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SECURITIES AND EXCHANGE COMMISSION
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WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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SECURITIES EXCHANGE ACT OF 1934
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FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
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COMMISSION FILE NUMBER 1-9601
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K-V PHARMACEUTICAL COMPANY
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 43-0618919
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(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
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INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN EXCHANGE ACT RULE 12b-2). YES X NO
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TITLE OF CLASS OF NUMBER OF SHARES
COMMON STOCK OUTSTANDING AS OF JULY 30, 2003
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CLASS A COMMON STOCK, PAR VALUE $.01 PER SHARE 21,743,958
CLASS B COMMON STOCK, PAR VALUE $.01 PER SHARE 10,604,829
1
PART I. - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited; in thousands, except per share data)
THREE MONTHS ENDED,
JUNE 30,
-------------------------
2003 2002
------- -------
Net revenues ........................ $59,379 $49,227
Cost of sales ....................... 20,990 19,078
------- -------
Gross profit ........................ 38,389 30,149
------- -------
Operating expenses:
Research and development ........ 5,542 3,469
Selling and administrative ...... 17,723 15,497
Amortization of intangible assets 1,111 578
------- -------
Total operating expenses ............ 24,376 19,544
------- -------
Operating income .................... 14,013 10,605
------- -------
Other income (expense):
Interest and other income ....... 363 53
Interest expense ................ (1,085) (37)
------- -------
Total other income (expense), net ... (722) 16
------- -------
Income before income taxes .......... 13,291 10,621
Provision for income taxes .......... 4,718 3,898
------- -------
Net income .......................... $ 8,573 $ 6,723
======= =======
Net income per common share-basic ... $ 0.25 $ 0.22
======= =======
Net income per common share-diluted . $ 0.25 $ 0.21
======= =======
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
JUNE 30, MARCH 31,
2003 2003
---- ----
(unaudited)
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents............................................................ $ 233,909 $ 96,288
Receivables, less allowance for doubtful accounts of $362 and $422
at June 30, 2003 and March 31, 2003, respectively................................. 46,192 57,385
Inventories, net..................................................................... 50,230 42,343
Prepaid and other assets............................................................. 2,738 2,709
Deferred tax asset................................................................... 12,463 14,791
----------- -----------
Total Current Assets.............................................................. 345,532 213,516
Property and equipment, less accumulated depreciation................................ 62,682 51,903
Intangible assets and goodwill, net.................................................. 82,074 82,577
Other assets......................................................................... 10,605 4,672
----------- -----------
TOTAL ASSETS......................................................................... $ 500,893 $ 352,668
=========== ===========
LIABILITIES
-----------
CURRENT LIABILITIES:
Accounts payable..................................................................... $ 17,844 $ 15,588
Accrued liabilities.................................................................. 30,098 52,548
Current maturities of long-term debt................................................. 8,128 7,484
----------- -----------
Total Current Liabilities......................................................... 56,070 75,620
Long-term debt....................................................................... 218,192 10,106
Other long-term liabilities.......................................................... 2,988 2,913
Deferred tax liability............................................................... 3,636 3,413
----------- -----------
TOTAL LIABILITIES.................................................................... 280,886 92,052
----------- -----------
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, 2003 and March 31, 2003 (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 23,708,028 and 23,651,290 at June 30, 2003
and March 31, 2003, respectively.............................................. 237 236
Class B - issued 10,658,257 and 10,577,119 at June 30, 2003 and March 31, 2003,
respectively (convertible into Class A shares on a one-for-one basis)......... 106 106
Additional paid-in capital........................................................... 122,162 120,961
Retained earnings.................................................................... 147,530 139,341
Less: Treasury stock, 1,992,062 shares of Class A and 53,428 shares of Class B
Common Stock at June 30, 2003, respectively, and 32 shares of Class A and
53,428 shares of Class B Common Stock at March 31, 2003, respectively, at cost.... (50,028) (28)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY........................................................... 220,007 260,616
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................................... $ 500,893 $ 352,668
=========== ===========
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,
--------------------------
2003 2002
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OPERATING ACTIVITIES:
Net income ................................................ $ 8,573 $ 6,723
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, amortization and other non-cash charges .. 2,954 1,647
Deferred income tax provision (benefit) ................ 2,551 (376)
Deferred compensation .................................. 75 50
Changes in operating assets and liabilities:
Decrease in receivables, net ........................... 11,193 11,911
Increase in inventories, net ........................... (9,510) (3,742)
(Increase) decrease in prepaid and other assets ........ (1,183) 742
(Decrease) increase in accounts payable and accrued
liabilities ......................................... (4,271) 132
-------- -------
Net cash provided by operating activities ................. 10,382 17,087
-------- -------
INVESTING ACTIVITIES:
Purchase of property and equipment, net ................ (3,552) (4,461)
Purchase of stock and intangible assets ................ -- (3,000)
Product acquisition .................................... (14,300) --
-------- -------
Net cash used in investing activities ..................... (17,852) (7,461)
-------- -------
FINANCING ACTIVITIES:
Principal payments on long-term debt ................... (194) (96)
Dividends paid on preferred stock ...................... (384) (18)
Proceeds from issuance of convertible notes ............ 194,467 --
Purchase of common stock for treasury .................. (50,000) --
Sale of common stock to employee profit sharing plan ... -- 385
Exercise of common stock options ....................... 1,202 70
-------- -------
Net cash provided by financing activities ................. 145,091 341
-------- -------
Increase in cash and cash equivalents ..................... 137,621 9,967
Cash and cash equivalents:
Beginning of year ...................................... 96,288 12,109
-------- -------
End of period .......................................... $233,909 $22,076
======== =======
SUPPLEMENTAL INFORMATION:
Interest paid .......................................... $ 195 $ 136
Income taxes paid ...................................... 6,651 2,783
NON CASH FINANCING ACTIVITY:
Term loan to finance building purchase ................ $ 8,800 --
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Dollars in thousands, except per share data)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of K-V
Pharmaceutical Company ("KV" or the "Company") have been prepared in
accordance with accounting principles generally accepted in the United
States 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 accounting principles generally
accepted in the United States 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-month
period ended June 30, 2003 are not necessarily indicative of the results of
operations and cash flows that may be expected for the fiscal year ending
March 31, 2004. 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 fiscal
year ended March 31, 2003. The balance sheet information as of March 31,
2003 has been derived from the Company's audited consolidated balance sheet
as of that date.
2. STOCK-BASED COMPENSATION
The Company grants stock options for a fixed number of shares to employees
with an exercise price greater than or equal to the fair value of the shares
at the date of grant. As permissible under Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, the
Company elected to continue to account for stock option grants to employees
in accordance with Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees and related interpretations. APB 25
requires that compensation cost related to fixed stock option plans be
recognized only to the extent that the fair value of the shares at the grant
date exceeds the exercise price. Accordingly, no compensation expense is
recognized for stock option awards granted to employees at or above fair
value. Had the Company determined compensation expense using the fair value
method prescribed by SFAS 123, the Company's net income and earnings per
share would have been as follows:
THREE MONTHS ENDED
JUNE 30,
--------------------------
2003 2002
---- ----
Net income, as reported........................ $ 8,573 $ 6,723
Stock based employee
compensation expense,
net of tax................................... (169) (175)
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Pro forma net income........................... $ 8,404 $ 6,548
========= ========
Earnings per share:
Basic - as reported......................... $ 0.25 $ 0.22
Basic - pro forma........................... 0.24 0.21
Diluted - as reported....................... 0.25 0.21
Diluted - pro forma......................... 0.24 0.20
The weighted average fair value of the options has been estimated on the
date of grant using the following weighted average assumptions for grants
during the three months ended June 30, 2003 and 2002, respectively: no
dividend yield; expected volatility of 44% and 45%; risk-free interest rate
of 2.57% and 2.40% per annum; and expected option terms ranging from 3 to 10
years for both periods. Weighted averages are used because of varying
assumed exercise dates.
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3. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
THREE MONTHS ENDED
JUNE 30,
------------------------
2003 2002
---- ----
Numerator:
Net income............................................ $ 8,573 $ 6,723
Preferred stock dividends............................. (384) (18)
------- -------
Numerator for basic earnings per
share - income available to common
shareholders....................................... 8,189 6,705
Effect of dilutive securities:
Preferred stock dividends.......................... 384 18
------- -------
Numerator for diluted earnings per
share - income available to common
shareholders after assumed conversions............. $ 8,573 $ 6,723
======= =======
Denominator:
Denominator for basic earnings per
share - weighted-average shares................... 33,198 30,770
------- -------
Effect of dilutive securities:
Employee stock options............................ 1,110 1,204
Convertible preferred stock........................ 225 225
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Dilutive potential common shares...................... 1,335 1,429
------- -------
Denominator for diluted earnings per
share - adjusted weighted-average shares and
assumed conversions................................ 34,533 32,199
======= =======
Basic earnings per share(1) .......................... $ 0.25 $ 0.22
======= =======
Diluted earnings per share(1)(2) ..................... $ 0.25 $ 0.21
======= =======
(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 146,550 and 1,000 shares of common
stock at June 30, 2003 and 2002, respectively, are not presented
because these options are anti-dilutive. The exercise prices of these
options exceeded the average market prices of the shares under option
in each respective period.
4. REVENUE RECOGNITION
Revenue from product sales is recognized when the merchandise is shipped to
an unrelated third party pursuant to Staff Accounting Bulletin No. 101,
Revenue Recognition in Financial Statements. Accordingly, revenue is
recognized when all of the following occur: a purchase order is received
from a customer; title and risk of loss pass to the Company's customer upon
shipment of the merchandise under the terms of FOB shipping point; prices
and estimated sales provisions for product returns, sales rebates, payment
discounts, chargebacks, and other
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promotional allowances are reasonably determinable; and the customer's
payment ability has been reasonably assured.
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 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 $21,816 and $19,558 for the three months ended June 30,
2003 and 2002, respectively. The reserve balances related to the sales
provisions totaled $28,366 and $29,658 at June 30, 2003 and March 31, 2003,
respectively, and are included in "Receivables, less allowance for doubtful
accounts" in the accompanying consolidated balance sheets.
5. INVENTORIES
Inventories consist of the following:
JUNE 30, 2003 MARCH 31, 2003
------------- --------------
Finished goods..................... $30,167 $26,524
Work-in-process.................... 4,648 4,290
Raw materials...................... 16,562 12,532
------- -------
51,377 43,346
Reserves for obsolescence.......... (1,147) (1,003)
------- -------
$50,230 $42,343
======= =======
Management establishes reserves for potentially obsolete or slow moving
inventory based on an evaluation of inventory levels, forecasted demand, and
market conditions.
6. INTANGIBLE ASSETS AND GOODWILL
JUNE 30, 2003 MARCH 31, 2003
-------------------------- -------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
-------- ------------ -------- ------------
Product rights - Micro-K(R)................ $36,140 $ (7,746) $36,140 $(7,294)
Product rights - PreCare(R)................ 8,433 (1,651) 8,433 (1,546)
Trademarks acquired........................ 42,476 (531) 42,476 -
License agreements......................... 1,000 - 1,000 -
Trademarks and patents..................... 3,722 (326) 3,114 (303)
------- -------- ------- -------
Total intangible assets.................. 91,771 (10,254) 91,163 (9,143)
Goodwill................................... 557 - 557 -
------- -------- ------- -------
$92,328 $(10,254) $91,720 $(9,143)
======= ======== ======= =======
Amortization expense for intangible assets as of June 30, 2003 is estimated
to be $3,339 for the remainder of fiscal 2004 and $4,450 in each of the four
succeeding fiscal years thereafter.
7
On March 31, 2003, the Company acquired from Schwarz Pharma (Schwarz) the
product rights and trademarks to the Niferex(R) line of hematinic products
for $14,300, plus expenses. The acquisition was financed with a cash payment
made in April 2003. The purchase price was allocated to trademarks acquired
and is being amortized over an estimated life of 20 years.
Also on March 31, 2003, the Company acquired from a subsidiary of Altana
Pharma AG (Altana) the worldwide product rights and trademarks to the
Chromagen(R) and StrongStart(R) product lines for $27,000, plus expenses.
The Chromagen(R) product line includes three hematinic products used in the
treatment of anemia and one prenatal vitamin, while the StrongStart(R)
product line consists of two prenatal vitamin products. The acquisition was
financed with a $13,000 cash payment made on March 31, 2003 and two
non-interest bearing $7,000 promissory notes issued to Altana, which are due
on the first and second anniversaries of the agreement. The promissory
notes, which are non-interest bearing, were discounted using imputed
interest rates of 3.36% and 4.08%, respectively. The purchase price was
allocated to trademarks acquired and is being amortized over an estimated
life of 20 years.
7. PURCHASE OF BUILDING
On April 28, 2003, the Company completed the purchase of a building for
$8,800. The facility consists of approximately 275,000 square feet of
office, production, distribution and warehouse space. The purchase of the
building was financed with a term loan secured by the property under a
floating rate loan with a bank. The remaining principal balance plus any
unpaid interest is due in April 2008. The Company also entered into an
interest rate swap agreement with the same bank, which fixed the interest
rate of the building mortgage at 5.31% for the term of the loan.
8. ISSUANCE OF $200,000 CONTINGENT CONVERTIBLE SUBORDINATED NOTES
On May 16, 2003, the Company issued $200,000 of 2.50% Contingent Convertible
Subordinated Notes (the Convertible Subordinated Notes) that are
convertible, under certain circumstances, into shares of the Company's Class
A common stock at an initial conversion price of $34.51. The Convertible
Subordinated Notes bear interest at a rate of 2.50% per annum which is
payable on May 16 and November 16 of each year, beginning November 16, 2003.
The Company also will 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 Convertible Subordinated Notes per
$1,000 principal amount for the five trading day period ending on the third
trading day immediately preceding the first day of the applicable six-month
period equals $1,200 or more. The Convertible Subordinated Notes are
scheduled to mature on May 16, 2033.
The Company may redeem some or all of the Convertible Subordinated Notes at
any time on or after May 21, 2006, at a redemption price, payable in cash,
of 100% of the principal amount of the Convertible Subordinated Notes, plus
accrued and unpaid interest, including contingent interest, if any. Holders
of the Convertible Subordinated Notes may require the Company to repurchase
all or a portion of their Convertible Subordinated Notes on May 16, 2008,
2013, 2018, 2023 and 2028 and upon a change in control, as defined in the
indenture governing the Convertible Subordinated Notes, at a purchase price,
payable in cash, of 100% of the principal amount of the Convertible
Subordinated Notes, plus accrued and unpaid interest, including contingent
interest, if any.
The Convertible Subordinated 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
Convertible Subordinated Notes on the last trading day of the
previous quarter. The Convertible Subordinated Notes are
initially convertible at a conversion price of $34.51 per
share, which is equal to a conversion rate of approximately
28.9771 shares per $1,000 principal amount of the Convertible
Subordinated Notes;
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o if the Company has called the Convertible Subordinated Notes
for redemption;
o during the five trading day period immediately following any
nine consecutive day trading period in which the trading
price of the Convertible Subordinated 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 Convertible Subordinated
Notes; or
o upon the occurrence of specified corporate transactions.
The Convertible Subordinated 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. The Convertible Subordinated Notes are
subordinate to all of the Company's existing and future senior indebtedness.
The Company incurred approximately $5,500 of fees and other origination
costs related to the issuance of the Convertible Subordinated Notes. These
costs are being amortized over a five-year period.
9. SEGMENT REPORTING
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, corporate property and equipment, intangible
and other assets and all income tax related assets. Accounting policies of
the segments are the same as the Company's consolidated accounting policies.
The following represents information for the Company's reportable operating
segments for the three months ended June 30, 2003 and 2002.
THREE MONTHS
ENDED BRANDED SPECIALTY SPECIALTY ALL
JUNE 30, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED
-------- -------- -------- --------- ----- ------------ ------------
Net revenues 2003 $14,781 $39,455 $3,902 $ 1,241 $ - $ 59,379
2002 7,134 37,052 4,539 502 - 49,227
Segment profit (loss) 2003 4,843 21,777 317 (13,646) - 13,291
2002 (615) 19,826 837 (9,427) - 10,621
Identifiable assets 2003 12,328 59,410 8,526 421,787 (1,158) 500,893
2002 7,837 55,164 8,965 131,805 (1,158) 202,613
Property and 2003 117 - 5 12,230 - 12,352
equipment additions 2002 13 18 33 4,397 - 4,461
Depreciation and 2003 80 14 35 2,825 - 2,954
amortization 2002 21 13 41 1,572 - 1,647
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.
9
10. TREASURY STOCK TRANSACTIONS
During May 2003, the Company used $50,000 of the net proceeds from the
Convertible Subordinated Notes issuance to fund the repurchase of 2.0
million shares of its Class A common stock.
11. CONTINGENCIES - RESERVE FOR POTENTIAL LEGAL DAMAGES
ETHEX Corporation (ETHEX), a subsidiary of the Company, is a defendant in a
lawsuit styled Healthpoint, Ltd. v. ETHEX Corporation, filed in federal
court in San Antonio, Texas. In general, the plaintiffs allege that ETHEX's
comparative promotion of its Ethezyme(TM) to Healthpoint's Accuzyme(R)
product resulted in false advertising and misleading statements under
various federal and state laws, and constituted 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 $16,500. On October 1, 2002, the U.S. District Court for the
Western District of Texas denied ETHEX's motion to set aside the jury's
verdict. On December 17, 2002, the court entered a judgment awarding
attorneys' fees to Healthpoint in an amount to be subsequently determined.
The Company believes that the jury award is excessive and is not
sufficiently supported by the facts or the law. The Company intends to
vigorously prosecute an appeal. The Company and its counsel believe that
there are meritorious arguments to be raised during the appeal process;
however, we cannot give any assurance that we will prevail on appeal. As a
result of the court's earlier decisions, the Company's results of operations
for the quarter ended September 30, 2002 included a provision for potential
damages of $16,500, which was reflected in accrued liabilities on the
Company's consolidated balance sheet as of June 30, 2003. To date
Healthpoint has requested reimbursement for approximately $1,800 in
attorneys' fees in addition to the judgment discussed above. The Company is
contesting Healthpoint's entitlement to, and its requested amount of
attorneys' fees. As of this date, the court has not entered any order
specifying the amount of attorneys' fees to be awarded. The Company's
counsel has advised that the amount could range from zero to $1,800, the
amount requested by Healthpoint. Based on management's current analysis, the
Company believes that the accrual for contingent liability as recorded will
be adequate to cover any judgment, including attorneys' fees, which may
result at the end of the appeal process. The Company is continually
evaluating the need for additional reserves as the case progresses through
the appeal process.
KV previously distributed several low volume pharmaceutical products that
contained phenylpropanolamine, or PPA, and that were discontinued in 2000
and 2001. The Company is presently named as one of several defendants in two
product liability lawsuits in federal court in Nevada and Mississippi
involving PPA. The Nevada case is Deuel, David, et al v. KV Pharmaceutical
Company, Inc et al. The suit was filed on June 11, 2001. Discovery has been
initiated in this case, and the Company currently has completed the basic
fact discovery and depositions, however, no discovery cut-off date has been
assigned and presently no trial date has been set. The Mississippi case is
Virginia Madison, et al. v. Bayer Corporation, et al. KV is one of several
defendants named in the lawsuit. The suit was filed on December 23, 2002,
but was not served on KV until February 2003. The case was originally filed
in the Circuit Court of Hinds County, Mississippi, and was removed to the
United States District Court for the Southern District of Mississippi by
co-defendant Bayer Corporation. The plaintiffs have filed a motion to remand
the case to the Circuit Court of Hinds County, Mississippi, which has caused
the Court to enter a stay of all proceedings pending a resolution of the
motion. So far, the Court has not ruled on the remand motion. Both the
Nevada and Mississippi cases have been transferred to a Judicial Panel on
Multi-District Litigation for PPA claims sitting in 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 the Company's distributed pharmaceuticals containing PPA that
have since been discontinued and/or reformulated to exclude PPA. Management
believes that the Company has substantial defenses to these claims, though
the ultimate outcome of these cases and the potential effect cannot be
determined.
KV is being defended and indemnified in the Nevada PPA lawsuits by its
products liability insurer subject to a reservation of rights. The Company's
product liability coverage was obtained on a claims made basis and provides
coverage for judgments, settlements and defense costs arising from product
liability claims. However, such insurance may not be adequate to eliminate
the risk from some or all product liability claims, including PPA
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claims, and is subject to the limitations described in the terms of the
policies. Furthermore, 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 has provided for legal
defense costs and indemnity payments involving PPA claims on a going forward
basis, including the Mississippi lawsuit that was filed after June 15, 2002.
Moreover, the Company may not be able to obtain product liability insurance
in the future for PPA claims with adequate coverage limits at commercially
reasonable prices for subsequent periods. From time to time in the future,
KV may be subject to further litigation resulting from products containing
PPA that it formerly distributed. The Company intends to vigorously defend
any claims that may be raised in the current and future litigation.
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 1
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 or
operations.
12. RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2002, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation (FIN) No. 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
of Others. FIN 45 elaborates on disclosures to be made by a guarantor in its
financial statements about its obligations under certain guarantees that it
has issued. It also clarifies that a guarantor is required to recognize, at
the inception of the guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee. The initial recognition and
measurement provisions of FIN 45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002 and the disclosure
requirements are effective for all financial statements of periods ending
after December 31, 2002. At June 30, 2003, the Company was not a guarantor
on any debt instruments.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and Disclosure -- an amendment of FASB Statement
No. 123. SFAS 148 amends SFAS 123, Accounting for Stock-Based Compensation,
to provide alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation.
In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to
require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. SFAS 148
became effective for the Company on January 1, 2003. The Company did not
adopt the fair value method of valuing stock options, however, the required
disclosures of SFAS 148 are included in Note 2.
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51. FIN 46 provides guidance
on: 1) the identification of entities for which control is achieved through
means other than through voting rights and 2) how to determine when and
which business enterprise should consolidate such entities. FIN 46 is
effective immediately for all new variable interest entities created or
acquired after January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, the provisions of FIN 46 must be applied
for the first interim or annual period beginning after June 15, 2003. The
Company does not anticipate the adoption of FIN 46 will have any impact on
its financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS 150
establishes standards for how entities classify and measure in their
statement of financial position certain financial instruments with
characteristics of both liabilities and equity. The provisions of SFAS 150
are effective for financial instruments entered into or modified after May
31, 2003, and otherwise shall be effective at the beginning of the first
fiscal interim period beginning after June 15, 2003. The Company does not
expect adoption of this statement will have a material impact on its results
of operations or financial position.
11
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Form 10-Q, including the documents that are incorporated herein by
reference, contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Any statements about our
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
phrases such as "anticipate," "estimate," "plans," "projects," "continuing,"
"ongoing," "expects," "management believes," "we believe," "we intend" 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 we are successful in developing new products and
commercializing products under development; (2) the degree to which we are
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) the availability of raw materials; (7) the regulatory environment; (8)
fluctuations in operating results; (9) the difficulty of predicting the
pattern of inventory movements by our customers; (10) the impact of
competitive response to our efforts to leverage our brand power with product
innovation, promotional programs, and new advertising; (11) the availability
of third-party reimbursement for our products; (12) our dependence on sales
to a limited number of large pharmacy chains and wholesale drug distributors
for a large portion of our total net sales; and (13) the risks detailed from
time to time in our filings with the Securities and Exchange Commission.
Because the factors referred to above, as well as the statements included
under the caption "Management's Discussion and Analysis of Financial
Condition and Results of Operations," 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 us or on our behalf, you should
not place undue reliance on any forward-looking statements. Further, any
forward-looking statement speaks only as of the date on which it is made
and, unless applicable law requires to the contrary, we undertake no
obligation to update any forward-looking statement to reflect events or
circumstances after the date on which the statement is made or to reflect
the occurrence of unanticipated events. New factors emerge from time to
time, and it is not possible for us to predict which factors will arise,
when they will arise and/or their effects. In addition, we cannot assess the
impact of each factor on 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.
12
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 our actual
results to differ materially from those expressed or implied by those
forward-looking statements. These risks, uncertainties and other factors are
discussed above 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 our Annual
Report on Form 10-K for the fiscal year ended March 31, 2003, 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.
BACKGROUND
- ----------
We are a fully integrated specialty pharmaceutical company that develops,
acquires, manufactures and markets technologically distinguished branded and
non-branded/generic prescription pharmaceutical products. We have a broad
range of dosage form capabilities including tablets, capsules, creams,
liquids and ointments. We conduct our branded pharmaceutical operations
through Ther-Rx Corporation and our non-branded/generic pharmaceutical
operations through ETHEX Corporation, which focuses principally on
technologically distinguished generic products. Through Particle Dynamics,
Inc., we develop, manufacture and market technologically advanced,
value-added raw material products for the pharmaceutical, nutritional,
personal care, food and other markets.We have a broad portfolio of drug
delivery technologies which we leverage to create technologically
distinguished brand name and specialty non-branded/generic products. We have
developed and patented 15 drug delivery and formulation technologies
primarily in four principal areas: SITE RELEASE(R) bioadhesives, oral
controlled release, tastemasking and quick dissolving tablets. We
incorporate these technologies in the products we market to control and
improve the absorption and utilization of active pharmaceutical compounds.
These technologies provide a number of benefits, including reduced frequency
of administration, reduced side effects, improved drug efficacy, enhanced
patient compliance and improved taste.
Our drug delivery technologies allow us to differentiate our products in the
marketplace, both in the branded and non-branded/generic pharmaceutical
areas. We believe that this differentiation provides substantial competitive
advantages for our products, allowing us to establish a strong record of
growth and profitability and a leadership position in certain segments of
our industry. Between fiscal years 1998 and 2003, both our net revenues and
net income grew at a compounded annual growth rate of 20.0%. Ther-Rx, which
was established in 1999, has grown substantially since its inception, and it
represented approximately 18.0% of our net sales for the fiscal year ended
March 31, 2003. Of more than 100 products sold by our ETHEX subsidiary,
approximately 58% are identified as the leading product and approximately
90% were identified as the first or second leading products in their
respective generic categories by IMS America, or IMS, an independent
healthcare market research firm.
13
RESULTS OF OPERATIONS
- ---------------------
THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THE THREE MONTHS ENDED
JUNE 30, 2002
NET REVENUES BY SEGMENT
THREE MONTHS ENDED JUNE 30,
---------------------------------------------------
CHANGE
($ IN THOUSANDS): 2003 2002 $ %
------- ------- ------- ------
Branded products 14,781 $ 7,134 $ 7,647 107.2%
As % of net revenues 24.9% 14.5%
Specialty generics 39,455 37,052 2,403 6.5%
As % of net revenues 66.4% 75.3%
Specialty materials 3,902 4,539 (637) (14.0)%
As % of net revenues 6.6% 9.2%
Other 1,241 502 739 147.2%
------- ------- -------
Total net revenues $59,379 $49,227 $10,152 20.6%
======= ======= =======
The increase in branded product sales was due primarily to continued growth
of our women's healthcare family of products and the initial sales impact of
products acquired by us on March 31, 2003. Sales from the women's healthcare
product group increased $4.8 million, or 95.9%, during the first quarter of
fiscal 2004 compared to the first quarter of fiscal 2003. Included in the
women's healthcare family of products is the PreCare(R) product line which
contributed $4.6 million of incremental sales in the first quarter of fiscal
2004. This increase was partially attributable to increased sales volume
associated with PrimaCare(R), a prescription prenatal/postnatal multivitamin
and mineral supplement with essential fatty acids, which has continued to
show growth in market share since its introduction in the fourth quarter of
fiscal 2002. The sales increase experienced by the PreCare(R) product line
also was impacted by customer buying that occurred during the fourth quarter
of fiscal 2002 in anticipation of a year-end price increase. The customer
buying at the end of fiscal 2002 lead to a reduction in sales for the first
quarter of fiscal 2003. Further, the PreCare(R) family of products continues
to be the leading branded line of prescription prenatal nutritional
supplements in the United States as market share for the product line grew
to 33.9% in the first quarter of fiscal 2004 compared to 29.8% in the
comparative fiscal 2003 quarter. Gynazole-1(R), our vaginal antifungal
product, continued to experience growth as its market share increased to
19.7% at the end of the first quarter, compared to 13.7% at the end of the
prior year comparative quarter. Increased sales from our women's healthcare
family of products were supplemented in the first quarter by $2.7 million of
sales from the two hematinic product lines, Chromagen(R) and Niferex(R), and
by $0.4 million of sales from the StrongStart(R) prenatal vitamin product
line, all of which were acquired at the end of fiscal 2003. These increases
were partially offset by a $0.3 million, or 12.3%, decline in sales from the
cardiovascular product line.
The growth of $2.4 million in specialty generic sales resulted from $0.9
million of increased sales volume on existing products, $1.0 million of
incremental sales volume from new product introductions, principally in the
cough/cold product line, and $0.5 million in higher sales due to price
increases on certain products in the pain management and cardiovascular
categories. The higher sales volume for existing products primarily resulted
from volume increases associated with certain products in the pain
management product line. These increases were offset in part by a decline in
the sales volume associated with certain cardiovascular products that were
introduced in the comparative prior year quarter.
The decrease in specialty material product sales was primarily due to a
significant slowdown in a major customer's business in the vitamin
supplement market.
14
GROSS PROFIT BY SEGMENT
THREE MONTHS ENDED JUNE 30,
--------------------------------------------------
CHANGE
------------------
($ IN THOUSANDS): 2003 2002 $ %
------- ------- ------ -----
Branded products $12,875 $ 6,355 $6,520 102.6%
as % of net revenues 87.1% 89.1%
Specialty generics 23,962 21,735 2,227 10.2%
as % of net revenues 60.7% 58.7%
Specialty materials 1,154 1,712 (558) (32.6)%
as % of net revenues 29.6% 37.7%
Other 398 347 51 14.7%
------- ------- ------
Total gross profit $38,389 $30,149 $8,240 27.3%
======= ======= ======
as % of total net revenues 64.7% 61.2%
The increase in gross profit was primarily attributable to the sales growth
experienced by the branded products and specialty generics segments, offset
partially by a sales decline in the specialty materials segment. The higher
gross profit percentage on a consolidated basis was favorably impacted by a
shift in the mix of product sales toward higher margin branded products
which comprised a larger percentage of net revenues, and lower costs
associated with a profit-sharing arrangement on certain specialty generic
products. The gross profit percentage decrease experienced by the branded
products segment was due to the newly acquired hematinic and prenatal
products, which have a slightly lower gross margin than the previously
existing branded product line. The lower gross profit percentage in the
specialty materials segment resulted from unfavorable cost variances
associated with lower production.
RESEARCH AND DEVELOPMENT
THREE MONTHS ENDED JUNE 30,
-------------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2003 2002 $ %
------ ------ ------ -----
Research and development $5,542 $3,469 $2,073 59.8%
as % of net revenues 9.3% 7.0%
The increase in research and development expense was primarily due to higher
costs associated with the continued expansion of clinical testing connected
to our internal product development efforts and higher personnel expenses
related to the growth of our research and development staff. We expect
research and development costs for fiscal 2004 to increase by approximately
30% over fiscal 2003 levels.
15
SELLING AND ADMINISTRATIVE
THREE MONTHS ENDED JUNE 30,
-------------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2003 2002 $ %
------- ------- ------ -----
Selling and administrative $17,723 $15,497 $2,226 14.4%
as % of net revenues 29.8% 31.5%
The increase in selling and administrative expense was due primarily to
higher personnel expenses resulting from an increase in management group
personnel, an increase in expenses associated with additional office,
production, distribution and warehouse facilities, and higher insurance
costs related to the growth of our Company and escalating insurance rates.
We also experienced an increase in legal expense as the prior year's first
quarter included a portion of insurance reimbursements for defense costs in
the Healthpoint litigation (see Note 11 in the accompanying Notes to
Consolidated Financial Statements). These increases were partially offset by
a reduction in officers' life insurance expense due to an increase in the
cash surrender value of the policies.
AMORTIZATION OF INTANGIBLE ASSETS
THREE MONTHS ENDED JUNE 30,
-------------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2003 2002 $ %
------ ------ ------ -----
Amortization of intangible assets $1,111 $578 $533 92.2%
The increase in amortization of intangible assets was due primarily to the
amortization of trademarks acquired in the two product acquisitions
completed on March 31, 2003 (see Note 6 in the accompanying Notes to
Consolidated Financial Statements).
INTEREST AND OTHER INCOME
THREE MONTHS ENDED JUNE 30,
-------------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2003 2002 $ %
------ ------ ------ -----
Interest and other income $363 $53 $310 584.9%
The increase in interest and other income was due to the investment of
$144.5 million of net proceeds from the May 2003 Convertible Subordinated
Notes offering into short-term, highly liquid investments (see Notes 8 and
10 in the accompanying Notes to Consolidated Financial Statements) combined
with the impact of an $82.3 million increase in short-term investments
during fiscal 2003.
16
INTEREST EXPENSE
THREE MONTHS ENDED JUNE 30,
-------------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2003 2002 $ %
------ ------- ------ -----
Interest expense $1,085 $37 $1,048 2,832.4%
The increase in interest expense resulted primarily from the issuance of
$200.0 million of Convertible Subordinated Notes on May 16, 2003 (see Note 8
in the accompanying Notes to Consolidated Financial Statements).
PROVISION FOR INCOME TAXES
THREE MONTHS ENDED JUNE 30,
-------------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2003 2002 $ %
------- ------- ------ -----
Provision for income taxes $4,718 $3,898 $820 21.0%
effective tax rate 35.5% 36.7%
The decline in the effective tax rate was primarily due to the increased use
of research and development tax credits as a means of lowering our tax rate.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Cash and cash equivalents and working capital were $233.9 million and $289.5
million, respectively, at June 30, 2003, compared to $96.3 million and
$137.9 million, respectively, at March 31, 2003. Internally generated funds
from product sales growth continued to be a significant source of operating
capital used in the funding of our businesses. The net cash flow from
operating activities was $10.4 million for the three months ended June 30,
2003 compared to $17.1 million for the corresponding prior year period. The
$6.7 million decrease in net cash flow from operating activities resulted
primarily from an increase in inventories and a decrease in accounts payable
and accrued liabilities. The increase in inventories resulted primarily from
increased production of branded and specialty generic products in
anticipation of continued sales growth, significant purchases of controlled
substance raw materials, and receipt of Niferex(R), Chromagen(R) and
StrongStart(R) inventories in accordance with the corresponding product
acquisition agreements (see Note 6 in the accompanying Notes to Consolidated
Financial Statements). The net decrease in accounts payable and accrued
liabilities resulted primarily from an increase in the amount of income tax
payments made during the first quarter of fiscal 2004 compared to the first
quarter of the prior fiscal year.
Net cash flow used in investing activities was $17.9 million for the first
quarter of fiscal 2004 compared to $7.5 million for the corresponding prior
year period. Capital expenditures of $3.6 million were funded by net cash
flows from operating activities. Our investment in capital assets was
primarily for purchasing machinery and equipment to upgrade and expand our
pharmaceutical manufacturing and distribution capabilities. On March 31,
2003, we completed the purchase of product rights and trademarks to the
Chromagen(R) and StrongStart(R) product lines from a subsidiary of Altana
Pharma AG (Altana) and the Niferex(R) product line from Schwarz Pharma. The
acquisition of the Chromagen(R) and StrongStart(R) product lines was
financed with a $13.0 million cash payment made on March 31, 2003 and two
non-interest bearing $7.0 million promissory notes issued to Altana, which
are due on the first and second anniversaries of the agreement. A cash
payment of $14.3 million was made in April 2003 for the Niferex(R) product
line. Other investing activities for the corresponding prior year quarter
included a $3.0 million payment related to the purchase of certain licensing
rights combined with an equity investment in a women's healthcare company.
Debt increased to $226.3 million at June 30, 2003 compared to $17.6 million
at March 31, 2003. The increase primarily resulted from the issuance in May
2003 of $200.0 million in Convertible Subordinated Notes that are
convertible, under certain circumstances, into shares of our Class A common
stock at an initial conversion price of $34.51 per share (see Note 8 in the
accompanying Notes to Consolidated Financial Statements). The Convertible
Subordinated Notes bear interest at a rate of 2.50% and mature on May 16,
2033. We may redeem some or all of the Convertible Subordinated Notes at any
time on or after May 21, 2006, at a redemption price, payable in cash, of
100% of the principal amount of the Convertible Subordinated Notes, plus
accrued and unpaid interest (including contingent interest, if any) to the
date of redemption. Holders may require us to repurchase all or a
17
portion of their Convertible Subordinated Notes on May 16, 2008, 2013, 2018,
2023 and 2028, and upon a change in control, as defined in the indenture
governing the Convertible Subordinated Notes, at 100% of the principal
amount of the Convertible Subordinated Notes, plus accrued and unpaid
interest (including contingent interest, if any) to the date of repurchase,
payable in cash. The Convertible Subordinated Notes are subordinate to all
of our existing and future senior obligations. The net proceeds to us were
approximately $194.5 million, after deducting underwriting discounts,
commissions and offering expenses. Also during the first quarter of fiscal
2004, we financed the purchase of an $8.8 million building with a term loan
secured by the property under a floating rate loan with a bank. The facility
consists of approximately 275,000 square feet of office, production,
distribution and warehouse space. The remaining principal balance plus any
unpaid interest is due in April 2008. We also entered into an interest rate
swap agreement with the same bank, which fixed the interest rate of the
building mortgage at 5.31% for the term of the loan.
As of June 30, 2003, we have a credit agreement with a bank that provides
for a revolving line of credit for borrowing up to $60 million. The credit
agreement provides for a $40 million unsecured revolving line of credit
along with an unsecured supplemental credit line of $20 million for
financing acquisitions. The $40 million unsecured revolving line of credit
expires in October 2004 and the unsecured supplemental credit line of $20
million expires in December 2003. At June 30, 2003, we had no cash
borrowings outstanding under either credit facility.
As a result of the significant increase in debt related to the $200.0
million Convertible Subordinated Notes issuance, the $60 million revolving
line of credit we have with a bank was amended. The credit agreement, which
previously included covenants that impose minimum levels of earnings before
interest, taxes, depreciation and amortization, a maximum funded debt ratio,
and a limit on capital expenditures and dividend payments, was expanded to
include a minimum fixed charge ratio and a maximum senior leverage ratio.
During May 2003, we used $50.0 million of the net proceeds from the
Convertible Subordinated Notes issuance to fund the repurchase of 2.0
million shares of our Class A common stock.
We believe our cash and cash equivalents balance, cash flows from
operations, funds available under our credit facilities, and proceeds
received from the Convertible Subordinated Notes issuance will be adequate
to fund operating activities for the presently foreseeable future, including
the payment of short-term and long-term debt obligations, capital
improvements, research and development expenditures, product development
activities and expansion of marketing capabilities for the branded
pharmaceutical business. In addition, we continue to examine opportunities
to expand our business through the acquisition of or investment in
companies, technologies, product rights, research and development and other
investments that are compatible with existing businesses. We intend to use
our available cash to help in funding any acquisitions or investments. As
such, cash has been invested in short-term, highly liquid instruments. We
also may use funds available under our credit facility, or financing sources
that subsequently become available, including the future issuances of
additional debt or equity securities, to fund these acquisitions or
investments. If we were to fund one or more such acquisitions or
investments, our capital resources, financial condition and results of
operations could be materially impacted in future periods.
INFLATION
- ---------
Inflation may apply upward pressure on the cost of goods and services used
by us in the future. However, we believe that the net effect of inflation on
our operations during the past three years has been minimal. In addition,
changes in the mix of products sold and the effect of competition has made a
comparison of changes in selling prices less meaningful relative to changes
in the overall rate of inflation over the past three years.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
- ------------------------------------------
Our consolidated financial statements are presented on the basis of
accounting principles that are generally accepted in the United States.
Certain of our accounting policies are particularly important to the
portrayal of our financial position and results of operations and require
the application of significant judgment by our management. As a result,
these policies are subject to an inherent degree of uncertainty. In applying
these policies, we make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses and related
disclosures. We base our estimates and judgments on historical experience,
the terms of existing contracts,
18
observance of trends in the industry, information that is obtained from
customers and outside sources, and on various other assumptions that are
believed to be reasonable and appropriate under the circumstances, the
results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Although we believe that our estimates and assumptions are
reasonable, actual results may differ significantly from our estimates.
Changes in estimates and assumptions based upon actual results may have a
material impact on our results of operations and/or financial condition. Our
critical accounting policies are described below.
REVENUE RECOGNITION AND SALES ALLOWANCES. We recognize revenue on product
sales upon shipment when title and risk of loss have transferred to the
customer, when estimated sales provisions for product returns, sales
rebates, payment discounts, chargebacks, and other promotional programs are
reasonably determinable and when the customer's payment ability has been
reasonably assured. Accruals for sales provisions are presented in the
consolidated financial statements as reductions to revenues and accounts
receivable.
Provisions for estimated product returns, sales rebates, payment discounts,
and other promotional programs require a limited degree of subjectivity, yet
combined represent a significant portion of the provisions. These provisions
are estimated based on historical payment experience, historical
relationship to revenues, estimated customer inventory levels and contract
terms. Such provisions are reasonably determinable due to the limited number
of assumptions and consistency of historical experience.
The provision for chargebacks is the most significant and complex estimate
used in the recognition of revenue. We establish contract prices for
indirect customers who are supplied by our wholesale customers. A chargeback
represents the difference between our invoice price to the wholesaler and
the indirect customer's contract price, which is lower. We credit the
wholesaler for purchases by indirect customers at the lower price.
Accordingly, we record these chargebacks at the time we recognize revenue in
connection with our sales to wholesalers. Provisions for estimating
chargebacks are calculated primarily using historical chargeback experience,
actual contract pricing and estimated wholesaler inventory levels. We
continually monitor our assumptions giving consideration to estimated
wholesaler inventory levels and current pricing trends and make adjustments
to these provisions when we believe that the actual chargeback credits will
differ from the estimated provisions.
ALLOWANCE FOR INVENTORIES. Inventories consist of finished goods held for
distribution, raw materials and work in process. Our inventories are stated
at the lower of cost or market, with cost determined on the first-in,
first-out basis. In evaluating whether inventory is to be stated at the
lower of cost or market, we consider such factors as the amount of inventory
on hand and in the distribution channel, estimated time required to sell
existing inventory, remaining shelf life and current and expected market
conditions, including levels of competition. We establish reserves, when
necessary, for slow-moving and obsolete inventories based upon our
historical experience and management's assessment of current product demand.
If it is determined that inventory is overvalued based upon the above
factors, then the necessary provisions to reduce inventories to their net
realizable value are made.
INTANGIBLE ASSETS. Our intangible assets consist of product rights, license
agreements and trademarks resulting from product acquisitions and legal fees
and similar costs relating to the development of patents and trademarks.
Intangible assets that are acquired are stated at cost, less accumulated
amortization, and are amortized on a straight-line basis over estimated
useful lives of 20 years. Upon approval, costs associated with the
development of patents and trademarks are amortized on a straight-line basis
over estimated useful lives ranging from five to 17 years. We determine
amortization periods for intangible assets that are acquired based on our
assessment of various factors impacting estimated useful lives and cash
flows of the acquired products. Such factors include the product's position
in its life cycle, the existence or absence of like products in the market,
various other competitive and regulatory issues, and contractual terms.
Significant changes to any of these factors may result in a reduction in the
intangible asset's useful life and an acceleration of related amortization
expense.
We assess the impairment of intangible assets whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. Some
factors considered important which could trigger an impairment review
include the following; (1) significant underperformance relative to expected
historical or projected future operating results; (2) significant changes in
the manner of our use of the acquired assets or the strategy for our overall
business; and (3) significant negative industry or economic trends.
19
When we determine that the carrying value of intangible assets may not be
recoverable based upon the existence of one or more of the above indicators
of impairment, we first perform an assessment of the asset's recoverability.
Recoverability is determined by comparing the carrying amount of an
intangible asset against an estimate of the undiscounted future cash flows
expected to result from its use and eventual disposition. If the sum of the
expected future undiscounted cash flows is less than the carrying amount of
the intangible asset, an impairment loss is recognized based on the excess
of the carrying amount over the estimated fair value of the intangible
asset.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk is limited to fluctuating interest rates
associated with variable rate indebtedness that is subject to interest rate
changes.
Advances to us under our credit facilities bear interest at a rate that
varies consistent with increases or decreases in the publicly announced
prime rate and/or the LIBOR rate with respect to LIBOR-related loans, if
any. A material increase in such rates could significantly increase
borrowing expenses. We did not have any cash borrowings under our credit
facilities at June 30, 2003.
In May 2003, we issued $200.0 million of Convertible Subordinated Notes. The
interest rate on the Convertible Subordinated Notes is fixed at 2.50% and
therefore not subject to interest rate changes.
In April 2003, we entered into an $8.8 million term loan secured by a
building under a floating rate loan with a bank. We also entered into an
interest rate swap agreement with the same bank, which fixed the interest
rate of the building mortgage at 5.31% for the term of the loan.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Company management,
including the chief executive officer and chief financial officer, have
evaluated the Company's disclosure controls and procedures as of the end of
the period covered by this Quarterly Report on Form 10-Q. Based on that
evaluation, the chief executive officer and chief financial officer have
concluded that the Company's disclosure controls and procedures are
effective to ensure that information required to be disclosed by the Company
in reports that it files or submits under the Securities Exchange Act of
1934 is recorded, processed, summarized and reported within the time period
specified in the Securities and Exchange Commission's rules and forms.
CHANGES IN INTERNAL CONTROLS. There have been no significant changes in the
Company's internal control over financial reporting or in other factors that
could, or could be reasonably likely to, significantly affect internal
control over financial reporting subsequent to the date of the evaluation.
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ETHEX Corporation (ETHEX), a subsidiary of the Company, is a defendant in a
lawsuit styled Healthpoint, Ltd. v. ETHEX Corporation, filed in federal
court in San Antonio, Texas. In general, the plaintiffs allege that ETHEX's
comparative promotion of its Ethezyme(TM) to Healthpoint's Accuzyme(R)
product resulted in false advertising and misleading statements under
various federal and state laws, and constituted 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. On October 1, 2002, the U.S. District Court for the
Western District of Texas denied ETHEX's motion to set aside the jury's
verdict. On December 17, 2002, the court entered a judgment awarding
attorneys' fees to Healthpoint in an amount to be subsequently determined.
We believe that the jury award is excessive and is not sufficiently
supported by the facts or the law. We intend to vigorously prosecute an
appeal. We and our counsel believe that there are meritorious arguments to
be raised during the appeal process; however, we cannot give any assurance
that we will prevail on appeal. As a result of the
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court's earlier decisions, our results of operations for the quarter ended
September 30, 2002 included a provision for potential damages of $16.5
million, which is reflected in accrued liabilities on its consolidated
balance sheet as of June 30, 2003. To date Healthpoint has requested
reimbursement for approximately $1.8 million in attorneys' fees in addition
to the judgment discussed above. We are contesting Healthpoint's entitlement
to and its requested amount of attorneys' fees. As of this date, the court
has not entered any order specifying the amount of attorneys' fees to be
awarded. Our counsel has advised us that the amount could range from zero to
$1.8 million, the amount requested by Healthpoint. Based on management's
current analysis, we believe that the accrual for contingent liability as
recorded will be adequate to cover any judgment, including attorneys' fees,
which may result at the end of the appeal process. We are continually
evaluating the need for additional reserves as the case progresses through
the appeal process.
We previously distributed several low volume pharmaceutical products that
contained phenylpropanolamine, or PPA, and that were discontinued in 2000
and 2001. We are presently named as one of several defendants in two product
liability lawsuits in federal court in Nevada and Mississippi involving PPA.
The Nevada case is Deuel, David, et al v. KV Pharmaceutical Company, Inc et
al. The suit was filed on June 11, 2001. Discovery has been initiated in
this case, and we currently have completed the basic fact discovery and
depositions, however, no discovery cut-off date has been assigned and there
is presently no trial date. The Mississippi case is Virginia Madison, et al.
v. Bayer Corporation, et al. We are one of several defendants named in the
lawsuit. The suit was filed on December 23, 2002, but was not served on us
until February 2003. The case was originally filed in the Circuit Court of
Hinds County, Mississippi, and was removed to the United States District
Court for the Southern District of Mississippi by co-defendant Bayer
Corporation. The Plaintiffs have filed a motion to remand the case to the
Circuit Court of Hinds County, Mississippi, which has caused the Court to
enter a stay of all proceedings pending a resolution of the motion. So far,
the Court has not ruled on the remand motion. Both the Nevada and
Mississippi cases have been transferred to a Judicial Panel on Multi-District
Litigation for PPA claims sitting in 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
our distributed pharmaceuticals containing PPA that have since been
discontinued and/or reformulated to exclude PPA. We believe that the Company
has substantial defenses to these claims, though the ultimate outcome of
these cases and the potential effect cannot be determined.
We are being defended and indemnified in the Nevada PPA lawsuits by its
products liability insurer subject to a reservation of rights. Our product
liability coverage was obtained on a claims made basis and provides coverage
for judgments, settlements and defense costs arising from product liability
claims. However, such insurance may not be adequate to eliminate the risk
from some or all product liability claims, including PPA claims, and is
subject to the limitations described in the terms of the policies.
Furthermore, our product liability coverage for PPA claims expired for
claims made after June 15, 2002. Although we renewed our product liability
coverage for coverage after June 15, 2002, that policy excludes future PPA
claims in accordance with the standard industry exclusion. Consequently, as
of June 15, 2002, we have provided for legal defense costs and indemnity
payments involving PPA claims on a going forward basis, including the
Mississippi lawsuit that was after June 15, 2002. Moreover, we may not be
able to obtain product liability insurance in the future for PPA claims with
adequate coverage limits at commercially reasonable prices for subsequent
periods. From time to time in the future, we may be subject to further
litigation resulting from products containing PPA that it formerly
distributed. We intend to vigorously defend any claims that may be raised in
the current and future litigation.
From time to time, we become involved in various legal matters in addition
to the above-described matters that it considers to be in the ordinary
course of business. While we are not presently able to determine the
potential liability, if any, related to such matters, we believe none of
such matters, individually or in the aggregate, will have a material adverse
effect on our financial position.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On May 16, 2003, we completed the sale of $200 million of our Contingent
Convertible Subordinated Notes Due 2033 (the "Notes") in a private placement
pursuant to Rule 144A under the Securities Act of 1933, as amended. The
Notes were sold to Deutsche Bank Securities, Inc. and Banc of America
Securities LLC, as representatives of the several purchasers. The Notes were
issued under an indenture, dated as of May 16, 2003, between us and
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Deutsche Bank Trust Company Americas, as trustee. The Notes have an annual
interest rate of 2.5% and are convertible into our Class A common stock in
the following circumstances:
o During any quarter commencing after June 30, 2003, if the
closing sale price of our Class A common stock for at least 20
trading days in the period of 30 consecutive trading days
ending on the last trading day of the quarter preceding the
quarter in which the conversion occurs exceeds 120% of the
conversion price per share of our Class A common stock on that
30th trading day;
o If we have 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
per $1,000 principal amount of the Notes 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 other specified corporate transactions.
Holders may convert any outstanding Notes into shares of our Class A common
stock at the conversion price of $34.51. This represents a conversion rate
of approximately 28.9771 shares of Class A common stock per $1,000 principal
amount of Notes.
We used $50 million of the proceeds from the offering of the Notes to fund
the repurchase of $50 million of our Class A common stock and intend to use
the remaining proceeds: (1) for future acquisitions of products,
technologies and businesses, and (2) for general corporate purposes.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- -------- --------------------------------
a) Exhibits. See Exhibit Index.
b) Reports on Form 8-K. On April 3, 2003, the Company
filed a Current Report on Form 8-K dated April 1,
2003, under Item 7 and Item 9, to announce that the
Company had completed an agreement with Schwarz Pharma
to acquire the Niferex(R) product line for its Ther-Rx
Corporation branded marketing division. The Report
also announced that the Company had completed an
agreement with a subsidiary of Altana Pharma AG to
acquire the Chromagen(R) and StrongStart(R) product
lines for its Ther-Rx Corporation branded marketing
division.
On April 29, 2003, the Company filed a Current Report
on Form 8-K dated April 29, 2003, under Item 7 and
Item 9, to announce that it expected to report results
in line with current market expectations for its
fiscal fourth quarter and fiscal year ended March 31,
2003.
On May 16, 2003, the Company filed a Current Report on
Form 8-K dated May 12, 2003, under Item 7 and Item 9,
to announce its intention to raise approximately $130
million through an overnight offering of 30-year
Contingent Convertible Subordinated Notes in a private
placement pursuant to Rule 144A under the Securities
Act of 1933.
On May 21, 2003, the Company filed a Current Report on
Form 8-K dated May 16, 2003, under Item 7 and Item 9,
to announce the completion of the sale of $200 million
of Contingent Convertible Subordinated Notes due in
2033 at an annual interest rate of 2.5%.
On June 4, 2003, the Company filed a Current Report on
Form 8-K dated June 2, 2003, under Item 7 and Item 9,
to announce its operating results for its fiscal
fourth quarter and fiscal year ended March 31, 2003.
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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 14, 2003 By /s/ Marc S. Hermelin
--------------------------------
Marc S. Hermelin
Vice Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: August 14, 2003 By /s/ Gerald R. Mitchell
--------------------------------
Gerald R. Mitchell
Vice President, Treasurer and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
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EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
31.1 Certification of Chief Financial Officer.
31.2 Certification of Chief Executive 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.
24