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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 SEPTEMBER 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 OF 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 NOVEMBER 5, 2003
----------------- ----------------------------------
CLASS A COMMON STOCK, PAR VALUE $.01 PER SHARE 33,726,842
CLASS B COMMON STOCK, PAR VALUE $.01 PER SHARE 15,957,122
1
PART I. - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited; dollars in thousands, except per share data)
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ---------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Net revenues..................................... $ 71,019 $ 60,482 $ 130,398 $ 109,709
Cost of sales.................................... 24,140 23,481 45,129 42,559
--------- --------- --------- ---------
Gross profit..................................... 46,879 37,001 85,269 67,150
--------- --------- --------- ---------
Operating expenses:
Research and development..................... 4,028 5,086 9,570 8,555
Selling and administrative................... 23,171 17,330 40,893 32,822
Amortization of intangible assets............ 1,113 579 2,224 1,162
Litigation................................... (1,700) 16,500 (1,700) 16,500
--------- --------- --------- ---------
Total operating expenses......................... 26,612 39,495 50,987 59,039
--------- --------- --------- ---------
Operating income (loss).......................... 20,267 (2,494) 34,282 8,111
--------- --------- --------- ---------
Other expense (income):
Interest expense............................. 1,700 60 2,785 97
Interest and other income.................... (411) (334) (773) (387)
--------- --------- --------- ---------
Total other expense (income), net................ 1,289 (274) 2,012 (290)
--------- --------- --------- ---------
Income (loss) before income taxes................ 18,978 (2,220) 32,270 8,401
Provision (benefit) for income taxes............. 6,737 (815) 11,456 3,083
--------- --------- --------- ---------
Net income (loss)................................ $ 12,241 $ (1,405) $ 20,814 $ 5,318
========= ========= ========= =========
Net income (loss) per common share - basic....... $0.25 $(0.03) $0.42 $0.11
===== ====== ===== =====
Net income (loss) per common share - diluted..... $0.24 $(0.03) $0.41 $0.11
===== ====== ===== =====
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
SEPTEMBER 30, MARCH 31,
2003 2003
---- ----
(Unaudited)
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents............................................................ $ 235,587 $ 96,288
Receivables, less allowance for doubtful accounts of $391 and $422
at September 30, 2003 and March 31, 2003, respectively............................ 53,682 57,385
Inventories, net..................................................................... 53,479 42,343
Prepaid and other assets............................................................. 4,285 2,709
Deferred tax asset................................................................... 13,510 14,791
----------- -----------
Total Current Assets.............................................................. 360,543 213,516
Property and equipment, less accumulated depreciation................................ 65,602 51,903
Intangible assets and goodwill, net.................................................. 81,663 82,577
Other assets......................................................................... 10,808 4,672
----------- -----------
TOTAL ASSETS......................................................................... $ 518,616 $ 352,668
=========== ===========
LIABILITIES
-----------
CURRENT LIABILITIES:
Accounts payable..................................................................... $ 14,515 $ 15,588
Accrued liabilities.................................................................. 38,030 52,548
Current maturities of long-term debt................................................. 8,184 7,484
----------- -----------
Total Current Liabilities......................................................... 60,729 75,620
Long-term debt....................................................................... 218,016 10,106
Other long-term liabilities.......................................................... 3,063 2,913
Deferred tax liability............................................................... 3,828 3,413
----------- -----------
TOTAL LIABILITIES.................................................................... 285,636 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 September 30, 2003 and March 31, 2003 (convertible into
Class A shares at a ratio of 8.4375 to one)....................................... - -
Class A and Class B Common Stock, $.01 par value; 150,000,000 and
75,000,000 shares authorized, respectively;
Class A - issued 36,670,749 and 35,476,935 at September 30, 2003
and March 31, 2003, respectively.............................................. 367 236
Class B - issued 16,057,264 and 15,865,678 at September 30, 2003 and March 31,
2003, respectively (convertible into Class A shares on a one-for-one basis)... 160 106
Additional paid-in capital........................................................... 122,910 120,961
Retained earnings.................................................................... 159,571 139,341
Less: Treasury stock, 2,988,930 shares of Class A and 80,142 shares of Class B
Common Stock at September 30, 2003, respectively, and 48 shares of Class A and
80,142 shares of Class B Common Stock at March 31, 2003, respectively, at cost.... (50,028) (28)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY........................................................... 232,980 260,616
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................................... $ 518,616 $ 352,668
=========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; dollars in thousands)
SIX MONTHS ENDED
SEPTEMBER 30,
----------------------------
2003 2002
----------- -----------
OPERATING ACTIVITIES:
Net income............................................................. $ 20,814 $ 5,318
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, amortization and other non-cash charges............... 6,082 3,507
Deferred income tax provision (benefit)............................. 1,696 (6,959)
Deferred compensation............................................... 150 125
Litigation.......................................................... 1,825 16,500
Changes in operating assets and liabilities:
Decrease in receivables, net........................................ 3,703 11,701
Increase in inventories, net........................................ (12,759) (6,446)
(Increase) decrease in prepaid and other assets..................... (3,183) 654
Decrease in accounts payable and accrued liabilities................ (1,493) (726)
----------- -----------
Net cash provided by operating activities.............................. 16,835 23,674
----------- -----------
INVESTING ACTIVITIES:
Purchase of property and equipment, net............................. (8,080) (9,710)
Purchase of stock and intangible assets............................. - (3,000)
Product acquisition................................................. (14,300) -
----------- -----------
Net cash used in investing activities.................................. (22,380) (12,710)
----------- -----------
FINANCING ACTIVITIES:
Principal payments on long-term debt................................ (437) (220)
Dividends paid on preferred stock................................... (401) (35)
Proceeds from issuance of convertible notes......................... 194,236 -
Purchase of common stock for treasury............................... (50,000) -
Proceeds from issuance of common stock.............................. - 72,472
Sale of common stock to employee profit sharing plan................ - 891
Exercise of common stock options.................................... 1,446 170
----------- -----------
Net cash provided by financing activities.............................. 144,844 73,278
----------- -----------
Increase in cash and cash equivalents.................................. 139,299 84,242
Cash and cash equivalents:
Beginning of year................................................... 96,288 12,109
----------- -----------
End of period....................................................... $ 235,587 $ 96,351
=========== ===========
SUPPLEMENTAL INFORMATION:
Interest paid....................................................... $ 195 $ 214
Income taxes paid................................................... 9,701 10,901
NON-CASH FINANCING ACTIVITY:
Term loan to finance building purchase............................. $ 8,800 $ -
Issuance of common stock under product development
agreement...................................................... 505 -
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- and
six-month periods ended September 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 SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -------------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income (loss), as reported................. $ 12,241 $ (1,405) $ 20,814 $ 5,318
Stock based employee compensation expense,
net of tax................................... (340) (365) (509) (539)
--------- --------- --------- ---------
Pro forma net income (loss).................... $ 11,901 $ (1,770) $ 20,305 $ 4,779
========= ========== ========= =========
Earnings (loss) per share:
Basic - as reported.......................... $ 0.25 $ (0.03) $ 0.42 $ 0.11
Basic - pro forma............................ 0.25 (0.04) 0.41 0.10
Diluted - as reported........................ 0.24 (0.03) 0.41 0.11
Diluted - pro forma.......................... 0.23 (0.03) 0.40 0.10
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 and six months ended September 30, 2003 and 2002,
respectively: no dividend yield; expected volatility of 43% and 45%;
risk-free interest rate of 3.16% 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.
5
3. EARNINGS (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -------------------------
2003 2002 2003 2002
---- ---- ---- ----
Numerator:
Net income (loss) (3)(4)........................ $ 12,241 $ (1,405) $ 20,814 $ 5,318
Preferred stock dividends....................... (17) (17) (401) (35)
--------- --------- --------- ---------
Numerator for basic earnings (loss) per
share - income (loss) available to common
shareholders.................................. 12,224 (1,422) 20,413 5,283
Effect of dilutive securities:
Preferred stock dividends..................... 17 17 401 35
--------- --------- --------- ---------
Numerator for diluted earnings (loss) per
share - income (loss) available to common
shareholders after assumed conversions........ $ 12,241 $ (1,405) $ 20,814 $ 5,318
========= ========= ========= =========
Denominator:
Denominator for basic earnings (loss) per
share - weighted-average shares............... 48,501 50,726 49,145 48,453
--------- --------- --------- ---------
Effect of dilutive securities:
Employee stock options........................ 1,816 - 1,740 1,536
Convertible preferred stock................... 338 - 338 338
--------- --------- --------- ---------
Dilutive potential common shares................ 2,154 - 2,078 1,874
--------- --------- --------- ---------
Denominator for diluted earnings (loss) per
share - adjusted weighted-average shares and
assumed conversions........................... 50,655 50,726 51,223 50,327
========= ========= ========= =========
Basic earnings (loss) per share(1) ............. $ 0.25 $ (0.03) $ 0.42 $ 0.11
========= ========= ========= =========
Diluted earnings (loss) per share(1)(2) ........ $ 0.24 $ (0.03) $ 0.41 $ 0.11
========= ========= ========= =========
(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) Excluded from the computation of diluted earnings per share are
outstanding stock options whose exercise prices are greater than
the average market price of the common shares for the period
reported. For the quarter ended September 30, 2003, stock options
to purchase 50,850 Class A and Class B common shares were excluded
from the computation. For the six-month periods, excluded from the
computation were stock options to purchase 211,350 and 435,150 of
Class A and Class B common shares at September 30, 2003 and 2002,
respectively. For the quarter ended September 30, 2002, there were
stock options to purchase 3,451,630 shares of Class A and Class B
Common Stock and preferred shares convertible into 337,500 shares
of Class A Common Stock that were excluded from the computation of
diluted loss per share because their effect would have been
anti-dilutive.
(3) Net income for the three and six months ended September 30, 2003
included a net gain of $1,700 related to two litigation matters.
The impact of the net gain, net of applicable tax effect, was to
increase net income by $1,100, or $0.02 per diluted share.
(4) Net income for the three and six months ended September 30, 2002
included a provision of $16,500 for potential damages associated
with a lawsuit (see Note 11). The impact of the litigation reserve,
net of applicable tax effect, was to reduce net income by $10,444,
or $0.21 per diluted share.
6
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 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 $22,201 and $24,710 for the three months ended September
30, 2003 and 2002, respectively, and $44,016 and $44,268 for the six months
ended September 30, 2003 and 2002, respectively. The reserve balances
related to the sales provisions totaled $30,867 and $29,658 at September 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:
SEPTEMBER 30, 2003 MARCH 31, 2003
------------------ --------------
Finished goods..................... $ 31,201 $ 26,524
Work-in-process.................... 4,775 4,290
Raw materials...................... 18,631 12,532
----------- ----------
54,607 43,346
Reserves for obsolescence.......... (1,128) (1,003)
----------- ----------
$ 53,479 $ 42,343
=========== ==========
Management establishes reserves for potentially obsolete or slow moving
inventory based on an evaluation of inventory levels, forecasted demand, and
market conditions.
7
6. INTANGIBLE ASSETS AND GOODWILL
SEPTEMBER 30, 2003 MARCH 31, 2003
---------------------------- ----------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
------ ------------ ------ ------------
Product rights - Micro-K(R)................ $36,140 $ (8,197) $36,140 $(7,294)
Product rights - PreCare(R)................ 8,433 (1,757) 8,433 (1,546)
Trademarks acquired........................ 42,476 (1,062) 42,476 -
License agreements......................... 2,235 - 1,000 -
Trademarks and patents..................... 3,189 (351) 3,114 (303)
------- -------- ------- -------
Total intangible assets.................. 92,473 (11,367) 91,163 (9,143)
Goodwill................................... 557 - 557 -
------- -------- ------- -------
$93,030 $(11,367) $91,720 $(9,143)
======= ======== ======= =======
As of September 30, 2003, amortization expense for intangible assets is
estimated to be $2,226 for the remainder of fiscal 2004 and $4,450 in each
of the four succeeding fiscal years.
7. 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 and six months ended September 30, 2003 and 2002.
THREE MONTHS
ENDED BRANDED SPECIALTY SPECIALTY ALL
SEPTEMBER 30, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED
------------- -------- -------- --------- ----- ------------ ------------
Net revenues............... 2003 $16,879 $48,785 $4,279 $ 1,076 $ - $ 71,019
2002 11,286 44,393 4,377 426 - 60,482
Segment profit (loss)...... 2003 4,392 28,544 557 (14,515) - 18,978
2002 1,702 23,579 616 (28,117) - (2,220)
Identifiable assets........ 2003 12,902 67,673 9,072 430,127 (1,158) 518,616
2002 9,828 53,023 9,377 219,161 (1,158) 290,231
Property and 2003 6 - 30 4,492 - 4,528
equipment additions.... 2002 612 2 38 4,597 - 5,249
Depreciation and 2003 81 13 35 2,999 - 3,128
Amortization........... 2002 90 12 43 1,715 - 1,860
8
SIX MONTHS
ENDED BRANDED SPECIALTY SPECIALTY ALL
SEPTEMBER 30, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED
------------- -------- -------- --------- ----- ------------ ------------
Net revenues............... 2003 $31,660 $88,240 $8,180 $ 2,318 $ - $130,398
2002 18,420 81,445 8,916 928 - 109,709
Segment profit (loss)...... 2003 9,235 50,320 874 (28,159) - 32,270
2002 1,086 43,405 1,453 (37,543) - 8,401
Property and 2003 123 - 35 7,922 - 8,080
equipment additions.... 2002 625 20 71 8,994 - 9,710
Depreciation and 2003 161 28 70 5,823 - 6,082
Amortization........... 2002 111 25 84 3,287 - 3,507
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.
8. EQUITY TRANSACTIONS
On September 8, 2003, the Company's Board of Directors declared a
three-for-two stock split in the form of a 50% stock dividend on its Class A
and Class B common stock paid on September 29, 2003 to shareholders of
record as of September 18, 2003. Class A and Class B common stock was
credited and retained earnings was charged for the aggregate par value of
the shares issued. The stated par value on a per share basis was not changed
from $.01.
All per share data herein has been restated to reflect the aforementioned
three-for-two stock split in the form of a 50% stock dividend.
9. 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 September 30, 2003. As discussed
above, Healthpoint also requested reimbursement for approximately $1,800 in
attorneys' fees in addition to the judgment. In September 2003, the court
entered an order specifying the amount of attorneys' fees to be awarded. As
a result of this decision, during the quarter ended September 30, 2003, the
Company recorded an additional provision of $1,825, which was reflected in
accrued liabilities on the Company's consolidated balance sheet as of
September 30, 2003.
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 a
product liability lawsuit in federal court in Mississippi involving PPA. The
Mississippi case is Virginia
9
Madison, et al. v. Bayer Corporation, et al. 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 Mississippi case has been
transferred to a Judicial Panel on Multi-District Litigation for PPA claims
sitting in the Western District of Washington. It 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. Discovery has only recently begun and management believes that
the Company has substantial defenses to these claims, though the ultimate
outcome of this case and the potential effect cannot be determined.
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.
On September 25, 2003, the Commonwealth of Massachusetts filed Commonwealth
of Massachusetts v. Mylan Laboratories, Inc. et al, No. 1:03-cv-11865-PBS
(D. Mass.), against ETHEX Corp. and twelve other manufacturers of generic
pharmaceutical products, including Mylan Laboratories, Inc., Barr
Laboratories, Inc., Duramed Pharmaceuticals, Inc., IVAX Corporation, Warrick
Pharmaceuticals Corporation, Watson Pharmaceuticals, Inc., Schein
Pharmaceuticals, Inc., TEVA Pharmaceuticals USA, Inc., Par Pharmaceuticals,
Inc., Dey, Inc., Purepac Pharmaceutical Co., and Roxanne Laboratories, Inc.
The complaint alleges, among other things, that the defendants reported
inflated pricing information for their drugs to data reporting services, and
that Massachusetts relied on this pricing data in setting reimbursement
rates under the Medicaid program. The complaint also alleges
10
that Massachusetts received rebates from the defendants under the Medicaid
Drug Rebate Program that were materially less than that to which
Massachusetts was entitled. Massachusetts seeks to recover from the
defendants the amount that it believes it overpaid and the amount it is owed
in rebates, based on claims under Massachusetts and federal law. The case is
in its early stages, and fact discovery has not yet begun. ETHEX is
vigorously defending the litigation.
We are involved in various other legal proceedings in the ordinary course of
our business. These legal proceedings include various patent infringement
actions brought by potential competitors with respect to products we propose
to market and for which we have filed Abbreviated New Drug Applications and
provided notice of certification required under the provisions of the Hatch
Waxman Act. While it is not feasible to predict the ultimate outcome of such
other proceedings, we believe that the ultimate outcome of such other
proceedings will not have a material adverse effect on our results of
operations or financial position.
10. 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 September 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 December 15, 2003.
The Company is currently evaluating what impact, if any, FIN 46 will have
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 adoption of this
statement did not have a material impact on the Company's 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 our business or financial condition or the extent
to which any factor, or combination of factors, may cause our 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 generic/non-branded pharmaceutical
operations through ETHEX Corporation, which focuses principally on
technologically distinguished generic products. Through Particle Dynamics,
Inc., we develop, manufacture and market technologically advanced,
value-added raw material products for the pharmaceutical, nutritional,
personal care, food and other markets.
We have a 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.
RESULTS OF OPERATIONS
- ---------------------
NET REVENUES BY SEGMENT
- -----------------------
($ IN THOUSANDS):
- -----------------------
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------ -----------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------------ ------------ ------------- ------------ ------------- ------------
Branded products $ 16,879 $ 11,286 49.6% $ 31,660 $ 18,420 71.9%
as % of total net revenues 23.8% 18.7% 24.3% 16.8%
Specialty generics 48,785 44,393 9.9% 88,240 81,445 8.3%
as % of total net revenues 68.7% 73.4% 67.7% 74.2%
Specialty materials 4,279 4,377 (2.2)% 8,180 8,916 (8.3)%
as % of total net revenues 6.0% 7.2% 6.3% 8.1%
Other 1,076 426 152.6% 2,318 928 149.8%
Total net revenues $ 71,019 $ 60,482 17.4% $ 130,398 $ 109,709 18.9%
13
The increase in branded product sales of $5.6 million and $13.2 million for
the three- and six-month periods, respectively, was due primarily to
continued growth of our women's healthcare family of products and the sales
impact of products acquired by us on March 31, 2003. Sales from the women's
healthcare product group increased $1.7 million, or 19.1%, in the second
quarter and $6.5 million, or 46.2%, for the six-month period. Included in
the women's healthcare family of products is the PreCare(R) product line
which contributed $1.3 million and $6.0 million of incremental sales in the
three- and six-month periods, respectively. These increases were
attributable to increased sales volume associated with higher market shares
for PrimaCare(R), our prescription prenatal/postnatal multivitamin and
mineral supplement with essential fatty acids, and the PreCare(R) prenatal
vitamin. Gynazole-1(R), our vaginal antifungal cream product, continued to
experience growth in the three- and six-month periods as its market share
continued to increase. Sales of Gynazole-1(R) increased $.4 million, or
11.9%, in the three-month period and $.5 million, or 8.5%, for the six-month
period. Our share of the prescription vaginal antifungal cream market
increased to 21.6% at the end of the second quarter, compared to 15.1% at
the end of the prior year comparative quarter. Increased sales from our
women's healthcare family of products were supplemented by $4.4 million and
$7.6 million of sales in the three- and six-month periods, respectively,
from our two hematinic product lines, Chromagen(R) and Niferex(R), and the
Strong Start prenatal vitamin product line that were acquired at the end of
fiscal 2003. Near the end of the second quarter, we began introducing
technology-improved versions of these products that incorporate our
proprietary drug delivery technologies. These increases were partially
offset by a $0.6 million and $0.8 million decline in sales from the
Micro-K(R) product line for the three- and six-month periods, respectively.
The growth in specialty generic sales of $4.4 million and $6.8 million for
the three- and six-month periods, respectively, resulted from $2.3 million
and $3.3 million, respectively, of incremental sales volume from new product
introductions, primarily in the cough/cold and prenatal vitamin product
lines, and $3.3 million and $3.8 million, respectively, in higher sales due
to price increases on certain products principally in the cardiovascular
category, which were partially offset by a decline in sales volume for
certain existing products of $1.2 million and $0.3 million for the three-
and six-month periods, respectively.
The decrease in specialty material product sales for the three- and six-month
periods was primarily due to a slowdown in a major customer's business in
the vitamin supplement market.
The increase in other revenue for the three- and six-month periods was
primarily due to the impact of a profit sharing arrangement entered into in
the second quarter of fiscal 2003 whereby three pain management products
manufactured by us are marketed in Canada by another pharmaceutical company.
GROSS PROFIT BY SEGMENT
- -----------------------
($ IN THOUSANDS):
- -----------------------
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------ -----------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------------ ------------ ------------- ------------ ------------- ------------
Branded products $ 14,528 $ 9,883 47.0% $ 27,403 $ 16,238 68.8%
as % of net revenues 86.1% 87.6% 86.6% 88.2%
Specialty generics 30,789 25,836 19.2% 54,752 47,572 15.1%
as % of net revenues 63.1% 58.2% 62.0% 58.4%
Specialty materials 1,435 1,625 (11.7)% 2,588 3,337 (22.5)%
as % of net revenues 33.5% 37.1% 31.6% 37.4%
Other 127 (343) NM 526 3 NM
Total gross profit $ 46,879 $ 37,001 26.7% $ 85,269 $ 67,150 27.0%
as % of total net revenues 66.0% 61.2% 65.4% 61.2%
The increase in consolidated gross profit of $9.9 million and $18.1 million
for the three- and six-month periods, respectively, was primarily
attributable to the sales growth experienced by the branded products and
specialty generics segments, offset partially by a sales decline in the
specialty materials segment. The higher gross profit percentage on a
consolidated basis for both the quarter and six-month period was favorably
impacted by a shift in the mix of product sales toward higher margin branded
products, which comprised a larger percentage of net revenues and higher
pricing on certain specialty generic products. The gross profit percentage
decreases
14
experienced by the branded products segment were due to the acquired
hematinic products, which have a slightly lower gross margin than the other
products in the branded line. The lower gross profit percentages in the
specialty materials segment resulted from unfavorable cost variances
associated with lower production.
RESEARCH AND DEVELOPMENT
- ------------------------
($ IN THOUSANDS):
- ------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------ -----------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------------ ------------ ------------- ------------ ------------- ------------
Research and development $ 4,028 $ 5,086 (20.8)% $ 9,570 $ 8,555 11.9%
as % of total net revenues 5.7% 8.4% 7.3% 7.8%
The $1.1 million decrease in research and development expense for the
quarter was primarily due to the timing of certain clinical studies. The
$1.0 million increase in research and development expense for the six-month
period resulted from higher costs associated with the continued expansion of
clinical testing connected to our internal product development efforts and
higher personnel expenses related to the growth of our research and
development staff. We still expect research and development costs for fiscal
2004 to increase by approximately 30% over fiscal 2003 levels.
SELLING AND ADMINISTRATIVE
- --------------------------
($ IN THOUSANDS):
- --------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------ -----------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------------ ------------ ------------- ------------ ------------- ------------
Selling and administrative $ 23,171 $ 17,330 33.7% $ 40,893 $ 32,822 24.6%
as % of total net revenues 32.6% 28.7% 31.4% 29.9%
The increase in selling and administrative expense of $5.8 million and $8.1
million for the three- and six-month periods, respectively, was due to
higher personnel expenses resulting from an increase in corporate management
personnel and expansion of the branded sales force, an increase in rent,
depreciation and utilities associated with additional facilities, higher
insurance costs related to the growth of our Company and escalating
insurance rates, and an increase in branded marketing expense associated
with our hematinic product lines acquired at the end of fiscal 2003. We also
experienced an increase in legal expense due to an increase in litigation
activity coupled with the prior year's first and second quarters including
insurance reimbursements for defense costs in the Healthpoint litigation
(see Note 9 in the accompanying Notes to Consolidated Financial Statements).
These increases were partially offset by a reduction in life insurance
expense.
AMORTIZATION OF INTANGIBLE ASSETS
- ---------------------------------
($ IN THOUSANDS):
- ---------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------ -----------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------------ ------------ ------------- ------------ ------------- ------------
Amortization of intangible assets $ 1,113 $ 579 92.2% $ 2,224 $ 1,162 91.4%
as % of total net revenues 1.6% 1.0% 1.7% 1.1%
The increase in amortization of intangible assets of $0.5 million and $1.1
million for the three- and six-month periods, respectively, was due
primarily to the amortization of trademarks acquired in the two product
acquisitions completed on March 31, 2003.
15
LITIGATION
- --------------------
($ IN THOUSANDS):
- --------------------
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------ -----------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------------ ------------ ------------- ------------ ------------- ------------
Litigation $ (1,700) $ 16,500 110.3% $ (1,700) $ 16,500 110.3%
as % of total net revenues (2.4)% 27.3% (1.3)% 15.0%
In September 2002, we recorded a litigation reserve of $16.5 million for
potential damages associated with the adverse decision made by a federal
court in Texas to uphold a previously rendered jury verdict in a lawsuit
against ETHEX Corporation, a wholly-owned subsidiary of the Company. In the
second quarter of fiscal 2004, we recorded an additional litigation reserve
related to this matter of $1.8 million for attorney's fees awarded to the
plaintiffs by the court (see Note 9 in the accompanying Notes to
Consolidated Financial Statements). The impact of this reserve was more than
offset by a $3.5 million net payment, received by us during the second
quarter of fiscal 2004 related to a branded company interfering with our
right to a timely introduction of a generic product in a previous fiscal
year.
INTEREST EXPENSE
- ------------------------
($ IN THOUSANDS):
- ------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------ -----------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------------ ------------ ------------- ------------ ------------- ------------
Interest expense $ 1,700 $ 60 NM $ 2,785 $ 97 NM
as % of total net revenues 2.4% 0.1% 2.1% 0.1%
The increase in interest expense for both the three- and six-month periods
resulted primarily from the issuance of $200.0 million of Convertible
Subordinated Notes on May 16, 2003 and the interest expense accrued thereon.
INTEREST AND OTHER INCOME
- -------------------------
($ IN THOUSANDS):
- -------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------ -----------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------------ ------------ ------------- ------------ ------------- ------------
Interest and other income $ 411 $ 334 23.1% $ 773 $ 387 99.7%
as % of total net revenues 0.6% 0.6% 0.6% 0.4%
The increase in interest and other income for the three- and six-month
periods was due to the investment of $144.2 million of net proceeds from the
May 2003 Convertible Subordinated Notes offering into short-term, highly
liquid investments with the impact of an $82.3 million increase in
short-term investments during fiscal 2003.
PROVISION FOR INCOME TAXES
- --------------------------
($ IN THOUSANDS):
- --------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------ -----------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------------ ------------ ------------- ------------ ------------- ------------
Provision (benefit) for income
taxes $ 6,737 $ (815) NM % $ 11,456 $ 3,083 271.6%
Effective tax rate 35.5% (36.7)% 35.5% 36.7%
The decline in the effective tax rate for both the quarter and six-month
period was primarily due to the increased use of research and development
tax credits as a means of lowering our tax rate.
16
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Cash and cash equivalents and working capital were $235.6 million and $299.8
million, respectively, at September 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 $16.8 million for the six months ended September
30, 2003 compared to $23.7 million for the corresponding prior year period.
The $6.8 million decrease in net cash flow from operating activities
resulted primarily from the delayed collection of a year-end receivable in
the first quarter of the prior year and an increase in inventories due to
increased production of branded and specialty generic products in
anticipation of continued sales growth and new product launches, build-up of
the cough/cold product line to support seasonal demand, significant
purchases of controlled substance raw materials, in addition to the impact
associated with production of the new Niferex(R), Chromagen(R) and
StrongStart(R) brands that were acquired at the end of fiscal 2003.
Net cash flow used in investing activities was $22.4 million for the six
months ended September 30, 2003 compared to $12.7 million for the
corresponding prior year period. Capital expenditures of $8.1 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 and 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 period 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 $226.2 million at September 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 $23.01 per share. 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 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 $194.2
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.
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.
As of September 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. We are in the process of reviewing the
supplemental credit line. At September 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.
17
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, 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.
18
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.
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 September 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
19
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.
20
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 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 was
reflected in accrued liabilities on our consolidated balance sheet as of
September 30, 2003. As discussed above, Healthpoint also requested
reimbursement for approximately $1.8 million in attorneys' fees in addition
to the judgment. In September 2003, the court entered an order specifying
the amount of attorneys' fees to be awarded. As a result of this decision,
we recorded, during the quarter ended September 30, 2003, an additional
provision of $1.8 million, which was reflected in accrued liabilities on our
consolidated balance sheet as of September 30, 2003.
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 a product
liability lawsuit in federal court in Mississippi involving PPA. The
Mississippi case is Virginia Madison, et al. v. Bayer Corporation, et al.
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
Mississippi case has been transferred to a Judicial Panel on Multi-District
Litigation for PPA claims sitting in the Western District of Washington. It
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. Discovery has only recently begun and we
believe that we have substantial defenses to these claims, though the
ultimate outcome of this case and the potential effect cannot be determined.
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 we formerly distributed. We
intend to vigorously defend any claims that may be raised in the current and
future litigation.
21
On September 25, 2003, the Commonwealth of Massachusetts filed Commonwealth
of Massachusetts v. Mylan Laboratories, Inc. et al, No. 1:03-cv-11865-PBS
(D. Mass.), against ETHEX Corp. and twelve other manufacturers of generic
pharmaceutical products, including Mylan Laboratories, Inc., Barr
Laboratories, Inc., Duramed Pharmaceuticals, Inc., IVAX Corporation, Warrick
Pharmaceuticals Corporation, Watson Pharmaceuticals, Inc., Schein
Pharmaceuticals, Inc., TEVA Pharmaceuticals USA, Inc., Par Pharmaceuticals,
Inc., Dey Inc., Purepac Pharmaceutical Co., and Roxanne Laboratories, Inc.
The complaint alleges, among other things, that the defendants reported
inflated pricing information for their drugs to data reporting services, and
that Massachusetts relied on this pricing data in setting reimbursement
rates under the Medicaid program. The complaint also alleges that
Massachusetts received rebates from the defendants under the Medicaid Drug
Rebate Program that were materially less than that to which Massachusetts
was entitled. Massachusetts seeks to recover from the defendants the amount
that it believes it overpaid and the amount it is owed in rebates, based on
claims under Massachusetts and federal law. The case is in its early stages,
and fact discovery has not yet begun. ETHEX is vigorously defending the
litigation.
We are involved in various other legal proceedings in the ordinary course of
our business. These legal proceedings include various patent infringement
actions brought by potential competitors with respect to products we propose
to market and for which we have filed Abbreviated New Drug Applications and
provided notice of certification required under the provisions of the Hatch
Waxman Act. While it is not feasible to predict the ultimate outcome of
such other proceedings, we believe that the ultimate outcome of such other
proceedings will not have a material adverse effect on our results of
operations or financial position.
22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our 2003 annual meeting of shareholders was held on August 28, 2003. Of
32,362,563 shares of Class A and Class B Common Stock issued, outstanding
and eligible to be voted at the meeting, holders of 29,705,996 shares,
constituting a quorum, were represented in person or by proxy at the
meeting. One matter was submitted to a vote of the security holders at the
meeting, the election of two Class B director nominees to our board of
directors, each to continue in office until the year 2006. Upon tabulation
of the votes cast, it was determined that both nominees had been elected.
The voting results are set forth below:
CLASS B DIRECTOR NOMINEES
ABSTENTIONS AND
NAME FOR AGAINST BROKER NON-VOTES
---- --- ------- ----------------
Victor M. Hermelin 9,648,796 10,804 1,425,871
Alan G. Johnson 9,648,796 10,804 1,425,871
Because we have a staggered board, the terms of office of the following
named Class A and Class C directors continued after the meeting:
CLASS A (TO CONTINUE IN OFFICE UNTIL 2005)
------------------------------------------
Marc S. Hermelin
Kevin S. Carlie
CLASS C (TO CONTINUE IN OFFICE UNTIL 2004)
------------------------------------------
Jean M. Bellin
Norman D. Schellenger
John P. Isakson
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits. See Exhibit Index.
b) None.
23
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: November 14, 2003 By /s/ Marc S. Hermelin
--------------------------------
Marc S. Hermelin
Vice Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: November 14, 2003 By /s/ Gerald R. Mitchell
--------------------------------
Gerald R. Mitchell
Vice President, Treasurer and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
24
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.
25
Exhibit 31.1
CERTIFICATIONS
I, Gerald R. Mitchell, certify that:
1. I have reviewed this quarterly report on Form 10-Q of KV
Pharmaceutical Company;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer(s) and I are
responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for
the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case of
an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have
disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 14, 2003 /s/ Gerald R. Mitchell
-----------------------------------------------------
Gerald R. Mitchell
Vice President, Treasurer and Chief Financial Officer
Exhibit 31.2
CERTIFICATIONS
I, Marc S. Hermelin, certify that:
1. I have reviewed this quarterly report on Form 10-Q of KV
Pharmaceutical Company;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer(s) and I are
responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for
the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case of
an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have
disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 14, 2003 /s/ Marc S. Hermelin
--------------------------------------------------
Marc S. Hermelin
Vice Chairman and Chief Executive Officer
Exhibit 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a)
and (b) of Section 1350, Chapter 63 of Title 18, United States Code), each
of the undersigned officers of KV Pharmaceutical Company, a Delaware
corporation (the "Company"), does hereby certify that, to the best of their
knowledge:
The Quarterly Report on Form 10-Q for the three and six months ended
September 30, 2003 (the "Form 10-Q") of the Company fully complies with the
requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934 and information contained in the Form 10-Q fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Date: November 14, 2003 /s/ Marc S. Hermelin
-----------------------------------------------------
Marc S. Hermelin
Vice Chairman and Chief Executive Officer
Date: November 14, 2003 /s/ Gerald R. Mitchell
-----------------------------------------------------
Gerald R. Mitchell
Vice President, Treasurer and Chief Financial Officer
A signed original of this written statement required by Section 906 has been
provided to KV Pharmaceutical Company and will be retained by KV
Pharmaceutical Company and furnished to the Securities and Exchange
Commission or its staff upon request.