribution
channel. We have written-off the value of the products subject to the
hold in our inventory as of March 31, 2008. We also evaluated the
active pharmaceutical ingredients and excipients used in the
manufacture of the hold products and determined that they should also
be written-off since we will be discontinuing further manufacturing
and many of them cannot be returned or sold to other manufacturers.
The write-off included in the results of operations for the fourth
quarter of fiscal 2008 totaled $5.5 million.
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. We have timely filed an IND for such products.
In addition to obtaining pre-market approval for certain of our
products, we are required to maintain all facilities in compliance
with the FDA's current Good Manufacturing Practice, or cGMP,
requirements. In addition to compliance with cGMP each pharmaceutical
manufacturer's facilities must be registered with the FDA.
Manufacturers must also be registered with the U.S. Drug Enforcement
Administration, or DEA, and similar state and local regulatory
authorities if they handle controlled substances, 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, if 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
18
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, 2008, we employed a total of 1,590 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, in January 2008, the employee members of the union voted to
decertify their union representation. The decertification became
effective in February 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.
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 OF
THE BOARD OF DIRECTORS AND THE RESTATEMENT IN PRIOR PERIODS OF THE
COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS MAY RESULT IN ADDITIONAL
LITIGATION AND GOVERNMENT ENFORCEMENT ACTIONS.
In October 2006, the Board of Directors formed a Special Committee of
independent 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 concluded
that there was no intentional violation of law or accounting rules
with respect to the Company's historical stock option grant
practices. The Special Committee concluded, and based on its internal
review, management agreed, that incorrect measurement dates were used
for financial accounting purposes for stock option grants made in
certain prior periods. Therefore, we recorded
19
additional non-cash stock-based compensation expense, and related tax
effects, with regard to certain past stock option grants, and we
restated certain previously filed financial statements included in
our Form 10-K for fiscal 2007.
The independent investigation and management's internal review and
related activities required us to incur substantial expenses for
legal, accounting, tax and other professional services, 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 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 12 of the Notes to the Consolidated
Financial Statements, "Commitments and Contingencies," derivative
lawsuits were filed in state and federal courts against certain
current and former directors and executive officers pertaining to
allegations relating to stock option grants. The parties recently
agreed to settle these derivative lawsuits, subject to court
approval. 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. If the Company is subject to adverse findings in
litigation, regulatory proceedings or government enforcement actions,
we could be required to pay damages or penalties or have other
remedies imposed, all of which could have a material adverse effect
on our financial condition, results of operations or cash flows. The
resolution of these matters could continue to be time-consuming,
expensive, and a distraction to some of our management from the
conduct of the Company's business.
WE HAVE A MATERIAL WEAKNESS IN INTERNAL CONTROL OVER FINANCIAL
REPORTING AND CANNOT ASSURE YOU THAT ADDITIONAL MATERIAL WEAKNESSES
WILL NOT BE IDENTIFIED IN THE FUTURE. IF WE FAIL TO MAINTAIN AN
EFFECTIVE SYSTEM OF INTERNAL CONTROLS OR DISCOVER MATERIAL WEAKNESSES
IN OUR INTERNAL CONTROL OVER FINANCIAL REPORTING, WE MAY NOT BE ABLE
TO REPORT OUR FINANCIAL RESULTS ACCURATELY OR TIMELY OR DETECT FRAUD,
WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
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, the effectiveness of our internal control over financial
reporting.
Management concluded that there was a material weakness, as defined
in the Public Company Accounting Oversight Board's Auditing Standard
No. 5, in our internal control over financial reporting as of March
31, 2008. Management is implementing steps to remediate this material
weakness, however, we cannot assure you that such remediation will be
effective.
Management also 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 implemented steps to remediate these material
weaknesses as of March 31, 2008. See the discussion included in Part
I, 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
20
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 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, 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
21
products. The pharmaceutical field is crowded and a substantial
number of patents have been issued. In addition, the patent position
of pharmaceutical companies can be highly uncertain and frequently
involves complex legal and factual questions. As a result, the
breadth of claims allowed in patents relating to pharmaceutical
applications or their validity and enforceability cannot be
predicted. Patents are examined for patentability at patent offices
against bodies of prior art which by their nature may be incomplete
and imperfectly categorized. Therefore, even presuming that the
examiner has been able to identify and cite the best prior art
available to him during the examination process, any patent issued to
us could later be found by a court or a patent office during
post-issuance proceedings to be invalid in view of newly-discovered
prior art or already considered prior art or other legal reasons.
Furthermore, there are categories of "secret" prior art unavailable
to any examiner, such as the prior inventive activities of others,
which could form the basis for invalidating any patent. In addition,
there are other reasons why a patent may be found to be invalid, such
as an offer for sale or public use of the patented invention in the
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. For example, a third party company has recently
filed a declaratory judgment complaint in federal court challenging
patents pertaining to Ther-Rx's PrimaCare ONE(R). See 12 of the Notes
to Consolidated Financial Statements. 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.
22
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.
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. We
are involved in defending various patent lawsuits resulting from ANDA
filings by ETHEX or an effort by a third party company to invalidate
certain of our patents. See Note 12 of the Notes to Consolidated
Financial Statements. 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 five patent
infringement lawsuits pending against us and one declaratory judgment
lawsuit by a third party seeking to invalidate certain of our
patents. 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.
OUR DEPENDENCE ON KEY EXECUTIVES AND SCIENTISTS COULD IMPACT THE
DEVELOPMENT AND MANAGEMENT OF OUR BUSINESS.
We are highly dependent upon our ability to attract and retain
qualified scientific, technical and managerial personnel. There is
intense competition for qualified personnel in the pharmaceutical and
biotechnology industries, and we cannot be sure that we will be able
to continue to attract and retain qualified personnel necessary for
the development and management of our business. Although we do not
believe the loss of one individual would materially harm our
business, our business might be harmed by the loss of services of
multiple existing personnel, as well as the failure to recruit
additional key scientific, technical and managerial personnel in a
timely manner. Much of the know-how we have developed resides in our
scientific and technical personnel and is not readily transferable to
other personnel. While we have employment agreements with our key
executives, we do not ordinarily enter into employment agreements
with our other scientific, technical and managerial employees.
23
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, 2008, our
three largest customers, which are wholesale distributors, accounted
for 24.6%, 23.9% and 9.8% 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. For example, during June 2008, a third party
company introduced a product purporting to be substitutable for our
PrimaCare ONE(R), for which no FDA approval is required. We are
currently in litigation with this company with respect to patent and
trademark infringement and other claims. See Note 12 of the Notes to
Consolidated Financial Statements.
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 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.
In March 2008, representatives of the Missouri Department of Health
and Senior Services, accompanied by representatives of the FDA,
notified us of a hold on our inventory of certain unapproved drug
products restricting our ability to remove or dispose of those
inventories without permission.
The hold relates to a misinterpretation about the intended scope of
recent FDA notices setting limits on the marketing of unapproved
guaifenesin products. In response to notices issued by the 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, we timely
discontinued a number of our guaifenesin products and believed that,
by doing so, had complied with those notices. The recent action to
place a hold on certain of our products indicates that additional
guaifenesin products should also have been discontinued. In addition,
the FDA expanded the hold to include other products that did not
contain guaifenesin but were being marketed without FDA approval
under certain "grandfather clauses" and statutory and regulatory
exceptions to the pre-market approval requirement for "new drugs"
under the FDCA. FDA policies permit the agency to initiate broad
action against the marketing of additional categories of our
unapproved products, if the FDA deems approval necessary, even if the
agency has not instituted similar actions against the marketing of
such products by other parties. Pursuant to discussions with the
Missouri Department of Health and Senior Services and with the FDA,
the affected Morphine and Oxycodone products have been released from
the hold. We will discontinue
24
manufacturing and marketing all of the other unapproved products
subject to the hold with the exception of most of our Hyoscyamine
products. Discussions are continuing with respect to those products.
The FDA has not proposed, nor do we expect them to propose, that the
products subject to the hold be recalled from the distribution
channel. We have written-off the value of the products subject to the
hold in our inventory as of March 31, 2008. We also evaluated the
active pharmaceutical ingredients and excipients used in the
manufacture of the hold products and determined that they should also
be written-off since we will be discontinuing further manufacturing
and many of them cannot be returned or sold to other manufacturers.
The write-off included in the results of operations for the fourth
quarter of fiscal 2008 totaled $5.5 million.
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
25
the economic benefits of some of our products, we may decide to risk
an amount that may exceed the profit we anticipate making on our
product. There are a number of factors we would need to consider in
order to decide whether to launch our product prior to final
resolution, including (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 through license agreements. 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.
26
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 19.5% over the five
fiscal year period ended March 31, 2008, 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 OR
FINISHED PRODUCT 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
(including Evamist(TM) and, once approved, Gestiva(TM)), 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 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
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
27
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 in October 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. In August 2007, ETHEX settled the
Massachusetts lawsuit for $0.6 million in cash and agreed to supply
$0.2 million in free pharmaceutical products 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, we may not prevail in one or more of such
cases and 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.
28
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 2008, sales of our branded products and generic/non-branded
products accounted for 35.7% and 61.1%, respectively, of our net
revenues. During that year, branded products and generic/non-branded
products contributed gross margins of 89.7% and 63.1%, respectively,
to our consolidated gross profit margin of 69.0% in fiscal 2008.
Factors that may cause our sales mix to vary include:
o the amount and timing of new product introductions;
o marketing exclusivity on products, if any, which may be
obtained;
o the level of competition in the marketplace for certain
products;
o the availability of raw materials and finished products from our
suppliers;
o the buying patterns of our three largest wholesaler customers;
o the scope and outcome of governmental regulatory action that may
involve us;
o periodic dependence on a relatively small number of products for
a significant portion of net revenue or income; and
o 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, 2008, we had $269.5 million of outstanding debt,
consisting of $200.0 million principal amount of Contingent
Convertible Subordinated Notes due 2033 (the "Notes"), the remaining
principal balance of a $43.0 million mortgage loan entered into in
March 2006, and $30.0 million of borrowings outstanding under our
credit facility. We have a credit agreement with ten banks that
provides for a revolving line of credit for borrowing up to $320.0
million. This credit facility also includes a provision for
increasing the revolving commitment, at the lenders' sole discretion,
by up to an additional $50.0 million. The credit agreement is
unsecured unless we, under certain specified circumstances, utilize
the facility to redeem part or all of our outstanding Notes. The
credit facility has a five-year term expiring in June 2011. Our level
of indebtedness may have several important effects on our future
operations, including:
o we will be required to use a portion of our cash flow from
operations for the payment of any principal or interest due
on our outstanding indebtedness;
o our outstanding indebtedness and leverage will increase the
impact of negative changes in general economic and industry
conditions, as well as competitive pressures and increases
in interest rates; and
29
o the level of our outstanding debt and the impact it has on
our ability to meet debt covenants associated with our
revolving line of credit arrangement may affect our ability
to obtain additional financing for working capital, capital
expenditures, acquisitions or general corporate purposes.
General economic conditions, industry cycles and financial, business
and other factors affecting our operations, many of which are beyond
our control, may affect our future performance. As a result, our
business might not continue to generate cash flow at or above current
levels. If we cannot generate sufficient cash flow from operations in
the future to service our debt, we may, among other things:
o seek additional financing in the debt or equity markets;
o refinance or restructure all or a portion of our
indebtedness;
o sell selected assets;
o reduce or delay planned capital expenditures; or
o reduce or delay planned research and development
expenditures.
These measures might not be sufficient to enable us to service our
debt. In addition, any financing, refinancing or sale of assets might
not be available on economically favorable terms or at all.
We may also consider issuing additional debt or equity securities in
the future to fund potential acquisitions or investments, to
refinance existing debt, 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. Even though no holders required
us to repurchase all or a portion of their Notes on May 16, 2008, we
classified the Notes as a current liability as of March 31, 2008 due
to the right the holders had to require us to repurchase the Notes on
May 16, 2008. Since the holders did not elect to cause us to
repurchase any of the Notes, the Notes will be reclassified as
long-term liabilities beginning with our consolidated balance sheet
as of June 30, 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.
WE MAY BE ADVERSELY IMPACTED BY ECONOMIC FACTORS BEYOND OUR CONTROL
AND MAY INCUR IMPAIRMENT CHARGES TO OUR INVESTMENT PORTFOLIO.
We have funds invested in auction rate securities ("ARS"). Consistent
with our investment policy guidelines, the ARS held by us 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
30
markets and the ARS held by us may experience failed auctions as the
amount of securities submitted for sale may exceed the amount of
purchase orders. As a result, we may not be able to liquidate some or
all of our ARS prior to their maturities at prices approximating
their face amounts.
During the fourth quarter of fiscal 2008, disruption in the credit
and capital markets adversely affected the auction market for the
type of securities we own and the ARS held by us experienced failed
auctions as the amount of securities submitted for sale exceeded the
amount of purchase orders. If uncertainties in these credit and
capital markets continue or these markets deteriorate further we may
incur other-than-temporary impairments to our investments in ARS,
which could negatively affect our financial condition, cash flow and
reported earnings. (See Note 4 of the Notes to Consolidated Financial
Statements for further discussion of the Company's investment in
ARS.) We believe that as of March 31, 2008, based on our current
cash, cash equivalents and marketable securities balances of $126.9
million (exclusive of auction rate securities) and our current
borrowing capacity of $290.0 million under our credit facility, the
current lack of liquidity in the auction rate market will not have a
material impact on our ability to fund our operations or interfere
with our external growth plans, although, we cannot assure you that
this will continue to be the case.
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
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 CONDITION 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
31
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 health maintenance
organizations ("HMO's") and managed care organizations ("MCO's").
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:
o the trend toward managed health care in the U.S.;
o the growth of organizations such as HMOs and MCOs;
o legislative proposals to reform health care and government
insurance programs; and
o price controls and non-reimbursement of new and highly
priced medicines for which the economic therapeutic
rationales are not established.
These cost-containment measures and health care reform proposals
could affect our ability to sell our products.
The reimbursement status of a newly approved pharmaceutical product
or of unapproved products may be uncertain. Reimbursement policies
may not include some of our products or government agencies or third
parties may assert that certain of our products are not eligible for
Medicaid, Medicare or other reimbursement and were not so eligible in
the past, possibly resulting in demands for damages or refunds. Even
if reimbursement policies of third parties grant reimbursement status
for a product, we cannot be sure that these reimbursement policies
will remain in effect. Limits on reimbursement could reduce the
demand for our products. The unavailability or inadequacy of third
party reimbursement for our products could reduce or possibly
eliminate demand for our products. We are unable to predict whether
governmental authorities will enact additional legislation or
regulation which will affect third party coverage and reimbursement
that reduces demand for our products.
Our ability to market generic pharmaceutical products successfully
depends, in part, on the acceptance of the products by independent
third parties, including pharmacies, government formularies and other
retailers, as well as patients. We manufacture a number of
prescription drugs which are used by patients who have severe health
conditions. Although the brand-name products generally have been
marketed safely for many years prior to our introduction of a
generic/non-branded alternative, there is a possibility that one of
these products could produce a side effect which could result in an
adverse effect on our ability to achieve acceptance by managed care
providers, pharmacies and other retailers, customers and patients. If
these independent third parties do not accept our products, it could
have a material adverse effect on our business, financial condition,
results of operations or cash flows.
32
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 Company received a subpoena from the Office of Inspector General
of the Department of Health and Human Services, seeking documents
with respect to two of ETHEX's nitroglycerin products. Both are
unapproved products, that is, they have not received FDA approval.
(FDA approval is not necessarily required for all drugs to be sold in
the marketplace, such as pre-1938 "grandfathered" products or certain
drugs reviewed under the so-called DESI process. The Company believes
that its two products come within these exceptions.) The subpoena
states that it is in connection with an investigation into potential
false claims under Title 42 of the U.S. Code, and appears to pertain
to whether these products are eligible for reimbursement under
federal health care programs, such as Medicaid and VA programs.
On June 6, 2008, ETHEX initiated a voluntary recall of a single lot
of morphine sulfate 60 mg extended release tablets due to a report
that a tablet with as much as double the appropriate thickness was
identified and therefore the possibility that other oversized tablets
could have been commercially released in the affected lot. On June
13, 2008, the recall was expanded to include additional specific lots
of morphine sulfate 60 mg extended release tablets and specific lots
of morphine sulfate 30 mg extended release tablets. We accrued a
liability of $0.9 million in the fourth quarter of fiscal 2008 for
the anticipated cost of the recall. No oversized tablets have been
identified in any additional distributed lots of these products and
based on our investigation, there are likely to be few, if any,
oversized tablets in the recall lots. In addition, under ordinary
pharmacy dispensing procedures, any significantly oversized tablets
would likely be identified at the time of dispensing. However, the
decision to recall the additional lots has been taken as a
responsible precaution because of the possibility that there may be
oversized tablets in the recalled lots.
33
The process for obtaining governmental approval to manufacture and
market pharmaceutical products is rigorous, time-consuming and
costly, and we cannot predict the extent to which we may be affected
by legislative and regulatory developments. We are dependent on
receiving FDA and other governmental or third-party approvals prior
to manufacturing, marketing and shipping many of our products.
Consequently, there is always the chance that we will not obtain FDA
or other necessary approvals, or that the rate, timing and cost of
such approvals, will adversely affect our product introduction plans
or results of operations.
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 actual or potential
investigations regarding our former stock option grant practices, our
reporting of prices used by government agencies or third parties in
setting reimbursement rates, the introduction by other companies of
generic or competing products, or the eligibility of our products for
Medicaid, Medicare or other reimbursement; 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, 2008, an aggregate of 3,697,049 shares of our Class A
Common Stock and 236,415 shares of our Class B Common Stock were
issuable upon exercise of outstanding stock options under our stock
option plans, and an additional 96,405 shares of our Class A Common
Stock and 1,212,500 shares of Class B Common Stock were reserved for
the issuance of additional options and shares under these plans. In
addition, as of March 31, 2008, 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, 2008, our directors and executive officers beneficially
own approximately 16.4% of our Class A Common Stock and approximately
89.3% of our Class B Common Stock. As a result, these persons control
approximately 57.3% 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
34
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 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.
35
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 02/29/10 2 Years
23,000 KV Office/R&D/Mfg. 12/31/11 5 Years(1)
41,316 KV Warehouse 11/30/16 None
33,860 Pharmaceutical Division Offices 05/01/13 5 Years
------
153,326
Owned Facilities
126,168 KV Office/Mfg
121,472 KV Office/Whse./Lab(2)
87,250 KV Mfg.
88,850 KV Lab
302,940 KV Mfg/Whse/ETHEX/Ther-Rx Office (2)
259,990 ETHEX/Ther-Rx/PDI Distribution(2)
96,360 KV Warehouse
------
1,083,030
<FN>
----------------------------------------
(1) Two five-year options.
(2) In March 2006, we entered into a $43.0 million mortgage loan
agreement with one of our primary lenders secured, in part, by
these properties. This loan bears interest at a rate of 5.91%
and matures on April 1, 2021.
Properties used in our operations are considered suitable for the
purposes for which they are used and are believed to be adequate to
meet our needs for the reasonably foreseeable future. However, we
will consider leasing or purchasing additional facilities from time
to time, when attractive facilities become available, to accommodate
the consolidation of certain operations and to meet future expansion
plans.
ITEM 3. LEGAL PROCEEDINGS
-----------------
The information set forth under Note 12 - Commitments and
Contingencies - of the Notes to Consolidated Financial Statements
included in Part I, 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, 2008.
36
ITEM 4 A. EXECUTIVE OFFICERS OF THE REGISTRANT
------------------------------------
The following is a list of current executive officers of our Company,
their ages, their positions with our Company and their principal
occupations for at least the past five years.
NAME AGE POSITION HELD AND PAST EXPERIENCE
- ----------------------------------------------------------------------------------------------------------------------------------
Michael S. Anderson 59 Corporate Vice President, Industry Presence and Development since February 2006; Chief
Executive Officer, Ther-Rx Corporation from February 2000 to February 2006.
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.
Rita E. Bleser 52 President, Pharmaceutical Manufacturing Division since April 2007; Vice President,
Technology, Tyco Healthcare from September 2001 to April 2007.
Paul T. Brady 45 Corporate Vice President, Business Development Administration, KV Pharmaceutical since 2007;
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.
Richard H. Chibnall 52 Vice President, Finance and Chief Accounting Officer since June 2005; Vice President, Finance
from February 2000 to June 2005.
Raymond F. Chiostri 74 Corporate Vice President, KV Pharmaceutical since September 2006; Chairman and Chief Executive
Officer of Particle Dynamics, Inc. from 1999 to September 2006.
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.
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.
Ronald J. Kanterman 53 Vice President, Chief Financial Officer, Treasurer and Assistant Secretary since March 2008;
Vice President, Strategic Financial Management, Treasurer, and Assistant Secretary from
March 2006 to February 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.
Patricia K. McCullough 56 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.
David A. Van Vliet 53 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.
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.
37
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 March 31, 2008, was 893 and 313, 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 2008 and 2007, as reported
on the New York Stock Exchange were as follows:
CLASS A COMMON STOCK
--------------------
FISCAL 2008 FISCAL 2007
----------- -----------
QUARTER HIGH LOW HIGH LOW
------- ---------------------- -----------------------
First...................... $28.35 $24.58 $24.31 $17.50
Second..................... 28.80 26.09 23.94 16.90
Third...................... 31.34 27.16 24.91 21.74
Fourth..................... 28.20 24.71 26.28 22.83
CLASS B COMMON STOCK
--------------------
FISCAL 2008 FISCAL 2007
----------- -----------
QUARTER HIGH LOW HIGH LOW
------- ---------------------- -----------------------
First...................... $28.40 $24.61 $24.27 $17.48
Second..................... 28.90 25.96 23.92 16.92
Third...................... 31.25 27.30 24.86 21.78
Fourth..................... 28.09 24.63 26.21 22.71
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 each of
fiscal 2008 and 2007 on 40,000 shares of outstanding Cumulative
Convertible Preferred Stock. There were no undeclared and unaccrued
cumulative preferred dividends at March 31, 2008.
38
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 16 of
the 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
- ------------------------- ---------------------- ----------------------- ---------------------- ----------------------
1/1/08 - 1/31/08 104 $27.61 - -
- ---------------------------------------------------------------------------------------------------------------------
2/1/08 - 2/29/08 37 $27.51 - -
- ---------------------------------------------------------------------------------------------------------------------
3/1/08 - 3/31/08 1,247 $25.46 - -
- ---------------------------------------------------------------------------------------------------------------------
Total 1,388 $25.67 - -
- ---------------------------------------------------------------------------------------------------------------------
<FN>
(a) Shares were purchased from employees upon their termination
pursuant to the terms of the Company's Stock Option Plan.
39
EQUITY COMPENSATION PLAN INFORMATION
The following information regarding compensation plans of the Company
is furnished as of March 31, 2008, 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) 3,697,049 $19.09 96,405
Equity compensation plans not
approved by security holders -- -- --
--------- ------ ------
Total 3,697,049 $19.09 96,405
========= ======
<FN>
- -------------------------------
(1) Consists of the Company's 1991 and 2001 Incentive Stock Option Plans. See Note 16 of the 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) 236,415 $14.85 1,212,500
Equity compensation plans not
approved by security holders -- -- --
------- ------ ---------
Total 236,415 $14.85 1,212,500
======= =========
<FN>
- -------------------------------
(1) Consists of the Company's 1991 and 2001 Incentive Stock Option Plans.
See Note 16 of the Notes to Consolidated Financial Statements.
40
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, 2003, 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 GRAPH]
YEARS ENDED MARCH 31,
---------------------
2004 2005 2006 2007 2008
---- ---- ---- ---- ----
K-V PHARMACEUTICAL COMPANY 210.92 200.13 201.57 202.83 203.75
NYSE COMPOSITE 142.52 158.13 185.71 213.48 207.39
S&P PHARMACEUTICALS 105.12 100.38 101.53 113.21 104.33
41
ITEM 6. SELECTED FINANCIAL DATA
-----------------------
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and the notes thereto
in Part II, Item 8 and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in Part II, Item 7 of this report. The
selected consolidated financial data presented below under the captions
"BALANCE SHEET DATA" and "INCOME STATEMENT DATA" as of and for each of the
years in the five-year period ended March 31, 2008 is derived, with respect to
the years ended March 31, 2008, 2007 and 2006, from our audited consolidated
financial statements, and, with respect to the years ended March 31, 2005 and
2004, from the selected financial data of the Company included in our Form
10-K for the year ended March 31, 2007. The consolidated financial statements
as of March 31, 2008 and 2007, and for each of the years in the three-year
period ended March 31, 2008, which have been audited by KPMG LLP, our
independent registered public accounting firm, are included in Part II, Item 8
of this report.
BALANCE SHEET DATA
(in thousands) MARCH 31,
-------------------------------------------------------------------------------
2008 2007 2006 2005 2004
-------- -------- -------- -------- --------
Cash, cash equivalents and
marketable securities $126,893 $240,386 $207,469 $205,519 $226,911
Working capital 88,764 372,291 304,958 296,240 301,604
Property and equipment, net 196,200 186,900 178,042 131,624 75,777
Total assets 869,027 707,783 619,313 558,952 527,679
Current liabilities 280,655 59,179 44,332 41,577 55,745
Long-term debt 67,432 239,451 241,319 209,767 210,741
Shareholders' equity 459,282 364,827 302,999 286,477 252,721
INCOME STATEMENT DATA
(in thousands, except per share data) YEARS ENDED MARCH 31,
--------------------------------------------------------------------------------
2008 2007 2006 2005 2004
--------- --------- --------- --------- ---------
Net revenues $ 601,896 $ 443,627 $ 367,640 $ 304,656 $ 282,994
Operating income (a)(b) 130,370 88,156 36,157 51,684 70,600
Net income (a)(b) 88,354 58,090 11,416 31,217 41,700
Earnings per share:
Diluted - Class A common $ 1.57 $ 1.05 $ 0.23 $ 0.60 $ 0.78
Diluted - Class B common 1.35 0.91 0.20 0.52 0.68
Shares used in per share calculation:
Diluted - Class A common 59,144 58,953 49,997 58,633 57,792
Diluted - Class B common 12,281 12,489 13,113 15,072 16,175
Preferred stock dividends $ 70 $ 70 $ 70 $ 70 $ 436
<FN>
- ----------------------
(a) Operating income in fiscal 2008 included purchased in-process
research and development expenses of $10.0 million and $7.5 million
recorded in connection with the Evamist(TM) and Gestiva(TM)
acquisitions, respectively (see Note 3 of the Notes to the
Consolidated Financial Statements). The impact of these items was to
decrease net income on an after-tax basis by $11.7 million in fiscal
2008.
(b) Operating income in fiscal 2006 included an expense of $30.4 million
recognized in connection with the FemmePharma acquisition that
consisted of $29.6 million for acquired in-process research and
development and $0.9 million for direct expenses related to the
transaction (see Note 3 of 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.
42
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 should be read in conjunction with "Selected
Financial Data" and our consolidated financial statements and the
notes thereto appearing elsewhere in this Form 10-K.
BACKGROUND
We are a fully integrated specialty pharmaceutical company that
develops, 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), oral controlled release, tastemasking and
oral quick dissolving tablets. We incorporate these technologies in
the products we market to control and improve the absorption and
utilization of active pharmaceutical compounds. These technologies
provide a number of benefits, including reduced frequency of
administration, reduced side effects, improved drug efficacy,
enhanced patient compliance and improved taste.
Our drug delivery technologies allow us to differentiate our products
in the marketplace, both in the branded and generic/non-branded
pharmaceutical areas. We believe that this differentiation provides
substantial competitive advantages for our products, allowing us to
establish a strong record of growth and profitability and a
leadership position in certain segments of our industry.
RESULTS OF OPERATIONS
Net revenues for fiscal 2008 increased $158.3 million, or 35.7%, as
we experienced sales growth of 56.1% in our specialty
generics/non-branded products segment. The increase in specialty
generic net revenues resulted primarily from the launch in July 2007
of the 100 mg and 200 mg strengths of metoprolol succinate
extended-release tablets, which along with the 25 mg approved and
launched in March 2008, generated net revenues of $120.0 million in
fiscal 2008. The resulting $119.0 million increase in gross profit
was offset in part by a $76.8 million increase in operating expenses.
The increase in operating expenses was primarily due to increases in
personnel costs, branded marketing and promotions expense, legal
fees, research and development expense, and amortization of
intangibles. Operating expenses for fiscal 2008 also included
purchased in-process research and development expenses of $10.0
million and $7.5 million recorded in connection with the Evamist(TM)
and Gestiva(TM) acquisitions, respectively (see Note 3 of the Notes
to the Consolidated Financial Statements). As a result, net income
for fiscal 2008 increased $30.3 million, or 52.1%, to $88.4 million.
43
FISCAL 2008 COMPARED TO FISCAL 2007
NET REVENUES BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
-------------------
($ IN THOUSANDS): 2008 2007 $ %
------------- ------------ ---------- -----
Branded products $ 214,863 $ 188,681 $ 26,182 13.9%
as % of net revenues 35.7% 42.5%
Specialty generics/non-branded 367,862 235,594 132,268 56.1%
as % of net revenues 61.1% 53.1%
Specialty materials 18,020 17,436 584 3.3%
as % of net revenues 3.0% 3.9%
Other 1,151 1,916 (765) (39.9)%
------------- ------------ ----------
Total net revenues $ 601,896 $ 443,627 $ 158,269 35.7%
The increase in branded product sales was due primarily to continued
sales growth of our anti-infective brand, Clindesse(R), coupled with
increased sales from our prescription prenatal and hematinic product
lines. Sales of Clindesse(R) increased 27.4% to $40.5 million during
fiscal 2008 due to an increase in prescription volume of 27.4%
coupled with the impact of price increases over the past year. Sales
from our PreCare(R) product line increased 13.7% to $82.5 million
during fiscal 2008. This increase was primarily due to sales growth
experienced by PrimaCare ONE(R) and PreCare Premier(R), coupled with
product line price increases. Specifically sales of PrimaCare ONE(R)
increased $13.3 million, or 30.3%, to $57.0 million in fiscal 2008.
This increase reflected the impact of price increases over the past
12 months coupled with continued market share gains as PrimaCare
ONE(R)'s share of the prescription prenatal vitamin market improved
to 27.2% at the end of the fiscal 2008, up from 23.1% at the end of
fiscal 2007. During June 2008, a third party company has introduced a
product that purports to be substitutable for PrimaCare ONE(R), and
we are currently in litigation with this company with respect to
patent and trademark infringement and other claims. See Note 12 of
the Notes to Consolidated Financial Statements. Sales of our
hematinic products increased 11.6% to $53.8 million in fiscal 2008,
which primarily reflected sales growth of our newest hematinic
product, Repliva 21/7(R). Sales of Gynazole-1(R), our vaginal
antifungal cream product, declined 2.7% to $24.0 million during
fiscal 2008. The fluctuation in Gynazole-1(R) sales reflected the
impact of a decline in market share, offset in part by price
increases that occurred in the first and fourth quarters of fiscal
2008. Branded product sales were also impacted by the introduction of
Evamist(TM) at the end of fiscal 2008. Evamist(TM), a unique
transdermal estrogen therapy that delivers a low dose of estradiol in
a once-daily spray, was acquired in May 2007 and received FDA
approval in July 2007. We began shipping this new product at the end
of March 2008 and generated fiscal 2008 sales of $2.0 million. 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.
The growth in specialty generic/non-branded sales resulted primarily
from the launch in July 2007 of 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 and they generated net
revenues of $119.1 million during fiscal 2008. We received FDA
approval to market the 25 mg strength of metoprolol succinate
extended-release tablets in March 2008 and began shipping this
product at that time. Sales of this product totaled $0.9 million in
fiscal 2008. In addition, we received FDA approval to market the 50
mg strength of metoprolol succinate extended-release tablets in May
2008. As a result of the recent 50 mg approval, we now offer the
complete line of all four dosage strengths of metoprolol succinate
extended-release tablets - 200 mg, 100 mg, 50
44
mg and 25 mg - and as of March 2008, we had a 69.1% and 72.5% share
of the generic market according to IMS Inc. for the 200 mg and 100 mg
strengths, respectively. Our specialty generic sales for the year
were also favorably impacted by sales of six strengths of Diltiazem
HCI ER Capsules (AB rated to Tiazac(R)) which we launched in
September 2006. These products generated net revenues of $22.1
million in fiscal 2008, an increase of $10.5 million over the prior
year amount.
GROSS PROFIT BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
---------------------------------------------------
CHANGE
--------------------
($ IN THOUSANDS): 2008 2007 $ %
------------ ----------- ---------- ------
Branded products $ 192,666 $ 167,864 $ 24,802 14.8%
as % of net revenues 89.7% 89.0%
Specialty generics/non-branded 232,182 138,272 93,910 67.9%
as % of net revenues 63.1% 58.7%
Specialty materials 7,173 6,005 1,168 19.5%
as % of net revenues 39.8% 34.4%
Other (16,680) (15,777) (903) (5.7)%
------------- ----------- ----------
Total gross profit $ 415,341 $ 296,364 $ 118,977 40.1%
as % of total net revenues 69.0% 66.8%
The increase in gross profit was primarily due to the sales growth
experienced by our specialty generics and branded products segments.
The increase in specialty generic sales resulted primarily from the
launch in July 2007 of the 100 mg and 200 mg strengths of metoprolol
succinate extended-release tablets, which along with the 25 mg
approved and launched in March 2008, generated net revenues of $120.0
million in fiscal 2008. 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. The gross profit
percentages at our specialty generic/non-branded segment and on a
consolidated basis increased over the prior year because the 180-day
exclusivity period allowed us to offer the 100 mg and 200 mg
strengths of metoprolol succinate extended-release tablets at
relatively higher margins than our other generic/non-branded
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. During fiscal 2008, the provision for obsolete inventory
increased to $18.8 million compared to $12.0 million in fiscal 2007.
The increase in the provision for obsolete inventory was primarily
due to the impact of the FDA hold on certain unapproved specialty
generic products that occurred in March 2008. We included in the
reserve for obsolete inventory $5.5 million for all of the unapproved
specialty generic products subject to the FDA hold, including the raw
materials used to manufacture the products and work-in-process
inventories that we had on hand at March 31, 2008.
RESEARCH AND DEVELOPMENT
------------------------
YEARS ENDED MARCH 31,
---------------------------------------------------
CHANGE
------------------
($ IN THOUSANDS): 2008 2007 $ %
----------- ----------- ---------- ----
Research and development $ 46,634 $ 31,462 $ 15,172 48.2%
as % of net revenues 7.7% 7.1%
45
The increase in research and development expense was primarily due to
a growing product development pipeline, 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): 2008 2007 $ %
----------- ----------- ----------- -----
Purchased in-process research
and development $ 17,500 $ - $ 17,500 NM
In May 2007, we acquired from VIVUS, Inc the U.S. marketing rights to
Evamist(TM), a new estrogen replacement therapy product delivered
with a patented metered-dose transdermal spray system (see Note 3 of
the Notes to Consolidated Financial Statements). Under terms of the
agreement, we paid $10.0 million in cash at closing and made
additional cash payments of $141.5 million in July 2007 when final
approval of the product was received from the FDA. Since the product
had not yet obtained FDA approval when the initial payment was made
at closing, we recorded a $10.0 million purchased in-process research
and development charge in fiscal 2008.
In January 2008, we entered into a definitive asset purchase
agreement with 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. Under the terms of the asset purchase agreement, we agreed to
pay $82.0 million for Gestiva(TM), $7.5 million of which was paid at
closing. Because the product had not obtained FDA approval when the
initial payment was made, we recorded the $7.5 million payment as
in-process research and development expense in fiscal 2008.
SELLING AND ADMINISTRATIVE
--------------------------
YEARS ENDED MARCH 31,
-----------------------------------------------
CHANGE
----------------
($ IN THOUSANDS): 2008 2007 $ %
--------- --------- -------- ----
Selling and administrative $ 208,206 $ 171,936 $ 36,270 21.1%
as % of net revenues 34.6% 38.8%
The increase in selling and administrative expenses was
primarily due to:
o $13.9 million increase in personnel costs due to increases
in management, sales and other personnel;
o $8.3 million increase in branded marketing and promotions
expense;
o $2.3 million increase in travel and auto leasing costs at
our branded products segment;
o $4.0 million increase in legal and professional expense
commensurate with an increase in litigation activity; and
o $4.5 million increase in costs associated with
redistribution fees paid to major wholesalers and chains.
Redistribution fees are fees paid to large customers for
single point shipping services which allow manufacturers to
ship to a single location rather than to multiple customer
warehouse locations.
46
AMORTIZATION AND IMPAIRMENT OF INTANGIBLE ASSETS
------------------------------------------------
YEARS ENDED MARCH 31,
--------------------------------------------
CHANGE
----------------
($ IN THOUSANDS): 2008 2007 $ %
---------- ----------- ------- -----
Amortization and impairment of intangible assets $ 12,631 $ 4,810 $ 7,821 162.6%
as % of net revenues 2.1% 1.1%
The increase in the amortization of intangible assets of $6.7 million
was primarily due to the purchase of Evamist(TM) in May 2007 and the
impact of intangible assets that we recorded thereon (see Note 3 of
the Notes to Consolidated Financial Statements). Under terms of the
purchase agreement, we made two cash payments: $10.0 million was paid
in May 2007 and expensed as in-process research and development and
$141.5 million was paid in July 2007 when final approval of the
product was received from the FDA. The preliminary purchase price
allocation, which is subject to change based on the final fair value
assessment, resulted in estimated identifiable intangible assets of
$52.4 million to product rights; $15.2 million to trademark rights;
$66.4 million to rights under a sublicense agreement; and, $7.5
million to a covenant not to compete. Upon FDA approval in July 2007,
we began amortizing the product rights, trademark rights and rights
under the sublicense agreement over 15 years and the covenant not to
compete over nine years.
During the year ended March 31, 2008, we recognized an impairment
charge of $1.1 million for the intangible asset related to a product
right acquired under an external development agreement. Price erosion
on the product eliminated the economics of marketing the product. The
entire balance of the intangible asset was written-off as the product
is no longer expected to generate positive future cash flows.
OPERATING INCOME
----------------
YEARS ENDED MARCH 31,
-------------------------------------------------
CHANGE
------------------
($ IN THOUSANDS): 2008 2007 $ %
--------- -------- --------- ----
Operating income $ 130,370 $ 88,156 $ 42,214 47.9%
The improvement in operating income was primarily due to sales of the
100 mg and 200 mg strengths of metoprolol succinate extended-release
tablets. We began shipping these two products in July 2007 and they
generated net revenues of $119.1 million during the year. The related
increase in gross profit of $119.0 million was offset in part by a
$76.8 million increase in operating expenses, which included
purchased in-process research and development expenses of $10.0
million and $7.5 million recorded in connection with the Evamist(TM)
and Gestiva(TM) acquisitions, respectively (see Note 3 of the Notes
to the Consolidated Financial Statements). Excluding the effect of
the $17.5 million of purchased in-process research and development
expense, operating income for fiscal 2008 would have increased $59.7
million, or 67.7%.
INTEREST EXPENSE
----------------
YEARS ENDED MARCH 31,
---------------------------------------------
CHANGE
----------------
($ IN THOUSANDS): 2008 2007 $ %
--------- ------- ------- ----
Interest expense $ 10,353 $ 8,985 $ 1,368 15.2%
The increase in interest expense was primarily the result of interest
incurred on the $50.0 million of borrowings made under our credit
facility in August 2007. The advance against our credit facility was
used, along with cash on hand, to fund the $141.5 million payment for
the purchase of Evamist(TM) (see Note 3 of the Notes to
47
Consolidated Financial Statements). We repaid $20.0 million of the
borrowing against our credit facility in November 2007.
INTEREST AND OTHER INCOME
-------------------------
YEARS ENDED MARCH 31,
------------------------------------------------
CHANGE
----------------
($ IN THOUSANDS): 2008 2007 $ %
---------- ------- ------- ----
Interest and other income $ 11,646 $ 9,901 $ 1,745 17.6%
The increase in interest and other income resulted primarily from an
increase in the weighted average interest rate earned on short-term
investments. The increase in the weighted average interest rate
resulted principally from a restructuring of the investment portfolio
in the prior year from short-term tax-exempt securities to short-term
taxable securities.
PROVISION FOR INCOME TAXES
--------------------------
YEARS ENDED MARCH 31,
-------------------------------------------------
CHANGE
------------------
($ IN THOUSANDS EXCEPT PER SHARE DATA): 2008 2007 $ %
--------- --------- --------- ----
Provision for income taxes $ 43,309 $ 32,958 $ 10,351 31.4%
effective tax rate 32.9% 37.0%
The lower effective tax rate in fiscal 2008 resulted primarily from
the reversal of certain tax liabilities associated with tax positions
from previous years that were determined to no longer be necessary as
the relevant statute of limitations had expired. The effective tax
rates for both the current and prior periods were favorably impacted
by the domestic manufacturer's deduction and the use of business
credits. (See Note 15 of the Notes to Consolidated Financial
Statements). The fiscal 2007 tax rate was adversely affected by the
recording of additional liabilities associated with tax positions
claimed on filed tax returns.
NET INCOME AND DILUTED EARNINGS PER SHARE
-----------------------------------------
YEARS ENDED MARCH 31,
-------------------------------------------------
CHANGE
------------------
($ IN THOUSANDS EXCEPT PER SHARE DATA): 2008 2007 $ %
-------- -------- --------- ----
Net income $ 88,354 $ 58,090 $ 30,264 52.1%
Diluted earnings per Class A share 1.57 1.05 0.52 49.5%
Diluted earnings per Class B share 1.35 0.91 0.44 48.4%
The improvement in net income per share was primarily due to sales of
the 100 mg and 200 mg strengths of metoprolol succinate
extended-release tablets. We began shipping these two products in
July 2007 and along with the approval and launch of the 25 mg in
March 2008, they generated net revenues of $120.0 million during the
year. The increase in gross profit of $119.0 million was offset in
part by a $76.8 million increase in operating expenses, which
included purchased in-process research and development expenses of
$10.0 million and $7.5 million recorded in connection with the
Evamist(TM) and Gestiva(TM) acquisitions, respectively (see Note 3 of
the Notes to the Consolidated Financial Statements). Excluding the
effect of the purchased in-process research and development expense,
net income for fiscal 2008 would have increased $42.0 million, or
72.3%.
48
FISCAL 2007 COMPARED TO FISCAL 2006
NET REVENUES BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
---------------------------------------------------
CHANGE
-------------------
($ IN THOUSANDS): 2007 2006 $ %
------------ ------------ ---------- ----
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 ONE(R), the introduction of
PreCare Premier(R) and product line price increases that occurred
over the past 12 months. Sales of PrimaCare ONE(R) in fiscal 2007
increased $22.3 million, or 104.2%, due primarily to market share
gains over the past two years. Specifically, PrimaCare ONE(R)
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(R), 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 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 $9.1 million,
or 24.2%, due to incremental sales from three product approvals
received late in fiscal 2006 and increased prices on the other pain
management products.
The increase in specialty material product sales was primarily due to
the impact of price increases on certain products.
49
GROSS PROFIT BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
--------------------
($ IN THOUSANDS): 2007 2006 $ %
------------ ----------- ---------- ------
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 $4.2 million, respectively.
RESEARCH AND DEVELOPMENT
------------------------
YEARS ENDED MARCH 31,
---------------------------------------------------
CHANGE
------------------
($ 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 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
50
During fiscal 2006, we recorded expense of $30.4 million in
connection with the FemmePharma acquisition (see Note 3 of the Notes
to the Consolidated Financial Statements) "Acquisitions and License
Agreement" that consisted of $29.6 million for acquired in-process
research and development and $0.9 million in direct expenses related
to the transaction. The valuation of acquired in-process research and
development represents the estimated fair value of the worldwide
marketing rights to an endometriosis product we acquired as part of
the FemmePharma acquisition that, at the time of the acquisition, had
no alternative future use and for which technological feasibility had
not been established.
SELLING AND ADMINISTRATIVE
--------------------------
YEARS ENDED MARCH 31,
--------------------------------------------------
CHANGE
------------------
($ IN THOUSANDS): 2007 2006 $ %
--------- --------- --------- ----
Selling and administrative $ 171,936 $ 143,437 $ 28,499 20.0%
as % of net revenues 38.8% 39.0%
The increase in selling and administrative expense was primarily due
to:
o $14.8 million increase in personnel costs due to increases
in management and other personnel;
o $3.4 million increase in branded marketing and promotions
expense and
o $2.2 million increase in expense resulting from facility
expansion.
The increase in personnel costs included $3.1 million of incremental
stock-based compensation expense resulting from the adoption of SFAS
123R, "Share-Based Payment," and an increase in accrued payroll
taxes, interest and penalties associated with the disqualification of
certain stock options. We adopted SFAS 123R using the modified
prospective method and, as a result, did not retroactively adjust
results from prior periods. Prior to the adoption of SFAS 123R, we
accounted for stock-based compensation using the intrinsic value
method prescribed in APB 25.
AMORTIZATION OF INTANGIBLE ASSETS
---------------------------------
YEARS ENDED MARCH 31,
------------------------------------------
CHANGE
--------------
($ 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.
OPERATING INCOME
----------------
YEARS ENDED MARCH 31,
----------------------------------------------------
CHANGE
--------------------
($ IN THOUSANDS): 2007 2006 $ %
-------- -------- --------- -----
Operating income $ 88,156 $ 36,157 $ 51,999 143.8%
51
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 $21.6 million, or 32.4%.
INTEREST EXPENSE
----------------
YEARS ENDED MARCH 31,
-----------------------------------------------
CHANGE
----------------
($ 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
----------------
($ IN THOUSANDS): 2007 2006 $ %
-------- -------- ------- ----
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 $30.4 million. The effective tax rates in both fiscal 2007
and 2006 were adversely affected by the recording of additional
liabilities associated with tax positions claimed on filed tax
returns for those years.
52
NET INCOME AND DILUTED EARNINGS PER SHARE
-----------------------------------------
YEARS ENDED MARCH 31,
-----------------------------------------------
CHANGE
------------------
($ IN THOUSANDS): 2007 2006 $ %
-------- -------- --------- -----
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.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
The Company reports cash and cash equivalents and working capital of
$86.3 million and $88.8 million, respectively, at March 31, 2008,
compared to $82.6 million and $372.3 million, respectively, at March
31, 2007. The decrease in working capital resulted primarily from the
$200.0 million principal amount of Convertible Subordinated Notes
(the "Notes") that we classified as a current liability at March 31,
2008 due to the holders having the right to require us to repurchase
all or a portion of their Notes on May 16, 2008. Working capital was
also reduced in fiscal 2008 by the reclassification of $81.5 million
of auction rate securities from current assets to non-current assets
(see Note 4 of 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. Our net cash flow from operating activities of $122.4 million
in fiscal 2008 resulted primarily from net income adjusted for
non-cash items.
Net cash flow used in investing activities included capital
expenditures of $23.7 million in fiscal 2008 compared to $25.1
million for the prior year. Investing activities in fiscal 2008 also
consisted of two cash payments made under the Evamist(TM) purchase
agreement: $10.0 million was paid in May 2007 and expensed as
in-process research and development and $141.5 million was paid in
July 2007 when final approval of the product was received from the
FDA. The preliminary purchase price allocation, which is subject to
change based on the final fair value assessment, resulted in
estimated identifiable intangible assets of $52.4 million to product
rights; $15.2 million to trademark rights; $66.4 million to rights
under a sublicense agreement; and $7.5 million to a covenant not to
compete. Upon FDA approval in July 2007, we began amortizing the
product rights, trademark rights and rights under the sublicense
agreement over 15 years and the covenant not to compete over nine
years. In addition, other investing activities in fiscal 2008
included a $7.5 million payment we made when we acquired the U.S. and
worldwide rights to Gestiva(TM) in January 2008. Because the product
had not obtained FDA approval when the initial payment was made at
closing, we recorded the $7.5 million as in-process research and
development expense. The remainder of the purchase price is payable
on the completion of two milestones: (1) $2.0 million on the earlier
to occur of the seller'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 us and receipt by us of defined launch quantities of
finished Gestiva(TM) suitable for commercial sale. We expect approval
of the Gestiva(TM) NDA in fiscal 2009. Finally, other investing
activities for 2008 included $125.4 million and $158.8 million of
purchases and sales, respectively, of investment securities
classified as available for sale.
At March 31, 2008, we had invested $83.9 million in principal
amount of auction rate securities ("ARS"). Our investments in ARS
represent interests in securities that have student loans as
collateral that are guaranteed by the U.S. Government. Accordingly,
ARS that are backed by student loans are viewed as having low default
risk and very low risk of downgrade. 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.
The auctions have historically provided a liquid market for these
securities. The ARS investments held by us all had AAA credit ratings
at the time of purchase and at the end of our fiscal 2008 year end.
With the liquidity issues experienced in global credit
53
and capital markets, the ARS held by us at March 31, 2008 experienced
failed auctions beginning in February 2008 as the amount of
securities submitted for sale exceeded the amount of purchase orders.
Given the failed auctions, our ARS will continue to be illiquid until
there is a successful auction for them. We cannot predict how long
the current imbalance in the auction rate market will continue. The
estimated fair value of our ARS holdings at March 31, 2008 was $81.5
million, which reflected a $2.4 million difference from the principal
amount of $83.9 million. The estimated fair value of the ARS was
based on a discounted cash flow model that considered, among other
factors, the time to work out the market disruption in the
traditional trading mechanism, the stream of cash flows (coupons)
earned until maturity, the prevailing risk free yield curve, credit
spreads applicable to a portfolio of student loans with various
tenures and ratings and an illiquidity premium. These factors were
used in a Monte Carlo simulation based methodology to derive the
estimated fair value of the ARS. Although the ARS continue to pay
interest according to their stated terms, we recorded during the
fourth quarter of fiscal 2008 an unrealized loss of $1.6 million, net
of tax, as a reduction to shareholders' equity in accumulated other
comprehensive loss, reflecting adjustments to the ARS holdings that
we have concluded have a temporary decline in value.
ARS have historically been classified as short-term marketable
securities in our consolidated balance sheet. Given the failed
auctions, we have reclassified the $81.5 million of ARS as of March
31, 2008 from current assets to non-current assets (see Note 4 to the
Notes to Consolidated Financial Statements). We believe that as of
March 31, 2008, based on our current cash, cash equivalents and
marketable securities balances of $126.9 million and our current
borrowing capacity under our credit facility of $290.0 million, the
current lack of liquidity in the auction rate market will not have a
material impact on our ability to fund our operations or interfere
with our external growth plans, although we cannot assure you that
this will continue to be the case.
Our debt balance, including current maturities, was $269.5 million at
March 31, 2008 compared to $241.3 million at March 31, 2007. In
August 2007, we borrowed $50.0 million under our credit facility, the
proceeds of which were used in the funding of the Evamist(TM)
purchase. We repaid $20.0 million of the borrowing under our credit
facility in November 2007.
In May 2003, we issued $200.0 million principal amount of Notes that
are convertible, under certain circumstances, into shares of our
Class A Common Stock at an initial conversion price of $23.01 per
share. The 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. In November 2007, the average
trading price of the Notes reached the threshold for the five-day
trading period that results in the payment of contingent interest and
beginning November 16, 2007 the Notes began to bear interest at a
rate of 3.00% per annum. 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. Even though no holders required us to
repurchase all or a portion of their Notes on May 16, 2008, we
classified the Notes as a current liability as of March 31, 2008 due
to the right the holders had to require us to repurchase the Notes on
May 16, 2008. Since the holders did not elect to cause us to
repurchase any of the Notes, the Notes will be reclassified as
long-term beginning with our consolidated balance sheet as of June
30, 2008. The Notes are subordinate to all of our existing and future
senior obligations.
We have a credit agreement with ten banks that provides for a
revolving line of credit for borrowing up to $320.0 million. The
credit agreement also includes a provision for increasing the
revolving commitment, at the lenders' sole discretion, by up to an
additional $50.0 million. This 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 senior debt
to EBITDA. The 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
credit facility has a five-year term expiring in June 2011. As of
March 31, 2008, we were in
54
compliance with all of our financial covenants. At March 31, 2008, we
had $0.9 million in open letters of credit issued under the revolving
credit line and $30.0 million of cash borrowings outstanding under
the facility.
In December 2005, we entered into a financing arrangement with St.
Louis County, Missouri related to expansion of our operations in St.
Louis County (see Note 11 of 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 to the property being placed in service. Industrial
revenue bonds totaling $120.4 million were outstanding at March 31,
2008. 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 5
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS YEARS
----- ------ --------- --------- -----
OBLIGATIONS AT MARCH 31, 2008
-----------------------------
Long-term debt obligations(1) $ 269,452 $ 202,020 $ 4,420 $ 34,976 $ 28,036
Operating lease obligations 8,147 2,183 2,909 2,116 939
Other long-term obligations(2) 8,551 - - - 8,551
--------- ----------- -------- --------- ---------
Total contractual cash obligations(3)(4) $ 286,150 $ 204,203 $ 7,329 $ 37,092 $ 37,526
========= =========== ======== ========= =========
<FN>
------------------
(1) Holders of the $200.0 million aggregate principal amount of
Notes had the right to require the Company to repurchase them
for an amount equal to the unpaid principal amount in May 2008.
No bonds were tendered to the Company under the holders put
right.
(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) Excluded from the contractual obligations table is the
liability for unrecognized tax benefits totaling $11.7 million.
This liability for unrecognized tax benefits has been excluded
because we cannot make a reliable estimate of the period in
which the unrecognized tax benefits will be realized.
(4) 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 $31.0 million as of March 31, 2008. Also, under
terms of the Evamist(TM) asset purchase agreement, it 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 addition, under terms of the Gestiva(TM) asset
purchase agreement, the remainder of the purchase price is
payable on the completion of two milestones: (1) $2.0 million
on the earlier to occur of the seller'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 us and receipt by us of defined launch quantities of
finished Gestiva(TM) suitable for commercial sale.
On February 14, 2006, the Company announced it had entered into an
agreement with Gedeon Richter under which the Company had acquired
exclusive rights to market a group of generic products in the U.S.
However, due to changes in the generic drug marketplace, the Company
and Gedeon Richter have agreed the current portfolio of products
covered by the agreement, which has now been terminated, no longer
represent market opportunities that are worth pursuing. The two
companies remain committed partners in other endeavors and are
keeping options open to explore other more meaningful joint
opportunities.
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 generally has been invested in short-term, highly liquid
instruments, however, certain of our investments in auction-rate
securities have become illiquid, as described
55
above. 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.
GOVERNMENT REGULATION
In March 2008, representatives of the Missouri Department of Health
and Senior Services, accompanied by representatives of the FDA,
notified us of a hold on our inventory of certain unapproved drug
products, restricting our ability to remove or dispose of those
inventories without permission.
The hold relates to a misinterpretation about the intended scope of
recent FDA notices setting limits on the marketing of unapproved
guaifenesin products. In response to notices issued by the 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, we timely
discontinued a number of our guaifenesin products and believed that,
by doing so, had complied with those notices. The recent action to
place a hold on certain of our products indicates that additional
guaifenesin products should also have been discontinued. In addition,
the FDA expanded the hold to include other products that did not
contain guaifenesin but were being marketed by us without FDA
approval under certain "grandfather clauses" and statutory and
regulatory exceptions to the pre-market approval requirement for "new
drugs" under the FDCA. FDA policies permit the agency to initiate
broad action against the marketing of additional categories of our
unapproved products, if the FDA deems approval necessary, even if the
agency has not instituted similar actions against the marketing of
such products by other parties. Pursuant to discussions with the
Missouri Department of Health and Senior Services and with the FDA,
the affected Morphine and Oxycodone products have been released from
the hold. We will discontinue manufacturing and marketing
substantially all unapproved products subject to the hold.
The FDA has not proposed, nor do we expect them to propose, that the
products subject to the hold be recalled from the distribution
channel. As such, we have written-off the value of the products
subject to the hold in our inventory as of March 31, 2008. We also
evaluated the active pharmaceutical ingredients and excipients used
in the manufacture of the hold products and determined that they
should also be written-off since we will be discontinuing further
manufacturing and many of them cannot be returned or sold to other
manufacturers. The write-off included in the results of operations
for the fourth quarter of fiscal 2008 totaled $5.5 million.
During most of fiscal 2008, we marketed approximately 30 products in
our generic/non-branded respiratory line, which consisted primarily
of cough/cold products. The cough/cold line accounted for $38.5
million, or 10.5%, of our specialty generic net revenues in fiscal
2008. As a result of the FDA hold discussed above, we are currently
marketing one generic cough/cold product with four strengths that has
been approved by the FDA. Since its launch in December 2007, this
approved product generated sales of $0.9 million during fiscal 2008.
On June 6, 2008, ETHEX initiated a voluntary recall of a single lot
of morphine sulfate 60 mg extended release tablets due to a report
that a tablet with as much as double the appropriate thickness was
identified and therefore the possibility that other oversized tablets
could have been commercially released in the affected lot. On June
13, 2008, the recall was expanded to include additional specific lots
of morphine sulfate 60 mg extended release tablets and specific lots
of morphine sulfate 30 mg extended release tablets. We accrued a
liability of $0.9 million in the fourth quarter of fiscal 2008 for
the anticipated cost of the recall. No oversized tablets have been
identified in any additional distributed lot of these products and
based on our investigation, there are likely to be few, if any,
oversized tablets in the recall lots. In addition, under ordinary
pharmacy dispensing procedures, any significantly oversized tablets
would likely be identified at the time of dispensing. However, the
decision to recall the additional lots has been taken as a
responsible precaution because of the possibility that there may be
oversized tablets in the recalled lots.
INFLATION
Inflation may apply upward pressure on the cost of goods and services
used by us in the future. However, we believe that the net effect of
inflation on our operations during the past three years has been
minimal. In addition, changes in the mix of products sold and the
effects of competition have 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 of
the Notes to Consolidated Financial Statements. Certain of our
accounting policies are particularly important to the presentation of
our financial condition 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
56
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 10.4% and 11.6% of total gross revenues for
fiscal 2008 and fiscal 2007, 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 2008,
through an internal analysis that considers, among other things,
wholesaler purchases, wholesaler contract sales, available end
consumer prescription information and inventory data received from
our three largest wholesale customers. We believe that our evaluation
of wholesaler inventory levels allows us to make reasonable estimates
of our reserve balances. Further, our products are typically sold
with adequate shelf life to permit sufficient time for our wholesaler
customers to sell our products in their inventory through to the end
consumer.
57
The following table reflects the fiscal 2008 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, 2008
Accounts Receivable Reserves:
Chargebacks $ 13,005 $ 145,005 $ - $ (140,410) $ 17,600
Sales rebates 5,386 36,582 - (29,384) 12,584
Sales returns 2,873 15,733 - (14,311) 4,295
Cash discounts and other allowances 3,511 26,674 - (24,518) 5,667
Medicaid rebates 6,506 10,433 - (10,439) 6,500
-------- --------- ------------ ---------- --------
Total $ 31,281 $ 234,427 $ - $ (219,062) $ 46,646
======== ========= ============ ========== ========
The increase in the reserve for chargebacks at March 31, 2008 was
primarily due to chargeback reserves established on the 100 mg and
200 mg strengths of metoprolol succinate extended-release tablets,
the generic version of Toprol-XL(R) (marketed by AstraZeneca). We
began shipping these two products in July 2007, and along with the
approval and launch of the 25 mg in March 2007, they generated net
revenues of $120.0 million in fiscal 2008. The increases in the
reserves for sales rebates and cash discounts and other allowances at
March 31, 2008 were also primarily due to the impact of sales
associated with the two strengths of metoprolol succinate
extended-release tablets. We received FDA approval to market the 25
mg strength of metoprolol succinate extended-release tablets in March
2008 and began shipping this product at that time. Sales of this
product near year-end and wholesaler inventory levels of such at
March 31, 2008 increased the reserves for chargebacks and sales
rebates as well. The increase in the reserve for sales returns
resulted primarily from the discontinuance of certain cardiovascular
products late in fiscal 2008 coupled with higher returns of two pain
management products in fiscal 2008.
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
-------- -------------- ------------- -------------- --------
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.
58
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/non-branded business segment. During fiscal 2008
and 2007, the chargeback provision reduced the gross sales of our
specialty generics segment by $142.9 million and $93.9 million,
respectively. These amounts accounted for 98.8% and 99.2% of the
total chargeback provisions recorded in fiscal 2008 and 2007,
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:
o 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 2008, unit sales to our three major
wholesale customers accounted for 82% of our total unit sales to
all wholesalers, and the aggregate inventory position of the
three major wholesalers at March 31, 2008 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, 2008, each week
of inventory for those remaining wholesalers represented
approximately $0.2 million, or 1.2%, of the reported reserve for
chargebacks.
o 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, 2008, the aggregate weighted average
percentage of sales to wholesalers assumed to result in
chargebacks was approximately 95%, with each 1% representing
approximately $0.2 million, or 1.0%, of the reported reserve for
chargebacks.
o Contract pricing and the resulting chargeback per unit. The
chargeback provision is based on the difference between our
invoice price to the wholesaler (referred to as wholesale
acquisition cost, or "WAC") and the contract price negotiated
with either our indirect customer or with the wholesaler for
sales by the wholesaler to the indirect customers. We calculate
the price difference, or chargeback per unit, for each product
and for each major wholesale customer using historical weighted
average pricing, based on actual chargeback experience. Use of
weighted average pricing over time compensates for changes in
the mix of indirect customers and products from period to
period. As of March 31, 2008, a 5% shift in the calculated
chargeback per unit in the same direction across all products
and customers would result in a $0.8 million, or 4.5%, impact on
the reported reserve for chargebacks.
59
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 generic/non-branded products, we paid
shelf-stock adjustments of $7.6 million to our wholesale customers
during fiscal 2008.
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 generic/non-branded 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, 2008 by approximately $0.2 million, or 5.6%, 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, 2008 by approximately $0.3 million,
or 8.1%, 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, 2008 by
$0.5 million, or 8.3% 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 8.3% 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.
60
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 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. We 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 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 on or subsequent to the effective date of SFAS 123R
based on the grant date fair value estimated in accordance with the
provisions of that statement. 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
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 the financial reporting and
tax basis of assets and liabilities. 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. If
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 tax 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 regulations are subject to interpretation and tax
litigation is inherently uncertain, these evaluations
61
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.
Our accounting for income taxes was affected by the adoption of FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes -
an interpretation of FASB Statement No. 109," on April 1, 2007. See
Note 15 of the Notes to Consolidated Financial Statements.
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 condition or results of
operations, such estimates are considered to be critical accounting
estimates. After review, it was determined at March 31, 2008 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 September 2006, the Financial Accounting Standards Board ("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. We plan to adopt SFAS 157 at the
beginning of fiscal 2009 and are evaluating the impact, if any, the
adoption of SFAS 157 will have on our 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. We plan to adopt SFAS 159 at the beginning of fiscal
2009 and are evaluating the impact, if any, the adoption of SFAS 159
will have on our 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. We plan to adopt
Issue 06-10 at the beginning of fiscal 2009 and are evaluating the
impact of the adoption of Issue 06-10 on our 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"),
62
which is effective for fiscal years beginning after 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. We plan to adopt Issue 07-3 at the beginning of fiscal
2009 and are evaluating the impact of the adoption of this issue on
our 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 companies will be required to apply the provisions through
retrospective application. We plan to adopt Issue 07-1 at the
beginning of fiscal 2010 and are evaluating the impact of the
adoption of Issue 07-1 on our 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 business
combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after
December 15, 2008 and earlier adoption is prohibited. We plan to
adopt SFAS 141(R) at the beginning of fiscal 2010 and are evaluating
the impact of SFAS 141(R) on our 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. We plan to adopt SFAS 160 at the beginning of
fiscal 2010 and are evaluating the impact of SFAS 160 on our
financial condition and results of operations.
In May 2008, the FASB issued FASB Staff Position No. APB 14-a,
"Accounting for Convertible Debt Instruments That May Be Settled in
Cash Upon Conversion (Including Partial Cash Settlement)." Under the
new rules for convertible debt instruments that may be settled
entirely or partially in cash upon conversion, an entity
63
should separately account for the liability and equity components of
the instrument in a manner that reflects the issuer's economic
interest cost. The effect of the proposed new rules for the
debentures is that the equity component would be included in the
paid-in-capital section of shareholders' equity on an entity's
consolidated balance sheet and the value of the equity component
would be treated as original issue discount for purposes of
accounting for the debt component of convertible debt. The FSP will
be effective for fiscal years beginning after December 15, 2008, and
for interim periods within those fiscal years, with retrospective
application required. Early adoption is not permitted. We are
currently evaluating the proposed new rules and the impact on our
financial condition and results of operations.
64
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.
We currently have investments in taxable auction rate securities. The
rates on these securities reset at pre-determined intervals up to 35
days. As of March 31, 2008, we had invested $83.9 million principal
amount in auction rate securities consisting of high quality (AAA
rated) bonds secured by student loans which are guaranteed by the U.
S. Government. The maturity of these securities is greater than 10
years. During the fourth quarter of fiscal 2008, certain developments
in the capital and credit markets adversely affected the market for
auction rate securities, which has resulted in a loss of liquidity
for these investments. We have evaluated these securities to
determine if other-than-temporary impairment of the carrying value of
the securities has occurred due to the loss of liquidity. At March
31, 2008, the fair value of auction rate securities was $81.5 million
and the resultant difference of $2.4 million was recorded in
accumulated other comprehensive loss as the unrealized losses were
considered to be temporary (see Note 4 of the Notes to Consolidated
Financial Statements). We believe that as of March 31, 2008, based on
our cash, cash equivalents and short-term marketable securities
balances of $126.9 million, excluding auction rate securities, and
our current borrowing capacity of $290.0 million under our credit
facility, the current lack of liquidity in the auction rate market
will not have a material impact on our ability to fund our operations
or interfere with our external growth plans, although we cannot
assure you that this will continue to be the case.
The favorable impact on our pre-tax 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 $0.5 million, $1.1
million or $2.2 million annually based on our average cash, cash
equivalents and short-term marketable investment balances during the
fiscal year ended March 31, 2008.
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. At March 31, 2008, we had
$30.0 million of borrowings outstanding under our credit facility.
The unfavorable impact on our pre-tax 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 $0.1 million, $0.2
million or $0.3 million annually based on the $30.0 million of
borrowings that were outstanding under our line of credit at March
31, 2008.
In May 2003, we issued $200.0 million principal amount of Convertible
Subordinated Notes. 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.
In November 2007, the average trading price of the Notes reached the
threshold for the five-day trading period that results in the payment
of contingent interest and beginning November 16, 2007 the Notes
began to bear interest at a rate of 3.00% per annum. 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. Even though no holders required us to repurchase all
or a portion of their Notes on May 16, 2008, we have classified the
Notes as a current liability as of March 31, 2008 due to the right
the holders had to require us to repurchase the Notes on May 16,
2008. Since the holders did not elect to cause us to repurchase any
of the Notes, the Notes will be reclassified as long-term liabilities
beginning with our consolidated balance sheet as of June 30, 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.
65
ITEM 8. 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, 2008 and
2007, 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, 2008. In connection with our audits of the consolidated
financial statements, we also have 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, 2008 and 2007, and the
results of their operations and their cash flows for each of the years in the
three-year period ended March 31, 2008, in conformity with U.S. generally
accepted accounting principles. Also in our opinion, the related financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, the Company
adopted the provisions of Statement of Financial Accounting Standards No. 123
(Revised 2004), "Share-Based Payment", effective April 1, 2006.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), K-V Pharmaceutical Company's
internal control over financial reporting as of March 31, 2008, 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 June 25, 2008 expressed an adverse opinion on the
effectiveness of the Company's internal control over financial reporting.
St. Louis, Missouri
June 25, 2008
66
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
MARCH 31,
---------------------------
2008 2007
----------- -----------
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents............................................................ $ 86,345 $ 82,574
Marketable securities................................................................ 40,548 157,812
Receivables, less allowance for doubtful accounts of $867 and $716
in 2008 and 2007, respectively.................................................... 107,070 78,634
Inventories, net..................................................................... 94,980 91,515
Prepaid and other assets............................................................. 7,792 6,571
Income taxes receivable.............................................................. 9,872 --
Deferred tax asset................................................................... 22,812 14,364
----------- -----------
Total Current Assets.............................................................. 369,419 431,470
Property and equipment, less accumulated depreciation................................ 196,200 186,900
Investment securities................................................................ 81,516 --
Intangible assets and goodwill, net.................................................. 198,784 69,010
Other assets......................................................................... 23,108 20,403
----------- -----------
TOTAL ASSETS......................................................................... $ 869,027 $ 707,783
=========== ===========
LIABILITIES
-----------
CURRENT LIABILITIES:
Accounts payable..................................................................... $ 32,119 $ 18,506
Accrued liabilities.................................................................. 46,516 33,218
Income taxes payable................................................................. -- 5,558
Current maturities of long-term debt................................................. 202,020 1,897
----------- -----------
Total Current Liabilities......................................................... 280,655 59,179
Long-term debt....................................................................... 67,432 239,451
Other long-term liabilities.......................................................... 22,359 6,319
Deferred tax liability............................................................... 39,299 38,007
----------- -----------
TOTAL LIABILITIES.................................................................... 409,745 342,956
----------- -----------
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, 2008 and
2007 (convertible into Class A shares on a 8.4375 to one basis)................... -- --
Class A and Class B Common Stock, $.01 par value;150,000,000 and
75,000,000 shares authorized, respectively;
Class A - issued 40,764,603 and 40,316,426 at March 31, 2008
and 2007, respectively........................................................ 407 403
Class B - issued 12,170,172 and 12,393,982 at March 31, 2008 and
2007, respectively (convertible into Class A shares on a one-for-one basis)... 122 124
Additional paid-in capital........................................................... 158,742 150,818
Retained earnings.................................................................... 357,714 269,430
Accumulated other comprehensive (loss) income........................................ (1,543) 33
Less: Treasury stock, 3,289,324 shares of Class A and 92,902 shares of Class B Common
Stock at March 31, 2008, and 3,237,023 shares of Class A and 92,902 shares
of Class B Common Stock at March 31, 2007, at cost................................ (56,160) (55,981)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY........................................................... 459,282 364,827
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................................... $ 869,027 $ 707,783
=========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
67
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
YEARS ENDED MARCH 31,
-----------------------------------------------------
2008 2007 2006
--------- --------- ---------
Net revenues....................................................... $ 601,896 $ 443,627 $ 367,640
Cost of sales...................................................... 186,555 147,263 123,935
--------- --------- ---------
Gross profit....................................................... 415,341 296,364 243,705
--------- --------- ---------
Operating expenses:
Research and development....................................... 46,634 31,462 28,886
Purchased in-process research and
development and transaction costs.......................... 17,500 -- 30,441
Selling and administrative..................................... 208,206 171,936 143,437
Amortization and impairment of intangible assets............... 12,631 4,810 4,784
--------- --------- ---------
Total operating expenses........................................... 284,971 208,208 207,548
--------- --------- ---------
Operating income................................................... 130,370 88,156 36,157
--------- --------- ---------
Other expense (income):
Interest expense............................................... 10,353 8,985 6,045
Interest and other income...................................... (11,646) (9,901) (5,737)
--------- --------- ---------
Total other expense (income), net.................................. (1,293) (916) 308
--------- --------- ---------
Income before income taxes and cumulative effect
of change in accounting principle.............................. 131,663 89,072 35,849
Provision for income taxes......................................... 43,309 32,958 24,433
--------- --------- ---------
Income before cumulative effect of change
in accounting principle........................................ 88,354 56,114 11,416
Cumulative effect of change in accounting
principle (net of $670 in taxes)............................... -- 1,976 --
--------- --------- ---------
Net income......................................................... $ 88,354 $ 58,090 $ 11,416
========= ========= =========
(CONTINUED)
68
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME - (CONTINUED)
(In thousands, except per share data)
YEARS ENDED MARCH 31,
-------------------------------------------------------
2008 2007 2006
----------- ----------- -----------
Earnings per share before cumulative effect of change in
accounting principle:
Basic - Class A common.............................. $ 1.87 $ 1.19 $ 0.24
Basic - Class B common.............................. 1.55 0.99 0.20
Diluted - Class A common............................ 1.57 1.02 0.23
Diluted - Class B common............................ 1.35 0.88 0.20
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.............................. $ 1.87 $ 1.23 $ 0.24
Basic - Class B common.............................. 1.55 1.03 0.20
Diluted - Class A common............................ 1.57 1.05 0.23
Diluted - Class B common............................ 1.35 0.91 0.20
Shares used in per share calculation:
Basic - Class A common.............................. 37,150 36,813 35,842
Basic - Class B common.............................. 12,198 12,390 12,918
Diluted - Class A common............................ 59,144 58,953 49,997
Diluted - Class B common............................ 12,281 12,489 13,113
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
69
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
YEARS ENDED MARCH 31,
-----------------------------------------------
2008 2007 2006
----------- ---------- ------------
Net income............................................................. $ 88,354 $ 58,090 $ 11,416
Unrealized gain (loss) on available for sale securities:
Unrealized holding gain (loss) during the period.................... (2,424) 100 (118)
Reclassification of losses included in net income................... -- 270 --
Tax impact related to other comprehensive income (loss)............. 848 (126) 40
----------- ---------- ------------
Total other comprehensive income (loss).......................... (1,576) 244 (78)
----------- ---------- ------------
Total comprehensive income............................................. $ 86,778 $ 58,334 $ 11,338
=========== ========== ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
70
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED MARCH 31, 2008, 2007 AND 2006
-------------------------------------------------------------------------------------------
ACCUMULATED TOTAL
CLASS A CLASS B ADDITIONAL OTHER SHARE-
PREFERRED COMMON COMMON PAID-IN TREASURY RETAINED COMPREHENSIVE HOLDERS'
STOCK STOCK STOCK CAPITAL STOCK EARNINGS INCOME (LOSS) EQUITY
----- ----- ----- ------- ----- -------- ------------- ------
(Dollars in thousands)
BALANCE AT MARCH 31, 2005............... $ -- $ 386 $ 133 $ 139,678 $ (53,651) $ 200,064 $ (133) $ 286,477
Net income.............................. -- -- -- -- -- 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................ -- -- -- 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..................... -- 4 1 3,138 -- -- -- 3,143
Excess income tax benefits from
stock option exercises................ -- -- -- 1,437 -- -- -- 1,437
Other comprehensive loss................ -- -- -- -- -- -- (78) (78)
-----------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2006............... -- 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
Net income.............................. -- -- -- -- -- 88,354 -- 88,354
Dividends paid on preferred stock....... -- -- -- -- -- (70) -- (70)
Conversion of 234,528 Class B
shares to Class A shares.............. -- 2 (2) -- -- -- -- --
Stock-based compensation................ -- -- -- 5,205 -- -- -- 5,205
Purchase of common stock for
treasury.............................. -- -- -- -- (179) -- -- (179)
Stock options exercised - 174,813
shares of Class A and 9,427 shares
of Class B........................... -- 2 -- 1,343 -- -- -- 1,345
Excess income tax benefits from
stock option exercises............... -- -- -- 1,376 -- -- -- 1,376
Reimbursement payment received
from CEO - 45,531 shares of
Class A Common Stock................. -- -- -- -- -- -- -- --
Other comprehensive loss .............. -- -- -- -- -- -- (1,576) (1,576)
-----------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2008.............. $ -- $ 407 $ 122 $ 158,742 $ (56,160) $ 357,714 $ (1,543) $ 459,282
=========================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
71
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
YEARS ENDED MARCH 31,
-----------------------------------------------
2008 2007 2006
------------ ---------- ----------
Operating Activities:
Net income............................................................. $ 88,354 $ 58,090 $ 11,416
Adjustments to reconcile net income to net cash provided by
operating activities:
Acquired in-process research and development........................ 17,500 -- 29,570
Cumulative effect of change in accounting principle................. -- (1,976) --
Depreciation and amortization ..................................... 31,120 22,388 18,002
Deferred income tax (benefit) provision............................. (6,308) 7,698 6,062
Deferred compensation............................................... 2,232 877 965
Stock-based compensation............................................ 5,205 3,984 927
Excess tax benefits associated with stock options................... (1,376) (683) --
Other............................................................... 1,440 270 --
Changes in operating assets and liabilities:
Decrease (increase) in receivables, net............................. (28,436) (25,063) 7,593
Increase in inventories............................................. (3,465) (20,349) (16,792)
Increase in prepaid and other assets................................ (6,443) (2,771) (1,185)
(Decrease) increase in income taxes payable......................... (1,622) 2,413 3,659
Increase in accounts payable and accrued
liabilities...................................................... 24,157 12,257 4,392
------------ ---------- ----------
Net cash provided by operating activities.............................. 122,358 57,135 64,609
------------ ---------- ----------
Investing Activities:
Purchase of property and equipment.................................. (23,656) (25,066) (58,334)
Purchase of marketable securities................................... (125,426) (178,949) (61,187)
Sale of marketable securities....................................... 158,750 128,000 --
Purchase of preferred stock......................................... -- (400) (11,300)
Product acquisitions................................................ (159,000) -- (25,643)
------------ ---------- ----------
Net cash used in investing activities.................................. (149,332) (76,415) (156,464)
------------ ---------- ----------
Financing Activities:
Principal payments on long-term debt................................ (1,896) (1,652) (892)
Proceeds from borrowing of long-term debt........................... -- -- 32,764
Proceeds from borrowing on line of credit........................... 50,000 -- --
Repayment of borrowing on line of credit............................ (20,000) -- --
Dividends paid on preferred stock................................... (70) (70) (70)
Purchase of common stock for treasury............................... (179) (2,077) (253)
Excess tax benefits associated with stock options................... 1,376 683 --
Cash deposits received for stock options............................ 1,514 4,264 1,187
------------ ---------- ----------
Net cash provided by financing activities............................. 30,745 1,148 32,736
------------ ---------- ----------
Increased (decrease) in cash and cash equivalents..................... 3,771 (18,132) (59,119)
Cash and cash equivalents:
Beginning of year................................................... 82,574 100,706 159,825
------------ ---------- ----------
End of year......................................................... $ 86,345 $ 82,574 $ 100,706
============ ========== ==========
Non-cash investing and financing activities:
Term loans refinanced............................................... $ -- $ -- $ 9,859
Stock options exercised (at expiration of two-year
forfeiture period).......................................... 1,345 3,620 3,143
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
72
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.
INVESTMENT SECURITIES
---------------------
The Company's investment securities consist of mutual funds
comprised of U.S. government guaranteed investments and auction
rate securities. The Company classifies its investment
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 the
ability to liquidate them through a dutch auction process that
occurs on pre-determined intervals, up to 35 days. The Company
reclassified these securities to non-current investment
securities at March 31, 2008 to reflect the current lack of
liquidity in these investments (see Note 4).
73
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 ranging from
nine to 20 years. Costs associated with the development of
patents and trademarks are amortized on a straight-line basis
over estimated useful lives ranging from five to 17 years. 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
2008 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 the cost method. Such
investments are included in "Other assets" in the accompanying
consolidated balance sheets and relate primarily to the
Company's $12,284 investment at March 31, 2008 in the preferred
stock of Strides Arcolab Limited.
74
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.
o Payment discounts are reductions to invoiced amounts
offered to customers for payment within a specified
period and are estimated utilizing historical customer
payment experience.
o 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.
o 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.
o 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.
Provisions for estimated chargebacks are calculated
primarily using historical chargeback experience,
actual contract pricing and estimated and actual
wholesaler inventory levels.
o 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
75
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.
o 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 $234,427, $148,822 and
$154,662 for the years ended March 31, 2008, 2007 and 2006,
respectively. The reserve balances related to the sales
provisions totaled $46,646 and $31,281 at March 31, 2008 and
2007, 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 U.S. As a result, the Company is required
to estimate the level of receivables which ultimately will not
be paid. The Company calculates this estimate based on prior
experience supplemented by a customer specific review when it is
deemed necessary. On a periodic basis, the Company performs
evaluations of the financial condition of all customers to
further limit its credit risk exposure. Actual losses from
uncollectible accounts have historically been insignificant.
The Company's three largest customers accounted for
approximately 31.0%, 28.6% and 9.0%, and 33.7%, 19.7% and 15.1%
of gross receivables at March 31, 2008 and 2007, respectively.
For the year ended March 31, 2008, KV's three largest customers
accounted for 24.6%, 23.9% and 9.8% of gross revenues. For the
years ended March 31, 2007 and 2006, the Company's three largest
customers accounted for gross revenues of 21.1%, 25.7% and 14.4%
and 15.7%, 26.9% and 12.7%, respectively.
The Company maintains cash balances at certain financial
institutions that are greater than the FDIC insurable limit.
SHIPPING AND HANDLING COSTS
---------------------------
The Company classifies shipping and handling costs in cost of
sales. The Company does not derive revenue from shipping.
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
76
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
$27,545, $21,932 and $18,366 for the years ended March 31, 2008,
2007 and 2006, respectively. Advertising expense includes the
cost of product samples given to physicians for marketing to
their patients.
LITIGATION
----------
The Company is subject to litigation in the ordinary course of
business and to certain other contingencies (see Note 12). Legal
fees and other expenses related to litigation and contingencies
are recorded as incurred. The Company, in consultation with its
legal counsel, also assesses the need to record a liability for
litigation and contingencies on a case-by-case basis. Accruals
are recorded when the Company determines that a loss related to
a matter is both probable and reasonably estimable.
DEFERRED FINANCING COSTS
------------------------
Deferred financing costs of $5,835 were incurred in connection
with the issuance of convertible debt (see Note 10). 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 $5,635 and $4,471 at March 31, 2008 and
2007, respectively. Deferred financing costs, net of accumulated
amortization, are included in "Other Assets" in the accompanying
consolidated balance sheets.
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. 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.
The Company presents 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. The Company presents 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,
77
convertible preferred stock and the Notes. 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 Notes 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.
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 amount of existing
assets and liabilities and the respective tax basis. 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 evaluates the
realizability of its deferred tax assets by assessing its
valuation allowance and by adjusting the amount of such
allowance, if necessary. The factors used to assess the
likelihood of realization include the Company's forecast of
future taxable income and available tax planning strategies that
could be implemented to realize the net deferred tax assets.
Failure to achieve forecasted taxable income in applicable tax
jurisdictions could affect the ultimate realization of deferred
tax assets and could result in an increase in the Company's
effective tax rate on future earnings.
The Company accounts for uncertain tax positions in accordance
with FASB Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes -- an Interpretation of FASB Statement No. 109"
("FIN 48"), which was issued in July 2006. 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 50%
likelihood of being realized upon ultimate settlement. The
Company recognizes interest and penalties, if any, related to
unrecognized tax benefits in income tax expense.
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.
78
The following table provides the pro forma effects on net income
and earnings per share for fiscal 2006 as if the fair value
recognition provisions of SFAS 123 had been applied to options
granted under the Company's employee compensation plans:
YEAR ENDED
MARCH 31, 2006
-------------------
Net income $ 11,416
Add: Stock-based compensation expense
included in net income, net of tax 641
Deduct: Stock-based compensation using the
fair value based method for all awards (2,669)
-------------------
Pro forma net income $ 9,388
===================
Earnings per share:
Basic - Class A common $ 0.24
Basic - Class B common 0.20
Diluted - Class A common 0.23
Diluted - Class B common 0.20
Earnings per share - pro forma:
Basic - Class A common $ 0.20
Basic - Class B common 0.17
Diluted - Class A common 0.19
Diluted - Class B common 0.16
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, a mortgage loan agreement, and borrowings under the
Company's line of credit. 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 investment in the preferred stock of Strides
Arcolab Limited of $14,311, including accrued but unpaid
dividends, had a fair value of $14,600 at March 31, 2008 based
on a valuation analysis. Based on quoted market rates, the
Company's convertible debt had a fair value of $228,360 and
$229,240 at March 31, 2008 and 2007, respectively. The carrying
amount of the mortgage loan agreement and the outstanding
balance of the line of credit approximate their fair values
because their terms are similar to those which can be obtained
for similar financial instruments in the current marketplace.
79
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, 2008, 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 September 2006, the Financial Accounting Standards Board
("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
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 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 for
fiscal years beginning after 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
80
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
plans to adopt Issue 07-3 at the beginning of fiscal 2009 and is
evaluating the impact of the adoption of this issue 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 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 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 date fair
values. SFAS 141(R) is effective for business combinations for
which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after December 15,
2008 and earlier adoption is prohibited. 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.
In May 2008, the FASB issued FASB Staff Position No. APB 14-a,
"Accounting for Convertible Debt Instruments That May Be Settled
in Cash Upon Conversion (Including Partial Cash Settlement)."
Under the new rules for convertible debt instruments that may be
settled entirely or partially in cash upon conversion, an
81
entity should separately account for the liability and equity
components of the instrument in a manner that reflects the
issuer's economic interest cost. The effect of the proposed new
rules for the debentures is that the equity component would be
included in the paid-in-capital section of shareholders' equity
on an entity's consolidated balance sheet and the value of the
equity component would be treated as original issue discount for
purposes of accounting for the debt component of convertible
debt. The FSP will be effective for fiscal years beginning after
December 15, 2008, and for interim periods within those fiscal
years, with retrospective application required. Early adoption
is not permitted. The Company is currently evaluating the
proposed new rules and the impact on its financial condition and
results of operations.
3. ACQUISITIONS AND LICENSE AGREEMENT
----------------------------------
In January 2008, we 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 $82,000 for
Gestiva(TM), $7,500 of which was paid at closing. For the year ended
March 31, 2008, the Company recorded the $7,500 payment as in-process
research and development expense because the product had not obtained
FDA approval when the initial payment was made. The remainder of the
purchase price 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.
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 $141,500 upon final approval of the product by the U.S.
Food and Drug Administration ("FDA"). 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. For the year ended March 31, 2008, the Company recorded the
$10,000 payment made at closing as in-process research and
development expense because the product had not obtained FDA approval
when the initial payment was made. In July 2007, FDA approval for
Evamist(TM) was received and the payment of $141,500 was made to
VIVUS, Inc. The preliminary purchase price allocation, which is
subject to change based on the final fair value assessment, resulted
in estimated identifiable intangible assets of $52,446 to product
rights; $15,166 to trademark rights; $66,417 to rights under a
sublicense agreement; and, $7,471 to a covenant not to compete. Upon
FDA approval in July 2007, the Company began amortizing the product
rights, trademark rights and rights under the sublicense agreement
over 15 years and the covenant not to compete over nine years.
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 separate agreements, 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 U.S. 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
82
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.
4. INVESTMENT SECURITIES
---------------------
The carrying amount of available-for-sale securities and their
approximate fair values at March 31, 2008 and 2007 were as follows.
MARCH 31, 2008
----------------------------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ----- ------ -----
Short-term marketable securities..... $ 40,538 $ 10 $ - $ 40,548
Non-current auction rate
securities........................ 83,900 - (2,384) 81,516
---------- ---------- ---------- ----------
Total............................ $ 124,438 $ 10 $ (2,384) $ 122,064
========== ========== ========== ==========
MARCH 31, 2007
----------------------------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ----- ------ -----
Short-term marketable securities..... $ 38,612 $ 50 $ - $ 38,662
Short-term auction rate
securities........................ 119,150 - - 119,150
---------- ---------- ---------- ----------
Total............................ $ 157,762 $ 50 $ - $ 157,812
========== ========== ========== ==========
The Company accounts for its investment securities in accordance with
SFAS 115, "Accounting for Certain Investments in Debt and Equity
Securities," and classifies them as "available for sale." The
Company's marketable securities at March 31, 2008 are recorded at
fair value based on quoted market prices using the specific
identification method and consisted of mutual funds comprised of U.S.
government investments. These marketable securities 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 marketable 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, 2008 and 2006.
At March 31, 2008 and 2007, the Company also had $83,900 and $119,150
of principal invested in auction rate securities ("ARS"). These
securities all have a maturity in excess of 10 years. The Company's
investments in ARS primarily represent interests in collateralized
debt obligations supported by pools of student loans, the principal
of which is guaranteed by the U.S. Government. ARS backed by student
loans are viewed as having low default risk and therefore very low
risk of credit downgrade. The ARS held by the Company are AAA rated
securities with long-term nominal maturities for which the interest
rates are reset through a dutch auction at pre-determined intervals,
up to 35 days. The auctions historically have provided a liquid
market for these securities.
With the liquidity issues experienced in global credit and capital
markets, the ARS held by the Company at March 31, 2008 have
experienced multiple failed auctions beginning in February 2008 as
the amount of securities
83
submitted for sale has exceeded the amount of purchase orders. Given
the failed auctions, the Company's ARS are illiquid until a
successful auction for them occurs.
The estimated fair value of the Company's ARS holdings at March 31,
2008 was $81,516, which reflects a $2,384 difference from the
principal value of $83,900. Although the ARS continue to pay interest
according to their stated terms, the Company has recorded an
unrealized loss of $1,550, net of tax, as a reduction to
shareholders' equity in accumulated other comprehensive loss,
reflecting adjustments to the ARS holdings that the Company has
concluded have a temporary decline in value.
The ARS are valued based on a discounted cash flow model that
considers, among other factors, the time to work out the market
disruption in the traditional trading mechanism, the stream of cash
flows (coupons) earned until maturity, the prevailing risk free yield
curve, credit spreads applicable to a portfolio of student loans with
various tenures and ratings and an illiquidity premium. These factors
were used in a Monte Carlo simulation based methodology to derive the
estimated fair value of the ARS.
At March 31, 2007, ARS are classified as current assets and included
in the line item "Marketable securities." Given the failed auctions,
the Company's ARS are illiquid until there is a successful auction
for them. Accordingly, the $81,516 of ARS have been reclassified at
March 31, 2008 from current assets to non-current assets and are
included in the line item "Investment securities."
5. INVENTORIES
-----------
Inventories as of March 31, consist of:
2008 2007
---- ----
Finished goods..................... $ 27,654 $ 35,420
Work-in-process.................... 15,925 13,294
Raw materials...................... 51,401 42,801
--------- ---------
$ 94,980 $ 91,515
========= =========
6. PROPERTY AND EQUIPMENT
----------------------
Property and equipment as of March 31, consist of:
2008 2007
---- ----
Land and improvements................................. $ 6,253 $ 6,253
Buildings and building improvements................... 109,128 108,631
Machinery and equipment............................... 86,490 73,461
Office furniture and equipment........................ 32,417 27,819
Leasehold improvements................................ 21,057 21,057
Construction-in-progress.............................. 14,870 5,865
---------- ----------
270,215 243,086
Less accumulated depreciation......................... (74,015) (56,186)
---------- ----------
Net property and equipment......................... $ 196,200 $ 86,900
========== ==========
Capital additions to property and equipment were $23,656, $25,066 and
$58,334 for the years ended March 31, 2008, 2007 and 2006,
respectively. Depreciation of property and equipment was $18,317,
$16,208 and $11,916 for the years ended March 31, 2008, 2007 and
2006, respectively.
Property and equipment projects classified as
construction-in-progress at March 31, 2008 are projected to be
completed during the next 12 months at an estimated cost of $4,595.
During the year ended March 31, 2006, the Company recorded
capitalized interest on qualifying construction projects of $940. In
fiscal 2008 and 2007, the Company did not record any capitalized
interest.
84
7. INTANGIBLE ASSETS AND GOODWILL
------------------------------
Intangible assets and goodwill as of March 31, consist of:
2008 2007
--------------------------------- ---------------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
------ ------------ ------ ------------
Product rights acquired:
Micro-K(R).......................... $ 36,140 $ (16,318) $ 36,140 $ (14,513)
PreCare(R).......................... 8,433 (3,654) 8,433 (3,233)
Evamist(TM).......................... 52,446 (2,378) -- --
Trademarks acquired:
Niferex(R).......................... 14,834 (3,709) 14,834 (2,967)
Chromagen(R)/StrongStart(R)........... 27,642 (6,910) 27,642 (5,528)
Evamist(TM).......................... 15,166 (688) -- --
License agreements:
Evamist(TM).......................... 66,417 (3,011) -- --
Other............................. 2,300 -- 4,400 (480)
Covenants not to compete:
Evamist(TM).......................... 7,471 (565) -- --
Other............................. 375 (109) 375 (72)
Trademarks and patents............... 5,317 (972) 4,196 (774)
---------- ---------- ---------- ----------
Total intangible assets..... 236,541 (38,314) 96,020 (27,567)
Goodwill........................ 557 - 557 -
---------- ---------- ---------- ----------
$ 237,098 $ (38,314) $ 96,577 $ (27,567)
========== ========== ========== ==========
As of March 31, 2008, the Company's intangible assets have a weighted
average useful life of approximately 16 years. Amortization of
intangible assets was $11,491, $4,810 and $4,784 for the years ended
March 31, 2008, 2007 and 2006, respectively.
During the year ended March 31, 2008, the Company recognized an
impairment charge of $1,140 for the intangible asset related to a
product right acquired under an external development agreement. Price
erosion on the product eliminated the economics of marketing the
product. The entire balance of the intangible asset was written-off
as the product is no longer expected to generate positive future cash
flows. The impairment loss is included in "Amortization and
impairment of intangible assets" in the Consolidated Statement of
Income and is included under the All Other segment in Note 21.
Assuming no other 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 $14,500 in each of
the five succeeding fiscal years.
85
8. OTHER ASSETS
------------
Other assets as of March 31, consist of:
2008 2007
---- ----
Cash surrender value of life insurance............... $ 4,300 $ 3,874
Preferred stock investments.......................... 12,684 11,806
Accrued dividends on preferred stock ................ 2,027 1,198
Deferred financing costs, net........................ 859 2,159
Deposits............................................. 3,238 1,366
---------- ----------
$ 23,108 $ 20,403
========== ==========
9. ACCRUED LIABILITIES
-------------------
Accrued liabilities as of March 31, consist of:
2008 2007
---- ----
Salaries, wages, incentives and benefits....... $ 30,314 $ 20,669
Accrued interest payable....................... 2,721 2,192
Professional fees.............................. 4,837 5,921
Promotion expenses............................. 4,984 369
Stock option deposits.......................... 2,729 2,560
Other.......................................... 931 1,507
--------- ----------
$ 46,516 $ 33,218
========= ==========
10. LONG-TERM DEBT
--------------
Long-term debt as of March 31, consists of:
2008 2007
---- ----
Building mortgages............................. $ 39,452 $ 41,348
Line of credit................................. 30,000 --
Convertible notes.............................. 200,000 200,000
----------- -----------
269,452 241,348
Less current portion........................... (202,020) (1,897)
----------- -----------
$ 67,432 $ 239,451
=========== ===========
In June 2006, the Company entered into a credit agreement with ten
banks that provides for a revolving line of credit for borrowing up
to $320,000. This credit facility also includes a provision for
increasing the revolving commitment, at the lenders' sole discretion,
by up to an additional $50,000. The credit agreement is unsecured
unless the Company, under certain specified circumstances, utilizes
the facility to redeem part or all of its outstanding Notes. Interest
is charged under the credit 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 credit facility has a five-year term
expiring in June 2011. The 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. At March 31, 2008, the Company had $942 in open
letters of credit issued under the revolving credit line and $30,000
of cash borrowings outstanding 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
86
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. In November 2007,
the average trading price of the Notes reached the threshold for the
five-day trading period that resulted in the payment of contingent
interest and beginning November 16, 2007 the Notes began to bear
interest at a rate of 3.00% per annum.
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.
Even though no holders required the Company to repurchase all or a
portion of their Notes on May 16, 2008, the Company classified the
Notes as a current liability as of March 31, 2008 due to the right
the holders had to require the Company to repurchase the Notes on May
16, 2008. Since the holders did not elect to cause us to repurchase
any of the Notes, the Notes will be reclassified as long-term
beginning with our consolidated balance sheet as of June 30, 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:
o during any quarter commencing after June 30, 2003, if the
closing sale price of the Company's Class A Common Stock
over a specified number of trading days during the previous
quarter is more than 120% of the conversion price of the
Notes on the last trading day of the previous quarter. The
Notes are initially convertible at a conversion price of
$23.01 per share, which is equal to a conversion rate of
approximately 43.4594 shares per $1,000 principal amount of
Notes;
o if the Company has called the Notes for redemption;
o during the five trading day period immediately following any
nine consecutive day trading period in which the trading
price of the Notes per $1,000 principal amount for each day
of such period was less than 95% of the product of the
closing sale price of our Class A Common Stock on that day
multiplied by the number of shares of our Class A Common
Stock issuable upon conversion of $1,000 principal amount of
the Notes; or
o upon the occurrence of specified corporate transactions.
The Company has reserved 8,691,880 shares of Class A Common Stock for
issuance in the event the Notes are converted.
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, 2008, 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.
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The aggregate maturities of long-term debt as of March 31, 2008 are
as follows:
Due in one year............... $ 202,020
Due in two years.............. 2,144
Due in three years............ 2,276
Due in four years............. 32,411
Due in five years............. 2,565
Thereafter.................... 28,036
----------
$ 269,452
==========
The Company paid interest of $8,648 and $7,316 for the years ended
March 31, 2008 and 2007, respectively. For the year ended March 31,
2006, the Company paid interest, net of capitalized interest, of
$4,692.
11. TAXABLE INDUSTRIAL REVENUE BONDS
--------------------------------
In December 2005, the Company entered into a financing arrangement
with St. Louis County, Missouri related to expansion of its
operations in St. Louis County. Up to $135,500 of industrial revenue
bonds may be issued to the Company by St. Louis County relative to
capital improvements made through December 31, 2009. This agreement
provides that 50% of the real and personal property taxes on up to
$135,500 of capital improvements will be abated for a period of ten
years subsequent to the property being placed in service. Industrial
revenue bonds totaling $120,407 were outstanding at March 31, 2008.
The industrial revenue bonds are issued by St. Louis County to the
Company upon its payment of qualifying costs of capital improvements,
which are then leased by the Company for a period ending December 1,
2019, unless earlier terminated. The Company has the option at any
time to discontinue the arrangement and regain full title to the
abated property. The industrial revenue bonds bear interest at 4.25%
per annum and are payable as to principal and interest concurrently
with payments due under the terms of the lease. The Company has
classified the leased assets as property and equipment and has
established a capital lease obligation equal to the outstanding
principal balance of the industrial revenue bonds. Lease payments may
be made by tendering an equivalent portion of the industrial revenue
bonds. As the capital lease payments to St. Louis County may be
satisfied by tendering industrial revenue bonds (which is the
Company's intention), the capital lease obligation, industrial
revenue bonds and related interest expense and interest income,
respectively, have been offset for presentation purposes in the
consolidated financial statements.
12. COMMITMENTS AND CONTINGENCIES
-----------------------------
LEASES
The Company leases manufacturing, office and warehouse facilities,
equipment and automobiles under operating leases expiring through
fiscal 2021. Total rent expense for the years ended March 31, 2008,
2007 and 2006 was $4,536, $4,132 and $3,819, respectively.
Future minimum lease commitments under non-cancelable operating
leases are as follows:
2009.......................... $ 2,183
2010.......................... 1,531
2011.......................... 1,378
2012.......................... 1,255
2013.......................... 861
Thereafter.................... 939
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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 condition 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 $31,000.
LITIGATION
The Company and its subsidiaries Drugtech Corporation and Ther-Rx
Corporation were named as defendants in a declaratory judgment case
filed in the U.S. District Court for the District of Delaware by
Lannett Company, Inc. ("Lannett") on June 6, 2008 and styled Lannett
Company Inc. v. KV Pharmaceuticals et. al. Lannett has subsequently
amended its complaint. The action seeks a declaratory judgment of
patent invalidity, patent non-infringement, and patent
unenforceability for inequitable conduct with respect to five patents
owned by, and two patents licensed to, the Company or its
subsidiaries and pertaining to the PrimaCare ONE(R) product marketed
by Ther-Rx Corporation; unfair competition; deceptive trade
practices; and antitrust violations. No specific amount of damages
was stated in the complaint or amended complaint. We have not yet
been served with either the complaint or the amended complaint.
However, on June 17 2008, the Company filed a counterclaim against
Lannett in that action asserting patent infringement; federal and
common law trademark infringement, false advertising, and unfair
competition; federal false designation of origin, false description
and false representation; and common law misappropriation. The
Company has requested a temporary restraining order and preliminary
injunction against Lannett's continued sale of its product and
continued infringement of the Company's trademarks and patents,
unfair competition or misappropriation, and to require Lannett to
recall all of its shipped product. A briefing schedule has been set
by the court on the Company's motion and a hearing has been scheduled
before the court on the Company's motion on June 25, 2008. No
discovery has yet commenced nor a trial date been set.
The Company is named as a defendant in a patent infringement case
filed in the U.S. District Court for the District of Delaware by UCB,
Inc. and Celltech Manufacturing CA, Inc. (collectively, "UCB") on
April 21, 2008 and styled UCB, Inc. et al. v. KV Pharmaceutical
Company. After the Company filed an ANDA with the FDA seeking
permission to market a generic version of the 40 mg, 50 mg and 60 mg
strengths of Metadate CD(R) methylphenidate hydrochloride
extended-release capsules, UCB filed this lawsuit under a patent
owned by Celltech. In a Paragraph IV certification accompanying the
ANDA, KV contended that its proposed 40mg generic formulation would
not infringe Celltech's patent. Because the patent was not listed in
the Orange Book for the 50mg and 60mg dosages, a Paragraph I
certification was filed with respect to them. Pursuant to the
Hatch-Waxman Act, the filing of the suit against the Company
instituted an automatic stay of FDA approval of the Company's ANDA
with respect to the 40 mg strength of this product until the earlier
of a judgment in the Company's favor, or 30 months from the date of
suit. Inasmuch as the Celltech patent was not listed in the Orange
Book with respect to the 50 mg and 60 mg strengths, it is the
Company's belief that the automatic stay does not apply to the
Company's 50 mg and 60 mg strengths of this product. UCB may,
however, seek to keep these strengths tied up in the litigation. The
Company has filed an answer, asserted certain affirmative defenses
(including that Plaintiffs are estopped to assert infringement of the
50 mg and 60 mg dosages due to their not listing the Celltech patent
in the Orange Book for these dosages), and has asserted a
counterclaim in which it seeks a declaratory judgment of invalidity
and non-infringement of the claims in the Celltech patent, and an
award of attorneys fees and costs. The case has recently commenced
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.
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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 this lawsuit 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. Discovery is on-going, but no trial date has yet been
set. Following the Company's filing of an ANDA pertaining to a
generic version of the 24 mg strength of Razadyne(R) ER (formerly
Reminyl(R)) galantamine hydrobromide extended-release capsules and
the Company's giving of notice of this filing to Janssen, Janssen has
filed in June 2008 a second complaint in the same federal court,
naming the Company as a defendant in a related patent infringement
case under the same Janssen patent with respect to such 24 mg generic
version. The time to answer the new complaint has not yet run. The
Company anticipates that both cases will be coordinated before the
court. 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. Celgene
has moved to disqualify the Company's counsel in the case, asserting
a conflict of interest despite its signing of an advance waiver with
such counsel, and this motion is pending before the court. Should
this motion be granted, the Company will need to retain new counsel.
The Company does not believe that this would materially delay the
progress of the lawsuit. The Company has filed a motion for sanctions
against plaintiffs pursuant to Rule 11 of the Federal Rules of Civil
Procedure for bringing an action without proper basis and is seeking
an order dismissing the patent infringement complaint filed by
plaintiffs, and awarding the Company its costs and attorneys' fees.
Celgene has asked the court to dismiss the Company's Rule 11 motion,
and the matter is pending before the court. 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 Purdue's patents are invalid,
unenforceable, or will not be infringed by KV's proposed generic
versions. On February 12, 2007, a second patent infringement 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
90
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 similar lawsuits pending against additional unrelated
companies in federal court in New York.
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. The Company, among others, has asked the court to lift the stay
so that the remainder of the case may resume but the stay has not yet
been lifted. Discovery in the suit has not yet commenced but is
expected to commence shortly after the stay is lifted on the case. 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. The product involved in this lawsuit is currently subject to
a hold on the Company's inventory of certain unapproved products
notified to the Company in March 2008 by representatives of the
Missouri Department of Health and Senior Services and the FDA. In the
event that such hold is lifted, ETHEX intends to resume marketing the
product during the stay in the lawsuit with CIMA. The Company intends
to vigorously defend its interests when or if the stay is lifted;
however, it cannot give any assurance it will prevail or that the
stay will be lifted.
The Company and ETHEX are named as defendants in a case brought by
Axcan ScandiPharm Inc. and styled 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. Plaintiffs have recently
filed a motion to amend their complaint to seek declaratory judgments
that Axcan does not have "unclean hands" nor violated any antitrust
or unfair competition laws. This motion is pending before the court.
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
91
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.
The Company was named as a defendant in a case filed in U.S. District
Court in Missouri by AstraZeneca AB, Aktiebolaget Hassle and
AstraZeneca LP (collectively, "AstraZeneca") and styled AstraZeneca
AB et. al. v. KV Pharmaceutical Company. 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 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 United States Supreme Court. As a
result, the Company no longer faces the prospect of any liability to
AstraZeneca in connection with this lawsuit. KV continued to proceed
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. In May
2008, the Company entered into a settlement agreement with
AstraZeneca and settled its remaining counterclaims against
AstraZeneca in exchange for a payment of $2,700.
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 $575 in cash and pharmaceutical products
valued at $150, both of which are to be paid or delivered 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
92
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 court 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, as well as a motion to dismiss
the lawsuit based on expiration of the statute of limitations. This
motion is pending before the court, with a hearing scheduled by the
court on July 7, 2008. A trial date has been set for November 2008.
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 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
93
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 attorney's
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 moved to terminate the litigation based
on a determination by members of a Special Committee of the Board of
Directors that continuation of the litigation was not in the best
interest of KV and its shareholders. All individual officer and
director defendants joined in that motion. Plaintiffs filed a motion
for rule to show cause why the defendants' motion to terminate the
lawsuit should not be stricken and dismissed. On February 15, 2008,
the court stayed proceedings in the case until April 9, 2008, to
permit mediation pursuant to the parties' stipulation. Mediation
occurred on April 2, 2008. On May 23, 2008, all remaining parties to
the litigation filed a proposed settlement with the court which, if
approved by the court, would resolve all claims asserted in the
Action. The proposed settlement provides for a payment of fees and
expenses to plaintiffs' counsel not to exceed $1,650, which amount is
expected to be covered by insurance. The proposed settlement received
preliminary approval by the court on June 3, 2008. Notice of the
terms of the settlement has been mailed to all shareholders of record
as of May 23, 2008 and a final fairness hearing has been scheduled by
the court to be conducted on August 26, 2008.
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. In December 2007, the SEC
staff, pursuant to a formal order of investigation, issued subpoenas
for additional documents and testimony by certain employees. The
production of additional documents called for by the subpoena and the
testimony of the employees was completed in May 2008.
The Company has received a subpoena from the Office of Inspector
General of the Department of Health and Human Services, seeking
documents with respect to two of ETHEX's nitroglycerin products. Both
are unapproved products, that is, they have not received FDA
approval. (FDA approval is not necessarily required for all drugs to
be sold in the marketplace, such as pre-1938 "grandfathered" products
or certain drugs reviewed under the so-called DESI process. The
Company believes that its two products come within these exceptions.)
The subpoena states that it is in connection with an investigation
into potential false claims under Title 42 of the U.S. Code, and
appears to pertain to whether these products are eligible for
reimbursement under federal health care programs, such as Medicaid
and VA programs.
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.
There are uncertainties and risks associated with all litigation and
there can be no assurance the Company will prevail in any particular
litigation.
94
13. EMPLOYMENT AGREEMENTS
---------------------
The Company has employment agreements with certain officers and key
employees which extend for one to five years. These agreements
provide for base levels of compensation and, in certain instances,
also provide for incentive bonuses and separation benefits. Also, the
agreement with the Chief Executive Officer ("CEO") contains
provisions for partial salary continuation under certain conditions,
contingent upon non-compete 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
$2,232, $877 and $965 for the years ended March 31, 2008, 2007 and
2006, respectively.
14. 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 "Selling and Administrative" expense line item of
operating income for the year ended March 31, 2007 and was recorded
net of approximately $1,192 of attorney-related fees.
15. INCOME TAXES
------------
The income tax provisions for the years ended March 31, 2008, 2007
and 2006, 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, 2008, 2007 and 2006 are as follows:
2008 2007 2006
---- ---- ----
PROVISION
Current:
Federal............................... $ 44,280 $ 23,434 $ 17,035
State................................. 3,414 1,918 1,552
-------- -------- --------
47,694 25,352 18,587
-------- -------- --------
Deferred:
Federal............................... (4,073) 7,042 5,521
State................................. (312) 564 325
-------- -------- --------
(4,385) 7,606 5,846
-------- -------- --------
$ 43,309 $ 32,958 $ 24,433
======== ======== ========
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:
2008 2007 2006
---- ---- ----
Expected income tax expense................. $ 46,082 $ 31,175 $ 12,547
Purchased in-process research
and development.......................... -- -- 10,654
State income taxes, net of
federal income tax benefit............... 2,016 1,613 1,218
Business credits............................ (1,213) (945) (831)
Domestic manufacturer deduction............. (2,829) (707) (512)
Adjustment to unrecognized tax benefits..... (2,464) 1,910 1,712
Other ...................................... 1,717 (88) (355)
--------- -------- ---------
Provision for income tax expense............ $ 43,309 $ 32,958 $ 24,433
========= ======== =========
95
As of March 31, 2008 and 2007, the tax effect of temporary
differences between the tax basis of assets and liabilities and their
financial reporting amounts are as follows:
2008 2007
-------------------------------- ---------------------------------
CURRENT NON-CURRENT CURRENT NON-CURRENT
------- ----------- ------- -----------
Fixed asset basis differences........ $ -- $ (16,996) $ -- $ (14,121)
Reserves for inventory and
receivables....................... 14,728 -- 10,307 --
Accrued compensation................. 1,612 -- -- --
Deferred compensation................ -- 3,138 -- 2,320
Amortization......................... -- 2,120 -- (3,440)
Convertible notes interest........... -- (30,305) -- (22,766)
Stock-based compensation............. 2,592 -- 1,525 --
Payroll taxes........................ 3,227 -- 2,196 --
Other................................ 653 2,744 336 --
--------- ---------- --------- ----------
Net deferred tax asset (liability) $ 22,812 $ (39,299) $ 14,364 $ (38,007)
========= ========== ========= ==========
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 non-qualified stock options 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.
The Company paid income taxes of $49,862, $22,134, and $15,482 during
the years ended March 31, 2008, 2007 and 2006, respectively.
The Company adopted FIN 48 effective April 1, 2007. The adoption of
FIN 48 was not material to the Company's consolidated financial
position, however, certain reclassifications of various income tax
related balance sheet amounts were required.
Upon adoption of FIN 48, the Company had $12,980 of gross
unrecognized tax benefits, of which $12,980 represents the amount of
unrecognized tax benefits that, if recognized, would favorably affect
the effective income tax rate in future periods.
96
A reconciliation of the unrecognized tax benefits at the beginning
and end of the period is as follows:
Balance of unrecognized tax benefits at April 1, 2007 $ 12,980
Increase/(decrease) in unrecognized tax benefits
resulting from tax positions taken during current period 1,347
Increase/(decrease) in unrecognized tax benefits
resulting from tax positions taken in prior periods 0
Reduction to unrecognized tax benefits as a result
of a settlement with taxing authorities 0
Reduction to unrecognized tax benefits as a result
of the lapse of the applicable statute of limitations (2,670)
--------
Balance of unrecognized tax benefits at March 31, 2008 $ 11,657
========
The Company recognizes interest and penalties associated with
uncertain tax positions as a component of income tax expense. At
April 1, 2007, the Company had accrued $1,950 for interest and
penalties. Through March 31, 2008, the Company accrued an additional
$1,450 of interest and penalties and released $1,248 of interest and
penalties as a result of the expiration of the statute of
limitations. As of March 31, 2008, the accrual for interest and
penalties was $2,152.
It is anticipated the Company will recognize approximately $1,100 of
unrecognized tax benefits within the next 12 months. This recognition
is as a result of the expected expiration of the relevant statute of
limitations.
The Company is subject to taxation in the U.S. and various states and
is subject to examination by those authorities. The Company's federal
statute of limitations has expired for fiscal years prior to 2005 and
the relevant state statutes vary. The Company currently is being
audited by the IRS for its March 31, 2006 and 2007 tax years. The IRS
is also currently auditing the employment tax returns of the Company
for calendar years 2004, 2005, 2006 and 2007. Various information
requests with respect to the periods under audit have been received
and responded to. The Company expects the IRS to issue additional
information requests. The Company does not have any state
examinations in progress at this time.
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 the Company's estimates are not
representative of actual outcomes, recorded tax liabilities could be
materially impacted.
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
97
resulting tax liability. The Company recorded liabilities related to
this matter of $9,765 as of March 31, 2008 in accrued liabilities on
the consolidated balance sheet.
16. 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.
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. The shares
issuable upon exercise of these options are accounted for as issued
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. For the year ended March 31, 2007, 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.
98
The Company recognized, in accordance with SFAS 123R, stock-based
compensation expense of $5,205 and $3,984, respectively, and related
tax benefits of $1,250 and $1,134, respectively, for the years ended
March 31, 2008 and 2007. Stock-based compensation expense of $927 and
a related tax benefit of $286 were recognized in the year ended March
31, 2006. There was no stock-based employee compensation cost
capitalized as of March 31, 2008 or 2007. Cash received as deposits
for option exercises was $1,514, $4,264, and $1,187 and the actual
tax benefit realized for the tax deductions from option exercises (at
expiration of two-year forfeiture period) was $1,522, $934, and
$1,709 for 2008, 2007 and 2006, respectively.
The following weighted average assumptions were used for stock
options granted during the years ended March 31, 2008, 2007 and 2006:
YEARS ENDED MARCH 31,
---------------------------------------
2008 2007 2006
---- ---- ----
Dividend yield........................... None None None
Expected volatility...................... 42% 45% 48%
Risk-free interest rate.................. 4.53% 4.93% 4.91%
Expected term............................ 9.0 years 8.9 years 8.8 years
Weighted average fair value per
share at grant date................... $ 15.40 $ 12.98 $ 12.74
A summary of the changes in the Company's stock option plan for the
years ended March 31, 2008, 2007 and 2006 consisted of the following:
WEIGHTED AVERAGE
-----------------------------
REMAINING AGGREGATE
EXERCISE EXPECTED INTRINSIC
SHARES PRICE TERM VALUE
------ ----- ---- -----
Balance, March 31, 2005............... 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............... 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
Options granted....................... 944 27.02
Options exercised..................... (184) 5.19 3,644
Options canceled...................... (493) 19.28
------
Balance, March 31, 2008............... 3,933 $ 18.84 5.8 $24,114
======
Expected to vest at
March 31, 2008................... 3,048 $ 18.84 5.8 $18,688
Options exercisable at March 31, 2008
(excluding shares in the two-year
forfeiture period)............... 1,197 $ 16.64 5.1 $10,210
As of March 31, 2008, the Company had $42,137 of total unrecognized
compensation expense, related to stock option grants, which will be
recognized over the remaining weighted average period of 5.0 years.
99
17. 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, $500 and $400 for the years ended March
31, 2008, 2007 and 2006, 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 $2,477, $2,227 and $1,877 were made to the 401(k)
investment funds for the years ended March 31, 2008, 2007 and 2006,
respectively.
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. Amounts charged to pension expense and
contributed to this plan were $170, $197 and $180 for the years ended
March 31, 2008, 2007 and 2006, respectively.
In January 2008,133 employees represented by the Teamsters Union
voted to decertify union representation effective February 7, 2008.
As a result of the decertification, the Company recorded in fiscal
2008 a withdrawal liability of $923 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.
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 $797 and $935 at
March 31, 2008 and 2007, respectively. For union employees, the
Company participated in a fully funded insurance plan sponsored by
the union. The Company's participation in the union plan ended as a
result of the decertification of union representation effective
February 7, 2008. Total health and medical insurance expense for the
two plans was $13,731, $12,029 and $9,662 for the years ended March
31, 2008, 2007 and 2006, respectively.
18. 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, 2008, 2007 and
2006 totaled $303, $296, and $284, respectively.
19. EQUITY TRANSACTIONS
-------------------
As of March 31, 2008 and 2007, 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.
100
There were no undeclared and accrued cumulative preferred dividends
at March 31, 2008 and 2007. Also, under the terms of its credit
agreement, the Company may not pay cash dividends in excess of 25% of
the prior fiscal year's consolidated net income.
The Company has reserved 750,000 shares of Class A Common Stock for
issuance under KV's 2002 Consultants Plan. These shares may be issued
from time to time in consideration for consulting and other services
provided to the Company by independent consultants. Since inception
of this plan, the Company has issued 47,732 Class A shares as payment
for certain milestones under product development agreements.
Holders of Class A Common Stock are entitled to receive dividends per
share equal to 120% of the dividends per share paid on the Class B
Common Stock and have one-twentieth vote per share in the election of
directors and on other matters.
Under the terms of the Company's current loan agreement (see Note
10), the Company has limitations on paying dividends, except in
stock, on its Class A and Class B Common Stock. Payment of dividends
may also be restricted under Delaware corporation law.
In accordance with the Special Committee's investigation of the
Company's stock option grant practices, a remediation plan was
developed by the Committee that recommended reimbursement of $1,401
by the Company's CEO. The recommended reimbursement was made by the
CEO in November 2007 by delivery to the Company of 45,531 shares of
Class A Common Stock.
101
20. EARNINGS PER SHARE
------------------
The following table sets forth the computation of basic and diluted
earnings per share:
2008 2007 2006
CLASS A CLASS B CLASS A CLASS B CLASS A CLASS B
-------- -------- -------- -------- ------- -------
Basic earnings per share:
Numerator:
Allocation of undistributed earnings before
cumulative effect of change in accounting
principle $ 69,317 $ 18,967 $ 43,768 $ 12,276 $ 8,725 $ 2,621
Allocation of cumulative effect of
change in accounting principle - - 1,543 433 - -
-------- -------- -------- -------- -------- -------
Allocation of undistributed earnings $ 69,317 $ 18,967 $ 45,311 $ 12,709 $ 8,725 $ 2,621
======== ======== ======== ======== ======== =======
Denominator:
Weighted average shares outstanding 37,582 12,299 37,180 12,455 36,277 13,065
Less - weighted average unvested
common shares subject to repurchase (432) (101) (367) (65) (435) (147)
-------- -------- -------- -------- -------- -------
Number of shares used in per
share computations 37,150 12,198 36,813 12,390 35,842 12,918
======== ======== ======== ======== ======== =======
Basic earnings per share before cumulative
effect of change in accounting principle $ 1.87 $ 1.55 $ 1.19 $ 0.99 $ 0.24 $ 0.20
Per share effect of cumulative effect of
change in accounting principle - - 0.04 0.04 - -
-------- -------- -------- -------- -------- -------
Basic earnings per share $ 1.87 $ 1.55 $ 1.23 $ 1.03 $ 0.24 $ 0.20
======== ======== ======== ======== ======== =======
Diluted earnings per share:
Numerator:
Allocation of undistributed earnings
for basic computation before cumulative
effect of change in accounting principle $ 69,317 $ 18,967 $ 43,768 $ 12,276 $ 8,725 $ 2,621
Reallocation of undistributed earnings as a
result of conversion of Class B to
Class A shares 18,967 - 12,276 - 2,621 -
Reallocation of undistributed earnings to
Class B shares - (2,344) - (1,297) - (12)
Add - preferred stock dividends 70 - 70 - 70 -
Add - interest expense convertible notes 4,388 - 3,883 - - -
-------- -------- -------- -------- -------- -------
Allocation of undistributed earnings
for diluted computation before cumulative
effect of change in accounting principle 92,742 16,623 59,997 10,979 11,416 2,609
Allocation of cumulative effect of
change in accounting principle - - 1,976 362 - -
-------- -------- -------- -------- -------- -------
Allocation of undistributed earnings $ 92,742 $ 16,623 $ 61,973 $ 11,341 $ 11,416 $ 2,609
======== ======== ======== ======== ======== =======
(CONTINUED)
102
-----------------------------------------------------------------------------
2008 2007 2006
------------------------ ------------------------ -----------------------
CLASS A CLASS B CLASS A CLASS B CLASS A CLASS B
----------- ----------- ----------- ----------- ----------- ----------
Diluted earnings per share (continued):
Denominator:
Number of shares used in basic computation 37,150 12,198 36,813 12,390 35,842 12,918
Weighted average effect of dilutive securities:
Conversion of Class B to Class A shares 12,198 - 12,390 - 12,918 -
Employee stock options 766 83 720 99 899 195
Convertible preferred stock 338 - 338 - 338 -
Convertible notes 8,692 - 8,692 - - -
--------- --------- --------- --------- --------- ---------
Number of shares used in per share
computations 59,144 12,281 58,953 12,489 49,997 13,113
========= ========= ========= ========= ========= =========
Diluted earnings per share before cumulative
effect of change in accounting principle $ 1.57 $ 1.35 $ 1.02 $ 0.88 $ 0.23 $ 0.20
Per share effect of cumulative effect of
change in accounting principle - - 0.03 0.03 - -
--------- --------- --------- --------- --------- ---------
Diluted earnings per share (1) (2) $ 1.57 $ 1.35 $ 1.05 $ 0.91 $ 0.23 $ 0.20
========== ========= ========= ========= ========= =========
<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, 2008, 2007 and
2006, excluded from the computation were options to purchase
649, 216 and 291 of Class A and Class B common shares,
respectively.
(2) For the year ended March 31, 2006, the $200,000 principal amount
of 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.
21. 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.
103
The following represents information for the Company's reportable
operating segments for fiscal 2008, 2007 and 2006.
YEAR
ENDED BRANDED SPECIALTY SPECIALTY ALL
MARCH 31, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED
--------- -------- -------- --------- ----- ------------ ------------
------------------------------------------------------------------------------------------------------------------------------
NET REVENUES
2008 $214,863 $367,862 $18,020 $1,151 $ - $601,896
2007 188,681 235,594 17,436 1,916 - 443,627
2006 145,503 203,787 16,988 1,362 - 367,640
------------------------------------------------------------------------------------------------------------------------------
SEGMENT PROFIT (LOSS)
2008 95,143 218,111 5,900 (187,491) - 131,663
2007 87,346 125,596 2,799 (126,669) - 89,072
2006 58,704 100,731 1,082 (124,668) - 35,849
------------------------------------------------------------------------------------------------------------------------------
IDENTIFIABLE ASSETS
2008 39,955 99,567 7,990 722,673 (1,158) 869,027
2007 32,995 84,581 8,410 582,955 (1,158) 707,783
2006 23,582 62,953 7,353 526,583 (1,158) 619,313
------------------------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT ADDITIONS
2008 257 - 119 23,280 - 23,656
2007 96 - 108 24,862 - 25,066
2006 540 1,097 269 56,428 - 58,334
------------------------------------------------------------------------------------------------------------------------------
DEPRECIATION AND AMORTIZATION
2008 753 319 177 29,871 - 31,120
2007 709 338 163 21,178 - 22,388
2006 587 317 173 16,925 - 18,002
------------------------------------------------------------------------------------------------------------------------------
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.
22. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
---------------------------------------
1ST 2ND 3RD 4TH FULL
QUARTER QUARTER QUARTER QUARTER YEAR
--------------------------------------------------------------------
YEAR ENDED MARCH 31, 2008
- -------------------------
Net revenues $ 114,358 $172,925 $161,623 $ 152,990 $601,896
Gross profit 74,788 127,793 111,627 101,133 415,341
Income before income taxes 9,917 62,002 46,093 13,651 131,663
Net income 6,200 40,223 32,612 9,319 88,354
Earnings per share:
Basic - Class A common 0.13 0.85 0.69 0.20 1.87
Basic - Class B common 0.11 0.71 0.57 0.16 1.55
Diluted - Class A common 0.12 0.70 0.57 0.18 1.57
Diluted - Class B common 0.10 0.60 0.49 0.15 1.35
104
1ST 2ND 3RD 4TH FULL
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
105
Report of Independent Registered Public Accounting Firm
- -------------------------------------------------------
The Board of Directors and Shareholders
K-V Pharmaceutical Company:
We have audited K-V Pharmaceutical Company's (the Company) internal control
over financial reporting as of March 31, 2008, 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, included in the accompanying Management's
Report on Internal Control Over Financial Reporting, appearing under Item
9A(a). Our responsibility is to express an opinion on 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, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audit also included
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 deficiency, or a combination of deficiencies, in
internal control over financial reporting, such that there is a reasonable
possibility that a material misstatement of the company's annual or interim
financial statements will not be prevented or detected on a timely basis. A
material weakness has been identified and included in management's assessment
that states the Company had inadequate policies and procedures over the
accounting for customer rebates.
106
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, 2008 and 2007, 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, 2008. This material weakness was considered in
determining the nature, timing and extent of audit tests applied in our audit
of the March 31, 2008 consolidated financial statements, and this report does
not affect our report dated June 25, 2008, which expressed an unqualified
opinion on those consolidated financial statements.
In our opinion, because of the effect of the aforementioned material weakness
on the achievement of the objectives of the control criteria, K-V
Pharmaceutical Company has not maintained effective internal control over
financial reporting as of March 31, 2008, based on criteria established in
Internal Control - Integrated Framework issued by COSO.
St. Louis, Missouri
June 25, 2008
107
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 Financial Officer, conducted an
evaluation of the effectiveness of our internal control over
financial reporting as of March 31, 2008. 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.
Exchange Act Rule 12b-2 defines a material weakness as a deficiency,
or a combination of deficiencies, in internal control over financial
reporting, such that there is a reasonable possibility that a
material misstatement of the company's annual or interim financial
statements will not be prevented or detected on a timely basis.
Based on our evaluation of internal control over financial reporting
as of March 31, 2008, management has determined that the following
material weakness existed in our internal control over financial
reporting.
The design of the Company's policies and procedures did not
adequately address the financial reporting risks associated with
customer rebate agreements. Specifically, the Company's policies and
procedures were inadequate to ensure that the necessary information
for new or modified rebate agreements was captured and communicated
to those responsible for evaluating the accounting implications. This
deficiency resulted in a reasonable possibility that a material
misstatement of the Company's annual or interim financial statements
will not be prevented or detected on a timely basis.
As a result of the material weakness described above, management has
concluded that the Company did not maintain effective internal
control over financial reporting as of March 31, 2008 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 adverse opinion on the
effectiveness of
108
our internal control over financial reporting as of March 31, 2008.
This report appears on page 66 of this annual report.
(b) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There were changes in the Company's internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act) during the quarter ended March 31, 2008 that
have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting.
These changes consisted of controls we implemented to remediate the
material weaknesses identified in our annual report on the
effectiveness of internal control over financial reporting as of
March 31, 2007, which related to the Company's accounting for
stock-based compensation, income taxes and revenue recognition:
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 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.
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.
Revenue Recognition - The design of the Company's policies and
procedures did not adequately address the financial reporting risks
associated with customer shipping terms.
During the quarter ended March 31, 2008, we implemented changes to
internal control over financial reporting to complete remediation of
the material weaknesses described above as follows:
Stock-Based Compensation
o Expanded the General Counsel's role to include oversight of the
process of documenting stock option grants in order to assure
that grants are properly awarded under the approved plan
document and proper grant dates are associated with awards.
o Engaged 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.
o Established an Employee Compensation Reporting Committee
comprised of senior tax, legal, human resource, and
accounting/finance personnel, to assure that grants are properly
awarded under the plan document, proper grant dates are assigned
for measurement purposes, the reasonableness of key assumptions
used in the valuation of stock options are reviewed for
appropriateness and any modifications to the standard terms of
outstanding awards are reviewed for appropriate accounting
treatment.
o Established a procedure whereby senior financial management
reviews employment agreements, employment offers, and other
employee agreements to ensure proper accounting based upon the
terms and conditions of such agreements.
109
o 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.
o Established quarterly testing by the Company's Internal Audit
Department of controls relating to stock option activity and the
accuracy of the model used in valuing the Company's stock
options.
Income Taxes
o Established quarterly meetings between the tax department,
operating division executives and other management personnel to
facilitate communication of relevant business issues impacting
accounting for income taxes, and;
o Implemented procedures that require the documentation of tax
liabilities and facilitate an effective review of the
recognition and measurement of tax liabilities.
Revenue Recognition
o Implemented 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.
o Implemented a policy requiring that shipping terms for all
customers are properly documented and reviewed by
finance/accounting personnel to verify the appropriate timing of
revenue recognition.
(c) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial 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,
2008, 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, 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 weakness 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, 2008. Notwithstanding the material weakness described
above, our management 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, 2008, we are taking several steps to
remediate the material weakness related to revenue recognition
described in (a) above by designing policies and procedures that
require that all new or modified customer agreements are reviewed
by accounting personnel with relevant GAAP knowledge to determine the
appropriate accounting treatment.
ITEM 9B. OTHER INFORMATION
-----------------
The Board of Directors of the Company has called the 2008 Annual
Meeting of Stockholders (the "Annual Meeting") for Friday, September
5, 2008, at 9:00 A.M., Central Daylight Savings Time, at The St.
Louis Club (Lewis and Clark Room, 16th Floor), 7701 Forsyth
Boulevard, Clayton, Missouri 63105.
Proposals of stockholders and nominations for directors intended to
be presented at the Annual Meeting must be received by the Company's
Assistant Secretary no later than July 1, 2008 in order to be
considered for inclusion
110
in the Company's proxy statement and proxy card for that meeting.
Upon receipt of any such proposal, the Company will determine whether
or not to include such proposal in the proxy statement and proxy in
accordance with regulations governing the solicitation of proxies.
Stockholder proposals and nominations for directors that do not
appear in the proxy statement may be considered at the Annual Meeting
only if written notice of the proposal is received by the Company's
Assistant Secretary no later than July 1, 2008. Such notice must
include a description of the proposed business and the reasons
therefor. The Board of Directors or the presiding officer at the
Annual Meeting may reject any proposal that is not made in accordance
with these procedures or that is not a proper subject for stockholder
action in accordance with applicable law. These requirements are
separate from the procedural requirements a stockholder must meet to
have a proposal included in the Company's proxy statement. All
proposals should be addressed to the Assistant Secretary, K-V
Pharmaceutical Company, 2503 South Hanley Road, St. Louis, MO 63144.
111
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
--------------------------------------------------
The information contained under the caption "INFORMATION CONCERNING
NOMINEES AND DIRECTORS CONTINUING IN OFFICE" in the Company's
definitive proxy statement to be filed pursuant to Regulation 14(A)
for its 2008 Annual Meeting of Shareholders, which involves the
election of directors, is incorporated herein by this reference. Also
see Item 4(a) of Part I hereof.
ITEM 11. EXECUTIVE COMPENSATION
----------------------
The information contained under the captions "EXECUTIVE COMPENSATION"
and "INFORMATION AS TO STOCK OPTIONS" in the Company's definitive
proxy statement to be filed pursuant to Regulation 14(A) for its 2008
Annual Meeting of Shareholders is incorporated herein by this
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
------------------------------------------------------------------
RELATED STOCKHOLDER MATTERS
---------------------------
The information contained under the captions "SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS" and "SECURITY OWNERSHIP OF MANAGEMENT" in
the Company's definitive proxy statement to be filed pursuant to
Regulation 14(A) for its 2008 Annual Meeting of Shareholders is
incorporated herein by this reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
-----------------------------------------------------------
INDEPENDENCE
------------
The information contained under the caption "COMPENSATION COMMITTEE
INTERLOCKS AND INSIDER PARTICIPATION; TRANSACTIONS WITH DIRECTORS AND
EXECUTIVE OFFICERS" in the Company's definitive proxy statement to be
filed pursuant to Regulation 14(A) for its 2008 Annual Meeting of
Shareholders is incorporated herein by this reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
--------------------------------------
The information contained under the caption "FEES BILLED BY
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM" in the Company's
definitive proxy statement to be filed pursuant to Regulation 14(A)
for its 2008 Annual Meeting of Shareholders is incorporated herein by
this reference.
112
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 of this report:
Report of Independent Registered Public Accounting Firm........................ 66
Consolidated Balance Sheets as of March 31, 2008 and 2007...................... 67
Consolidated Statements of Income for the Years Ended March 31,
2008, 2007 and 2006............................................................ 68-69
Consolidated Statements of Comprehensive Income for the Years
Ended March 31, 2008, 2007 and 2006............................................ 70
Consolidated Statements of Shareholders' Equity for the Years
Ended March 31, 2008, 2007 and 2006............................................ 71
Consolidated Statements of Cash Flows for the Years Ended
March 31, 2008, 2007 and 2006.................................................. 72
Notes to Consolidated Financial Statements..................................... 73-105
2. Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts................................ 115
(b) Exhibits. See Exhibit Index on pages 116 through 121 of this Report.
Management contracts and compensatory plans are designated on the
Exhibit Index.
113
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
K-V PHARMACEUTICAL COMPANY
Date: June 25, 2008 By /s/ Marc S. Hermelin
---------------- ---------------------------------------------
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: June 25, 2008 By /s/ Ronald J. Kanterman
---------------- -----------------------------------------
Vice President and Chief Financial Officer
(Principal Financial Officer)
Date: June 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: June 25, 2008 By /s/ Marc S. Hermelin
------------- -----------------------------------------
Marc S. Hermelin
Date: June 25, 2008 By /s/ Norman D. Schellenger
------------- -----------------------------------------
Norman D. Schellenger
Date: June 25, 2008 By /s/ Kevin S. Carlie
------------- -----------------------------------------
Kevin S. Carlie
Date: June 25, 2008 By /s/ Jonathon E. Killmer
------------- -----------------------------------------
Jonathon E. Killmer
Date: June 25, 2008 By /s/ Jean M. Bellin
------------- -----------------------------------------
Jean M. Bellin
Date: June 25, 2008 By /s/ Terry B. Hatfield
------------- -----------------------------------------
Terry B. Hatfield
Date: June 25, 2008 By /s/ David S. Hermelin
------------- -----------------------------------------
David S. Hermelin
Date: June 25, 2008 By /s/ Ronald J. Kanterman
------------- -----------------------------------------
Ronald J. Kanterman
114
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, 2006:
Allowance for doubtful accounts............ $ 461 $ (49) $ 15 $ 397
Reserves for sales allowances.............. 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.............. 28,697 148,822 146,238 31,281
Inventory obsolescence..................... 1,700 11,979 4,650 9,029
------------- ------------- ------------- --------------
$ 30,794 $ 161,121 $ 150,889 $ 41,026
============= ============= ============= ==============
Year Ended March 31, 2008:
Allowance for doubtful accounts............ $ 716 $ 168 $ 17 $ 867
Reserves for sales allowances.............. 31,281 234,427 219,062 46,646
Inventory obsolescence..................... 9,029 18,849 12,411 15,467
------------- ------------- ------------- --------------
$ 41,026 $ 253,444 $ 231,490 $ 62,980
============= ============= ============= ==============
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.
115
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.
116
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.
3(r) Amendment to Bylaws of the Company, effective March 26,
2008, which was filed as Exhibit 3.1 to the Company's
current Report on Form 8-K, filed March 28, 2008, 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(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(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.
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.
117
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.
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.
118
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,
which was filed as Exhibit 10(x) to the Company's Annual
Report on Form 10-K for the year ended March 31, 2007, is
incorporated herein by this reference.
10(y)* Employment Agreement between the Company and Gregory S.
Bentley, Senior Vice President and General Counsel, dated
April 24, 2006, which was filed as Exhibit 10(y) to the
Company's Annual Report on Form 10-K for the year ended
March 31, 2007, is incorporated herein by this reference.
10(z)* Employment Agreement between the Company and David A. Van
Vliet, Chief Administration Officer, dated September 29,
2006, which was filed as Exhibit 10(z) to the Company's
Annual Report on Form 10-K for the year ended March 31,
2007, is incorporated herein by this reference.
10(aa)* Employment Agreement between the Company and Rita E. Bleser,
President, Pharmaceutical Division, dated April 30, 2007,
which was filed as Exhibit 10(aa) to the Company's Annual
Report on Form 10-K for the year ended March 31, 2007, is
incorporated herein by this reference.
10(bb)* Employment Agreement between Ther-Rx and Gregory J. Divis,
Jr., President, Ther-Rx Corporation, dated July 20, 2007,
which was filed as Exhibit 10(bb) to the Company's Annual
Report on Form 10-K for the year ended March 31, 2007, is
incorporated herein by this reference.
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, is incorporated herein by this
reference.
10(dd)* Employment Agreement by and between Particle Dynamics, Inc.
and Paul T. Brady, President, Particle Dynamics, Inc., dated
May 5, 2005, which was filed as Exhibit 10(dd) to the
Company's Annual Report on Form 10-K for the year ended March
31, 2007, is incorporated herein by this reference,
10(ee)* Employment Agreement between the Company and David S.
Hermelin, Vice President, Corporate Strategy and Operations
Analysis, dated April 8, 1998, as amended by amendment dated
August 16,
119
2004, which was filed as Exhibit 10(ee) to the Company's
Annual Report on Form 10-K for the year ended March 31, 2007,
is incorporated herein by this reference.
10(ff)* Amendment to Employment Agreement between the Company and
Ronald J. Kanterman, Vice President and Chief Financial
Officer, dated March 23, 2008, filed herewith.
10(gg)* Consulting agreement, dated March 23, 2008, between the
Company and Gerald R. Mitchell, filed herewith.
10(hh)** Asset Purchase Agreement by and between the Company and
VIVUS, Inc., dated as of March 30, 2007, which was filed as
Exhibit 10.1 to The Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 2007, is incorporated
herein by this reference.
10(ii) Asset Purchase Agreement by and among the Company, CYTYC
Prenatal Products, Corp. and Hologic, Inc., dated as of
January 16, 2008, filed herewith.
120
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, 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, 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.
** Confidential portions of this exhibit have been redacted and filed
separately with the Commission pursuant to a confidential treatment
request in accordance with Rule 24b-2 of the Securities Exchange Act of
1934, as amended.
121
APPENDIX
Page 41 of the 10-K contains a Comparison of 5 Year Cumulative Total Return
Graph. The information displayed in the graph is presented in a tabular format
immediately following the graph.