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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 DECEMBER 31, 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
--- ---
TITLE OF CLASS OF NUMBER OF SHARES
COMMON STOCK OUTSTANDING AS OF FEBRUARY 6, 2004
------------ ----------------------------------
CLASS A COMMON STOCK, PAR VALUE $.01 PER SHARE 32,948,944
CLASS B COMMON STOCK, PAR VALUE $.01 PER SHARE 15,956,597
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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------------- ---------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Net revenues..................................... $ 69,598 $ 61,929 $ 199,996 $ 171,638
Cost of sales.................................... 22,761 23,728 67,891 66,287
--------- --------- --------- ---------
Gross profit..................................... 46,837 38,201 132,105 105,351
--------- --------- --------- ---------
Operating expenses:
Research and development..................... 5,239 5,689 14,808 14,244
Selling and administrative................... 21,536 16,569 62,429 49,390
Amortization of intangible assets............ 1,112 583 3,336 1,746
Litigation................................... -- -- (1,700) 16,500
--------- --------- --------- ---------
Total operating expenses......................... 27,887 22,841 78,873 81,880
--------- --------- --------- ---------
Operating income................................. 18,950 15,360 53,232 23,471
--------- --------- --------- ---------
Other expense (income):
Interest expense............................. 1,826 113 4,611 209
Interest and other income.................... (750) (308) (1,523) (694)
--------- --------- --------- ---------
Total other expense (income), net................ 1,076 (195) 3,088 (485)
--------- --------- --------- ---------
Income before income taxes....................... 17,874 15,555 50,144 23,956
Provision for income taxes....................... 6,345 5,409 17,801 8,492
--------- --------- --------- ---------
Net income....................................... $ 11,529 $ 10,146 $ 32,343 $ 15,464
========= ========= ========= =========
Net income per common share-basic................ $0.24 $0.20 $0.65 $0.31
===== ===== ===== =====
Net income per common share-diluted.............. $0.23 $0.19 $0.63 $0.30
===== ===== ===== =====
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
DECEMBER 31, MARCH 31,
2003 2003
---- ----
(Unaudited)
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents............................................................ $ 223,171 $ 96,288
Receivables, less allowance for doubtful accounts of $408 and $422
at December 31, 2003 and March 31, 2003, respectively............................. 56,713 57,385
Inventories, net..................................................................... 54,281 42,343
Prepaid and other assets............................................................. 8,314 2,709
Deferred tax asset................................................................... 10,150 14,791
----------- -----------
Total Current Assets.............................................................. 352,629 213,516
Property and equipment, less accumulated depreciation................................ 69,615 51,903
Intangible assets and goodwill, net.................................................. 80,960 82,577
Other assets......................................................................... 10,794 4,672
----------- -----------
TOTAL ASSETS......................................................................... $ 513,998 $ 352,668
=========== ===========
LIABILITIES
-----------
CURRENT LIABILITIES:
Accounts payable..................................................................... $ 10,006 $ 15,588
Accrued liabilities.................................................................. 27,191 52,548
Current maturities of long-term debt................................................. 8,121 7,484
----------- -----------
Total Current Liabilities......................................................... 45,318 75,620
Long-term debt....................................................................... 217,635 10,106
Other long-term liabilities.......................................................... 3,138 2,913
Deferred tax liability............................................................... 4,076 3,413
----------- -----------
TOTAL LIABILITIES.................................................................... 270,167 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 December 31, 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 35,966,589 and 35,476,935 at December 31, 2003
and March 31, 2003, respectively.............................................. 360 236
Class B - issued 16,104,301 and 15,865,678 at December 31, 2003 and March 31,
2003, respectively (convertible into Class A shares on a one-for-one basis)... 161 106
Additional paid-in capital........................................................... 123,186 120,961
Retained earnings.................................................................... 171,093 139,341
Less: Treasury stock, 3,028,286 shares of Class A and 80,142 shares of Class B
Common Stock at December 31, 2003, respectively, and 48 shares of Class A and
80,142 shares of Class B Common Stock at March 31, 2003, respectively, at cost.... (50,969) (28)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY........................................................... 243,831 260,616
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................................... $ 513,998 $ 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)
NINE MONTHS ENDED
DECEMBER 31,
----------------------------
2003 2002
---------- ----------
OPERATING ACTIVITIES:
Net income............................................................. $ 32,343 $ 15,464
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, amortization and other non-cash charges............... 9,327 5,402
Deferred income tax provision (benefit)............................. 5,304 (7,685)
Deferred compensation............................................... 225 200
Litigation.......................................................... 1,825 16,500
Changes in operating assets and liabilities:
Decrease in receivables, net........................................ 672 6,770
Increase in inventories, net........................................ (13,561) (8,191)
(Increase) decrease in prepaid and other assets..................... (7,809) 1,122
Decrease in accounts payable and accrued liabilities................ (16,841) (1,078)
---------- ----------
Net cash provided by operating activities.............................. 11,485 28,504
---------- ----------
INVESTING ACTIVITIES:
Purchase of property and equipment, net............................. (13,709) (12,549)
Purchase of stock and intangible assets............................. - (3,000)
Product acquisition................................................. (14,300) -
---------- ----------
Net cash used in investing activities.................................. (28,009) (15,549)
---------- ----------
FINANCING ACTIVITIES:
Principal payments on long-term debt................................ (1,140) (646)
Dividends paid on preferred stock................................... (418) (53)
Proceeds from issuance of convertible notes......................... 194,180 -
Purchase of common stock for treasury............................... (50,941) -
Proceeds from issuance of common stock.............................. - 72,385
Sale of common stock to employee profit sharing plan................ - 905
Exercise of common stock options.................................... 1,726 452
---------- ----------
Net cash provided by financing activities.............................. 143,407 73,043
---------- ----------
Increase in cash and cash equivalents.................................. 126,883 85,998
Cash and cash equivalents:
Beginning of year................................................... 96,288 12,109
---------- ----------
End of period....................................................... $ 223,171 $ 98,107
========== ==========
SUPPLEMENTAL INFORMATION:
Interest paid....................................................... $ 3,041 $ 316
Income taxes paid................................................... 19,161 15,844
NON-CASH FINANCING ACTIVITY:
Term loan to finance building purchase............................. $ 8,800 $ -
Term loan refinanced............................................... - 1,738
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
nine-month periods ended December 31, 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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------ -------------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income, as reported........................ $ 11,529 $ 10,146 $ 32,343 $ 15,464
Stock based employee
compensation expense,
net of tax................................... (172) (204) (512) (568)
--------- --------- --------- ---------
Pro forma net income........................... $ 11,357 $ 9,942 $ 31,831 $ 14,896
========= ========= ========= =========
Earnings per share:
Basic - as reported.......................... $ 0.24 $ 0.20 $ 0.65 $ 0.31
Basic - pro forma............................ 0.23 0.19 0.64 0.30
Diluted - as reported........................ 0.23 0.19 0.63 0.30
Diluted - pro forma.......................... 0.22 0.19 0.62 0.29
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 nine months ended December 31, 2003 and 2002,
respectively: no dividend yield; expected volatility of 42% and 45%;
risk-free interest rate of 3.25% 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 PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------- -----------------------
2003 2002 2003 2002
---- ---- ---- ----
Numerator:
Net income(1)(2)................................ $11,529 $10,146 $32,343 $15,464
Preferred stock dividends....................... (17) (18) (418) (53)
------- ------- ------- -------
Numerator for basic earnings per
share - income available to common
shareholders.................................. 11,512 10,128 31,925 15,411
Effect of dilutive securities:
Preferred stock dividends..................... 17 18 418 53
------- ------- ------- -------
Numerator for diluted earnings per
share - income available to common
shareholders after assumed conversions........ $11,529 $10,146 $32,343 $15,464
======= ======= ======= =======
Denominator:
Denominator for basic earnings per
share - weighted-average shares............... 48,769 51,132 49,020 49,349
------- ------- ------- -------
Effect of dilutive securities:
Employee stock options........................ 1,870 1,368 1,783 1,480
Convertible preferred stock................... 338 338 338 338
------- ------- ------- -------
Dilutive potential common shares................ 2,208 1,706 2,121 1,818
------- ------- ------- -------
Denominator for diluted earnings per
share - adjusted weighted-average shares and
assumed conversions........................... 50,977 52,838 51,141 51,167
======= ======= ======= =======
Basic earnings per share(3) .................... $ 0.24 $ 0.20 $ 0.65 $ 0.31
======= ======= ======= =======
Diluted earnings per share(3)(4) ............... $ 0.23 $ 0.19 $ 0.63 $ 0.30
======= ======= ======= =======
(1) Net income for the nine months ended December 31, 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 $1,097, or $0.02 per diluted share.
(2) Net income for the nine months ended December 31, 2002 included a
provision of $16,500 for potential damages associated with a
lawsuit (see Note 10). 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.
(3) 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
share of Class B common stock is convertible into one share of
Class A common stock.
(4) 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 three-month period ended December 31, 2002,
excluded from the computation were options to purchase 435 Class A
and Class B common shares, and for the nine-month periods, excluded
from the computation were options to purchase 140 and 435 Class A
and Class B common shares at December 31, 2003 and 2002,
respectively.
6
4. REVENUE RECOGNITION
The Company recognizes revenue from product sales when the merchandise is
shipped to an unrelated third party pursuant to Staff Accounting Bulletin
No. 101, Revenue Recognition in Financial Statements. Accordingly, the
Company recognizes revenue 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 $24,720 and $24,075 for the three months ended December
31, 2003 and 2002, respectively, and $68,736 and $68,342 for the nine months
ended December 31, 2003 and 2002, respectively. The reserve balances related
to the sales provisions totaled $25,976 and $29,658 at December 31, 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:
DECEMBER 31, 2003 MARCH 31, 2003
----------------- --------------
Finished goods..................... $ 32,491 $ 26,524
Work-in-process.................... 6,282 4,290
Raw materials...................... 16,717 12,532
----------- ----------
55,490 43,346
Reserves for obsolescence.......... (1,209) (1,003)
----------- ----------
$ 54,281 $ 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
DECEMBER 31, 2003 MARCH 31, 2003
--------------------------- ---------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
------ ------------ ------ ------------
Product rights - Micro-K(R)................ $ 36,140 $ (8,648) $ 36,140 $ (7,294)
Product rights - PreCare(R)................ 8,433 (1,862) 8,433 (1,546)
Trademarks acquired........................ 42,476 (1,593) 42,476 -
License agreements......................... 2,525 - 1,000 -
Trademarks and patents..................... 3,307 (375) 3,114 (303)
-------- -------- -------- --------
Total intangible assets.................. 92,881 (12,478) 91,163 (9,143)
Goodwill................................... 557 - 557 -
-------- -------- -------- --------
$ 93,438 $(12,478) $ 91,720 $ (9,143)
======== ======== ======== ========
As of December 31, 2003, amortization expense for intangible assets is
estimated to be $1,113 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 nine months ended December 31, 2003 and 2002.
THREE MONTHS
ENDED BRANDED SPECIALTY SPECIALTY ALL
DECEMBER 31, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED
------------ -------- -------- --------- ----- ------------ ------------
Net revenues 2003 $20,928 $44,071 $3,905 $ 694 $ - $ 69,598
2002 12,079 44,537 3,865 1,448 - 61,929
Segment profit (loss) 2003 8,009 24,518 654 (15,307) - 17,874
2002 3,315 24,072 (5) (11,827) - 15,555
Identifiable assets 2003 16,348 70,247 8,871 419,690 (1,158) 513,998
2002 7,962 60,565 9,199 223,132 (1,158) 299,700
Property and 2003 - - - 5,629 - 5,629
equipment additions 2002 4 - 14 2,821 - 2,839
Depreciation and 2003 78 13 34 3,120 - 3,245
amortization 2002 72 11 39 1,773 - 1,895
8
NINE MONTHS
ENDED BRANDED SPECIALTY SPECIALTY ALL
DECEMBER 31, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED
------------ -------- -------- --------- ----- ------------ ------------
Net revenues 2003 $52,588 $132,311 $12,085 $ 3,012 $ - $ 199,996
2002 30,499 125,982 12,781 2,376 - 171,638
Segment profit (loss) 2003 17,244 74,839 1,527 (43,466) - 50,144
2002 4,401 67,477 1,448 (49,370) - 23,956
Property and 2003 123 - 35 13,551 - 13,709
equipment additions 2002 625 20 71 11,833 - 12,549
Depreciation and 2003 240 41 102 8,944 - 9,327
amortization 2002 183 36 123 5,060 - 5,402
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. REVOLVING CREDIT AGREEMENT
During December 2003, the Company increased its credit agreement with a bank
to $65,000. The revised agreement provides for an extension of the Company's
$40,000 revolving line of credit along with an increase from $20,000 to
$25,000 in the supplemental credit line that is available for financing
acquisitions. These credit facilities expire in October 2006 and December
2004, respectively. The revolving credit lines are unsecured and interest is
charged at the lower of the prime rate or the one-month LIBOR rate plus 150
basis points. At December 31, 2003, the Company had no cash borrowings
outstanding under either credit facility.
10. 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
9
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 December 31, 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
December 31, 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 a defendant in a product liability
lawsuit in federal court in Mississippi involving PPA. The suit originated
out of a case, Virginia Madison, et al. v. Bayer Corporation, et al. The
original 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 then co-defendant Bayer Corporation.
The case has been transferred to a Judicial Panel on Multi-District
Litigation for PPA claims sitting in the Western District of Washington. The
claims against the Company have now been segregated into a lawsuit brought
by Johnny Fulcher individually and on behalf of the wrongful death
beneficiaries of Linda Fulcher, deceased, against KV. 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 may have 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 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.
The Company is involved in various other legal proceedings in the ordinary
course of its business. These legal proceedings include various patent
infringement actions brought by potential competitors with respect to
products the Company proposes to market and for which it has 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, the
Company believes that the ultimate outcome of such other proceedings will
not have a material adverse effect on its results of operations or financial
position.
10
11. 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 December 31, 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 March 15, 2004. 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.
12. SUBSEQUENT EVENT
On April 18, 2002, the Company entered into an agreement with FemmePharma,
Inc. ("FemmePharma") whereby the Company was granted an exclusive license to
manufacture and sell in North America and certain foreign markets
intravaginal products and certain vaginal anti-infective products under
development (the "License Agreement"). The initial product covered by the
License Agreement is intended for use in the treatment of endometriosis
under FemmePharma's patented Pardel(TM) technology. In April 2002, the
Company made an initial $1,000 payment for use of the Pardel(TM) trademark
and, under a separate agreement, invested $2,000 in FemmePharma's
convertible preferred stock.
In January 2004, following successful completion of Phase II studies and
commencement of Phase III studies on the endometriosis product, the Company
made an additional $1,000 payment for the Pardel(TM) trademark and purchased
an additional $3,000 of FemmePharma's convertible preferred stock.
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 Results of
Operations and Financial Condition," and elsewhere in this Form 10-Q, could
cause actual results or outcomes to differ materially from those expressed
in any forward-looking statements made by 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
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 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 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 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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
----------------------------------- ------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
-------- -------- ------- --------- --------- ------
Branded products $ 20,928 $ 12,079 73.3% $ 52,588 $ 30,499 72.4%
as % of total net revenues 30.1% 19.5% 26.3% 17.8%
Specialty generics 44,071 44,537 (1.0)% 132,311 125,982 5.0%
as % of total net revenues 63.3% 71.9% 66.2% 73.4%
Specialty materials 3,905 3,865 1.0% 12,085 12,781 (5.4)%
as % of total net revenues 5.6% 6.2% 6.0% 7.4%
Other 694 1,448 (52.1)% 3,012 2,376 26.8%
Total net revenues $ 69,598 $ 61,929 12.4% $ 199,996 $ 171,638 16.5%
The increases in branded product sales of $8.8 million and $22.1 million for
the three- and nine-month periods, respectively, were due primarily to
continued growth of our women's healthcare family of products and the sales
13
impact of products acquired by us on March 31, 2003. Sales from the women's
healthcare product group increased $4.3 million, or 49.9%, in the third
quarter and $10.8 million, or 47.6%, for the nine-month period compared to
the corresponding prior year periods. Included in the women's healthcare
family of products is the PreCare(R) product line which contributed $2.4
million and $8.4 million of incremental sales in the three- and nine-month
periods, respectively. These increases were attributable to increased sales
volume associated with higher market shares for both 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 nine-month periods as our share of the prescription vaginal
antifungal cream market increased to 25.8% at the end of the third quarter,
from 16.2% at the end of the third quarter of the prior year. Sales of
Gynazole-1(R) increased $1.9 million, or 56.6%, in the three-month period
and $2.4 million, or 25.3%, for the nine-month period. Increased sales from
our women's healthcare family of products were supplemented by $5.4 million
and $13.0 million of sales in the three- and nine-month periods,
respectively, from our two hematinic product lines, Chromagen(R) and
Niferex(R), and the StrongStart(R) prenatal vitamin product line that we
acquired at the end of fiscal 2003. Near the end of the second quarter, we
began introducing technology-improved versions of these products. These
increases were partially offset by a $0.9 million and $1.7 million decline
in sales from the Micro-K(R) product line for the three- and nine-month
periods, respectively.
The minimal decline in specialty generic sales for the quarter resulted from
lower sales of existing products in the cough/cold, prenatal vitamin and
other product lines. This decline was largely offset by $2.3 million of
incremental sales volume attributable primarily to new cough/cold product
introductions and $5.3 million of increased sales from our cardiovascular
and pain management product lines. The growth in specialty generic sales of
$6.3 million for the nine-month period resulted from $5.6 million of
incremental sales volume from new product introductions, primarily in the
cough/cold, cardiovascular and prenatal vitamin product lines, and $2.9
million in increased sales due to price increases on certain products,
principally in the cardiovascular category. These increases were partially
offset by a decline in sales volume from existing products of $2.2 million.
The decrease in specialty material product sales for the nine-month period
was primarily due to a slowdown in a major customer's business in the
vitamin supplement market.
The decrease in other revenue for the three-month period resulted from a
smaller contract manufacturing customer base due to continued de-emphasis of
this lower margin operation in our business strategy. The increase in other
revenue for the nine-month period was primarily due to the impact of a
profit-sharing arrangement entered into in the second quarter of fiscal 2003
whereby three pain management products manufactured by us are marketed in
Canada by another pharmaceutical company.
GROSS PROFIT BY SEGMENT
- -----------------------
($ IN THOUSANDS):
- -----------------------
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
----------------------------------- ------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
--------- -------- ------ --------- --------- ------
Branded products $ 18,316 $ 10,650 72.0% $ 45,719 $ 26,888 70.0%
as % of net revenues 87.5% 88.2% 86.9% 88.2%
Specialty generics 26,829 26,247 2.2% 81,580 73,819 10.5%
as % of net revenues 60.9% 58.9% 61.7% 58.6%
Specialty materials 1,459 1,208 20.8% 4,047 4,544 (10.9)%
as % of net revenues 37.4% 31.3% 33.5% 35.6%
Other 233 96 NM 759 100 NM
Total gross profit $ 46,837 $ 38,201 22.6% $ 132,105 $ 105,351 25.4%
as % of total net revenues 67.3% 61.7% 66.1% 61.4%
The increases in consolidated gross profit of $8.6 million and $26.8 million
for the three- and nine-month periods, respectively, were primarily
attributable to the sales growth experienced by the branded products
segment. The higher gross profit percentages on a consolidated basis for both
the quarter and nine-month period reflected favorable shifts in the mix of
product sales toward higher margin branded products, which comprised a
larger
14
percentage of net revenues, and the impact during the nine-month period of
pricing increases on certain specialty generic products. The gross profit
percentage decreases experienced by the branded products segment were due to
the acquired hematinic products, which have a slightly lower gross margin
than the other products in the branded line. The increased gross profit
percentages for the specialty generics segment resulted from lower costs
associated with a profit-sharing arrangement on certain pain management
products combined with the impact of pricing increases during the nine-month
period on certain specialty generic products.
RESEARCH AND DEVELOPMENT
- ------------------------
($ IN THOUSANDS):
- ------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------------------- ------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------ ------ ------ ------- ------- ------
Research and development $5,239 $5,689 (7.9)% $14,808 $14,244 4.0%
as % of total net revenues 7.5% 9.2% 7.4% 8.3%
The $0.5 million decrease in research and development expense for the
quarter was primarily due to the timing of certain clinical studies. The
$0.6 million increase in research and development expense for the nine-month
period resulted from increased costs associated with the continued expansion
of clinical testing for our internal product development efforts and
increased personnel expenses related to the growth of our research and
development staff. The increase in research and development expense for the
nine-month period was below management's expectation of larger spending
due to rescheduling of the timing of certain clinical studies.
SELLING AND ADMINISTRATIVE
- --------------------------
($ IN THOUSANDS):
- --------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------------------ ------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------- ------- ------ ------- ------- ------
Selling and administrative $21,536 $16,569 30.0% $62,429 $49,390 26.4%
as % of total net revenues 30.9% 26.8% 31.2% 28.8%
The increases in selling and administrative expense of $5.0 million and
$13.0 million for the three- and nine-month periods, respectively, were due
to greater personnel expenses resulting from an increase in corporate
management personnel and expansion of the branded sales force, an increase
in rent, depreciation and utilities associated with recently added
facilities, and an increase in branded marketing expense associated with our
hematinic product lines acquired at the end of fiscal 2003. We also
experienced greater legal expense due to an increase in litigation activity
coupled with the fact that selling and administrative expense in the prior
year's first and second quarters included insurance reimbursements for
defense costs in the Healthpoint litigation (see Note 10 in the accompanying
Notes to Consolidated Financial Statements). These increases were partially
offset by a reduction in life insurance expense.
15
AMORTIZATION OF INTANGIBLE ASSETS
- ---------------------------------
($ IN THOUSANDS):
- ---------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
----------------------------------- ------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------ ------- ------ ------- ------- ------
Amortization of intangible assets $1,112 $ 583 90.7% $ 3,336 $ 1,746 91.1%
as % of total net revenues 1.6% 0.9% 1.7% 1.0%
The increases in amortization of intangible assets of $0.5 million and $1.6
million for the three- and nine-month periods, respectively, were due
primarily to the amortization of trademarks acquired in the two product
acquisitions completed on March 31, 2003.
LITIGATION
- ----------
($ IN THOUSANDS):
- ----------------------
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
----------------------------------- ------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------ ------ ------ ------- ------- ------
Litigation $ - $ - -% $(1,700) $16,500 110.3%
as % of total net revenues -% -% (0.9)% 9.6%
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 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 of $1.8 million
related to this matter for attorney's fees awarded to the plaintiffs by the
court during that quarter (see Note 10 in the accompanying Notes to
Consolidated Financial Statements). The impact of this reserve was more than
offset by a $3.5 million net payment, received by us during the second
quarter of fiscal 2004 from a settlement with a branded company of our claim
that the branded company interfered with our right to a timely introduction
of a generic product in a previous fiscal year.
INTEREST EXPENSE
- ----------------
($ IN THOUSANDS):
- ----------------------
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
----------------------------------- ------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------ ------ ------ ------- ------- ------
Interest expense $1,826 $ 113 NM $ 4,611 $ 209 NM
as % of total net revenues 2.6% 0.2% 2.3% 0.1%
The increases in interest expense for both the three- and nine-month periods
resulted primarily from the issuance of $200.0 million of Convertible
Subordinated Notes on May 16, 2003 and the interest expense accrued thereon.
16
INTEREST AND OTHER INCOME
- -------------------------
($ IN THOUSANDS):
- -------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------------------- ------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------ ------ ------ ------- ------- ------
Interest and other income $ 750 $ 308 143.5% $ 1,523 $ 694 119.5%
as % of total net revenues 1.1% 0.5% 0.8% 0.4%
The increases in interest and other income for the three- and nine-month
periods were due to the investment of $144.2 million of net proceeds from
the May 2003 Convertible Subordinated Notes offering in short-term, highly
liquid investments combined with the impact of an $82.3 million increase in
short-term investments during fiscal 2003 from the proceeds of a secondary
offering during that year.
PROVISION FOR INCOME TAXES
- --------------------------
($ IN THOUSANDS):
- --------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
----------------------------------- ------------------------------------
% %
2003 2002 CHANGE 2003 2002 CHANGE
------ ------ ------ ------- ------- ------
Provision for income taxes $6,345 $5,409 17.3% $17,801 $ 8,492 109.6%
Effective tax rate 35.5% 34.8% 35.5% 35.5%
The lower effective tax rate in the prior comparative quarter was primarily
due to the use of tax credits which lowered our tax rate.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Cash and cash equivalents and working capital were $223.2 million and $307.3
million, respectively, at December 31, 2003, compared to $96.3 million and
$137.9 million, respectively, at March 31, 2003. Internally generated funds
from product sales continued to be a significant source of operating capital
used in the funding of our businesses. The net cash flow from operating
activities was $11.5 million for the nine months ended December 31, 2003
compared to $28.5 million for the corresponding prior year period. The $17.0
million decrease in net cash flow from operating activities resulted
primarily from the delayed collection of a fiscal 2002 year-end receivable
to the first quarter of fiscal 2003, an increase in production of branded
and specialty generic products in anticipation of continued sales growth and
increased production associated with the new Niferex(R), Chromagen(R) and
StrongStart(R) brands that were acquired at the end of fiscal 2003, an
increase in prepaid and other assets, and a decrease in current liabilities
due primarily to the timing of payments made on accounts payable and accrued
income taxes.
Net cash flow used in investing activities was $28.0 million for the nine
months ended December 31, 2003 compared to $15.5 million for the
corresponding prior year period. Capital expenditures of $13.7 million were
principally 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 acquired the product rights
and trademarks to the Niferex(R) line of hematinic products for a cash
payment made in April 2003 for $14.3 million. 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 FemmePharma, Inc., a women's healthcare company. In January
2004, we made an additional $4.0 million payment to FemmePharma, Inc. to
complete the purchase of certain trademark rights for a product under
development and to increase our equity investment in the company.
Debt increased to $225.8 million at December 31, 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,
17
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.
We currently have a $40.0 million unsecured revolving line of credit with a
bank that expires in October 2006. In December 2003, we increased our
unsecured supplemental credit line with the same bank from $20.0 million to
$25.0 million. The unsecured supplemental credit line of $25.0 million,
which is available for financing acquisitions, expires in December 2004.
As a result of the significant increase in debt related to the $200.0
million Convertible Subordinated Notes issuance, the revolving line of
credit agreement 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.
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
18
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.
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.
19
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 December 31, 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
not subject to market 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 effectiveness of the design and operation of 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
have, or could be reasonably likely to, materially affect internal control
over financial reporting during the three months ended December 31, 2003.
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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
December 31, 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 December 31, 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 a defendant in a product liability
lawsuit in federal court in Mississippi involving PPA. The suit originated
out of a case, Virginia Madison, et al. v. Bayer Corporation, et al. The
original 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 then co-defendant Bayer Corporation.
The case has been transferred to a Judicial Panel on Multi-District
Litigation for PPA claims sitting in the Western District of Washington. The
claims against us have now been segregated into a lawsuit brought by Johnny
Fulcher individually and on behalf of the wrongful death beneficiaries of
Linda Fulcher, deceased, against KV. 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
only recently has begun and we believe that we may 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 served 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.
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 12 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
21
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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. See Exhibit Index.
(b) None.
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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: February 13, 2004 By /s/ Marc S. Hermelin
----------------- ----------------------------------
Marc S. Hermelin
Vice Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: February 13, 2004 By /s/ Gerald R. Mitchell
----------------- ----------------------------------
Gerald R. Mitchell
Vice President, Treasurer and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
23
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