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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2005
Commission file number 1-9601
K-V PHARMACEUTICAL COMPANY
(Exact name of registrant as specified in its charter)
2503 South Hanley Road
St. Louis, Missouri 63144
(314) 645-6600
DELAWARE 43-0618919
(State of Incorporation) (IRS Employer Identification No.)
Securities Registered Pursuant to Section 12(b) of the Act:
Class A Common Stock, par value $.01 per share New York Stock Exchange
Class B Common Stock, par value $.01 per share New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act:
7% Cumulative Convertible Preferred, par value $.01 per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes X No
--- ---
The aggregate market value of the shares of Class A and Class B Common Stock
held by nonaffiliates of the registrant as of September 30, 2004, the last
business day of the registrant's most recently completed second fiscal
quarter, was $502,350,165 and $144,631,685, respectively. As of June 9,
2005, the registrant had outstanding 35,962,654 and 13,322,699 shares of
Class A and Class B Common Stock, respectively, exclusive of treasury
shares.
DOCUMENTS INCORPORATED BY REFERENCE
Part III: Portions of the definitive proxy statement of the registrant (to
be filed pursuant to Regulation 14A for registrant's 2005 Annual Meeting of
Shareholders, which involves the election of directors), are incorporated by
reference into Items 10, 11, 12, 13 and 14 to the extent stated in such items.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Form 10-K, including the documents that we incorporate herein by
reference, contains various forward-looking statements within the meaning of
the United States Private Securities Litigation Reform Act of 1995
("PSLRA"), which may be based on or include assumptions, concerning our
operations, future results and prospects. Such statements may be identified
by the use of words like "plans," "expect," "aim," "believe," "projects,"
"anticipate," "commit," "intend," "estimate," "will," "should," "could," and
other expressions that indicate future events and trends.
All statements that address expectations or projections about the future,
including without limitation, statements about our strategy for growth,
product development, regulatory approvals, market position, expenditures and
financial results, are forward-looking statements.
All forward-looking statements are based on current expectations and are
subject to risk and uncertainties. In connection with the "safe harbor"
provisions, we provide the following cautionary statements identifying
important economic, political and technology factors which, among others,
could cause the actual results or events to differ materially from those set
forth or implied by the forward-looking statements and related assumptions.
Such factors include (but are not limited to) the following: (1) changes in
the current and future business environment, including interest rates and
capital and consumer spending; (2) the difficulty of predicting FDA
approvals, including the timing, and that any period of exclusivity may not
be realized; (3) acceptance and demand for new pharmaceutical products; (4)
the impact of competitive products and pricing; (5) new product development
and launch, including but limited to the possibility that any product launch
may be delayed or that product acceptance may be less than anticipated; (6)
reliance on key strategic alliances; (7) the availability of raw materials;
(8) the regulatory environment; (9) fluctuations in operating results; (10)
the difficulty of predicting international regulatory approval, including
the timing; (11) the difficulty of predicting the pattern of inventory
movements by our customers; (12) the impact of competitive response to our
sales, marketing and strategic efforts; (13) risks that we may not
ultimately prevail in our litigation; and (14) the risks detailed from time
to time in our filings with the Securities and Exchange Commission.
This discussion is by no means exhaustive, but is designed to highlight
important factors that may impact the Company's outlook.
Because the factors referred to above, as well as the statements included
under the captions "Narrative Description of Business," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and elsewhere in this Form 10-K, 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 actual results to differ materially from
those contained in any forward-looking statements.
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ITEM 1. BUSINESS
--------
(a) GENERAL DEVELOPMENT OF BUSINESS
-------------------------------
Unless the context otherwise indicates, when we use the words "we,"
"our," "us," "our company" or "KV" we are referring to K-V
Pharmaceutical Company and its wholly-owned subsidiaries, including
Ther-Rx Corporation, ETHEX Corporation and Particle Dynamics, Inc.
We were incorporated under the laws of Delaware in 1971 as a
successor to a business originally founded in 1942. Victor M.
Hermelin, our Chairman and founder, invented and obtained initial
patents for early controlled release and enteric coating which
became part of our core business and a platform for future drug
delivery emphasis.
We develop advanced drug delivery technologies which enhance the
effectiveness of new therapeutic agents, existing pharmaceutical
products and prescription nutritional products. We have developed
and patented a wide variety of drug delivery and formulation
technologies which are primarily focused in four principal areas:
SITE RELEASE(R) bioadhesives; tastemasking; oral controlled
release; and oral quick dissolving tablets. We incorporate these
technologies in the products we market to control and improve the
absorption and utilization of active pharmaceutical compounds. In
1990, we established a generic marketing capability through a
wholly-owned subsidiary, ETHEX Corporation ("ETHEX"), which we
believe makes us one of the only drug delivery research and
development companies that also markets "technologically
distinguished" generic products. In 1999, we established a
wholly-owned subsidiary, Ther-Rx Corporation ("Ther-Rx"), to market
branded pharmaceuticals directly to physician specialists.
Our wholly-owned subsidiary, Particle Dynamics, Inc. ("PDI"), was
acquired in 1972. Through PDI, we develop and market specialty
value-added raw materials, including drugs, directly compressible
and microencapsulated products, and other products used in the
pharmaceutical, nutritional, food, personal care and other markets.
(b) SIGNIFICANT BUSINESS DEVELOPMENTS
---------------------------------
In September 2004, we made a settlement payment in the amount of
$16.5 million to resolve all previously pending claims between us
and Healthpoint, Ltd. without the admission of any liability. The
settlement was fully reserved by us in September 2002 and therefore
had no impact on our earnings in fiscal 2005.
In December 2004, we increased our available credit facilities to
$140.0 million. The revised credit facilities provide for an
increase from $40.0 million to $80.0 million in our revolving line
of credit along with an increase from $25.0 million to $60.0
million in the supplemental credit line that is available for
financing acquisitions. These credit facilities expire in October
2006 and December 2005, respectively.
In January 2005, Ther-Rx introduced its second New Drug
Application, or NDA, approved product, Clindesse(TM), the first
approved single-dose therapy for bacterial vaginosis. Similar to
Gynazole-1(R), our vaginal antifungal cream product, Clindesse(TM)
incorporates our proprietary VagiSite(R) bioadhesive drug delivery
technology.
During fiscal 2005, we entered into two separate licensing
agreements for the right to market both Gynazole-1(R) and
Clindesse(TM) in Spain, Portugal, Andorra, and Mexico. These
arrangements expanded Gynazole-1's future international presence
beyond the over 50 markets in Europe, Latin America, the Middle
East, Asia, Indonesia, the People's Republic of China, Australia
and New Zealand covered in other previously signed licensing
agreements. Also, during fiscal 2005, we received our second
regulatory approval to market Gynazole-1(R) into an international
market.
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In April 2005, the Company completed the purchase of a 260,000
square foot building in the St. Louis metropolitan area for $11.8
million. The property had been leased by the Company since April
2000 and will continue to function as the Company's main
distribution facility. The purchase price was paid with cash on
hand.
In May 2005, we entered into a long-term product development and
marketing license agreement with Strides Arcolab, Ltd, (Strides) an
Indian generic pharmaceutical developer and manufacturer, for
exclusive marketing rights in the United States and Canada for 10
new generic drugs. Under the agreement, Strides will be responsible
for developing, submitting for regulatory approval and
manufacturing the 10 products and we will be responsible for
exclusively marketing the products in the territories covered by
the agreement. Under a separate agreement, we invested $11.3
million in Strides' redeemable preferred stock.
In May 2005, the Company and FemmePharma, Inc. (FemmePharma)
mutually agreed to terminate the license agreement we entered into
with them in April 2002. As part of this transaction, we acquired
all of the common stock of FemmePharma for $25.0 million after
certain assets of the entity had been distributed to FemmePharma's
other shareholders. Included in our acquisition of FemmePharma are
the worldwide marketing rights to an endometriosis product that has
successfully completed Phase II clinical trials. This product was
originally part of the licensing arrangement with FemmePharma that
provided us, among other things, marketing rights for the product
principally in the United States. In accordance with the new
agreement, we are assuming responsibility for conducting the Phase
III clinical study, have acquired worldwide licensing rights of the
endometriosis product, are no longer responsible for milestone
payments and royalties specified in the original licensing
agreement, and have secured exclusive worldwide rights for use of
the FemmePharma technology for vaginal anti-infective products. We
believe the Phase III clinical study for the endometriosis product
will begin during fiscal 2006. In connection with this transaction,
we expect to incur a charge of approximately $30.0 million in the
first quarter of fiscal 2006, which includes the write-off of the
$25.0 million payment plus preferred stock investments previously
made, and which principally relates to in-process research and
development.
(c) INDUSTRY SEGMENTS
-----------------
We operate principally in three industry segments, consisting of
branded products marketing, specialty generics marketing and
specialty raw materials marketing. Revenues are derived primarily
from directly marketing our own technologically distinguished
generic/non-branded and brand-name products. Revenues may also be
received in the form of licensing revenues and/or royalty payments
based upon a percentage of the licensee's sales of the product, in
addition to manufacturing revenues, when marketing rights to
products using our advanced drug delivery technologies are
licensed. See Note 20 to our consolidated financial statements.
(d) NARRATIVE DESCRIPTION OF BUSINESS
---------------------------------
OVERVIEW
We are a fully integrated specialty pharmaceutical company that
develops, acquires, manufactures and markets technologically
distinguished branded and generic/non-branded 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 and our generic/non-branded pharmaceutical operations
through ETHEX. Through PDI, we also 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/non-branded 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 oral quick dissolving tablets. We
incorporate these technologies in the products we market to control
and improve the absorption and utilization of active pharmaceutical
compounds.
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These technologies provide a number of benefits, including reduced
frequency of administration, reduced side effects, improved drug
efficacy, enhanced patient compliance and improved taste.
We have a long history of developing drug delivery technologies. In
the 1950's, we received what we believe to be the first patents for
sustained release delivery systems which enhance the convenience
and effectiveness of pharmaceutical products. In our early years,
we used our technologies to develop products for other drug
marketers. Our technologies have been used in several well known
products including Actifed(R) 12-hour, Sudafed(R) SA, Centrum
Jr.(R) and Kaopectate(R) Chewable. Since the 1990's, we have chosen
to focus our drug development expertise on internally developed
products for our branded and generic/non-branded pharmaceutical
businesses.
For example, since its inception in March 1999, our Ther-Rx
business has successfully launched seven internally developed
branded pharmaceutical products, all of which incorporate our drug
delivery technologies. We have also introduced technology-improved
versions for three of the branded products acquired by us.
Furthermore, most of the internally developed generic/non-branded
products marketed by our ETHEX business incorporate one or more of
our drug delivery technologies.
Our drug delivery technology allows us to differentiate our
products in the marketplace, both in the branded and
generic/non-branded 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. From 1998 to 2005, we have grown net revenues and net
income at compounded annual growth rates of 17.6% and 17.1%,
respectively. Ther-Rx has grown substantially since its inception
in March 1999 and continues to gain market share in its women's
healthcare family of products. Also, by focusing on the development
and marketing of technology-distinguished, multisource drugs, over
half of the more than 140 specialty generic/non-branded products
sold by our ETHEX subsidiary are market leaders in the
multisource-brand market.
THER-RX -- OUR BRAND NAME PHARMACEUTICAL BUSINESS
We established Ther-Rx in 1999 to market brand name pharmaceutical
products which incorporate our proprietary technologies. Since its
inception, Ther-Rx has introduced over 10 products into two
principal therapeutic categories - women's health and oral
hematinics - where physician specialists can be reached using a
highly focused sales force. By targeting physician specialists, we
believe Ther-Rx can compete successfully without the need for a
sales force as large as pharmaceutical companies with less
specialized product lines. Ther-Rx's net revenues grew from $82.9
million in fiscal 2004 to $90.1 million in fiscal 2005 and
represented 29.7% of our fiscal 2005 total net revenues.
We established our women's healthcare franchise through the August
1999 acquisition of PreCare(R), a prescription prenatal vitamin,
from UCB Pharma, Inc. Since the acquisition, Ther-Rx has
reformulated the original product using proprietary technologies,
and subsequently has launched five internally developed products as
extensions to the PreCare(R) product line. Building upon the
PreCare(R) acquisition, we have developed a line of proprietary
products which makes Ther-Rx the leading provider of branded
prescription prenatal vitamins in the United States.
The first of our internally developed, patented line extensions to
PreCare(R) was PreCare(R) Chewables, the world's first prescription
chewable prenatal vitamin. PreCare(R) Chewables addressed a
longstanding challenge to improve pregnant women's compliance with
prenatal vitamin regimens by alleviating the difficulty that
patients experience in swallowing large prenatal pills. Ther-Rx's
second internally developed product, PremesisRx(TM), is an
innovative prenatal prescription product that incorporates our
controlled release Vitamin B(6). This product is designed for use in
conjunction with a physician-supervised program to reduce
pregnancy-related nausea and vomiting, which is experienced by 50%
to 90% of women who become pregnant. The third product, PreCare(R)
Conceive(TM), is the first product designed as a prescription
nutrional pre-conception supplement. The fourth
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product, PrimaCare(R), is the first prescription prenatal/postnatal
nutritional supplement with essential fatty acids specially
designed to help provide nutritional support for women during
pregnancy, postpartum recovery and throughout the childbearing
years. The fifth product, PrimaCare(R) ONE, was launched in fiscal
2005 as a proprietary line extension to PrimaCare(R) and is the
first prenatal product to contain essential fatty acids in a
one-dose-per-day dosage form. All of the products in the PreCare(R)
product line have been formulated to contain 1 mg. of folic acid,
which has been shown to reduce the incidence of fetal neural tube
defects by at least 50%.
In June 2000, Ther-Rx launched its first NDA approved product,
Gynazole-1(R), the only one-dose prescription cream treatment for
vaginal yeast infections. Gynazole-1(R) incorporates our patented
drug delivery technology, VagiSite(R), the only clinically proven
and Federal Food and Drug Administration, or FDA, approved
controlled release bioadhesive system. Since its launch, the
product has gained a 31.5% market share in the U.S. prescription
vaginal antifungal cream market.
In addition, we have entered into licensing agreements for the
right to market Gynazole-1(R) in over 50 markets in Europe, Latin
America, the Middle East, Asia, Indonesia, the People's Republic of
China, Australia, New Zealand and Mexico. We also received, during
fiscal 2005, our second regulatory approval to market Gynazole-1(R)
into an international market.
In January 2005, Ther-Rx introduced its second NDA approved
product, Clindesse(TM), the first approved single-dose therapy for
bacterial vaginosis. Similar to Gynazole-1(R), Clindesse(TM)
incorporates our proprietary VagiSite(R) bioadhesive drug delivery
technology. Since its launch, Clindesse(TM) has garnered 13.1% of
the intravaginal bacterial vaginosis market in the United States.
We have also entered into licensing agreements for the right to
market Clindesse(TM) in Spain, Portugal, Andorra, Brazil and
Mexico.
We established our hematinic product line by acquiring two leading
hematinic brands, Chromagen(R) and Niferex(R), in March 2003. We
re-launched technology-improved versions of these products mid-way
through fiscal 2004. In fiscal 2005, the reformulated hematinic
brands have generated 64.8% growth in new prescription volume
compared to new prescription volume in the prior year.
Ther-Rx's cardiovascular product line consists of Micro-K(R), an
extended-release potassium supplement used to replenish
electrolytes, primarily in patients who are on medication which
depletes the levels of potassium in the body. We acquired
Micro-K(R) in March 1999 from the pharmaceutical division of Wyeth.
Based on the addition of new products and our expectation of
continued growth in our branded business, Ther-Rx expanded its
branded sales force by 80 specialty sales representatives and sales
management personnel in fiscal 2004 and Ther-Rx added an additional
30 specialty sales representatives late in fiscal 2005. Ther-Rx's
sales force focuses on physician specialists who are identified
through available market research as frequent prescribers of our
prescription products. Ther-Rx also has a corporate sales and
marketing management team dedicated to planning and managing
Ther-Rx's sales and marketing efforts.
ETHEX -- OUR TECHNOLOGICALLY DISTINGUISHED GENERIC/NON-BRANDED DRUG
BUSINESS
We established ETHEX, currently our largest business segment, in
1990 to utilize our portfolio of drug delivery systems to develop
and market hard-to-copy generic/non-branded pharmaceuticals. We
believe many of our ETHEX products enjoy higher gross margins than
other generic pharmaceutical companies due to our approach of
selecting products that benefit from our proprietary drug delivery
systems and our specialty manufacturing capabilities. These
advantages can act as barriers to entry which may limit competition
and reduce the rate of price erosion typically experienced in the
generic market. ETHEX's net revenues were $191.9 million for fiscal
2005, which represented 63.2% of our total net revenues.
We have incorporated our proprietary drug delivery technology in
many of our generic/non-branded pharmaceutical products. For
example, we have included METER RELEASE(R), one of our proprietary
controlled
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release technologies, into the only generic equivalent to
Norpace(R) CR, an antiarrhythmic that is taken twice daily.
Further, we have used our KV/24(R) once daily technology in the
generic equivalent to IMDUR(R), a cardiovascular drug that is taken
once per day. In addition, utilizing our specialty manufacturing
expertise and a sublingual delivery system, we produced and
marketed the first non-branded alternative to Nitrostat(R)
sublingual, an anti-angina product which historically has been
difficult to manufacture.
To capitalize on ETHEX's unique product capabilities, we continue
to expand our ETHEX product portfolio. Over the past two years, we
have introduced more than 20 new generic/non-branded products and
have a number of products currently in development to be marketed
by ETHEX. Since January 1, 2004, we have received six new
Abbreviated New Drug Application, or ANDA, approvals. We also
anticipate receipt of ANDA approvals for Diltiazem and
Levothyroxine, among other products, in fiscal 2006.
In addition to our internal marketing efforts, we have licensed the
exclusive rights to co-develop and market more than 15 products
with other drug delivery companies. These products are generic
equivalents to brand name products with aggregate annual sales
totaling over $4 billion and, subject to completion of development
and regulatory approvals, are expected to be launched at various
times beginning in fiscal 2006 and continuing through fiscal 2008.
In fiscal 2005, we began marketing the 50mg/200mg strength of
Carbidopa-Levodopa, the generic equivalent to Sinemet(R), under a
co-development licensing agreement with another drug delivery
company.
By focusing our efforts on the development and marketing of
technology-distinguished, multisource drugs, over half of the more
than 140 specialty generic/non-branded products sold by our ETHEX
subsidiary are leaders in their respective multisource-brand
markets.
ETHEX primarily focuses on the therapeutic categories of
cardiovascular, women's health, pain management and respiratory,
leveraging our expertise in developing and manufacturing products
in these areas. In addition, we pursue opportunities outside of
these categories where we also may differentiate our products based
upon our proprietary drug delivery systems and our specialty
manufacturing expertise.
CARDIOVASCULAR. ETHEX currently markets over 40 products in its
cardiovascular line, including products to treat angina, arrhythmia
and hypertension, as well as for potassium supplementation. The
cardiovascular line accounted for 44.6% of ETHEX's net revenues in
fiscal 2005.
PAIN MANAGEMENT. ETHEX currently markets over 20 products in its
pain management line. Included in this line are several controlled
substance drugs, such as morphine, hydromorphone and oxycodone. The
pain management line accounted for 18.6% of ETHEX's net revenues in
fiscal 2005.
RESPIRATORY. ETHEX currently markets over 30 products in its
respiratory line, which consists primarily of cough/cold products.
ETHEX is the leading provider on a unit basis of prescription
cough/cold products in the United States today. The cough/cold line
accounted for 15.2% of ETHEX's net revenues in fiscal 2005.
WOMEN'S HEALTH CARE. ETHEX currently markets over 20 products in
its women's healthcare line, all of which are prescription prenatal
vitamins. Based on the number of units sold, ETHEX is the leading
provider of prescription prenatal vitamins in the United States.
The women's healthcare line accounted for 10.5% of ETHEX's net
revenues in fiscal 2005.
OTHER THERAPEUTICS. In addition to our core therapeutic lines,
ETHEX markets over 30 products in the gastrointestinal,
dermatological, anti-anxiety, digestive enzyme and dental
categories.
ETHEX has a dedicated sales and marketing team, which includes an
outside sales team of regional managers and national account
managers and an inside sales team. The outside sales force calls on
wholesalers and distributors
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and national drugstore chains, as well as hospitals, nursing homes,
independent pharmacies and mail order firms. The inside sales force
calls on independent pharmacies to create pull-through at the
wholesale level.
PDI - OUR VALUE-ADDED RAW MATERIAL BUSINESS
PDI develops and markets specialty raw material products for the
pharmaceutical, nutritional, food and personal care industries. Its
products include value-added active drug molecules, vitamins,
minerals and other raw material ingredients that provide benefits
such as improved taste, altered or controlled release profiles,
enhanced product stability or more efficient and other
manufacturing process advantages. PDI is also a significant
supplier of value-added raw material for our Ther-Rx and ETHEX
businesses. Net revenues for PDI were $18.3 million in fiscal 2005,
which represented 6.0% of our total net revenues. PDI currently
offers three distinct lines of specialty raw material products:
o DESCOTE(R) is a family of microencapsulated tastemasked
vitamins and minerals for use in chewable nutritional
products, quick dissolve dosage forms, foods, children's
vitamins and other products.
o DESTAB(TM) is a family of direct compression products that
enables pharmaceutical manufacturers to produce tablets and
caplets more efficiently and economically.
o MicroMask(TM) is a family of products designed to alleviate
problems associated with swallowing tablets. This is
accomplished by offering superior tasting, chewable or quick
dissolving dosage forms of medication.
BUSINESS STRATEGY
Our goal is to enhance our position as a leading fully integrated
specialty pharmaceutical company that utilizes its expanding drug
delivery expertise to bring technologically distinguished brand
name and generic/non-branded products to market. Our strategies
incorporate the following key elements:
INTERNALLY DEVELOP BRAND NAME PRODUCTS. We apply our existing drug
delivery technologies, research and development and manufacturing
expertise to introduce new products which can expand our existing
franchises. In January 2005, Ther-Rx introduced its second NDA
approved product, Clindesse(TM), the first approved single-dose
therapy for bacterial vaginosis. Similar to Gynazole-1(R),
Clindesse(TM) incorporates our proprietary VagiSite(R) bioadhesive
drug delivery technology. We plan to continue to use our research
and development, manufacturing and marketing expertise to create
unique brand name products within our core therapeutic areas and we
currently have a number of new products in clinical development.
CAPITALIZE ON ACQUISITION OPPORTUNITIES. We actively seek
acquisition opportunities for both Ther-Rx and ETHEX. Ther-Rx
continually looks for platform acquisition opportunities similar to
PreCare(R) around which we can build franchises. We believe that
consolidation among large pharmaceutical companies, coupled with
cost-containment pressures, has increased the level of sales
necessary for an individual product to justify active marketing and
promotion. This has led large pharmaceutical companies to focus
their marketing efforts on drugs with higher volume sales, newer or
novel drugs which have the potential for high volume sales and
products which fit within core therapeutic or marketing priorities.
As a result, major pharmaceutical companies increasingly have
sought to divest small or non-strategic product lines, which can be
profitable for specialty pharmaceutical companies like us.
In making acquisitions, we apply several important criteria in our
decision-making process. We pursue products with the following
attributes:
o products which we believe have relevance for treatment of
significant clinical needs;
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o promotionally sensitive maintenance drugs which require
continual use over a long period of time, as opposed to more
limited use products for acute indications;
o products which are predominantly prescribed by physician
specialists, which can be cost-effectively marketed by our
focused sales force; and
o products which we believe have potential for technological
enhancements and line extensions based upon our drug delivery
technologies.
FOCUS SALES EFFORTS ON HIGH VALUE NICHE MARKETS. We focus our
Ther-Rx sales efforts on niche markets where we believe we can
target a relatively narrow physician audience. Because our products
are sold to specialty physician groups that tend to be relatively
concentrated, we believe that we can address these markets cost
effectively with a focused sales force. Based on the addition of
new products and our expectation of continued growth in our branded
business, Ther-Rx expanded its branded sales force by 80 specialty
sales representatives and sales management personnel in fiscal 2004
and Ther-Rx added an additional 30 specialty sales representatives
late in fiscal 2005. We plan to continue to build our sales force
as necessary to accommodate current and future expansions of our
product lines.
PURSUE ATTRACTIVE GROWTH OPPORTUNITIES WITHIN THE GENERIC INDUSTRY.
We plan to continue introducing generic and non-branded
alternatives to select drugs whose patents have expired,
particularly when we can add value through our drug delivery
technologies. Such generic or off-patent pharmaceutical products
are generally sold at significantly lower prices than the branded
product. Accordingly, generic pharmaceuticals provide a
cost-efficient alternative to users of branded products. We believe
the health care industry will continue to support growth in the
generic pharmaceutical market and that industry trends favor
generic product expansion into the managed care, long-term care and
government contract markets. We further believe that we are
uniquely positioned to capitalize on this growing market given our
large base of proprietary drug delivery technologies and our proven
ability to lead the therapeutic categories we enter.
ADVANCE EXISTING AND DEVELOP NEW DRUG DELIVERY TECHNOLOGIES. We
believe our drug delivery platform of 15 distinguished technologies
has unique breadth and depth. These technologies have enabled us to
create innovative products, including Gynazole-1(R) and
Clindesse(TM), which incorporate VagiSite(TM), our proprietary
bioadhesive controlled release system. In addition, our
tastemasking and controlled release systems are incorporated into
our prenatal vitamins, providing them with differentiated benefits
over other products on the market.
We plan to continue to develop our drug delivery technologies and
have various technologies currently under development, such as:
TransCell(R) for oral esophageal delivery of bioactive peptides and
proteins that are normally degraded by stomach enzymes or
first-pass liver effects; PulmoSite(TM) which applies bioadhesive
and controlled release characteristics to drug agents that are
inhaled for either local action in the lung or for systemic
absorption; and Ocusite(TM) for the delivery of active agents by a
bioadhesive topical application to the eye.
OUR PROPRIETARY DRUG DELIVERY TECHNOLOGIES
We believe we are a leader in the development of proprietary drug
delivery systems and formulation technologies which enhance the
effectiveness of new therapeutic agents, existing pharmaceutical
products and nutritional supplements. We have used many of these
technologies to successfully commercialize technologically
distinguished branded and generic/non-branded products.
Additionally, we continue to invest our resources in the
development of new technologies. The following describes our
principal drug delivery technologies.
SITE RELEASE(R) TECHNOLOGIES. SITE RELEASE(R) is our largest family
of technologies and includes eight systems designed specifically
for oral, topical or interorificial use. These systems rely on
controlled bioadhesive properties to optimize the delivery of drugs
to either wet mucosal tissue or the skin and are the subject of
issued
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patents and pending patent applications. Of the technologies
developed, products using the VagiSite(TM) and DermaSite(TM)
technologies have been successfully commercialized. Our fully
developed technologies include the following:
o VagiSite(TM) is a controlled release bioadhesive delivery
system that incorporates advanced polyphasic principles to
create a bioemulsion system delivering therapeutic agents to
the vagina. We have outlicensed VagiSite(TM) for sale in
international markets for the treatment of vaginal infections.
VagiSite(TM) technology is used in Gynazole-1(R), a one-dose
prescription cream treatment for vaginal yeast infections and
Clindesse(TM), a one-dose prescription cream treatment for
bacterial vaginosis.
o DermaSite(TM) is a semi-solid SITE RELEASE(R) configuration
for topical applications to the skin. The bioadhesive and
controlled release properties of the delivery platform have
made possible the development of products requiring a
significantly reduced frequency of application. DermaSite(TM)
technology is used in Dermarin-L(TM), a topical antifungal
product being marketed by the leading over-the-counter
pharmaceutical company in Japan, Taisho Pharmaceutical, Ltd.
o OraSite(R) is a controlled release mucoadhesive delivery
system administered orally in a solid or liquid form. A drug
formulated with the OraSite(R) technology may be formulated as
a liquid or as a lozenge in which the dosage form liquefies
upon insertion and adheres to the mucosal surface of the
mouth, throat and esophagus. OraSite(R) possesses
characteristics particularly advantageous to therapeutic
categories such as oral hygiene, sore throat and periodontal
and upper gastrointestinal tract disorders.
o OraSert(TM) is a solid dosage-form application system
specifically designed for localized delivery of active agents
to the oral tissues. The product is formulated as a "cough
drop" type tablet, which immediately liquefies upon placement
in the mouth and bioadheres to mucosal tissue in the mouth,
throat and esophagus. OraSert(TM) possesses characteristics
particularly advantageous to therapeutic applications such as
periodontal disease, respiratory conditions, pharyngeal
conditions and upper gastrointestinal tract disorders.
o BioSert(TM) is a bioadhesive delivery system in a solid insert
formulation for vaginal or rectal administration, similar in
appearance to a vaginal or rectal suppository, which can be
used for both local and systemic delivery of drugs. The
BioSert(TM) dosage form liquefies and bioadheres to vaginal or
rectal tissues, which is of particular benefit when a patient
can no longer tolerate orally administered medications. We are
currently developing several drug products that utilize the
BioSert(TM) technology, including non-steroidal
anti-inflammatory drugs, or NSAIDs, and antifungals for a
local effect and opioids for a systemic effect.
In addition, the following SITE RELEASE(R) technologies are
currently under development:
o Trans-Cell(R) is a novel bioadhesive, controlled release
delivery system that may permit oral delivery of bioactive
peptides and proteins that are normally degraded by stomach
enzymes or first-pass liver effects. This technology was
specifically designed to provide an oral delivery alternative to
biotechnology and other compounds that currently are delivered
as injections or infused.
o OcuSite(TM) is a liquid, microemulsion delivery system
intended for topical applications in the eye. The
microemulsion formulation lends optical clarity to the
application and is particularly well suited for ophthalmic
use. The bioadhesive and controlled release properties of this
delivery system allow for reduced dosing regimentation.
o PulmoSite(TM) applies bioadhesive and controlled release
characteristics to drug agents that are to be inhaled for
either local action to the lung or for systemic absorption.
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ORAL CONTROLLED RELEASE TECHNOLOGIES. The technological preeminence
of our advanced drug delivery systems was established in the
development of our three oral controlled release technologies, all
of which have been commercialized. Our systems can be individually
designed to achieve the desired release profile for a given drug.
The release profile is dependent on many parameters, such as drug
solubility, protein binding and site of absorption. Some of the
products utilizing our oral controlled release systems in the
market include Isosorbide-5-Mononitrate (an AB rated generic
equivalent to IMDUR(R)) and Disopyramide Phosphate (an AB rated
generic equivalent of Norpace(R) CR). Our patented technologies
include the following:
o KV/24(R) is a multi-particulate drug delivery system that
encapsulates one or more drug compounds into spherical
particles which release the active drug or drugs systemically
over an 18- to 24-hour period, permitting the development of
once-a-day drug formulations. We believe that our KV/24(R)
oral dosing system is the only commercialized 24-hour oral
controlled release system that is successfully able to
incorporate more than one active compound.
o METER RELEASE(R) is a polymer-based drug delivery system that
offers different release characteristics than KV/24(R) and is
used for products that require drug release rates of between
eight and 12 hours. We have developed METER RELEASE(R) systems
in tablet, capsule and caplet form that have been
commercialized in ETHEX products in the cardiovascular,
gastrointestinal and upper respiratory product categories.
o MICRO RELEASE(R) is a microparticulate formulation that
encapsulates therapeutic agents, employing smaller particles
than KV/24(R) and METER RELEASE(R). This system is used to
extend the release of drugs in the body where precise release
profiles are less important. MICRO RELEASE(R) has been
commercialized in prescription products marketed by ETHEX and
Ther-Rx as well as over-the-counter nutritional products.
TASTEMASKING TECHNOLOGIES. Our tastemasking technologies improve
the taste of unpleasant drugs. Our three patented tastemasking
systems can be applied to liquids, chewables or dry powders. We
first introduced tastemasking technologies in 1991 and have
utilized them in a number of Ther-Rx and ETHEX products, including
PreCare(R) Chewables and most of the liquid products that are sold
in ETHEX's cough/cold line. Our patented technologies include the
following:
o LIQUETTE(R) is a tastemasking system that incorporates
unpleasant tasting drugs into a hydrophilic and lipophilic
polymer matrix to suppress the taste of a drug. This
technology is used for mildly to moderately distasteful drugs
where low manufacturing costs are particularly important.
o FlavorTech(R) is a liquid formulation technology designed to
reduce the objectionable taste of a wide variety of
therapeutic products. FlavorTech(R) technology has been used
in cough/cold syrup products sold by ETHEX and has special
application to other products, such as antibiotic, geriatric
and pediatric pharmaceuticals.
o MicroMask(TM) is a tastemasking technology that incorporates a
dry powder, microparticulate approach to reducing
objectionable tastes by sequestering the unpleasant drug agent
in a specialized matrix. This formulation technique has the
effect of "shielding" the drug from the taste receptors
without interfering with the dissolution and ultimate
absorption of the agent within the gastrointestinal tract.
MicroMask(TM) is a more potent tastemasking technology than
LIQUETTE(R) and has been used in connection with two Ther-Rx
products.
QUICK DISSOLVING TECHNOLOGY. Our quick dissolving oral tablet
technology provides the ability to tastemask, yet dissolves in the
mouth in a matter of seconds. Most other quick-dissolving
technologies offer either quickness at the expense of poor
tastemasking or excellent tastemasking at the expense of quickness.
While still under development, this system allows for a drug to be
quickly dissolved in the mouth, and can be combined with
tastemasking capabilities that offer a unique dosage form for the
most bitter tasting drug compounds. We have been issued patents and
have patents pending for this system with the U.S. Patent and
Trademark Office, or PTO.
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SALES AND MARKETING
Ther-Rx has a national sales and marketing infrastructure which
includes approximately 240 sales representatives dedicated to
promoting and marketing our branded pharmaceutical products to
targeted physician specialists. Based on the addition of new
products and our expectation of continued growth in our branded
business, Ther-Rx expanded its branded sales force by 80 specialty
sales representatives and sales management personnel in fiscal 2004
and added an additional 30 specialty sales representatives late in
fiscal 2005. Ther-Rx's sales force focuses on physician specialists
who are identified through available market research as frequent
prescribers of our prescription products. Ther-Rx also has a
corporate sales and marketing management team dedicated to planning
and managing Ther-Rx's sales and marketing efforts.
We attempt to increase sales of our branded pharmaceutical products
through physician sales calls and promotional efforts, including
sampling, advertising and direct mail. For acquired branded
products, we generally increase the level of physician sales calls
and promotion relative to the previous owner. For example, with the
PreCare(R) prenatal sales efforts, we increased the level of
physician sales calls and sampling to the highest prescribers of
prenatal vitamins. We also have enhanced our PreCare(R) brand
franchise by launching five more line extensions to address unmet
needs, including the launch of PreCare(R) Chewables, Premesis
Rx(TM), PreCare(R) Conceive(TM), PrimaCare(R) and PrimaCare(R) ONE.
The PreCare(R) product line enables us to deliver a full range of
nutritional products for physicians to prescribe to women in their
childbearing years. In addition, we added to our women's health
care family of products in June 2000 with the introduction of our
first NDA approved product, Gynazole-1(R), the only one-dose
prescription cream treatment for vaginal yeast infections. In
fiscal 2004, we further expanded our branded product offerings when
we launched technology improved versions of the Chromagen(R) and
Niferex(R) oral hematinic product lines that were acquired at the
end of fiscal 2003. In January 2005, we introduced our second NDA
approved product, Clindesse(TM), the first approved single-dose
therapy for bacterial vaginosis. By offering multiple products to
the same group of physician specialists, we are able to maximize
the effectiveness of our experienced sales force.
ETHEX has an experienced sales and marketing team, which includes
an outside sales team, regional account managers, national account
managers and an inside sales team. The outside sales force calls on
wholesalers, distributors and national drugstore chains, as well as
hospitals, nursing homes, mail order firms and independent
pharmacies. The inside sales team calls on independent pharmacies
to create pull-through at the wholesale level.
We believe that industry trends favor generic product expansion
into the managed care, long-term care and government contract
markets. Further, we believe that our competitively priced,
technology-distinguished generic/non-branded products can fulfill
the increasing need of these markets to contain costs and improve
patient compliance. Accordingly, we intend to continue to devote
significant marketing resources to the penetration of those
markets.
Particle Dynamics has a specialized technical sales group that
calls on the leading companies in the pharmaceutical, nutritional,
personal care, food and other markets in the United States.
During fiscal 2005, our three largest customers accounted for 27%,
16% and 12% of gross revenues. These customers were McKesson Drug
Company, Cardinal Health and Amerisource Corporation, respectively.
In fiscal 2004 and 2003, these customers accounted for gross
revenues of 25%, 16% and 13% and 23%, 14% and 18%, respectively.
Although we sell internationally, we do not have material
operations or sales in foreign countries and our sales are not
subject to significant geographic concentration.
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RESEARCH AND DEVELOPMENT
We have long recognized that development of successful new products
is critical to achieving our goal of sustainable growth over the
long term. As such, our investment in research and development,
which increased at a compounded annual growth rate of 26.2% over
the past four fiscal years, reflects our continued commitment to
develop new products and/or technologies through our internal
development programs, and with our external strategic partners.
Our research and development activities include the development of
new and next generation drug delivery technologies, the formulation
of brand name proprietary products and the development of
technologically distinguished generic/non-branded versions of
previously approved brand name pharmaceutical products. In fiscal
2005, 2004 and 2003, total research and development expenses were
$23.5 million, $20.7 million and $19.1 million, respectively.
In January 2005, Ther-Rx introduced its second NDA approved
product, Clindesse(TM), the first approved single-dose therapy for
bacterial vaginosis. Similar to Gynazole-1(R), Clindesse(TM)
incorporates our proprietary VagiSite(R) bioadhesive drug delivery
technology. Ther-Rx currently has a number of products in its
research and development pipeline at various stages of development.
We believe we have the technological expertise required to develop
unique products to meet currently unmet needs in the area of
women's health, as well as other therapeutic areas.
To capitalize on ETHEX's unique product capabilities, we continue
to expand our ETHEX product portfolio. Over the past two fiscal
years, we have introduced more than 20 new generic/non-branded
products and have a number of products currently in development to
be marketed by ETHEX. Our development process typically consists of
formulation, development and laboratory testing, and where required
(1) preliminary bioequivalency studies of pilot batches of the
manufactured product, (2) full scale bioequivalency studies using
commercial quantities of the manufactured product and (3)
submission of an ANDA to the FDA. We believe that, unlike many
generic drug companies, we have the technical expertise required to
develop generic substitutes for hard-to-copy branded pharmaceutical
products. Since January 1, 2004, we have received six new ANDA
approvals. We also anticipate receipt of ANDA approvals for
Diltiazem and Levathyroxine, among other products, in fiscal 2006.
In addition to our internal marketing efforts, we have licensed the
exclusive rights to co-develop and market more than 15 products
with other drug delivery companies. These products are generic
equivalents to brand name products with aggregate annual sales
totaling over $4 billion and, subject to completion of development
and regulatory approvals, are expected to be launched at various
times beginning in fiscal 2006 and continuing through fiscal 2008.
In fiscal 2005, we began marketing the 50mg/200mg strength of
Carbidopa-Levodopa, the generic equivalent to Sinemet(R), under a
co-development licensing agreement with another drug delivery
company.
PDI currently has a number of products in its research and
development pipeline at various stages of development. PDI applies
its technologies to a diverse number of active and inactive
chemicals for more efficient processing of materials to achieve
benefits such as prolonged action of release, tastemasking, making
materials more site specific and other benefits. Typically, the
finished products into which the specialty raw materials are
incorporated do not require FDA approval.
We continually apply our scientific and development expertise to
refine and enhance our existing drug delivery systems and
formulation technologies and to create new technologies that may be
used in our drug development programs. Certain of these
technologies currently under development include advanced oral
controlled release systems, quick dissolving oral delivery systems
(with and without tastemasking characteristics) and transesophageal
and intrapulmonary delivery technologies.
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PATENTS AND OTHER PROPRIETARY RIGHTS
We actively seek, when appropriate and available, protection for
our products and proprietary information by means of U.S. and
foreign patents, trademarks, trade secrets, copyrights, and
contractual arrangements. Patent protection in the pharmaceutical
field, however, can involve complex legal and factual issues.
Moreover, broad patent protection for new formulations or new
methods of use of existing chemical entities is sometimes difficult
to obtain, primarily because the active ingredient and many of the
formulation techniques have been known for some time. Consequently,
some patents claiming new formulations or new methods of use for
old drugs may not provide meaningful protection against
competition. Nevertheless, we intend to seek patent protection when
appropriate and available and otherwise to rely on
regulatory-related exclusivity and trade secrets to protect certain
of our products, technologies and other scientific information.
There can be no assurance, however, that any steps taken to protect
such proprietary information will be effective.
Our policy is to file patent applications in appropriate situations
to protect and preserve, for our own use, technology, inventions
and improvements that we consider important to the development of
our business. We currently hold domestic and foreign issued patents
the last of which expires in fiscal 2022 relating to our controlled
release, site-specific, quick dissolve and tastemasking
technologies. We have been granted 33 U.S. patents and have 22 U.S.
patent applications pending. In addition, we have 11 foreign issued
patents and a total of 100 patent applications pending primarily in
Canada, Europe, Australia, Japan, South America, Mexico and South
Korea (see "We depend on our patents and other proprietary rights"
under "Risk Factors" for additional information).
We currently own more than 100 U.S. and foreign trademark
registrations and have also applied for trademark protection for
the names of our proprietary controlled-release, tastemasking,
site-specific and quick dissolve technologies. We intend to
continue to trademark new technology and product names as they are
developed.
To protect our trademark, domain name, and related rights, we
generally rely on trademark and unfair competition laws, which are
subject to change. Some, but not all, of our trademarks are
registered in the jurisdictions where they are used. Some of our
other trademarks are the subject of pending applications in the
jurisdictions where they are used or intended to be used and others
are not.
MANUFACTURING AND FACILITIES
We believe that our administrative, research, manufacturing and
distribution facilities are an important factor in achieving our
long-term growth objectives. All facilities at March 31, 2005,
aggregating approximately 1.1 million square feet, are located in
the St. Louis, Missouri area. We own approximately 600,000 square
feet, with the balance under various leases at pre-determined
annual rates under agreements expiring from fiscal 2006 through
fiscal 2012, subject in most cases to renewal at our option.
We manufacture drug products in liquid, semi-solid, tablet, capsule
and caplet forms for distribution by Ther-Rx, ETHEX and our
corporate licensees and value-added specialty raw materials for
distribution by Particle Dynamics. We believe that all of our
facilities are in material compliance with applicable regulatory
requirements.
We seek to maintain inventories at sufficient levels to support
current production and sales levels. During fiscal 2005, we
encountered no serious shortage of any particular raw materials,
except that in the fourth quarter of fiscal 2005, we experienced a
supply disruption of a key ingredient for our PrimaCare(R) ONE
product. This interruption in production was temporary and has
since been resolved. Although there can be no assurance that
14
raw material supply will not adversely affect our future
operations, we do not believe that additional shortages will occur
in the foreseeable future.
COMPETITION
Competition in the development and marketing of pharmaceutical
products is intense and characterized by extensive research efforts
and rapid technological progress. Many companies, including those
with financial and marketing resources and development capabilities
substantially greater than our own, are engaged in developing,
marketing and selling products that compete with those that we
offer. Our branded pharmaceutical products may also be subject to
competition from alternate therapies during the period of patent
protection and thereafter from generic equivalents. In addition,
our generic/non-branded pharmaceutical products may be subject to
competition from pharmaceutical companies engaged in the
development of alternatives to the generic/non-branded products we
offer or of which we undertake development. Our competitors may
develop generic products before we do or may have pricing
advantages over our products. In our specialty pharmaceutical
businesses, we compete primarily on the basis of product efficacy,
breadth of product line and price. We believe that our patents,
proprietary trade secrets, technological expertise, product
development and manufacturing capabilities will enable us to
maintain a leadership position in the field of advanced drug
delivery technologies and to continue to develop products to
compete effectively in the marketplace.
In addition, we compete with pharmaceutical companies that acquire
branded product lines from other pharmaceutical companies. These
competitors may have substantially greater financial and marketing
resources than we do. Accordingly, our competitors may succeed in
product line acquisitions that we seek to acquire.
We also compete with drug delivery companies engaged in the
development of alternative drug delivery systems. We are aware of a
number of companies currently seeking to develop new non-invasive
drug delivery systems, including oral delivery and transmucosal
systems. Many of these companies may have greater research and
development capabilities, experience, manufacturing, marketing,
financial and managerial resources than we do. Accordingly, our
competitors may succeed in developing competing technologies,
obtaining FDA approval for products or gaining market acceptance
more rapidly than we do.
GOVERNMENT REGULATION
All pharmaceutical manufacturers are subject to extensive
regulation by the federal government, principally the FDA, and, to
a lesser extent, by state, local and foreign governments. The
Federal Food, Drug and Cosmetic Act, or FDCA, and other federal
statutes and regulations govern or influence, among other things,
the development, testing, manufacture, safety, labeling, storage,
recordkeeping, approval, advertising, promotion, sale and
distribution of pharmaceutical products. Pharmaceutical
manufacturers are also subject to certain record keeping and
reporting requirements, establishment registration and product
listing, and FDA inspections.
With respect to any non-biological "new drug" product with active
ingredients not previously approved by the FDA, a prospective
manufacturer must submit a full NDA, including complete reports of
preclinical, clinical and other studies to prove the product's
safety and efficacy. A full NDA may also need to be submitted for a
drug product with a previously approved active ingredient if, among
other things, the drug will be used to treat an indication for
which the drug was not previously approved, or if the abbreviated
procedure discussed below is otherwise not available. A
manufacturer intending to conduct clinical trials in humans for a
new drug may be required first to submit a Notice of Claimed
Investigational Exception for a New Drug, or IND, to the FDA
containing information relating to preclinical and clinical
studies. INDs and full NDAs may be required to be filed to obtain
approval of certain of our products, including those that do not
qualify for abbreviated application procedures. The full NDA
process, including clinical development and testing, is expensive
and time consuming.
The Drug Price Competition and Patent Restoration Act of 1984,
known as the Hatch-Waxman Act, established ANDA procedures for
obtaining FDA approval for generic versions of many non-biological
drugs for which
15
patent or marketing exclusivity rights have expired and which are
bioequivalent to previously approved drugs. "Bioequivalence" for
this purpose, with certain exceptions, generally means that the
proposed generic formulation is absorbed by the body at the same
rate and extent as a previously approved "reference drug." Approval
to manufacture these drugs is obtained by filing abbreviated
applications, such as ANDAs. As a substitute for clinical studies,
the FDA requires data indicating the ANDA drug formulation is
bio-equivalent to a previously approved reference drug among other
requirements. The same abbreviated application procedures apply to
antibiotic drug products that are bio-equivalent to previously
approved antibiotics, except that products containing certain older
antibiotic ingredients are not subject to the special patent or
marketing exclusivity protections afforded by the Hatch-Waxman Act
to other drug products. The advantage of the ANDA approval
mechanism, compared to an NDA, is that an ANDA applicant is not
required to conduct preclinical and clinical studies to demonstrate
that the product is safe and effective for its intended use and may
rely, instead, on studies demonstrating bio-equivalence to a
previously approved reference drug.
In addition to establishing ANDA approval mechanisms, the
Hatch-Waxman Act fosters pharmaceutical innovation through such
incentives as non-patent exclusivity and patent restoration. The
Act provides two distinct exclusivity provisions that either
preclude the submission or delay the approval of an ANDA. A
five-year exclusivity period is provided for new chemical
compounds, and a three-year marketing exclusivity period is
provided for changes to previously approved drugs which are based
on new clinical investigations essential to the approval. The
three-year marketing exclusivity period may be applicable to the
approval of a novel drug delivery system. The marketing exclusivity
provisions apply equally to patented and non-patented drug
products, but do not apply to products containing antibiotic
ingredients first submitted for approval on or before November 20,
1997. These provisions do not delay or otherwise affect the
approvability of full NDAs even when effective ANDA approvals are
not available. For drugs covered by patents, patent extension may
be provided for up to five years as compensation for reduction of
the effective life of the patent resulting from time spent in
conducting clinical trials and in FDA review of a drug application.
There has been substantial litigation in the biomedical,
biotechnology and pharmaceutical industries with respect to the
manufacture, use and sale of new products that are alleged to
infringe outstanding patent rights. One or more patents cover most
of the proprietary products for which we are developing generic
versions. When we file an ANDA for such drug products, we will, in
most cases, be required to certify to the FDA that any patent which
has been listed with the FDA as covering the product is invalid or
will not be infringed by our sale of our product. Alternatively, we
could certify that we would not market our proposed product until
the applicable patent expires. A patent holder may challenge a
notice of noninfringement or invalidity by filing suit for patent
infringement, which would, in most cases, prevent FDA approval
until the suit is resolved or until at least 30 months has elapsed
(or until the patent expires, whichever is earlier). Should any
entity commence a lawsuit with respect to any alleged patent
infringement by us, the uncertainties inherent in patent litigation
would make the outcome of such litigation difficult to predict.
In addition to marketing drugs which are subject to FDA review and
approval, we market certain drug products in the United States
without FDA approval under certain "grandfather" clauses and
statutory and regulatory exceptions to the pre-market approval
requirement for "new drugs" under the FDCA. A determination as to
whether a particular product does or does not require FDA
pre-market review and approval can involve consideration of
numerous complex and imprecise factors. If a determination is made
by the FDA that any product marketed without approval requires such
approval, the FDA may institute enforcement actions, including
product seizure, or an action seeking an injunction against further
marketing and may or may not allow sufficient time to obtain the
necessary approvals before it seeks to curtail further marketing.
For example, in October 2002, the FDA sent warning letters to us
and other manufacturers and distributors of unapproved prescription
drug products containing the expectorant guaifenesin as a single
entity in a solid oral extended-release dosage form. Citing the
recent approval of one such product, the FDA warning letters
asserted that the marketing of all such products without NDA or
ANDA approval should stop. The FDA subsequently agreed to allow
continued manufacture through May 2003 and sale through November
2003 of the products, and we complied with those deadlines. We are
not in a position to predict whether or when the FDA might choose
to raise similar objections
16
to the marketing without NDA or ANDA approval of another category
or categories of drug products represented in our product lines. In
the event such objections are raised, we could be required or could
decide to cease distribution of additional products until
pre-market approval is obtained. In addition, we may not be able to
obtain any particular approval that may be required or such
approval may not be obtained on a timely basis.
In addition to obtaining pre-market approval for certain of our
products, we are required to maintain all facilities in compliance
with the FDA's current Good Manufacturing Practice, or cGMP,
requirements. In addition to compliance with cGMP each
pharmaceutical manufacturer's facilities must be registered with
the FDA. Manufacturers must also be registered with the U.S. Drug
Enforcement Administration or DEA, and similar state and local
regulatory authorities if they handle controlled substances, and
with the EPA and similar state and local regulatory authorities if
they generate toxic or dangerous wastes, and must comply with other
applicable DEA and EPA requirements. Noncompliance with applicable
requirements can result in fines, recall or seizure of products,
total or partial suspension of production and distribution, refusal
of the government to enter into supply contracts or to approve
NDA's, ANDA's or other applications and criminal prosecution. The
FDA also has the authority to revoke for-cause drug approvals
previously granted.
The Prescription Drug Marketing Act, or PDMA, which amended various
sections of the FDCA, requires, among other things, state licensing
of wholesale distributors of prescription drugs under federal
guidelines that include minimum standards for storage, handling and
record keeping. All of our facilities are registered with the State
of Missouri, where they are located, as required by Federal and
Missouri law. The PDMA also imposes detailed requirements on the
distribution of prescription drug samples such as those distributed
by the Ther-Rx sales force. The PDMA sets forth substantial civil
and criminal penalties for violations of these and other
provisions. Many states also require registration of out-of-state
drug manufacturers and distributors who sell products in their
states, and may also impose additional requirements or restrictions
on out-of-state firms. These requirements vary widely from
state-to-state and are subject to change with little or no direct
notice to potentially affected firms. We believe that we are
currently in compliance in all material respects with applicable
state requirements. However, in the event that we are found to have
failed to comply with applicable state requirements, we may be
subject to sanctions, including monetary penalties, and potential
restrictions on our sales or other activities within particular
states.
For international markets, a pharmaceutical company is subject to
regulatory requirements, inspections and product approvals
substantially the same as those in the United States. In connection
with any future marketing, distribution and license agreements that
we may enter into, our licensees may accept or assume
responsibility for such foreign regulatory approvals. The time and
cost required to obtain these international market approvals may be
greater or lesser than those required for FDA approval.
Product development and approval within this regulatory framework
take a number of years, involve the expenditure of substantial
resources and is uncertain. Many drug products ultimately do not
reach the market because they are not found to be safe or effective
or cannot meet the FDA's other regulatory requirements. In
addition, the current regulatory framework may change and
additional regulatory or approval requirements may arise at any
stage of our product development that may affect approval, delay
the submission or review of an application or require additional
expenditures by us. We may not be able to obtain necessary
regulatory clearances or approvals on a timely basis, if at all,
for any of our products under development, and delays in receipt or
failure to receive such clearances or approvals, the loss of
previously received clearances or approvals, or failure to comply
with existing or future regulatory requirements could have a
material adverse effect on our business.
EMPLOYEES
As of March 31, 2005, we employed a total of 1,072 employees. We
are party to a collective bargaining agreement covering 119
employees that will expire December 31, 2009. We believe that our
relations with our employees are good.
17
ENVIRONMENT
We do not expect that compliance with Federal, state or local
provisions regulating the discharge of materials into the
environment or otherwise relating to the protection of the
environment will have a material effect on our capital
expenditures, earnings or competitive position.
AVAILABLE INFORMATION
We make available, free of charge through our Internet website
(http://www.kvpharmaceutical.com), our Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and
amendments to these reports filed or furnished pursuant to Section
13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as
reasonably practicable after we electronically file these reports
with, or furnish them to, the Securities and Exchange Commission,
or SEC. Also, copies of our Corporate Governance Guidelines, Audit
Committee Charter, Compensation Committee Charter, Nominating and
Corporate Governance Committee Charter, Code of Ethics for Senior
Executives and Standard of Business Ethics for all Directors and
employees are available on our Internet website, and available in
print to any stockholder who requests it.
In addition, the SEC maintains an Internet website
(http://www.sec.gov) that contains reports, proxy and information
statements, and other information regarding issuers that file
electronically with the SEC.
RISK FACTORS
We operate in a rapidly changing environment that involves a number
of risks, some of which are beyond our control. The following
discussion highlights some of these risks and others are discussed
elsewhere in this report. Additional risks presently unknown to us
or that we currently consider immaterial or unlikely to occur could
also impair our operations. These and other risks could materially
and adversely affect our business, financial condition, operating
results or cash flows.
RISKS RELATED TO OUR BUSINESS
OUR FUTURE GROWTH IS LARGELY DEPENDENT UPON OUR ABILITY TO DEVELOP
NEW PRODUCTS.
We need to continue to develop and commercialize new brand name
products and generic products utilizing our proprietary drug
delivery systems to maintain the growth of Ther-Rx, ETHEX and
Particle Dynamics. To do this we will need to identify, develop and
commercialize technologically enhanced branded products and
identify, develop and commercialize drugs that are off-patent and
that can be produced and sold by us as generic products using our
drug delivery technologies. If we are unable to identify, develop
and commercialize new products, we may need to obtain licenses to
additional rights to branded or generic products, assuming they
would be available for licensing, which could decrease our
profitability. We cannot assure you that we will be successful in
pursuing this strategy.
IF WE ARE UNABLE TO COMMERCIALIZE PRODUCTS UNDER DEVELOPMENT, OUR
FUTURE OPERATING RESULTS MAY SUFFER.
Certain products we are developing will require significant
additional development and investment, including preclinical and
clinical testing, where required, prior to their commercialization.
We expect that many of these products will not be commercially
available for several years, if at all. We cannot assure you that
such products or future products will be successfully developed,
prove to be safe and effective in clinical trials (if required),
meet applicable regulatory standards, or be capable of being
manufactured in commercial quantities at reasonable cost.
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OUR ACQUISITION STRATEGY MAY NOT BE SUCCESSFUL.
We intend to continue to acquire pharmaceutical products, novel
drug delivery technologies and/or companies that fit into our
research, manufacturing, distribution or sales and marketing
operations or that could provide us with additional products,
technologies or sales and marketing capabilities. We may not be
able to successfully identify, evaluate and acquire any such
products, technologies or companies or, if acquired, we may not be
able to successfully integrate such acquisitions into our business.
We compete with many specialty pharmaceutical companies for
products and product line acquisitions. These competitors may have
substantially greater financial and managerial resources than we
have.
WE DEPEND ON OUR PATENTS AND OTHER PROPRIETARY RIGHTS AND CANNOT BE
CERTAIN OF THEIR CONFIDENTIALITY AND PROTECTION.
Our success depends, in large part, on our ability to protect our
current and future technologies and products, to defend our
intellectual property rights and to avoid infringing on the
proprietary rights of others. We have been issued numerous patents
in the United States and in certain foreign countries, which cover
certain of our technologies, and have filed, and expect to continue
to file, patent applications seeking to protect newly developed
technologies and products. The pharmaceutical field is crowded and
a substantial number of patents have been issued. In addition, the
patent position of pharmaceutical companies can be highly uncertain
and frequently involves complex legal and factual questions. As a
result, the breadth of claims allowed in patents relating to
pharmaceutical applications or their validity and enforceability
cannot be predicted. Patents are examined for patentability at
patent offices against bodies of prior art which by their nature
may be incomplete and imperfectly categorized. Therefore, even
presuming that the examiner has been able to identify and cite the
best prior art available to him during the examination process, any
patent issued to us could later be found by a court or a patent
office during post issuance proceedings to be invalid in view of
newly-discovered prior art or already considered prior art or other
legal reasons. Furthermore, there are categories of "secret" prior
art unavailable to any examiner, such as the prior inventive
activities of others, which could form the basis for invalidating
any patent. In addition, there are other reasons why a patent may
be found to be invalid, such as an offer for sale or public use of
the patented invention in the United States more than one year
before the filing date of the patent application. Moreover, a
patent may be deemed unenforceable if, for example, the inventor or
the inventor's agents failed to disclose prior art to the PTO that
they knew was material to patentability.
The coverage claimed in a patent application can be significantly
reduced before a patent is issued, either in the United States or
abroad. Consequently, there can be no assurance that any of our
pending or future patent applications will result in the issuance
of patents. Patents issued to us may be subjected to further
proceedings limiting their scope and may not provide significant
proprietary protection or competitive advantage. Our patents also
may be challenged, circumvented, invalidated or deemed
unenforceable. Patent applications in the United States filed prior
to November 29, 2000 are currently maintained in secrecy until and
unless patents issue, and patent applications in certain other
countries generally are not published until more than 18 months
after they are first filed (which generally is the case in the
United States for applications filed on or after November 29,
2000). In addition, publication of discoveries in scientific or
patent literature often lags behind actual discoveries. As a
result, we cannot be certain that we or our licensors will be
entitled to any rights in purported inventions claimed in pending
or future patent applications or that we or our licensors were the
first to file patent applications on such inventions. Furthermore,
patents already issued to us or our pending applications may become
subject to dispute, and any dispute could be resolved against us.
For example, we may become involved in re-examination, reissue or
interference proceedings in the PTO, or opposition proceedings in a
foreign country. The result of these proceedings can be the
invalidation or substantial narrowing of our patent claims. We also
could be subject to court proceedings that could find our patents
invalid or unenforceable or could substantially narrow the scope of
our patent claims. In addition, statutory differences in patentable
subject matter may limit the protection we can obtain on some of
our inventions outside of the United States. For example, methods
of treating humans are not patentable in many countries outside of
the United States.
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These and other issues may prevent us from obtaining patent
protection outside of the United States. Furthermore, once patented
in foreign countries, the inventions may be subjected to mandatory
working requirements and/or subject to compulsory licensing
regulations.
We also rely on trade secrets, unpatented proprietary know-how and
continuing technological innovation that we seek to protect, in
part by confidentiality agreements with licensees, suppliers,
employees and consultants. These agreements may be breached by the
other parties to these agreements. We may not have adequate
remedies for any breach. Disputes may arise concerning the
ownership of intellectual property or the applicability or
enforceability of our confidentiality agreements and there can be
no assurance that any such disputes would be resolved in our favor.
Furthermore, our trade secrets and proprietary technology may
become known or be independently developed by our competitors, or
patents may not be issued with respect to products or methods
arising from our research, and we may not be able to maintain the
confidentiality of information relating to those products or
methods. Furthermore, certain unpatented technology may be subject
to intervening rights.
WE DEPEND ON OUR TRADEMARKS AND RELATED RIGHTS.
To protect our trademarks and goodwill associated therewith, domain
name, and related rights, we generally rely on federal and state
trademark and unfair competition laws, which are subject to change.
Some, but not all, of our trademarks are registered in the
jurisdictions where they are used. Some of our other trademarks are
the subject of pending applications in the jurisdictions where they
are used or intended to be used, and others are not.
It is possible that third parties may own or could acquire rights
in trademarks or domain names in the United States or abroad that
are confusingly similar to or otherwise compete unfairly with our
marks and domain names, or that our use of trademarks or domain
names may infringe or otherwise violate the intellectual property
rights of third parties. The use of similar marks or domain names
by third parties could decrease the value of our trademarks or
domain names and hurt our business, for which there may be no
adequate remedy.
THIRD PARTIES MAY CLAIM THAT WE INFRINGE ON THEIR PROPRIETARY
RIGHTS, OR SEEK TO CIRCUMVENT OURS.
We may be required to defend against charges of infringement of
patents, trademarks or other proprietary rights of third parties.
This defense could require us to incur substantial expense and to
divert significant effort of our technical and management
personnel, and could result in our loss of rights to develop or
make certain products or require us to pay monetary damages or
royalties to license proprietary rights from third parties. If a
dispute is settled through licensing or similar arrangements, costs
associated with such arrangements may be substantial and could
include ongoing royalties. Furthermore, we cannot be certain that
the necessary licenses would be available to us on acceptable
terms, if at all. Accordingly, an adverse determination in a
judicial or administrative proceeding or failure to obtain
necessary licenses could prevent us from manufacturing, using,
selling and/or importing in to the United States certain of our
products. Litigation also may be necessary to enforce our patents
against others or to protect our know-how or trade secrets. That
litigation could result in substantial expense or put our
proprietary rights at risk of loss, and we cannot assure you that
any litigation will be resolved in our favor. There currently are
two patent infringement lawsuits pending against us. Although we
do not believe they will have a material adverse effect on our
future financial condition or results of operations, we cannot
assure you of that.
WE MAY BE UNABLE TO MANAGE OUR GROWTH.
Over the past ten years, our businesses and product offerings have
grown substantially. This growth and expansion has placed, and is
expected to continue to place, a significant strain on our
management, operational and financial resources. To manage our
growth, we must continue to (1) expand our operational, customer
support and financial control systems and (2) hire, train and
retain qualified personnel. We cannot assure you that
20
we will be able to adequately manage our growth. If we are unable
to manage our growth effectively, our business, results of
operations and financial condition could be materially adversely
affected.
WE MAY NOT OBTAIN REGULATORY APPROVAL FOR OUR NEW PRODUCTS ON A
TIMELY BASIS, OR AT ALL.
Many of our new products will require FDA approval. FDA approval
typically involves lengthy, detailed and costly laboratory and
clinical testing procedures, as well as the FDA's review and
approval of the information submitted. We cannot assure you that
the products we develop will be determined to be safe and effective
in these testing procedures, or that they will be approved by the
FDA. The FDA also has the authority to revoke for-cause drug
approvals previously granted.
WE MAY BE ADVERSELY AFFECTED BY THE CONTINUING CONSOLIDATION OF OUR
DISTRIBUTION NETWORK AND THE CONCENTRATION OF OUR CUSTOMER BASE.
Our principal customers are wholesale drug distributors, major
retail drug store chains, independent pharmacies and mail order
firms. These customers comprise a significant part of the
distribution network for pharmaceutical products in the United
States. This distribution network is continuing to undergo
significant consolidation marked by mergers and acquisitions among
wholesale distributors and the growth of large retail drug store
chains. As a result, a small number of large wholesale distributors
control a significant share of the market, and the number of
independent drug stores and small drug store chains has decreased.
We expect that consolidation of drug wholesalers and retailers will
increase pricing and other competitive pressures on drug
manufacturers. For the fiscal year ended March 31, 2005, our three
largest customers accounted for 27%, 16% and 12% of our gross
sales. The loss of any of these customers could materially and
adversely affect our results of operations or financial condition.
THE REGULATORY STATUS OF CERTAIN OF OUR GENERIC PRODUCTS MAY MAKE
THEM SUBJECT TO INCREASED COMPETITION.
Many of our products are manufactured and marketed without FDA
approval. For example, our prenatal products, which contain folic
acid, are sold as prescription multiple vitamin supplements. These
types of prenatal vitamins are typically regulated by the FDA as
prescription drugs, but are not covered by an NDA or ANDA. As a
result, competitors may more easily and rapidly introduce products
competitive with our prenatal and other products that have a
similar regulatory status.
One of the key motivations for challenging patents is the reward of
a 180-day period of market exclusivity. Under the Hatch-Waxman Act,
the developer of a generic version of a product which is the first
to have its ANDA accepted for filing by the FDA, and whose filing
includes a certification that the patent is invalid, unenforceable
and/or not infringed (a so-called "Paragraph IV certification"),
may be eligible to receive a 180-day period of generic market
exclusivity. This period of market exclusivity provides the patent
challenger with the opportunity to earn a risk-adjusted return on
legal and development costs associated with bringing a product to
market. In cases such as these where suit is filed by the
manufacturer of the branded product, final FDA approval of an ANDA
generally requires a favorable disposition of the suit, either by
judgment that the patents at issue are invalid and/or not infringed
or by settlement. There can be no assurance that we will ultimately
prevail in these litigations, that we will receive final FDA
approval of our ANDAs, or that any expectation of a period of
generic exclusivity for certain of these products will actually be
realized when and if resolution of the litigations and receipt of
final approvals from the FDA occur.
Since enactment of the Hatch-Waxman Act in 1984, the interpretation
and implementation of the statutory provisions relating to the
180-day period of generic market exclusively have been the subject
of controversy, court decisions, formal changes to FDA regulations
and guidelines, and other changes in FDA interpretation. In
addition, on December 8, 2003, significant changes were enacted in
the statutory provisions themselves, some of which were retroactive
and others of which apply only prospectively or to situations where
the first ANDA filing with a Paragraph IV certification occurs
after the date of enactment. These interpretations and changes,
over time,
21
have had significant affects on the ability of sponsors of
particular generic drug products to qualify for or utilize fully
the 180-day generic marketing exclusivity period. These
interpretations and changes have, in turn, affected the ability of
sponsors of corresponding innovator drugs to market their branded
products without any generic competition and the ability of
sponsors of other generic versions of the same products to market
their products in competition with the first generic applicant.
Because application of these provisions, and any changes in them or
in the applicable interpretations of them, depends almost entirely
on the specific facts of the particular NDA and ANDA filings at
issue, many of which are not in our control, we cannot predict
whether any changes would, on balance, have a positive or negative
effect on our business as a whole, although particular changes may
have predictable, and potentially significant positive or negative
affects on particular pipeline products. In addition, continuing
uncertainty over the interpretation and implementation of the
original Hatch-Waxman provisions, as well as the December 8, 2003
statutory revisions, is likely to continue to impair our ability to
predict the likely exclusivity that we may be granted, or blocked
by, based on the outcome of particular patent challenges in which
we are involved.
WE FACE THE RISK OF PRODUCT LIABILITY CLAIMS, FOR WHICH WE MAY BE
INADEQUATELY INSURED.
Manufacturing, selling and testing pharmaceutical products involve
a risk of product liability. Even unsuccessful product liability
claims could require us to spend money on litigation, divert
management's time, damage our reputation and impair the
marketability of our products. A successful product liability claim
outside of or in excess of our insurance coverage could require us
to pay substantial sums and adversely affect our results of
operations and financial condition.
We previously distributed several pharmaceutical products that
contained phenylpropanolamine, or PPA, and that were discontinued
in 2000 and 2001. We are 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 in December
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 Federal 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 been segregated into a
lawsuit brought by Johnny Fulcher individually and on behalf of the
wrongful death beneficiaries of Linda Fulcher, deceased, against
the Company. 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. In May 2004, the case was dismissed with prejudice by
the Federal District Court for the Western District of Washington
for a failure to timely file an individual complaint as required by
certain court orders. The plaintiff filed a request for
reconsideration which was opposed and subsequently denied by the
Court in June 2004. In July 2004, the plaintiff filed a notice of
appeal of the dismissal. We have opposed this appeal. We intend to
vigorously defend our interests; however, we cannot give any
assurance we will prevail.
We have also been advised that one of our former distributor
customers is being sued in Florida state court in a case captioned
Darrian Kelly v. K-Mart et. al. for personal injury allegedly
caused by ingestion of K-Mart diet caplets that are alleged to have
been manufactured by us and to contain PPA. The distributor has
tendered defense of the case to us and has asserted a right to
indemnification for any financial judgment it must pay. We
previously notified our product liability insurer of this claim in
1999, and we have demanded that the insurer assume our defense. The
insurer has stated that it has retained counsel to secure
additional factual information and will defer its coverage decision
until that information is received. We intend to vigorously defend
our interests; however, we cannot give any assurance that we will
not be impleaded into the action, or that, if we are impleaded,
that we would prevail.
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 will provide for
legal
22
defense costs and indemnity payments involving PPA claims on a
going forward basis as incurred, including the Mississippi lawsuit
that was filed 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
our interests; however, we cannot give any assurances we will
prevail.
WE DEPEND ON LICENSES FROM OTHERS, AND ANY LOSS OF THESE LICENSES
COULD HARM OUR BUSINESS, MARKET SHARE AND PROFITABILITY.
We have acquired the rights to manufacture, use and/or market
certain products. We also expect to continue to obtain licenses for
other products and technologies in the future. Our license
agreements generally require us to develop the markets for the
licensed products. If we do not develop these markets, the
licensors may be entitled to terminate these license agreements.
We cannot be certain that we will fulfill all of our obligations
under any particular license agreement for any variety of reasons,
including insufficient resources to adequately develop and market a
product, lack of market development despite our efforts and lack of
product acceptance. Our failure to fulfill our obligations could
result in the loss of our rights under a license agreement.
Certain products we have the right to license are at certain stages
of clinical tests and FDA approval. Failure of any licensed product
to receive regulatory approval could result in the loss of our
rights under its license agreement.
OUR POLICIES REGARDING RETURNS, ALLOWANCES AND CHARGEBACKS, AND
MARKETING PROGRAMS ADOPTED BY WHOLESALERS, MAY REDUCE OUR REVENUES
IN FUTURE FISCAL PERIODS.
Based on industry practice, generic product manufacturers,
including us, have liberal return policies and have been willing to
give customers post-sale inventory allowances. Under these
arrangements, from time to time, we give our customers credits on
our generic products that our customers hold in inventory after we
have decreased the market prices of the same generic products.
Therefore, if additional competitors enter the marketplace and
significantly lower the prices of any of their competing products,
we would likely reduce the price of our comparable products. As a
result, we would be obligated to provide significant credits to our
customers who are then holding inventories of such products, which
could reduce sales revenue and gross margin for the period the
credit is provided. Like our competitors, we also give credits for
chargebacks to wholesale customers that have contracts with us for
their sales to hospitals, group purchasing organizations,
pharmacies or other retail customers. A chargeback is the
difference between the price the wholesale customer pays and the
price that the wholesale customer's end-customer pays for a
product. Although we establish reserves based on our prior
experience and our best estimates of the impact that these policies
may have in subsequent periods, we cannot ensure that our reserves
are adequate or that actual product returns, allowances and
chargebacks will not exceed our estimates.
INVESTIGATIONS OF THE CALCULATION OF AVERAGE WHOLESALE PRICES MAY
ADVERSELY AFFECT OUR BUSINESS.
Many government and third-party payors, including Medicare,
Medicaid, health maintenance organizations, or HMOs, and managed
care organizations, or MCOs, reimburse doctors and others for the
purchase of certain prescription drugs based on a drug's average
wholesale price, or AWP. In the past several years, state and
federal government agencies have conducted ongoing investigations
of manufacturers' reporting practices with respect to AWP, in which
they have suggested that reporting of inflated AWP's have led to
excessive payments for prescription drugs. Determination of AWP is
complex and third party payors may disagree with our calculations.
23
KV and/or ETHEX have been named as defendants in certain
multi-defendant cases alleging that the defendants reported
improper or fraudulent pharmaceutical pricing information, i.e.,
AWP and/or Wholesale Acquisition Cost, or WAC, information, which
caused the governmental plaintiffs to incur excessive costs for
pharmaceutical products under the Medicaid program. Cases of this
type have been filed against KV and/or ETHEX and other
pharmaceutical manufacturer defendants by the State of
Massachusetts, the State of Alabama, New York City, and
approximately 25 counties in New York State (less than ten of which
have been formally served on KV or ETHEX). The New York City case
and all but one of the New York County cases have been transferred
(or will be the subject of a notice of related action in order to
effectuate transfer) to the Federal District Court for the District
of Massachusetts for coordinated or consolidated pretrial
proceedings under the Average Wholesale Price Multidistrict
Litigation (MDL No. 1456). Each of these actions is in the early
stages, and fact discovery has not yet begun in any of the cases
other than the Alabama case, where the State's first discovery
request has been filed. We intend to vigorously defend our
interests in the actions described above; however, we cannot give
any assurance we will prevail.
We believe that various other governmental entities have commenced
investigations into the generic and branded pharmaceutical industry
at large regarding pricing and price reporting practices. Although
we believe our pricing and reporting practices have complied in all
material respects with our legal obligations, we cannot give any
assurance that we would prevail if legal actions are instituted by
these governmental entities.
RISING INSURANCE COSTS COULD NEGATIVELY IMPACT PROFITABILITY.
The cost of insurance, including workers' compensation, product
liability and general liability insurance, has risen significantly
in the past few years and is expected to continue to increase. In
response, we may increase deductibles and/or decrease certain
coverages to mitigate these costs. These increases, and our
increased risk due to increased deductibles and reduced coverages,
could have a negative impact on our results of operations,
financial condition and cash flows.
INCREASED INDEBTEDNESS MAY IMPACT OUR FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
As a result of our issuance of 2.5% Contingent Convertible
Subordinated Notes, or the Notes, in May 2003, our indebtedness
increased by $200.0 million. In addition, we increased our
available credit facilities in December 2004 to $140.0 million. The
revised credit facilities provide for an increase from $40.0
million to $80.0 million in our revolving line of credit along with
an increase from $25.0 million to $60.0 million in the supplemental
credit line that is available for financing acquisitions. These
credit facilities expire in October 2006 and December 2005,
respectively. At March 31, 2005, we had no cash borrowings under
either credit facility. Our level of indebtedness may have several
important effects on our future operations, including:
o we will be required to use a portion of our cash flow from
operations for the payment of any principal or interest due on
our outstanding indebtedness;
o our outstanding indebtedness and leverage will increase the
impact of negative changes in general economic and industry
conditions, as well as competitive pressures; and
o the level of our outstanding debt and the impact it has on
our ability to meet debt covenants associated with our
revolving line of credit arrangement may affect our
ability to obtain additional financing for working
capital, capital expenditures, acquisitions or general
corporate purposes.
General economic conditions, industry cycles and financial,
business and other factors affecting our operations, many of which
are beyond our control, may affect our future performance. As a
result, our business might not continue to generate cash flow at or
above current levels. If we cannot generate sufficient cash flow
from operations in the future to service our debt, we may, among
other things:
o seek additional financing in the debt or equity markets;
24
o refinance or restructure all or a portion of our indebtedness;
o sell selected assets;
o reduce or delay planned capital expenditures; or
o reduce or delay planned research and development expenditures.
These measures might not be sufficient to enable us to service our
debt. In addition, any financing, refinancing or sale of assets
might not be available on economically favorable terms.
Holders of the Notes may require us to offer to repurchase their
Notes for cash upon the occurrence of a change in control or on May
16, 2008, 2013, 2018, 2023 and 2028. The source of funds for any
repurchase required as a result of any such events will be our
available cash or cash generated from operating activities or other
sources, including borrowings, sales of assets, sales of equity or
funds provided by a new controlling entity. The use of available
cash to fund the repurchase of the Notes may impair our ability to
obtain additional financing in the future.
WE MAY HAVE FUTURE CAPITAL NEEDS AND FUTURE ISSUANCES OF EQUITY
SECURITIES WILL RESULT IN DILUTION.
We anticipate that funds generated internally, together with funds
available under our credit facility, and the proceeds received from
our Notes offering completed in May 2003, will be sufficient to
implement our business plan for the foreseeable future, subject to
additional needs as may arise if acquisition opportunities become
available. We also may need additional capital if unexpected events
occur or opportunities arise. Additional capital might be raised
through the public or private sale of debt or equity securities. If
we sell equity securities, holders of our common stock could
experience dilution. Furthermore, those securities could have
rights, preferences and privileges more favorable than those of the
Class A or Class B common stock. We cannot assure you that
additional funding will be available, or available on terms
favorable to us. If the funding is not available, we may not be
able to fund our expansion, take advantage of acquisition
opportunities or respond to competitive pressures.
WE MAY INCUR CHARGES FOR INTANGIBLE ASSET IMPAIRMENT.
When we acquire the rights to manufacture and sell a product, we
record the aggregate purchase price, along with the value of the
product related liabilities we assume, as intangible assets. We use
the assistance of valuation experts to help us allocate the
purchase price to the fair value of the various intangible assets
we have acquired. Then, we must estimate the economic useful life
of each of these intangible assets in order to amortize their cost
as an expense in our consolidated statement of income over the
estimated economic useful life of the related asset. The factors
that drive the actual economic useful life of a pharmaceutical
product are inherently uncertain, and include patent protection,
physician loyalty and prescribing patterns, competition by products
prescribed for similar indications, future introductions of
competing products not yet FDA approved, the impact of promotional
efforts and many other issues. We use all of these factors in
initially estimating the economic useful lives of our products, and
we also continuously monitor these factors for indications of
appropriate revisions.
In assessing the recoverability of our intangible assets, we must
make assumptions regarding estimated undiscounted future cash flows
and other factors. If the estimated undiscounted future cash flows
do not exceed the carrying value of the intangible assets we must
determine the fair value of the intangible assets. If the fair
value of the intangible assets is less than its carrying value, an
impairment loss will be recognized in an amount equal to the
difference. If these estimates or their related assumptions change
in the future, we may be required to record impairment charges for
these assets. We review intangible assets for impairment at least
annually and whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. If we
determine that an intangible asset is impaired, a non-cash
impairment charge would be recognized.
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As circumstances after an acquisition can change, the value of
intangible assets may not be realized by us. If we determine that
an impairment has occurred, we would be required to write-off the
impaired portion of the unamortized intangible assets, which could
have a material adverse effect on our results of operations in the
period in which the write-off occurs. For example, we expect to
report a non-cash charge of approximately $30.0 million in the
first quarter of fiscal 2006 reflecting primarily a write-off of
in-process research and development costs in connection with our
acquisition of FemmePharma and all of the worldwide marketing
rights to an endometriosis product that has successfully completed
Phase II clinical trials and was originally part of a licensing
arrangement with FemmePharma. In addition, in the event of a sale
of any of our assets, we cannot be certain that our recorded value
of such intangible assets would be recovered.
RISKS RELATED TO OUR INDUSTRY
LEGISLATIVE PROPOSALS, REIMBURSEMENT POLICIES OF THIRD PARTIES,
COST CONTAINMENT MEASURES AND HEALTH CARE REFORM COULD AFFECT THE
MARKETING, PRICING AND DEMAND FOR OUR PRODUCTS.
Various legislative proposals, including proposals relating to
prescription drug benefits, could materially impact the pricing and
sale of our products. Further, reimbursement policies of third
parties may affect the marketing of our products. Our ability to
market our products will depend in part on reimbursement levels for
the cost of the products and related treatment established by
health care providers, including government authorities, private
health insurers and other organizations, such as HMOs and MCOs.
Insurance companies, HMOs, MCOs, Medicaid and Medicare
administrators and others are increasingly challenging the pricing
of pharmaceutical products and reviewing their reimbursement
practices. In addition, the following factors could significantly
influence the purchase of pharmaceutical products, which could
result in lower prices and a reduced demand for our products:
o the trend toward managed health care in the United States;
o the growth of organizations such as HMOs and MCOs;
o legislative proposals to reform health care and government
insurance programs; and
o price controls and non-reimbursement of new and highly priced
medicines for which the economic therapeutic rationales are
not established.
These cost-containment measures and health care reform proposals
could affect our ability to sell our products.
The reimbursement status of a newly approved pharmaceutical product
may be uncertain. Reimbursement policies may not include some of
our products. Even if reimbursement policies of third parties grant
reimbursement status for a product, we cannot be sure that these
reimbursement policies will remain in effect. Limits on
reimbursement could reduce the demand for our products. The
unavailability or inadequacy of third party reimbursement for our
products could reduce or possibly eliminate demand for our
products. We are unable to predict whether governmental authorities
will enact additional legislation or regulation which will affect
third party coverage and reimbursement that reduces demand for our
products.
Our ability to market generic pharmaceutical products successfully
depends, in part, on the acceptance of the products by independent
third parties, including pharmacies, government formularies and
other retailers, as well as patients. We manufacture a number of
prescription drugs which are used by patients who have severe
health conditions. Although the brand-name products generally have
been marketed safely for many years prior to our introduction of a
generic/non-branded alternative, there is a possibility that one of
these products could produce a side effect which could result in an
adverse effect on our ability to achieve acceptance by managed care
providers,
26
pharmacies and other retailers, customers and patients. If these
independent third parties do not accept our products, it could have
a material adverse effect on our financial condition and results of
operations.
EXTENSIVE INDUSTRY REGULATION HAS HAD, AND WILL CONTINUE TO HAVE, A
SIGNIFICANT IMPACT ON OUR BUSINESS, ESPECIALLY OUR PRODUCT
DEVELOPMENT, MANUFACTURING AND DISTRIBUTION CAPABILITIES.
All pharmaceutical companies, including us, are subject to
extensive, complex, costly and evolving regulation by the federal
government, principally the FDA and, to a lesser extent, the DEA
and state government agencies. The Federal Food, Drug and Cosmetic
Act, the Controlled Substances Act and other federal statutes and
regulations govern or influence the testing, manufacturing,
packing, labeling, storing, record keeping, safety, approval,
advertising, promotion, sale and distribution of our products.
Failure to comply with applicable FDA or other regulatory
requirements may result in criminal prosecution, civil penalties,
injunctions, recall or seizure of products and total or partial
suspension of production, as well as other regulatory actions
against our products and us.
We market certain drug products in the United States without FDA
approval under certain "grandfather" clauses and statutory and
regulatory exceptions to the pre-market approval requirement for
"new drugs" under the Federal Food, Drug and Cosmetic Act, or the
FDCA. A determination as to whether a particular product does or
does not require FDA pre-market review and approval can involve
consideration of numerous complex and imprecise factors. If a
determination is made by the FDA that any product marketed without
approval requires such approval, the FDA may institute enforcement
actions, including product seizure, or an action seeking an
injunction against further marketing and may or may not allow
sufficient time to obtain the necessary approvals before it seeks
to curtail further marketing. For example, in October 2002, FDA
sent warning letters to us and other manufacturers and distributors
of unapproved prescription drug products containing the expectorant
guaifenesin as a single entity in a solid oral extended-release
dosage form. Citing the recent approval of one such product, the
FDA warning letters asserted that the marketing of all such
products without NDA or ANDA approval should stop. The FDA
subsequently agreed to allow continued manufacture through May 2003
and sale through November 2003 of the products, and we complied
with those deadlines. We are not in a position to predict whether
or when the FDA might choose to raise similar objections to the
marketing without NDA or ANDA approval of another category or
categories of drug products represented in our product lines. In
the event such objections are raised, we could be required or could
decide to cease distribution of additional products until
pre-market approval is obtained. In addition, we may not be able to
obtain any particular approval that may be required or such
approvals may not be obtained on a timely basis.
In addition to compliance with current Good Manufacturing Practice,
or cGMP, requirements, drug manufacturers must register each
manufacturing facility with the FDA. Manufacturers and distributors
of prescription drug products are also required to be registered in
the states where they are located and in certain states that
require registration by out-of-state manufacturers and
distributors. Manufacturers also must be registered with the Drug
Enforcement Administration, or DEA, and similar applicable state
and local regulatory authorities if they handle controlled
substances, and with the Environmental Protection Agency, or EPA,
and similar state and local regulatory authorities if they generate
toxic or dangerous wastes, and must also comply with other
applicable DEA and EPA requirements. We believe that we are
currently in material compliance with cGMP and are registered with
the appropriate state and federal agencies. Non-compliance with
applicable cGMP requirements or other rules and regulations of
these agencies can result in fines, recall or seizure of products,
total or partial suspension of production and/or distribution,
refusal of government agencies to grant pre-market approval or
other product applications and criminal prosecution. Despite our
ongoing efforts, cGMP requirements and other regulatory
requirements, and related enforcement priorities and policies may
evolve over time and we may not be able to remain continuously in
material compliance with all of these requirements.
From time to time, governmental agencies have conducted
investigations of pharmaceutical companies relating to the
distribution and sale of drug products to government purchasers or
subject to government or third party reimbursement. We believe that
we have marketed our products in compliance with applicable laws
and
27
regulations. However, standards sought to be applied in the course
of governmental investigations can be complex and may not be
consistent with standards previously applied to our industry
generally or previously understood by us to be applicable to our
activities.
The process for obtaining governmental approval to manufacture and
market pharmaceutical products is rigorous, time-consuming and
costly, and we cannot predict the extent to which we may be
affected by legislative and regulatory developments. We are
dependent on receiving FDA and other governmental or third-party
approvals prior to manufacturing, marketing and shipping many of
our products. Consequently, there is always the chance that we will
not obtain FDA or other necessary approvals, or that the rate,
timing and cost of such approvals, will adversely affect our
product introduction plans or results of operations. In many
instances we carry inventories of products in anticipation of
launch, and if such products are not subsequently launched, we may
be required to write-off the related inventory.
OUR INDUSTRY IS HIGHLY COMPETITIVE.
Numerous pharmaceutical companies are involved or are becoming
involved in the development and commercialization of products
incorporating advanced drug delivery systems. Our business is
highly competitive, and we believe that competition will continue
to increase in the future. Many pharmaceutical companies have
invested, and are continuing to invest, significant resources in
the development of proprietary drug delivery systems. In addition,
several companies have been formed to develop specific advanced
drug delivery systems. Many of these pharmaceutical and other
companies who may develop drug delivery systems have greater
financial, research and development and other resources than we do,
as well as more experience in commercializing pharmaceutical and
drug delivery products. Those companies may develop products using
their drug delivery systems more rapidly than we do or develop drug
delivery systems that are more effective than ours and thus may
represent significant potential competitors.
Our branded pharmaceutical business is subject to competition from
larger companies with greater financial resources that can support
larger sales forces. The ability of a sales force to compete is
affected by the number of physician calls it can make, which is
directly related to its size, the brand name recognition it has in
the marketplace and its advertising and promotional efforts. We are
not as well established in our branded product sales initiative as
larger pharmaceutical companies and could be adversely affected by
competition from companies with larger, more established sales
forces and higher advertising and promotional expenditures.
Our generic pharmaceutical business is also subject to competitive
pressures from a number of companies, some of which have greater
financial resources and broader product lines. To the extent that
we succeed in being first to market with a generic/non-branded
version of a significant product, our sales and profitability can
be substantially increased in the period following the introduction
of such product and prior to additional competitors' introduction
of an equivalent product. Competition is generally on price, which
can have an adverse effect on profitability as falling prices erode
margins. In addition, the continuing consolidation of the customer
base (wholesale distributors and retail drug chains) and the impact
of managed care organizations will increase competition as
suppliers compete for fewer customers. Consolidation of competitors
will increase competitive pressures as larger suppliers are able to
offer a broader product line. Further, companies continually seek
new ways to defeat generic competition, such as filing applications
for new patents to cover drugs whose original patent protection is
about to expire, developing and marketing other dosage forms
including patented controlled-release products or developing and
marketing as over-the-counter products those branded products which
are about to lose exclusivity and face generic competition.
In addition to litigation over patent rights, pharmaceutical
companies are often the subject of objections by competing
manufacturers over the qualities of their branded or generic
products and/or their promotional activities. For example,
marketers of branded products have challenged the marketing of
certain of our non-branded products that do not require FDA
approval and are not rated for therapeutic equivalence.
28
Currently, the Company and ETHEX are named as defendants in ongoing
litigation with Solvay Pharmaceuticals, Inc. regarding Solvay's
allegations that ETHEX's comparative promotion of its
Pangestyme(TM) CN 10 and Pangestyme(TM) CN 20 products to Solvay's
Creon(R) 10 and Creon(R) 20 products resulted in false advertising
and misleading statements under various Federal and state laws, and
constituted unfair and deceptive trade practices. Discovery is
active and the case is required to be ready for trial by February
1, 2006. The Company intends to vigorously defend its interests;
however, it cannot give any assurance it will prevail.
Competitors' objections also may be pursued in complaints before
governmental agencies or courts. These objections can be very
expensive to pursue or to defend, and the outcome of agency or
court review of the issues raised is impossible to predict. In
these proceedings, companies can be subjected to restrictions on
their activities or to liability for alleged damages despite their
belief that their products and procedures are in full compliance
with appropriate standards. In addition, companies that pursue what
they believe are legitimate complaints about competing
manufacturers and/or their products may nevertheless be unable to
obtain any relief.
OUR INDUSTRY EXPERIENCES RAPID TECHNOLOGICAL CHANGE.
The drug delivery industry is a rapidly evolving field. A number of
companies, including major pharmaceutical companies, are developing
and marketing advanced delivery systems for the controlled delivery
of drugs. Products currently on the market or under development by
competitors may deliver the same drugs, or other drugs to treat the
same indications, as many of the products we market or are
developing. The first pharmaceutical branded or generic/non-branded
product to reach the market in a therapeutic area often obtains and
maintains significant market share relative to later entrants to
the market. Our products also compete with drugs marketed not only
in similar delivery systems but also in traditional dosage forms.
New drugs, new therapeutic approaches or future developments in
alternative drug delivery technologies may provide advantages over
the drug delivery systems and products that we are marketing, have
developed or are developing.
Changes in drug delivery technology may require substantial
investments by companies to maintain their competitive position and
may provide opportunities for new competitors to enter the
industry. Developments by others could render our drug delivery
products or other technologies uncompetitive or obsolete. If others
develop drugs which are cheaper or more effective or which are
first to market, sales or prices of our products could decline.
RISKS RELATED TO OUR COMMON STOCK
MANAGEMENT STOCKHOLDERS CONTROL OUR COMPANY.
At March 31, 2005, our directors and executive officers
beneficially own approximately 13% of our Class A Common Stock and
approximately 60% of our Class B Common Stock. As a result, these
persons control approximately 53% of the combined voting power
represented by our outstanding securities. These persons will
retain effective voting control of our company and are expected to
continue to have the ability to effectively determine the outcome
of any matter being voted on by our stockholders, including the
election of directors and any merger, sale of assets or other
change in control of our company.
THE MARKET PRICE OF OUR STOCK HAS BEEN AND MAY CONTINUE TO BE
VOLATILE.
The market prices of securities of companies engaged in
pharmaceutical development and marketing activities historically
have been highly volatile. In addition, any or all of the following
may have a significant impact on the market price of our common
stock: announcements by us or our competitors of technological
innovations or new commercial products; delays in the development
or approval of products; developments or disputes concerning patent
or other proprietary rights; publicity regarding actual or
potential medical results relating to products marketed by us or
products under development; regulatory developments in both the
United States and foreign countries; publicity regarding actual or
potential acquisitions; public concern as to the safety of drug
29
technologies or products; financial results which are different
from securities analysts' forecasts; and economic and other
external factors, as well as period-to-period fluctuations in our
financial results.
FUTURE SALES OF COMMON STOCK COULD ADVERSELY AFFECT THE MARKET
PRICE OF OUR CLASS A OR CLASS B COMMON STOCK.
As of March 31, 2005, an aggregate of 2,707,207 shares of our Class
A common stock and 395,591 shares of our Class B common stock were
issuable upon exercise of outstanding stock options under our stock
option plans, and an additional 988,473 shares of our Class A
common stock and 1,214,399 shares of Class B common stock were
reserved for the issuance of additional options and shares under
these plans. In addition, as of March 31, 2005, 8.7 million shares
of Class A common stock were reserved for issuance upon conversion
of $200.0 million principal amount of convertible notes, and
337,500 shares of our Class A common stock were reserved for
issuance upon conversion of our outstanding 7% cumulative
convertible preferred stock.
Future sales of our common stock and instruments convertible or
exchangeable into our common stock and transactions involving
equity derivatives relating to our common stock, or the perception
that such sales or transactions could occur, could adversely affect
the market price of our common stock. This could, in turn, have an
adverse effect on the trading price of the Notes resulting from,
among other things, a delay in the ability of holders to convert
their Notes into our Class A common stock.
OUR CHARTER PROVISIONS AND DELAWARE LAW MAY HAVE ANTI-TAKEOVER
EFFECTS.
Our Amended Certificate of Incorporation authorizes the issuance of
common stock in two classes, Class A common stock and Class B
common stock. Each share of Class A common stock entitles the
holder to one-twentieth of one vote on all matters to be voted upon
by stockholders, while each share of Class B common stock entitles
the holder to one full vote on each matter considered by the
stockholders. In addition, our directors have the authority to
issue additional shares of preferred stock and to determine the
price, rights, preferences, privileges and restrictions of those
shares without any further vote or action by the stockholders. The
rights of the holders of common stock will be subject to, and may
be adversely affected by, the rights of the holders of any
preferred stock that may be issued in the future. The existence of
two classes of common stock with different voting rights and the
ability of our directors to issue additional shares of preferred
stock could make it more difficult for a third party to acquire a
majority of our voting stock. Other provisions of our Amended
Certificate of Incorporation and Bylaws, such as a classified board
of directors, also may have the effect of discouraging, delaying or
preventing a merger, tender offer or proxy contest, which could
have an adverse effect on the market price of our Class A common
stock.
In addition, certain provisions of Delaware law applicable to our
company could also delay or make more difficult a merger, tender
offer or proxy contest involving our company, including Section 203
of the Delaware General Corporation Law, which prohibits a Delaware
corporation from engaging in any business combination with any
interested stockholder for a period of three years unless certain
conditions are met. Our senior management is entitled to certain
payments upon a change in control. All of our stock option plans
provide for the acceleration of vesting in the event of a change in
control of our company.
30
ITEM 2. PROPERTIES
----------
Our corporate headquarters is located at 2503 South Hanley Road in
St. Louis County, Missouri, and contains approximately 40,000
square feet of floor space. We have a lease on the building for a
period of ten years expiring December 31, 2006, with one five-year
option to renew and a successive three-year renewal option. The
building is leased from an affiliated partnership of an officer and
director of the Company.
In addition, we lease or own the facilities shown in the following
table. All of these facilities are located in the St. Louis
metropolitan area.
SQUARE LEASE RENEWAL
FOOTAGE USAGE EXPIRES OPTIONS
-----------------------------------------------------------------------------------------
31,630 PDI Office/Mfg./Whse. 11/30/07 5 Years(1)
10,000 PDI/KV Lab/Whse. 11/30/05 None
15,000 KV/Ther-Rx Office 02/28/08 2 Years(3)
23,000 KV Office/R&D/Mfg. 12/31/06 5 Years(2)
122,350 KV Office/Whse./Lab Owned N/A
90,000 KV Mfg. Oper. Owned N/A
87,020 Under renovation(5) Owned N/A
302,940 Under renovation(6) Owned N/A
260,160 ETHEX/Ther-Rx/PDI Distribution(7) 04/30/12 5 Years(2)
40,000 KV Warehouse 11/30/05 1 Year(4)
128,960 ETHEX/PDI Office/Whse. 06/14/11 5 Years(2)
-------
(1) One five-year option.
(2) Two five-year options.
(3) Two two-year options.
(4) Two one-year options.
(5) This facility is currently being renovated to provide an
additional research lab facility.
(6) This facility is currently being renovated into office space
for ETHEX, Ther-Rx and certain KV administrative functions and
production space for additional operations. We financed the
purchase of this facility with a term loan secured by the
facility.
(7) On April 14, 2005, the Company completed the purchase of this
building for $11.8 million. The property had been leased by
the Company since April 2000 and will continue to function as
the Company's main distribution facility. The purchase price
of the building was paid with cash on hand.
Properties used in our operations are considered suitable for the
purposes for which they are used and are believed to be adequate to
meet our Company's needs for the reasonably foreseeable future.
However, we will consider leasing or purchasing additional
facilities from time to time, when attractive facilities become
available, to accommodate the consolidation of certain operations
and to meet future expansion plans.
ITEM 3. LEGAL PROCEEDINGS
-----------------
The Company and ETHEX are named as defendants in a case brought by
CIMA LABS, Inc. and Schwarz Pharma, Inc. and styled CIMA LABS, Inc.
et. al. v. KV Pharmaceutical Company et. al. filed in Federal
District Court in Minnesota. It is alleged that the Company and
ETHEX infringed on a CIMA patent in connection with the manufacture
and sale of Hyoscyamine Sulfate Orally Dissolvable Tablets, 0.125
mg. The court has denied the plaintiffs' motion for a preliminary
injunction, which allows ETHEX to continue marketing the product
during the pendancy of the subject lawsuit. The Company has filed
several motions for summary judgment requesting that the Court rule
that the relevant patent is unenforceable, invalid or not
infringed. These motions have been denied and the issues will be
considered at trial. CIMA and Schwarz filed a summary judgment
motion seeking the Court to rule that the patent is valid in the
face of some prior art references cited by the Company as providing
support for its invalidity defense. The Court granted the motion;
however, the issue of invalidity based on prior art
31
that was not the subject of the motion will be tried. The Company
intends to vigorously defend its interests; however, it cannot give
any assurance it will prevail.
The Company and ETHEX are named as defendants in a case brought by
Solvay Pharmaceuticals, Inc. and styled Solvay Pharmaceuticals,
Inc. v. ETHEX Corporation, filed in Federal District Court in
Minnesota. In general, Solvay alleges that ETHEX's comparative
promotion of its Pangestyme(TM) CN 10 and Pangestyme(TM) CN 20
products to Solvay's Creon(R) 10 and Creon(R) 20 products resulted
in false advertising and misleading statements under various
federal and state laws, and constituted unfair and deceptive trade
practices. Discovery is active and the case is required to be trial
ready by February 1, 2006. The Company intends to vigorously defend
its interests; however, it cannot give any assurance it will
prevail.
KV previously distributed several 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 in December
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 Federal 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 been segregated
into a lawsuit brought by Johnny Fulcher individually and on behalf
of the wrongful death beneficiaries of Linda Fulcher, deceased,
against the Company. 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. In May 2004, the case was
dismissed with prejudice by the Federal District Court for the
Western District of Washington for a failure to timely file an
individual complaint as required by certain court orders. The
plaintiff filed a request for reconsideration which was opposed and
subsequently denied by the Court in June 2004. In July 2004, the
plaintiff filed a notice of appeal of the dismissal. The Company
has opposed this appeal. The Company intends to vigorously defend
its interests; however, it cannot give any assurance it will
prevail.
The Company has also been advised that one of its former
distributor customers is being sued in Florida state court in a
case captioned Darrian Kelly v. K-Mart et. al. for personal injury
allegedly caused by ingestion of K-Mart diet caplets that are
alleged to have been manufactured by the Company and to contain
PPA. The distributor has tendered defense of the case to the
Company and has asserted a right to indemnification for any
financial judgment it must pay. The Company previously notified its
product liability insurer of this claim in 1999, and the Company
has demanded that the insurer assume the Company's defense. The
insurer has stated that it has retained counsel to secure
additional factual information and will defer its coverage decision
until that information is received. The Company intends to
vigorously defend its interests; however, it cannot give any
assurance that it will not be impleaded into the action, or that,
if it is impleaded, that it would prevail.
KV's product liability coverage for PPA claims expired for claims
made after June 15, 2002. Although the Company renewed its product
liability coverage for coverage after June 15, 2002, that policy
excludes future PPA claims in accordance with the standard industry
exclusion. Consequently, as of June 15, 2002, the Company will
provide for legal defense costs and indemnity payments involving
PPA claims on a going forward basis as incurred, 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 its
interests; however, it cannot give any assurance it will prevail.
After the Company filed ANDAs with the FDA seeking permission to
market a generic version of the 50 mg, 100 mg, and 200 mg strengths
of Toprol(R) XL in extended release capsule form, AstraZeneca filed
lawsuits against KV for patent infringement under the provisions of
the Hatch-Waxman Act. In the Company's Paragraph IV certification,
KV contended that its proposed generic versions do not infringe
AstraZeneca's patents. Pursuant to
32
the Hatch-Waxman Act, the filing date of the suit against the
Company instituted an automatic stay of FDA approval of the
Company's ANDA until the earlier of a judgment of non-infringement
or invalidity, or 30 months from the date the application was
filed. The Company has filed a motion for summary judgment with the
Federal District Court in Missouri alleging, among other things,
that AstraZeneca's patent is invalid. There is no trial setting.
The Company intends to vigorously defend its interests; however, it
cannot give any assurances it will prevail.
The Company and/or ETHEX have been named as defendants in certain
multi-defendant cases alleging that the defendants reported
improper or fraudulent pharmaceutical pricing information, i.e.,
AWP and/or Wholesale Acquisition Cost, or WAC, information, which
caused the governmental plaintiffs to incur excessive costs for
pharmaceutical products under the Medicaid program. Cases of this
type have been filed against the Company and/or ETHEX and other
pharmaceutical manufacturer defendants by the State of
Massachusetts, the State of Alabama, New York City, and
approximately 25 counties in New York State (less than ten of which
have been formally served on the Company or ETHEX). The New York
City case and all but one of the New York County cases have been
transferred (or will be the subject of a notice of related action
in order to effectuate transfer) to the Federal District Court for
the District of Massachusetts for coordinated or consolidated
pretrial proceedings under the Average Wholesale Price
Multidistrict Litigation (MDL No. 1456). Each of these actions is
in the early stages, and fact discovery has not yet begun in any of
the cases other than the Alabama case, where the State's first
discovery request has been filed. The Company intends to vigorously
defend its interests in the actions described above; however, it
cannot give any assurance it will prevail.
The Company believes that various other governmental entities have
commenced investigations into the generic and branded
pharmaceutical industry at large regarding pricing and price
reporting practices. Although the Company believes its pricing and
reporting practices have complied in all material respects with its
legal obligations, it cannot give any assurances that it would
prevail if legal actions are instituted by these governmental
entities.
On May 20, 2005 the Company was notified by the SEC that a
non-public formal investigation was initiated that appears to
relate to the Form 8-K disclosures the Company made on July 13,
2004. The Company is cooperating fully and believes the matter will
be satisfactorily resolved.
From time to time, 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 submitted ANDA filings and provided
notice of certification required under the provisions of the 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.
There are uncertainties and risks associated with all litigation
and there can be no assurance that the Company will prevail in any
particular litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
No matters were submitted to a vote of security holders during the
fourth quarter of the Company's fiscal year ended March 31, 2005.
33
ITEM 4(A). EXECUTIVE OFFICERS OF THE REGISTRANT
------------------------------------
The following is a list of current executive officers of our
Company, their ages, their positions with our Company and their
principal occupations for at least the past five years.
NAME AGE POSITION HELD AND PAST EXPERIENCE
- ----------------------------------------------------------------------------------------------------------------------------------
Marc S. Hermelin 63 Vice Chairman of the Board of the Company since 1974; Chief Executive Officer from 1975 to
February 1994 and since December 1994; Director and Vice President of Particle Dynamics, Inc.
since 1974.(1)
Alan G. Johnson 70 Director, Senior Vice President-Strategic Planning and Corporate Growth since September 1999 and
Secretary of the Company; Chairman of Johnson Research & Capital, Inc., an investment banking and
institutional research firm from January to September 1999; Member of the law firm Gallop,
Johnson & Neuman, L.C. 1976 to 1998; Director of Siboney Corporation.
Gerald R. Mitchell 65 Vice President and Chief Financial Officer since 1981.
Richard H. Chibnall 49 Vice President, Finance since February 2000.
Michael S. Anderson 56 Chief Executive Officer, Ther-Rx Corporation since February 2000.
Jerald J. Wenker 43 President, Ther-Rx Corporation since June 2004; Vice President, Licensing and New Business
Development, Abbot Corporation from January 2002 to April 2004; Vice President and General
Manager, Anti-Infective Franchise Abbot Corporation from April 2000 to January 2002.
Philip J. Vogt 48 President, ETHEX Corporation since February 2000.
Ray F. Chiostri 71 Chairman and Chief Executive Officer, Particle Dynamics, Inc. since 1999.
Paul T. Brady 42 President, Particle Dynamics, Inc. since 2003; Senior Vice President and General Manager,
International Specialty Products Corporation from June 2002 to January 2003; Senior Vice
President, Commercial Director, North and South America International Specialty Products
from 2000 to 2002.
Eric D. Moyermann 47 President, Pharmaceutical Manufacturing since February 2000.
Executive officers of the Company serve at the pleasure of the
Board of Directors.
- ----------
(1) Marc S. Hermelin is the son of Victor M. Hermelin, Chairman of the
Board of Directors of the Company since 1971 and father of David S.
Hermelin, a member of the Board of Directors since 2004.
34
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
a) PRINCIPAL MARKET
----------------
Our Class A common stock and Class B common stock are traded on the
New York Stock Exchange under the symbols KV.A and KV.B,
respectively.
b) APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK
---------------------------------------------
The number of holders of record of Class A and Class B Common Stock
as of June 9, 2005 was 786 and 389, respectively (not separately
counting shareholders whose shares are held in "nominee" or
"street" names, which are estimated to represent approximately
5,000 additional Class A common stock and Class B common stock
shareholders combined).
c) STOCK PRICE AND DIVIDEND INFORMATION
------------------------------------
The high and low closing sales prices of our Class A and Class B
common stock during each quarter of fiscal 2005 and 2004, as
reported on the New York Stock Exchange and as adjusted for the 3
for 2 stock split effective on September 8, 2003 were as follows:
CLASS A COMMON STOCK
--------------------
FISCAL 2005 FISCAL 2004
----------- -----------
QUARTER HIGH LOW HIGH LOW
------- -------------------- ---------------------
First...................... $26.24 $22.25 $20.29 $12.61
Second..................... 23.11 15.31 23.49 17.91
Third...................... 22.14 18.18 27.67 22.22
Fourth..................... 23.20 19.78 27.51 22.10
CLASS B COMMON STOCK
--------------------
FISCAL 2005 FISCAL 2004
----------- -----------
QUARTER HIGH LOW HIGH LOW
------- -------------------- ---------------------
First...................... $29.60 $25.00 $20.39 $12.63
Second..................... 25.05 16.35 23.53 18.09
Third...................... 22.77 18.65 27.77 22.31
Fourth..................... 23.49 20.42 29.40 22.60
Since 1980, we have not declared or paid any cash dividends on our
common stock and we do not plan to do so in the foreseeable future.
No dividends may be paid on Class A common stock or Class B common
stock unless all dividends on the Cumulative Convertible Preferred
Stock have been declared and paid. Dividends must be paid on Class
A common stock when, and if, we declare and distribute dividends on
the Class B common stock. Dividends of $70,000 were paid in fiscal
2005 and 2004 on 40,000 shares of outstanding Cumulative
Convertible Preferred Stock. Also, $366,000, or $9.14 per share, of
undeclared and unaccrued cumulative preferred dividends were paid
on May 12, 2003. There were no undeclared and unaccrued cumulative
preferred dividends at March 31, 2005.
35
Also, under the terms of our credit agreement, we may not pay cash
dividends in excess of 25% of the prior fiscal year's consolidated
net income. For the foreseeable future, we plan to use cash
generated from operations for general corporate purposes, including
funding potential acquisitions, research and development and
working capital. Our board of directors reviews our dividend policy
periodically. Any payment of dividends in the future will depend
upon our earnings, capital requirements, financial condition and
other factors considered relevant by our board of directors. See
also Item 12 for information relating to the Company's equity
compensation plans.
- ----------------------------------------------------------------------------------------------------------------------
Issuer Purchases of Equity Securities
- ----------------------------------------------------------------------------------------------------------------------
Period Total number of Average price paid Total number of Maximum number (or
shares purchased per share shares purchased approximate dollar
(a) as part of publicly value) of shares (or
announced plans or units) that may yet
programs be purchased under
the plans or programs
- ----------------------------------------------------------------------------------------------------------------------
1/1/05 - 1/31/05 188 $21.75 -- --
- ----------------------------------------------------------------------------------------------------------------------
2/1/05 - 2/28/05 104 $20.22 -- --
- ----------------------------------------------------------------------------------------------------------------------
3/1/05 - 3/31/05 64 $21.85 -- --
- ----------------------------------------------------------------------------------------------------------------------
Total 356 $21.32 -- --
- ----------------------------------------------------------------------------------------------------------------------
(a) Shares were purchased from employees upon their termination pursuant to the
terms of the Company's stock option plan.
36
ITEM 6. SELECTED FINANCIAL DATA
-----------------------
(in thousands, except per share data)
MARCH 31,
--------------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
BALANCE SHEET DATA:
Total assets $558,317 $528,438 $352,668 $195,192 $151,417
Long-term debt 209,767 210,741 10,106 4,387 5,080
Shareholders' equity 292,702 257,749 260,616 158,792 125,942
INCOME STATEMENT DATA:
YEARS ENDED MARCH 31,
--------------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
Net revenues $303,493 $283,941 $244,996 $204,105 $177,767
% Increase from prior period 6.9% 15.9% 20.0% 14.8% 24.5%
Operating income(a)(b)(c) $ 52,412 $ 73,771 $ 42,929 $ 49,294 $ 37,972
Net income(a)(b)(c) 33,269 45,848 28,110 31,464 23,625
Net income
per common
share-diluted(d) (e) $ 0.63 $ 0.84 $ 0.55 $ 0.65 $ 0.49
Preferred stock dividends $ 70 $ 436 $ 70 $ 70 $ 420
- ---------------------------
(a) Operating income in fiscal 2005 included a $0.6 million net payment
received by us in accordance with a legal settlement and additional
income of $0.8 million for the reversal of a portion of the
Healthpoint litigation reserve that remained after payment of the
$16.5 million settlement amount and related litigation costs (see
Note 11 in the accompanying Notes to Consolidated Financial
Statements). The impact of these items, net of applicable income
taxes, was to increase net income by $1.0 million and diluted
earnings per share by $.02 in fiscal 2005.
(b) Operating income in fiscal 2004 included a $3.5 million net payment
received by us in accordance with a legal settlement (see Note 13
in the accompanying Notes to Consolidated Financial Statements) and
an additional reserve of $1.8 million for attorney's fees
associated with a lawsuit. The impact of these items, net of
applicable income taxes, was to increase net income by $1.1 million
and diluted earnings per share by $.02 in fiscal 2004.
(c) Operating income in fiscal 2003 included a reserve of $16.5 million
for potential damages associated with the Healthpoint litigation.
The impact of the litigation reserve, net of applicable income
taxes, was to reduce net income by $10.4 million and diluted
earnings per share by $.20 in fiscal 2003.
(d) Previously reported amounts give effect to the three-for-two stock
splits effected in the form of a 50% stock dividend that occurred
on September 29, 2003 and September 7, 2000.
(e) Amounts for fiscal year 2004 have been restated to report shares
issuable upon conversion of contingent convertible notes, which
were issued in May 2003, pursuant to Emerging Issues Task Force
(EITF) Issue No. 04-08, the Effect of Contingently Convertible Debt
on Diluted Earnings per Share.
37
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS,
--------------------------------------------------------------
AND LIQUIDITY AND CAPITAL RESOURCES
-----------------------------------
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 such forward-looking statements.
These risks, uncertainties and other factors are discussed
throughout this report and specifically under the captions
"Cautionary Statement Regarding Forward-Looking Information" and
"Risk Factors." In addition, the following discussion and analysis
of the financial condition and results of operations should be read
in conjunction with "Selected Financial Data" and our consolidated
financial statements and notes thereto appearing elsewhere in this
Form 10-K.
BACKGROUND
We are a fully integrated specialty pharmaceutical company that
develops, acquires, manufactures and markets technologically-
distinguished branded and generic/non-branded 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 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 oral 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
In fiscal 2005, net revenues increased 6.9% as we experienced sales
growth compared to fiscal 2004 in all three of our operating
segments: branded products, specialty generics and specialty
materials. Our sales growth in fiscal 2005 was constrained by
slower than anticipated ANDA approvals by the FDA on two brand
equivalent products that we expected to introduce in the fourth
quarter of fiscal 2005 and delays in the timing of other certain
approvals during the year. We expect these approvals will be
received in the second half of fiscal 2006. Sales of our branded
segment also were negatively impacted in the fourth quarter by a
shortage of raw material for one of our products. The $10.3 million
increase in gross profit was more than offset by an increase in
operating expenses of $31.7 million. The increase in operating
expenses was primarily due to: greater personnel expenses
associated with an increase in management personnel and expansion
of the branded sales force, an increase in branded marketing
expense primarily related to the approval and introduction of the
Company's second NDA product - Clindesse(TM), increases in
professional fees and legal expenses, and an increase in research
and development expense. As a result, net income decreased $12.6
million, or 27.4%, to $33.3 million compared to fiscal 2004.
38
FISCAL 2005 COMPARED TO FISCAL 2004
NET REVENUES BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2005 2004 $ %
-------- -------- ------- -----
Branded products $ 90,085 $ 82,868 $ 7,217 8.7%
as % of net revenues 29.7% 29.2%
Specialty generics 191,870 181,455 10,415 5.7%
as % of net revenues 63.2% 63.9%
Specialty materials 18,345 16,550 1,795 10.8%
as % of net revenues 6.0% 5.8%
Other 3,193 3,068 125 4.1%
======== ======== =======
Total net revenues $303,493 $283,941 $19,552 6.9%
The increase in branded product sales was due primarily to the
introduction of Clindesse(TM) in the fourth quarter of fiscal 2005,
continued growth of Gynazole-1(R) and increased sales of our two
hematinic brands. The introduction of Clindesse(TM), a single-dose
prescription cream therapy indicated to treat bacterial vaginosis,
contributed $4.2 million of incremental sales during the fourth
quarter of fiscal 2005. Since its launch in January 2005,
Clindesse(TM) has garnered 13.1% of the intravaginal bacterial
vaginosis market in the United States. Sales of Gynazole-1, our
vaginal antifungal cream product, increased $2.7 million, or 14.4%,
to $21.3 million during fiscal 2005 as our share of the
prescription vaginal antifungal cream market increased to 31.5% at
the end of fiscal 2005, from 26.9% at the end of the prior year.
Sales from our two hematinic product lines, Chromagen(R) and
Niferex(R), increased 22.6% to $25.4 million during fiscal 2005 as
both product lines experienced significant growth in new
prescriptions filled. During the year, new prescription growth for
Chromagen(R) and Niferex(R) was 74.7% and 52.7%, respectively,
compared to the prior year. Also included in branded product sales
is the PreCare(R) product line which contributed $31.7 million of
sales during fiscal 2005. Although sales of our PreCare(R) product
line declined 2.7% during the year, the PreCare(R) family of
products continued to be the leading branded line of prescription
prenatal nutritional supplements in the United States. The $0.9
million decrease in sales of our PreCare(R) product line was
partially the result of a temporary fourth quarter supply
disruption of PrimaCare(R) ONE, our proprietary line extension to
PrimaCare(R), that was launched in the second quarter. Prior to the
occurrence of this supply issue, which has since been resolved,
PrimaCare(R) ONE generated $4.1 million of incremental sales in
fiscal 2005. The increase in branded product sales for fiscal 2005
was partially offset by a $2.2 million decline in sales of our
Micro-K(R) product line.
The growth in specialty generic sales resulted from $15.9 million
of incremental sales volume from new product introductions,
principally in our lower margin cough/cold product line, coupled
with $8.8 million of increased sales volume from existing products
in our cardiovascular and pain management product lines. These
increases were offset in part by product price erosion of $14.3
million principally in the second half of the fiscal year, that
resulted from pricing pressures on certain products in the
cardiovascular, pain management and cough/cold product lines.
Although specialty generic sales increased in fiscal 2005, we
experienced a $9.0 million, or 18.2%, decline in sales for the
three months ended March 31, 2005. This decrease resulted from a
significant decline in cardiovascular products sales due in part to
the absence of trade shows that occurred in the fourth quarter of
the prior year and resulted in an unfavorable mix in product
categories in the fourth quarter of fiscal 2005. The anticipated
approval of Diltiazem and another product in the fourth quarter of
fiscal 2005, would have more than offset the above decrease, had
the approvals been received. We now expect them to be launched in
the second half of fiscal 2006.
39
The increase in specialty material product sales was primarily due
to renewed focus on expanding the specialty materials business, the
addition of a new major customer in fiscal 2005 that resulted in
$1.3 million of incremental sales and an increased emphasis on
international markets that provided additional sales of $1.0
million in fiscal 2005.
GROSS PROFIT BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
-----------------------------------------
CHANGE
-----------------
($ IN THOUSANDS): 2005 2004 $ %
-------- -------- ------- -------
Branded products $ 78,844 $ 72,008 $ 6,836 9.5%
as % of net revenues 87.5% 86.9%
Specialty generics 113,084 110,180 2,904 2.6%
as % of net revenues 58.9% 60.7%
Specialty materials 6,394 4,789 1,605 33.5%
as % of net revenues 34.9% 28.9%
Other (2,511) (1,463) (1,048) (71.6)%
======== ======== =======
Total gross profit $195,811 $185,514 $10,297 5.6%
as % of total net
revenues 64.5% 65.3%
The increase in gross profit was primarily attributable to the
sales growth experienced by all three of our segments: branded
products, specialty generics and specialty materials. The lower
gross profit percentage on a consolidated basis primarily reflected
the impact of price erosion on certain specialty generic products
beginning in the second quarter and extending through the balance
of fiscal 2005, offset in part by certain selective price increases
taken near the end of the third quarter. The gross profit
percentage decline experienced by the specialty generics segment
was offset in part by a shift in the mix of branded product sales
toward higher margin products with the introduction of
Clindesse(TM) in the fourth quarter coupled with improved pricing
and lower raw material costs at our specialty materials business.
RESEARCH AND DEVELOPMENT
------------------------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2005 2004 $ %
------- ------- ------ -----
Research and development $23,538 $20,651 $2,887 14.0%
as % of net revenues 7.8% 7.3%
The increase in research and development expense primarily resulted
from increased spending on bioequivalency studies for products in
our internal development pipeline and higher personnel expenses
related to the growth of our research and development staff. In May
2005, we announced an agreement with FemmePharma to terminate the
license agreement we entered into with them in April 2002. As part
of this transaction, we acquired FemmePharma for $25.0 million
after the assets of the entity had been distributed to
FemmePharma's other shareholders. Included in our acquisition of
FemmePharma are all of the worldwide marketing rights to an
endometriosis product that has successfully completed Phase II
clinical trials and was originally part of the licensing
arrangement with FemmePharma. In connection with this transaction,
we expect to incur an in-process
40
research and development charge of approximately $30.0 million in
the first quarter of fiscal 2006, which includes the write-off of
the $25.0 million payment plus preferred stock investments
previously made.
SELLING AND ADMINISTRATIVE
--------------------------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2005 2004 $ %
-------- ------- ------- -----
Selling and administrative $116,638 $88,333 $28,305 32.0%
as % of net revenues 38.4% 31.1%
The increase in selling and administrative expense was due
primarily to: greater personnel expenses resulting from an increase
in management personnel ($4.3 million) and expansion of the branded
sales force ($5.1 million including approximately $1.1 million for
sales representatives added during the fourth quarter of fiscal
2005); a $2.2 million increase in branded marketing and promotions
expense commensurate with the growth of the segment; a $2.9 million
increase in rent, depreciation, insurance and utilities expense
associated with expansion of our office facilities over the past
two years; a $1.7 million increase in professional fees associated
primarily with implementation of the internal control provisions of
the Sarbanes-Oxley Act of 2002; a $1.2 million increase in legal
expense; and $3.0 million of costs incurred in the fourth quarter
to support the launch of Clindesse(TM). The increase in legal
expense was due to an increase in litigation activity, which
included various patent infringement actions brought by potential
competitors with respect to products we propose to market and for
which we have submitted ANDA filings and provided notice of
certification required under the provisions of the Hatch-Waxman
Act.
AMORTIZATION OF INTANGIBLE ASSETS
---------------------------------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2005 2004 $ %
------ ------ ---- ----
Amortization of intangible
assets $4,653 $4,459 $194 4.4%
as % of net revenues 1.5% 1.6%
The increase in amortization of intangible assets was due primarily
to the amortization of license costs incurred under a
co-development arrangement in fiscal 2005.
41
LITIGATION
----------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2005 2004 $ %
-------- -------- ----- -------
Litigation $(1,430) $(1,700) $270 (15.9)%
The $1.4 million of income reflected in "Litigation" consists of a
$0.6 million net payment received by us in accordance with a
favorable legal settlement of vitamin antitrust litigation and $0.8
million related to the reversal of excess reserves related to the
Healthpoint litigation (see Note 11 in the accompanying Notes to
Consolidated Financial Statements).
In the second quarter of the prior year, we received $3.5 million
for 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. The impact of this
payment was offset in part by an additional litigation reserve of
$1.8 million related to attorneys' fees awarded in the Healthpoint
matter, which subsequently was settled.
OPERATING INCOME
----------------
YEARS ENDED MARCH 31,
-----------------------------------------
CHANGE
-----------------
($ IN THOUSANDS): 2005 2004 $ %
------- ------- -------- -------
Operating income $52,412 $73,771 $(21,359) (29.0)%
The decrease in operating income resulted primarily from a
$28.3 million, or 32.0%, increase in selling and administrative
expense coupled with a $2.9 million increase in research and
development expense, offset in part by a $10.3 million increase in
gross profit.
INTEREST EXPENSE
----------------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2005 2004 $ %
------ ------ ------ ------
Interest expense $5,432 $5,865 $(433) (7.4)%
The decrease in interest expense was primarily due to an increase
in the level of capitalized interest recorded on capital projects
that we have in process.
42
INTEREST AND OTHER INCOME
-------------------------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2005 2004 $ %
------ ------ ---- -----
Interest and other income $3,048 $2,092 $956 45.7%
The increase in interest and other income was primarily due to an
increase in the weighted average interest rate earned on short-term
investments, offset in part by a decline in the average balance of
short-term investments.
PROVISION FOR INCOME TAXES
--------------------------
YEARS ENDED MARCH 31,
-----------------------------------------
CHANGE
-----------------
($ IN THOUSANDS): 2005 2004 $ %
------- ------- -------- ------
Provision for income taxes $16,759 $24,150 $(7,391) (30.6)%
effective tax rate 33.5% 34.5%
The decrease in the provision for income taxes resulted from a
corresponding decrease in income before taxes coupled with a
decline in the effective tax rate. The decline in the effective tax
rate primarily resulted from the implementation of various tax
planning initiatives, as well as the generation of income tax
credits at both the Federal and state levels.
NET INCOME AND DILUTED EARNINGS PER SHARE
-----------------------------------------
YEARS ENDED MARCH 31,
-----------------------------------------
CHANGE
-----------------
($ IN THOUSANDS): 2005 2004 $ %
------- ------- --------- -------
Net income $33,269 $45,848 $(12,579) (27.4)%
Diluted earnings per share 0.63 0.84 (0.21) (25.0)%
The decrease in net income resulted primarily from a $28.3 million,
or 32.0%, increase in selling and administrative expense coupled
with a $2.9 million increase in research and development expense,
offset in part by a $10.3 million increase in gross profit.
43
FISCAL 2004 COMPARED TO FISCAL 2003
NET REVENUES BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
-----------------------------------------
CHANGE
-----------------
($ IN THOUSANDS): 2004 2003 $ %
-------- -------- ------- -------
Branded products $ 82,868 $ 43,677 $ 39,191 89.7%
as % of net revenues 29.2% 17.8%
Specialty generics 181,455 179,724 1,731 1.0%
as % of net revenues 63.9% 73.4%
Specialty materials 16,550 17,395 (845) (4.9)%
as % of net revenues 5.8% 7.1%
Other 3,068 4,200 (1,132) (27.0)%
======== ======== ========
Total net revenues $283,941 $244,996 $ 38,945 15.9%
The increase in branded product sales 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. The
increase was also impacted by a March 1, 2004 price increase
instituted by Ther-Rx on all of its products. In anticipation of
the scheduled price increase, customers made larger than normal
purchases, which the Company limits to a 30-day supply and is
consistent with prior price increase policies. This forward
purchasing approximated $7.4 million during the fourth quarter.
Sales from the women's healthcare product group increased $17.9
million, or 53.6%, in fiscal 2004. Included in the women's
healthcare family of products is the PreCare(R) product line which
contributed $11.8 million of incremental sales in fiscal 2004. This
increase was 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. The
PreCare(R) family of products continues to be the leading branded
line of prescription prenatal nutritional supplements in the United
States as market share for the product line grew to 37.6% at the
end of fiscal 2004 compared to 31.0% at the end of fiscal 2003.
Sales of Gynazole-1(R), our vaginal antifungal cream product,
increased $6.1 million, or 48.8%, during fiscal 2004 as our share
of the prescription vaginal antifungal cream market increased to
26.9% at the end of fiscal 2004, from 18.1% at the end of the prior
year. The increase in sales from our women's healthcare family of
products was supplemented by $22.6 million of sales during fiscal
2004 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. Introduction of
technology-improved versions of the hematinic products in the
second quarter of fiscal 2004, generated 69% growth in new
prescription volume. The increase in branded product sales for
fiscal 2004 was partially offset by a $1.2 million decline in sales
of the Micro-K(R) product line.
The minimal growth in specialty generic sales resulted from $8.8
million of incremental sales volume from new product introductions,
primarily in the cough/cold, cardiovascular and prenatal vitamin
product lines, offset by a $7.3 million decline in sales volume
from existing products primarily in our cough/cold product line.
During fiscal 2004, we introduced 16 new products, including the
February 2004 ANDA approval for four strengths of Benazepril
Hydrochloride tablets (generic equivalent to Lotensin(R)). The
decline in sales of existing cough/cold products was due primarily
to an FDA order which required us and all manufacturers of
unapproved single-ingredient, extended-release guaifenesin products
to discontinue distribution of these products after November 2003.
The FDA ruling affected five of our guaifenesin products that were
first introduced when ANDA approval was not required. Also, we
experienced slower than anticipated ANDA approvals by the FDA on a
number of brand equivalent products that we expected to introduce
in fiscal 2004.
The decrease in specialty material product sales was primarily due
to a slowdown in a major customer's business in the vitamin
supplement market.
The decrease in other revenue resulted from a smaller contract
manufacturing customer base due to continued de-emphasis of this
lower margin operation in our business strategy.
44
GROSS PROFIT BY SEGMENT
-----------------------
YEARS ENDED MARCH 31,
------------------------------------------
CHANGE
------------------
($ IN THOUSANDS): 2004 2003 $ %
-------- -------- ------- --------
Branded products $ 72,008 $ 38,460 $33,548 87.2%
as % of net revenues 86.9% 88.1%
Specialty generics 110,180 106,854 3,326 3.1%
as % of net revenues 60.7% 59.5%
Specialty materials 4,789 5,720 (931) (16.3)%
as % of net revenues 28.9% 32.9%
Other (1,463) (565) (898) (158.9)%
======== ======== =======
Total gross profit $185,514 $150,469 $35,045 23.3%
as % of total net
revenues 65.3% 61.4%
The increase in consolidated gross profit was primarily
attributable to the sales growth experienced by the branded
products and specialty generics segments, offset in part by a sales
decline in the specialty materials segment. The increased gross
profit percentage on a consolidated basis reflected a favorable
shift in the mix of product sales toward higher margin branded
products, which comprised a larger percentage of net revenues. The
gross profit percentage decrease experienced by the branded
products segment was due to the acquired hematinic products, which
have a slightly lower gross margin than other products in the
branded line. While the gross profit percentage in specialty
generics increased for the fiscal year, the segment experienced a
decline in gross profit as a percent of net revenues during the
fourth quarter due to more competitive pricing and higher costs
associated with a new product launch. Gross profit as a percent of
net revenues also declined in the specialty raw materials segment
during the fourth quarter as a result of unfavorable costs
variances associated with lower production volume.
RESEARCH AND DEVELOPMENT
------------------------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2004 2003 $ %
------- ------- ------ ----
Research and development $20,651 $19,135 $1,516 7.9%
as % of net revenues 7.3% 7.8%
The increase in research and development expense resulted from
higher costs associated with the continued expansion of clinical
testing for our product development efforts and increased personnel
expenses related to the growth of our research and development
staff. The increase in research and development expense was below
management's expectation of greater spending due to rescheduling
the timing of certain clinical studies.
SELLING AND ADMINISTRATIVE
--------------------------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2004 2003 $ %
------- ------- ------- -----
Selling and administrative $88,333 $69,584 $18,749 26.9%
as % of net revenues 31.1% 28.4%
45
The increase in selling and administrative expense was due
primarily to greater personnel expenses resulting from an increase
in management personnel ($1.7 million) and expansion of the branded
sales force ($4.9 million), an increase in rent, depreciation and
utilities associated with recently added facilities ($2.5 million),
and an increase in branded marketing expense ($3.7 million)
commensurate with the growth of the segment and to support the
launch and on-going promotion of technology-improved versions of
the Chromagen(R) and Niferex(R) products we acquired at the end of
fiscal 2003. We also experienced a $4.3 million increase in legal
expense due to an increase in litigation activity coupled with the
appeal of the Healthpoint litigation, Paragraph IV litigation and
other matters.
AMORTIZATION OF INTANGIBLE ASSETS
---------------------------------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2004 2003 $ %
------ ------ ------- -----
Amortization of intangible
assets $4,459 $2,321 $2,138 92.1%
as % of net revenues 1.6% 0.9%
The increase in amortization of intangible assets was due primarily
to the amortization of trademarks acquired in the two product
acquisitions completed on March 31, 2003.
LITIGATION
----------
YEARS ENDED MARCH 31,
------------------------------------------
CHANGE
------------------
($ IN THOUSANDS): 2004 2003 $ %
-------- ------- --------- --------
Litigation $(1,700) $16,500 $(18,200) (110.3)%
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. During 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.
The impact of this reserve was more than offset by a $3.5 million
net payment, received by us during fiscal 2004, for a settlement
with a branded company of our claim that the branded company
interfered with our right to a timely introduction of a generic
product in a previous fiscal year.
OPERATING INCOME
----------------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2004 2003 $ %
------- ------- ------- -----
Operating income $73,771 $42,929 $30,842 71.8%
The increase in operating income resulted primarily from a $35.0
million, or 23.3%, increase in gross profit in fiscal 2004, offset
in part by a $4.2 million increase in fiscal 2004 operating
expenses. The $18.7 million increase in our fiscal 2004 selling and
administrative expenses was primarily offset by the impact on
fiscal 2003 operating
46
expenses of a $16.5 million litigation reserve established by us
for potential damages associated with a lawsuit that was settled in
fiscal 2005.
INTEREST EXPENSE
----------------
YEARS ENDED MARCH 31,
-----------------------------------------
CHANGE
-----------------
($ IN THOUSANDS): 2004 2003 $ %
------ ---- ------ --------
Interest expense $5,865 $325 $5,540 1,704.6%
The increase in interest expense resulted primarily from the
interest expense accrued on the $200.0 million of Convertible
Subordinated Notes issued May 16, 2003.
INTEREST AND OTHER INCOME
-------------------------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2004 2003 $ %
------ ---- ------ ------
Interest and other income $2,092 $977 $1,115 114.1%
The increase in interest and other income was 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 $82.3 million increase
in short-term investments during fiscal 2003 from the proceeds of a
secondary offering during that year.
PROVISION FOR INCOME TAXES
--------------------------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2004 2003 $ %
------- ------- ------ -----
Provision for income taxes $24,150 $15,471 $8,679 56.1%
effective tax rate 34.5% 35.5%
The increase in the provision for income taxes resulted from a
corresponding increase in income before taxes. The decline in the
effective tax rate primarily resulted from the implementation of
various tax planning initiatives, as well as the generation of
income tax credits at both the Federal and state levels.
47
NET INCOME AND DILUTED EARNINGS PER SHARE
-----------------------------------------
YEARS ENDED MARCH 31,
---------------------------------------
CHANGE
---------------
($ IN THOUSANDS): 2004 2003 $ %
------- ------- ------- -----
Net income $45,848 $28,110 $17,738 63.1%
Diluted earnings per share 0.84 0.55 0.29 52.7%
The increase in net income resulted primarily from a $38.9 million,
or $15.9%, increase in our fiscal 2004 net revenues coupled with
the impact on fiscal 2003 net income of a $16.5 million litigation
reserve established by us in September 2002 for potential damages
associated with a lawsuit that was settled in fiscal 2005.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Cash and cash equivalents and working capital were $159.8 million
and $302.5 million, respectively, at March 31, 2005, compared to
$191.6 million and $306.6 million, respectively, at March 31, 2004.
Internally generated funds from product sales was the primary
source of operating capital used in the funding of our businesses
in fiscal 2005. Net cash flow from operating activities was $49.0
million in fiscal 2005 compared to $34.0 in fiscal 2004. Cash flow
from operations was favorably impacted by net income adjusted for
non-cash items and an increase in accounts payable related to the
timing of payments, offset in part by the $18.3 million payment
attributable to settlement of the Healthpoint litigation.
In September 2004, we made a settlement payment in the amount of
$16.5 million to resolve all previously pending claims between us
and Healthpoint, Ltd. without the admission of any liability. The
settlement was fully reserved by us in September 2002 and therefore
had no impact on our earnings in fiscal 2005. The $0.8 million of
income reflected in "Litigation" for the year ended March 31, 2005
represents a reversal of the portion of the Healthpoint litigation
reserve that remained after payment of the settlement amount and
related litigation costs.
Net cash flow used in investing activities primarily consisted of
capital expenditures of $63.6 million in fiscal 2005 compared to
$21.8 million for the prior year. Capital expenditures in fiscal
2005 were primarily for building renovation projects and for
purchasing machinery and equipment to upgrade and expand our
pharmaceutical manufacturing and distribution capabilities. Other
investing activities in fiscal 2005 included $10.6 million in
purchases of marketable securities that are classified as available
for sale. In the prior year, we made cash payments of $14.3 million
in April 2003 to complete the acquisition of the Niferex(R) product
line and $4.0 million in January 2004 to FemmePharma, Inc. to
complete the licensing of certain trademark rights and to increase
our equity investment in the company.
Our debt balance was $210.7 million at March 31, 2005 compared to
$218.7 million at March 31, 2004. In May 2003, we issued $200.0
million principal amount of 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 are also obligated to pay contingent
interest at a rate equal to 0.5% per annum during any six-month
period commencing May 16, 2006, if the average trading price of the
Notes per $1,000 principal amount for the five-trading day period
ending on the third trading day immediately preceding the first day
of the applicable six-month period equals $1,200 or more. 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, or
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.
On March 31,
48
2005, we repaid the second of two $7.0 million promissory notes
entered into in conjunction with the Altana acquisition agreement
(see Note 3 in the accompanying Notes to Consolidated Financial
Statements).
In December 2004, we increased our available credit facilities to
$140.0 million. The revised agreement provided for an increase from
$40.0 million to $80.0 million in our revolving line of credit
along with an increase from $25.0 million to $60.0 million in the
supplemental credit line that is available for financing
acquisitions. These credit facilities expire in October 2006 and
December 2005, respectively. The revolving and supplemental credit
lines are unsecured and interest is charged at the lower of the
prime rate or the one-month LIBOR rate plus 175 basis points. At
March 31, 2005, we had $3.9 million in open letters of credit
issued under the revolving credit line and no cash borrowings under
either credit facility. The revised agreement contains
substantially identical financial and other covenants,
representations, warranties, conditions and default provisions as
the replaced facility. The financial covenants impose minimum
levels of earnings before interest, taxes, depreciation and
amortization, a maximum funded debt ratio, a limit on capital
expenditures and dividend payments, a minimum fixed charge coverage
ratio and a maximum senior leverage ratio. As of March 31, 2005, we
were in compliance with all of our covenants.
The following table summarizes our contractual obligations (in
thousands):
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
----- ------ --------- --------- -------
OBLIGATIONS AT MARCH 31, 2005
-----------------------------
Long-term debt obligations $210,740 $ 973 $3,853 $5,914 $200,000
Operating lease obligations 5,257 1,598 1,949 1,086 624
Other long-term obligations 4,477 - - - 4,477
---------------------------------------------------------------
Total contractual cash obligations(a) $220,474 $2,571 $5,802 $7,000 $205,101
---------------------------------------------------------------
(a) The Company has licensed the exclusive rights to co-develop
and market various generic equivalent products with other drug
delivery companies. These collaboration agreements require the
Company to make up-front and ongoing payments as development
milestones are attained. If all milestones remaining under
these agreements were reached, payments by the Company could
total up to $15,455.
We believe our cash and cash equivalents balance, cash flows from
operations and funds available under our credit facilities, 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 our 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 fiscal years.
49
CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are presented on the basis of
U.S. generally accepted accounting principles. Our significant
accounting policies are described in Note 2 in the accompanying
notes to consolidated financial statements. 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 estimates are
described below.
REVENUE AND PROVISION FOR SALES RETURNS AND ALLOWANCES. Revenue is
------------------------------------------------------
generally realized or realizable and earned when persuasive
evidence of an arrangement exists, delivery has occurred or
services have been rendered, the seller's price to the buyer is
fixed or determinable, and collectibility is reasonably assured.
Accordingly, we record revenue from product sales when title and
risk of ownership have been transferred to the customer, which is
typically upon shipment to the customer. We also enter into
long-term agreements under which we assign marketing rights for the
products we have developed to pharmaceutical marketers. Royalties
under these arrangements are earned based on the sale of products.
When we sell our products, we reduce the amount of revenue we
recognize from such sales by an estimate of future product returns
and sales allowances. Sales allowances include cash discounts,
rebates, chargebacks, and other similar expected future payments
relating to products sold in the current period. Factors that are
considered in our estimates of future product returns and sales
allowances include historical payment experience in relationship to
revenues, estimated customer inventory levels, and current contract
prices and terms with both direct and indirect customers. If actual
future payments for product returns and sales allowances exceed the
estimates we made at the time of sale, our financial position,
results of operations and cash flows would be negatively impacted.
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 estimates when we
believe that the actual chargeback amounts payable in the future
will differ from our original estimates.
INVENTORY VALUATION. 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.
INTANGIBLE ASSETS AND GOODWILL. 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
50
patents and trademarks. Intangible assets that are acquired are
stated at cost, less accumulated amortization, and are amortized on
a straight-line basis over their estimated useful lives. 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 we consider 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 an intangible asset
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.
CONTINGENCIES. The Company is involved in various legal
-------------
proceedings, some of which involve claims for substantial amounts.
An estimate is made to accrue for a loss contingency relating to
any of these legal proceedings if it is probable that a liability
was incurred as of the date of the financial statements and the
amount of loss can be reasonably estimated. Because of the
subjective nature inherent in assessing the outcome of litigation
and because of the potential that an adverse outcome in legal
proceedings could have a material impact on our financial position
or results of operations, such estimates are considered to be
critical accounting estimates. After review, it was determined at
March 31, 2005 that for each of the various legal proceedings in
which we are involved, the conditions mentioned above were not met.
We will continue to evaluate all legal matters as additional
information becomes available.
RECENTLY ISSUED ACCOUNTING STANDARDS
In March 2004, the EITF completed its discussion of and provided
consensus guidance on Issue No. 03-06, Participating Securities and
the Two-Class Method under FASB Statement No. 128, Earnings per
Share. The consensus interpreted the definition of a "participating
security," required the use of the two-class method in the
calculation and disclosure of basic earnings per share for
companies with participating securities or more than one class of
common stock, and provided guidance on the allocation of earnings
and losses for purposes of calculating basic earnings per share.
Since the Company has two classes of common stock, this consensus
has been applied in the calculation of basic earnings per share for
all periods presented. There was no impact on diluted earnings per
share as reported.
In April 2004, the Financial Accounting Standards Board (FASB)
issued FASB Staff Position No. 129-1 (FSP 129-1), Disclosure
Requirements under FASB Statement No. 129, Disclosure of
Information about Capital Structure, Relating to Contingently
Convertible Securities. This FSP requires the disclosure provisions
of Statement 129 to apply to all existing and newly created
contingently convertible securities and to their potentially
dilutive effects on earnings per share. The adoption of the
disclosure provisions of FSP 129-1 did not have a material impact
on the Company's financial condition or results of operations.
In September 2004, the EITF reached a consensus that contingently
convertible debt instruments should be included in diluted earnings
per share computations (if dilutive) regardless of whether the
market price trigger (or
51
other contingent feature) has been met. Additionally, the EITF
stated that prior period earnings per share amounts presented for
comparative purposes should be restated to conform to this
consensus, which is effective for reporting periods ending after
December 15, 2004. The consensus adopted by the EITF required the
addition of approximately 8.7 million shares associated with the
conversion of the Company's $200.0 million principal amount
Convertible Subordinated Notes to the number of shares outstanding
for the calculation of diluted earnings per share for all reported
periods since the issuance of the Notes.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an
Amendment to ARB No. 43, Chapter 4 which requires that abnormal
amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage) costs be recognized as current period
charges. In addition, this statement requires that allocation of
fixed production overheads to the costs of conversion be based on
the normal capacity of the production facilities. This statement is
effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. The Company is currently determining
the impact, if any, the adoption of this statement will have on its
financial condition and results of operations.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment" (SFAS 123R), which replaces SFAS No. 123,
"Accounting for Stock-Based Compensation," (SFAS 123) and
supercedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees". SFAS 123R requires all share-based payments to
employees, including grants of employee stock options, to be
recognized in the financial statements based on their fair values.
The pro forma disclosures previously permitted under SFAS 123 no
longer will be an alternative to financial statement recognition.
Under SFAS 123R, we must determine the appropriate fair value model
to be used for valuing share-based payments, the amortization
method for compensation cost and the transition method to be used
at date of adoption. The transition methods include modified
prospective and modified retrospective adoption options. Under the
modified retrospective option, prior periods may be restated either
as of the beginning of the year of adoption or for all periods
presented. The modified prospective method requires that
compensation expense be recorded for all unvested stock options and
restricted stock at the beginning of the first quarter of adoption
of SFAS 123R, while the modified retrospective method would record
compensation expense for all unvested stock options and restricted
stock beginning with the first period restated. We are evaluating
the requirements of SFAS 123R. We have not yet determined the
method of adoption or the effect of adopting SFAS 123R, and we have
not determined whether the adoption will result in amounts that are
similar to the current pro forma disclosures under SFAS 123.
In April 2005, the Securities and Exchange Commission announced an
amendment to Regulation S-X to amend the date for compliance with
SFAS 123R. The amendment requires each registrant that is not a
small business issuer to adopt SFAS 123R in the first fiscal year
commencing after June 15, 2005. As a result, we are required to
adopt SFAS 123R beginning April 1, 2006. Adoption of SFAS 123R will
have an impact on our consolidated financial statements, as we will
be required to expense the fair value of our employee stock option
grants rather than disclose the pro forma impact on our
consolidated net income within the footnotes to our consolidated
financial statements, as is our current practice.
ITEM 7A. 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 March 31, 2005.
In May 2003, we issued $200.0 million principal amount of
Convertible Subordinated Notes. The interest rate on the
Convertible Subordinated Notes is fixed at 2.50% per annum and not
subject to market interest rate changes. Beginning May 16, 2006, we
will become obligated to pay contingent interest at a rate equal to
0.5% per annum during any six-month period, if the average trading
price of the Convertible Subordinated Notes per $1,000 principal
amount for the five-trading day period ending on the third trading
day immediately preceding the first day of the applicable six-month
period equals $1,200 or more.
52
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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
53
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors and Shareholders
K-V Pharmaceutical Company:
We have audited the accompanying consolidated balance sheet of K-V
Pharmaceutical Company and subsidiaries as of March 31, 2005, and the
related consolidated statements of income, comprehensive income,
shareholders' equity, and cash flows for the year ended March 31, 2005. In
connection with our audit of the consolidated financial statements, we have
also audited the accompanying financial statement schedule. These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements and financial
statement schedule based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We
believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of K-V
Pharmaceutical Company and subsidiaries as of March 31, 2005, and the
results of their operations and their cash flows for the year ended March
31, 2005, in conformity with U.S. generally accepted accounting principles.
Also in our opinion, the related financial statement schedule for the year
ended March 31, 2005, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, during
fiscal 2005, the Company adopted the provisions of Emerging Issues Task
Force (EITF) Issue No. 03-6 Participating Securities and the Two-Class
Method under FASB Statement No. 128 and EITF Issue No. 04-8 The Effect of
Contingently Convertible Instruments on Diluted Earnings per Share.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of internal
control over financial reporting of K-V Pharmaceutical Company as of March
31, 2005, based on the criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), and our report dated June 14, 2005 expressed an
unqualified opinion on management's assessment of, and the effective
operation of, internal control over financial reporting.
/s/ KPMG LLP
St. Louis, Missouri
June 14, 2005
54
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors
of K-V Pharmaceutical Company
We have audited the accompanying consolidated balance sheets of K-V
Pharmaceutical Company and Subsidiaries as of March 31, 2004 and the related
consolidated statements of income, shareholders' equity and cash flows for
each of the two years in the period ended March 31, 2004. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of K-V
Pharmaceutical Company and Subsidiaries at March 31, 2004, and the results
of its operations and its cash flows for each of the two years in the period
ended March 31, 2004, in conformity with accounting principles generally
accepted in the United States of America.
/s/ BDO Seidman, LLP
Chicago, Illinois
June 4, 2004
55
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
MARCH 31,
---------------------
2005 2004
---- ----
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents............................................................ $159,825 $191,581
Marketable securities................................................................ 45,694 35,330
Receivables, less allowance for doubtful accounts of $461 and $402
in 2005 and 2004, respectively.................................................... 62,361 65,872
Inventories, net..................................................................... 53,945 50,697
Prepaid and other assets............................................................. 9,530 6,591
Deferred tax asset................................................................... 5,827 8,037
-------- --------
Total Current Assets.............................................................. 337,182 358,108
Property and equipment, less accumulated depreciation................................ 131,624 75,777
Intangible assets and goodwill, net.................................................. 76,430 80,809
Other assets......................................................................... 13,081 13,744
-------- --------
TOTAL ASSETS......................................................................... $558,317 $528,438
======== ========
LIABILITIES
-----------
CURRENT LIABILITIES:
Accounts payable..................................................................... $ 18,011 $ 12,650
Accrued liabilities.................................................................. 15,733 30,917
Current maturities of long-term debt................................................. 973 7,909
-------- --------
Total Current Liabilities......................................................... 34,717 51,476
Long-term debt....................................................................... 209,767 210,741
Other long-term liabilities.......................................................... 4,477 3,122
Deferred tax liability............................................................... 16,654 5,350
-------- --------
TOTAL LIABILITIES.................................................................... 265,615 270,689
-------- --------
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 both 2005 and 2004 (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 39,059,428 and 36,080,583 at March 31, 2005
and 2004, respectively........................................................ 391 362
Class B - issued 13,422,101 and 16,148,739 at March 31, 2005 and
2004, respectively (convertible into Class A shares on a one-for-one basis)... 134 162
Additional paid-in capital........................................................... 128,182 123,828
Retained earnings.................................................................... 217,779 184,580
Accumulated other comprehensive loss................................................. (133) --
Less: Treasury stock, 3,111,003 shares of Class A and 92,902 shares of Class B Common
Stock in 2005, and 3,035,948 shares of Class A and 80,142 shares of Class B
Common Stock in 2004, at cost..................................................... (53,651) (51,183)
-------- --------
TOTAL SHAREHOLDERS' EQUITY........................................................... 292,702 257,749
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................................... $558,317 $528,438
======== ========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
56
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
YEARS ENDED MARCH 31,
-----------------------------------
2005 2004 2003
-------- -------- -------
Net revenues........................................................... $303,493 $283,941 $244,996
Cost of sales.......................................................... 107,682 98,427 94,527
-------- -------- --------
Gross profit........................................................... 195,811 185,514 150,469
-------- -------- --------
Operating expenses:
Research and development............................................ 23,538 20,651 19,135
Selling and administrative.......................................... 116,638 88,333 69,584
Amortization of intangible assets................................... 4,653 4,459 2,321
Litigation.......................................................... (1,430) (1,700) 16,500
-------- -------- --------
Total operating expenses............................................... 143,399 111,743 107,540
-------- -------- --------
Operating income....................................................... 52,412 73,771 42,929
-------- -------- --------
Other expense (income):
Interest expense.................................................... 5,432 5,865 325
Interest and other income........................................... (3,048) (2,092) (977)
-------- -------- --------
Total other expense (income), net...................................... 2,384 3,773 (652)
-------- -------- ---------
Income before income taxes............................................. 50,028 69,998 43,581
Provision for income taxes............................................. 16,759 24,150 15,471
-------- -------- --------
Net income............................................................. $ 33,269 $ 45,848 $ 28,110
======== ======== ========
Earnings per common share:
Basic - Class A common.............................................. $ 0.71 $ 0.98 $ 0.59
Basic - Class B common.............................................. 0.59 0.82 0.50
Diluted............................................................. $ 0.63 $ 0.84 $ 0.55
======== ======== =======
Weighted Average Shares Outstanding:
Basic - Class A common.............................................. 34,228 33,046 33,997
Basic - Class B common.............................................. 15,005 15,941 15,803
Diluted............................................................. 59,468 58,708 51,561
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
57
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
YEARS ENDED MARCH 31,
---------------------------------
2005 2004 2003
------- ------- -------
Net income............................................................. $33,269 $45,848 $28,110
Other comprehensive income (loss):
Unrealized loss on available for sale securities.................... (201) -- --
Less related taxes.................................................. 68 -- --
------- ------- -------
Total unrealized loss on available for sale securities, net...... (133) -- --
------- ------- -------
Total comprehensive income............................................. $33,136 $45,848 $28,110
======= ======= =======
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
58
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED MARCH 31, 2005, 2004 AND 2003
----------------------------------------------------------------------------
CLASS A CLASS B ADDITIONAL
PREFERRED COMMON COMMON PAID IN TREASURY RETAINED
STOCK STOCK STOCK CAPITAL STOCK EARNINGS
----- ----- ----- ------- ----- --------
(Dollars in thousands)
BALANCE AT MARCH 31, 2002........................ $ -- $201 $108 $ 47,231 $ (49) $111,301
Net income....................................... -- -- -- -- -- 28,110
Dividends paid on preferred stock................ -- -- -- -- -- (70)
Conversion of 175,000 Class B
shares to Class A shares...................... -- 2 (2) -- -- --
Issuance of 3,285,000 Class A shares............. -- 33 -- 72,347 -- --
Sale of 40,461 Class A shares to employee
profit sharing plan........................... -- -- -- 884 21 --
Stock Options exercised - 49,563 shares of
Class A less 9,502 shares repurchased and
40,717 shares of Class B less 112 shares
repurchased................................... -- -- -- 499 -- --
----------------------------------------------------------------------------
BALANCE AT MARCH 31, 2003........................ -- 236 106 120,961 (28) 139,341
Net income....................................... -- -- -- -- -- 45,848
Dividends paid on preferred stock................ -- -- -- -- -- (436)
Conversion of 117,187 Class B shares to
Class A shares................................ -- 1 (1) -- -- --
Issuance of 27,992 Class A shares
under product development agreement........... -- -- -- 505 -- --
Purchase of common stock for treasury............ -- -- -- -- (51,155) --
Three-for-two stock dividend..................... -- 120 53 -- -- (173)
Stock Options exercised - 552,617 shares of
Class A less 91,538 shares repurchased and
413,419 shares of Class B less 15,625 shares
repurchased................................... -- 5 4 2,362 -- --
----------------------------------------------------------------------------
BALANCE AT MARCH 31, 2004........................ -- 362 162 123,828 (51,183) 184,580
Net income....................................... -- -- -- -- -- 33,269
Dividends paid on preferred stock................ -- -- -- -- -- (70)
Conversion of 2,783,537 Class B shares to
Class A shares................................ -- 28 (28) -- -- --
Issuance of 14,679 Class A shares under product
development agreement......................... -- -- -- 237 -- --
Purchase of common stock for treasury............ -- -- -- -- (2,468) --
Stock Options exercised - 180,629 shares of
Class A and 56,899 shares of Class B.......... -- 1 -- 4,117 -- --
Unrealized loss on marketable securities
available for sale, net of related taxes
of $68........................................ -- -- -- -- -- --
----------------------------------------------------------------------------
BALANCE AT MARCH 31, 2005........................ $ $391 $134 $128,182 $(53,651) $217,779
============================================================================
-------------------------------
ACCUMULATED OTHER TOTAL
COMPREHENSIVE SHAREHOLDERS'
LOSS, NET EQUITY
--------- ------
BALANCE AT MARCH 31, 2002........................ $ -- $158,792
Net income....................................... -- 28,110
Dividends paid on preferred stock................ -- (70)
Conversion of 175,000 Class B
shares to Class A shares...................... -- --
Issuance of 3,285,000 Class A shares............. -- 72,380
Sale of 40,461 Class A shares to employee
profit sharing plan........................... -- 905
Stock Options exercised - 49,563 shares of
Class A less 9,502 shares repurchased and
40,717 shares of Class B less 112 shares
repurchased................................... -- 499
-------------------------------
BALANCE AT MARCH 31, 2003........................ -- 260,616
Net income....................................... -- 45,848
Dividends paid on preferred stock................ -- (436)
Conversion of 117,187 Class B shares to
Class A shares................................ -- --
Issuance of 27,992 Class A shares
under product development agreement........... -- 505
Purchase of common stock for treasury............ -- (51,155)
Three-for-two stock dividend..................... -- --
Stock Options exercised - 552,617 shares of
Class A less 91,538 shares repurchased and
413,419 shares of Class B less 15,625 shares
repurchased................................... -- 2,371
-------------------------------
BALANCE AT MARCH 31, 2004........................ -- 257,749
Net income....................................... -- 33,269
Dividends paid on preferred stock................ -- (70)
Conversion of 2,783,537 Class B shares to
Class A shares................................ -- --
Issuance of 14,679 Class A shares under product
development agreement......................... -- 237
Purchase of common stock for treasury............ -- (2,468)
Stock Options exercised - 180,629 shares of
Class A and 56,899 shares of Class B.......... -- 4,118
Unrealized loss on marketable securities
available for sale, net of related taxes
of $68........................................ (133) (133)
-------------------------------
BALANCE AT MARCH 31, 2005........................ $(133) $292,702
===============================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
59
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
YEARS ENDED MARCH 31,
---------------------------------------
2005 2004 2003
-------- -------- --------
Operating Activities:
Net income............................................................. $ 33,269 $ 45,848 $ 28,110
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, amortization and other non-cash charges............... 13,904 12,663 7,773
Deferred income tax provision (benefit)............................. 13,582 8,691 (8,091)
Deferred compensation............................................... 1,355 209 196
Litigation.......................................................... (843) 1,825 16,500
Changes in operating assets and liabilities:
Decrease (increase) in receivables, net............................. 3,511 (8,487) (3,167)
Increase in inventories............................................. (3,248) (9,977) (5,623)
(Increase) decrease in prepaid and other assets..................... (3,520) (6,294) 496
(Decrease) increase in accounts payable and accrued.................
liabilities...................................................... (8,980) (10,471) 7,127
-------- -------- --------
Net cash provided by operating activities.............................. 49,030 34,007 43,321
-------- -------- --------
Investing Activities:
Purchase of property and equipment.................................. (63,622) (21,792) (16,113)
Purchase of marketable securities................................... (10,565) (278) (35,052)
Purchase of stock and intangible assets............................. - (4,000) (3,000)
Product acquisition................................................. - (14,300) (13,000)
-------- -------- --------
Net cash used in investing activities.................................. (74,187) (40,370) (67,165)
-------- -------- --------
Financing Activities:
Principal payments on long-term debt................................ (8,179) (8,237) (743)
Dividends paid on preferred stock................................... (70) (436) (70)
Proceeds from issuance of convertible notes......................... - 194,165 -
Purchase of common stock for treasury............................... (2,468) (51,155) -
Proceeds from issuance of common stock.............................. - - 72,380
Sale of common stock to employee profit sharing plan................ - - 905
Exercise of common stock options.................................... 4,118 2,371 499
-------- -------- --------
Net cash (used in) provided by financing activities.................... (6,599) 136,708 72,971
-------- -------- --------
(Decrease) increase in cash and cash equivalents....................... (31,756) 130,345 49,127
Cash and cash equivalents:
Beginning of year................................................... 191,581 61,236 12,109
-------- -------- --------
End of year......................................................... $159,825 $191,581 $ 61,236
======== ======== ========
Non-cash investing and financing activities:
Term loan to finance building purchase.............................. $ - $ 8,800 $ -
Term loans refinanced............................................... - - 1,738
Issuance of common stock under product development
agreement........................................................ 237 505 -
Payments due on product acquisitions................................ - - 15,983
Portion of product acquisition financed by promissory notes......... - - 13,234
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)
1. DESCRIPTION OF BUSINESS
-----------------------
K-V Pharmaceutical Company and its subsidiaries ("KV" or the
"Company") are primarily engaged in the development, acquisition,
manufacture, marketing and sale of technologically distinguished
branded and generic/non-branded prescription pharmaceutical
products. The Company was incorporated in 1971 and has become a
leader in the development of advanced drug delivery and formulation
technologies that are designed to enhance therapeutic benefits of
existing drug forms. Through internal product development and
synergistic acquisitions of products, KV has grown into a fully
integrated specialty pharmaceutical company. The Company also
develops, manufactures and markets technologically advanced,
value-added raw material products for the pharmaceutical,
nutritional, food and personal care industries.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
BASIS OF PRESENTATION
---------------------
The Company's consolidated financial statements are prepared
in accordance with U.S. generally accepted accounting
principles. The consolidated financial statements include the
accounts of KV and its wholly-owned subsidiaries. All material
inter-company accounts and transactions have been eliminated
in consolidation. Certain reclassifications, none of which
affected net income or retained earnings, have been made to
prior year amounts to conform to the current year
presentation.
USE OF ESTIMATES
----------------
The preparation of financial statements in conformity with
U.S. generally accepted accounting principles requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, the disclosure of
contingent liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results in subsequent
periods may differ from the estimates and assumptions used in
the preparation of the accompanying consolidated financial
statements.
The most significant estimates made by management include the
determination of sales allowances, valuation of inventory
balances, the determination of useful lives for intangible
assets, and the evaluation of intangible assets and goodwill
for impairment. Management periodically evaluates estimates
used in the preparation of the consolidated financial
statements and makes changes on a prospective basis when
adjustments are necessary.
CASH EQUIVALENTS
----------------
Cash equivalents consist of interest-bearing deposits that can
be redeemed on demand and investments that have original
maturities of three months or less.
MARKETABLE SECURITIES
---------------------
The Company's marketable securities consist of mutual funds
comprised of U.S. government investments and auction rate
securities. The Company classifies its marketable securities
as available-for-sale securities with net unrealized gains or
losses recorded as a separate component of stockholders'
equity, net of any related tax effect. Auction rate securities
generally have long-term stated maturities of 20 to 30 years.
However, these
61
securities have certain economic characteristics of short-term
investments due to a rate-setting mechanism and the ability to
liquidate them through a Dutch auction process that occurs on
pre-determined intervals of less than 90 days. The Company had
previously classified its auction rate securities as cash and
cash equivalents. In fiscal 2005, the Company reclassified
$10,000 of auction rate securities from cash and cash
equivalents to marketable securities because the underlying
instrument has a maturity date in August 2030. Prior periods
have been reclassified to provide consistent presentation.
INVENTORIES
-----------
Inventories consist of finished goods held for distribution,
raw materials and work in process. Inventories are stated at
the lower of cost or market, with the cost determined on the
first-in, first-out (FIFO) basis. Reserves for obsolete,
excess or slow moving inventory are established by management
based on evaluation of inventory levels, forecasted demand,
and market conditions.
PROPERTY AND EQUIPMENT
----------------------
Property and equipment are stated at cost, less accumulated
depreciation. Major renewals and improvements are capitalized,
while routine maintenance and repairs are expensed as
incurred. At the time properties are retired from service, the
cost and accumulated depreciation are removed from the
respective accounts and the related gains or losses are
reflected in earnings. The Company capitalizes interest on
qualified construction projects.
Depreciation expense is computed over the estimated useful
lives of the related assets using the straight-line method.
The estimated useful lives are principally 10 years for land
improvements, 10 to 40 years for buildings and improvements, 3
to 15 years for machinery and equipment, and 3 to 10 years for
office furniture and equipment. Leasehold improvements are
amortized on a straight-line basis over the shorter of the
respective lease terms or the estimated useful life of the
assets.
The Company assesses property and equipment for impairment
whenever events or changes in circumstances indicate that an
asset's carrying amount may not be recoverable.
INTANGIBLE ASSETS AND GOODWILL
------------------------------
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. Costs associated with the development of patents
and trademarks are amortized on a straight-line basis over
estimated useful lives ranging from 5 to 17 years. The Company
evaluates its intangible assets for impairment whenever events
or changes in circumstances indicate that an intangible
asset's carrying amount may not be recoverable. 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.
Goodwill relates to the 1972 acquisition of the Company's
specialty materials segment and is recorded net of accumulated
amortization through March 31, 2002. In accordance with the
Company's adoption of Statement of Financial Accounting
Standards (SFAS) No. 142, Goodwill and Other Intangible
Assets, on April 1, 2002, amortization of goodwill was
discontinued. Instead, goodwill is subject to at least an
annual assessment of impairment on a fair value basis. If the
Company determines through the assessment process that
goodwill
62
has been impaired, the Company will record the impairment
charge in its results of operations. The Company's test for
goodwill impairment in fiscal 2005 determined there was no
goodwill impairment.
OTHER ASSETS
------------
Non-marketable equity investments for which the Company does
not have the ability to exercise significant influence over
operating and financial policies (generally less than 20%
ownership) are accounted for using the cost method. Such
investments are included in "Other assets" in the accompanying
consolidated balance sheets and relate to the Company's $5,000
investment in the preferred stock of FemmePharma, Inc. (see
Note 3).
This investment is periodically reviewed for
other-than-temporary declines in fair value. Other than
temporary declines in fair value are identified by evaluating
market conditions, the entity's ability to achieve forecast
and regulatory submission guidelines, as well as the entity's
overall financial condition.
REVENUE RECOGNITION
-------------------
Revenue is generally realized or realizable and earned when
persuasive evidence of an arrangement exists, delivery has
occurred or services have been rendered, the seller's price to
the buyer is fixed or determinable, and the customer's payment
ability has been reasonably assured. Accordingly, the Company
records revenue from product sales when title and risk of
ownership have been transferred to the customer, which is
typically upon shipment to the customer. The Company also
enters into long-term agreements under which it assigns
marketing rights for the products it has developed to
pharmaceutical marketers. Royalties under these arrangements
are earned based on the sale of products.
Concurrently with the recognition of revenue, the Company
records estimated sales provisions for product returns, sales
rebates, payment discounts, chargebacks, and other sales
allowances. Sales provisions are established based upon
consideration of a variety of factors, including but not
limited to, historical relationship to revenues, historical
payment and return experience, estimated customer inventory
levels, customer rebate arrangements, and current contract
sales terms with wholesale and indirect customers. The
following briefly describes the nature of each provision and
how such provisions are estimated.
o Payment discounts are reductions to invoiced amounts
offered to customers for payment within a specified
period and are estimated utilizing historical
customer payment experience.
o Sales rebates are offered to certain customers to
promote customer loyalty and encourage greater
product sales. These rebate programs provide that,
upon the attainment of pre-established volumes or
the attainment of revenue milestones for a specified
period, the customer receives credit against
purchases. Other promotional programs are incentive
programs periodically offered to customers. Due to
the nature of these programs, the Company is able to
estimate provisions for rebates and other
promotional programs based on the specific terms in
each agreement.
o Consistent with common industry practices, the
Company has agreed to terms with its customers to
allow them to return product that is within a
certain period of the expiration date. Upon
recognition of revenue from product sales to
customers, the Company provides for an estimate of
product to be returned. This estimate is determined
by applying a historical relationship of customer
returns to amounts invoiced.
o Generally, the Company provides credits to customers
for decreases that are made to selling prices for
the value of inventory that is owned by customers at
the date of the price reduction. The Company has not
contractually agreed to provide price adjustment
credits to its customers; instead, the Company
issues price adjustment credits at its discretion.
Price
63
adjustment credits are estimated at the time
the price reduction occurs. The amount is calculated
based on an estimate of customer inventory levels.
o KV has arrangements with certain parties
establishing prices for the Company's products for
which the parties independently select a wholesaler
from which to purchase. Such parties are referred to
as indirect customers. A chargeback represents the
difference between the Company's invoice price to
the wholesaler and the indirect customer's contract
price, which is lower. Provisions for estimated
chargebacks are calculated primarily using
historical chargeback experience, actual contract
pricing and estimated wholesaler inventory levels.
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
$133,475, $103,262 and $98,929 for the years ended March 31,
2005, 2004 and 2003, respectively. The reserve balances
related to the sales provisions totaled $21,056 and $20,648 at
March 31, 2005 and 2004, respectively, and are included in
"Receivables, less allowance for doubtful accounts" in the
accompanying consolidated balance sheets.
CONCENTRATION OF CREDIT RISK
----------------------------
The Company extends credit on an uncollateralized basis
primarily to wholesale drug distributors and retail pharmacy
chains throughout the United States. As a result, the Company
is required to estimate the level of receivables which
ultimately will not be paid. The Company calculates this
estimate based on prior experience supplemented by a customer
specific review when it is deemed necessary. On a periodic
basis, the Company performs evaluations of the financial
condition of all customers to further limit its credit risk
exposure. Actual losses from uncollectible accounts have
historically been insignificant.
The Company's three largest customers accounted for
approximately 23%, 18% and 16%, and 31%, 16% and 11% of gross
receivables at March 31, 2005 and 2004, respectively.
For the year ended March 31, 2005, KV's three largest
customers accounted for 27%, 16% and 12% of gross revenues.
During the years ended March 31, 2004 and 2003, the Company's
three largest customers accounted for gross revenues of 25%,
16% and 13% and 23%, 18% and 14%, respectively.
The Company maintains cash balances at certain financial
institutions that are greater than the FDIC insurable limit.
SHIPPING AND HANDLING COSTS
---------------------------
The Company classifies shipping and handling costs in cost of
sales. The Company does not derive revenue from shipping.
64
RESEARCH AND DEVELOPMENT
------------------------
Research and development costs, including licensing fees for
early stage development products, are expensed in the period
incurred.
The Company has licensed the exclusive rights to co-develop
and market various products with other drug delivery
companies. These collaborative agreements usually require the
Company to pay up-front fees and ongoing milestone payments.
When the Company makes an up-front or milestone payment,
management evaluates the stage of the related product to
determine the appropriate accounting treatment. If the product
is considered to be beyond the early development stage but has
not yet been approved by regulatory authorities, the Company
will evaluate the facts and circumstances of each case to
determine if a portion or all of the payment has future
economic benefit and should be capitalized. Payments made to
third parties subsequent to regulatory approval are
capitalized with that cost generally amortized over the
shorter of the patented life of the product or the term of the
licensing agreement.
The Company accrues estimated costs associated with clinical
studies performed by contract research organizations based on
the total of costs incurred through the balance sheet date.
The Company monitors the progress of the trials and their
related activities to the extent possible, and adjusts the
accruals accordingly. These accrued costs are recorded as a
component of research and development expense.
ADVERTISING
-----------
Costs associated with advertising are expensed in the period
in which the advertising is used and these costs are included
in selling and administrative expense. Advertising expenses
totaled $10,885, $7,264 and $5,662 for the years ended March
31, 2005, 2004 and 2003, respectively. Advertising expense
includes the cost of product samples given to physicians for
marketing to their patients.
LITIGATION
----------
The Company is subject to litigation in the ordinary course of
business and to certain other contingencies (see Note 11).
Legal fees and other expenses related to litigation and
contingencies are recorded as incurred. The Company, in
consultation with its legal counsel, also assesses the need to
record a liability for litigation and contingencies on a
case-by-case basis. Accruals are recorded when the Company
determines that a loss related to a matter is both probable
and reasonably estimable.
DEFERRED FINANCING COSTS
------------------------
Deferred financing costs of $5,835 were incurred in connection
with the issuance of the 2.5% Contingent Convertible Notes due
2033. These costs are being amortized into interest expense on
a straight-line basis over the five-year period that ends on
the first date the debt can be put by the holders to the
Company. Accumulated amortization totaled $2,143 and $979 at
March 31, 2005 and 2004, respectively. Deferred financing
costs, net of accumulated amortization, are included in "Other
Assets" in the accompanying consolidated balance sheet.
EARNINGS PER SHARE
------------------
Basic earnings per share is calculated by dividing net income
available to common shareholders for the period by the
weighted average number of common shares outstanding during
the period. Diluted earnings per share is computed by dividing
net income by the weighted average common shares and common
share equivalents outstanding during the periods presented
assuming the conversion of preferred shares and the exercise
of all in-the-money stock options based on the treasury stock
method. Common share equivalents
65
have been excluded from the computation of diluted earnings
per share where their inclusion would be anti-dilutive.
In June 2004, the Company adopted the guidance in Emerging
Issues Task Force (EITF) Issue No. 03-6, Participating
Securities and the Two-Class Method under FASB Statement No.
128. The pronouncement required the use of the two-class
method in the calculation and disclosure of basic earnings per
share and provided guidance on the allocation of earnings and
losses for purposes of calculating basic earnings per share.
Accordingly, all periods presented have been retroactively
adjusted to give effect to such guidance. For purposes of
calculating basic earnings per share, undistributed earnings
are allocated to each class of common stock based on the
contractual participation rights of each class of security.
Holders of Class A common stock are entitled to receive
dividends per share equal to 120% of the dividends per share
paid on the Class B common stock.
In December 2004, the Company adopted the guidance in EITF
04-8, The Effect of Contingently Convertible Instruments on
Diluted Earnings per Share. The EITF consensus required that
the impact of contingently convertible debt instruments be
included in diluted earnings per share computations (if
dilutive) regardless of whether the market price trigger (or
other contingent feature) had been met. Additionally, the EITF
stated that prior period earnings per share amounts presented
for comparative purposes should be restated to conform to this
consensus.
INCOME TAXES
------------
Income taxes are accounted for under the asset and liability
method where deferred tax assets and liabilities are
recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts
of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income
in the period that includes the enactment date. A valuation
allowance is established when it is more likely than not that
some portion or all of the deferred tax assets will not be
realized.
66
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 with exercise prices 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:
YEARS ENDED MARCH 31,
---------------------------------
2005 2004 2003
---- ---- ----
Net income, as reported........................ $33,269 $45,848 $28,110
Stock based employee
compensation expense,
net of related tax effects................... (640) (695) (815)
------- ------- -------
Pro forma net income........................... $32,629 $45,153 $27,295
======= ======= =======
Earnings per share:
Basic Class A common - as reported.......... $ 0.71 $ 0.98 $ 0.59
Basic Class A common - pro forma............ 0.70 0.97 0.58
Basic Class B common - as reported.......... 0.59 0.82 0.50
Basic Class B common - pro forma............ 0.58 0.80 0.48
Diluted - as reported....................... 0.63 0.84 0.55
Diluted - pro forma......................... 0.62 0.83 0.53
The weighted average fair value of the options has been
estimated on the date of grant using the following weighted
average assumptions for grants issued during the years ended
March 31, 2005, 2004 and 2003, respectively: no dividend
yield; expected volatility of 36%, 43% and 45% for Class A
common stock; expected volatility of 33%, 39% and 45% for
Class B common stock; risk-free interest rate of 3.65%, 3.00%
and 2.40% per annum; and expected option terms ranging from 3
to 10 years for all three periods. Weighted averages are used
because of varying assumed exercise dates.
COMPREHENSIVE INCOME
--------------------
Comprehensive income includes all changes in equity during a
period except those that resulted from investments by or
distributions to the Company's shareholders. Other
comprehensive income refers to revenues, expenses, gains and
losses that, under generally accepted accounting principles,
are included in comprehensive income, but excluded from net
income as these amounts are recorded directly as an adjustment
to shareholders' equity. For the Company, other comprehensive
income (loss) is comprised of the net changes in unrealized
gains and losses on available-for-sale securities, net of
applicable income taxes.
FAIR VALUE OF FINANCIAL INSTRUMENTS
-----------------------------------
The fair values of the Company's cash and cash equivalents,
receivables, accounts payable and accrued liabilities
approximate their carrying values due to the relatively short
maturity of these items. The carrying
67
amount of all long-term financial obligations approximates
their fair value because their terms are similar to those
which can be obtained for similar financial instruments in the
current marketplace.
The Company's $5,000 investment in the preferred stock of
FemmePharma, Inc. had a fair value of $19,200 and $11,840 at
March 31, 2005 and 2004, respectively, based on an annual
independent valuation analysis. Based on quoted market rates,
the Company's $200,000 principal amount of Convertible
Subordinated Notes had a fair value of $217,620 and $247,940
at March 31, 2005 and 2004, respectively.
DERIVATIVE FINANCIAL INSTRUMENTS
--------------------------------
In April 2003, the Company entered into an interest rate swap
agreement with a major financial institution to hedge variable
interest rate exposure related to a term loan with the same
financial institution. Under the agreement, the Company fixed
the interest rate of the debt at 5.31% per annum for the term
of the loan. The swap is settled monthly and is recorded at
each reporting date on the Company's consolidated balance
sheet at fair value. Since the swap has not been designated as
a hedge, any unrealized gains and losses are recognized in
earnings.
The Company's derivative financial instruments also consist of
embedded derivatives related to the 2.5% Convertible
Subordinated Notes due 2033. These embedded derivatives
include certain conversion features and a contingent interest
feature. Although the conversion features represent embedded
derivative financial instruments, based on the de minimis
value of these features at the time of issuance and at March
31, 2005, no value has been assigned to these embedded
derivatives. The contingent interest feature provides unique
tax treatment under the Internal Revenue Service's contingent
debt regulations. In essence, interest accrues, for tax
purposes, on the basis of the instrument's comparable yield
(the yield at which the issuer would issue a fixed rate
instrument with similar terms).
NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------
In March 2004, the EITF completed its discussion of and
provided consensus guidance on Issue No. 03-06, Participating
Securities and the Two-Class Method under FASB Statement No.
128, Earnings per Share. The consensus interpreted the
definition of a "participating security," required the use of
the two-class method in the calculation and disclosure of
basic earnings per share for companies with participating
securities or more than one class of common stock, and
provided guidance on the allocation of earnings and losses for
purposes of calculating basic earnings per share. Since the
Company has two classes of common stock, this consensus has
been applied in the calculation of basic earnings per share
for all periods presented. There was no impact on diluted
earnings per share as reported.
In April 2004, the FASB issued FASB Staff Position No. 129-1
(FSP 129-1), Disclosure Requirements under FASB Statement No.
129, Disclosure of Information about Capital Structure,
Relating to Contingently Convertible Securities. This FSP
requires the disclosure provisions of Statement 129 to apply
to all existing and newly created contingently convertible
securities and to their potentially dilutive effects on
earnings per share. The adoption of the disclosure provisions
of FSP 129-1 did not have a material impact on the Company's
financial condition or results of operations.
In September 2004, the EITF reached a consensus that
contingently convertible debt instruments should be included
in diluted earnings per share computations (if dilutive)
regardless of whether the market price trigger (or other
contingent feature) has been met. Additionally, the EITF
stated that prior period earnings per share amounts presented
for comparative purposes should be restated to conform to this
consensus, which is effective for reporting periods ending
after December 15, 2004. The consensus adopted by the EITF
required
68
the addition of approximately 8.7 million shares associated
with the conversion of the Company's $200,000 principal amount
Convertible Subordinated Notes to the number of shares
outstanding for the calculation of diluted earnings per share
for all reported periods since the issuance of the Notes.
In November 2004, the FASB issued SFAS No. 151, Inventory
Costs, an Amendment to ARB No. 43, Chapter 4 which requires
that abnormal amounts of idle facility expense, freight,
handling costs, and wasted material (spoilage) costs be
recognized as current period charges. In addition, this
statement requires that allocation of fixed production
overheads to the costs of conversion be based on the normal
capacity of the production facilities. This statement is
effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. The Company is currently
determining the impact, if any, the adoption of this statement
will have on its financial condition and results of
operations.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment" (SFAS 123R), which replaces SFAS No.
123, "Accounting for Stock-Based Compensation" (SFAS 123), and
supercedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees." SFAS 123R requires all share-based payments to
employees, including grants of employee stock options, to be
recognized in the financial statements based on their fair
values. The pro forma disclosures previously permitted under
SFAS 123 no longer will be an alternative to financial
statement recognition. Under SFAS 123R, the Company must
determine the appropriate fair value model to be used for
valuing share-based payments, the amortization method for
compensation cost and the transition method to be used at date
of adoption. The transition methods include modified
prospective and modified retrospective adoption options. Under
the modified retrospective option, prior periods may be
restated either as of the beginning of the year of adoption or
for all periods presented. The modified prospective method
requires that compensation expense be recorded for all
unvested stock options and restricted stock at the beginning
of the first quarter of adoption of SFAS 123R, while the
modified retrospective method would record compensation
expense for all unvested stock options and restricted stock
beginning with the first period restated. The Company is
evaluating the requirements of SFAS 123R. The Company has not
yet determined the method of adoption or the effect of
adopting SFAS 123R, and it has not determined whether the
adoption will result in amounts that are similar to the
current pro forma disclosures under SFAS 123.
In April 2005, the Securities and Exchange Commission
announced an amendment to Regulation S-X to amend the date for
compliance with SFAS 123R. The amendment requires each
registrant that is not a small business issuer to adopt SFAS
123R in the first fiscal year commencing after June 15, 2005.
As a result, the Company is required to adopt SFAS 123R
beginning April 1, 2006. Adoption of SFAS 123R will have an
impact on the Company's consolidated financial statements, as
it will be required to expense the fair value of its employee
stock option grants rather than disclose the pro forma impact
on its consolidated net income within the footnotes to the
Company's consolidated financial statements, as is its current
practice.
69
3. ACQUISITIONS AND LICENSE AGREEMENT
----------------------------------
On March 31, 2003, the Company acquired from Schwarz Pharma
(Schwarz) the product rights and trademarks to the Niferex(R) line
of hematinic products for $14,300, plus expenses. The acquisition
was financed with cash on hand. The purchase price was allocated to
the trademark rights acquired and is being amortized over an
estimated life of 20 years.
On March 31, 2003, the Company acquired from a subsidiary of Altana
Pharma AG (Altana) the world-wide product rights and trademarks to
the Chromagen(R) line of hematinic products and the StrongStart(R)
line of prenatal vitamin products for $27,000, plus expenses. The
purchase price was allocated to the trademark rights acquired and
is being amortized over an estimated life of 20 years.
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
was intended for use in the treatment of endometriosis using
FemmePharma's patented PARDEL(TM) technology. In consideration for
the rights and licenses received, the Company paid $2,000 for use
of the PARDEL(TM) trademark (see Note 21).
Under a separate agreement, the Company invested $2,000 in
FemmePharma's convertible preferred stock in fiscal 2003 and made
an additional $3,000 convertible preferred stock investment in
January 2004 upon the completion of Phase II studies on the initial
product covered by the License Agreement. The $5,000 investment has
been accounted for using the cost method and is included in "Other
assets" in the accompanying consolidated balance sheets (see Note
21).
4. MARKETABLE SECURITIES
---------------------
The carrying amount of available-for-sale securities and their
approximate fair values at March 31, 2005 and 2004 were as follows.
MARCH 31, 2005
--------------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ----- ------ -----
Auction rate securities......... $10,000 $ - $ - $10,000
Equity securities............... 35,895 - (201) 35,694
------- ----- ----- -------
Total....................... $45,895 $ - $(201) $45,694
======= ===== ===== =======
MARCH 31, 2004
--------------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ----- ------ -----
Auction rate securities......... $10,000 $ - $ - $10,000
Equity securities............... 25,330 - - 25,330
------- ----- ----- -------
Total....................... $35,330 $ - $ - $35,330
======= ===== ===== =======
70
The Company's marketable securities are classified as
available-for-sale and are recorded at fair value based on quoted
market prices using the specific identification method. These
investments are classified as current as the Company has the
ability to use them for current operating and investing purposes.
There were no realized gains or losses for the years ended March
31, 2005, 2004 and 2003. At March 31, 2005, the Company has
determined that its unrealized losses are temporary based on the de
minimis amount of losses compared to cost and the duration of the
losses being less than 12 months. The Company expects that all
losses will be recovered, and intends to hold these marketable
securities to recovery. If market conditions deteriorate, we may
incur future impairments.
Included in the Company's marketable securities at March 31, 2005
and 2004 are $10,000 of auction rate securities. Auction rate
securities are investments with an underlying component of
long-term debt or an equity instrument. These auction rate
securities trade or mature on a shorter term than the underlying
instrument based on an auction bid that resets the interest rate of
the security. The auction or reset dates occur at intervals that
are typically less than three months providing high liquidity to
otherwise longer term investments. The Company had previously
classified its auction rate securities as cash and cash
equivalents. In fiscal 2005, the Company reclassified auction rate
securities from cash and cash equivalents to marketable securities
because the underlying instrument has a maturity date of August
2030. Prior periods have been reclassified to provide consistent
presentation.
5. INVENTORIES
-----------
Inventories as of March 31, consist of:
2005 2004
---- ----
Finished goods..................... $30,521 $30,432
Work-in-process.................... 5,773 4,736
Raw materials...................... 17,651 15,529
------- -------
$53,945 $50,697
======= =======
6. PROPERTY AND EQUIPMENT
----------------------
Property and equipment as of March 31, consist of:
2005 2004
---- ----
Land and improvements............... $ 2,030 $ 2,083
Building and building improvements.. 19,984 17,767
Machinery and equipment............. 41,399 43,442
Office furniture and equipment...... 14,871 15,051
Leasehold improvements.............. 9,985 11,338
Construction-in-progress............ 74,394 24,529
-------- --------
162,663 114,210
Less accumulated depreciation....... (31,039) (38,433)
-------- ---------
Net property and equipment....... $131,624 $ 75,777
======== ========
Capital additions to property and equipment were $63,622, $30,592
and $16,113 for the years ended March 31, 2005, 2004 and 2003,
respectively. Depreciation of property and equipment was $7,775,
$6,718 and $5,434 for the years ended March 31, 2005, 2004 and
2003, respectively.
Property and equipment projects classified as construction-in-
progress at March 31, 2005 are projected to be completed during the
next 12 months at an estimated cost of $14,775.
71
During the years ended March 31, 2005 and 2004, the Company
recorded capitalized interest on qualifying construction projects
of $1,511 and $577, respectively. In fiscal 2003, the Company did
not record any capitalized interest.
7. INTANGIBLE ASSETS AND GOODWILL
------------------------------
Intangible assets and goodwill as of March 31, consist of:
2005 2004
------------------------------ -----------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
------ ------------ ------ ------------
Product rights - Micro-K(R)..... $36,140 $(10,904) $36,140 $ (9,099)
Product rights - PreCare(R)..... 8,433 (2,389) 8,433 (1,968)
Trademarks acquired:
Niferex(R)................... 14,834 (1,484) 14,834 (742)
Chromagen(R)/StrongStart(R).. 27,642 (2,764) 27,642 (1,382)
License agreements.............. 4,168 (120) 3,825 -
Trademarks and patents.......... 2,814 (497) 2,980 (411)
------- -------- ------- --------
Total intangible assets..... 94,031 (18,158) 93,854 (13,602)
Goodwill........................ 557 - 557 -
------- -------- ------- --------
$94,588 $(18,158) $94,411 $(13,602)
======= ======== ======= ========
As of March 31, 2005, the Company's intangible assets have a
weighted average useful life of approximately 19 years.
Amortization of intangible assets was $4,653, $4,459 and $2,321 for
the years ended March 31, 2005, 2004 and 2003, respectively.
Assuming no additions, disposals or adjustments are made to the
carrying values and/or useful lives of the intangible assets,
annual amortization expense on product rights, trademarks acquired
and other intangible assets is estimated to be approximately $4,730
in each of the five succeeding fiscal years.
8. OTHER ASSETS
------------
Other assets as of March 31, consist of:
2005 2004
---- ----
Cash surrender value of life insurance......... $ 2,822 $ 2,531
Preferred stock in FemmePharma................. 5,000 5,000
Deferred financing costs, net.................. 3,852 4,993
Deposits....................................... 1,407 1,220
------- -------
$13,081 $13,744
======= =======
72
9. ACCRUED LIABILITIES
-------------------
Accrued liabilities as of March 31, consist of:
2005 2004
---- ----
Salaries, wages, incentives and benefits....... $10,383 $ 6,160
Income taxes - current......................... - 2,409
Promotion expenses............................. 131 635
Litigation reserve............................. - 18,325
Other.......................................... 5,219 3,388
------- -------
$15,733 $30,917
======= =======
10. LONG-TERM DEBT
--------------
Long-term debt as of March 31, consists of:
2005 2004
---- ----
Industrial revenue bonds....................... $ - $ 205
Notes payable.................................. - 6,731
Building mortgages............................. 10,740 11,714
Convertible notes.............................. 200,000 200,000
-------- --------
210,740 218,650
Less current portion........................... (973) (7,909)
-------- --------
$209,767 $210,741
======== ========
In December 2004, the Company increased its available credit
facilities to $140,000. The revised agreement provides for an
increase from $40,000 to $80,000 in the Company's revolving line of
credit along with an increase from $25,000 to $60,000 in the
supplemental credit line that is available for financing
acquisitions. These credit facilities expire in October 2006 and
December 2005, respectively. The revolving and supplemental credit
lines are unsecured and interest is charged at the lower of the
prime rate or the one-month LIBOR rate plus 175 basis points (4.61%
at March 31, 2005). At March 31, 2005, the Company had no cash
borrowings outstanding under either credit facility and $3,856 in
open letters of credit issued under the credit facilities. The
revised agreement contains substantially identical financial and
other covenants, representations, warranties, conditions and
default provisions as the replaced facility. The financial
covenants impose minimum levels of earnings before interest, taxes,
depreciation and amortization, a maximum funded debt ratio, a limit
on capital expenditures and dividend payments, a minimum fixed
charge coverage ratio and a maximum senior leverage ratio. As of
March 31, 2005, the Company was in compliance with the covenants.
The industrial revenue bonds, which paid interest at 7.35% per
annum, matured serially through 2005 and were collateralized by
certain property and equipment, as well as through a letter of
credit, which was only accessible in case of default on the bonds.
The bonds were paid in full in fiscal 2005.
In April 2003, the Company 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 remaining principal balance plus any
unpaid interest is due in April 2008. The Company also entered into
an interest rate swap agreement with the same bank, which fixed the
interest rate of the building mortgage at 5.31% for the term of the
loan. At March 31, 2005, the Company's other two outstanding
building mortgages bear interest at 7.57% and 6.27% and the
remaining principal balances plus any unpaid interest are due in
December 2006 and December 2007, respectively.
73
Notes payable related to a $7,000 unsecured promissory note that
was entered into in conjunction with the Altana acquisition
agreement (see Note 3) and was repaid on March 31, 2005. This note,
which was non-interest bearing, was discounted using an imputed
interest rate of 4.08%, which approximated the Company's borrowing
rate for similar debt instruments at the time of the borrowing. The
original discount on this note of $538 was amortized to interest
expense over the two year term of the note. A second $7,000
unsecured promissory note entered into with Altana was repaid on
March 31, 2004.
On May 16, 2003, the Company issued $200,000 principal amount of
Convertible Subordinated Notes (the "Notes") that are convertible,
under certain circumstances, into shares of Class A common stock at
an initial conversion price of $23.01 per share. The Notes, which
are due May 16, 2033, bear interest that is payable on May 16 and
November 16 of each year at a rate of 2.50% per annum. The Company
also is obligated to pay contingent interest at a rate equal to
0.5% per annum during any six-month period from May 16 to November
15 and from November 16 to May 15, with the initial six-month
period commencing May 16, 2006, if the average trading price of the
Notes per $1,000 principal amount for the five trading day period
ending on the third trading day immediately preceding the first day
of the applicable six-month period equals $1,200 or more. As this
contingent interest feature is based on the underlying trading
price of the Notes, the contingent interest meets the criteria of
and qualifies as an embedded derivative. At the time of issuance
and at March 31, 2005, management determined that the fair value of
this contingent interest embedded derivative was de minimis and,
accordingly, no value has been assigned to this embedded
derivative.
The Company may redeem some or all of the Notes at any time on or
after May 21, 2006, at a redemption price, payable in cash, of 100%
of the principal amount of the Notes, plus accrued and unpaid
interest, including contingent interest, if any. Holders may
require the Company to repurchase all or a portion of their Notes
on May 16, 2008, 2013, 2018, 2023 and 2028 or upon a change in
control, as defined in the indenture governing the Notes, at a
purchase price, payable in cash, of 100% of the principal amount of
the Notes, plus accrued and unpaid interest, including contingent
interest, if any. The Notes are subordinate to all of our existing
and future senior obligations. The net proceeds to the Company were
approximately $194.2 million, after deducting underwriting
discounts, commissions and offering expenses.
The Notes are convertible, at the holders' option, into shares of
the Company's Class A common stock prior to the maturity date under
the following circumstances:
o during any quarter commencing after June 30,
2003, if the closing sale price of the Company's
Class A common stock over a specified number of
trading days during the previous quarter is more
than 120% of the conversion price of the Notes
on the last trading day of the previous quarter.
The Notes are initially convertible at a
conversion price of $23.01 per share, which is
equal to a conversion rate of approximately 43.4594
shares per $1,000 principal amount of Notes;
o if the Company has called the Notes for redemption;
o during the five trading day period immediately
following any nine consecutive day trading
period in which the trading price of the Notes
per $1,000 principal amount for each day of such
period was less than 95% of the product of the
closing sale price of our Class A common stock
on that day multiplied by the number of shares
of our Class A common stock issuable upon
conversion of $1,000 principal amount of the Notes; or
o upon the occurrence of specified corporate transactions.
The Company has reserved 8,691,880 shares of Class A common stock
for issuance in the event the Notes are converted into the
Company's common shares.
74
The Notes, which are unsecured, do not contain any restrictions on
the payment of dividends, the incurrence of additional indebtedness
or the repurchase of the Company's securities, and do not contain
any financial covenants.
The aggregate maturities of long-term debt as of March 31, 2005 are
as follows:
Due in one year............... $ 973
Due in two years.............. 2,179
Due in three years............ 1,674
Due in four years............. 5,914
Due in five years............. -
Thereafter.................... 200,000
--------
$210,740
========
The Company paid interest, net of capitalized interest, of $4,156
during the year ended March 31, 2005. For the years ended March 31,
2004 and 2003, the Company paid interest of $3,215 and $389,
respectively.
11. COMMITMENTS AND CONTINGENCIES
-----------------------------
LEASES
The Company leases manufacturing, office and warehouse facilities,
equipment and automobiles under operating leases expiring through
fiscal 2013. Total rent expense for the years ended March 31, 2005,
2004 and 2003 was $5,734, $5,246 and $4,785, respectively.
Future minimum lease commitments under non-cancelable leases are as
follows:
2006.......................... $1,598
2007.......................... 1,167
2008.......................... 782
2009.......................... 551
2010.......................... 535
Later years................... 624
A building leased by the Company on March 31, 2005 was purchased on
April 14, 2005 (see Note 21). The future minimum lease payments
under this lease were only included above through the date of the
purchase. Payments that would have been due under this lease were
$1,324 per year through April 2008 and $1,454 per year through
April 2012.
CONTINGENCIES
The Company is currently subject to legal proceedings and claims
that have arisen in the ordinary course of business. While the
Company is not presently able to determine the potential liability,
if any, related to such matters, the Company believes none of the
matters it currently faces, individually or in the aggregate, will
have a material adverse effect on its financial position or
operations except for the specific cases described in "Litigation"
below.
The Company has licensed the exclusive rights to co-develop and
market various generic equivalent products with other drug delivery
companies. These collaboration agreements require the Company to
make up-front and ongoing payments as development milestones are
attained. If all milestones remaining under these agreements were
reached, payments by the Company could total up to $15,455.
75
LITIGATION
ETHEX Corporation (ETHEX), a subsidiary of the Company, was a
defendant in a lawsuit styled Healthpoint, Ltd. v. ETHEX
Corporation, filed in federal court in San Antonio, Texas. The
Company and ETHEX were also named as defendants in a second lawsuit
brought by Healthpoint and others styled Healthpoint Ltd. v. ETHEX
Corporation, filed in federal court in San Antonio, Texas. In
September 2004, the Company made a settlement payment in the amount
of $16,500 to resolve all previously pending claims between KV and
Healthpoint without the admission of any liability. The settlement
was fully reserved by the Company in September 2002 and therefore
had no impact on KV's earnings for the year ended March 31, 2005.
The $1,430 of income reflected in "Litigation" on the Company's
consolidated income statement for the year ended March 31, 2005
represents a $587 net payment received by us in accordance with a
settlement of vitamin antitrust litigation and $843 related to the
reversal of the portion of the Healthpoint litigation reserve that
remained after payment of the settlement amount and related
litigation costs.
The Company and ETHEX are named as defendants in a case brought by
CIMA LABS, Inc. and Schwarz Pharma, Inc. and styled CIMA LABS, Inc.
et. al. v. KV Pharmaceutical Company et. al. filed in Federal
District Court in Minnesota. It is alleged that the Company and
ETHEX infringed on a CIMA patent in connection with the manufacture
and sale of Hyoscyamine Sulfate Orally Dissolvable Tablets, 0.125
mg. The court has denied the plaintiffs' motion for a preliminary
injunction, which allows ETHEX to continue marketing the product
during the pendancy of the subject lawsuit. The Company has filed
several motions for summary judgment requesting that the Court rule
that the relevant patent is unenforceable, invalid or not
infringed. These motions have been denied and the issues will be
considered at trial. CIMA and Schwarz filed a summary judgment
motion seeking the court to rule that the patent is valid in the
face of some prior art references cited by the Company as providing
support for its invalidity defense. The Court granted the motion;
however, the issue of invalidity based on prior art that was not
the subject of the motion will be tried. The Company intends to
vigorously defend its interests; however, it cannot give any
assurance it will prevail.
The Company and ETHEX are named as defendants in a case brought by
Solvay Pharmaceuticals, Inc. and styled Solvay Pharmaceuticals,
Inc. v. ETHEX Corporation, filed in Federal District Court in
Minnesota. In general, Solvay alleges that ETHEX's comparative
promotion of its Pangestyme(TM) CN 10 and Pangestyme(TM) CN 20
products to Solvay's Creon(R) 10 and Creon(R) 20 products resulted
in false advertising and misleading statements under various
federal and state laws, and constituted unfair and deceptive trade
practices. Discovery is active and the case is required to be trial
ready by February 1, 2006. The Company intends to vigorously defend
its interests; however, it cannot give any assurance it will
prevail.
KV previously distributed several 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 in December
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 Federal 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 been segregated
into a lawsuit brought by Johnny Fulcher individually and on behalf
of the wrongful death beneficiaries of Linda Fulcher, deceased,
against the Company. 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. In May 2004, the case was
dismissed with prejudice by the Federal District Court for the
Western District of Washington for a failure to timely file an
individual complaint
76
as required by certain court orders. The plaintiff filed a request
for reconsideration which was opposed and subsequently denied by
the Court in June 2004. In July 2004, the plaintiff filed a notice
of appeal of the dismissal. The Company has opposed this appeal.
The Company intends to vigorously defend its interests; however, it
cannot give any assurance it will prevail.
The Company has also been advised that one of its former
distributor customers is being sued in Florida state court in a
case captioned Darrian Kelly v. K-Mart et. al. for personal injury
allegedly caused by ingestion of K-Mart diet caplets that are
alleged to have been manufactured by the Company and to contain
PPA. The distributor has tendered defense of the case to the
Company and has asserted a right to indemnification for any
financial judgment it must pay. The Company previously notified its
product liability insurer of this claim in 1999, and the Company
has demanded that the insurer assume the Company's defense. The
insurer has stated that it has retained counsel to secure
additional factual information and will defer its coverage decision
until that information is received. The Company intends to
vigorously defend its interests; however, it cannot give any
assurance that is will not be impleaded into the action, or that,
if it is impleaded, that it would prevail.
KV's product liability coverage for PPA claims expired for claims
made after June 15, 2002. Although the Company renewed its product
liability coverage for coverage after June 15, 2002, that policy
excludes future PPA claims in accordance with the standard industry
exclusion. Consequently, as of June 15, 2002, the Company will
provide for legal defense costs and indemnity payments involving
PPA claims on a going forward basis as incurred, 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 its
interests; however, it cannot give any assurance it will prevail.
After the Company filed ANDAs with the FDA seeking permission to
market a generic version of the 50 mg, 100 mg, and 200 mg strengths
of Toprol(R) XL in extended release capsule form, AstraZeneca filed
lawsuits against KV for patent infringement under the provisions of
the Hatch-Waxman Act. In the Company's Paragraph IV certification,
KV contended that its proposed generic versions do not infringe
AstraZeneca's patents. Pursuant to the Hatch-Waxman Act, the filing
date of the suit against the Company instituted an automatic stay
of FDA approval of the Company's ANDA until the earlier of a
judgment, or 30 months from the date of the suit. The Company has
filed a motion for summary judgment with the Federal District Court
in Missouri alleging, among other things, that AstraZeneca's patent
is invalid. There is no trial setting. The Company intends to
vigorously defend its interests; however, it cannot give any
assurance it will prevail.
The Company and/or ETHEX have been named as defendants in certain
multi-defendant cases alleging that the defendants reported
improper or fraudulent pharmaceutical pricing information, i.e.,
Average Wholesale Price, or AWP, and/or Wholesale Acquisition Cost,
or WAC, information, which caused the governmental plaintiffs to
incur excessive costs for pharmaceutical products under the
Medicaid program. Cases of this type have been filed against the
Company and/or ETHEX and other pharmaceutical manufacturer
defendants by the State of Massachusetts, the State of Alabama, New
York City, and approximately 25 counties in New York State (less
than ten of which have been formally served on the Company or
ETHEX). The New York City case and all but one of the New York
County cases have been transferred (or will be the subject of a
notice of related action in order to effectuate transfer) to the
Federal District Court for the District of Massachusetts for
coordinated or consolidated pretrial proceedings under the Average
Wholesale Price Multidistrict Litigation (MDL No. 1456). Each of
these actions is in the early stages, and fact discovery has not
yet begun in any of the cases other than the Alabama case, where
the State's first discovery request has been filed. The Company
intends to vigorously defend its interests in the actions described
above; however, it cannot give any assurance it will prevail.
The Company believes that various other governmental entities have
commenced investigations into the generic and branded
pharmaceutical industry at large regarding pricing and price
reporting practices. Although the
77
Company believes its pricing and reporting practices have complied
in all material respects with its legal obligations, it cannot give
any assurance that it would prevail if legal actions are instituted
by these governmental entities.
On May 20, 2005, the Company was notified by the SEC that a
non-public formal investigation was initiated that appears to
relate to the Form 8-K disclosures the Company made on July 13,
2004. The Company is cooperating fully and believes the matter will
be satisfactorily resolved.
From time to time, 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 submitted ANDA filings and provided
notice of certification required under the provisions of the 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.
There are uncertainties and risks associated with all litigation
and there can be no assurance that the Company will prevail in any
particular litigation.
12. EMPLOYMENT AGREEMENTS
---------------------
The Company has employment agreements with certain officers and key
employees which extend for one to five years. These agreements
provide for base levels of compensation and, in certain instances,
also provide for incentive bonuses and separation benefits. Also,
the agreement with the Chief Executive Officer (CEO) contains
provisions for partial salary continuation under certain
conditions, contingent upon noncompete restrictions and providing
consulting services to the Company as specified in the agreement.
In addition, the CEO is entitled to receive retirement compensation
paid in the form of a single annuity equal to 30% of the CEO's
final average compensation payable each year beginning at
retirement and continuing for the longer of 10 years or the life of
the CEO. In accordance with this agreement, the Company recognized
retirement expense of $1,355, $209 and $196 for the years ended
March 31, 2005, 2004 and 2003, respectively. In fiscal 2005, the
Company actuarily updated the appropriateness of the liability.
13. GAIN FROM LEGAL SETTLEMENT
--------------------------
In September 2003, the Company received a payment from a branded
pharmaceutical company in the amount of $4,000. The payment
received by the Company was made in response to the Company's claim
that the branded company violated federal antitrust laws and
interfered with the Company's right to a timely introduction of a
generic pharmaceutical product in a previous fiscal year. The
payment was reflected by the Company in the "Litigation" line item
of operating income and was recorded net of approximately $500 of
attorney-related fees.
14. INCOME TAXES
------------
The income tax provisions for the years ended March 31, 2005, 2004
and 2003 were based on estimated Federal and state taxable income
using the applicable statutory rates. The current and deferred
Federal and state income tax provisions for the years ended March
31, 2005, 2004 and 2003 are as follows:
2005 2004 2003
---- ---- ----
PROVISION
Current
Federal............................... $ 2,982 $14,184 $21,524
State................................. 195 1,275 2,038
------- ------- -------
3,177 15,459 23,562
------- ------- -------
Deferred
Federal............................... 12,473 7,792 (7,207)
State................................. 1,109 899 (884)
------- ------- -------
13,582 8,691 (8,091)
------- ------- -------
$16,759 $24,150 $15,471
======= ======= =======
78
The reasons for the differences between the provision for income
taxes and the expected Federal income taxes at the statutory rate
are as follows:
2005 2004 2003
---- ---- ----
Expected income tax expense................. $17,510 $24,499 $15,253
State income taxes, less
Federal income tax benefit............... 847 1,413 750
Business credits............................ (1,080) (1,240) (370)
Other ...................................... (518) (522) (162)
------- ------- -------
$16,759 $24,150 $15,471
======= ======= =======
As of March 31, 2005 and 2004, the tax effect of temporary
differences between the tax basis of assets and liabilities and
their financial reporting amounts are as follows:
2005 2004
------------------------- ------------------------
CURRENT NON-CURRENT CURRENT NON-CURRENT
------- ----------- ------- -----------
Fixed asset basis differences........ $ - $ (6,658) $ - $(4,870)
Reserves for inventory and
receivables....................... 5,510 - 5,313 -
Vacation pay reserve................. 249 - 460 -
Deferred compensation................ - 1,620 - 1,164
Amortization......................... - (2,121) - (1,644)
Litigation reserve................... - - 6,704 -
Convertible notes interest........... - (9,495) (4,566) -
Other................................ 68 - 126 -
------ -------- ------- -------
Net deferred tax asset (liability) $5,827 $(16,654) $ 8,037 $(5,350)
====== ======== ======= =======
The Company paid income taxes of $8,769, $22,201, and $22,088
during the years ended March 31, 2005, 2004 and 2003, respectively.
Included in "Prepaid and other assets" at March 31, 2005 in the
accompanying consolidated balance sheet was income tax refunds
receivable of $2,518.
15. EMPLOYEE BENEFITS
-----------------
STOCK OPTION PLAN AND AGREEMENTS
On August 30, 2002, the Company's shareholders approved KV's 2001
Incentive Stock Option Plan (the "2001 Plan"), which allows for the
issuance of up to 3,000,000 shares of common stock. Prior to the
approval of the 2001 Plan, the Company operated under the 1991
Incentive Stock Option Plan, as amended, which still allows for the
issuance of up to 750,000 shares of common stock. Under the
Company's stock option plans, options to acquire shares of common
stock have been made available for grant to certain employees. Each
option granted has an exercise price of not less than 100% of the
market value of the common stock on the date of grant. The
contractual life of each option is generally 10 years. The
exercisability of the grants varies according to the individual
options granted. In addition to these plans, the Company has issued
stock options periodically to executives with employment agreements
and to non-employee directors. At March 31, 2005, options to
purchase 34,875 shares of stock were outstanding pursuant to
employment agreements and grants to non-employee directors.
79
The following summary shows the transactions for the years ended
March 31, 2005, 2004 and 2003 under option arrangements:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------- -------------------
AVERAGE AVERAGE
NO. OF PRICE PER NO. OF PRICE PER
SHARES SHARE SHARES SHARE
------ ----- ------ -----
Balance, March 31, 2002........... 3,198,579 $ 8.12 1,435,756 $ 7.41
Options granted................... 700,538 12.35 - -
Options becoming exercisable...... - - 566,455 9.21
Options exercised................. (135,420) 5.26 (135,420) 5.26
Options canceled.................. (260,664) 11.67 (75,952) 10.97
--------- ---------
Balance March 31, 2003............ 3,503,033 8.81 1,790,839 8.00
Options granted................... 677,313 19.56 - -
Options becoming exercisable...... - - 541,924 12.17
Options exercised................. (966,036) 7.80 (966,036) 7.80
Options canceled.................. (437,502) 11.72 (132,869) 10.37
--------- ---------
Balance March 31, 2004............ 2,776,808 11.33 1,233,858 9.71
Options granted................... 676,250 22.19 - -
Options becoming exercisable...... - - 431,164 14.42
Options exercised................. (220,743) 6.44 (220,743) 6.44
Options canceled.................. (129,517) 16.30 (34,285) 13.35
--------- ---------
Balance March 31, 2005............ 3,102,798 $13.84 1,409,994 $11.58
========= =========
The weighted average fair value of options granted at market price
was $3.29, $3.42, and $2.18 per share for the years ended March 31,
2005, 2004 and 2003, respectively. The weighted average fair value
of options granted with an exercise price exceeding market price on
the date of grant was $2.94, $1.97, and $0.14 per share for the
years ended March 31, 2005, 2004 and 2003, respectively.
The following table summarizes information about stock options
outstanding at March 31, 2005:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------------- -----------------------------
RANGE OF NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED
EXERCISE OUTSTANDING LIFE AVERAGE EXERCISABLE AVERAGE
PRICES AT 3/31/05 REMAINING EXERCISE PRICE AT 3/31/05 EXERCISE PRICE
------ ---------- --------- -------------- ---------- --------------
$ 0.82 - $ 5.00 365,186 1 Years $ 3.14 306,717 $ 3.06
$ 5.01 - $10.00 614,120 5 Years $ 7.37 308,035 $ 7.23
$10.01 - $15.00 795,534 6 Years $12.04 379,562 $12.07
$15.01 - $20.00 614,938 7 Years $17.79 252,405 $18.24
$20.01 - $27.50 713,020 8 Years $23.48 163,275 $24.32
PROFIT SHARING PLAN
The Company has a qualified trustee profit sharing plan (the
"Plan") covering substantially all non-union employees. The
Company's annual contribution to the Plan, as determined by the
Board of Directors, is discretionary and was $300, $400, and $375
for the years ended March 31, 2005, 2004 and 2003, respectively.
The Plan includes features as described under Section 401(k) of the
Internal Revenue Code.
80
The Company's contributions to the 401(k) investment funds are 50%
of the first 7% of the salary contributed by each participant.
Contributions of $1,547, $1,286, and $1,185 were made to the 401(k)
investment funds during the years ended March 31, 2005, 2004 and
2003, respectively.
Contributions are also made to multi-employer defined benefit plans
administered by labor unions for certain union employees. Amounts
charged to pension expense and contributed to these plans were
$200, $202, and $231 for the years ended March 31, 2005, 2004 and
2003, respectively.
HEALTH AND MEDICAL INSURANCE PLAN
The Company contributes to health and medical insurance programs
for its non-union and union employees. For non-union employees, the
Company self-insures the first $150,000 of each employee's covered
medical claims. Included in accrued liabilities in the consolidated
balance sheets as of March 31, 2005 and 2004 were $20 and $450 of
accrued health insurance reserves, respectively, for claims
incurred but not reported. In fiscal 2005, the Company established
a Voluntary Employees' Beneficiary Association for its non-union
employees to fund payments made by the Company for covered medical
claims. As a result of initially funding this plan, the Company's
liability for claims incurred but not reported was reduced by $680.
For union employees, the Company participates in a fully funded
insurance plan sponsored by the union. Total health and medical
insurance expense for the two plans was $9,431, $7,331, and $6,636
for the years ended March 31, 2005, 2004 and 2003, respectively.
16. RELATED PARTY TRANSACTIONS
--------------------------
The Company currently leases certain real property from an
affiliated partnership of an officer and director of the Company.
Lease payments made for this property for the years ended March 31,
2005, 2004 and 2003 totaled $277, $271, and $269, respectively.
17. EQUITY TRANSACTIONS
-------------------
As of March 31, 2005 and 2004, the Company had 40,000 shares of 7%
Cumulative Convertible Preferred Stock (par value $.01 per share)
outstanding at a stated value of $25 per share. The preferred stock
is non-voting with dividends payable quarterly. The preferred stock
is redeemable by the Company at its stated value. Each share of
preferred stock is convertible into Class A common stock at a
conversion price of $2.96 per share. The preferred stock has a
liquidation preference of $25 per share plus all accrued but unpaid
dividends prior to any liquidation distributions to holders of
Class A or Class B common stock. No dividends may be paid on Class
A or Class B common stock unless all dividends on the Cumulative
Convertible Preferred Stock have been declared and paid. There were
no undeclared and unaccrued cumulative preferred dividends at March
31, 2005 and 2004. Also, under the terms of its credit agreement,
the Company may not pay cash dividends in excess of 25% of the
prior fiscal year's consolidated net income.
The Company has reserved 750,000 shares of Class A common stock for
issuance under KV's 2002 Consultants Plan. These shares may be
issued from time to time in consideration for consulting and other
services provided to the Company by independent consultants. Since
inception of this plan, the Company has issued 47,732 Class A
shares as payment for certain milestones under product development
agreements.
Holders of Class A common stock are entitled to receive dividends
per share equal to 120% of the dividends per share paid on the
Class B common stock and have one-twentieth vote per share in the
election of directors and on other matters.
81
Under the terms of the Company's current loan agreement (see Note
10), the Company has limitations on paying dividends, except in
stock, on its Class A and Class B common stock. Payment of
dividends may also be restricted under Delaware Corporation law.
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 of
its common stock to shareholders of record on September 18, 2003,
payable on September 29, 2003. Common stock was credited and
retained earnings was charged for the aggregate par value of the
shares issued. The stated par value of each share was not changed
from $0.01.
All per share data in this report has been restated to reflect the
aforementioned three-for-two stock split in the form of a 50% stock
dividend.
In May 2003, the Company used $50,000 of the net proceeds from the
Convertible Subordinated Notes issuance (see Note 10) to fund the
repurchase of 2,000,000 shares of the Company's Class A common
stock.
82
18. EARNINGS PER SHARE
------------------
The following table sets forth the computation of basic and diluted
earnings per share:
2005 2004 2003
---- ---- ----
Undistributed earnings:
Net income ....................................... $33,269 $45,848 $28,110
Less - preferred stock dividends.................. (70) (436) (70)
------- ------- -------
Undistributed earnings - basic EPS................ 33,199 45,412 28,040
Add - preferred stock dividends................... 70 436 70
Add - interest expense on convertible
notes, net of tax.............................. 4,099 3,507 -
------- ------- -------
Net income - diluted EPS.......................... $37,368 $49,355 $28,110
======= ======= =======
Allocation of undistributed earnings:
Class A common stock.............................. $24,316 $32,391 $20,211
Class B common stock.............................. 8,883 13,021 7,829
------- ------- -------
Total allocated earnings - basic EPS........... $33,199 $45,412 $28,040
======= ======= =======
Weighted average shares outstanding - basic:
Class A common stock.............................. 34,228 33,046 33,997
Class B common stock.............................. 15,005 15,941 15,803
------- ------- -------
Total weighted average shares
outstanding - basic......................... 49,233 48,987 49,800
------- ------- -------
Effect of dilutive securities:
Employee stock options............................ 1,205 1,760 1,423
Convertible preferred stock....................... 338 338 338
Convertible notes................................. 8,692 7,623 -
------- ------- -------
Dilutive potential common shares............... 10,235 9,721 1,761
------- ------- -------
Total weighted average shares
outstanding - diluted....................... 59,468 58,708 51,561
======= ======= =======
Basic earnings per share:
Class A common stock.............................. $ 0.71 $ 0.98 $ 0.59
Class B common stock.............................. 0.59 0.82 0.50
Diluted earnings per share(1)........................ 0.63 0.84 0.55
======= ======= =======
- -----------------
(1) 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 years ended March 31, 2005, 2004
and 2003, options to purchase 712,770, 206,771 and 405,735
Class A and Class B common shares, respectively, were excluded
from the computation.
83
19. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
---------------------------------------
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- ----
YEAR ENDED MARCH 31, 2005
- -------------------------
Net sales.................................. $66,087 $79,322 $86,857 $71,227 $303,493
Gross profit............................... 42,353 52,466 56,922 44,070 195,811
Pretax income (loss)....................... 11,543 19,591 20,062 (1,168) 50,028
Net income (loss).......................... 7,561 12,676 13,552 (520) 33,269
Basic earnings per share:
Class A common stock.................... 0.16 0.27 0.29 (0.01) 0.71
Class B common stock.................... 0.14 0.23 0.24 (0.01) 0.59
Diluted earnings per share................. 0.14 0.23 0.25 (0.01) 0.63
YEAR ENDED MARCH 31, 2004
- -------------------------
Net sales.................................. $59,379 $71,019 $69,598 $83,945 $283,941
Gross profit............................... 38,389 46,879 46,837 53,409 185,514
Pretax income.............................. 13,291 18,978 17,874 19,855 69,998
Net income................................. 8,573 12,241 11,529 13,505 45,848
Basic earnings per share:
Class A common stock.................... 0.17 0.27 0.25 0.29 0.98
Class B common stock.................... 0.14 0.22 0.21 0.24 0.82
Diluted earnings per share................. 0.16 0.22 0.21 0.24 0.84
84
20. SEGMENT REPORTING
-----------------
The reportable operating segments of the Company are branded
products, specialty generics and specialty materials. The Company
has aggregated its branded product lines in a single segment
because of similarities in regulatory environment, manufacturing
processes, methods of distribution and types of customer. This
segment includes patent-protected products and certain trademarked
off-patent products that the Company sells and markets as brand
pharmaceutical products. The specialty generics business segment
includes off-patent pharmaceutical products that are
therapeutically equivalent to proprietary products. The Company
sells its brand and generic products primarily to pharmaceutical
wholesalers, drug distributors and chain drug stores. The specialty
materials segment is distinguished as a single segment because of
differences in products, marketing and regulatory approval when
compared to the other segments.
Accounting policies of the segments are the same as the Company's
consolidated accounting policies. Segment profits are measured
based on income before taxes and are determined based on each
segment's direct revenues and expenses. The majority of research
and development expense, corporate general and administrative
expenses, amortization and interest expense, as well as interest
and other income, are not allocated to segments, but included in
the "all other" classification. Identifiable assets for the three
reportable operating segments primarily include receivables,
inventory, and property and equipment. For the "all other"
classification, identifiable assets consist of cash and cash
equivalents, corporate property and equipment, intangible and other
assets and all income tax related assets.
The following represents information for the Company's reportable
operating segments for fiscal 2005, 2004 and 2003.
FISCAL YEAR
ENDED BRANDED SPECIALTY SPECIALTY ALL
MARCH 31, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED
--------- -------- -------- --------- ----- ------------ ------------
- --------------------------------------------------------------------------------------------------------------------------------
NET REVENUES
2005 $90,085 $191,870 $18,345 $ 3,193 $ - $303,493
2004 82,868 181,455 16,550 3,068 - 283,941
2003 43,677 179,724 17,395 4,200 - 244,996
- --------------------------------------------------------------------------------------------------------------------------------
SEGMENT PROFIT (LOSS)
2005 24,037 102,937 3,043 (79,989) - 50,028
2004 31,661 101,163 1,365 (64,191) - 69,998
2003 8,361 97,339 1,692 (63,811) - 43,581
- --------------------------------------------------------------------------------------------------------------------------------
IDENTIFIABLE ASSETS
2005 25,015 66,834 8,001 459,625 (1,158) 558,317
2004 24,585 70,581 8,343 426,087 (1,158) 528,438
2003 7,819 69,303 8,797 267,907 (1,158) 352,668
- --------------------------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT ADDITIONS
2005 2,463 - 318 60,841 - 63,622
2004 420 1,685 71 28,416 - 30,592
2003 634 116 143 15,220 - 16,113
- --------------------------------------------------------------------------------------------------------------------------------
DEPRECIATION AND AMORTIZATION
2005 217 235 140 13,312 - 13,904
2004 332 123 141 12,067 - 12,663
2003 260 55 164 7,294 - 7,773
- --------------------------------------------------------------------------------------------------------------------------------
Consolidated revenues are principally derived from customers in
North America and substantially all property and equipment is
located in St. Louis, Missouri.
85
21. SUBSEQUENT EVENTS
-----------------
On April 14, 2005, the Company completed the purchase of a 260,000
square foot building for $11,800. The property had been leased by
the Company since April 2000 and will continue to function as the
Company's main distribution facility. The purchase of the building
was financed with cash on hand.
In May 2005, the Company and FemmePharma mutually agreed to
terminate the license agreement they entered into in April 2002
(see Note 3). As part of this transaction, the Company acquired all
of the common stock of FemmePharma for $25,000 after certain assets
of the entity had been distributed to FemmePharma's other
shareholders. Included in the Company's acquisition of FemmePharma
are the worldwide marketing rights to an endometriosis product that
has successfully completed Phase II clinical trials. This product
was originally part of the licensing arrangement with FemmePharma
that provided the Company, among other things, marketing rights for
the product principally in the United States. In accordance with
the new agreement, the Company is assuming responsibility for
conducting the Phase III clinical study; has acquired worldwide
licensing rights of the endometriosis product; is no longer
responsible for milestone payments and royalties specified in the
original licensing agreement; and has secured exclusive worldwide
rights for use of the FemmePharma technology for vaginal
anti-infective products. The Company believes the Phase III
clinical study for the endometriosis product will begin during
fiscal 2006. In connection with this transaction, the Company
expects to incur a charge of approximately $30,000 in the first
quarter of fiscal 2006, which includes the write-off of the $25,000
payment plus preferred stock investments previously made, and which
principally relates to in-process research and development.
In May 2005, the Company entered into a long-term product
development and marketing license agreement with Strides Arcolab,
Ltd, (Strides) an Indian generic pharmaceutical developer and
manufacturer, for exclusive marketing rights in the United States
and Canada for 10 new generic drugs. Under the agreement, Strides
will be responsible for developing, submitting for regulatory
approval and manufacturing the 10 products and the Company will be
responsible for exclusively marketing the products in the
territories covered by the agreement. Under a separate agreement,
the Company invested $11,300 in Strides' redeemable preferred
stock.
86
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
On August 17, 2004, the Company engaged KPMG LLP as its independent
auditor. KMPG LLP replaced BDO Seidman LLP after their resignation
which was reported in an 8-K filed July 13, 2004.
There have been no disagreements with accountants on accounting or
financial disclosure matters.
ITEM 9A. CONTROLS AND PROCEDURES
-----------------------
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in its
Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and
forms, and that such information is accumulated and communicated to
the Company's management, including its principal executive officer
and principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure. In designing and
evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management
necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
As of the end of the period covered by this report, the Company
carried out an evaluation, under the supervision and with the
participation of its management, including its principal executive
officer and principal financial officer, of the effectiveness of
the design and operation of its disclosure controls and procedures.
Based on the foregoing, the Company's principal executive officer
and principal financial officer concluded that the Company's
disclosure controls and procedures were effective as of the end of
the period covered by this report.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of the Company is responsible for establishing and
maintaining adequate internal control over financial reporting. The
Company's internal control over financial reporting is designed to
provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting
principles.
The Company's internal control over financial reporting includes
those policies and procedures that (i) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
Company; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements
in accordance with generally accepted accounting principles, and
that receipts and expenditures of the Company are being made only
in accordance with authorizations of management and directors of
the Company; and (iii) provide reasonable assurance regarding the
prevention or timely detection of unauthorized acquisition, use or
disposition of the Company's assets that could have a material
effect on the financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
Management performed an assessment of the effectiveness of the
Company's internal control over financial reporting as of March 31,
2005. Management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in
Internal Control - Integrated Framework. As a result of this
assessment and based on the criteria set forth in the COSO
framework, management has concluded that, as of March 31, 2005, the
Company's internal control over financial reporting was effective.
87
Management's assessment of the effectiveness of the Company's
internal control over financial reporting as of March 31, 2005 has
been audited by KPMG LLP, an independent registered public
accounting firm, as stated in their report appearing herein.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There have been no changes in the Company's internal control over
financial reporting, during the fiscal quarter ended March 31,
2005, that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial
reporting.
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors and Shareholders
K-V Pharmaceutical Company:
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that K-V
Pharmaceutical Company maintained effective internal control over financial
reporting as of March 31, 2005, based on the criteria established in
Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is
responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control
over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether effective internal control over financial reporting was maintained
in all material respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating management's
assessment, testing and evaluating the design and operating effectiveness of
internal control, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles. A company's
internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
88
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that K-V Pharmaceutical Company
maintained effective internal control over financial reporting as of March
31, 2005, is fairly stated, in all material respects, based on the criteria
established in Internal Control--Integrated Framework issued by COSO. Also,
in our opinion, K-V Pharmaceutical Company maintained, in all material
respects, effective internal control over financial reporting as of March
31, 2005, based on criteria established in Internal Control--Integrated
Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet
of K-V Pharmaceutical Company and subsidiaries as of March 31, 2005, and the
related consolidated statements of income, comprehensive income,
shareholders' equity, and cash flows for the year ended March 31, 2005, and
our report dated June 14, 2005 expressed an unqualified opinion on those
consolidated financial statements.
/s/ KPMG LLP
St. Louis, Missouri
June 14, 2005
89
ITEM 9B. OTHER INFORMATION
-----------------
DEPARTURE OF DIRECTORS OR PRINCIPAL OFFICERS; ELECTION OF
DIRECTORS; APPOINTMENT OF PRINCIPAL OFFICERS.
On June 13, 2005, K-V Pharmaceutical Company (the "Registrant")
designated Richard H. Chibnall, age 49, as its principal accounting
officer. Mr. Chibnall has served as the Registrant's Vice
President, Finance since February 2000 and will continue to serve
in such position in addition to his duties as principal accounting
officer. Gerald R. Mitchell, the Registrant's Vice President and
Chief Financial Officer, formerly acted as both principal financial
officer and principal accounting officer and will continue to serve
as the Registrant's principal financial officer.
Mr. Chibnall is employed by the Registrant pursuant to an
employment agreement, dated December 22, 1995, as amended February
1, 2000, and April 1, 2005. Under the employment agreement, Mr.
Chibnall is entitled to an annual base salary of $220,000, which
may be increased from year to year, and certain separation
benefits. Mr. Chibnall is also entitled to participate in any
fringe benefits normally provided to employees of the Registrant at
comparable employment levels. The employment agreement
automatically renews for successive one-year periods until
terminated under the terms of the agreement.
Under the employment agreement, if Mr. Chibnall's employment is
involuntarily terminated without cause by the Registrant (other
than within two years after a change of control of the Registrant),
Mr. Chibnall will be entitled to severance pay equal to one-half of
his then current salary. He would also receive continuation of any
health and welfare benefits for a period of 6 months following the
involuntary termination. In addition, all stock options held by Mr.
Chibnall would immediately vest and become exercisable.
Except in the case of Mr. Chibnall's death or disability, if Mr.
Chibnall's employment is involuntarily terminated with or without
cause within two years after the occurrence of a change of control
(as defined in the employment agreement), Mr. Chibnall is entitled
to severance pay equal to one and one-half times the sum of his
annual salary and 18 months' worth of bonus. Mr. Chibnall also
would continue to receive health and welfare benefits for a period
of 18 months after such a termination. All stock options held by
Mr. Chibnall would immediately vest and become exercisable.
The employment agreement also contains restrictive covenants
preventing Mr. Chibnall from competing against the Registrant or
soliciting customers or employees of the Registrant for a period of
24 months after termination of his employment.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
--------------------------------------------------
The information contained under the caption "INFORMATION CONCERNING
NOMINEES AND DIRECTORS CONTINUING IN OFFICE" in the Company's
definitive proxy statement to be filed pursuant to
90
Regulation 14(a) for its 2005 Annual Meeting of Shareholders, which
involves the election of directors, is incorporated herein by this
reference. Also see Item 4(a) of Part I hereof.
ITEM 11. EXECUTIVE COMPENSATION
----------------------
The information contained under the captions "EXECUTIVE
COMPENSATION" and "INFORMATION AS TO STOCK OPTIONS" in the
Company's definitive proxy statement to be filed pursuant to
Regulation 14(a) for its 2005 Annual Meeting of Shareholders is
incorporated herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
The information contained under the captions "SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS" and "SECURITY OWNERSHIP OF MANAGEMENT"
in the Company's definitive proxy statement to be filed pursuant to
Regulation 14(a) for its 2005 Annual Meeting of Shareholders is
incorporated herein by this reference.
EQUITY COMPENSATION PLAN INFORMATION
The following information regarding compensation plans of the
Company is furnished as of March 31, 2005, the end of the Company's
most recently completed fiscal year.
EQUITY COMPENSATION PLAN INFORMATION
REGARDING CLASS A COMMON STOCK
- --------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO BE FUTURE ISSUANCE UNDER
ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS
OUTSTANDING OPTIONS, PRICE OF OUTSTANDING (EXCLUDING SECURITIES
WARRANTS AND RIGHTS OPTIONS, WARRANTS AND RIGHTS REFLECTED IN COLUMN (a))
------------------- ---------------------------- ------------------------
PLAN CATEGORY (a) (b) (c)
Equity compensation plans
approved by security holders(1) 2,700,457 $14.12 988,473
Equity compensation plans not
approved by security holders(2) 6,750 $3.22 N/A
---------
Total 2,707,207 $14.10
=========
(1) Consists of the Company's 2001 Incentive Stock Option Plan. See Note 15
of Notes to Consolidated Financial Statements.
(2) Consists of options granted to non-employee members of the Board of Directors.
91
EQUITY COMPENSATION PLAN INFORMATION
REGARDING CLASS B COMMON STOCK
- --------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO BE FUTURE ISSUANCE UNDER
ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS
OUTSTANDING OPTIONS, PRICE OF OUTSTANDING (EXCLUDING SECURITIES
WARRANTS AND RIGHTS OPTIONS, WARRANTS AND RIGHTS REFLECTED IN COLUMN (a))
------------------- ---------------------------- ------------------------
PLAN CATEGORY (a) (b) (c)
Equity compensation plans
approved by security holders(1) 367,466 $13.08 1,214,399
Equity compensation plans not
approved by security holders(2) 28,125 $4.82 N/A
------
Total 395,591 $12.49
=======
(1) Consists of the Company's 2001 Incentive Stock Option Plan. See Note 15
of Notes to Consolidated Financial Statements.
(2) Consists of options granted to non-employee members of the Board of Directors.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------
The information contained under the caption "TRANSACTIONS WITH
DIRECTORS AND EXECUTIVE OFFICERS" in the Company's definitive proxy
statement to be filed pursuant to Regulation 14(a) for its 2005
Annual Meeting of Shareholders is incorporated herein by this
reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
--------------------------------------
The information contained under the caption "FEES PAID TO
INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS" in the Company's
definitive proxy statement to be filed pursuant to Regulation 14(a)
for its 2005 Annual Meeting of Shareholders is incorporated herein
by this reference.
92
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
---------------------------------------
(a) 1. Financial Statements: Page
The following consolidated financial statements of the Company
are included in Part II, Item 8:
Report of Independent Registered Public Accounting Firm......... 54
Report of Independent Registered Public Accounting Firm......... 55
Consolidated Balance Sheets as of March 31, 2005 and 2004....... 56
Consolidated Statements of Income for the Years Ended March 31,
2005, 2004 and 2003............................................. 57
Consolidated Statements of Comprehensive Income for the Years
Ended March 31, 2005, 2004 and 2003............................. 58
Consolidated Statements of Shareholders' Equity for the Years
Ended March 31, 2005, 2004 and 2003............................. 59
Consolidated Statements of Cash Flows for the Years Ended
March 31, 2005, 2004 and 2003................................... 60
Notes to Financial Statements................................... 61-86
Controls and Procedures......................................... 87
Evaluation of Disclosure Controls and Procedures................ 87
Management's Report on Internal Control over Financial
Reporting....................................................... 87
Changes in Internal Control over Financial Reporting............ 88
Report of Independent Registered Public Accounting Firm......... 88
2. Financial Statement Schedules:
Report of Independent Registered Public Accounting Firm
regarding Financial Statement Schedule.......................... 94
Schedule II - Valuation and Qualifying Accounts................. 95
(b) Exhibits. See Exhibit Index on pages 97 through 104 of
this Report. Management contracts and compensatory plans are
designated on the Exhibit Index.
(c) Financial Statement Schedules.
93
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors
of K-V Pharmaceutical Company
The audits referred to in our report dated June 4, 2004, relating to the
consolidated financial statements of K-V Pharmaceutical Company, which are
included in Item 8 of this Form 10-K, included the audits of the
accompanying financial statement schedule for the years ended March 31, 2004
and 2003. This financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion on this
financial statement schedule based upon our audits. In our opinion, the 2004
and 2003 financial statement schedule presents fairly, in all material
respects, the information set forth therein.
/s/ BDO SEIDMAN, LLP
Chicago, Illinois
June 4, 2004
94
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
BALANCE AT CHARGED TO AMOUNTS BALANCE
BEGINNING COSTS AND CHARGED TO AT END
OF YEAR EXPENSES RESERVES OF YEAR
------- -------- -------- -------
(in thousands)
Year Ended March 31, 2003:
Allowance for doubtful accounts............ $ 403 $ (81) $ (100) $ 422
Reserves for sales allowances.............. 18,958 98,929 88,229 29,658
Inventory obsolescence..................... 1,108 2,053 2,158 1,003
------- -------- -------- -------
$20,469 $100,901 $ 90,287 $31,083
======= ======== ======== =======
Year Ended March 31, 2004:
Allowance for doubtful accounts............ $ 422 $ (20) $ - $ 402
Reserves for sales allowances.............. 29,658 103,262 112,272 20,648
Inventory obsolescence..................... 1,003 2,442 2,443 1,002
------- -------- -------- -------
$31,083 $105,684 $114,715 $22,052
======= ======== ======== =======
Year Ended March 31, 2005:
Allowance for doubtful accounts............ $ 402 $ 235 $ 176 $ 461
Reserves for sales allowances.............. 20,648 133,475 133,067 21,056
Inventory obsolescence..................... 1,002 3,182 2,891 1,293
------- -------- -------- -------
$22,052 $136,892 $136,134 $22,810
======= ======== ======== =======
Financial statements of K-V Pharmaceutical Company (separately) are omitted
because KV is primarily an operating company and its subsidiaries included
in the financial statements are wholly-owned and are not materially indebted
to any person other than through the ordinary course of business.
95
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
K-V PHARMACEUTICAL COMPANY
Date: June 14, 2005 By /s/ Marc S. Hermelin
------- -----------------------------------
Vice Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: June 14, 2005 By /s/ Gerald R. Mitchell
------- -----------------------------------
Vice President and Chief
Financial Officer
(Principal Financial Officer)
Date: June 14, 2005 By /s/ Richard H. Chibnall
------- -----------------------------------
Vice President, Finance
(Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on the dates indicated by the following persons
on behalf of the Company and in their capacities as members of the Board of
Directors of the Company:
Date: June 14, 2005 By /s/ Marc S. Hermelin
-----------------------------------
Marc S. Hermelin
Date: June 14, 2005 By /s/ Victor M. Hermelin
-----------------------------------
Victor M. Hermelin
Date: June 14, 2005 By /s/ Norman D. Schellenger
-----------------------------------
Norman D. Schellenger
Date: June 14, 2005 By /s/ Alan G. Johnson
-----------------------------------
Alan G. Johnson
Date: June 14, 2005 By /s/ Kevin S. Carlie
-----------------------------------
Kevin S. Carlie
Date: June 14, 2005 By /s/ David A. Van Vliet
-----------------------------------
David Van Vliet
Date: June 14, 2005 By /s/ Jean M. Bellin
-----------------------------------
Jean M. Bellin
Date: June 14, 2005 By /s/ Terry B. Hatfield
-----------------------------------
Terry B. Hatfield
Date: June 14, 2005 By /s/ David S. Hermelin
-----------------------------------
David S. Hermelin
96
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
3(a) The Company's Certificate of Incorporation, which was
filed as Exhibit 3(a) to the Company's Annual Report on
Form 10-K for the year ended March 31, 1981, is
incorporated herein by this reference.
3(b) Certificate of Amendment to Certificate of Incorporation
of the Company, effective March 7, 1983, which was filed
as Exhibit 3(c) to the Company's Annual Report on Form
10-K for the year ended March 31, 1983, is incorporated
herein by this reference.
3(c) Certificate of Amendment to Certificate of Incorporation
of the Company, effective June 9, 1987, which was filed as
Exhibit 3(d) to the Company's Annual Report on Form 10-K
for the year ended March 31, 1988, is incorporated herein
by this reference.
3(d) Certificate of Amendment to Certificate of Incorporation
of the Company, effective September 24, 1987, which was
filed as Exhibit 3(f) to the Company's Annual Report on
Form 10-K for the year ended March 31, 1988, is
incorporated herein by this reference.
3(e) Certificate of Amendment to Certificate of Incorporation
of the Company, effective July 17, 1986, which was filed
as Exhibit 3(e) to the Company's Annual Report on Form
10-K for the year ended March 31, 1996, is incorporated
herein by this reference.
3(f) Certificate of Amendment to Certificate of Incorporation
of the Company, effective December 23, 1991, which was
filed as Exhibit 3(f) to the Company's Annual Report on
Form 10-K for the year ended March 31, 1996, is
incorporated herein by this reference.
3(g) Certificate of Amendment to Certificate of Incorporation
of the Company, effective September 3, 1998, which was
filed as Exhibit 4(g) to the Company's Registration
Statement on Form S-3 (Registration Statement No.
333-87402), filed May 1, 2002, is incorporated herein by
this reference.
3(h) Bylaws of the Company, as amended through November 18,
1982, which was filed as Exhibit 3(e) to the Company's
Annual Report on Form 10-K for the year ended March 31,
1993, is incorporated herein by this reference.
3(i) Amendment to Bylaws of the Company, effective July 2,
1984, which was filed as Exhibit 4(i) to the Company's
Registration Statement on Form S-3 (Registration Statement
No. 333-87402), filed May 1, 2002, is incorporated herein
by this reference.
3(j) Amendment to Bylaws of the Company, effective December 4,
1986, which was filed as Exhibit 4(j) to the Company's
Registration Statement on Form S-3 (Registration Statement
No. 333-87402), filed May 1, 2002, is incorporated herein
by this reference.
3(k) Amendment to Bylaws of the Company effective March 17,
1992, which was filed as Exhibit 4(k) to the Company's
Registration Statement on Form S-3 (Registration Statement
No. 333-87402), filed May 1, 2002, is incorporated herein
by this reference.
3(l) Amendment to Bylaws of the Company effective November 18,
1992, which was filed as Exhibit 4(l) to the Company's
Registration Statement on Form S-3 (Registration Statement
No. 333-87402), filed May 1, 2002, is incorporated herein
by this reference.
97
3(m) Amendment to Bylaws of the Company, effective December 30,
1993, which was filed as Exhibit 3(h) to the Company's
Annual Report on Form 10-K for the year ended March 31,
1996, is incorporated herein by this reference.
3(n) Amendment to Bylaws of the Company, effective September
24, 2002, which was filed as Exhibit 4(n) to the Company's
Registration Statement on Form S-3 (Registration Statement
No. 333-106294), filed June 19, 2003, is incorporated
herein by this reference.
4(a) Certificate of Designation of Rights and Preferences of 7%
Cumulative Convertible preferred stock of the Company,
effective June 9, 1987, and related Certificate of
Correction, dated June 17, 1987, which was filed as
Exhibit 4(f) to the Company's Annual Report on Form 10-K
for the year ended March 31, 1987, is incorporated herein
by this reference.
4(b) Loan Agreement dated June 18, 1997 between the Company and
its subsidiaries and LaSalle National Bank ("LaSalle"),
which was filed as Exhibit 4(i) to the Company's Annual
Report on Form 10-K for the year ended March 31, 1997, is
incorporated herein by this reference.
4(c) Revolving Note, dated June 18, 1997, by the Company and
its subsidiaries in favor of LaSalle, which was filed as
Exhibit 4(j) to the Company's Annual Report on Form 10-K
for the year ended March 31, 1997, is incorporated herein
by this reference.
4(d) Term Note, dated June 24, 1997, by the Company and its
subsidiaries in favor of LaSalle, which was filed as
Exhibit 4(k) to the Company's Annual Report on Form 10-K
for the year ended March 31, 1997, is incorporated herein
by this reference.
4(e) Reimbursement Agreement dated as of October 16, 1997,
between the Company and LaSalle, which was filed as
Exhibit 4(f) to the Company's Annual Report on Form 10-K
for the year ended March 31, 1998, is incorporated herein
by this reference.
4(f) Deed of Trust and Security Agreement dated as of October
16, 1997, between the Company and LaSalle, which was filed
as Exhibit 4(g) to the Company's Annual Report on Form
10-K for the year ended March 31, 1998, is incorporated
herein by this reference.
4(g) First Amendment, dated as of October 28, 1998, to Loan
Agreement between the Company and its subsidiaries and
LaSalle, which was filed as Exhibit 4(h) to the Company's
Annual Report on Form 10-K for the year ended March 31,
1999, is incorporated herein by this reference.
4(h) Second Amendment, dated as of March 11, 1999, to Loan
Agreement between the Company and its subsidiaries and
LaSalle, which was filed as Exhibit 4(i) to the Company's
Annual Report on Form 10-K for the year ended March 31,
1999, is incorporated herein by this reference.
4(i) Third Amendment, dated June 22, 1999, to Loan Agreement
between the Company and its subsidiaries and LaSalle,
which was filed as Exhibit 4(j) to the Company's Annual
Report on Form 10-K for the year ended March 31, 2000, is
incorporated herein by this reference.
98
4(j) Fourth Amendment, dated December 17, 1999, to Loan
Agreement between the Company and its subsidiaries and
LaSalle, which was filed as Exhibit 4(k) to the Company's
Annual Report on Form 10-K for the year ended March 31,
2000, is incorporated herein by this reference.
4(k) Fifth Amendment, dated December 21, 2001, to Loan
Agreement between the Company and its subsidiaries and
LaSalle, which was filed as Exhibit 4(l) to the Company's
Annual Report on Form 10-K for the year ended March 31,
2002, is incorporated herein by this reference.
4(l) Sixth Amendment, dated December 20, 2002, to Loan
Agreement between the Company and its subsidiaries and
LaSalle, which was filed as Exhibit 4(m) to the Company's
Annual Report on Form 10-K for the year ended March 31,
2003, is incorporated herein by this reference.
4(m) Seventh Amendment, dated April 28, 2003, to Loan Agreement
between the Company and its subsidiaries and LaSalle,
which was filed as Exhibit 4(n) to the Company's Annual
Report on Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
4(n) Indenture dated as of May 16, 2003, by and between the
Company and Deutsche Bank Trust Company Americas, filed on
May 21, 2003, as Exhibit 4.1 to the Company's Current
Report on Form 8-K, is incorporated herein by this
reference.
4(o) Registration Rights Agreement dated as of May 16, 2003, by
and between the Company and Deutsche Bank Securities,
Inc., as representative of the several Purchasers, filed
on May 21, 2003 as Exhibit 4.2 to the Company's Current
Report on Form 8-K, is incorporated herein by this
reference.
4(p) Eighth Amendment, dated June 30, 2003, to loan Agreement
between the Company and its subsidiaries and LaSalle,
which was filed as Exhibit 4(q) to the Company's Annual
Report on Form 10-K for the year ended March 31, 2004, is
incorporated herein by this reference.
4(q) Ninth Amendment, dated December 19, 2003, to Loan
Agreement between the Company and its subsidiaries and
LaSalle, which was filed as Exhibit 4(r) to the Company's
Annual Report on Form 10-K for the year ended March 31, 2004,
is incorporated herein by this reference.
4(r) Tenth Amendment, dated December 20, 2004, to Loan
Agreement between the Company and its subsidiaries and
LaSalle, filed on January 18, 2005, as Exhibit 10.1 to the
Company's Current Report on Form 8-K, is incorporated
herein by this reference.
4(s) Amended and Restated Loan Agreement, dated December 31,
2004, among the Company and its subsidiaries, LaSalle
National Bank Association and Citibank, F.S.B., filed on
January 18, 2005, as Exhibit 10.2 to the Company's Current
Report on Form 8-K, is incorporated herein by this
reference.
10(a)* First Amendment to and Restatement of the KV
Pharmaceutical 1981 Employee Incentive Stock Option Plan,
dated March 9, 1987 (the "Restated 1981 Option Plan"),
which was filed as Exhibit 10(t) to the Company's Annual
Report on Form 10-K for the year ended March 31, 1988, is
incorporated herein by this reference.
10(b)* Second Amendment to the Restated 1981 Option Plan, dated
June 12, 1987, which was filed as Exhibit 10(u) to the
Company's Annual Report on Form 10-K for the year ended
March 31, 1988, is incorporated herein by this reference.
10(c)* Revised Form of Stock Option Agreement, effective June 12,
1987, for the Restated 1981 Option Plan, which was filed
as Exhibit 10(v) to the Company's Annual Report on Form
10-K for the year ended March 31, 1988, is incorporated
herein by this reference.
99
10(d)* Consulting Agreement between the Company and Victor M.
Hermelin, Chairman of the Board, dated October 30, 1978,
as amended October 30, 1982, and Employment Agreement
dated February 20, 1974, referred to therein (which was
filed as Exhibit 10(m) to the Company's Annual Report on
Form 10-K for the year ended March 31, 1983) and
subsequent Amendments dated as of August 12, 1986, which
was filed as Exhibit 10(f) to the Company's Annual Report
on Form 10-K for the year ended March 31, 1987, and dated
as of September 15, 1987 (which was filed as Exhibit 10(s)
to the Company's Annual Report on Form 10-K for the year
ended March 31, 1988), and dated October 25, 1988 (which
was filed as Exhibit 10(n) to the Company's Annual Report
on Form 10-K for the year ended March 31, 1989), and dated
October 30, 1989 (which was filed as Exhibit 10(n) to the
Company's Annual Report on Form 10-K for the year ended
March 31, 1990), and dated October 30, 1990 (which was
filed as Exhibit 10(n) to the Company's Annual Report on
Form 10-K for the year ended March 31, 1991), and dated as
of October 30, 1991 (which was filed as Exhibit 10(i) to
the Company's Annual Report on Form 10-K for the year
ended March 31, 1992), are incorporated herein by this
reference.
10(e)* Restated and Amended Employment Agreement between the
Company and Gerald R. Mitchell, Vice President, Finance,
dated as of March 31, 1994, is incorporated herein by this
reference.
10(f)* Employment Agreement between the Company and Raymond F.
Chiostri, Corporate Vice-President and
President-Pharmaceutical Division, which was filed as
Exhibit 10(l) to the Company's Annual Report on Form 10-K
for the year ended March 31, 1992, is incorporated herein
by this reference.
10(g) Lease of the Company's facility at 2503 South Hanley Road,
St. Louis, Missouri, and amendment thereto, between the
Company as Lessee and Marc S. Hermelin as Lessor, which
was filed as Exhibit 10(n) to the Company's Annual Report
on Form 10-K for the year ended March 31, 1983, is
incorporated herein by this reference.
10(h) Amendment to the Lease for the facility located at 2503
South Hanley Road, St. Louis, Missouri, between the
Company as Lessee and Marc S. Hermelin as Lessor, which
was filed as Exhibit 10(p) to the Company's Annual Report
on Form 10-K for the year ended March 31, 1992, is
incorporated herein by this reference.
10(i)* KV Pharmaceutical Company Fourth Restated Profit Sharing
Plan and Trust Agreement dated September 18, 1990, which
was filed as Exhibit 4.1 to the Company's Registration
Statement on Form S-8 No. 33-36400, is incorporated herein
by this reference.
10(j)* First Amendment to the KV Pharmaceutical Company Fourth
Restated Profit Sharing Plan and Trust dated September 18,
1990, is incorporated herein by this reference.
10(k)* Employment Agreement between the Company and Marc S.
Hermelin, Vice-Chairman, dated November 15, 1993, which
was filed as Exhibit 10(u) to the Company's Annual Report
on Form 10-K for the year ended March 31, 1994, is
incorporated herein by this reference.
100
10(l)* Second Amendment dated as of June 1, 1995, to Employment
Agreement between the Company and Marc S. Hermelin, which
was filed as Exhibit 10(x) to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1996,
is incorporated herein by this reference.
10(m)* Stock Option Agreement dated as of January 22, 1996,
granting stock options to MAC & Co., which was filed as
Exhibit 10(z) to the Company's Annual Report on Form 10-K
for the year ended March 31, 1996, is incorporated herein
by this reference.
10(n)* Third Amendment dated as of November 22, 1995, to
Employment Agreement between the Company and Marc S.
Hermelin, which was filed as Exhibit 10(aa) to the
Company's Annual Report on Form 10-K for the year ended
March 31, 1996, is incorporated herein by this reference.
10(o)* Stock Option Agreement dated as of November 22, 1995,
granting a stock option to Victor M. Hermelin, which was
filed as Exhibit 10(bb) to the Company's Annual Report on
Form 10-K for the year ended March 31, 1996, is
incorporated herein by this reference.
10(p)* Stock Option Agreement dated as of November 6, 1996,
granting a stock option to Alan G. Johnson, which was
filed as Exhibit 10(s) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(q)* Fourth Amendment to and Restatement, dated as of January
2, 1997, of the KV Pharmaceutical Company 1991 Incentive
Stock Option Plan, which was filed as Exhibit 10(y) to the
Company's Annual Report on Form 10-K for the year ended
March 31, 1997, is incorporated herein by this reference.
10(r)* Agreement between the Company and Marc S. Hermelin, Vice
Chairman, dated December 16, 1996, with supplemental
letter attached, which was filed as Exhibit 10(z) to the
Company's Annual Report on Form 10-K for the year ended
March 31, 1997, is incorporated herein by this reference.
10(s) Amendment to Lease dated February 17, 1997, for the
facility located at 2503 South Hanley Road, St. Louis,
Missouri, between the Company as Lessee and Marc S.
Hermelin as Lessor, which was filed as Exhibit 10(aa) to
the Company's Annual Report on Form 10-K for the year
ended March 31, 1997, is incorporated herein by this
reference.
10(t)* Stock Option Agreement dated as of January 3, 1997,
granting a stock option to Marc S. Hermelin, which was
filed as Exhibit 10(bb) to the Company's Annual Report on
Form 10-K for the year ended March 31, 1999, is
incorporated herein by this reference.
10(u)* Stock Option Agreement dated as of May 15, 1997, granting
a stock option to Marc S. Hermelin, which was filed as
Exhibit 10(cc) to the Company's Annual Report on Form 10-K
for the year ended March 31, 1999, is incorporated herein
by this reference.
101
10(v)* Amendment, dated as of October 30, 1998, to Employment
Agreement between the Company and Marc S. Hermelin, which
was filed as Exhibit 10(ee) to the Company's Annual Report
on Form 10-K for the year ended March 31, 1999, is
incorporated herein by this reference.
10(w) Exclusive License Agreement, dated as of April 1, 1999
between Victor M. Hermelin as licenser and the Company as
licensee, which was filed as Exhibit 10(ff) to the
Company's Annual Report on Form 10-K for the year ended
March 31, 1999 is incorporated herein by this reference.
10(x)* Stock Option Agreement dated as of March 31, 1999,
granting a stock option to Victor M. Hermelin, which was
filed as Exhibit 10(aa) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2001, is
incorporated by this reference.
10(y)* Stock Option Agreement dated as of March 31, 1999,
granting a stock option to Norman D. Schellenger, which
was filed as Exhibit 10(cc) to the Company's Annual Report
on Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(z)* Stock Option Agreement dated as of April 1, 1999, granting
a stock option to Marc S. Hermelin, which was filed as
Exhibit 10(gg) to the Company's Annual Report on Form 10-K
for the year ended March 31, 2000, is incorporated by this
reference.
10(aa)* Stock Option Agreement dated as of August 16, 1999,
granting a stock option to Marc S. Hermelin, which was
filed as Exhibit 10 (hh) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2000, is
incorporated by this reference.
10(bb)* Stock Option Agreement dated as of October 13, 1999,
granting a stock option to Alan G. Johnson, which was
filed as Exhibit 10(ff) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(cc)* Stock Option Agreement dated as of October 13, 1999,
granting a stock option to Alan G. Johnson, which was
filed as Exhibit 10(gg) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(dd)* Stock Option Agreement dated as of October 13, 1999,
granting a stock option to Alan G. Johnson, which was
filed as Exhibit 10(hh) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(ee)* Stock Option Agreement dated as of October 13, 1999,
granting a stock option to Alan G. Johnson, which was
filed as Exhibit 10(ii) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(ff)* Amendment, dated December 2, 1999, to Employment Agreement
between the Company and Marc S. Hermelin, Vice-Chairman,
which was filed as Exhibit 10(ii) to the Company's Annual
Report on Form 10-K for the year ended March 31, 2000, is
incorporated by this reference.
10(gg)* Employment Agreement between the Company and Alan G.
Johnson, Senior Vice-President, Strategic Planning and
Corporate Growth, dated September 27, 1999, which was
filed as Exhibit 10(jj) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2000, is
incorporated by this reference.
102
10(hh)* Consulting Agreement, dated as of May 1, 1999, between the
Company and Victor M. Hermelin, Chairman, which was filed
as Exhibit 10(kk) to the Company's Annual Report on Form
10-K for the year ended March 31, 2000, is incorporated by
this reference.
10(ii)* Stock Option Agreement dated as of June 1, 2000, granting
a stock option to Marc S. Hermelin, which was filed as
Exhibit 10(gg) to the Company's Annual Report on Form 10-K
for the year ended March 31, 2001, is incorporated by this
reference.
10(jj)* Stock Option Agreement dated as of June 1, 2000, granting
a stock option to Marc S. Hermelin, which was filed as
Exhibit 10(hh) to the Company's Annual Report on Form 10-K
for the year ended March 31, 2001, is incorporated by this
reference.
10(kk)* Stock Option Agreement dated as of April 9, 2001, granting
a stock option to Kevin S. Carlie, which was filed as
Exhibit 10(ii) to the Company's Annual Report on Form 10-K
for the year ended March 31, 2002, is incorporated herein
by this reference.
10(ll)* Stock Option Agreement dated as of April 9, 2001, granting
a stock option to Marc S. Hermelin, which was filed as
Exhibit 10(jj) to the Company's Annual Report on Form 10-K
for the year ended March 31, 2002, is incorporated herein
by this reference.
10(mm)* Stock Option Agreement dated as of April 9, 2001, granting
a stock option to Marc S. Hermelin, which was filed as
Exhibit 10(kk) to the Company's Annual Report on Form 10-K
for the year ended March 31, 2002, is incorporated herein
by this reference.
10(nn)* Stock Option Agreement dated as of July 26, 2002, granting
a stock option to Marc S. Hermelin, which was filed as
Exhibit 10(rr) to the Company's Annual Report on Form 10-K
for the year ended March 31, 2003, is incorporated herein
by this reference.
10(oo)* Stock Option Agreement dated as of October 21, 2002,
granting a stock option to John P. Isakson, which was
filed as Exhibit 10(ss) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(pp) License Agreement by and between the Company and
FemmePharma, Inc., dated as of April 18, 2002, which was
filed as Exhibit 10(tt) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(qq) Stock Purchase Agreement by and between the Company and
FemmePharma, Inc., dated as of April 18, 2002, which was
filed as Exhibit 10(uu) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(rr) Product Acquisition Agreement by and between the Company
and Schwarz Pharma dated as of March 31, 2003, which was
filed as Exhibit 10(vv) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(ss) Product Acquisition Agreement by and between the Company
and Altana Inc. dated as of March 31, 2003, which was
filed as Exhibit 10(ww) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
10(tt)* Stock Option Agreement dated as of October 21, 2002,
granting a stock option to John P. Isakson, which was
filed as Exhibit 10(xx) to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003, is
incorporated herein by this reference.
103
10 (uu)* Stock Option Agreement dated as of May 30, 2003, granting a
stock option to Marc S. Hermelin, which was filed as Exhibit
10(yy) to the Company's Annual Report on Form 10-K for the
year ended March 31, 2004, is incorporated herein by this
reference.
10(vv)* Amendment, dated November 5, 2004, to Employment Agreement
between the Company and Marc S. Hermelin, Vice-Chairman,
which was filed as Exhibit 10(a) to the Company's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 2004, is incorporated herein by this
reference.
10(ww) Agreement and Plan of Merger by and among K-V Pharmaceutical
Company, Kestrel-Falcon Acquisition Corporation, FP1096, Inc.,
and FemmePharma Holding Company, Inc., dated as of May 4,
2005, filed herewith.
21 List of Subsidiaries, filed herewith.
23.1 Consent of KPMG LLP, filed herewith.
23.2 Consent of BDO Seidman, LLP, filed herewith.
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) or Rule 15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, is filed
herewith.
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) or Rule 15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, is filed
herewith.
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
filed herewith.
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
filed herewith.
*Management contract or compensation plan.
104