UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
- --------------------------------------------------------------------------------
FORM 10-Q/A
AMENDMENT NO. 1
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-9601
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K-V PHARMACEUTICAL COMPANY
(Exact name of registrant as specified in its charter)
DELAWARE 43-0618919
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2503 SOUTH HANLEY ROAD, ST. LOUIS, MISSOURI 63144
(Address of principal executive offices, including ZIP code)
Registrant's telephone number, including area code: (314) 645-6600
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [ ] No [ X ]
Indicate by check mark 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).
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 Exchange Act). Yes [ ] No [ X ]
As of June 6, 2008, the registrant had outstanding 37,755,099 and 12,256,159
shares of Class A and Class B Common Stock, respectively, exclusive of
treasury shares.
1
EXPLANATORY NOTE
KV Pharmaceutical is filing this Form 10-Q/A ("Amended Filing") in order to
amend our Form 10-Q for the quarter and nine months ended December 31, 2007,
originally filed on June 25, 2008 ("Original Filing"), to correct errors in
the Consolidated Statement of Cash Flows for the nine months ended December
31, 2007. The following line items, under the heading "Changes in operating
assets and liabilities" in the Consolidated Statement of Cash Flows, have been
changed:
o Increase in prepaid and other assets
o Increase in income taxes payable
No other changes to the Form 10-Q are included in this Amendment.
As part of the Amended Filing, Exhibits 31.1, 31.2, 32.1 and 32.2 containing
the certifications of our Chief Executive Officer and Chief Financial Officer
that were filed as exhibits to the Original Filing have been re-executed and
re-filed as of the date of this Amended Filing.
2
PART I. - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited; dollars in thousands)
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------------- ---------------------------
2007 2006 2007 2006
--------- --------- --------- ---------
Net revenues................................................ $ 161,623 $ 117,949 $ 448,904 $ 323,132
Cost of sales............................................... 49,996 38,439 134,697 110,764
--------- --------- --------- ---------
Gross profit................................................ 111,627 79,510 314,207 212,368
--------- --------- --------- ---------
Operating expenses:
Research and development................................ 11,156 8,319 32,702 22,605
Purchased in-process research and
development......................................... -- -- 10,000 --
Selling and administrative.............................. 50,846 41,965 147,019 124,974
Amortization of intangibles............................. 3,668 1,204 7,868 3,602
--------- --------- --------- ---------
Total operating expenses.................................... 65,670 51,488 197,589 151,181
--------- --------- --------- ---------
Operating income............................................ 45,957 28,022 116,618 61,187
--------- --------- --------- ---------
Other expense (income):
Interest expense........................................ 2,644 2,214 7,542 6,755
Interest and other income............................... (2,780) (2,240) (8,936) (6,606)
--------- --------- --------- ---------
Total other expense (income), net........................... (136) (26) (1,394) 149
--------- --------- --------- ---------
Income before income taxes and cumulative effect
of change in accounting principle....................... 46,093 28,048 118,012 61,038
Provision for income taxes.................................. 13,481 9,586 38,977 22,369
--------- --------- --------- ---------
Income before cumulative effect of change
in accounting principle................................. 32,612 18,462 79,035 38,669
Cumulative effect of change in accounting
principle (net of $670 in taxes)........................ -- -- -- 1,976
--------- --------- --------- ---------
Net income.................................................. $ 32,612 $ 18,462 $ 79,035 $ 40,645
========= ========= ========= =========
(CONTINUED)
3
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME - (CONTINUED)
(Unaudited; dollars in thousands)
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------- -------------------------
2007 2006 2007 2006
------- ------- ------- -------
Earnings per share before effect of change in
accounting principle:
Basic - Class A common........................... $ 0.69 $ 0.39 $ 1.67 $ 0.82
Basic - Class B common........................... 0.57 0.33 1.39 0.68
Diluted - Class A common......................... 0.57 0.33 1.39 0.71
Diluted - Class B common......................... 0.49 0.29 1.20 0.61
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........................... $ 0.69 $ 0.39 $ 1.67 $ 0.86
Basic - Class B common........................... 0.57 0.33 1.39 0.72
Diluted - Class A common......................... 0.57 0.33 1.39 0.74
Diluted - Class B common......................... 0.49 0.29 1.20 0.64
Shares used in per share calculation:
Basic - Class A common........................... 37,193 36,926 37,094 36,757
Basic - Class B common........................... 12,179 12,336 12,231 12,422
Diluted - Class A common......................... 59,244 59,016 59,147 58,928
Diluted - Class B common......................... 12,264 12,412 12,314 12,529
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited; dollars in thousands)
DECEMBER 31, MARCH 31,
2007 2007
---- ----
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents............................................................ $ 72,953 $ 82,574
Marketable securities................................................................ 123,484 157,812
Receivables, less allowance for doubtful accounts of $843 and $716
at December 31, 2007 and March 31, 2007, respectively............................. 100,986 78,634
Inventories, net..................................................................... 91,021 91,515
Prepaid and other assets............................................................. 8,269 6,571
Income taxes receivable.............................................................. 7,732 --
Deferred tax asset................................................................... 19,061 14,364
----------- -----------
Total Current Assets.............................................................. 423,506 431,470
Property and equipment, less accumulated depreciation of $69,704 and $56,186 at
December 31, 2007 and March 31, 2007, respectively............................... 187,205 186,900
Intangible assets and goodwill, net.................................................. 203,819 69,010
Other assets......................................................................... 22,957 20,403
----------- -----------
TOTAL ASSETS......................................................................... $ 837,487 $ 707,783
=========== ===========
LIABILITIES
-----------
CURRENT LIABILITIES:
Accounts payable..................................................................... $ 17,659 $ 18,506
Accrued liabilities.................................................................. 38,391 33,218
Income taxes payable................................................................. -- 5,558
Current maturities of long-term debt................................................. 201,984 1,897
----------- -----------
Total Current Liabilities......................................................... 258,034 59,179
Long-term debt....................................................................... 67,956 239,451
Other long-term liabilities.......................................................... 21,958 6,319
Deferred tax liability............................................................... 40,180 38,007
----------- -----------
TOTAL LIABILITIES.................................................................... 388,128 342,956
----------- -----------
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 December 31, 2007 and March 31,
2007 (convertible into Class A shares 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 40,619,336 and 40,316,426 at December 31, 2007
and March 31, 2007, respectively.............................................. 406 403
Class B - issued 12,242,114 and 12,393,982 at December 31, 2007 and March 31,
2007, respectively (convertible into Class A shares on a one-for-one basis)..... 122 124
Additional paid-in capital........................................................... 156,493 150,818
Retained earnings.................................................................... 348,413 269,430
Accumulated other comprehensive income............................................... 50 33
Less: Treasury stock, 3,287,936 shares of Class A and 92,902 shares of Class B
Common Stock at December 31, 2007, respectively, and 3,237,023 shares of Class A
and 92,902 shares of Class B Common Stock at March 31, 2007, respectively, at cost (56,125) (55,981)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY........................................................... 449,359 364,827
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................................... $ 837,487 $ 707,783
=========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; dollars in thousands)
NINE MONTHS ENDED
DECEMBER 31,
------------------------------
2007 2006
------------- ----------
OPERATING ACTIVITIES:
Net income............................................................. $ 79,035 $ 40,645
Adjustments to reconcile net income to net cash provided by
operating activities:
Acquired in-process research and development........................ 10,000 --
Cumulative effect of change in accounting principle................. -- (1,976)
Depreciation, amortization and other non-cash charges............... 22,368 16,662
Deferred income tax (benefit) provision............................. (2,532) 5,126
Deferred compensation............................................... 1,674 565
Stock-based compensation............................................ 4,089 2,948
Excess tax benefits associated with stock options................... (972) (565)
Other............................................................... -- 270
Changes in operating assets and liabilities:
Increase in receivables, net........................................ (22,352) (30,288)
Decrease (increase) in inventories, net............................. 494 (10,854)
Increase in prepaid and other assets................................ (6,405) (2,910)
Increase in income taxes payable.................................... 675 3,210
Increase in accounts payable and accrued
liabilities...................................................... 4,306 1,397
------------- ----------
Net cash provided by operating activities.............................. 90,380 24,230
------------- ----------
INVESTING ACTIVITIES:
Purchase of property and equipment, net............................. (13,090) (21,634)
Purchase of marketable securities................................... (101,122) (171,014)
Sale of marketable securities....................................... 135,475 122,700
Purchase of preferred stock......................................... -- (400)
Product acquisition................................................. (151,500) --
------------- ----------
Net cash used in investing activities.................................. (130,237) (70,348)
------------- ----------
FINANCING ACTIVITIES:
Principal payments on long-term debt................................ (1,408) (1,185)
Proceeds from borrowing on line of credit........................... 50,000 --
Repayment of borrowing on line of credit............................ (20,000) --
Dividends paid on preferred stock................................... (52) (52)
Purchase of common stock for treasury............................... (144) (2,033)
Excess tax benefits associated with stock options................... 972 565
Cash deposits received for stock options............................ 868 3,667
------------- ----------
Net cash provided by financing activities.............................. 30,236 962
------------- ----------
Decrease in cash and cash equivalents.................................. (9,621) (45,156)
Cash and cash equivalents:
Beginning of year................................................... 82,574 100,706
------------- ----------
End of period....................................................... $ 72,953 $ 55,550
============= ==========
SUPPLEMENTAL INFORMATION:
Interest paid....................................................... $ 7,599 $ 6,700
Income taxes paid................................................... 39,862 13,629
Stock options exercised (at expiration of two-year forfeiture period) 615 3,317
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(in thousands, except per share data)
1. BASIS OF PRESENTATION
K-V Pharmaceutical Company and its subsidiaries ("KV" or the "Company") are
primarily engaged in the development, acquisition, manufacture, marketing and
sale of technologically distinguished branded and generic/non-branded
prescription pharmaceutical products. The Company was incorporated in 1971 and
has become a leader in the development of advanced drug delivery and
formulation technologies that are designed to enhance therapeutic benefits of
existing drug forms. Through internal product development and synergistic
acquisitions of products, KV has grown into a fully integrated specialty
pharmaceutical company. The Company also develops, manufactures and markets
technologically advanced, value-added raw material products for the
pharmaceutical, nutritional, food and personal care industries.
The accompanying unaudited consolidated financial statements of the Company
have been prepared in accordance with U.S. generally accepted accounting
principles ("GAAP") for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by GAAP for
complete financial statements. However, in the opinion of management, all
adjustments (consisting of only normal recurring accruals) considered
necessary for a fair presentation have been included. The results of
operations and cash flows for the three- and nine-month periods ended December
31, 2007 are not necessarily indicative of the results of operations and cash
flows that may be expected for the fiscal year ended March 31, 2008. The
interim consolidated financial statements and accompanying notes should be
read in conjunction with the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K for the fiscal
year ended March 31, 2007. The balance sheet information as of March 31, 2007
has been derived from the Company's audited consolidated balance sheet as of
that date.
2. ACQUISITION
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 up to $20,000 will be made.
Because the product had not obtained FDA approval when the initial payment was
made at closing, the Company recorded $10,000 of in-process research and
development expense during the nine months ended December 31, 2007. In July
2007, FDA approval for Evamist(TM) was received and a 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.
3. 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 also 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
7
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, convertible preferred
stock and the Convertible Subordinated 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 Convertible Subordinated 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.
The following table sets forth the computation of basic and diluted earnings
per share for the three months ended December 31, 2007 and 2006:
THREE MONTHS ENDED THREE MONTHS ENDED
DECEMBER 31, 2007 DECEMBER 31, 2006
--------------------------------- ---------------------------------
CLASS A CLASS B CLASS A CLASS B
---------------- ---------------- ---------------- ----------------
Basic earnings per share:
Numerator:
Allocation of undistributed earnings $ 25,607 $ 6,988 $ 14,428 $ 4,017
---------------- ---------------- ---------------- ----------------
Denominator:
Weighted average shares outstanding 37,620 12,282 37,288 12,372
Less - weighted average unvested
common shares subject to repurchase (427) (103) (362) (36)
---------------- ---------------- ---------------- ----------------
Number of shares used in per
share computations 37,193 12,179 36,926 12,336
================ ================ ================ ================
Basic earnings per share $ 0.69 $ 0.57 $ 0.39 $ 0.33
================ ================ ================ ================
Diluted earnings per share:
Numerator:
Allocation of undistributed earnings
for basic computation $ 25,607 $ 6,988 $ 14,428 $ 4,017
Reallocation of undistributed earnings as a
result of conversion of Class B to
Class A shares 6,988 - 4,017 -
Reallocation of undistributed earnings to
Class B shares - (947) - (480)
Add - preferred stock dividends 17 - 17 -
Add - interest expense convertible notes 1,199 - 1,014 -
---------------- ---------------- ---------------- ----------------
Allocation of undistributed earnings $ 33,811 $ 6,041 $ 19,476 $ 3,537
================ ================ ================ ================
Denominator:
Number of shares used in basic computation 37,193 12,179 36,926 12,336
Weighted average effect of dilutive securities:
Conversion of Class B to Class A shares 12,179 - 12,336 -
Employee stock options 842 85 724 76
Convertible preferred stock 338 - 338 -
Convertible notes 8,692 - 8,692 -
---------------- ---------------- ---------------- ----------------
Number of shares used in per share
computations 59,244 12,264 59,016 12,412
================ ================ ================ ================
Diluted earnings per share (1) $ 0.57 $ 0.49 $ 0.33 $ 0.29
================ ================ ================ ================
<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 three months ended December 31, 2006, excluded from the
computation were options to purchase 518 shares of Class A and Class
B Common Stock.
8
The following table sets forth the computation of basic and diluted earnings
per share for the nine months ended December 31, 2007 and 2006:
NINE MONTHS ENDED DECEMBER 31,
-------------------------------------------------------------------------
2007 2006
------------------------------------ ------------------------------------
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 $ 61,958 $ 17,025 $ 30,131 $ 8,486
Allocation of cumulative effect of
change in accounting principle - - 1,542 434
----------------- ----------------- ------------------ -----------------
Allocation of undistributed earnings $ 61,958 $ 17,025 $ 31,673 $ 8,920
================= ================= ================== =================
Denominator:
Weighted average shares outstanding 37,531 12,332 37,100 12,475
Less - weighted average unvested
common shares subject to repurchase (437) (101) (343) (53)
----------------- ----------------- ------------------ -----------------
Number of shares used in per
share computations 37,094 12,231 36,757 12,422
================= ================= ================== =================
Basic earnings per share before cumulative
effect of change in accounting principle $ 1.67 $ 1.39 $ 0.82 $ $ 0.68
Per share effect of cumulative effect of
change in accounting principle - - 0.04 0.04
----------------- ----------------- ------------------ -----------------
Basic earnings per share $ 1.67 $ 1.39 $ 0.86 $ 0.72
================= ================= ================== =================
Diluted earnings per share:
Numerator:
Allocation of undistributed earnings
for basic computation before cumulative
effect of change in accounting principle $ 61,958 $ 17,025 $ 30,131 $ 8,486
Reallocation of undistributed earnings as a
result of conversion of Class B to
Class A shares 17,025 - 8,486 -
Reallocation of undistributed earnings to
Class B shares - (2,245) - (845)
Add - preferred stock dividends 52 - 52 -
Add - interest expense convertible notes 3,198 - 2,929 -
----------------- ----------------- ------------------ -----------------
Allocation of undistributed earnings
for diluted computation before cumulative
effect of change in accounting principle 82,233 14,780 41,598 7,641
Allocation of cumulative effect of
change in accounting principle - - 1,976 363
----------------- ----------------- ------------------ -----------------
Allocation of undistributed earnings $ 82,233 $ 14,780 $ 43,574 $ 8,004
================= ================= ================== =================
(CONTINUED)
9
NINE MONTHS ENDED DECEMBER 31,
--------------------------------------------------------------------------
2007 2006
------------------------------------ ------------------------------------
CLASS A CLASS B CLASS A CLASS B
----------------- ----------------- ----------------- -----------------
Diluted earnings per share (continued):
Denominator:
Number of shares used in basic computation 37,094 12,231 36,757 12,422
Weighted average effect of dilutive securities:
Conversion of Class B to Class A shares 12,231 - 12,422 -
Employee stock options 792 83 719 107
Convertible preferred stock 338 - 338 -
Convertible notes 8,692 - 8,692 -
----------------- ----------------- ----------------- -----------------
Number of shares used in per share
computations 59,147 12,314 58,928 12,529
================= ================= ================= =================
Diluted earnings per share before cumulative
effect of change in accounting principle $ 1.39 $ 1.20 $ 0.71 $ 0.61
Per share effect of cumulative effect of
change in accounting principle - - 0.03 0.03
----------------- ----------------- ----------------- -----------------
Diluted earnings per share (1) $ 1.39 $ 1.20 $ 0.74 $ 0.64
================= ================= ================= =================
<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 nine months ended December 31, 2007 and 2006, excluded from
the computation were options to purchase 36 and 778 shares of Class A
and Class B Common Stock, respectively.
4. STOCK-BASED COMPENSATION
Effective April 1, 2006, the Company adopted Statement of Financial Accounting
Standards 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 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 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.
On August 30, 2002, the Company's shareholders approved KV's 2001 Incentive
Stock Option Plan (the "2001 Plan"), which allows for the issuance of up to
4,500 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.
10
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 cannot 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 implementing SFAS 123R, 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 were not expected to vest as of the
adoption date. The cumulative adjustment increased net income for the nine
months ended December 31, 2006 by $1,976, net of tax, and increased diluted
earnings per share for Class A and Class B shares by $0.03 and $0.03,
respectively.
The Company recognized, in accordance with SFAS 123R, stock-based compensation
of $1,332 and $4,089, respectively, and related tax benefits of $302 and
$1,043, respectively, for the three and nine months ended December 31, 2007
and stock-based compensation of $1,029 and $2,948, respectively, and related
tax benefits of $289 and $859, respectively, for the three and nine months
ended December 31, 2006. There was no stock-based employee compensation cost
capitalized as of December 31, 2007. Cash received from stock option deposits
was $195 and $1,247 for the three months ended December 31, 2007 and 2006,
respectively, and $868 and $3,667 for the nine months ended December 31, 2007
and 2006, respectively. The actual tax benefit realized from tax deductions
associated with stock option exercises (at expiration of two-year forfeiture
period) was $526 and $339 for the three months ended December 31, 2007 and
2006, respectively, and $1,055 and $762 for the nine months ended December 31,
2007 and 2006, respectively.
The following weighted average assumptions were used for stock options granted
during the three and nine months ended December 31, 2007 and 2006:
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------ ------------------------
2007 2006 2007 2006
---- ---- ---- ----
Dividend yield............................... None None None None
Expected volatility.......................... 41% 45% 43% 45%
Risk-free interest rate...................... 4.16% 4.93% 4.79% 4.93%
Expected term ............................... 9.0 years 8.9 years 9.0 years 8.9 years
Weighted average fair value per share
at grant date.............................. $ 15.91 $ 14.14 $ 15.94 $ 12.98
11
A summary of the changes in the Company's stock option plans during the nine
months ended December 31, 2007 is presented below:
WEIGHTED
WEIGHTED AVERAGE
AVERAGE REMAINING AGGREGATE
EXERCISE CONTRACTUAL INTRINSIC
SHARES PRICE TERM VALUE
------ ----- ---- -----
Balance, March 31, 2007.................... 3,666 $ 16.11
Options granted............................ 753 27.60
Options exercised.......................... (116) 4.94 $ 2,745
Options canceled........................... (417) 19.06
-----------
Balance, December 31, 2007................. 3,886 18.34 5.7 $ 39,687
===========
Expected to vest at
December 31, 2007..................... 3,012 $ 18.34 5.7 $ 30,757
Options exercisable at December 31, 2007
(excluding shares in the two-year
forfeiture period)..................... 1,230 $ 16.25 5.2 $ 15,122
As of December 31, 2007, the Company had $41,611 of total unrecognized
compensation expense, related to stock option grants, which will be recognized
over the remaining weighted average period of 4.9 years.
5. 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 the products it has
developed to pharmaceutical marketers. Royalties under these arrangements are
earned based on the sale of products.
Concurrently with the recognition of revenue, the Company records estimated
sales provisions for product returns, sales rebates, payment discounts,
chargebacks, and other sales allowances. Sales provisions are established
based upon consideration of a variety of factors, including but not limited
to, historical relationship to revenues, historical payment and return
experience, estimated and actual customer inventory levels, customer rebate
arrangements, and current contract sales terms with wholesale and indirect
customers.
Actual product returns, chargebacks and other sales allowances incurred are,
however, 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 $57,201 and $42,617 for the three months ended December 31,
2007 and 2006, respectively, and $164,629 and $114,811 for the nine months
ended December 31, 2007 and 2006, respectively. The reserve balances related
to the sales provisions totaled $47,369 and $31,281 at December 31, 2007 and
March 31, 2007, respectively, and are included in "Receivables, less allowance
for doubtful accounts" in the accompanying consolidated balance sheets.
12
6. INVENTORIES
Inventories consist of the following:
DECEMBER 31, 2007 MARCH 31, 2007
----------------- --------------
Finished goods..................... $ 31,423 $ 35,420
Work-in-process.................... 13,820 13,294
Raw materials...................... 45,778 42,801
----------- -----------
$ 91,021 $ 91,515
=========== ===========
Management establishes reserves for potentially obsolete or slow-moving
inventory based on an evaluation of inventory levels, forecasted demand, and
market conditions.
7. INTANGIBLE ASSETS AND GOODWILL
Intangible assets and goodwill consist of the following:
DECEMBER 31, 2007 MARCH 31, 2007
------------------------------ -----------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
------ ------------ ------ ------------
Product rights - Micro-K(R).................. $ 36,140 $ (15,867) $ 36,140 $ (14,513)
Product rights - PreCare(R).................. 8,433 (3,549) 8,433 (3,233)
Product rights - Evamist(TM)................. 52,446 (1,504) -- --
Trademarks acquired:
Niferex(R).............................. 14,834 (3,523) 14,834 (2,967)
Chromagen(R)/StrongStart(R)............. 27,642 (6,565) 27,642 (5,528)
Evamist(TM)............................. 15,166 (435) -- --
License agreements - Evamist(TM)............. 66,417 (1,904) -- --
License agreements - other................... 4,400 (615) 4,400 (480)
Covenant not to compete - Evamist(TM)........ 7,471 (357) -- --
Covenant not to compete - other ............. 375 (100) 375 (72)
Trademarks and patents....................... 5,368 (1,011) 4,196 (774)
------------- ---------- ----------- ----------
Total intangible assets.................... 238,692 (35,430) 96,020 (27,567)
Goodwill..................................... 557 -- 557 --
------------- ---------- ----------- ----------
$ 239,249 $ (35,430) $ 96,577 $ (27,567)
============= ========== =========== ==========
As of December 31, 2007, the Company's intangible assets have a weighted
average useful life of approximately 16 years. Amortization expense for
intangible assets was $3,668 and $1,204 for the three months ended December
31, 2007 and 2006, respectively, and $7,868 and $3,602 for the nine months
ended December 31, 2007 and 2006, respectively.
Assuming no additions, disposals or adjustments are made to the carrying
values and/or useful lives of the intangible assets, annual amortization
expense on product rights, trademarks acquired and other intangible assets is
estimated to be approximately $3,680 for the remainder of fiscal 2008 and
approximately $14,700 in each of the four succeeding fiscal years.
8. REVOLVING CREDIT AGREEMENT
The Company has 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 Convertible
Subordinated Notes. Interest is charged under the credit facility at the lower
of the prime rate or LIBOR plus 62.5
13
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. As of September 30, 2007, the Company was in
compliance with all of its financial covenants. In addition, the agreement
requires that the Company submit quarterly financial statements within 45 days
of the close of each fiscal quarter. The Company has obtained the consent of
the lenders to extend the period for submission of the quarterly financial
statements for this quarter to June 30, 2008. At December 31, 2007, the
Company had $30,000 of borrowings outstanding under the credit facility (see
Note 9).
9. LONG-TERM DEBT
Long-term debt consists of the following:
DECEMBER 31, 2007 MARCH 31, 2007
----------------- --------------
Building mortgages.......................... $ 39,940 $ 41,348
Line of credit.............................. 30,000 --
Convertible notes........................... 200,000 200,000
----------- ----------
269,940 241,348
Less current portion........................ (201,984) (1,897)
----------- ----------
$ 67,956 $ 239,451
=========== ==========
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 loan was
used for working capital and general corporate purposes. This mortgage loan,
which is secured by three of the Company's buildings, bears interest at a rate
of 5.91% and matures on April 1, 2021.
On May 16, 2003, the Company issued $200,000 principal amount of Convertible
Subordinated Notes (the "Notes") that are convertible, under certain
circumstances, into shares of Class A Common Stock at an initial conversion
price of $23.01 per share. The Notes, which are due May 16, 2033, bear
interest that is payable on May 16 and November 16 of each year at a rate of
2.50% per annum. The Company also is obligated to pay contingent interest at a
rate equal to 0.5% per annum during any six-month period from May 16 to
November 15 and from November 16 to May 15, with the initial six-month period
commencing May 16, 2006, if the average trading price of the Notes per $1,000
principal amount for the five trading day period ending on the third trading
day immediately preceding the first day of the applicable six-month period
equals $1,200 or more. 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.
The Company may redeem some or all of the Notes at any time on or after May
21, 2006, at a redemption price, payable in cash, of 100% of the principal
amount of the Notes, plus accrued and unpaid interest, including contingent
interest, if any. Holders may require the Company to repurchase all or a
portion of their Notes on May 16, 2008, 2013, 2018, 2023 and 2028 or upon a
change in control, as defined in the indenture governing the Notes, at a
purchase price, payable in cash, of 100% of the principal amount of the Notes,
plus accrued and unpaid interest, including contingent interest, if any. The
Company has classified the Notes as a current liability as of December 31,
2007, due to the right the holders have to require the Company to repurchase
the Notes on May 16, 2008. Since the holders did not elect to cause the
Company to repurchase any of the Notes, the Notes will be reclassified as
long-term beginning with the Company's consolidated balance sheet as of June
30, 2008. The Notes are subordinate to all of the Company's existing and
future senior obligations.
14
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 trading day 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 8,692 shares of Class A Common Stock for issuance in
the event the Notes are converted.
Certain conversion features of the Notes and the contingent interest feature
meet the criteria of and qualify as embedded derivatives. Although these
features represent embedded derivative financial instruments, based on the de
minimis value of them at the time of issuance and at December 31, 2007, no
value has been assigned to these embedded derivatives.
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.
10. TAXABLE INDUSTRIAL REVENUE BONDS
In December 2005, the Company entered into a financing arrangement with St.
Louis County, Missouri related to expansion of its operations in St. Louis
County. Up to $135,500 of industrial revenue bonds may be issued to the
Company by St. Louis County relative to capital improvements made through
December 31, 2009. This agreement provides that 50% of the real and personal
property taxes on up to $135,500 of capital improvements will be abated for a
period of ten years subsequent to the property being placed in service.
Industrial revenue bonds totaling $109,397 were outstanding at December 31,
2007. The industrial revenue bonds are issued by St. Louis County to the
Company upon its payment of qualifying costs of capital improvements, which
are then leased by the Company for a period ending December 1, 2019, unless
earlier terminated. The Company has the option at any time to discontinue the
arrangement and regain full title to the abated property. The industrial
revenue bonds bear interest at 4.25% per annum and are payable as to principal
and interest concurrently with payments due under the terms of the lease. The
Company has classified the leased assets as property and equipment and has
established a capital lease obligation equal to the outstanding principal
balance of the industrial revenue bonds. Lease payments may be made by
tendering an equivalent portion of the industrial revenue bonds. As the
capital lease payments to St. Louis County may be satisfied by tendering
industrial revenue bonds (which is the Company's intention), the capital lease
obligation, industrial revenue bonds and related interest expense and interest
income, respectively, have been offset for presentation purposes in the
consolidated financial statements.
11. 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,
comprehensive income is comprised of net income and the net changes in
unrealized gains and losses on available for sale marketable securities, net
of applicable income taxes. Total comprehensive income totaled $32,666 and
$18,632 for the three months ended December 31, 2007 and 2006, respectively,
and $79,052 and $40,856 for the nine months ended December 31, 2007 and 2006,
respectively.
15
12. SEGMENT REPORTING
The reportable operating segments of the Company are branded products,
specialty generic/non-branded and specialty materials. The branded products
segment includes patent-protected products and certain trademarked off-patent
products that the Company sells and markets as brand pharmaceutical products.
The specialty generics segment includes off-patent pharmaceutical products
that are therapeutically equivalent to proprietary products. The Company sells
its branded and generic/non-branded products primarily to pharmaceutical
wholesalers, drug distributors and chain drug stores. The specialty materials
segment is distinguished as a single segment because of differences in
products, marketing and regulatory approval when compared to the other
segments.
Accounting policies of the segments are the same as the Company's consolidated
accounting policies. Segment profits are measured based on income before taxes
and are determined based on each segment's direct revenues and expenses. The
majority of research and development expense, corporate general and
administrative expenses, amortization and interest expense, as well as
interest and other income, are not allocated to segments, but included in the
"all other" classification. Identifiable assets for the three reportable
operating segments primarily include receivables, inventory, and property and
equipment. For the "all other" classification, identifiable assets consist of
cash and cash equivalents, corporate property and equipment, intangible and
other assets and all income tax related assets.
The following tables present information for the Company's reportable
operating segments for the three and nine months ended December 31, 2007 and
2006.
THREE MONTHS
ENDED BRANDED SPECIALTY SPECIALTY ALL
DECEMBER 31, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED
------------ -------- -------- --------- ----- ------------ ------------
Net revenues 2007 $ 54,526 $ 101,911 $ 4,700 $ 486 $ - $ 161,623
2006 48,311 64,745 4,545 348 - 117,949
Segment profit (loss) 2007 25,119 64,699 1,799 (45,524) - 46,093
2006 22,102 35,956 725 (30,735) - 28,048
Identifiable assets 2007 29,178 108,693 7,475 693,299 (1,158) 837,487
2006 28,858 87,736 7,967 552,380 (1,158) 675,783
Property and 2007 - - 15 6,154 - 6,169
equipment additions 2006 3 - - 3,292 - 3,295
Depreciation and 2007 198 80 45 8,334 - 8,657
amortization 2006 178 84 40 5,312 - 5,614
NINE MONTHS
ENDED BRANDED SPECIALTY SPECIALTY ALL
DECEMBER 31, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED
------------ -------- -------- --------- ----- ------------ ------------
Net revenues 2007 $ 157,764 $ 277,275 $ 12,719 $ 1,146 $ - $ 448,904
2006 138,453 170,072 13,206 1,401 - 323,132
Segment profit (loss) 2007 73,068 171,538 3,985 (130,579) - 118,012
2006 62,317 88,341 2,047 (91,667) - 61,038
Property and 2007 257 - 91 12,742 - 13,090
equipment additions 2006 96 - - 21,538 - 21,634
Depreciation and 2007 559 239 133 21,437 - 22,368
amortization 2006 533 253 121 15,755 - 16,662
16
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.
13. CONTINGENCIES - 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. The Company has 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 40 mg generic formulation would not infringe Celltech's
patent. Because the patent was not listed in the Orange Book for the 50 mg and
60 mg 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.
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
17
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 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
18
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
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.
19
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 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
20
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 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,
21
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.
14. INCOME TAXES
The Company adopted FASB Interpretation 48, "Accounting for Uncertainty in
Income Taxes - an interpretation of FASB Statement No. 109" ("FIN 48")
effective April 1, 2007. FIN 48 prescribes accounting for and disclosure of
uncertainty in tax positions. This interpretation addresses the determination
of whether tax benefits claimed or expected to be claimed on a tax return
should be recorded in the financial statements. Under FIN 48, the Company may
recognize the tax benefit from an uncertain tax position only if it is more
likely than not that the tax position will be sustained on examination by the
taxing authorities, based on the technical merits of the position. The tax
benefits recognized in the financial statements from such a position should be
measured based on the largest benefit that has a greater than 50% likelihood
of being realized upon ultimate settlement. FIN 48 also provides guidance on
derecognition of tax positions, financial statement classification,
recognition of interest and penalties, accounting in interim periods, and
disclosure and transition requirements. The Company's adoption of FIN 48 was
not material to its consolidated financial position; however, certain
reclassifications of various income tax-related balance sheet amounts were
required.
At April 1, 2007, upon adoption of FIN 48, the Company had $12,980 of gross
unrecognized tax benefits, which if recognized would favorably affect the
effective income tax rate in future periods.
As of December 31, the consolidated balance sheet reflects a liability for
unrecognized tax benefits of $11,884, excluding liabilities for interest and
penalties. Accrued interest and penalties included in the consolidated balance
sheet were $2,082 as of December 31, 2007.
The Company recognizes interest and penalties associated with uncertain tax
positions as a component of income tax expense in the consolidated statement
of income.
It is anticipated the Company will recognize approximately $1,300 of
unrecognized tax benefits within the next 12 months as a result of the
expected expiration of the relevant statute of limitations.
22
The Company is subject to taxation in the U.S. and various states and is
subject to examinations 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. We expect the IRS to issue additional information
requests. The Company does not have any state examinations in progress at this
time.
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 determined that certain options previously classified as Incentive
Stock Option ("ISO") grants were determined to have been granted with an
exercise price below the fair market value of the Company's stock on the
revised measurement dates. Under Internal Revenue Code Section 422, ISOs may
not be granted with an exercise price less than the fair market value on the
date of grant, and therefore these grants would not likely qualify for ISO tax
treatment. The disqualification of ISO classification exposes the Company and
the affected employees to payroll related withholding taxes once the
underlying shares are released from the post exercise two-year forfeiture
period and the substantial risk of forfeiture has lapsed, which creates a
taxable event. The Company and the affected employees may also be subject to
interest and penalties for failing to properly withhold taxes and report the
taxable event on their respective tax returns. The Company is currently
reviewing the potential disqualification of ISO grants and the related
withholding tax implications with the IRS in an effort to reach agreement on
the resulting tax liability. The Company recorded liabilities related to this
matter of $8,806 as of December 31, 2007, in accrued liabilities on the
consolidated balance sheet.
Management regularly reevaluates the Company's tax positions taken on filed
tax returns using information about recent court decisions and legislative
activities. Many factors are considered in making these evaluations, including
past history, recent interpretations of tax law, and the specific facts and
circumstances of each matter. Because tax law and regulations are subject to
interpretation and tax litigation is inherently uncertain, these evaluations
can involve a series of complex judgments about future events and can rely
heavily on estimates and assumptions. The recorded tax liabilities are based
on estimates and assumptions that have been deemed reasonable by management.
However, if our estimates are not representative of actual outcomes, recorded
tax liabilities could be materially impacted.
15. 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. 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.
23
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 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 fair values. SFAS 141(R) is
effective for business combinations for which the
24
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008 and early 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 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.
16. SUBSEQUENT EVENTS
In January 2008, the Company entered into a definitive asset purchase
agreement with CYTYC Prenatal Products and Hologic, Inc. ("CYTYC") to acquire
the U.S. and worldwide rights to Gestiva(TM) (17-alpha hydroxyprogesterone
caproate). The NDA for Gestiva(TM) is currently before the FDA, pending
approval for use in the prevention of preterm birth in certain categories of
pregnant women. The proposed indication is for women with a history of at
least one spontaneous preterm delivery (i.e., less than 37 weeks), who are
pregnant with a single fetus. Under the terms of the asset purchase agreement,
the Company agreed to pay $82,000 for Gestiva(TM), $7,500 of which was paid at
closing and recorded as in-process research and development expense. The
remainder is payable on the completion of two milestones: (1) $2,000 on the
earlier to occur of CYTYC's receipt of acknowledgement from the FDA that their
response to the FDA's October 20, 2006 "approvable" letter is sufficient for
the FDA to proceed with their review of the NDA or the receipt of FDA's
approval of the Gestiva(TM) NDA and (2) $72,500 on FDA approval of a
Gestiva(TM) NDA, transfer of all rights in the NDA to the Company and receipt
by the Company of defined launch quantities of finished Gestiva(TM) suitable
for commercial sale.
In January 2008, the 133 employees represented by the Teamsters Union voted to
decertify union representation effective February 7, 2008. As a result of the
decertification, the Company incurred a withdrawal liability for the portion
of the unfunded benefit obligation associated with the multi-employer pension
plan administered by the union applicable to its employees covered by the
plan. The withdrawal liability of $923 was recorded as an expense in the
fourth quarter of fiscal year 2008.
At March 31, 2008, the Company had invested $83,900 in the principal amount of
auction rate securities ("ARS"). The Company's 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 the Company all had AAA credit ratings
at the time of purchase and at the end of the Company's fiscal 2008 year end.
With the liquidity issues experienced in global credit and capital markets,
the ARS held by the Company at March 31, 2008 experienced failed auctions
beginning in February 2008 as the amount of securities submitted for sale
exceeded the
25
amount of purchase orders. Given the failed auctions, the Company's ARS will
continue to be illiquid until there is a successful auction for them. The
Company cannot predict how long the current imbalance in the auction rate
market will continue. The estimated fair value of the Company's ARS holdings
at March 31, 2008 was 81,516, which reflected a $2,384 difference from the
principal amount of $83,900. 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, the Company recorded during the fourth quarter of fiscal
2008 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.
ARS have historically been classified as short-term marketable securities in
the Company's consolidated balance sheet. Given the failed auctions, the
Company has reclassified the $81,516 of ARS as of March 31, 2008 from current
assets to non-current assets. The Company believes that as of March 31, 2008,
based on its current cash, cash equivalents and marketable securities balances
of $126,893 and its current borrowing capacity under its credit facility of
$290,000, the current lack of liquidity in the auction rate market will not
have a material impact on the Company's ability to fund its operations or
interfere with its external growth plans, although the Company cannot assure
you that this will continue to be the case.
In March 2008, representatives of the Missouri Department of Health and Senior
Services, accompanied by representatives of the FDA, notified the Company of a
hold on its inventory of certain unapproved drug products, restricting the
Company's 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, the
Company timely discontinued a number of its guaifenesin products and believed
that, by doing so, had complied with those notices. The recent action to place
a hold on certain of the Company's 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 the Company without FDA approval under certain
"grandfather clauses" and statutory and regulatory exceptions to the
pre-market approval requirement for "new drugs" under the FDA. FDA policies
permit the agency to initiate broad action against the marketing of additional
categories of the Company's 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. The
Company will discontinue manufacturing and marketing substantially all
unapproved products subject to the hold.
The FDA has not proposed, nor does the Company expect them to propose, that
the products subject to the hold be recalled from the distribution channel. As
such, the Company has written-off the value of the products subject to the
hold in its inventory as of March 31, 2008. The Company 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
the Company 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
$5,500.
During most of fiscal 2008, the Company marketed approximately 30 products in
its generic/non-branded respiratory line, which consisted primarily of
cough/cold products. The cough/cold line accounted for $38,536, or 10.5%, of
the Company's specialty generic net revenues in fiscal 2008. As a result of
the FDA hold discussed above, the Company is 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
$884 during fiscal 2008.
26
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Form 10-Q, including the documents that we incorporate herein by
reference, contains various forward-looking statements within the meaning of
the United States Private Securities Litigation Reform Act of 1995, 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, 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, political and technology 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 by no means exhaustive, but is designed to highlight
important factors that may impact the Company's outlook. We undertake no
obligation to update any of the forward-looking statements after the date of
this report.
27
ITEM 6. EXHIBITS
Exhibits. See Exhibit Index.
28
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 27, 2008 By /s/ Ronald J. Kanterman
------------------------------------------
Ronald J. Kanterman
Vice President and Chief Financial Officer
(Principal Financial Officer)
29
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
31.1 Certification of Chief Executive Officer.
31.2 Certification of Chief Financial Officer.
32.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
32.2 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
30