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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
COMMISSION FILE NUMBER 1-9601
K-V PHARMACEUTICAL COMPANY
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 43-0618919
-------- ----------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
2503 SOUTH HANLEY ROAD, ST. LOUIS, MISSOURI 63144
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(ADDRESS OR PRINCIPAL EXECUTIVE OFFICES)
(ZIP CODE)
(314) 645-6600
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(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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 SUCH SHORTER PERIOD THAT THE REGISTRANT
WAS REQUIRED TO FILE SUCH REPORTS) AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
--- ---
TITLE OF CLASS OF NUMBER OF SHARES
COMMON STOCK OUTSTANDING AS OF JULY 25, 2002
----------------- -------------------------------
CLASS A COMMON STOCK, PAR VALUE $.01 PER SHARE 23,618,602
CLASS B COMMON STOCK, PAR VALUE $.01 PER SHARE 10,484,353
1
PART I. - FINANCIAL INFORMATION
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands, except per share data)
THREE MONTHS ENDED
JUNE 30,
-----------------------
2002 2001
------- -------
Net revenues $49,227 $45,220
Cost of sales 19,078 17,575
------- -------
Gross profit 30,149 27,645
------- -------
Operating expenses:
Research and development 3,469 2,534
Selling and administrative 15,492 15,641
Amortization of intangible assets 583 589
------- -------
Total operating expenses 19,544 18,764
------- -------
Operating income 10,605 8,881
------- -------
Other income (expense):
Interest and other income 53 105
Interest expense (37) (103)
------- -------
Total other income (expense), net 16 2
------- -------
Income before income taxes 10,621 8,883
Provision for income taxes 3,898 3,220
------- -------
Net income $ 6,723 $ 5,663
======= =======
Net income per common share-basic $ 0.22 $ 0.19
======= =======
Net income per common share-diluted $ 0.21 $ 0.18
======= =======
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
2
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
JUNE 30, 2002 MARCH 31, 2002
------------- --------------
(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents $ 22,076 $ 12,109
Receivables, less allowance for doubtful accounts of
$335 and $403 at June 30, 2002 and March 31, 2002, respectively 42,307 54,218
Inventories, net 38,839 35,097
Prepaid and other assets 2,596 2,102
Deferred tax asset, net 5,778 5,227
--------- --------
Total Current Assets 111,596 108,753
Property and equipment, less accumulated depreciation 44,621 41,224
Goodwill and other intangible assets, net 41,464 41,292
Other assets 4,932 3,923
--------- --------
TOTAL ASSETS $ 202,613 $195,192
========= ========
LIABILITIES
Current Liabilities:
Accounts payable $ 11,377 $ 10,312
Accrued liabilities 15,399 16,332
Current maturities of long-term debt 712 712
--------- --------
Total Current Liabilities 27,488 27,356
Long-term debt 4,291 4,387
Other long-term liabilities 2,767 2,717
Deferred tax liability, net 2,115 1,940
--------- --------
TOTAL LIABILITIES 36,661 36,400
--------- --------
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 June 30, 2002 and March 31, 2002
(convertible into Class A shares at a ratio of 5.625-to-one) -- --
Class A and Class B Common Stock, $.01 par value; 150,000,000 and 75,000,000
shares authorized, respectively;
Class A-issued 20,348,064 and 20,158,334 at June 30, 2002 and
March 31, 2002, respectively 203 201
Class B-issued 10,537,556 and 10,711,514 at June 30, 2002 and
March 31, 2002, respectively (convertible into Class A shares on a
one-for-one basis) 106 108
Additional paid-in capital 47,679 47,231
Retained earnings 118,006 111,301
Less: Treasury Stock, 27,140 shares of Class A and 53,428 shares of Class B
Common Stock at June 30, 2002 and 40,493 shares of Class A and 53,428
shares of Class B Common Stock at March 31, 2002, at cost (42) (49)
--------- --------
TOTAL SHAREHOLDERS' EQUITY 165,952 158,792
--------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 202,613 $195,192
========= ========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
THREE MONTHS ENDED
JUNE 30,
---------------------------
2002 2001
--------- ---------
OPERATING ACTIVITIES
Net income $ 6,723 $ 5,663
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation, amortization and other non-cash charges 1,647 1,574
Change in deferred taxes (376) 75
Change in deferred compensation 50 75
Changes in operating assets and liabilities:
Decrease (increase) in receivables, net 11,911 (3,428)
(Increase) decrease in inventories, net (3,742) 2,865
Decrease in prepaid and other assets 742 1,741
Increase in accounts payable and accrued liabilities 132 730
--------- ----------
Net cash provided by operating activities 17,087 9,295
--------- ----------
INVESTING ACTIVITIES
Purchase of stock and other intangible assets (3,000) --
Purchase of property and equipment, net (4,461) (1,524)
--------- ----------
Net cash used in investing activities (7,461) (1,524)
--------- ----------
FINANCING ACTIVITIES
Principal payments on long-term debt (96) (78)
Dividends paid on preferred stock (18) (18)
Sale of common stock to employee profit sharing plan 385 --
Exercise of common stock options 70 49
--------- ----------
Net cash provided by (used in) financing activities 341 (47)
--------- ----------
Increase in cash and cash equivalents 9,967 7,724
Cash and cash equivalents at:
Beginning of year 12,109 4,128
--------- ----------
End of period $ 22,076 $ 11,852
========= ==========
Supplemental Information:
Interest paid 136 112
Income taxes paid 2,783 66
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of K-V
Pharmaceutical Company ("KV" or the "Company") have been prepared in accordance
with generally accepted accounting principles 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 generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of only normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three-month period ended June 30, 2002 are
not necessarily indicative of the results that may be expected for the fiscal
year ending March 31, 2003. The interim consolidated financial statements 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 year ended
March 31, 2002. The balance sheet information as of March 31, 2002, has been
derived from the Company's audited consolidated balance sheet as of that date.
NOTE B - INVENTORIES
Inventories consist of the following:
JUNE 30, 2002 MARCH 31, 2002
------------- --------------
Finished goods $ 24,809 $ 18,600
Work-in-process 3,522 4,702
Raw materials 11,330 12,903
-------- --------
39,661 36,205
Reserve for obsolescence (822) (1,108)
-------- --------
$ 38,839 $ 35,097
======== ========
NOTE C - REVENUE RECOGNITION
Revenue is recognized at the time product is shipped to customers. Net
revenues consist of gross sales to customers less provisions for expected
customer returns, rebates, discounts, chargebacks, and other sales allowances
which are established by the Company concurrently with the recognition of
revenue. Sales provisions totaled $19,558 and $29,969 for the three months ended
June 30, 2002 and 2001, respectively. The reserve balances related to the sales
provisions totaled $20,571 and $18,958 at June 30, 2002 and March 31, 2002,
respectively, and are included in "Receivables, less allowance for doubtful
accounts" in the accompanying consolidated balance sheets.
5
NOTE D - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
THREE MONTHS ENDED
JUNE 30,
--------------------------
2002 2001
------- -------
Numerator:
Net income $ 6,723 $ 5,663
Preferred stock dividends (18) (18)
------- -------
Numerator for basic earnings per
share-income available to common
shareholders 6,705 5,645
Effect of dilutive securities:
Preferred stock dividends 18 18
------- -------
Numerator for diluted earnings per
share-income available to
common shareholders after
assumed conversions $ 6,723 $ 5,663
======= =======
Denominator:
Denominator for basic earnings per
share-weighted-average shares 30,770 29,485
------- -------
Effect of dilutive securities:
Employee stock options 1,204 1,208
Convertible preferred stock 225 1,325
------- -------
Dilutive potential common shares 1,429 2,533
------- -------
Denominator for diluted earnings
per share-adjusted weighted-average
shares and assumed conversions 32,199 32,018
======= =======
Basic earnings per share (1) $ 0.22 $ 0.19
======= =======
Diluted earnings per share (1)(2) $ 0.21 $ 0.18
======= =======
(1) The two-class method for Class A and Class B Common Stock is not presented
because the earnings per share are equivalent to the if converted method
since dividends were not declared or paid and each class of Common Stock
has equal ownership of the Company.
(2) Employee stock options to purchase 1,000 and 13,500 shares of common stock
at June 30, 2002 and 2001, respectively, are not presented because these
options are anti-dilutive. The exercise prices of these stock options
exceeded the average market prices of the shares under option in each
respective period.
6
NOTE E - SEGMENT FINANCIAL INFORMATION
The reportable operating segments of the Company are branded products,
specialty generics and specialty materials. The operating segments are
distinguished by differences in products, marketing and regulatory approval.
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,
property and equipment, goodwill and other intangible assets, other assets and
all income tax related assets. The accounting policies of the segments are the
same as those described in the Company's Annual Report on Form 10-K for the year
ended March 31, 2002.
The following represents information for the Company's reportable
operating segments for the three months ended June 30, 2002 and 2001.
Three Months
Ended Branded Specialty Specialty All
June 30, Products Generics Materials Other Eliminations Consolidated
----------- -------- --------- --------- -------- ------------ ------------
(IN THOUSANDS)
Net revenues 2002 $7,134 $37,052 $4,539 $ 502 -- $ 49,227
2001 8,711 31,563 4,219 727 -- 45,220
Segment profit/(loss) 2002 (615) 19,826 837 (9,427) -- 10,621
2001 512 16,704 809 (9,142) -- 8,883
Identifiable assets 2002 7,837 55,164 8,965 131,805 (1,158) 202,613
2001 7,174 35,536 7,697 108,654 (1,158) 157,903
Property and 2002 13 18 33 4,397 -- 4,461
equipment additions 2001 2 21 77 1,424 -- 1,524
Depreciation and 2002 21 13 41 1,572 -- 1,647
amortization 2001 16 21 37 1,500 -- 1,574
7
NOTE F - GOODWILL AND OTHER INTANGIBLE ASSETS - ADOPTION OF SFAS NO. 142
Effective April 1, 2002, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets,
issued in June 2001. In accordance with SFAS 142, goodwill and indefinite-lived
intangible assets are no longer subject to amortization, while the value of
other identifiable intangible assets must be amortized over their estimated
useful life. SFAS 142 requires goodwill to be tested for impairment annually
using a two-step process, and written off when impaired. The Company has six
months from the initial date of adoption to complete the initial impairment test
for goodwill.
As of June 30, 2002, the net carrying amounts of goodwill and other
intangible assets were $556 and $40,908, respectively. Goodwill relates to the
1972 acquisition of the Company's specialty materials segment. The Company is in
the process of completing, as of April 1, 2002, its initial goodwill impairment
test for the applicable reporting unit. With the adoption of SFAS 142, the
Company determined its other intangible assets had finite useful lives and will
continue to be amortized over their estimated useful lives. The adoption of SFAS
142 did not have a material effect on the Company's financial condition or
results of operations.
The following table reflects consolidated financial results adjusted as
though the adoption of SFAS 142 occurred as of the beginning of the three-month
period ended June 30, 2001:
THREE MONTHS ENDED
JUNE 30,
--------------------
2002 2001
------ ------
Net income:
As reported $6,723 $5,663
Goodwill amortization -- 14
------ ------
As adjusted $6,723 $5,677
====== ======
Basic earnings per share:
As reported $ 0.22 $ 0.19
Goodwill amortization -- --
------ ------
As adjusted $ 0.22 $ 0.19
====== ======
Diluted earnings per share:
As reported $ 0.21 $ 0.18
Goodwill amortization -- --
------ ------
As adjusted $ 0.21 $ 0.18
====== ======
The following table reflects the components of intangible assets as of
June 30, 2002:
Gross
Carrying Accumulated
Amount Amortization
-------- ------------
Product rights $44,573 $ 7,170
Trademarks and patents 3,754 249
Goodwill 2,138 1,582
------- -------
Total intangible assets $50,465 $ 9,001
======= =======
8
Amortization expense for the three months ended June 30, 2002 was $578.
Estimated annual amortization expense for each of the five succeeding fiscal
years is as follows:
Fiscal Year Ending March 31: Amount
- ---------------------------- ------
2003 $2,311
2004 2,311
2005 2,311
2006 2,311
2007 2,311
NOTE G - RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2001, the Emerging Issues Task Force issued EITF 01-09,
Accounting for Consideration Given by a Vendor to a Customer or a Reseller of
the Vendor's Products. EITF 01-09 codified and reconciled the task force's
consensuses on prior issues and identified other issues related to various
aspects of the accounting for consideration given by a vendor to a customer or a
reseller of the vendor's products. EITF 01-09 requires certain items previously
reported as selling expenses to be reclassified as reductions of net revenues in
the income statement. EITF 01-09 was effective for reporting periods beginning
after December 15, 2001 and was adopted by the Company for the fourth quarter of
its fiscal year ended March 31, 2002. In connection with the adoption and to
conform to current period presentation, the Company reclassified certain prior
period items which had been included in selling and administrative expenses to
reduce net revenues. However, the reclassification did not affect reported net
income or net sales growth rates.
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS 143 addresses financial accounting and reporting
for obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. This statement is effective for fiscal
years beginning after June 15, 2002. Management does not believe the adoption of
this statement will have a material impact on its results of operations or
financial position.
In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets. It
supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed of, and certain provisions of Accounting
Principles Board Opinion No. 30, Reporting the Effects of Disposal of a Segment
of a Business and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, for the disposal of a segment of a business. SFAS 144 establishes
a single accounting model, based on the framework established in SFAS 121, for
long-lived assets to be disposed of by sale and resolves other implementation
issues related to SFAS 121. This statement was adopted by the Company effective
April 1, 2002. The adoption of SFAS 144 did not have a material impact on the
Company's results of operations or financial position.
9
NOTE H - CONTINGENCIES
ETHEX Corporation, a wholly-owned subsidiary of the Company, is a
defendant in a lawsuit styled, Healthpoint, Ltd. V. ETHEX Corporation. On
September 28, 2001, the jury returned verdicts, in the form of answers to
special interrogatories, against ETHEX on certain false advertising, unfair
competition and misappropriation claims and awarded damages aggregating $16.5
million. The court will enter a judgment after consideration of the post-trial
motions. The court's judgment may then be appealed. The Company and its counsel
believe that the jury's recommended award is excessive and is not sufficiently
supported by the facts or the law. The court may or may not accept the jury's
verdicts. The Company intends to vigorously appeal any adverse judgment that the
court may enter. The Company and its legal counsel are not presently able to
predict the outcome of the matter and cannot reasonably estimate the Company's
ultimate liability, if any. Accordingly, the Company has not recorded any
contingent liability in its consolidated financial statements related to this
matter. In the event an adverse decision against the Company occurs, appropriate
provisions for liability, if any, will be provided for in its consolidated
financial statements at the time of the court's ruling.
From time to time, the Company becomes involved in various legal
matters, in addition to the above-described matters, that the Company considers
to be in the ordinary course of business. For additional information regarding
legal proceedings in which the Company or its subsidiaries are a party, see Item
I of Part II of this report. While the Company is not presently able to
determine the potential liability, if any, related to such matters, the Company
believes none of such matters, individually or in the aggregate, will have a
material adverse effect on the Company's financial position.
NOTE I - SUBSEQUENT EVENT
During July 2002, the Company completed a secondary public offering of
approximately 3.3 million shares of Class A common stock. Net proceeds to the
Company were approximately $72.5 million, after deducting underwriting
discounts, commissions and estimated offering expenses. The impact of these
transactions is not reflected in the unaudited consolidated balance sheet as of
June 30, 2002.
10
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
The materials in this Form 10-Q may contain various forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Any statements about the Company's expectations, beliefs, plans,
objectives, assumptions or future events or performance are not historical facts
and may be forward-looking. These statements are often, but not always, made
through the use of words or phases such as "anticipate," "estimate," "plans,"
"projects," "continuing," "ongoing," "expects," "management believes," "the
Company believes," "the Company intends" and similar words or phrases.
Accordingly, these statements involve estimates, assumptions and uncertainties
that could cause actual results to differ materially from those expressed in
them. Any forward-looking statements are qualified in their entirety by
reference to the factors discussed throughout this Form 10-Q.
Factors that could cause actual results to differ materially from the
forward-looking statements include, but are not limited to, the following: (1)
the degree to which the Company is successful in developing new products and
commercializing products under development; (2) the degree to which the Company
is successful in acquiring new pharmaceutical products, drug delivery
technologies and/or companies that offer these properties; (3) the difficulty of
predicting FDA approvals; (4) acceptance and demand for new pharmaceutical
products; (5) the impact of competitive products and pricing; (6) reliance on
key strategic alliances; (7) the availability of raw materials; (8) the
regulatory environment; (9) fluctuations in operating results; (10) the
difficulty of predicting the pattern of inventory movements by the Company's
customers; (11) the impact of competitive response to the Company's efforts to
leverage its brand power with product innovation, promotional programs, and new
advertising; (12) the risks detailed from time to time in the Company's filings
with the Securities and Exchange Commission; (13) the availability of
third-party reimbursement for the Company's products; and (14) the Company's
dependence on sales to a limited number of large pharmacy chains and wholesale
drug distributors for a large portion of its total net sales.
Because the factors referred to above, as well as the statements
included under the caption "Management's Discussion and Analysis of Results of
Operations and Financial Condition," and elsewhere in this Form 10-Q, could
cause actual results or outcomes to differ materially from those expressed in
any forward-looking statements made by the Company or on its behalf, you should
not place undue reliance on any forward-looking statements. Further, any
forward-looking statement speaks only as of the date on which it is made and,
unless applicable law requires to the contrary, the Company undertakes no
obligation to update any forward-looking statement to reflect events or
circumstances after the date on which the statement is made or to reflect the
occurrence of unanticipated events. New factors emerge from time to time, and it
is not possible for the Company to predict which factors will arise, when they
will arise and/or their effects. In addition, the Company cannot assess the
impact of each factor on its business or financial condition or the extent to
which any factor, or combination of factors, may cause actual results to differ
materially from those contained in any forward-looking statements.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Except for the historical information contained herein, the following
discussion contains forward-looking statements that are subject to known and
unknown risks, uncertainties, and other factors that may cause the Company's
actual results to differ materially from those expressed or implied by such
forward-looking statements. These risks, uncertainties and other factors are
discussed under the caption "Cautionary Statement Regarding Forward-Looking
Information." In addition, the following discussion and analysis of financial
condition and results of operations should be read in conjunction with the
consolidated financial statements, the related notes to consolidated financial
statements and "Management's Discussion and Analysis of Results of Operations
and Financial Condition" included in the Company's Annual Report on Form 10-K
for the fiscal year ended March 31, 2002, and the unaudited interim consolidated
financial statements and related notes to unaudited interim consolidated
financial statements included in Item 1 of this Quarterly Report on Form 10-Q.
RESULTS OF OPERATIONS
Three Months Ended June 30, 2002 Compared to the Three Months Ended
June 30, 2001
REVENUES. Net revenues for the quarter ended June 30, 2002 increased
$4.0 million, or 8.9%, to $49.2 million from $45.2 million for the corresponding
quarter in the prior year. The increase in net revenues was due to higher sales
of specialty generic products.
Specialty generic product sales increased $5.5 million, or 17.4%, to
$37.1 million for the quarter ended June 30, 2002 compared to $31.6 million for
the quarter ended June 30, 2001. Specialty generic product sales comprised 75.3%
of the Company's total net revenues for the quarter ended June 30, 2002 compared
to 69.8% for the corresponding prior year quarter. The increase in sales was
primarily attributable to $2.3 million of incremental sales from new products,
including the recent ANDA approval of Potassium Chloride 20 mg. tablets (generic
equivalent to K-Dur(R)), as well as a $2.3 million increase in sales volume
across the established product line. In addition to the volume growth, the
increase in sales included $0.9 million attributable to product price increases.
Branded product sales decreased $1.6 million, or 18.1%, to $7.1 million
for the quarter ended June 30, 2002 compared to $8.7 million for the same
quarter last year. The decrease in sales was the result of price increases on
the cardiovascular and PreCare prenatal vitamin product lines, taken in the
fourth quarter of fiscal 2002, and the resulting customer buy-ins before the new
pricing became effective. These buy-ins resulted in lower sales during the
quarter compared to the prior year quarter for both product lines. Sales of
Gynazole-1(R) continued to grow and were $2.8 million, up $1.1 million, or
66.6%, over the first quarter in the prior year. For the quarter, sales of the
women's healthcare line and cardiovascular line declined $0.3 million and $1.3
million, respectively. The slowdown in sales following a buy-in is normal as
customers sell down inventory, and the Company does not believe it's indicative
of future sales trends. Underlying demand for Ther-Rx products, as measured by
prescription volume, continues to grow, particularly in the women's healthcare
line. Market share for Gynazole-1(R) increased to 13.7% at the end of the
quarter, compared to 10% at the end of the first quarter of fiscal 2002 and the
combined share of the PreCare(R) prenatal line increased to 29.8% compared to
25.9% at the end of the first quarter of last year. Based on these favorable
prescription trends, the Company expects branded product sales to return to
normal levels during the second quarter.
Net revenues from specialty raw material products increased $0.3
million, or 7.6%, to $4.5 million for the quarter ended June 30, 2002 compared
to $4.2 million for the quarter ended June 30,
12
2001. Specialty raw material product sales comprised 9.2% of the Company's total
net revenues for the quarter ended June 30, 2002 compared to 9.3% for the
corresponding prior year quarter. The increase in specialty raw material sales
was due primarily to increased sales of existing products.
GROSS PROFIT. Gross profit increased $2.5 million, or 9.1%, to $30.1
million for the quarter ended June 30, 2002 compared to $27.6 million for the
quarter ended June 30, 2001. The increase in gross profit was attributable to
the increased level of specialty generic product sales. Gross profit as a
percentage of net revenues increased slightly to 61.2% for the quarter ended
June 30, 2002 compared to 61.1% for the quarter ended June 30, 2001. The gross
profit percentage was impacted by price increases in the specialty generic and
branded businesses and favorable product mix associated with the introduction of
new higher margin specialty generic products.
OPERATING EXPENSES. Research and development expense increased $1.0
million, or 36.9%, to $3.5 million for the quarter ended June 30, 2002 compared
to $2.5 million for the quarter ended June 30, 2001. The increase in research
and development expense for the quarter was due to higher costs associated with
clinical testing related to the Company's internal product development efforts,
as well as costs related to co-development projects. Research and development
expense as a percentage of net revenues increased to 7.0% for the first quarter
of fiscal 2003 compared to 5.6% for the corresponding prior year quarter. In
April 2002, the Company announced that it had received favorable results from
screening studies on a number of products utilizing one of its newest drug
delivery technologies. Because of the significant revenue and profit potential
of these products, the Company initiated phase III clinical trials which are
expected to increase research and development expenditures by approximately 75%
to 80% for fiscal 2003 over fiscal 2002 levels.
Selling and administrative expense decreased $0.1 million, or 1.0%, to
$15.5 million for the quarter ended June 30, 2002 compared to $15.6 million for
the quarter ended June 30, 2001. The decrease in selling and administrative
expense was primarily the result of a reduction in legal expenses, partially
offset by higher insurance costs. Selling and administrative expense as a
percentage of net revenues decreased to 31.5% for the first quarter of fiscal
2003 compared to 34.6% for the corresponding prior quarter.
NET INCOME. As a result of the factors described above, net income
improved for the quarter ended June 30, 2002 by $1.0 million, or 18.7%, to $6.7
million compared to $5.7 million for the quarter ended June 30, 2001.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents and working capital were $22.1
million and $84.1 million, respectively, at June 30, 2002, compared to $12.1
million and $81.4 million, respectively, at March 31, 2002. Internally generated
funds from product sales growth continues to be the primary source of operating
capital used to fund the Company's businesses. The net cash flow from operating
activities was $17.1 million for the quarter ended June 30, 2002 compared to
$9.3 million for the corresponding quarter in the prior year. The 83.8% increase
in operating cash flow resulted from higher net income and a decrease in
receivables, offset partially by an increase in inventories. The decrease in
receivables was primarily due to the receipt of certain delayed customer
payments, which were due as of March 31, 2002 and collected during the quarter
ended June 30, 2002. The increase in inventories resulted from increased
production of specialty generic products in anticipation of continued sales
growth.
The net cash flow used in investing activities was $7.5 million for the
quarter ended June 30, 2002 compared to $1.5 million for the corresponding
quarter in the prior year. Capital expenditures of $4.5 million for the quarter
ended June 30, 2002 were funded by net cash flows from operating activities.
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The Company's investment in capital assets was primarily for purchasing
machinery and equipment to upgrade and expand the Company's pharmaceutical
manufacturing and distribution capabilities. Investing activities for the
quarter also included the purchase of certain intangible rights combined with an
equity investment in a women's healthcare company.
Long-term debt decreased to $5.0 million at June 30, 2002 compared to
$5.1 million at March 31, 2002. The decrease resulted from principal payments
made during the quarter ended June 30, 2002.
During the prior year, the Company increased the borrowing capacity of
its revolving credit agreement to $60 million. The revised agreement provided
for the continuation of the Company's $40 million unsecured revolving line of
credit along with an unsecured supplemental credit line of $20 million for
financing acquisitions. These credit facilities expire in October 2004 and
December 2002, respectively. At June 30, 2002, the Company had no cash
borrowings against either credit facility.
Subsequent to the end of the first fiscal quarter, in July 2002, the
Company completed a secondary public offering of approximately 3.3 million
shares of Class A common stock. Net proceeds to the Company were approximately
$72.5 million, after deducting underwriting discounts, commissions and offering
expenses. The proceeds from the offering will be used for general corporate
purposes, including potential acquisitions, research and development activities
and working capital. The impact of these transactions is not reflected in the
unaudited consolidated balance sheet as of June 30, 2002.
The Company believes its cash and cash equivalents balance, cash flow
from operations, funds available under its credit facilities and proceeds
received from its recently completed secondary public offering of Class A common
stock will be adequate to fund operating activities for the presently
foreseeable future, including the payment of short-term and long-term debt
obligations, capital improvements, product development activities and expansion
of marketing capabilities for the branded pharmaceutical business. In addition,
the Company continues to examine opportunities to expand its business through
the acquisition of or investment in companies, technologies, product rights or
other investments that are compatible with its existing business. The Company
intends to use its available cash to help in funding any acquisitions or
investments. As such, cash has been invested in short-term, highly liquid
instruments. The Company may also use funds available under its credit
facilities, or financing sources that subsequently become available, including
the issuance of additional debt or equity securities, to fund such acquisitions
or investments. If the Company was to fund one or more such acquisitions or
investments, the Company's capital resources, financial condition and results of
operations could be materially impacted in future periods.
INFLATION
Although at reduced levels in recent years, inflation continues to
apply upward pressure on the cost of goods and services used by the Company.
However, the Company believes that the net effect of inflation on its operations
has been minimal during the past three years. In addition, changes in the mix of
products sold and the effect of competition has made a comparison of changes in
selling prices less meaningful relative to changes in the overall rate of
inflation over the past three years.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires the Company to make
estimates and judgments that affect the reported amounts of
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assets, liabilities, revenues and expenses, and related disclosure of contingent
liabilities. On an on-going basis, the Company evaluates its estimates including
those related to the allowance for doubtful accounts receivable, allowance for
inventories, sales allowances and useful life or impairment of other
intangibles. The Company bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis of judgments regarding the
carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
The Company believes the following critical accounting policies affect
its more significant judgments and estimates used in the preparation of its
unaudited consolidated financial statements.
ALLOWANCE FOR DOUBTFUL ACCOUNTS RECEIVABLE. The Company maintains an
allowance for doubtful accounts receivable for estimated losses resulting from
the inability of its customers to make required payments. The Company extends
credit on an uncollateralized basis primarily to wholesale drug distributors and
retail pharmacy chains throughout the United States. Management specifically
analyzes accounts receivable, historical bad debts, customer concentrations,
customer credit-worthiness, percentage of accounts receivable by aging category
and changes in customer payment terms when evaluating the adequacy of the
allowance for doubtful accounts. The Company also performs ongoing credit
evaluations of its customers. If the financial condition of the Company's
customers were to deteriorate, resulting in an impairment of their ability to
make payments, additional allowances may be required. Historically, actual
losses from uncollectible accounts have been insignificant. As of June 30, 2002,
the Company had an allowance for doubtful accounts of $0.3 million.
ALLOWANCE FOR INVENTORIES. Inventories are stated at the lower of cost
or market, with cost determined on the first-in, first-out basis. In evaluating
whether inventory is stated at the lower of cost or market, management considers
such factors as the amount of inventory on hand and in the distribution channel,
estimated time required to sell such inventory, remaining shelf life and current
and expected market conditions, including levels of competition. As appropriate,
provisions are made to reduce inventories to their net realizable value. As of
June 30, 2002, the Company had an inventory reserve of $0.8 million.
REVENUE RECOGNITION AND SALES ALLOWANCES. Revenue is recognized at the
time product is shipped to customers. Sales provisions for estimated
chargebacks, discounts, rebates, returns, pricing adjustments and other sales
allowances are established by the Company concurrently with the recognition of
revenue. The sales provisions are established based upon consideration of a
variety of factors, including but not limited to, actual return and historical
experience by product type, the number and timing of competitive products
approved for sale, the expected market for the product, estimated customer
inventory levels by product, price declines and current and projected economic
conditions and levels of competition. Actual product returns, chargebacks and
other sales allowances incurred are, however, dependent upon future events. 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. As of June 30, 2002, reserve balances related to
the sales allowances totaled $20.6 million.
OTHER INTANGIBLE ASSETS. Effective April 1, 2002, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other
Intangible Assets, issued in June 2001. With the adoption of SFAS 142, the
Company determined its Other Intangible Assets had finite useful lives and will
continue to be amortized over their estimated useful life. (See Note F -
Goodwill And Other Intangible Assets - Adoption of SFAS No. 142 above for a
discussion on SFAS 142.) The adoption of SFAS 142 did not have a material effect
on the Company's financial condition or results of operations.
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Other Intangible Assets consist primarily of brand product rights
purchased from other pharmaceutical companies, all of which are being amortized
over 20-year periods. The amortization periods for product rights are based on
the Company's assessment of various factors impacting estimated useful lives and
cash flows of the acquired products. Such factors include the product's position
in its life cycle, competitive positioning, the existence or absence of like
products in the market and various competitive and technical issues. Other
Intangible Assets also consist of patents and trademarks, which are being
amortized over periods ranging from five to seventeen years. As of June 30,
2002, the net carrying amount of Other Intangibles Assets was $40.9 million.
Amortization is calculated using the straight-line method over the estimated
useful life. Intangible assets are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable.
ITEM 3. VARIABLE RATE RISKS
Advances to the Company under the Company's credit facilities bear
interest at a rate that varies consistent with increases or decreases in the
publicly-announced prime rate and/or the LIBOR rate with respect to
LIBOR-related loans, if any. A material increase in such rates could
significantly increase borrowing expenses. The Company did not have any cash
borrowings under the credit facilities at June 30, 2002.
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PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
ETHEX Corporation, a wholly-owned subsidiary of the Company, is a
defendant in a lawsuit styled, Healthpoint, Ltd. v. ETHEX Corporation, pending
in federal court in the Western District of Texas, San Antonio Division. The
suit was filed by Healthpoint on August 3, 2000, and later was joined by
companies affiliated with Healthpoint. In general, the plaintiffs allege that
ETHEX's promotion of its Ethezyme(TM) product as an alternative to Healthpoint's
Accuzyme(R) product resulted in false advertising and misleading statements
under various federal and state laws, and unfair competition and
misappropriation of trade secrets. In September 2001, the jury returned verdicts
against ETHEX on certain false advertising, unfair competition and
misappropriation claims. The jury awarded compensatory and punitive damages
totaling $16.5 million. In addition, Healthpoint has asked the court to enter
judgment in accordance with the jury's verdict with respect to compensatory and
punitive damages. Healthpoint has also asked the court to award $10 million in
enhanced damages ($2.7 million more than the jury recommended) and attorneys
fees which are believed to be in excess of $1 million. The Company and its
counsel believe that the jury's recommended award is excessive and is not
sufficiently supported by the facts or the law. The Company intends to
vigorously appeal any adverse judgment the court may enter. If the court were to
enter an adverse judgment on the verdict, the Company would make an appropriate
provision for liability, if any, in its consolidated financial statements at the
time of the court's ruling. The Company has filed motions asking the court to
overrule the jury's verdicts or, in the alternative, grant a new trial. However,
the Company can offer no assurances that it will prevail or that the jury's
verdicts will be reduced or set aside. If the Company does not prevail and is
ordered by the court to pay damages in accordance with the jury's verdicts or
the higher amount sought by Healthpoint, the Company's profitability would be
adversely impacted in the period the contingency was recorded and its liquidity
reduced.
The Company previously manufactured two low volume pharmaceutical
products that contained phenylpropanolamine, or PPA, that were discontinued
and/or reformulated to exclude PPA in 2000 and 2001, respectively. The Company
was named as one of several defendants in two product liability lawsuits in
federal courts involving PPA. These two lawsuits have been transferred to the
nationwide, multi-district litigation for PPA claims now pending in the U.S
District Court for the Western District of Washington. Each lawsuit alleges
bodily injury, wrongful death, economic injury, punitive damages, loss of
consortium and/or loss of services from the use of pharmaceuticals containing
PPA. Discovery in these cases is ongoing. The Company believes that it has
substantial defenses to these claims, although the ultimate outcome of these
cases and the potential material effect on the Company cannot be determined.
The Company is being defended and indemnified in these two PPA lawsuits
by its primary commercial general liability insurer subject to aggregate
products-completed operations policy limits in the amount of $10 million and
subject to a reservation of rights. The Company's product liability-completed
operations coverage was obtained on a claims made basis and provides coverage
for judgments, settlements and defense costs arising from product liability
claims. Although the Company renewed its product liability coverage for a policy
term of June 15, 2002 through June 15, 2003, that renewal policy excludes future
PPA claims in accordance with the standard industry exclusion. Consequently, as
of June 15, 2002, the Company must provide for legal defense costs and indemnity
payments involving future PPA claims, should they occur.
From time to time, the Company becomes involved in various legal
matters, in addition to the above-described matters, that the Company considers
to be in the ordinary course of business. While the Company is not presently
able to determine the potential liability, if any, related to such matters, the
17
Company believes none of such matters, individually or in the aggregate, will
have a material adverse effect on the Company's financial position.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits 99.1 and 99.2 - Certifications of Chief Executive
Officer and Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
b) Reports on Form 8-K. The Company filed a Current Report on
Form 8-K on April 1, 2002 to report that the Company had
announced that it had received favorable results from
screening studies on a number of products and that it
planned to significantly increase its research
expenditures in Fiscal 2003.
The Company filed a Current Report on Form 8-K dated June
28, 2002 filed on July 1, 2002 to file the opinion of
Thompson Coburn LLP and an amendment to the Bylaws of the
Company effective June 27, 2002 under Item 5.
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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: August 9, 2002 By /s/ Marc S. Hermelin
-------------------------------
Marc S. Hermelin
Vice Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: August 9, 2002 By /s/ Gerald R. Mitchell
-------------------------------
Gerald R. Mitchell
Vice President, Treasurer and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
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