UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended September 30, 2008
OR
¨
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from to
Commission file number 1-9601
K-V PHARMACEUTICAL COMPANY
(Exact Name of
Registrant as Specified in Its Charter)
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|
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Delaware
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43-0618919
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(State or other Jurisdiction of
Incorporation or Organization)
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(I.R.S. Employer
Identification No.)
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|
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One Corporate Woods Drive
Bridgeton, MO
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63044
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(Address of Principal Executive Offices)
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(Zip Code)
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Registrants Telephone Number, Including Area Code: (314) 645-6600
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
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. Yes
¨
No
x
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). Yes
¨
No
¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer
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x
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Accelerated filer
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¨
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Non-accelerated filer
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¨
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Smaller Reporting Company
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¨
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
¨
No
x
As of
February 28, 2010, the registrant had outstanding 37,736,871 and 12,111,835 shares of Class A and Class B Common Stock, respectively, exclusive of treasury shares.
EXPLANATORY NOTE
The filing of this Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2008 was delayed due to the time required to (1) complete the internal investigation conducted by the
Audit Committee (the Audit Committee) of our Board of Directors (the Board) with respect to a range of specific allegations involving, among other items, U.S. Food and Drug Administration (the FDA) regulatory and
other compliance matters and management misconduct, (2) resolve certain matters with a potential financial reporting impact resulting from such investigation and (3) evaluate the financial statement implications of the provisions of the
consent decree we entered into with the FDA on March 2, 2009 and of the previously disclosed actions to recall all of the drug products we manufactured, suspend manufacturing and shipment of our products, substantially reduce our workforce and
realign our cost and organizational structure.
Prior to the filing of this Quarterly Report on Form 10-Q, we filed our Annual Report on Form
10-K for fiscal year ended March 31, 2009 (the 2009 Form 10-K). This Quarterly Report on Form 10-Q includes references to specified disclosures contained in our 2009 Form 10-K. However, this Quarterly Report on Form 10-Q does not
reflect all events occurring after September 30, 2008 and does not update all disclosure affected by subsequent events. Therefore, you should read this Quarterly Report on Form 10-Q in conjunction with our 2009 Form 10-K, a copy of which can be
accessed at the website of the U.S. Securities and Exchange Commission (the SEC) at
www.sec.gov
.
Information provided
herein for periods after March 31, 2009 is preliminary. As such, this information is not final or complete, and remains subject to change, possibly materially.
2
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains various forward-looking statements within the meaning of the United States Private Securities Litigation Reform
Act of 1995 (the PSLRA) and 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 plan, expect,
aim, believe, project, anticipate, commit, intend, estimate, will, should, could, potential and other expressions
that indicate future events and trends.
All statements that address expectations or projections about the future, including without
limitation, statements about product development, product launches, regulatory approvals, governmental and regulatory actions and proceedings, market position, acquisitions, sale of assets, revenues, expenditures, resumption of manufacturing and
distribution of products and the impact of the recall and suspension of shipments on revenues, and other 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 PSLRAs safe harbor provisions, we provide the following
cautionary statements identifying important economic, competitive, political, regulatory and technological factors, among others, that could cause 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)
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the ability to continue as a going concern;
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(2)
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difficulties and uncertainties with respect to obtaining additional capital, as more fully described in Note 3Going Concern and Liquidity
Considerations of the Notes to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q;
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(3)
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the consent decree between us and the FDA and our suspension of the production and shipment of all of the products that we manufacture and the related nationwide
recall affecting all of the products that we manufacture, as well as the related material adverse effect on our revenue, assets and liquidity and capital resources, as more fully described in the 2009 Form 10-K;
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(4)
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the possibility of further reducing our operations, including further reductions of our employee base, and significantly curtailing some or all of our efforts to meet
the consent decrees requirements and return our approved products to market in order to maintain and attempt to increase our limited cash and financial resources;
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(5)
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the plea agreement between us and the U.S. Department of Justice and our obligations in connection therewith, as well as the related material adverse effect, if
any, on our revenue, assets and liquidity and capital resources, as more fully described in the 2009 Form 10-K;
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(6)
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changes in the current and future business environment, including interest rates and capital and consumer spending;
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(7)
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the difficulty of predicting FDA approvals, including timing, and that any period of exclusivity may not be realized;
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(8)
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the possibility of not obtaining FDA approvals or delay in obtaining FDA approvals;
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(9)
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acceptance of and demand for our new pharmaceutical products;
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(10)
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the introduction and impact of competitive products and pricing, including as a result of so-called authorized-generic drugs;
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(11)
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new product development and launch, including the possibility that any product launch may be delayed;
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(12)
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reliance on key strategic alliances;
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(13)
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the availability of raw materials and/or products manufactured for us under contract manufacturing arrangements with third parties;
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(14)
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the regulatory environment, including regulatory agency and judicial actions and changes in applicable law or regulations;
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(15)
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fluctuations in revenues;
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(16)
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the difficulty of predicting international regulatory approvals, including timing;
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(17)
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the difficulty of predicting the pattern of inventory movements by our customers;
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(18)
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the impact of competitive response to our sales, marketing and strategic efforts, including the introduction or potential introduction of generic or competing
products against products sold by us and our subsidiaries;
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(19)
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risks that we may not ultimately prevail in litigation, including product liability lawsuits and challenges to our intellectual property rights
by actual or potential competitors or to our ability to market generic products due to brand company patents and challenges to other companies introduction or potential introduction of generic or
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3
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competing products by third parties against products sold by us or our subsidiaries including without limitation the litigation and claims referred to in Note
19ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q;
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(20)
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the possibility that our current estimates of the financial effect of certain announced product recalls could prove to be incorrect;
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(21)
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whether any product recalls or product introductions result in litigation, agency action or material damages;
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(22)
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failure to supply claims by certain of our customers, including CVS Pharmacy, Inc., that, despite the formal discontinuation action by us of our products, we
should compensate such customers for any additional costs they allegedly incurred for procuring products we did not supply;
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(23)
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the satisfaction or waiver of the terms and conditions for the acquisition of the full U.S. and worldwide rights to Gestiva set forth in the previously
disclosed Gestiva acquisition agreement, as amended;
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(24)
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the series of putative class action lawsuits alleging violations of the federal securities laws by us and certain individuals, all as more fully described in
Note 19ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q;
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(25)
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the possibility that insurance proceeds are insufficient to cover potential losses that may arise from litigation, including with respect to product liability or
securities litigation;
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(26)
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the informal inquiry initiated by the SEC and any related or additional governmental investigative or enforcement proceedings as more fully described in Note
19ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q;
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(27)
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the possibility that the pending investigation by the Office of Inspector General of the Department of Health and Human Services into potential false claims
under Title 42 of the U.S. Code as more fully described in the 2009 Form 10-K could result in significant civil fines or penalties, including exclusion from participation in federal healthcare programs such as Medicare and Medicaid;
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(28)
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delays in returning, or failure to return, certain or many of our approved products to market, including loss of market share as a result of the suspension of
shipments, and related costs;
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(29)
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the ability to sell or license certain assets, and the terms of such transactions;
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(30)
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the possibility that default on one type or class of our indebtedness could result in cross default under, and the acceleration of, our other indebtedness; and
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(31)
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the risks detailed from time to time in our filings with the SEC.
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This discussion is not exhaustive, but is designed to highlight important factors that may impact our forward-looking statements.
Because the factors referred to above, as well as the statements included under the caption Part I, Item 2Managements Discussion and Analysis of Financial Condition and Results of
Operations and elsewhere in this Quarterly Report on Form 10-Q could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance
on any forward-looking statements. All forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements in this Cautionary Note Regarding Forward-Looking Statements and the risk factors
that are included under the caption Item 1ARisk Factors in our 2009 Form 10-K, as supplemented by our subsequent SEC filings. Further, any forward-looking statement speaks only as of the date on which it is made and we are
under no obligation to update any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q. 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 future 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.
4
PART I. FINANCIAL INFORMATION
Item 1.
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FINANCIAL STATEMENTS
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K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited; dollars in thousands, except per share data)
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Three Months Ended
September 30,
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Six Months Ended
September 30,
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2008
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2007 (1)
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2008
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2007 (1)
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Net revenues
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$
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136,487
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$
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171,176
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$
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273,016
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$
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284,631
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Cost of sales
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51,714
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46,367
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99,197
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86,461
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Gross profit
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84,773
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124,809
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173,819
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198,170
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|
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Operating expenses:
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Research and development
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18,384
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10,219
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33,901
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21,503
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Selling and administrative
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65,725
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49,422
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122,874
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96,736
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Amortization of intangible assets
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|
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3,612
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|
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3,015
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7,013
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4,200
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Acquired in-process research and development
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2,000
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10,000
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Litigation and governmental inquiries
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49,709
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49,709
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Total operating expenses
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137,430
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62,656
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215,497
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132,439
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|
|
|
|
|
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|
|
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Operating income (loss)
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(52,657
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)
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62,153
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|
|
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(41,678
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)
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|
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65,731
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Other expense (income):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Interest expense
|
|
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2,117
|
|
|
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2,803
|
|
|
|
4,635
|
|
|
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4,933
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|
Interest and other income
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|
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(596
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)
|
|
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(2,994
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)
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|
|
(1,475
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)
|
|
|
(7,117
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)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Total other expense (income), net
|
|
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1,521
|
|
|
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(191
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)
|
|
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3,160
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|
|
|
(2,184
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)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Income (loss) before income taxes
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|
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(54,178
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)
|
|
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62,344
|
|
|
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(44,838
|
)
|
|
|
67,915
|
|
Income tax provision (benefit)
|
|
|
(10,597
|
)
|
|
|
21,584
|
|
|
|
(6,828
|
)
|
|
|
23,888
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(43,581
|
)
|
|
$
|
40,760
|
|
|
$
|
(38,010
|
)
|
|
$
|
44,027
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Earnings (loss) per share:
|
|
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|
|
|
|
|
|
|
|
|
|
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Basic - Class A common
|
|
$
|
(0.88
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)
|
|
$
|
0.86
|
|
|
$
|
(0.77
|
)
|
|
$
|
0.93
|
|
Basic - Class B common
|
|
|
(0.88
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)
|
|
|
0.72
|
|
|
|
(0.77
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)
|
|
|
0.78
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|
Diluted - Class A common
|
|
|
(0.88
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)
|
|
|
0.71
|
|
|
|
(0.77
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)
|
|
|
0.78
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|
Diluted - Class B common
|
|
|
(0.88
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)
|
|
|
0.61
|
|
|
|
(0.77
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)
|
|
|
0.67
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|
|
|
|
|
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Shares used in per share calculation:
|
|
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Basic - Class A common
|
|
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37,434
|
|
|
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37,082
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|
|
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37,430
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|
|
|
37,044
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Basic - Class B common
|
|
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12,089
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|
|
|
12,234
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|
|
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12,085
|
|
|
|
12,257
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|
Diluted - Class A common
|
|
|
49,523
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|
|
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59,107
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|
|
|
49,515
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|
|
|
59,098
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|
Diluted - Class B common
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|
|
12,089
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|
|
|
12,317
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|
|
|
12,085
|
|
|
|
12,339
|
|
(1)
|
This financial statement reflects the correction of certain immaterial errors, as fully described in Note 4Correction of Immaterial Errors in Prior
Period Consolidated Financial Statements.
|
See Accompanying Notes to Consolidated Financial Statements
5
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited; dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
September 30,
2008
|
|
|
March 31,
2008 (1)
|
|
ASSETS
|
|
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Current Assets:
|
|
|
|
|
|
|
|
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Cash and cash equivalents
|
|
$
|
149,039
|
|
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$
|
88,493
|
|
Marketable securities
|
|
|
|
|
|
|
40,548
|
|
Receivables, less allowance for doubtful accounts of $801 and $867 at September 30, 2008 and March 31, 2008
respectively
|
|
|
119,876
|
|
|
|
131,776
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|
Inventories, net
|
|
|
92,579
|
|
|
|
94,330
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|
Prepaid and other assets
|
|
|
8,385
|
|
|
|
8,366
|
|
Income taxes receivable
|
|
|
16,420
|
|
|
|
11,015
|
|
Deferred tax asset
|
|
|
32,497
|
|
|
|
24,122
|
|
|
|
|
|
|
|
|
|
|
Total Current Assets
|
|
|
418,796
|
|
|
|
398,650
|
|
Property and equipment, less accumulated depreciation of $88,550 and $78,532 at September 30, 2008 and March 31, 2008
respectively
|
|
|
191,113
|
|
|
|
187,492
|
|
Investment securities
|
|
|
77,197
|
|
|
|
81,516
|
|
Intangible assets and goodwill, net
|
|
|
193,159
|
|
|
|
198,784
|
|
Other assets
|
|
|
21,261
|
|
|
|
24,005
|
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
901,526
|
|
|
$
|
890,447
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
|
|
|
|
|
|
|
|
|
Current Liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
27,785
|
|
|
$
|
32,020
|
|
Accrued liabilities
|
|
|
87,846
|
|
|
|
73,996
|
|
Current maturities of long-term debt
|
|
|
2,459
|
|
|
|
202,499
|
|
|
|
|
|
|
|
|
|
|
Total Current Liabilities
|
|
|
118,090
|
|
|
|
308,515
|
|
Long-term debt
|
|
|
267,373
|
|
|
|
68,674
|
|
Other long-term liabilities
|
|
|
71,696
|
|
|
|
22,519
|
|
Deferred tax liability
|
|
|
35,197
|
|
|
|
37,122
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
|
492,356
|
|
|
|
436,830
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
SHAREHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
7% cumulative convertible Preferred Stock, $.01 par value; $25.00 stated and liquidation value; 840,000 shares authorized; issued
and outstanding 40,000 shares at September 30, 2008 and March 31, 2008 (convertible into Class A shares on a 8.4375-to-one basis)
|
|
|
|
|
|
|
|
|
Class A and Class B Common Stock, $.01 par value; 150,000,000 and 75,000,000 shares authorized,
respectively;
|
|
|
|
|
|
|
|
|
Class A issued 40,876,032 and 40,764,603 at September 30, 2008 and March 31, 2008,
respectively
|
|
|
409
|
|
|
|
407
|
|
Class B issued 12,164,474 and 12,170,172 at September 30, 2008 and March 31, 2008, respectively
(convertible into Class A shares on a one-for-one basis)
|
|
|
122
|
|
|
|
122
|
|
Additional paid-in capital
|
|
|
163,396
|
|
|
|
159,443
|
|
Retained earnings
|
|
|
305,424
|
|
|
|
351,348
|
|
Accumulated other comprehensive loss
|
|
|
(3,888
|
)
|
|
|
(1,543
|
)
|
Less: Treasury stock, 3,295,012 shares of Class A and 92,902 shares of Class B Common Stock at September 30, 2008,
respectively, and 3,289,324 shares of Class A and 92,902 shares of Class B Common Stock at March 31, 2008, respectively, at cost
|
|
|
(56,293
|
)
|
|
|
(56,160
|
)
|
|
|
|
|
|
|
|
|
|
Total Shareholders Equity
|
|
|
409,170
|
|
|
|
453,617
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities and Shareholders Equity
|
|
$
|
901,526
|
|
|
$
|
890,447
|
|
|
|
|
|
|
|
|
|
|
(1)
|
This financial statement reflects the correction of certain immaterial errors, as fully described in Note 4Correction of Immaterial Errors in Prior
Period Consolidated Financial Statements.
|
See Accompanying Notes to Consolidated Financial
Statements
6
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
September 30,
|
|
|
|
2008
|
|
|
2007 (1)
|
|
Operating Activities:
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(38,010
|
)
|
|
$
|
44,027
|
|
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Acquired in-process research and development
|
|
|
2,000
|
|
|
|
10,000
|
|
Depreciation and amortization
|
|
|
17,814
|
|
|
|
14,139
|
|
Deferred income tax provision (benefit)
|
|
|
(8,818
|
)
|
|
|
(5,869
|
)
|
Deferred compensation
|
|
|
1,168
|
|
|
|
1,116
|
|
Stock-based compensation
|
|
|
2,665
|
|
|
|
3,142
|
|
Excess tax benefits associated with stock options
|
|
|
(368
|
)
|
|
|
(479
|
)
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Receivables, net
|
|
|
11,900
|
|
|
|
(57,922
|
)
|
Inventories, net
|
|
|
1,751
|
|
|
|
(2,982
|
)
|
Income taxes
|
|
|
(4,013
|
)
|
|
|
14,994
|
|
Accounts payable and accrued liabilities
|
|
|
10,130
|
|
|
|
12,324
|
|
Other assets and liabilities, net
|
|
|
41,291
|
|
|
|
(1,449
|
)
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
37,510
|
|
|
|
31,041
|
|
|
|
|
|
|
|
|
|
|
Investing Activities:
|
|
|
|
|
|
|
|
|
Purchase of property and equipment, net
|
|
|
(12,478
|
)
|
|
|
(6,761
|
)
|
Purchase of marketable securities
|
|
|
(559
|
)
|
|
|
(32,554
|
)
|
Sale of marketable securities
|
|
|
41,411
|
|
|
|
68,575
|
|
Product acquisition
|
|
|
(2,000
|
)
|
|
|
(151,500
|
)
|
Cash paid for acquired assets
|
|
|
(3,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) investing activities
|
|
|
23,374
|
|
|
|
(122,240
|
)
|
|
|
|
|
|
|
|
|
|
Financing Activities:
|
|
|
|
|
|
|
|
|
Principal payments on long-term debt
|
|
|
(1,341
|
)
|
|
|
(1,021
|
)
|
Proceeds from borrowing on long-term debt
|
|
|
|
|
|
|
50,000
|
|
Dividends paid on preferred stock
|
|
|
(35
|
)
|
|
|
(35
|
)
|
Purchase of common stock for treasury
|
|
|
(133
|
)
|
|
|
(105
|
)
|
Excess tax benefits associated with stock options
|
|
|
368
|
|
|
|
479
|
|
Cash deposits received for stock options
|
|
|
701
|
|
|
|
674
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities
|
|
|
(440
|
)
|
|
|
49,992
|
|
|
|
|
|
|
|
|
|
|
Effect of foreign exchange rate changes on cash
|
|
|
102
|
|
|
|
|
|
Increase (decrease) in cash and cash equivalents
|
|
|
60,546
|
|
|
|
(41,207
|
)
|
|
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
Beginning of year
|
|
|
88,493
|
|
|
|
84,753
|
|
|
|
|
|
|
|
|
|
|
End of period
|
|
$
|
149,039
|
|
|
$
|
43,546
|
|
|
|
|
|
|
|
|
|
|
Supplemental information:
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
4,835
|
|
|
$
|
3,771
|
|
Income taxes paid
|
|
|
6,438
|
|
|
|
13,862
|
|
Stock options exercised (at expiration of two-year forfeiture period)
|
|
|
920
|
|
|
|
575
|
|
Software financing arrangement
|
|
|
|
|
|
|
2,039
|
|
(1)
|
This financial statement reflects the correction of certain immaterial errors, as fully described in Note 4Correction of Immaterial Errors in Prior
Period Consolidated Financial Statements.
|
See Accompanying Notes to Consolidated Financial Statements
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(in thousands, except per share data)
1. DESCRIPTION OF BUSINESS
K-V Pharmaceutical Company was incorporated
under the laws of Delaware in 1971 as a successor to a business originally founded in 1942. K-V Pharmaceutical Company and its wholly-owned subsidiaries, including Ther-Rx Corporation (Ther-Rx), ETHEX Corporation (ETHEX) and
Particle Dynamics, Inc. (PDI), are referred to in the Notes to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q as KV or the Company. The Company has been engaged 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. It has developed and patented a wide variety of drug delivery and
formulation technologies that are primarily focused in four principal areas: SITE RELEASE
®
; tastemasking; oral
controlled release; and oral quick dissolving tablets. KV incorporates these technologies in the products it markets to control and improve the absorption and utilization of active pharmaceutical compounds. In 1990, the Company established a
generic, non-branded marketing capability through its wholly-owned subsidiary, ETHEX. In 1999, KV established a wholly-owned subsidiary, Ther-Rx, to market proprietary branded pharmaceuticals directly to physicians.
The Companys wholly-owned subsidiary, PDI, was acquired in 1972. Through PDI, KV develops and markets specialty value-added raw materials, including
drugs, directly compressible and microencapsulated products, and other products used in the pharmaceutical industry and other markets.
2.
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of the Company have been prepared in
accordance with U.S. Generally Accepted Accounting Principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by GAAP for complete financial statements. However, in the opinion of management, all adjustments (consisting of only normal recurring accruals) considered necessary for a fair presentation have been included. The results of
operations and cash flows for the three- and six-month periods ended September 30, 2008 are not necessarily indicative of the results of operations and cash flows that may be expected for the fiscal year ending March 31, 2009. The interim
consolidated financial statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes thereto included in the 2009 Form 10-K. The balance sheet information as of March 31, 2008 has been
derived from the Companys audited Consolidated Balance Sheet as of that date (see Note 4Correction of Immaterial Errors in Prior Period Consolidated Financial Statements).
Certain reclassifications, having no effect on net income (loss), have been made to the previously issued consolidated financial statements to conform to
the current periods presentation of the Companys consolidated financial statements.
3. GOING CONCERN AND LIQUIDITY
CONSIDERATIONS
The Companys consolidated financial statements are prepared using accounting principles generally accepted in the
United States applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The accompanying historical consolidated financial statements do not include any adjustments
that might be necessary if the Company is unable to continue as a going concern.
The assessment of the Companys ability to continue as
a going concern was made by management considering, among other factors: (i) the Companys need to obtain additional capital; (ii) the suspension of shipment of all products manufactured by the Company and the requirements under the
consent decree with the FDA; (iii) the timing and number of approved products that will be reintroduced to the market and the related costs; (iv) the potential outcome with respect to the governmental inquiries, litigation or other matters
described in the 2009 Form 10-K; and (v) the Companys ability to comply with debt covenants. The Companys assessment was
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
further affected by the Companys fiscal year 2009 net loss of $313,627 and the outstanding balance of cash, cash equivalents and short-term marketable securities of $75,730 as of
March 31, 2009. For periods subsequent to March 31, 2009, the Company expects losses to continue because the Company is unable to generate any significant revenues from its own manufactured products until the Company is able to resume
shipping certain or many of its approved products, which currently is not expected to occur until the fourth quarter of calendar year 2010 at the earliest. In addition, the Company must meet ongoing operating costs as well as costs related to the
steps the Company is currently taking to prepare for reintroducing its approved products to the market. If the Company is not able to obtain the FDAs clearance to resume manufacturing and distribution of its approved products in a timely
manner and at a reasonable cost, the Companys financial position, results of operations, cash flows and liquidity will continue to be materially adversely affected. These conditions raise substantial doubt about the Companys ability to
continue as a going concern.
The Company believes that it is not in compliance with one or more of the requirements of the Companys
mortgage loan arrangement as of March 31, 2009 (see the 2009 Form 10-K). Failure by the Company to comply with the requirements of the mortgage loan arrangement or to otherwise receive a waiver from the mortgage lender for any noncompliance
could result in the Companys outstanding mortgage debt obligation accelerating and immediately becoming due and payable. If the acceleration occurs and the mortgage debt is not immediately paid in full an event of default could also be deemed
to have occurred under the $200,000 principal amount of 2.5% Contingent Convertible Subordinated Notes (the Notes). If an event of default is deemed to have occurred on the Notes, the principal amount plus any accrued and unpaid interest
could also become immediately due and payable. The acceleration of these outstanding debt obligations would materially adversely affect the Companys business, financial condition and cash flows.
Based on current financial projections, the Company believes the continuation of the Company as a going concern is primarily dependent on
its ability to address, among other factors: (i) the Companys need to obtain additional capital; (ii) the suspension of shipment of all products manufactured by the Company and the requirements under the consent decree with the FDA;
(iii) the timing and number of approved products that will be reintroduced to the market and the related costs; (iv) the potential outcome with respect to the governmental inquiries, litigation or other matters described in Note
19ContingenciesLitigation and Governmental Inquiries; and (v) the Companys ability to comply with debt covenants. While the Company addresses these matters, it must continue to meet expected near-term obligations,
including normal course operating cash requirements and costs associated with reintroducing its approved products to the market (such as costs related to its employees, facilities and FDA compliance), remaining payments associated with the
acquisition of the rights to Gestiva (see the 2009 Form 10-K), the financial obligations pursuant to the plea agreement with the U.S. Department of Justice (see Note 19ContingenciesLitigation and Governmental
Inquiries), as well as the significant costs, such as legal and consulting fees, associated with the steps taken by the Company in connection with the consent decree and the litigation and governmental inquiries described in the 2009 Form
10-K. If the Company is not able to obtain the FDAs clearance to resume manufacturing and distribution of its approved products in a timely manner and at a reasonable cost, and/or if the Company experiences adverse outcomes with respect to any
of the governmental inquiries or litigation described in Note 19
ContingenciesLitigation and Governmental Inquiries, the Companys financial position, results of operations, cash flows and liquidity
will continue to be materially adversely affected.
In the near term, the Company is focused on meeting the requirements of the consent
decree, which will allow its approved products to be reintroduced to the market, and is pursuing various means to increase cash. Since March 31, 2009, the Company has generated non-recurring cash proceeds to support its on-going operating and
compliance requirement from the receipt of tax refunds, the monetization of its ARS and the sale of certain other assets (see the 2009 Form 10-K for more information regarding the cash received). The Company also generated cash from the sale of
certain products not manufactured by the Company under the distribution and supply agreement with Purdue (see Note 19ContingenciesLitigation and Governmental Inquiries). While these cash proceeds were sufficient to meet near
term cash requirements, the Company is pursuing ongoing efforts to increase cash including the continued implementation of cost savings, divestiture of PDI and other assets and the return of certain or many of the Companys approved products to
market in a timely manner. In addition, in order to continue to meet the expected near-term obligations described above, the Company will still need to obtain additional capital through additional asset sales. Based on the Companys continuing
assessment and identification of assets for future sale and the results of the currently proposed asset sales, the Company may elect to engage in external financing efforts. The Company currently does not anticipate issuing equity securities to
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
raise additional capital. However, the Company continues to evaluate its capital needs and availability of financing to assess and identify the best available external financing alternatives. The
Company cannot provide assurance that it will be able to realize the cost reductions it anticipates from reducing its operations or its employee base, that some or many of its approved products can be returned to the market in a timely manner, that
its higher profit approved products will return to the market in the near term, that the Company can obtain additional cash through asset sales, or that external financing can be obtained when needed, under acceptable terms or in the amounts
required. If the Company is unsuccessful in its efforts to sell assets and raise additional capital in the near term, the Company will be required to further reduce its operations, including further reductions of its employee base, or the Company
may be required to cease operations in order to offset the lack of available funding.
The Companys ability to obtain capital has been
and continues to be materially and negatively affected by a number of factors. The current and evolving credit market condition and general adverse economic conditions have caused the cost of prospective debt and equity financings to increase
considerably. These circumstances have materially adversely affected liquidity in the financial markets, making terms for certain financings unattractive, and in some cases have resulted in the unavailability of financing. The Company also
anticipates that the uncertainty created by the ongoing governmental inquiries and litigation, steps taken by the Company in connection with the nationwide recall and suspension of shipment of all drug products manufactured by the Company, the
consent decree and the uncertainty with respect to when it will resume shipment of its products, if at all, will affect the Companys ability to obtain capital on a timely basis, or at all. In light of the factors described above, the Company
may not be able to obtain additional capital. Even if it is able to obtain additional financing or issue debt securities under these circumstances, the cost to the Company likely will be high and the terms and conditions are likely to be onerous. In
addition, if the Company were to issue equity securities, such securities likely would be priced at or below the current market price for the Companys securities. As a result, sales of equity securities at or below current market prices likely
would result in substantial dilution for current shareholders who purchased the Companys equity securities at or above current market prices.
4. CORRECTION OF IMMATERIAL ERRORS IN PRIOR PERIOD CONSOLIDATED FINANCIAL STATEMENTS
The Company has determined that certain
of its previously filed financial statements contained certain errors. In order to assess materiality with respect to these errors, it applied the concepts set forth in SAB 99 and SAB 108 and determined that the impact of these errors on prior
period consolidated financial statements was immaterial. Accordingly, the Companys consolidated balance sheet as of March 31, 2008 and the related consolidated statements of operations for the three and six months ended September 30,
2007 and cash flows for the six months ended September 30, 2007 reflect the correction of these immaterial errors. The accompanying notes have also been revised as necessary. The impact of correcting these immaterial errors resulted in a
decrease in net revenues of $1,749 and an increase in operating income and net income of $124 and $537, respectively, for the three months ended September 30, 2007 and a decrease in net revenues, operating income and net income of $2,651,
$4,930 and $2,396, respectively, for the six months ended September 30, 2007. The Companys consolidated retained earnings as of March 31, 2008 reflects a decrease of $6,366 to correct all of the errors identified in the prior period
consolidated financial statements.
The following is a description of the areas in which corrections of these immaterial errors were made.
|
|
|
Reserve for chargebacks:
The Company conducted a comprehensive review of the accounting method used to estimate the reserve for chargebacks. The
review determined that a customer deposit was inappropriately applied in prior periods as an offset to the estimated chargeback reserve requirement. The identification of this and other immaterial errors resulted in revisions to prior period
consolidated financial statements that impacted receivables and net revenues.
|
|
|
|
Inventory variances:
In prior periods, the Company did not appropriately capitalize production related inventory variances. For fiscal year
2009, the Company corrected the error by transferring all production related variances to inventory and then recognizing them into cost of sales based on average inventory turns. The revisions to prior period consolidated financial statements
resulted in corrections to inventory and cost of sales.
|
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
|
|
|
R&D raw material inventory:
In prior periods, the Company did not appropriately record costs for materials used in research and development
activities and incorrectly capitalized materials that should have been expensed. The Company identified revisions to prior period consolidated financial statements that generally decreased inventory and increased research and development expense for
raw materials that did not meet the criteria for capitalization.
|
|
|
|
Stock-based compensation:
The Company determined that its calculation of stock-based compensation for options issued to retiree eligible
employees was not correct. As a result, the Company identified revisions to prior period consolidated financial statements that resulted in decreases to both stock-based compensation and additional paid-in capital. Also, the Company determined that
its calculation of stock-based compensation for options issued to employees who ceased being employees of the Company and instead worked for the Company as consultants during fiscal year 2008 was not correct. As a result, the Company recorded an
adjustment to the fiscal year 2008 consolidated financial statements to decrease stock-based compensation and additional paid-in capital.
|
|
|
|
Property and equipment:
The Company determined that its policies and procedures were inadequate to ensure that maintenance and repairs of
equipment were expensed as incurred, all asset costs were appropriately capitalized, depreciation expense was appropriately calculated and that the selection of useful lives of property and equipment was appropriately and consistently applied. As a
result, the Company identified revisions to prior period consolidated financial statements that generally resulted in decreases to property and equipment, net and increases to both cost of sales and selling and administrative expense.
|
|
|
|
Vacation accrual:
The Company determined that the vacation accrual was not calculated in accordance with the terms of the Companys
vacation policy. By recording the accrual in accordance with the related policy, the Company recorded adjustments that impacted accrued liabilities and compensation expense.
|
|
|
|
Software financing arrangement:
The Company determined that an agreement to purchase various software licenses and products by means of a third
party financing arrangement was not recorded. The Company has corrected this error by capitalizing the assets purchased and amortizing them over the service life. The Company also has recorded the corresponding liability with the financing company
as debt that matures in fiscal year 2012 and recognized interest expense thereon.
|
|
|
|
Income taxes
: Income tax adjustments were recorded to correct the Companys income tax expense and the applicable income tax liabilities
for the impact of the immaterial errors discussed above and other immaterial errors detected in the tax provision calculation.
|
|
|
|
Other
: The Company identified certain other immaterial errors not applicable to the above categories that resulted in revisions to prior period
consolidated financial statements.
|
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
The combined effect of recording the correction of the immaterial errors in the Companys
consolidated statement of income for the three and six months ended September 30, 2007 is presented in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30, 2007
|
|
Six Months Ended
September 30, 2007
|
|
|
As
Reported
|
|
As
Revised
|
|
As
Reported
|
|
As
Revised
|
Net revenues
|
|
$
|
172,925
|
|
$
|
171,176
|
|
$
|
287,282
|
|
$
|
284,631
|
Cost of sales
|
|
|
45,132
|
|
|
46,367
|
|
|
84,702
|
|
|
86,461
|
Gross profit
|
|
|
127,793
|
|
|
124,809
|
|
|
202,580
|
|
|
198,170
|
Research and development
|
|
|
11,750
|
|
|
10,219
|
|
|
21,546
|
|
|
21,503
|
Selling and administrative
|
|
|
50,999
|
|
|
49,422
|
|
|
96,173
|
|
|
96,736
|
Operating income
|
|
|
62,029
|
|
|
62,153
|
|
|
70,661
|
|
|
65,731
|
Interest expense
|
|
|
2,768
|
|
|
2,803
|
|
|
4,898
|
|
|
4,933
|
Interest and other income
|
|
|
2,741
|
|
|
2,994
|
|
|
6,156
|
|
|
7,117
|
Income before income taxes
|
|
|
62,002
|
|
|
62,344
|
|
|
71,919
|
|
|
67,915
|
Income tax provision
|
|
|
21,779
|
|
|
21,584
|
|
|
25,496
|
|
|
23,888
|
Net income
|
|
|
40,223
|
|
|
40,760
|
|
|
46,423
|
|
|
44,027
|
Earnings (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic - Class A common
|
|
$
|
0.85
|
|
$
|
0.86
|
|
$
|
0.98
|
|
$
|
0.93
|
Basic - Class B common
|
|
|
0.71
|
|
|
0.72
|
|
|
0.82
|
|
|
0.78
|
Diluted - Class A common
|
|
|
0.70
|
|
|
0.71
|
|
|
0.82
|
|
|
0.78
|
Diluted - Class B common
|
|
|
0.60
|
|
|
0.61
|
|
|
0.71
|
|
|
0.67
|
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
The combined effect of recording the correction of the immaterial errors on the consolidated balance
sheet at March 31, 2008 is presented in the following table:
|
|
|
|
|
|
|
|
|
March 31, 2008
|
|
|
As
Reported
|
|
As
Revised
|
Cash and cash equivalents
|
|
$
|
86,345
|
|
$
|
88,493
|
Receivables
|
|
|
107,070
|
|
|
131,776
|
Inventories
|
|
|
94,980
|
|
|
94,330
|
Prepaid and other assets
|
|
|
7,792
|
|
|
8,366
|
Income taxes receivable
|
|
|
9,872
|
|
|
11,015
|
Deferred income taxes
|
|
|
22,812
|
|
|
24,122
|
Total current assets
|
|
|
369,419
|
|
|
398,650
|
Property and equipment
|
|
|
196,200
|
|
|
187,492
|
Other assets
|
|
|
23,108
|
|
|
24,005
|
Total Assets
|
|
|
869,027
|
|
|
890,447
|
Accounts payable
|
|
|
32,119
|
|
|
32,020
|
Accrued liabilities
|
|
|
46,516
|
|
|
73,996
|
Current maturities
|
|
|
202,020
|
|
|
202,499
|
Total Current Liabilities
|
|
|
280,655
|
|
|
308,515
|
Long-term debt
|
|
|
67,432
|
|
|
68,674
|
Other long-term liabilities
|
|
|
22,359
|
|
|
22,519
|
Deferred income taxes
|
|
|
39,299
|
|
|
37,122
|
Total Liabilities
|
|
|
409,745
|
|
|
436,830
|
Additional paid-in capital
|
|
|
158,742
|
|
|
159,443
|
Retained earnings
|
|
|
357,714
|
|
|
351,348
|
Total Shareholders Equity
|
|
|
459,282
|
|
|
453,617
|
Total Liabilities and Shareholders Equity
|
|
|
869,027
|
|
|
890,447
|
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
The combined effect of recording the correction of the immaterial errors in the Companys
consolidated statement of cash flows for the six months ended September 30, 2007 is presented in the following table:
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
September 30, 2007
|
|
|
|
As
Reported
|
|
|
As
Revised
|
|
Net income (loss)
|
|
$
|
46,423
|
|
|
$
|
44,027
|
|
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
13,711
|
|
|
|
14,139
|
|
Deferred income tax benefit
|
|
|
(5,060
|
)
|
|
|
(5,869
|
)
|
Stock-based compensation
|
|
|
2,757
|
|
|
|
3,142
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Receivables, net
|
|
|
(52,319
|
)
|
|
|
(57,922
|
)
|
Inventories, net
|
|
|
(4,618
|
)
|
|
|
(2,982
|
)
|
Income taxes
|
|
|
(1,528
|
)
|
|
|
14,994
|
|
Accounts payable and accrued liabilities
|
|
|
16,215
|
|
|
|
12,324
|
|
Other assets and liabilities, net
|
|
|
4,798
|
|
|
|
(1,449
|
)
|
Net cash provided by operating activities
|
|
|
31,016
|
|
|
|
31,041
|
|
Purchase of property and equipment, net
|
|
|
(6,921
|
)
|
|
|
(6,761
|
)
|
Cash paid for acquired assets
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(122,400
|
)
|
|
|
(122,240
|
)
|
Principal payments on long-term debt
|
|
|
(927
|
)
|
|
|
(1,021
|
)
|
Proceeds from borrowing on long-term debt
|
|
|
50,000
|
|
|
|
50,000
|
|
Net cash provided by financing activities
|
|
|
50,085
|
|
|
|
49,992
|
|
Increase (decrease) in cash and cash equivalents
|
|
|
(41,299
|
)
|
|
|
(41,207
|
)
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
Beginning of year
|
|
|
82,574
|
|
|
|
84,753
|
|
End of period
|
|
|
41,275
|
|
|
|
43,546
|
|
5. RECENTLY ISSUED ACCOUNTING
STANDARDS
Effective April 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (SFAS 157),
for all financial assets and liabilities and any other assets and liabilities that are recognized or disclosed at fair value on a recurring basis. This pronouncement clarifies the principle that fair value should be based on the assumptions that
market participants would use when pricing an asset or liability, provides a framework for measuring fair value under GAAP and expands disclosure requirements about fair value measurements. Although the Companys adoption of SFAS No. 157
did not have a material effect on the Companys financial condition, results of operations or cash flows, additional disclosures were required (see Note 11Fair Value Measures of the Notes to the Consolidated Financial
Statements in this Quarterly Report on Form 10-Q).
In February 2008, the Financial Accounting Standards Board
(FASB) issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157 (FSP 157-2), which defers the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities,
except those that are recognized or disclosed at fair value in the financial statements on at least an annual basis, to fiscal years beginning after November 15, 2008. The Company has adopted the deferral of SFAS 157 with respect to the items
listed in FSP 157-2. The Company does not expect that the remaining provisions of this statement will have a material effect on its financial statements.
Effective April 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This standard allows an entity the irrevocable option
to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the fair value option), with changes in fair value reported in earnings. The Company did not elect fair value as an
alternative, as provided under SFAS 159, for any of its financial instruments or any other assets and liabilities that are not currently recorded at fair value. Therefore, short-term and long-term debt obligations and trade accounts receivable and
payable are still reported at their carrying values.
14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
In March 2007, the FASB ratified the consensus reached by the Emerging Issues Task
Force (EITF) in Issue No. 06-10, Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements (Issue 06-10). Issue 06-10 requires companies with collateral assignment split-dollar life
insurance arrangements that provide a benefit to an employee that extends to postretirement periods to recognize a liability for future benefits based on the substantive agreement with the employee. The provisions of Issue 06-10 also require an
employer to recognize and measure the asset in a collateral assignment split-dollar life insurance arrangement based on the nature and substance of the arrangement. The Company adopted the provisions of Issue 06-10 effective April 1, 2008. As a
result of the adoption, the Company recognized a liability of $5,551 which represented the present value of the future premium payments to be made under the existing policies. The Company also recognized a decrease in the related asset of $2,328
based on the nature and substance of the arrangements. In accordance with the transition provisions of EITF No. 06-10, a direct decrease of $7,879 was recorded to retained earnings, effective April 1, 2008.
In June 2007, the FASB ratified the consensus reached by the EITF on Issue No. 07-3, Accounting for Advance Payments for Goods
or Services Received for Use in Future Research and Development Activities (Issue 07-3), which is effective for fiscal years beginning after December 15, 2007 and is applied prospectively for new contracts entered into on or
after the effective date. Issue 07-3 addresses nonrefundable advance payments for goods or services for use in future research and development activities. Issue 07-3 will require that these payments that will be used or rendered for future research
and development activities be deferred and capitalized and recognized as an expense as the related goods are delivered or the related services are performed. If an entity does not expect the goods to be delivered or the services to be rendered, the
capitalized advance payments should be expensed. The Companys adoption of Issue 07-3 at the beginning of fiscal year 2009 did not have a material effect on its financial condition, results of operations or cash flows.
In September 2007, the EITF reached a consensus on Issue No. 07-1 (Issue 07-1), Accounting for Collaborative Arrangements. The
scope of Issue 07-1 is limited to collaborative arrangements where no separate legal entity exists and in which the parties are active participants and are exposed to significant risks and rewards that depend on the success of the activity. The EITF
concluded that revenue transactions with third parties and associated costs incurred should be reported in the appropriate line item in each companys financial statements pursuant to the guidance in Issue 99-19, Reporting Revenue Gross
as a Principal versus Net as an Agent. The EITF also concluded that the equity method of accounting under Accounting Principles Board Opinion 18, The Equity Method of Accounting for Investments in Common Stock, should not be
applied to arrangements that are not conducted through a separate legal entity. The EITF also concluded that the income statement classification of payments made between the parties in an arrangement should be based on a consideration of the
following factors: the nature and terms of the arrangement; the nature of the entities operations; and whether the partners payments are within the scope of existing GAAP. To the extent such costs are not within the scope of other
authoritative accounting literature, the income statement characterization for the payments should be based on an analogy to authoritative accounting literature or a reasonable, rational, and consistently applied accounting policy election. The
provisions of Issue 07-1 are effective for fiscal years beginning on or after December 15, 2008, and companies will be required to apply the provisions through retrospective application. The Company plans to adopt Issue 07-1 at the beginning of
fiscal year 2010 and is evaluating the impact of the adoption of Issue 07-1 on its financial condition and results of operations.
In December
2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS 141(R)), which replaces SFAS 141 but retains the fundamental concept of purchase method of accounting in a business combination and improves
reporting by creating greater consistency in the accounting and financial reporting of business combinations, resulting in more complete, comparable, and relevant information for investors and other users of financial statements. To achieve this
goal, the new standard requires the acquiring entity in a business combination to recognize all the assets acquired and liabilities assumed in the transaction and any non-controlling interest at the acquisition date at their fair value as of that
date. This statement requires measuring a non-controlling interest in the acquiree at fair value which will result in recognizing the goodwill attributable to the non-controlling interest in addition to that attributable to the acquirer. This
statement also requires the recognition of assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date, measured at their acquisition date fair values. SFAS 141(R) is effective for business combinations
for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 and earlier adoption is prohibited. The Company plans to adopt SFAS 141(R) at the beginning of fiscal year
2010 and is evaluating the impact of SFAS 141(R) on its financial condition and results of operations.
15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated
Financial Statements (SFAS 160) an amendment of ARB No. 51, which will affect only those entities that have an outstanding non-controlling interest in one or more subsidiaries or that deconsolidate a subsidiary by requiring
all entities to report non-controlling (minority) interests in subsidiaries in the same way as equity in the consolidated financial statements. In addition, SFAS 160 eliminates the diversity that currently exists in accounting for transactions
between an entity and non-controlling interests by requiring they be treated as equity transactions. SFAS 160 is effective for fiscal years beginning after December 15, 2008. The Company plans to adopt SFAS 160 at the beginning of fiscal year
2010 and is evaluating the impact of SFAS 160 on its financial condition and results of operations.
In May 2008, the FASB issued FASB Staff
Position (FSP) No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement). Under the new rules for convertible debt instruments that may be
settled entirely or partially in cash upon conversion, an entity is required to separately account for the liability and equity components of the instrument in a manner that reflects the issuers economic interest cost. The effect of the new
rules is that the equity component is included in the paid-in capital section of shareholders equity on an entitys consolidated balance sheet and the value of the equity component is treated as original issue discount for purposes of
accounting for the debt component of convertible debt. The FSP is effective for fiscal years beginning after December 15, 2008, and for interim periods within those fiscal years, with retrospective application required. Early adoption is not
permitted. The Company is currently evaluating the new rules and the impact on its financial condition and results of operations.
In April
2008, the FASB issued FASB Staff Position (FSP) No. FAS 142-3, Determination of the Useful Life of Intangible Assets, (FSP 142-3). FSP 142-3 amends the factors that should be considered in developing renewal or
extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets and also requires expanded disclosure related to the determination of intangible asset
useful lives. FSP 142-3 is effective for fiscal years beginning after December 15, 2008. Early adoption is prohibited. The company is currently evaluating the impact the adoption of FSP 142-3 will have on its consolidated financial statements.
In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principlesa replacement of FASB Statement No. 162 (SFAS 168), which identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial
statements of nongovernmental entities that are presented in conformity with GAAP. This is accomplished by authorizing the Codification to become the single source of authoritative U.S. accounting and reporting standards, except for rules and
interpretive releases of the Securities and Exchange Commission (the SEC) under authority of federal securities laws, which are sources of authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC accounting literature
not included in the Codification is now non-authoritative. SFAS No. 168 is effective for fiscal years, and interim periods within those fiscal years, beginning after September 15, 2009. The Company is in the process of analyzing the impact
of this standard on future filings, which will be adopted by the Company at the beginning of the third quarter of fiscal year 2010.
6.
ACQUISITIONS
In September 2008, the Company acquired assets from the pharmaceutical division of LycoRed Natural Products Industries Ltd.
(LycoRed), an Israeli company. Under the terms of the asset purchase agreement, the Company paid $3,000 for tangible assets and an assembled workforce. The acquirer of these assets is Nesher Solutions, Ltd., an Israeli entity that is
100% owned by Nesher Solutions USA, Inc., a wholly-owned KV company. The purpose of the acquisition was to expand the Companys expertise in the area of controlled-release products as well as enhance its generic pipeline development capacity.
The results of operations are included in the consolidated statement of operations since the date of acquisition.
The Company on
January 16, 2008, entered into an Asset Purchase Agreement (the Original Gestiva Agreement) with Cytyc Prenatal Products Corp. and Hologic, Inc. (Cytyc Prenatal Products Corp. and Hologic, Inc. are referred to collectively as
Hologic). On January 8, 2010, the Company and Hologic entered into an Amendment (the Gestiva Amendment) to the Original Gestiva Agreement.
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
The Original Gestiva Agreement provided for, among other things, the following:
|
|
|
The Company would acquire the U.S. and worldwide rights to Gestiva (17-alpha hydroxyprogesterone caproate) and certain related assets (the
Purchased Assets) upon approval of the pending New Drug Application for Gestiva (the Gestiva NDA) under review by the FDA.
|
|
|
|
The Purchased Assets would be transferred and sold to the Company free and clear of all encumbrances on the transfer date (the Transfer
Date), which is to occur no later than five business days after the satisfaction of certain conditions, including, among other things, (1) the approval of the Gestiva NDA by the FDA (as more fully described in the Original Gestiva
Agreement) and (2) the delivery by the Company of the Additional Purchase Price Amount (as defined below). As previously disclosed by the Company, the FDA has not yet approved the Gestiva NDA and the Transfer Date has not yet occurred.
|
|
|
|
The Company agreed to pay Hologic a total of $82,000 for the Purchased Assets, in the following increments:
|
|
|
|
A $7,500 cash payment (the Initial Purchase Price) on the initial closing date. The Company made such payment in February 2008.
|
|
|
|
A $2,000 cash payment (the NDA Milestone Payment) upon receipt by Hologic of an acknowledgement from the FDA that Hologics response
to the FDAs October 20, 2006 approvable letter was sufficient for the FDA to proceed with its review of the Gestiva NDA. The Company made such payment in May 2008.
|
|
|
|
A $72,500 cash payment (the Additional Purchase Price Amount) to be paid on the Transfer Date.
|
|
|
|
The Company and Hologic each had the right to terminate the Original Gestiva Agreement in the event that the Transfer Date did not occur by
February 19, 2010, the second anniversary of the initial closing date (the February 2010 Termination Right).
|
The following is a description of the material terms by which the Gestiva Amendment modifies the Original Gestiva Agreement (as amended, the Amended Gestiva Agreement):
|
|
|
Hologic is no longer entitled to receive the Additional Purchase Price Amount. Instead, the Company agrees to pay the following:
|
|
|
|
A $70,000 cash payment (the Amendment Payment) upon execution of the Gestiva Amendment. The Company made such payment on January 8,
2010.
|
|
|
|
Upon successful completion of agreed upon milestones, a series of additional future scheduled cash payments in the aggregate amount of $120,000, the
first of which payments is due on the Transfer Date (which will occur after, among other things, the FDA approves the Gestiva NDA) and the last of which payments is due no later than 21 months after the FDA approves the Gestiva NDA, provided that
the Transfer Date has already occurred. The Company has the right to prepay any such amounts at any time. In addition, if the Company is unable to obtain sufficient quantities of Gestiva for a period of time (not to exceed 12 months) under certain
specified circumstances set forth in the Amended Gestiva Agreement, then the due date of the next following scheduled cash payment will be delayed for such period of time. The date on which the Company makes the final cash payment is referred to as
the Final Payment Date.
|
|
|
|
If, prior to the Final Payment Date, the Company fails to timely pay a scheduled payment, the Company is obligated to transfer back to Hologic
ownership of the Purchased Assets, including certain improvements made thereto by the Company, as well as other after-acquired assets and rights used by the Company in connection with the Gestiva business (the Retransfer). Certain
liabilities associated with the foregoing are to be transferred to Hologic in connection with any Retransfer, subject to Hologics rights to reject the assumption of certain liabilities.
|
17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
|
|
|
The termination provisions set forth in the Original Gestiva Agreement have been modified to include the following to the existing termination rights
set forth in the Original Gestiva Agreement:
|
|
|
|
The February 2010 Termination Right has been eliminated.
|
|
|
|
Hologic has the right to terminate the Amended Gestiva Agreement if the Company fails to deliver the cash payment due on the Transfer Date (as
described above) within 10 days of receipt of notice from the Seller that all conditions related to the Transfer Date have been met.
|
Hologic informed the Company in January 2009 that the FDA, in a complete response letter, (1) indicated it would not approve Gestiva until additional data and information are submitted to and accepted by the FDA and
(2) requested Hologic to initiate a confirmatory clinical study and enroll a certain number of patients. The Company currently is working with Hologic to achieve the required patient enrollment and to submit the additional data and information
in order to obtain FDA approval of the Gestiva NDA.
In May 2007, the Company acquired the U.S. marketing rights to Evamist, a
transdermal estrogen therapy, from VIVUS, Inc. Under the terms of the asset purchase agreement for Evamist, the Company paid $10,000 in cash at closing and agreed to make an additional cash payment of $141,500 upon final approval of the product by
the FDA. The agreement also provides for two future payments upon achievement of certain net sales milestones. If Evamist achieves $100,000 of net sales in a fiscal year, a one-time payment of $10,000 will be made, and if net sales levels
reach $200,000 in a fiscal year, a one-time payment of up to $20,000 will be made. Because the product had not obtained FDA approval when the initial payment was made at closing, the Company recorded $10,000 of in-process research and development
expense during the three months ended June 30, 2007. In July 2007, FDA approval for Evamist was received and a payment of $141,500 was made to VIVUS, Inc. The final purchase price allocation completed during the fiscal year ended
March 31, 2009, resulted in estimated identifiable intangible assets of $44,078 for product rights; $12,774 for trademark rights; $82,542 for rights under a sublicense agreement; and, $2,106 for a covenant not to compete. Upon FDA approval in
July 2007, the Company began amortizing the product rights, trademark rights and rights under the sublicense agreement over 15 years and the covenant not to compete over nine years.
7. EARNINGS (LOSS) PER SHARE
The Company has two classes of common stock: Class A
Common Stock and Class B Common Stock that is convertible into Class A Common Stock. With respect to dividend rights, holders of Class A Common Stock are entitled to receive cash dividends per share equal to 120% of the dividends per share
paid on the Class B Common Stock. For purposes of calculating basic earnings (loss) per share, undistributed earnings are allocated to each class of common stock based on the contractual participation rights of each class of security.
The Company presents diluted earnings (loss) per share for Class B Common Stock for all periods using the two-class method which does not assume the
conversion of Class B Common Stock into Class A Common Stock. The Company presents diluted earnings (loss) per share for Class A Common Stock using the if-converted method which assumes the conversion of Class B Common Stock into
Class A Common Stock, if dilutive.
Basic earnings (loss) per share is computed using the weighted average number of common shares
outstanding during the period except that it does not include unvested common shares subject to repurchase. Diluted earnings (loss) per share is computed using the weighted average number of common shares and, if dilutive, potential common shares
outstanding during the period. Potential common shares consist of the incremental common shares issuable upon the exercise of stock options, unvested common shares subject to repurchase, convertible preferred stock and convertible notes. The
dilutive effects of outstanding stock options and unvested common shares subject to repurchase are reflected in diluted earnings (loss) per share by application of the treasury stock method. Convertible preferred stock and convertible notes are
reflected on an if-converted basis. The computation of diluted earnings (loss) per share for Class A Common Stock assumes the conversion of the Class B Common Stock, while the diluted earnings (loss) per share for Class B Common Stock does not
assume the conversion of those shares.
18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
The following table sets forth the computation of basic and diluted earnings (loss) per share for the
three months ended September 30, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
2008
|
|
|
Three Months Ended
September 30,
2007
|
|
|
Class A
|
|
|
Class B
|
|
|
Class A
|
|
|
Class B
|
|
Basic earnings (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allocation of undistributed earnings (loss)
|
|
$
|
(32,955
|
)
|
|
$
|
(10,643
|
)
|
|
$
|
31,957
|
|
|
$
|
8,786
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding
|
|
|
37,767
|
|
|
|
12,165
|
|
|
|
37,528
|
|
|
|
12,335
|
|
Less - weighted average unvested common shares subject to repurchase
|
|
|
(333
|
)
|
|
|
(76
|
)
|
|
|
(446
|
)
|
|
|
(101
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of shares used in per share computations
|
|
|
37,434
|
|
|
|
12,089
|
|
|
|
37,082
|
|
|
|
12,234
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings (loss) per share
|
|
$
|
(0.88
|
)
|
|
$
|
(0.88
|
)
|
|
$
|
0.86
|
|
|
$
|
0.72
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allocation of undistributed earnings (loss) for basic computation
|
|
$
|
(32,955
|
)
|
|
$
|
(10,643
|
)
|
|
$
|
31,957
|
|
|
$
|
8,786
|
|
Reallocation of undistributed earnings (loss) as a result of conversion of Class B to Class A shares
|
|
|
(10,643
|
)
|
|
|
|
|
|
|
8,786
|
|
|
|
|
|
Reallocation of undistributed earnings to Class B shares
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,272
|
)
|
Add - preferred stock dividends
|
|
|
|
|
|
|
|
|
|
|
17
|
|
|
|
|
|
Add - interest expense convertible notes
|
|
|
|
|
|
|
|
|
|
|
1,008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allocation of undistributed earnings (loss)
|
|
$
|
(43,598
|
)
|
|
$
|
(10,643
|
)
|
|
$
|
41,768
|
|
|
$
|
7,514
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of shares used in basic computation
|
|
|
37,434
|
|
|
|
12,089
|
|
|
|
37,082
|
|
|
|
12,234
|
|
Weighted average effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Conversion of Class B to Class A shares
|
|
|
12,089
|
|
|
|
|
|
|
|
12,234
|
|
|
|
|
|
Employee stock options
|
|
|
|
|
|
|
|
|
|
|
761
|
|
|
|
83
|
|
Convertible preferred stock
|
|
|
|
|
|
|
|
|
|
|
338
|
|
|
|
|
|
Convertible notes
|
|
|
|
|
|
|
|
|
|
|
8,692
|
|
|
|
|
|
Number of shares used in per share computations
|
|
|
49,523
|
|
|
|
12,089
|
|
|
|
59,107
|
|
|
|
12,317
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings (loss) per share
(1)
(2)
|
|
$
|
(0.88
|
)
|
|
$
|
(0.88
|
)
|
|
$
|
0.71
|
|
|
$
|
0.61
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
For the three months ended September 30, 2008, there were stock options to purchase 528 (excluding 1,699 out of the money shares) of Class A and Class B
Common Stock, preferred shares convertible into 338 shares of Class A Common Stock, and $200,000 principal amount of convertible notes convertible into 8,692 shares of Class A Common Stock that were excluded from the computation of diluted
loss per share because their effect would have been anti-dilutive.
|
(2)
|
For the three months ended September 30, 2007, excluded from the computation of diluted earnings per share were options to purchase 56 Class A and Class B
common shares with exercise prices greater than the average market price of the common shares for the period reported.
|
19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
The following table sets forth the computation of basic and diluted earnings (loss) per share for the
six months ended September 30, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
September 30,
2008
|
|
|
Six Months Ended
September 30,
2007
|
|
|
Class A
|
|
|
Class B
|
|
|
Class A
|
|
|
Class B
|
|
Basic earnings (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allocation of undistributed earnings (loss)
|
|
$
|
(28,759
|
)
|
|
$
|
(9,286
|
)
|
|
$
|
34,484
|
|
|
$
|
9,508
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding
|
|
|
37,763
|
|
|
|
12,165
|
|
|
|
37,486
|
|
|
|
12,357
|
|
Less - weighted average unvested common shares subject to repurchase
|
|
|
(333
|
)
|
|
|
(80
|
)
|
|
|
(442
|
)
|
|
|
(100
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of shares used in per share computations
|
|
|
37,430
|
|
|
|
12,085
|
|
|
|
37,044
|
|
|
|
12,257
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings (loss) per share
|
|
$
|
(0.77
|
)
|
|
$
|
(0.77
|
)
|
|
$
|
0.93
|
|
|
$
|
0.78
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allocation of undistributed earnings (loss) for basic computation
|
|
$
|
(28,759
|
)
|
|
$
|
(9,286
|
)
|
|
$
|
34,484
|
|
|
$
|
9,508
|
|
Reallocation of undistributed earnings (loss) as a result of conversion of Class B to Class A shares
|
|
|
(9,286
|
)
|
|
|
|
|
|
|
9,508
|
|
|
|
|
|
Reallocation of undistributed earnings (loss) to Class B shares
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,211
|
)
|
Add - preferred stock dividends
|
|
|
|
|
|
|
|
|
|
|
35
|
|
|
|
|
|
Add - interest expense convertible notes
|
|
|
|
|
|
|
|
|
|
|
1,998
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allocation of undistributed earnings (loss)
|
|
$
|
(38,045
|
)
|
|
$
|
(9,286
|
)
|
|
$
|
46,025
|
|
|
$
|
8,297
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of shares used in basic computation
|
|
|
37,430
|
|
|
|
12,085
|
|
|
|
37,044
|
|
|
|
12,257
|
|
Weighted average effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Conversion of Class B to Class A shares
|
|
|
12,085
|
|
|
|
|
|
|
|
12,257
|
|
|
|
|
|
Employee stock options
|
|
|
|
|
|
|
|
|
|
|
767
|
|
|
|
82
|
|
Convertible preferred stock
|
|
|
|
|
|
|
|
|
|
|
338
|
|
|
|
|
|
Convertible notes
|
|
|
|
|
|
|
|
|
|
|
8,692
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of shares used in per share computations
|
|
|
49,515
|
|
|
|
12,085
|
|
|
|
59,098
|
|
|
|
12,339
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share
(1)(2)
|
|
$
|
(0.77
|
)
|
|
$
|
(0.77
|
)
|
|
$
|
0.78
|
|
|
$
|
0.67
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
For the six months ended September 30, 2008, there were stock options to purchase 536 (excluding 1,757 out of the money shares) of Class A and Class B Common
Stock, preferred shares convertible into 338 shares of Class A Common Stock, and $200,000 principal amount of convertible notes convertible into 8,692 shares of Class A Common Stock that were excluded from the computation of diluted loss
per share because their effect would have been anti-dilutive.
|
(2)
|
For the six months ended September 30, 2007, excluded from the computation of diluted earnings per share were options to purchase 54 Class A and Class B
common shares with exercise prices greater than the average market price of the common shares for the period reported.
|
20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
8. STOCK-BASED COMPENSATION
In August 2002, the Companys shareholders approved KVs 2001 Incentive Stock Option Plan (the 2001 Plan), which allows for the issuance of up to 4,500 shares of common stock. In
September 2008, shareholders approved an amendment to the 2001 Plan to increase by 3,000 the number of shares of Class A Common Stock available for issuance under the 2001 Plan. Under the Companys stock option plan, options to acquire
shares of common stock have been made available for grant to all 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 ten years and the options generally vest at the rate of 10% per year from the date of grant.
The Company estimates the fair
value of stock options granted using the Black-Scholes option pricing model (the Option Model). The Option Model requires the use of subjective and complex assumptions, including the options expected term and the estimated future
price volatility of the underlying stock, which determine the fair value of the share-based awards. The Companys estimate of expected term was determined based on the average period of time that options granted are expected to be outstanding
considering current vesting schedules and the historical exercise patterns of existing option plans and the two-year forfeiture period. The expected volatility assumption used in the Option Model is based on historical volatility over a period
commensurate with the expected term of the related options. The risk-free interest rate used in the Option Model is based on the yield of U.S. Treasuries with a maturity closest to the expected term of the Companys stock options.
The Companys stock option agreements include a post-exercise service condition which provides that exercised options are to be held by the Company
for a two-year period during which time the shares cannot be sold by the employee. If the employees employment is terminated voluntarily or involuntarily (other than by retirement, death or disability) during the two-year period, the stock
option agreements provide the Company with the option of repurchasing the shares at the lower of the exercise price or the fair market value of the stock on the date of termination. This repurchase option is considered a forfeiture provision and the
two-year period is included in determining the requisite service period over which stock-based compensation expense is recognized. The requisite service period initially is equal to the expected term (as discussed above) and is revised when an
option exercise occurs.
If stock options expire unexercised or an employee terminates employment after options become exercisable, no
compensation expense associated with the exercisable, but unexercised, options is reversed. In those instances where an employee terminates employment before options become exercisable or the Company repurchases the shares during the two-year
forfeiture period, compensation expense for these options is reversed as a forfeiture.
When an employee exercises stock options, the exercise
proceeds received by the Company are recorded as a deposit and classified as a current liability for the two-year forfeiture period. The shares issuable upon exercise of these options are accounted for as issued when the two-year forfeiture period
lapses. Until the two-year forfeiture requirement is met, the underlying shares are not considered outstanding and are not included in calculating basic earnings per share.
The Company recognized stock-based compensation of $1,538 and $2,665, respectively, and related tax benefits of $298 and $460, respectively, for the three and six months ended September 30, 2008 and
stock-based compensation of $1,227 and $3,142, respectively, and related tax benefits of $281 and $754, respectively, for the three and six months ended September 30, 2007. There was no stock-based employee compensation cost capitalized as of
September 30, 2008 and March 31, 2008. Cash received from stock option deposits was $410 and $400 for the three months ended September 30, 2008 and 2007, respectively, and $701 and $674 for the six months ended September 30, 2008
and 2007, respectively. The actual tax benefit realized from tax deductions associated with stock option exercises (at expiration of two-year forfeiture period) was $203 and $393 for the three months ended September 30, 2008 and 2007,
respectively, and $470 and $511 for the six months ended September 30, 2008 and 2007, respectively.
The Company did not issue any new
stock option grants during the three months ended September 30, 2008.
21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
The following weighted average assumptions were used for stock options granted during the six months
ended September 30, 2008 and the three and six months ended September 30, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Six Months Ended
September 30,
|
|
|
|
2008
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Dividend yield
|
|
None
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Expected volatility
|
|
|
|
|
43
|
%
|
|
|
39
|
%
|
|
|
43
|
%
|
Risk-free interest rate
|
|
|
|
|
4.93
|
%
|
|
|
3.80
|
%
|
|
|
4.93
|
%
|
Expected term
|
|
|
|
|
9.0 years
|
|
|
|
9.0 years
|
|
|
|
9.0 years
|
|
Weighted average fair value per share at grant date
|
|
|
|
$
|
16.65
|
|
|
$
|
10.39
|
|
|
$
|
15.94
|
|
A summary of the changes in the
Companys stock option plans during the six months ended September 30, 2008 is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
Weighted
Average
Remaining
Contractual
Term
|
|
Aggregate
Intrinsic
Value
|
Balance, March 31, 2008
|
|
3,933
|
|
|
$
|
18.84
|
|
|
|
|
|
Options granted
|
|
148
|
|
|
|
19.42
|
|
|
|
|
|
Options exercised
|
|
(124
|
)
|
|
|
7.78
|
|
|
|
$
|
1,859
|
Options canceled
|
|
(310
|
)
|
|
|
22.69
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2008
|
|
3,647
|
|
|
|
18.91
|
|
5.7
|
|
$
|
18,485
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected to vest at September 30, 2008
|
|
2,816
|
|
|
$
|
18.91
|
|
5.7
|
|
$
|
14,271
|
|
|
|
|
|
Options exercisable at September 30, 2008 (excluding shares in the two-year forfeiture period)
|
|
1,285
|
|
|
$
|
16.97
|
|
4.8
|
|
$
|
8,334
|
As of September 30, 2008, the
Company had $39,613 of total unrecognized compensation expense related to stock option grants, which will be recognized over the remaining weighted average period of 4.8 years.
9. REVENUE RECOGNITION
Revenue is generally realized or realizable and earned when
persuasive evidence of an arrangement exists, the customers payment ability has been reasonably assured, title and risk of ownership have been transferred to the customer, and the sellers price to the buyer is fixed or reasonably
determinable. When these conditions have not been met, revenue is deferred and reflected as a liability on the consolidated balance sheet until any uncertainties or contingencies have been resolved. The Company also enters into long-term agreements
under which it assigns marketing rights for products it has developed to pharmaceutical markets. Royalties under these arrangements are earned based on the sale of products.
Concurrently with the recognition of revenue, the Company records estimated provisions for product returns, sales rebates, payment discounts, chargebacks, and other sales allowances. When the occurrence
of product recalls becomes probable, the Company also records estimated liabilities for product returns related to recalls. The Company records failure to supply claims when they are probable and reasonably estimable. 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 and actual customer inventory levels, customer rebate and failure to supply
arrangements, current contract sales terms with wholesale and indirect customers, and subsequent payment activity. The following briefly describes each provision and how such provisions are estimated.
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
|
|
|
Cash DiscountsPayment discounts are reductions to invoiced amounts offered to customers for payment within a specified period and are estimated
utilizing historical customer payment experience.
|
|
|
|
Sales RebatesSales 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.
|
|
|
|
Sales ReturnsConsistent 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.
|
|
|
|
ChargebacksThe Company markets and sells products directly to wholesalers, distributors, warehousing pharmacy chains, mail order pharmacies and
other direct purchasing groups. The Company also markets products indirectly to independent pharmacies, non-warehousing chains, managed care organizations, and group purchasing organizations, collectively referred to as indirect
customers. The Company enters into agreements with some indirect customers to establish contract pricing for certain products. These indirect customers then independently select a wholesaler from which to purchase the products at these
contracted prices. Alternatively, the Company may pre-authorize wholesalers to offer specified contract pricing to other indirect customers. Under either arrangement, the Company provides credit to the wholesaler for any difference between the
contracted price with the indirect customer and the wholesalers invoice price. This credit is called a chargeback. Provisions for estimated chargebacks are calculated primarily using historical chargeback experience, actual contract pricing,
estimated and actual wholesaler inventory levels, and subsequent payment activity.
|
|
|
|
Price ProtectionGenerally, the Company provides credits to wholesale customers for decreases that are made to selling prices for the value of
inventory that is owned by these customers at the date of the price reduction. These credits are customary in the industry and are intended to reduce a wholesale customers inventory cost to better reflect current market prices. Since a
reduction in the wholesalers invoice price reduces the chargeback per unit, price reduction credits are typically included as part of the reserve for chargebacks because they act essentially as accelerated chargebacks. Although the Company
contractually agreed to provide price adjustment credits to its major wholesale customers at the time they occur, the impact of any such price reductions not included in the reserve for chargebacks is immaterial to the amount of revenue recognized
in any given period.
|
|
|
|
Medicaid RebatesFederal law requires that a pharmaceutical manufacturer, as a condition of having its products receive federal reimbursement
under Medicaid and Medicare Part B, must pay rebates to state Medicaid programs for all units of its pharmaceuticals that are dispensed to Medicaid beneficiaries and paid for by a state Medicaid program. The provision for Medicaid rebates is based
upon historical experience of claims submitted by the various states. The Company also monitors Medicaid legislative changes to determine what impact such legislation may have on the provision for Medicaid rebates.
|
|
|
|
Product Recall ReturnsLiabilities for product returns related to recalls are based on estimated and actual customer inventory levels at the time
of the recall and actual contract pricing.
|
|
|
|
Failure to SupplyThe Company has entered into purchase agreements with certain customers that include a provision whereby the Company is required
to reimburse these customers for price differences on product orders that the Company is unable to fulfill. Based on the nature of this contractual term, the Company is able to estimate provisions for supply failures based on the specific terms in
each agreement.
|
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
Actual product returns, chargebacks and other sales allowances incurred are dependent upon future events
and may be different from the Companys 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.
The provisions discussed above are presented in the consolidated financial
statements as reductions to gross revenues and a decrease to accounts receivable or an increase to accrued liabilities. Provisions totaled $89,195 and $68,260 for the three months ended September 30, 2008 and 2007, respectively, and $181,800
and $110,081 for the six months ended September 30, 2008 and 2007, respectively.
The reserve balances related to the provisions are
included in Receivables, less allowance for doubtful accounts or Accrued liabilities in the accompanying consolidated balance sheets. A summary of activity for each reserve for the six months ended September 30, 2008
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning
Balance
|
|
Current
Provision
Related to Shipments
Made in the
Current Period
|
|
Current
Provision
Related to Sales
Made in
Prior Periods
|
|
Actual Returns
or
Credits
in the
Current Period
|
|
|
Ending
Balance
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended September 30, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts Receivable Reserves:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chargebacks
|
|
$
|
18,103
|
|
$
|
96,145
|
|
$
|
|
|
$
|
(93,658
|
)
|
|
$
|
20,590
|
Cash discounts and other allowances
|
|
|
3,848
|
|
|
10,337
|
|
|
|
|
|
(9,390
|
)
|
|
|
4,795
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales rebates
|
|
|
12,585
|
|
|
29,039
|
|
|
2,528
|
|
|
(33,132
|
)
|
|
|
11,020
|
Sales returns
|
|
|
3,950
|
|
|
6,374
|
|
|
|
|
|
(8,014
|
)
|
|
|
2,310
|
Medicaid rebates
|
|
|
7,953
|
|
|
8,140
|
|
|
|
|
|
(4,002
|
)
|
|
|
12,091
|
Medicare and Medicaid restitution
|
|
|
|
|
|
|
|
|
2,275
|
|
|
|
|
|
|
2,275
|
Product recall returns
|
|
|
346
|
|
|
2,050
|
|
|
|
|
|
(346
|
)
|
|
|
2,050
|
Failure to supply claims
|
|
|
|
|
|
2,145
|
|
|
|
|
|
(645
|
)
|
|
|
1,500
|
Other
|
|
|
6,120
|
|
|
22,767
|
|
|
|
|
|
(20,418
|
)
|
|
|
8,469
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
52,905
|
|
$
|
176,997
|
|
$
|
4,803
|
|
$
|
(169,605
|
)
|
|
$
|
65,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The liabilities for sales rebates, sales returns, Medicaid rebates,
product recall returns and failure to supply claims are classified as accrued liabilities in the consolidated balance sheets as of September 30, 2008 and March 31, 2008. The expense associated with these accruals is classified in the
consolidated statement of operations for the three and six months ended September 30, 2008 as a reduction of gross revenue. Please see the 2009 Form 10-K for information regarding certain product recalls initiated during fiscal year 2009.
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
10. INVESTMENT SECURITIES
The carrying amount of available-for-sale investment securities and their approximate fair values at September 30, 2008 and March 31, 2008 were as follows.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2008
|
|
Cost
|
|
Gross
Unrealized
Gains
|
|
Gross
Unrealized
Losses
|
|
|
Fair
Value
|
Non-current auction rate securities
|
|
$
|
83,500
|
|
$
|
|
|
$
|
(6,303
|
)
|
|
$
|
77,197
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2008
|
|
|
Cost
|
|
Gross
Unrealized
Gains
|
|
Gross
Unrealized
Losses
|
|
|
Fair
Value
|
Short-term marketable securities
|
|
$
|
40,538
|
|
$
|
10
|
|
$
|
|
|
|
$
|
40,548
|
Non-current auction rate securities
|
|
|
83,900
|
|
|
|
|
|
(2,384
|
)
|
|
|
81,516
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
124,438
|
|
$
|
10
|
|
$
|
(2,384
|
)
|
|
$
|
122,064
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company accounts for its investment securities in accordance with
SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, and classifies them as available for sale. The Companys short-term marketable securities at March 31, 2008 consisted of mutual funds
comprised of U.S. government investments that were recorded at fair value based on quoted market prices. For the three and six months ended September 30, 2008, a realized loss of $86 was recognized upon sale of these securities. There were no
realized gains or losses on the Companys short-term marketable securities for the three and six months ended September 30, 2007.
At September 30, 2008 and March 31, 2008, the Company had $83,500 and $83,900, respectively, of principal invested in auction rate securities (ARS). These securities all have a maturity in excess of 10 years. The Companys
investments in ARS primarily represent interests in collateralized debt obligations supported by pools of student loans, the principal of which is guaranteed by the U.S. Government. ARS backed by student loans are viewed as having low default risk
and therefore very low risk of credit downgrade. The ARS held by the Company are AAA-rated securities with long-term nominal maturities for which the interest rates are reset through a Dutch auction at pre-determined intervals, up to 35 days. The
auctions historically have provided a liquid market for these securities.
The estimated fair value of the Companys ARS holdings at
September 30, 2008 and March 31, 2008 was $77,197 and $81,516, respectively, which reflected a difference of $6,303 and $2,384, respectively, from the related principal value. Although the ARS continued to pay interest according to their
stated terms, the Company recorded unrealized losses of $3,990 and $1,550, net of tax, as reductions to shareholders equity in accumulated other comprehensive loss at September 30, 2008 and March 31, 2008, respectively, reflecting
adjustments to the ARS holdings that the Company concluded had a temporary decline in value.
The ARS are valued based on a discounted cash
flow model that considers, among other factors, the time to work out the market disruption in the traditional trading mechanism, the stream of cash flows (coupons) earned until maturity, the prevailing risk free yield curve, credit spreads
applicable to a portfolio of student loans with various tenures and ratings and an illiquidity premium. These factors were used in a Monte Carlo simulation based methodology to derive the estimated fair value of the ARS.
ARS have historically been classified as short-term marketable securities in the Companys consolidated balance sheet. With the liquidity issues
experienced in global credit and capital markets, the ARS held by the Company at
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
September 30, 2008 and March 31, 2008 experienced multiple failed auctions beginning in February 2008 as the amount of securities submitted for sale exceeded the amount of purchase
orders. Accordingly, the $77,197 and $81,516 of ARS at September 30, 2008 and March 31, 2008, respectively, were classified as non-current assets and are included in the line item Investment securities in the accompanying
Consolidated Balance Sheets.
See the 2009 Form 10-K for disclosure of certain events and transactions that occurred after September 30,
2008, including the Companys monetization of its ARS holdings.
11. FAIR VALUE MEASURES
As stated in Note 5Recently Issued Accounting Standards, the Company adopted SFAS 157 effective April 1, 2008 for all financial assets
and liabilities and any other assets and liabilities that are recognized or disclosed at fair value on a recurring basis. SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, SFAS 157 established a fair value hierarchy that ranks the quality and reliability of the information
used to measure fair value. Financial assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:
|
|
|
Level 1
Primarily consists of financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or
liabilities in an active market that the Company has the ability to access.
|
|
|
|
Level 2
Includes financial instruments measured using significant other observable inputs that are valued by reference to similar assets
or liabilities, such as: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the
asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
|
|
|
|
Level 3
Comprised of financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that
are both unobservable and significant to the overall fair value measurement. These inputs reflect managements own assumptions about the assumptions a market participant would use in pricing the asset or liability.
|
The following table presents the Companys fair value hierarchy as of September 30, 2008 for those financial assets measured at fair value on a
recurring basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at September 30, 2008
|
|
|
Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
Non-current auction rate securities
|
|
$
|
77,197
|
|
$
|
|
|
$
|
|
|
$
|
77,197
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Companys investments in non-current ARS primarily represent
interests in collateralized debt obligations supported by pools of student loans, the principal of which is guaranteed by the U.S. Government. The ARS held by the Company are AAA-rated securities with long-term nominal maturities for which the
interest rates are reset through a Dutch auction at pre-determined intervals, up to 35 days. Due to the lack of observable market quotes and an illiquid market for the Companys ARS portfolio as of September 30, 2008, the Company utilized
a valuation model that relied exclusively on Level 3 inputs, including those that are based on expected cash flow streams and collateral values.
The contingent interest feature of the $200,000 principal amount of Contingent Convertible Subordinated Notes (see Note 15Long-Term Debt) meets the criteria of and qualifies as an embedded derivative. Although this feature
represents an embedded derivative financial instrument, based on its
de minimis
value at the time of issuance and at September 30, 2008, no value has been assigned to this embedded derivative.
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
The following table presents the changes in fair value for financial assets measured at fair value on a
recurring basis using significant unobservable inputs (Level 3):
|
|
|
|
|
|
|
Non-Current Auction
Rate
Securities
(Level 3)
|
|
Balance at April 1, 2008
|
|
$
|
81,516
|
|
Unrealized losses included in accumulated other comprehensive loss
|
|
|
(3,919
|
)
|
Sale of ARS security
|
|
|
(400
|
)
|
|
|
|
|
|
Balance at September 30, 2008
|
|
$
|
77,197
|
|
|
|
|
|
|
12. INVENTORIES
Inventories consisted of the following:
|
|
|
|
|
|
|
|
|
September 30,
2008
|
|
March 31,
2008
|
Raw materials
|
|
$
|
39,728
|
|
$
|
42,939
|
Finished goods
|
|
|
33,975
|
|
|
36,187
|
Work-in-process
|
|
|
18,876
|
|
|
15,204
|
|
|
|
|
|
|
|
|
|
$
|
92,579
|
|
$
|
94,330
|
|
|
|
|
|
|
|
Management establishes reserves for potentially obsolete or
slow-moving inventory based on an evaluation of inventory levels, forecasted demand, and market conditions.
Inventories included $3,572 and
$2,846 of raw materials as of September 30, 2008 and March 31, 2008, respectively, that will be used in research and development activities.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
13. INTANGIBLE ASSETS AND GOODWILL
Intangible assets and goodwill consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2008
|
|
|
March 31, 2008
|
|
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Product rights acquired:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Micro-K
®
|
|
$
|
36,140
|
|
$
|
(17,242
|
)
|
|
$
|
36,140
|
|
$
|
(16,318
|
)
|
PreCare
®
|
|
|
8,433
|
|
|
(3,865
|
)
|
|
|
8,433
|
|
|
(3,654
|
)
|
Evamist
|
|
|
44,078
|
|
|
(3,468
|
)
|
|
|
52,446
|
|
|
(2,378
|
)
|
Trademarks acquired:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Niferex
®
|
|
|
14,834
|
|
|
(4,080
|
)
|
|
|
14,834
|
|
|
(3,709
|
)
|
Chromagen
®
/StrongStart
®
|
|
|
27,642
|
|
|
(7,601
|
)
|
|
|
27,642
|
|
|
(6,910
|
)
|
Evamist
|
|
|
12,774
|
|
|
(1,005
|
)
|
|
|
15,166
|
|
|
(688
|
)
|
License agreements:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Evamist
|
|
|
82,542
|
|
|
(6,494
|
)
|
|
|
66,417
|
|
|
(3,011
|
)
|
Other
|
|
|
2,675
|
|
|
|
|
|
|
2,300
|
|
|
|
|
Covenant not to compete:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Evamist
|
|
|
2,106
|
|
|
(276
|
)
|
|
|
7,471
|
|
|
(565
|
)
|
Other
|
|
|
375
|
|
|
(128
|
)
|
|
|
375
|
|
|
(109
|
)
|
Trademarks and patents
|
|
|
5,515
|
|
|
(1,088
|
)
|
|
|
5,317
|
|
|
(972
|
)
|
Assembled workforce
|
|
|
745
|
|
|
(10
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets
|
|
|
237,859
|
|
|
(45,257
|
)
|
|
|
236,541
|
|
|
(38,314
|
)
|
Goodwill
|
|
|
557
|
|
|
|
|
|
|
557
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
238,416
|
|
$
|
(45,257
|
)
|
|
$
|
237,098
|
|
$
|
(38,314
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2008, the Companys intangible assets had a weighted average useful life of approximately 17
years. Amortization expense for intangible assets was $3,612 and $3,015 for the three months ended September 30, 2008 and 2007, respectively, and $7,013 and $4,200 for the six months ended September 30, 2008 and 2007, respectively (see the
2009 Form 10-K for more information on the evaluation of impairment performed on each of our intangible assets subsequent to September 30, 2008).
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 $7,200 for the remainder of fiscal year 2009 and approximately $14,500 in each of the four succeeding fiscal years.
14.
REVOLVING CREDIT AGREEMENT
At September 30, 2008, the Company had a credit agreement with ten banks that provided for a revolving
line of credit for borrowing up to $320,000. This credit facility also included a provision for increasing the revolving commitment, at the lenders sole discretion, by up to an additional $50,000. The credit agreement was unsecured unless the
Company, under certain specified circumstances, utilized the facility to redeem part or all of its outstanding Convertible Subordinated Notes. Interest was charged under the credit facility at the lower of the prime rate or LIBOR plus 62.5 to 150
basis points depending on the ratio of senior debt to EBITDA. The credit facility had a five-year term expiring in June 2011. The credit agreement contained financial covenants that imposed limits on dividend payments, required minimum equity, a
maximum senior leverage ratio and minimum fixed charge coverage ratio. At September 30, 2008, the Company had $30,000 of borrowings outstanding under the credit facility (see Note 15Long-Term Debt).
See the 2009 Form 10-K for disclosure of certain events and transactions that occurred after September 30, 2008, including the termination of the
credit agreement in February 2009.
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
15. LONG-TERM DEBT
Long-term debt consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
September 30,
2008
|
|
|
March 31,
2008
|
|
Convertible notes
|
|
$
|
200,000
|
|
|
$
|
200,000
|
|
Building mortgages
|
|
|
38,467
|
|
|
|
39,452
|
|
Line of credit
|
|
|
30,000
|
|
|
|
30,000
|
|
Software financing arrangement
|
|
|
1,365
|
|
|
|
1,721
|
|
|
|
|
|
|
|
|
|
|
|
|
|
269,832
|
|
|
|
271,173
|
|
Less current portion
|
|
|
(2,459
|
)
|
|
|
(202,499
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
267,373
|
|
|
$
|
68,674
|
|
|
|
|
|
|
|
|
|
|
In May 2003, the Company issued $200,000 principal amount of 2.5% Contingent 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 mature on 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. In November 2007, the average trading price of the Notes reached the threshold for the five-day trading period that resulted in the payment of contingent interest and
for the period from November 16, 2007 to May 15, 2008 the Notes paid interest at a rate of 3.00% per annum. In May 2008, the average trading price of the Notes fell below the contingent interest threshold for the five-day trading
period and beginning May 16, 2008 the Notes began to pay interest at a rate of 2.50% per annum.
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, 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. Holders had the right to require the Company to repurchase all or a portion of their Notes on May 16, 2008 and, accordingly, the Company classified the Notes as a current
liability as of March 31, 2008. Since no holders required the Company to repurchase all or a portion of their Notes on this date and because the next occasion holders may require the Company to repurchase all or a portion of their Notes is
May 16, 2013, the Notes were classified as a long-term liability as of September 30, 2008. The Notes are subordinate to all of the Companys existing and future senior obligations.
The Notes are convertible, at the holders option, into shares of the Companys Class A Common Stock prior to the maturity date under the
following circumstances:
|
|
|
during any quarter commencing after June 30, 2003, if the closing sale price of the Companys 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;
|
|
|
|
if the Company has called the Notes for redemption;
|
|
|
|
during the five trading day period immediately following any nine consecutive trading day 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
|
|
|
|
upon the occurrence of specified corporate transactions.
|
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
The Company has reserved 8,692 shares of Class A Common Stock for issuance in the event the Notes
are converted.
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 Companys securities, and do not contain any financial covenants.
In March 2006, the Company
entered into a $43,000 mortgage loan arrangement with one of its primary lenders, in part, to refinance $9,859 of existing mortgages. The $32,764 of net proceeds the Company received from the mortgage loan was used for working capital and general
corporate purposes. The mortgage loan, which is secured by three of the Companys buildings, bears interest at a rate of 5.91% and matures on April 1, 2021.
In June 2007, the Company entered into an installment payment agreement with a financial institution for the purchase of software products and the right to receive consulting or other services from the
seller. Upon delivery of the products and services, the financial institution will pay the seller amounts owed for the software products and services. As a result, the Company recorded debt in the amount of $1,733 which will be paid ratably over 16
consecutive quarters to the financial institution. In August 2007, the Company entered into another agreement with the same financial institution for the payment of additional consulting services that will be provided on a time and material basis.
In exchange for the institution paying the seller for fees owed, the Company has recorded additional debt in the amount of $306 which will be paid to the financial institution ratably over 16 consecutive quarters. The two installment payment
agreements were discounted using an imputed annual interest rate that approximated the Companys borrowing rate for similar debt instruments at the time of the borrowings.
The aggregate maturities of long-term debt as of September 30, 2008 were as follows:
|
|
|
|
Due in one year
|
|
$
|
2,459
|
Due in two years
|
|
|
2,749
|
Due in three years
|
|
|
32,795
|
Due in four years
|
|
|
2,485
|
Due in five years
|
|
|
202,643
|
Thereafter
|
|
|
26,701
|
|
|
|
|
|
|
$
|
269,832
|
|
|
|
|
See the 2009 Form 10-K for disclosure of certain events and
transactions that occurred after September 30, 2008, including those related to the Companys long-term debt.
16. TAXABLE
INDUSTRIAL REVENUE BONDS
In December 2005, the Company entered into a financing arrangement with St. Louis County, Missouri related to
expansion of its operations in St. Louis County. Up to $135,500 of industrial revenue bonds could have been issued to the Company by St. Louis County relative to capital improvements made through December 31, 2009. This agreement provides that
50% of the real and personal property taxes on up to $135,500 of capital improvements will be abated for a period of ten years subsequent to the property being placed in service. Industrial revenue bonds totaling $120,407 were outstanding at
September 30, 2008. The industrial revenue bonds are issued by St. Louis County to the Company upon its payment of qualifying costs of capital improvements, which are then leased by the Company for a period ending December 1, 2019, unless
earlier terminated. The Company has the option at any time to discontinue the arrangement and regain full title to the abated property. The industrial revenue bonds bear interest at 4.25% per annum and are payable as to principal and interest
concurrently with payments due under the terms of the lease. The Company has classified the leased assets as property and equipment and has established a capital lease obligation equal to the outstanding principal balance of the industrial revenue
bonds. Lease payments may be made by tendering an equivalent portion of the
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
industrial revenue bonds. As the capital lease payments to St. Louis County may be satisfied by tendering industrial revenue bonds (which is the Companys intention), the capital lease
obligation, industrial revenue bonds and related interest expense and interest income, respectively, have been offset for presentation purposes in the Consolidated Financial Statements.
17. COMPREHENSIVE INCOME (LOSS)
Comprehensive income includes all changes in equity during
a period except those that resulted from investments by or distributions to the Companys shareholders. Other comprehensive income refers to revenues, expenses, gains and losses that, under GAAP, 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, comprehensive income (loss) is comprised of net income (loss), the net changes in unrealized gains and losses on
available for sale marketable securities, net of applicable income taxes, and changes in the cumulative foreign currency translation adjustment. Total comprehensive income (loss) totaled $(44,937) and $40,749 for the three months ended
September 30, 2008 and 2007, respectively, and $(40,355) and $43,990 for the six months ended September 30, 2008 and 2007, respectively.
18. SEGMENT REPORTING
The reportable operating segments of the Company are branded products, specialty generic/non-branded and
specialty materials. The branded products segment includes patent-protected products and certain trademarked off-patent products that the Company sells and markets as brand pharmaceutical products. The specialty generic/non-branded segment includes
off-patent pharmaceutical products that are therapeutically equivalent to proprietary products. The Company sells its branded and specialty generic/non-branded 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 Companys consolidated accounting policies. Segment profits are measured based on income before taxes and are determined based on each
segments 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.
See the 2009 Form 10-K for disclosure of certain events and transactions that occurred after September 30, 2008, including those related to the specialty materials segment.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
The following tables represent information for the Companys reportable operating segments for the
three and six months ended September 30, 2008 and 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
September 30,
|
|
Branded
Products
|
|
Specialty
Generics
|
|
Specialty
Materials
|
|
All
Other
|
|
|
Eliminations
|
|
|
Consolidated
|
|
Net revenues
|
|
2008
|
|
$
|
40,509
|
|
$
|
90,597
|
|
$
|
5,345
|
|
$
|
36
|
|
|
$
|
|
|
|
$
|
136,487
|
|
|
|
2007
|
|
|
53,402
|
|
|
112,898
|
|
|
4,406
|
|
|
470
|
|
|
|
|
|
|
|
171,176
|
|
|
|
|
|
|
|
|
|
Segment profit (loss)
|
|
2008
|
|
|
5,036
|
|
|
23,676
|
|
|
2,287
|
|
|
(85,177
|
)
|
|
|
|
|
|
|
(54,178
|
)
|
|
|
2007
|
|
|
26,604
|
|
|
75,045
|
|
|
1,611
|
|
|
(40,916
|
)
|
|
|
|
|
|
|
62,344
|
|
|
|
|
|
|
|
|
|
Identifiable assets
|
|
2008
|
|
|
36,861
|
|
|
112,740
|
|
|
9,653
|
|
|
743,430
|
|
|
|
(1,158
|
)
|
|
|
901,526
|
|
|
|
2007
|
|
|
42,813
|
|
|
148,327
|
|
|
8,573
|
|
|
649,222
|
|
|
|
(1,158
|
)
|
|
|
847,777
|
|
|
|
|
|
|
|
|
|
Property and equipment additions
|
|
2008
2007
|
|
|
242
|
|
|
|
|
|
86
29
|
|
|
8,122
4,641
|
|
|
|
|
|
|
|
8,208
4,912
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
2008
2007
|
|
|
149
153
|
|
|
72
78
|
|
|
51
48
|
|
|
8,652
7,673
|
|
|
|
|
|
|
|
8,924
7,952
|
|
|
|
|
|
|
|
|
|
|
|
Six Months
Ended
September 30,
|
|
Branded
Products
|
|
Specialty
Generics
|
|
Specialty
Materials
|
|
All
Other
|
|
|
Eliminations
|
|
|
Consolidated
|
|
Net revenues
|
|
2008
|
|
$
|
88,715
|
|
$
|
173,290
|
|
$
|
10,814
|
|
$
|
197
|
|
|
$
|
|
|
|
$
|
273,016
|
|
|
|
2007
|
|
|
103,347
|
|
|
172,604
|
|
|
8,020
|
|
|
660
|
|
|
|
|
|
|
|
284,631
|
|
|
|
|
|
|
|
|
|
Segment profit (loss)
|
|
2008
|
|
|
18,238
|
|
|
66,642
|
|
|
4,585
|
|
|
(134,303
|
)
|
|
|
|
|
|
|
(44,838
|
)
|
|
|
2007
|
|
|
48,312
|
|
|
105,072
|
|
|
2,211
|
|
|
(87,680
|
)
|
|
|
|
|
|
|
67,915
|
|
|
|
|
|
|
|
|
|
Property and equipment additions
|
|
2008
2007
|
|
|
242
|
|
|
|
|
|
130
76
|
|
|
12,348
6,443
|
|
|
|
|
|
|
|
12,478
6,761
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
2008
2007
|
|
|
303
300
|
|
|
150
157
|
|
|
98
96
|
|
|
17,263
13,586
|
|
|
|
|
|
|
|
17,814
14,139
|
|
Consolidated revenues are principally derived from customers in North America and substantially all property and equipment is located in the St. Louis,
Missouri metropolitan area.
19. CONTINGENCIESLITIGATION AND GOVERNMENTAL INQUIRIES
Resolution of one or more of the matters discussed below could have a material adverse effect on the Companys results of operations, financial
condition or liquidity. The Company intends to vigorously defend its interests in the matters described below while cooperating in governmental inquiries.
The Company and its subsidiaries Drugtech Corporation and Ther-Rx Corporation were named as defendants in a declaratory judgment case filed in the U.S. District Court for the District of Delaware by
Lannett Company, Inc. on June 6, 2008 and styled
Lannett Company Inc. v. KV Pharmaceuticals et al
. The action sought a declaratory judgment of patent invalidity, patent non-infringement, and patent unenforceability for inequitable
conduct with respect to five patents owned by, and two patents licensed to, the Company or its subsidiaries and pertaining to the PrimaCare ONE
®
product marketed by Ther-Rx Corporation; unfair competition; deceptive trade practices; and antitrust violations. On June 17, 2008, the Company filed suit
against Lannett in the form of a counterclaim,
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
asserting infringement of three of the Companys patents, infringement of its trademarks (PrimaCare
®
and PrimaCare ONE
®
), and
various other claims. On March 23, 2009 a Consent Judgment was entered by the U.S. District Court of Delaware, in which the patents were not found invalid or unenforceable, and the manufacture, sale, use, importation, and offer for sale of the
Lannett Products Multivitamin with Minerals and OB-Natal ONE was found to infringe the patents. Judgment was also entered in favor of the Company on its claim for trademark infringement based on Lannetts marketing of Multivitamin with Minerals
in bottles. Unless permitted by license, Lannett, its officers, directors, agents, and others in active concert and participation with them are permanently enjoined and restrained from infringing on these patents during the terms of such patents, by
making, using, selling, offering for sale, or importing the products or mere colorable variations thereof; and unless permitted by license, Lannett is permanently enjoined and restrained from infringing the trademark PrimaCare ONE. All other claims
and counterclaims have been dismissed with prejudice. On March 17, 2009, the Company and Lannett entered into a settlement and license agreement pursuant to which Lannett may continue to market its prenatal products under the Companys
U.S. Patent Nos. 6,258,846 (the 846 Patent), 6,576,666 (the 666 Patent) and 7,112,609 (the 609 Patent) until the later of (1) October 17, 2009, or (2) 45 days after the Company notifies Lannett in
writing that the Company has received regulatory approval to return PrimaCare ONE or a successor product to the market or that the Company has entered into an agreement with a third party that intends to introduce a product under the PrimaCare marks
evidenced by U.S. Trademark Registrations 2,582,817 and 3,414,475. In consideration for the foregoing, Lannett has agreed to pay the Company a royalty fee equal to (1) 20% of Lannetts net sales of its prenatal products using the license
set forth in the settlement and license agreement on or before October 17, 2009 and (2) 15% of such net sales after October 17, 2009.
The Company is named as a defendant in a patent infringement case filed in the U.S. District Court for the District of Delaware by UCB, Inc. and Celltech Manufacturing CA, Inc. (collectively,
UCB) on April 21, 2008 and styled
UCB, Inc. et al. v. KV Pharmaceutical Company
. After the Company filed an ANDA with the FDA seeking permission to market a generic version of the 40mg, 50mg and 60mg strengths of Metadate
CD
®
methylphenidate hydrochloride extended-release capsules, UCB filed this lawsuit under a patent owned by
Celltech. In a Paragraph IV certification accompanying the ANDA, KV contended that its proposed 40mg generic formulation would not infringe Celltechs patent. Because the patent was not listed in the Orange Book for the 50mg and 60mg dosages, a
Paragraph I certification was filed with respect to them. The Company has filed an answer, asserted certain affirmative defenses (including that Plaintiffs are estopped to assert infringement of the 50mg and 60mg dosages due to their not listing the
Celltech patent in the Orange Book for these dosages), and has asserted a counterclaim in which it seeks a declaratory judgment of invalidity and non-infringement of the claims in the Celltech patent, and an award of attorneys fees and costs.
A motion for summary judgment was filed on January 19, 2010 and is currently pending the Courts decision.
The
Company was named as a defendant in two related patent infringement cases filed on December 14, 2007 in the U.S. District Courts in New Jersey and Delaware by Janssen, L.P., Janssen Pharmaceutica N.V. and Ortho-McNeil Neurologics, Inc.
(collectively, Janssen) and styled
Janssen, L.P. et al. v. KV Pharmaceutical Company
. After the Company filed an ANDA with the FDA seeking permission to market a generic version of the 8mg and 16mg strengths of Razadyne
®
ER (formerly Reminyl
®
) Galantamine Hydrobromide Extended Release Capsules, Janssen filed these lawsuits for patent infringement under the provisions of the Hatch-Waxman Act with respect to
its U.S. Patent No. 7,160,599 (the 559 patent) under a patent owned by Janssen. In the Companys Paragraph IV certification, the Company contended that its proposed generic versions do not infringe Janssens patent
and/or that the patent is invalid. A Stipulated Dismissal of Action was ordered by the Court on March 31, 2009. In the dismissal, Janssen agreed to dismiss all claims regarding infringement of the 559 patent and the Company agreed to
dismiss with prejudice its counterclaim for non-infringement and invalidity of the 599 patent. Janssen also agreed that it will not use the existence or terms of this stipulated dismissal as evidence of infringement, validity or enforceability
of the 559 patent in any future action between the parties.
The Company is named as a defendant in a patent
infringement case filed in the U.S. District Court for the District of New Jersey by Celgene Corporation (Celgene) and Novartis Pharmaceuticals Corporation and Novartis Pharma AG (collectively, Novartis) on October 4,
2007 and styled
Celgene Corporation et al. v. KV Pharmaceutical Company
. After the Company filed an ANDA with the FDA seeking permission to market a generic version of the 10mg, 20mg, 30mg, and 40mg strengths of Ritalin LA
®
methylphenidate hydrochloride extended-release capsules, Celgene and Novartis filed this lawsuit for patent
infringement under the provisions of the Hatch-Waxman Act with respect to two patents owned by Celgene and licensed to Novartis. In the Companys Paragraph IV certification, the Company contended that its proposed generic versions do not
infringe Celgenes patents.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
The Company is named as a defendant in another patent infringement case filed in the
U.S. District Court for the District of New Jersey by Celgene and Novartis on December 5, 2008 and styled
Celgene Corporation et al. v. KV Pharmaceutical Company
. After the Company filed an ANDA with the FDA seeking approval to market a
generic version of FOCALIN XR
®
drug products, Celgene and Novartis filed this lawsuit for patent infringement
under the patent laws of the United States. In the Companys Paragraph IV Certification, the Company contended the Patents-In-Suit would not be infringed by the activities described in the Companys ANDA. On March 1, 2010, the Company
entered into a Settlement Agreement to settle the patent infringement actions with respect to Ritalin LA
®
and
FOCALIN XR
®
. The Agreement is currently under review by the Department of Justice and the Federal Trade
Commission.
The Company was named as a defendant in three patent infringement cases brought by Purdue Pharma L.P., The P.F. Laboratories,
Inc. and Purdue Pharmaceuticals L.P. (collectively Purdue). On January 16, 2007, after the Company filed an ANDA with the FDA seeking permission to market generic versions of the 10 mg, 20 mg, 40 mg and 80 mg dosage strengths of
OxyContin, a controlled-release oxycodone product marketed and sold under NDA No. 20-553 (OxyContin), in extended-release tablet form, Purdue filed a lawsuit in the U.S. District Court for the District of Delaware against the
Company and an unrelated third party for patent infringement under the provisions of Hatch-Waxman Act with respect to three Purdue patents. In the Companys Paragraph IV certification set forth in the Companys ANDA, the Company contended
that Purdues patents were invalid, unenforceable, or would not be infringed by the Companys proposed generic versions of OxyContin. On February 12, 2007, Purdue filed a second patent infringement lawsuit against the Company in the
same court, asserting patent infringement under the same three patents with respect to the Companys filing of an amendment to its ANDA to sell a generic equivalent of Purdues OxyContin, 30mg and 60mg dosage strengths, product. On
June 6, 2007, Purdue filed a third patent infringement lawsuit against the Company in the U.S. District Court for the Southern District of New York (the NY District Court), asserting infringement under the same three Purdue patents
with respect to the Companys filing of an amendment to its ANDA to sell a generic equivalent of Purdues OxyContin, 15mg dosage strength, product. The two lawsuits filed in federal court in Delaware were transferred to the NY District
Court for multi-district litigation purposes.
Pursuant to the Hatch-Waxman Act, the filing of the patent infringement lawsuits against the
Company by Purdue instituted an automatic stay of any FDA approval of the Companys ANDA, on a dosage strength-by-dosage strength basis, until the earlier of a judgment, or 30 months from the date that Purdue received notice from the Company
that its ANDA had been submitted to the FDA.
In connection with the above referenced litigation, on June 9, 2009, the Company entered
into a Settlement Agreement with Purdue (the Settlement Agreement). In connection with the Settlement Agreement, the Company and Purdue also entered into a Patent License Agreement (the Patent License Agreement) and a
Distribution and Supply Agreement (the Distribution Agreement).
Pursuant to the Settlement Agreement, the Company and Purdue
agreed to a complete settlement of Civil Actions No. 07 Civ. 3972, 07 Civ. 3973 and 07 Civ. 4810 (SHS) in the NY District Court regarding, among other things, the validity and enforceability of United States Patents Nos. 5,508,042 (the
042 Patent), 5,226,331, 5,549,912 and 5,656,295 relating to OxyContin (collectively, the Purdue Patents) as well as the alleged patent infringement by the Company. The Company has also agreed to no longer dispute, among
other things, the validity, enforceability or infringement of the Purdue Patents and to make, use or sell generic versions of controlled-release oxycodone product, including OxyContin that are described in the Companys ANDA (the Company
Product) only in accordance with the Patent License Agreement.
Pursuant to the terms of the Patent License Agreement, dated as of
June 9, 2009, Purdue granted to the Company a limited, non-exclusive, royalty-bearing, non-transferable (except as permitted by the Patent License Agreement) license of limited duration under the 042 Patent (the License) to
sell, in the United States, a certain amount of various dosage strengths of the Company Product under the Purdue NDA. The Company will pay Purdue a royalty fee as set forth in the Patent License Agreement. The License terminates upon certain
circumstances, including upon the effectiveness of the Distribution Agreement.
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
Pursuant to the Distribution Agreement, dated as of June 9, 2009, the Company was appointed, based
on certain contingencies, as an authorized, non-exclusive distributor in the United States of certain generic versions of OxyContin specified in the Distribution Agreement (the Product). The Company or Purdue may elect for the
Distribution Agreement to become effective within a period of time specified in the Distribution Agreement, so long as the Companys ANDA has not yet been approved by the FDA. The Company plans to take all actions reasonably necessary to obtain
FDA approval of the Companys ANDA as soon as reasonably practicable. On September 1, 2009, the Company elected for the Distribution Agreement to become effective as of September 1, 2009. Pursuant to the terms of the Distribution
Agreement, Purdue provided the Company with a specified amount of the Product to be distributed by the Company on the terms set forth in the Distribution Agreement, and the Company paid Purdue a royalty fee and reimbursed Purdue the cost of
manufacturing of the supplied Product.
The Company and ETHEX were 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 U.S. District Court for the District of Minnesota. CIMA 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 entered a stay pending the outcome of the U.S. Patent and Trademark Offices (USPTO) reexamination of a patent at issue in the suit. On
August 17, 2009, the Court entered an order administratively terminating this action in Minnesota, but any party has the right to seek leave to reinstitute the case. On September 30, 2009, on appeal of the Examiners
rejection of the claims, the Board of Patent Appeals and Interferences affirmed the Examiners rejections. After the Boards denial of CIMAs appeal, CIMA requested a rehearing with the Board, which remains pending.
The Company and its subsidiaries Ther-Rx Corporation and Drugtech Corporation, together with Albion International Inc., filed a patent
infringement case against Breckenridge Pharmaceutical, Inc. in the U.S. District Court for the Eastern District of Missouri on July 17, 2008, styled
KV Pharmaceutical Company et al. v. Breckenridge Pharmaceutical, Inc
. The Company and
the other plaintiffs alleged that Breckenridge infringed a patent owned by Albion which has been exclusively licensed to KV and its subsidiaries in the field of oral prescription products for prenatal products and hematinic products (including the
Companys Chromagen
®
and Chromagen
®
Forte hematinic products), among others, with respect to Breckenridges Multigen
®
and Multigen
®
Plus caplet
products. The Company and other plaintiffs sought injunctive relief and damages from Breckenridge.
The Company and its subsidiary Ther-Rx
Corporation together with Albion International, Inc., were named as defendants in a patent infringement case filed in the U.S. District Court for the Southern District of Florida on August 29, 2008 and styled
Breckenridge Pharmaceutical,
Inc. v. KV Pharmaceutical Company, Ther-Rx Corporation and Albion International, Inc.
Breckenridge sought a declaratory judgment of non-infringement and invalidity of the same patent in issue in the Eastern District of Missouri (described in the
preceding paragraph). This case was transferred to the U.S. District Court for the Eastern District of Missouri on June 2, 2009. The parties in the
KV Pharmaceutical et al v. Breckenridge Pharmaceutical, Inc.
and
Breckenridge
Pharmaceutical, Inc. v. KV Pharmaceutical Company, Ther-Rx Corporation and Albion International, Inc
. matters entered into a Settlement Agreement, dated June 22, 2009. Under the terms of the Settlement Agreement, Breckenridge
agreed to pay the Company a total of $1,000, payable in nine monthly payments beginning July 1, 2009, with the final payment due on March 1, 2010.
Stiefel Laboratories, Inc. (Stiefel) filed a patent infringement case against the Company on May 28, 2009 in the U.S. District Court for the District of Delaware styled
Stiefel
Laboratories, Inc. v. KV Pharmaceutical Company
. The suit arose from the Companys submission of a first to file Paragraph IV ANDA seeking permission to market a generic version of Duac
®
(clindamycin, 1% benzoyl peroxide, 5%) gel indicated for the topical treatment of mild to moderate acne vulgaris. Stiefel filed suit for patent infringement under the
provisions of the Hatch-Waxman Act with respect to its U.S. Patent No. 5,466,446 (the 446 Patent). On September 21, 2009, the Company entered into a sale agreement with Perrigo Company to sell the rights to the ANDA. (See the
2009 Form 10-K for more information.) Pursuant to the sale agreement, Perrigo Company assumed the Companys obligations under this litigation. On October 15, 2009, a stipulated dismissal with prejudice was submitted by the parties and
entered by the Court.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
The Company and ETHEX were named as defendants in a case brought by Axcan
ScandiPharm, Inc. and styled
Axcan ScandiPharm, Inc. v. ETHEX Corporation, et al.
, filed in U.S. District Court in Minnesota on June 1, 2007. In general, Axcan alleged that ETHEXs comparative promotion of its Pangestyme UL12
and Pangestyme UL18 products to Axcans Ultrase
®
MT12 and Ultrase
®
MT18 products constituted false advertising and misleading statements under various federal and state laws, and
constituted unfair and deceptive trade practices. The Company disagreed, and denied the material allegations of the complaint. Nonetheless, a confidential settlement agreement with Axcan was entered into on May 4, 2009 in which the Company
agreed to grant undertakings to cease and refrain from future marketing of its Pangestyme UL product line and to the payment of a global confidential settlement, payable in three installments. The first installment payment of $3,500 was paid in May
2009. On February 5, 2010, the Company satisfied all remaining payments owed to Axcan by paying Axcan $1,950.
On July 24, 2008, a
federal action was filed against certain unapproved drug products manufactured by the Company, in the U.S. District Court for the Eastern District of Missouri, styled
United States v. Various Quantities of Articles of Drug et al
. By this
complaint, which the Company received on July 29, 2008, the FDA sought to take possession of the Companys inventory of those products, in order to prevent their distribution. The lawsuit had been preceded in March 2008 by the Missouri
Department of Health and Senior Services, acting at the FDAs behest, embargoing most of the products that were later the subject of the federal seizure action and notifying the Company of a hold on its inventory of these products, restricting
its ability to remove or dispose of those inventories without permission. Ultimately, the products that were the subject of the lawsuit were destroyed.
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 allegedly 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 States of Massachusetts, Alabama, Mississippi, Utah and Iowa, by New York City, and by approximately 45 counties in New York State. The State of
Mississippi effectively voluntarily dismissed the Company and ETHEX without prejudice on October 5, 2006 by virtue of the States filing an Amended Complaint on such date that does not name either the Company or ETHEX as a defendant. On
August 13, 2007 ETHEX settled the Massachusetts lawsuit and received a general release of liability with no admission of liability. On October 7, 2008, ETHEX settled the Alabama lawsuit for $2,000 and received a general release of
liability with no admission of liability. On November 25, 2009, ETHEX settled the New York City and New York county cases (other than the Erie, Oswego and Schenectady County cases) and received a general release of liability.
In October 2006, the Board formed a Special Committee (the Option Special Committee) of independent directors to conduct an investigation of
past stock option grant practices. By letter dated December 18, 2006, the Company was notified by the SEC staff that it had commenced an investigation with respect to the Companys stock option plans, grants, exercises, and accounting
treatment. The Company cooperated with the SEC staff in its investigation and, among other things, provided them with copies of the Option Special Committees report and all documents collected by the Option Special Committee in the course of
its review. In December 2007, the SEC staff, pursuant to a formal order of investigation, issued subpoenas for additional documents and testimony by certain employees. The production of additional documents called for by the subpoena and the
testimony of the employees was completed in May 2008. On September 26, 2008, the SEC notified the Company that the investigation had been completed and no enforcement action would be taken.
The Company received a subpoena from the Office of Inspector General of the Department of Health and Human Services, seeking documents with respect to two
of ETHEXs nitroglycerin products. Both are unapproved products, that is, they have not received FDA approval. (FDA approval is not necessarily required for drugs to be sold in the marketplace.) The subpoena states that it is in connection with
an investigation into potential false claims under Title 42 of the U.S. Code, and appears to pertain to whether these products were eligible for reimbursement under federal health care programs. On or about July 2, 2008, the Company received a
supplementary subpoena in this matter, seeking additional documents and information. In a letter dated August 4, 2008, that subpoena was withdrawn and a separate supplementary subpoena was substituted. In October 2009, the Office of Inspector
General of the Department of Health and Human Services identified five additional products as being subject to its investigation: Hydro-tussin (carbinoxamine); Guaifenex (extended release);
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
Hyoscyamine sulfate (extended release); Hycoclear (hydrocodone); and Histinex (hydrocodone). The Company has provided additional documents requested in the subpoena, as supplemented. Discussions
with the U.S. Department of Justice and the United States Attorneys Office for the District of Massachusetts indicate that this matter is a False Claims Act qui tam action that is currently still under seal and that the government is reviewing
similar claims relating to other drugs manufactured by ETHEX, as well as drugs manufactured by other companies. The Company has not been provided a copy of the qui tam complaint. On or about March 26, 2009, the Company consented to an extension
of the time during which the government may elect to intervene in the qui tam lawsuit.
On December 12, 2008, by letter, the Company was
notified by the staff of the SEC that it had commenced an informal inquiry to determine whether there have been violations of certain provisions of the federal securities laws. The Company is cooperating with the government and, among other things,
has provided copies of requested documents and information.
As previously disclosed, the Company, at the direction of the Special Committee,
responded to requests for information from the Office of the United States Attorney for the Eastern District of Missouri and FDA representatives working with that office. In connection therewith, on February 25, 2010, the Board, at the
recommendation of the Special Committee, approved entering into a plea agreement subject to court approval with the Office of the United States Attorney for the Eastern District of Missouri and the Office of Consumer Litigation of the United States
Department of Justice (referred to herein collectively as the Department of Justice).
The plea agreement was executed by the
parties and was entered by the U.S. District Court, Eastern District of Missouri, Eastern Division on March 2, 2010. Pursuant to the terms of the plea agreement, ETHEX pleaded guilty to two felony counts, each stemming from the failure to make
and submit a field alert report to the FDA in September 2008 regarding the discovery of certain undistributed tablets that failed to meet product specifications. Sentencing pursuant to the plea agreement also took place on March 2, 2010.
Pursuant to the plea agreement, ETHEX agreed to pay a criminal fine in the amount of $23,437 in four installments. The first installment, in
the amount of $2,344, is due within 10 days of sentencing. The second and third installments, each in the amount of $5,859, are due on December 15, 2010 and July 11, 2011, respectively. The fourth and final installment, in the amount of
$9,375, is due on July 11, 2012. ETHEX also agreed to pay, within 10 days of sentencing, restitution to the Medicare and the Medicaid programs in the amounts of $1,762 and $573, respectively. In addition to the fine and restitution, ETHEX
agreed not to contest an administrative forfeiture in the amount of $1,796, which is payable 45 days after sentencing and satisfies any and all forfeiture obligations ETHEX may have as a result of the guilty plea. In total, ETHEX agreed to pay
fines, restitution and forfeiture in the aggregate amount of $27,569. For the three and six months ended September 30, 2008, the Company recorded litigation expense of $23,623 for the present value of the administrative forfeiture and four
expected installment payments related to the criminal fines and reduced net revenues by $2,275 for the restitution payments made to the Medicare and Medicaid programs on March 6, 2010. At September 30, 2008, $25,898 was recorded in other
long-term liabilities.
In exchange for the voluntary guilty plea, the Department of Justice agreed that no further federal prosecution will
be brought in the Eastern District of Missouri against ETHEX, the Company and the Companys wholly-owned subsidiary, Ther-Rx Corporation, regarding allegations of the misbranding and adulteration of any oversized tablets of drugs manufactured
by the Company, and the failure to file required reports regarding these drugs and patients use of these drugs with the FDA, during the period commencing on January 1, 2008 through December 31, 2008.
In connection with the guilty plea by ETHEX, ETHEX is expected to be excluded from participation in federal healthcare programs, including Medicare and
Medicaid. In addition, as a result of the guilty plea by ETHEX, the U.S. Department of Health and Human Services (HHS) may use its discretionary authority to also exclude the Company from participation in federal healthcare programs.
However, the Company is in receipt of correspondence from the Office of the Inspector General of HHS stating that, absent any transfer of assets or operations that would trigger successor liability, HHS has no present intent to exercise its
discretionary authority to exclude the Company as a result of the guilty plea by ETHEX.
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
In connection with the exclusion of ETHEX from participation in federal healthcare programs, the Company
plans to cease operations of ETHEX. However, the Company has retained the ability to manufacture (once the requirements under the consent decree have been met), market and distribute all generic products and is in possession of all intellectual
property related to generic products, including all New Drug Applications and Abbreviated New Drug Applications.
The Company currently does
not anticipate that the voluntary guilty plea by ETHEX will have a material adverse effect on the Companys efforts to comply with the requirements pursuant to the consent decree and to resume production and shipments of its approved products.
The Company has received a subpoena from the State of California, Department of Justice, seeking documents with respect to ETHEXs
NitroQuick product. In an email dated August 12, 2009, the California Department of Justice advised that after reading CMS Release 151, it might resolve the subpoena that was issued. The Company provided limited information requested by the
California Department of Justice on October 7, 2009, and on November 10, 2009 the California Department of Justice informed the Company that the California Department of Justice is contemplating what additional information, if any, it will
request.
On February 27, 2009, by letter, the Company was notified by the U.S. Department of Labor that it was conducting an
investigation of the Companys Fifth Restated Profit Sharing Plan and Trust, to determine whether such plan is conforming with the provisions of Title I of the Employee Retirement Income Security Act (ERISA) or any regulations or
orders thereunder. The Company cooperated with the Department of Labor in its investigation and on August 27, 2009, the Department of Labor notified the Company it had completed a limited review and no further review was contemplated at this
time.
On February 3, 2009, plaintiff Harold Crocker filed a putative class-action complaint against the Company in the United States
District Court for the Eastern District of Missouri,
Crocker v. KV Pharmaceutical Co., et al
., No. 4-09-cv-198-CEJ. The Crocker case was followed shortly thereafter by two similar cases, also in the Eastern District of Missouri
(
Bodnar v. KV Pharmaceutical Co., et al
., No. 4:09-cv-00222-HEA, on February 9, 2009, and
Knoll v. KV Pharmaceutical Co., et al
., No. 4:09-cv-00297-JCH, on February 24, 2009). The two later cases were consolidated
into
Crocker
so that only a single action now exists, and the plaintiffs filed a Consolidated Amended Complaint on June 26, 2009 (Complaint).
The Complaint purports to state claims against the Company and certain current and former employees for alleged breach of fiduciary duties to participants in the Companys 401(k) plan. Defendants,
including the Company and certain of its directors and officers, moved to dismiss the amended complaint on August 25, 2009, and briefing of those motions was completed on October 19, 2009. The court granted the motion to dismiss of the
Company and all individual defendants on March 24, 2010. The plaintiff has the right to appeal the courts determination within 30 days. In addition, the plaintiff has the right to make a motion for reconsideration within 28 days and, if such
motion were to be made, the deadline for the appeal would be suspended until the court makes a determination on such motion.
The Company was
named as a defendant in an ERISA and WARN Act putative class action filed on March 12, 2009 in the U.S. District Court, Eastern District of Missouri styled
John Foster on behalf of himself and all others similarly situated v. KV
Pharmaceutical Company
. The putative class action is being brought on behalf of terminated or laid off employees who allegedly were not provided sixty (60) days advance written notice as required by the WARN Act. Service was received on
April 8, 2009. A motion to dismiss or in the alternative a motion for summary judgment was filed on April 28, 2009 and on March 12, 2010, the court dismissed the case with prejudice pursuant to the Companys motion to dismiss or,
in the alternative, for summary judgment. The plaintiff has the right to appeal the courts determination within 30 days.
On
December 2, 2008, plaintiff Joseph Mas filed a complaint against the Company, in the United States District Court for the Eastern District of Missouri,
Mas v. KV Pharma. Co., et al
., Case No. 08-CV-1859. On January 9, 2009,
plaintiff Herman Unvericht filed a complaint against the Company also in the Eastern District of Missouri,
Unvericht v. KV Pharma. Co., et al
., Case No. 09-CV-0061. And on January 21, 2009, plaintiff Norfolk County Retirement System
filed a complaint against the Company, again in the Eastern District of Missouri,
Norfolk County Retirement System v. KV Pharma. Co., et al
., Case No. 09-CV-00138.
The operative complaints in these three cases purport to state claims arising under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 on behalf of a putative class of stock purchasers. On
April 15, 2009, the
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
Honorable Carol E. Jackson consolidated the
Unvericht
and
Norfolk County
cases into the
Mas
case already before her. The amended complaint for the consolidated action, styled
Public Pension Fund Group v. KV Pharma. Co., et al
., Case No. 4:08-CV-1859 (CEJ), was filed on May 22, 2009. Defendants, including the Company and certain of its directors and officers, moved to dismiss the amended complaint on
July 27, 2009, and briefing was completed on the motions to dismiss on September 3, 2009. The court granted the motion to dismiss of the Company and all individual defendants in February 2010. On March 18, 2010, the plaintiffs filed a
motion for relief from the order of dismissal and to amend their complaint, and also filed a notice of appeal.
On February 25, 2009, the
Company initiated a legal action against Citigroup Global Markets Inc. (CGMI) in connection with $72,200 in outstanding principal amount of certain ARS, which the Company acquired through CGMI, in the U.S. District Court for the Eastern
District of Missouri styled
K-V Pharmaceutical Company v. Citigroup Global Markets Inc
. On January 21, 2010, the Company and CGMI entered into a Purchase and Release Agreement, pursuant to which CGMI agreed to purchase the Companys
remaining ARS for an aggregate purchase price of approximately $61,707. The Company also received a two-year option (which expires on January 21, 2012) to reacquire the ARS (in whole or on a class-by-class basis) for the prices at which they
were sold, as well as the right to receive further payments in the event any ARS are redeemed prior to the expiration of the option. The Company agreed to release CGMI from any liability or claim arising from the Companys investment in ARS
sold by CGMI, and the Company and CGMI agreed to take all necessary steps to dismiss with prejudice all claims asserted by the Company against CGMI regarding the ARS, including the legal action referred to above. (See the 2009 Form 10-K for more
information regarding the settlement agreement and the proceeds received in connection therewith.)
On October 2, 2009, the U.S. Equal
Employment Opportunity Commission sent the Company a Notice of Charge of Discrimination regarding a charge, dated September 23, 2009, of employment discrimination based on religion (in connection with the termination of his employment with the
Company) filed against the Company by David S. Hermelin, a current director and former Vice President, Corporate Strategy and Operations Analysis of the Company. On January 29, 2010, the Company filed its response to the Notice of Charge of
Discrimination, which stated the Companys position that Mr. D. Hermelins termination had nothing to do with religious discrimination and that his claim should be dismissed.
The Company and/or ETHEX are named defendants in at least 30 pending product liability lawsuits that relate to the voluntary product recalls initiated by
the Company in late 2008 and early 2009. The plaintiffs in these lawsuits allege damages as a result of the ingestion of purportedly oversized tablets allegedly distributed in 2007 and 2008. The lawsuits are pending in federal and state courts in
various jurisdictions. Of the 30 pending lawsuits, the plaintiffs in 2 lawsuits allege economic harm, the plaintiffs in 15 lawsuits allege that a death occurred, and the plaintiffs in the remaining lawsuits allege non-fatal physical injuries.
Plaintiffs allegations of liability are based on various theories of recovery, including, but not limited to strict liability, negligence, various breaches of warranty, misbranding, fraud and other common law and/or statutory claims.
Plaintiffs seek substantial compensatory and punitive damages. Three of the lawsuits are putative class actions, one of the lawsuits is on behalf of 22 claimants, and the remaining lawsuits are individual lawsuits. The Company believes that these
lawsuits are without merit and is vigorously defending against them, except where, in its judgment, settlement is appropriate. In addition to the 30 pending lawsuits, there are at least 208 pending pre-litigation claims (at least 26 of which involve
a death) that may or may not eventually become lawsuits. The Company has also resolved a significant number of related product liability lawsuits and pre-litigation claims. In addition to self insurance, the Company possesses third party product
liability insurance, which the Company believes is applicable to the pending lawsuits and claims.
The Company and ETHEX are named as
defendants in a complaint filed by CVS Pharmacy, Inc. (CVS) in the United States District Court for the District of Rhode Island on or about February 26, 2010 and styled
CVS Pharmacy, Inc. v. K-V Pharmaceutical Company and Ethex
Corporation
(No. CA-10-095) (CVS Complaint). The CVS Complaint alleges three claims: breach of contract, breach of implied covenant of good faith and fair dealing, and, in the alternative, promissory estoppel. CVS claims are
premised on the allegation that the Company and/or ETHEX failed to perform their alleged promises to either supply CVS with its requirements for certain generic drugs or reimburse CVS for any higher price it must pay to obtain the generic drugs. CVS
seeks damages of no less than $100,000, plus interest and costs. The Company was served with the CVS Complaint on March 8, 2010 and has 30 days to answer the complaint or request additional time to respond. The Company believes it has strong
defenses and intends to vigorously defend its interests in this case.
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
(in thousands, except per share data)
From time to time, the Company is involved in various other legal proceedings in the ordinary course of
its business. While it is not feasible to predict the ultimate outcome of such other proceedings, the Company believes the ultimate outcome of such other proceedings will not have a material adverse effect on its results of operations, financial
condition or liquidity.
There are uncertainties and risks associated with all litigation and there can be no assurance the Company will
prevail in any particular litigation.
20. INCOME TAXES
The Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109 (FIN 48), effective April 1,
2007. FIN 48 prescribes accounting for and disclosure of uncertainty in tax positions.
The consolidated balance sheets reflect liabilities
for unrecognized tax benefits of $12,122 and $11,657 as of September 30, 2008 and March 31, 2008, respectively. Accrued interest and penalties included in the Consolidated Balance Sheets were $2,870 and $2,310 as of September 30, 2008
and March 31, 2008, respectively.
The Company recognizes interest and penalties associated with uncertain tax positions as a component
of income tax expense in the consolidated statements of income.
It is anticipated the Company will recognize approximately $1,500 of
unrecognized tax benefits within the next 12 months as a result of the expected expiration of the relevant statute of limitations.
The
Company is subject to taxation in the U.S. and various states and is subject to examination by those authorities. The Companys federal statute of limitations has expired for fiscal years prior to 2005 and the relevant state statutes vary. The
Company was audited by the Internal Revenue Service (the IRS) for its March 31, 2006 and 2007 tax years.
The Company and the
IRS reached an agreement in October 2008 with respect to the Companys employment tax returns for calendar years 2004, 2005, 2006 and 2007. The resulting tax liability of $3,311 was paid in October 2008.
Management regularly evaluates the Companys tax positions taken on filed tax returns using information about recent court decisions and legislative
activities. Many factors are considered in making these evaluations, including past history, recent interpretations of tax law, and the specific facts and circumstances of each matter. Because tax law and regulations are subject to interpretation
and tax litigation is inherently uncertain, these evaluations can involve a series of complex judgments about future events and can rely heavily on estimates and assumptions. The recorded tax liabilities are based on estimates and assumptions that
have been deemed reasonable by management. However, if the Companys estimates are not representative of actual outcomes, recorded tax liabilities could be materially impacted.
21. SUBSEQUENT EVENTS
See the 2009 Form 10-K for disclosure of certain events and
transactions that occurred after September 30, 2008, including, but not limited to: the Audit Committees internal investigation; the nationwide recall and suspension of shipment of all products manufactured by the Company; the consent
decree with the FDA; changes in debt agreements; impairment of assets; litigation and other contingencies, including the ongoing private litigation and governmental inquiries; the plea agreement entered into with the Department of Justice;
discontinued operations due to the planned sale of PDI; entry into new material agreements; and amendments to existing material agreements.
40
Item 2.
|
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
Except for the historical information contained herein, the following discussion contains forward-looking statements that are subject to
known and unknown risks, uncertainties, and other factors that may cause our actual results to differ materially from those expressed or implied by those forward-looking statements. These risks, uncertainties and other factors are discussed under
the caption Item 1ARisk Factors in our 2009 Form 10-K and above under the caption Cautionary Note Regarding Forward-Looking Statements. In addition, the following discussion and analysis of financial condition and
results of operations, which gives effect to the correction of immaterial errors in our prior period consolidated financial statements as more fully described in Note 4Correction of Immaterial Errors in Prior Period Consolidated
Financial Statements of the Notes to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q, should be read in conjunction with the consolidated financial statements, the related notes to consolidated financial statements
and Managements Discussion and Analysis of Financial Condition and Results of Operations included in our 2009 Form 10-K, and the unaudited interim consolidated financial statements and related notes to unaudited interim
consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. Information provided herein for periods after March 31, 2009 is preliminary. As such, this information is not final or complete, and
remains subject to change, possibly materially.
This Quarterly Report on Form 10-Q includes references to specified disclosures
contained in our 2009 Form 10-K. However, this Quarterly Report on Form 10-Q does not reflect all events occurring after September 30, 2008 and does not update all disclosure affected by subsequent events. Therefore, you should read this
Quarterly Report on Form 10-Q in conjunction with our 2009 Form 10-K.
Background
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 (Ther-Rx), ETHEX Corporation (ETHEX) and Particle Dynamics, Inc. (PDI).
We are a fully integrated specialty pharmaceutical company that develops, manufactures, acquires and markets technologically-distinguished branded and
generic/non-branded prescription pharmaceutical products. We have a broad range of dosage form manufacturing 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, which focuses principally on technologically-distinguished generic products. Through PDI, 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 diverse portfolio of drug
delivery technologies which we have utilized in our brand name and specialty generic products. We have developed and patented drug delivery and formulation technologies primarily in four principal areas: SITE RELEASE
®
, 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.
Significant Recent Developments
See the 2009 Form 10-K for disclosure of certain recent events and transactions that
occurred after September 30, 2008, including, but not limited to: the Audit Committees internal investigation; the nationwide recall and suspension of shipment of all products manufactured by the Company; the consent decree with the FDA;
changes in debt agreements; impairment of assets; litigation and other contingencies, including the ongoing private litigation and governmental inquiries; the plea agreement entered into with the Department of Justice; discontinued operations due to
the planned sale of PDI; entry into new material agreements; and amendments to existing material agreements.
41
Results of Operations
Net revenues for the three months ended September 30, 2008 decreased $34.7 million, or 20.3%, from the prior year quarter as we experienced reduced
sales levels at both our specialty generics and branded products segments. The $40.0 million decrease in consolidated gross profit for the quarter was affected by lower sales volumes and a decline in the specialty generics/non-branded products gross
profit percentage to 58.3% from 69.1% of net revenues in the prior quarter. Operating expenses for the quarter increased $74.8 million due to increases in personnel costs, branded marketing and promotions expense, legal and professional fees,
research and development expense, and litigation and governmental inquiries costs related to actual and probable legal settlements and government fines. The decrease in gross profit coupled with the increase in operating expenses resulted in an
operating loss for the quarter of $52.7 million compared to operating income of $62.2 million for the corresponding prior year quarter. We reported a net loss for the quarter of $43.6 million compared to net income of $40.8 million in the
corresponding prior year quarter.
Net revenues for the six months ended September 30, 2008 decreased $11.6 million, or 4.1%, as we
experienced decreased sales at our branded products segment. The $24.4 million decrease in gross profit was due primarily to a decline in the specialty generics/non-branded products gross profit percentage and reduced sales at our branded products
segment. Operating expenses for the six-month period increased $83.1 million due to increases in personnel costs, branded marketing and promotions expense, legal and professional fees, research and development expense, and litigation and
governmental inquiries costs related to actual and probable legal settlements and government fines. The decrease in gross profit coupled with the increase in operating expenses resulted in an operating loss for the six-month period of $41.7 million
compared to operating income of $65.7 million for the corresponding prior year six-month period. Operating expenses for the six months ended September 30, 2008 and 2007 also included purchased in-process research and development expenses of
$2.0 million and $10.0 million, respectively, recorded in connection with the Gestiva acquisition in fiscal year 2009 and the Evamist acquisition in fiscal year 2008 (see Note 6Acquisitions of the Notes to the
Consolidated Financial Statements in this Quarterly Report on Form 10-Q). We also reported a net loss for the six-month period ended September 30, 2008 of $38.0 million compared to net income of $44.0 million for the six-month period ended
September 30, 2007.
Net Revenues by Segment
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Six Months Ended
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
%
Change
|
|
|
2008
|
|
|
2007
|
|
|
%
Change
|
|
Branded products
|
|
$
|
40,509
|
|
|
$
|
53,402
|
|
|
(24.1
|
)%
|
|
88,715
|
|
|
$
|
103,347
|
|
|
(14.2
|
)%
|
as % of total net revenues
|
|
|
29.7
|
%
|
|
|
31.2
|
%
|
|
|
|
|
32.5
|
%
|
|
|
36.3
|
%
|
|
|
|
Specialty generics/non-branded
|
|
|
90,597
|
|
|
|
112,898
|
|
|
(19.8
|
)%
|
|
173,290
|
|
|
|
172,604
|
|
|
0.4
|
%
|
as % of total net revenues
|
|
|
66.4
|
%
|
|
|
66.0
|
%
|
|
|
|
|
63.5
|
%
|
|
|
60.6
|
%
|
|
|
|
Specialty materials
|
|
|
5,345
|
|
|
|
4,406
|
|
|
21.3
|
%
|
|
10,814
|
|
|
|
8,020
|
|
|
34.8
|
%
|
as % of total net revenues
|
|
|
3.9
|
%
|
|
|
2.6
|
%
|
|
|
|
|
4.0
|
%
|
|
|
2.8
|
%
|
|
|
|
Other
|
|
|
36
|
|
|
|
470
|
|
|
(92.3
|
)%
|
|
197
|
|
|
|
660
|
|
|
(70.2
|
)%
|
Total net revenues
|
|
$
|
136,487
|
|
|
$
|
171,176
|
|
|
(20.3
|
)%
|
|
273,016
|
|
|
$
|
284,631
|
|
|
(4.1
|
)%
|
The
decreases in branded product sales of $12.9 million and $14.6 million for the three- and six-month periods ended September 30, 2008, respectively, compared to the corresponding periods in the previous year were due primarily to lower sales of
our two anti-infective brands, Clindesse and Gynazole-1
®
, coupled with decreased sales from our hematinic
product line. Sales of Clindesse decreased 28.0% to $10.7 million for the three-month period and 20.6% to $15.5 million for the six-month period, while sales of our hematinic products decreased 28.6% to $11.7 million and 16.1% to $21.6 million
during the three- and six-month periods, respectively. These decreases resulted mainly from larger-than-normal customer purchases that occurred during the three months ended September 30, 2007 in anticipation of September 2007 price increases.
In addition, sales of our hematinic and anti-infective product lines were lower because of increased generic competition. Net sales of Gynazole-1
®
declined $1.4 million, or 34.5%, and $3.4 million, or 25.6%, for the three- and six-month periods, respectively, due primarily to a decline in the overall demand for
inter-vaginal products.
42
The $22.3 million decrease in specialty generic sales for the three months ended September 30, 2008
compared to the corresponding period in the previous year resulted primarily from reduced sales of our existing cardiovascular products. This decrease was due primarily to expected price reductions on the 100 mg and 200 mg strengths of metoprolol,
offset in part by sales generated on the 25 mg and 50 mg strengths of metoprolol, which we began shipping upon approval in March 2008 and May 2008, respectively. We were the first company to file with the FDA for generic approval of the 100 mg and
200 mg dosage strengths of metoprolol and were accorded the opportunity for a 180-day exclusivity period that ended in January 2008. During the 180-day exclusivity period, we were able to offer these products at higher prices. For the six months
ended September 30, 2008 compared to the corresponding period in the previous year, the $0.7 million of increased sales was due primarily to incremental sales volumes produced by the 25 mg and 50 mg strengths of metoprolol coupled with
increased sales volumes on existing cardiovascular products, offset in part by the impact of expected price reductions on the 100 mg and 200 mg strengths of metoprolol. Specialty generic net revenues for the three and six months ended
September 30, 2008 were also impacted by a decrease in cough/cold product sales of $7.8 million and $16.5 million, respectively, compared to the corresponding periods in the previous year. During most of fiscal year 2008, we marketed
approximately 30 products in our generic/non-branded respiratory line, which consisted primarily of cough/cold products. As a result of the FDA hold on certain unapproved generic/non branded products that occurred in March 2008, we marketed only one
FDA approved generic cough/cold product during fiscal 2009. Specialty generic sales for the three and six months ended September 30, 2008 were also affected by the $2.3 million we accrued for restitution payments made to the Medicare and
Medicaid programs on March 6, 2010 in accordance with the plea agreement with the Department of Justice (see Note 19ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements
in this Quarterly Report on Form 10-Q).
The increases in net revenues for our specialty materials segment for the three and six months ended
September 30, 2008 compared to the corresponding periods in the previous year were due primarily to increased sales volume, most of which was in our calcium carbonate business. We also were favorably impacted by price increases across our
specialty material product lines.
Gross Profit by Segment
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Six Months Ended
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
%
Change
|
|
|
2008
|
|
|
2007
|
|
|
%
Change
|
|
Branded products
|
|
$
|
36,260
|
|
|
$
|
48,410
|
|
|
(25.1
|
)%
|
|
$
|
78,946
|
|
|
$
|
92,239
|
|
|
(14.4
|
)%
|
as % of net revenues
|
|
|
89.5
|
%
|
|
|
90.7
|
%
|
|
|
|
|
|
89.0
|
%
|
|
|
89.3
|
%
|
|
|
|
Specialty generics/non-branded
|
|
|
52,833
|
|
|
|
78,015
|
|
|
(32.3
|
)%
|
|
|
99,033
|
|
|
|
111,115
|
|
|
(10.9
|
)%
|
as % of net revenues
|
|
|
58.3
|
%
|
|
|
69.1
|
%
|
|
|
|
|
|
57.1
|
%
|
|
|
64.4
|
%
|
|
|
|
Specialty materials
|
|
|
2,522
|
|
|
|
1,793
|
|
|
40.7
|
%
|
|
|
5,167
|
|
|
|
3,045
|
|
|
69.7
|
%
|
as % of net revenues
|
|
|
47.2
|
%
|
|
|
40.7
|
%
|
|
|
|
|
|
47.8
|
%
|
|
|
38.0
|
%
|
|
|
|
Other
|
|
|
(6,842
|
)
|
|
|
(3,409
|
)
|
|
(100.7
|
)%
|
|
|
(9,327
|
)
|
|
|
(8,229
|
)
|
|
(13.3
|
)%
|
Total gross profit
|
|
$
|
84,773
|
|
|
$
|
124,809
|
|
|
(32.1
|
)%
|
|
$
|
173,819
|
|
|
$
|
198,170
|
|
|
(12.3
|
)%
|
as % of total net revenues
|
|
|
62.1
|
%
|
|
|
72.9
|
%
|
|
|
|
|
|
63.7
|
%
|
|
|
69.6
|
%
|
|
|
|
The decrease in gross profit of $40.0 million for the quarter was primarily due to the reduced sales levels
experienced by our specialty generics and branded products segments. The $24.4 million decrease in gross profit during the six months ended September 30, 2008 compared to the corresponding period in the previous year was primarily due to a
decrease in net revenues at our branded products segment. For both the three and six months ended September 30, 2008, gross profit was further impacted by the decline in the specialty generics/non-branded products gross profit percentage. The
declines in the gross profit percentages for the three and six months ended September 30, 2008 at our specialty generics/non-branded products segment were primarily due to expected price reductions on the 100 mg and 200 mg strengths of
metoprolol. Gross profit for the three and six months ended September 30, 2008 at our specialty generics/non-branded products segment was also
43
negatively impacted by reductions in sales from our cough/cold product line as discussed above. The increase in gross profit at our specialty materials segment for both the three- and six-month
periods was primarily due to increased sales.
The Other category for gross profit reflected above includes contract manufacturing
revenues, purchase price and production variances from standard costs, and changes to inventory reserves associated with production. Any inventory reserve changes associated with finished goods are reflected in the applicable segment. The changes in
the Other category were primarily due to the impact of higher labor and overhead production cost variances that resulted from lower production volume during the three months ended September 30, 2008.
Research and Development
($ in
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Six Months Ended
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
%
Change
|
|
|
2008
|
|
2007
|
|
|
%
Change
|
|
Research and development
|
|
$
|
18,384
|
|
|
$
|
10,219
|
|
|
79.9
|
%
|
|
$33,901
|
|
$
|
21,503
|
|
|
57.7
|
%
|
as % of total net revenues
|
|
|
13.5
|
%
|
|
|
6.0
|
%
|
|
|
|
|
12.4%
|
|
|
7.6
|
%
|
|
|
|
Research and development expenses consist mainly of personnel-related costs and costs related to bioequivalency
studies for proposed generic products, laboratory and preclinical tests for proposed branded products, clinical studies to determine the safety and efficacy of proposed branded products, and material used in research and development activities. The
increases in research and development expense of $8.2 million and $12.4 million for the three and six months ended September 30, 2008, respectively, compared to the corresponding periods in the previous year were due primarily to the following:
|
|
|
Increases in salaries and benefits of $1.9 million and $3.7 million for the three and six months ended September 30, 2008, respectively, due to
increased headcount in our research and development staff.
|
|
|
|
Increases in costs associated with the testing of drugs under development of $3.1 million and $6.3 million for the three and six months ended
September 30, 2008, respectively, due to an increased level of bioequivalency studies and clinical trials.
|
|
|
|
Increases in research and development material costs of $2.7 million and $1.4 million for the three and six months ended September 30, 2008,
respectively, due to increased development activity.
|
Purchased In-Process Research and Development
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Six Months Ended
September 30,
|
|
|
|
2008
|
|
2007
|
|
%
Change
|
|
2008
|
|
2007
|
|
%
Change
|
|
Purchased in-process research and development
|
|
$
|
|
|
$
|
|
|
N/A
|
|
|
|
$
|
2,000
|
|
$
|
10,000
|
|
(80.0
|
)%
|
In January 2008, we entered
into the Original Gestiva Agreement with Hologic to acquire the U.S. and worldwide rights to Gestiva, which was subsequently amended on January 8, 2010. (See Note 6Acquisitions of the Notes to the Consolidated Financial
Statements in this Quarterly Report on Form 10-Q.) Under the terms of the Original Gestiva Agreement, we made a $2.0 million cash payment in May 2008 upon achievement of a milestone and a $7.5 million cash payment on February 20, 2008 on the
initial closing date. Because the product was not FDA approved at the time these payments were made, we recorded in-process research and development charges of $2.0 million and $7.5 million during the three months ended June 30, 2008 and
March 31, 2008, respectively.
44
In May 2007, we completed the acquisition of the U.S. marketing rights to Evamist, a new estrogen
replacement therapy product delivered with a patented metered-dose transdermal spray system, from VIVUS, Inc. (See Note 6Acquisitions of the Notes to the Consolidated Financial Statements in this in this Quarterly Report on Form
10-Q.) Under terms of the Agreement, we paid $10.0 million in cash at closing and made a cash payment of $141.5 million in July 2007 when final approval of the product was received from the FDA. Since the product had not yet obtained FDA approval
when the initial payment was made at closing, we recorded a $10.0 million in-process research and development charge during the six months ended September 30, 2007.
Selling and Administrative
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Six Months Ended
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
%
Change
|
|
|
2008
|
|
|
2007
|
|
|
%
Change
|
|
Selling and administrative
|
|
$
|
65,725
|
|
|
$
|
49,422
|
|
|
33.0
|
%
|
|
$
|
122,874
|
|
|
$
|
96,736
|
|
|
27.0
|
%
|
as % of total net revenues
|
|
|
48.2
|
%
|
|
|
28.9
|
%
|
|
|
|
|
|
45.0
|
%
|
|
|
34.0
|
%
|
|
|
|
The increases in selling and administrative expenses of $16.3 million and $26.1 million for the three and six
months ended September 30, 2008, respectively, compared to the corresponding periods in the previous year were primarily due to:
|
|
|
Increases in personnel costs at our branded products segment of $2.6 million and $4.2 million for the three and six months ended September 30,
2008, respectively, due primarily to the expansion of our branded sales force initiated in the third quarter of fiscal year 2008;
|
|
|
|
Increases in legal and professional services fees of $3.6 million and $4.1 million for the three and six months ended September 30, 2008,
respectively, due in part to costs incurred in connection with an internal investigation conducted by the Audit Committee;
|
|
|
|
Increases in branded marketing and promotions expense of $5.8 million and $11.4 million for the three and six months ended September 30, 2008,
respectively, due primarily to marketing and promotion expenses related to the launch of Evamist;
|
|
|
|
Increases of $3.2 million for both the three and six months ended September 30, 2008 due primarily to administrative costs accrued during the
three months ended September 30, 2008 in conjunction with the voluntary recall of multiple lots of 23 generic/non-branded products that were announced in November 2008.
|
Amortization of Intangible Assets
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Six Months Ended
September 30,
|
|
|
|
2008
|
|
2007
|
|
%
Change
|
|
|
2008
|
|
2007
|
|
%
Change
|
|
Amortization of intangible assets
|
|
$
|
3,612
|
|
$
|
3,015
|
|
19.8
|
%
|
|
|
|
$
|
7,013
|
|
$
|
4,200
|
|
67.0
|
%
|
The increase in amortization
of intangible assets for both the three and six months ended September 30, 2008 compared to the corresponding periods in the previous year was due primarily to the purchase of Evamist in May 2007 and the impact of intangible assets that
we recorded in connection with such purchase (see Note 6Acquisitions of the Notes to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q). Under the terms of the purchase agreement for Evamist, we made
two cash payments: $10.0 million was paid in May 2007 and expensed as in-process research and development and $141.5 million was paid in July 2007 when final approval of the product was received from the FDA. The final purchase price allocation
completed during the quarter ended June 30, 2008 resulted in estimated identifiable intangible assets of $44.1 million for product rights; $12.8 million for trademark rights; $82.5 million for rights under a sublicense agreement; and $2.1
million for a covenant not to compete. Upon FDA approval in July 2007, we began amortizing the product rights, trademark rights and rights under the sublicense agreement over 15 years and the covenant not to compete over nine years.
45
Litigation and Governmental Inquiries
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Six Months Ended
September 30,
|
|
|
2008
|
|
2007
|
|
%
Change
|
|
2008
|
|
2007
|
|
%
Change
|
Litigation and governmental inquiries
|
|
$
|
49,709
|
|
$
|
|
|
N/A
|
|
$
|
49,709
|
|
$
|
|
|
N/A
|
We have been named as defendants in
certain cases alleging that we reported improper or fraudulent pricing information under the Medicaid rebate program. During the quarter ended September 30, 2008, we recorded $6.5 million of litigation expense for settlements and to cover our
exposure under similar Medicaid cases that are still pending because settlement was determined to be probable and the related amount reasonably estimable.
We have been named as defendant in various product liability actions related to the voluntary product recalls initiated by us in calendar year 2008 and early 2009 and alleged damages as a result of the
ingestion of purportedly oversized tablets allegedly distributed in 2007 and 2008 (see Note 19
ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements in this Quarterly
Report on Form 10-Q). Based on our product liability insurance coverage and the number of product liability actions that are pending, that have been settled and that we expect will occur, we recorded product liability expense of $14.1 million during
the quarter ended September 30, 2008.
In May 2009, we entered into a global confidential settlement agreement with Axcan ScandiPharm,
Inc. (Axcan) to dismiss a suit Axcan filed against us in June 2007. The settlement agreement required us to pay Axcan in three installments, $3.5 million of which was paid in May 2009. Subsequent to May 2009, the original agreement with
Axcan was revised and we made a payment of $2.0 million to settle the remaining two payments due to Axcan. At September 30, 2008, we had recorded a settlement liability of $5.5 million in accrued liabilities.
Pursuant to the plea agreement that ETHEX entered into with the Department of Justice on March 2, 2010, ETHEX agreed to pay criminal fines, restitution
to the Medicare and Medicaid programs and an administrative forfeiture in the aggregate amount of $27.6 million (see Note 19
ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial
Statements in this Quarterly Report on Form 10-Q). The plea agreement requires us to pay the criminal fines in five installment payments beginning March 6, 2010 and ending July 11, 2012. For the quarter ended September 30, 2008, we
recorded litigation expense of $23.6 million for the present value of the administrative forfeiture and the five expected installment payments related to the criminal fines and reduced net revenues by $2.3 million for the restitution payments made
to the Medicare and Medicaid programs on March 6, 2010. We used risk-free interest rates averaging 2.16% to present value the installment payments due under the plea agreement.
See Note 19
ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q for more
information.
Interest Expense
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Six Months Ended
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
%
Change
|
|
|
2008
|
|
|
2007
|
|
|
%
Change
|
|
Interest expense
|
|
$
|
2,117
|
|
|
$
|
2,803
|
|
|
(24.5
|
)%
|
|
$
|
4,635
|
|
|
$
|
4,933
|
|
|
(6.0
|
)%
|
as % of total net revenues
|
|
|
1.5
|
%
|
|
|
1.6
|
%
|
|
|
|
|
|
1.7
|
%
|
|
|
1.7
|
%
|
|
|
|
The decreases in interest expense for both the three and six months ended September 30, 2008 compared to the
corresponding periods in the previous year resulted primarily from the deferred financing costs related to the issuance of the convertible notes becoming fully amortized during the first quarter of fiscal year 2009. In
46
addition, the decrease in interest expense for the quarter was due to a lower interest rate paid on the borrowings made under our credit facility. On August 6, 2007, we borrowed $50.0
million under our credit facility at a weighted average interest rate of 5.96% of which $20.0 million was repaid after ninety days. For the $30.0 million of credit line borrowings outstanding during the three and six months ended September 30,
2008, the weighted average interest rate was approximately 3.60%.
Interest and Other Income
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Six Months Ended
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
%
Change
|
|
|
2008
|
|
|
2007
|
|
|
%
Change
|
|
Interest and other income
|
|
$
|
596
|
|
|
$
|
2,994
|
|
|
(80.1
|
)%
|
|
$
|
1,475
|
|
|
$
|
7,117
|
|
|
(79.3
|
)%
|
as % of total net revenues
|
|
|
0.4
|
%
|
|
|
1.8
|
%
|
|
|
|
|
|
0.5
|
%
|
|
|
2.5
|
%
|
|
|
|
The decreases in interest and other income for the three and six months ended September 30, 2008 compared to
the corresponding periods in the previous year consisted of interest income declines of $1.3 million and $3.0 million, respectively, coupled with increased foreign currency transaction losses of $1.1 million and $2.7 million, respectively, on
investments denominated in the Indian Rupee. The decreases in interest income were primarily due to the impact of lower short-term market interest rates.
Income Tax Provision (Benefit)
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Six Months Ended
September 30,
|
|
|
|
2008
|
|
2007
|
|
|
%
Change
|
|
|
2008
|
|
|
2007
|
|
|
%
Change
|
|
Income tax provision (benefit)
|
|
$(10,597)
|
|
$
|
21,584
|
|
|
(149.1
|
)%
|
|
$
|
(6,828
|
)
|
|
$
|
23,888
|
|
|
(128.6
|
)%
|
Effective tax rate
|
|
19.6 %
|
|
|
34.6
|
%
|
|
|
|
|
|
15.2
|
%
|
|
|
35.2
|
%
|
|
|
|
The income tax benefits recorded during the three and six months ended September 30, 2008 were the result of
pretax losses for both periods. The effective tax rates for both the three and six months ended September 30, 2007 were favorably impacted by the domestic manufacturers deduction.
Liquidity, Capital Resources and Going Concern
Cash and cash equivalents and working capital were $149.0 million and $300.7 million, respectively, at September 30, 2008, compared to $88.5 million and $90.1 million, respectively, at March 31,
2008. Working capital is defined as total current assets minus total current liabilities. Our Notes contain conversion terms that impact whether they are classified as current or long-term liabilities and consequently affect our working capital
position. The $200.0 million principal amount of Notes were classified as a current liability as of March 31, 2008 due to the holders having the right to require us to repurchase all or a portion of their Notes on May 16, 2008. Since no
holders required us to repurchase all or a portion of their Notes on that date and because the next date on which holders may require us to repurchase all or a portion of their Notes is May 16, 2013, the Notes were classified as a long-term
liability as of September 30, 2008.
The primary source of operating cash flow used in the funding of our businesses was internally
generated funds from product sales. For the six months ended September 30, 2008, our net cash flow from operations of $37.5 million resulted primarily from the impact of non-cash items coupled with a decrease in receivables and increases in
accrued liabilities and other long-term liabilities. The decrease in receivables was primarily due to the timing of customer payments and the increase in accrued liabilities and other long-term liabilities was principally due to legal settlements of
$10.5 million and $41.5 million included in accrued expenses and other long-term liabilities, respectively, at September 30, 2008.
47
Net cash flow used in investing activities included capital expenditures of $12.5 million for the six months
ended September 30, 2008 compared to $6.8 million for the corresponding prior year period. The increase in capital expenditures during the six-month period was primarily for purchasing machinery and equipment to upgrade and expand our
pharmaceutical manufacturing and distribution capabilities. Other investing activities during the six months ended September 30, 2008 included $0.6 million and $41.4 million of purchases and sales, respectively, of short-term marketable
securities classified as available for sale and the $2.0 million milestone payment we made in conjunction with the Gestiva acquisition (see Note 6Acquisitions of the Notes to the Consolidated Financial Statements in this
Quarterly Report on Form 10-Q). Also, we paid $3.0 million during the three months ended September 30, 2008 to acquire assets associated with the pharmaceutical division of LycoRed, a product development company located in Israel.
At September 30, 2008, our investment securities included $83.5 million in principal amount of ARS. Consistent with our investment policy
guidelines, the ARS held by us were AAA-rated securities with long-term nominal maturities secured by student loans which are guaranteed by the U.S. Government. Liquidity for the ARS is typically provided by an auction process which allows holders
to sell their notes and resets the applicable interest rate at pre-determined intervals, typically between seven to 35 days. However, with the liquidity issues experienced in global credit and capital markets, the ARS experienced failed auctions
beginning in February 2008 and throughout fiscal year 2009. An auction failure means that the parties wishing to sell their securities could not be matched with an adequate volume of buyers. The securities for which auctions have failed continue to
accrue interest at the contractual rate and continue to be auctioned every seven, 14, 28 or 35 days, as the case may be, until the auction succeeds, the issuer calls the securities, or they mature.
The estimated fair value of our ARS holdings at September 30, 2008 was $77.2 million, which reflected a $6.3 million difference from the principal
amount of $83.5 million. The estimated fair value of the ARS was based on a discounted cash flow model that considered, among other factors, the time to work out the market disruption in the traditional trading mechanism, the stream of cash flows
(coupons) earned until maturity, the prevailing risk-free yield curve, credit spreads applicable to a portfolio of student loans with various tenures and ratings and an illiquidity premium. These factors were used in a Monte Carlo simulation based
methodology to derive the estimated fair value of the ARS. Although the ARS continue to pay interest according to their stated terms, we have recorded as of September 30, 2008 unrealized losses of $4.0 million, net of tax, as a reduction to
shareholders equity in accumulated other comprehensive loss, reflecting adjustments to the ARS holdings that we have concluded have a temporary decline in value. ARS have historically been classified as short-term marketable securities in our
consolidated balance sheet. Given the failed auctions, we classified the ARS held at September 30, 2008 and March 31, 2008 as non-current assets.
Our debt balance, including current maturities, was $269.8 million at September 30, 2008 compared to $271.2 million at March 31, 2008.
In June 2007, we entered into an installment payment agreement with a financial institution for the purchase of software products and the right to receive
consulting or other services from the seller. Upon delivery of the products and services, the financial institution will pay the seller amounts owed for the software products and services. As a result of the installment payment agreement, we
recorded debt in the amount of $1.7 million which will be paid ratably over 16 consecutive quarters to the financial institution. Also, in August 2007, we entered into another agreement with the same financial institution for the payment of
additional consulting services that will be provided on a time and material basis. In exchange for the institution paying the seller for fees owed, we have recorded additional debt in the amount of $0.3 million which will be paid to the
financial institution ratably over 16 consecutive quarters. The two installment payment agreements were discounted using an imputed annual interest rate that approximated our borrowing rate for similar debt instruments at the time of the borrowings.
In March 2006, we entered into a $43.0 million mortgage loan arrangement with one of our primary lenders, in part to refinance $9.9 million
of existing mortgages. The $32.8 million of net proceeds we received from the mortgage loan was used for working capital and general corporate purposes. The mortgage loan, which is secured by three of our buildings, bears interest at a rate of 5.91%
and matures on April 1, 2021. See Note 3Going Concern and Liquidity Considerations of the Notes to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q for information on compliance with the requirements
pursuant to the mortgage loan documentation.
48
In May 2003, we issued $200.0 million principal amount of 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 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. In November 2007, the average trading price of the Notes reached the threshold for the applicable five-day trading period which resulted in the payment of contingent interest and
beginning November 16, 2007 the Notes began to bear interest at a rate of 3.00% per annum. In May 2008, the average trading price of the Notes fell below the contingent interest threshold for the five-day trading period and beginning
May 16, 2008 the Notes began to pay interest at a rate of 2.50% per annum. We 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) to the date of redemption. Holders may require us to repurchase all or a portion of their Notes on May 16, 2013, 2018, 2023 and 2028, or upon a change in control,
as defined in the indenture governing the Notes, at 100% of the principal amount of the Notes, plus accrued and unpaid interest (including contingent interest, if any) to the date of repurchase, payable in cash. Holders had the right to require us
to repurchase all or a portion of their Notes on May 16, 2008 and, accordingly, we classified the Notes as a current liability as of March 31, 2008. Since no holders required us to repurchase all or a portion of their Notes on May 16,
2008 and because the next date holders may require us to repurchase all or a portion of their Notes is May 16, 2013, the Notes were classified as a long-term liability as of September 30, 2008. The Notes are subordinate to all of our
existing and future senior obligations.
At September 30, 2008, we had a credit agreement with ten banks that provided for a revolving
line of credit for borrowing up to $320.0 million. The credit facility also included a provision for increasing the revolving commitment, at the lenders sole discretion, by up to an additional $50.0 million. This credit facility was unsecured
unless we, under certain specified circumstances, utilized the facility to redeem part or all of our outstanding Notes. Interest was charged under the facility at the lower of the prime rate or one-month LIBOR plus 62.5 to 150 basis points,
depending on the ratio of senior debt to EBITDA. The credit facility had a five-year term expiring in June 2011. As of September 30, 2008, we had $30.0 million of cash borrowings outstanding under the facility, and we were in compliance with
all of our financial covenants (see the 2009 Form 10-K for more information regarding our repayment of the borrowings outstanding under the credit facility and the subsequent termination of the credit facility).
In December 2005, we entered into a financing arrangement with St. Louis County, Missouri related to expansion of our operations in St. Louis County (see
Note 16Taxable Industrial Revenue Bonds of the Notes to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q). Up to $135.5 million of industrial revenue bonds could have been issued to us by St. Louis County
relative to capital improvements made through December 31, 2009. This agreement provides that 50% of the real and personal property taxes on up to $135.5 million of capital improvements will be abated for a period of 10 years subsequent to the
property being placed in service. Industrial revenue bonds totaling $120.4 million were outstanding at September 30, 2008. The industrial revenue bonds are issued by St. Louis County to us upon our payment of qualifying costs of capital
improvements, which are then leased by us for a period ending December 1, 2019, unless earlier terminated. We have the option at any time to discontinue the arrangement and regain full title to the abated property. The industrial revenue bonds
bear interest at 4.25% per annum and are payable as to principal and interest concurrently with payments due under the terms of the lease. We have classified the leased assets as property and equipment and have established a capital lease
obligation equal to the outstanding principal balance of the industrial revenue bonds. Lease payments may be made by tendering an equivalent portion of the industrial revenue bonds. As the capital lease payments to St. Louis County may be satisfied
by tendering industrial revenue bonds (which is our intention), the capital lease obligation, industrial revenue bonds and related interest expense and interest income, respectively, have been offset for presentation purposes in the Consolidated
Financial Statements.
49
Ability to Continue as a Going Concern
There is substantial doubt about our ability to continue as a going concern. Our consolidated financial statements included in this Quarterly Report on Form
10-Q are prepared using accounting principles generally accepted in the United States applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The historical
consolidated financial statements included in this Quarterly Report on Form 10-Q do not include any adjustments that might be necessary if we are unable to continue as a going concern.
The assessment of our ability to continue as a going concern was made by management considering, among other factors: (i) our need to obtain additional capital; (ii) the suspension of shipment
of all products manufactured by us and the requirements under the consent decree with the FDA; (iii) the timing and number of approved products that will be reintroduced to the market and the related costs; (iv) the potential outcome with
respect to the governmental inquiries, litigation or other matters described in Note 19ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements included in this Quarterly Report
on Form 10-Q; and (v) our ability to comply with debt covenants. Our assessment was further affected by our fiscal year 2009 net loss of $313.6 million and the outstanding balance of cash, cash equivalents and short-term marketable securities
of $75.7 million as of March 31, 2009. For periods subsequent to March 31, 2009, we expect losses to continue because we are unable to generate any significant revenues from our own manufactured products until we are able to resume
shipping certain or many of our approved products, which currently is not expected to occur until the fourth quarter of calendar year 2010 at the earliest. In addition, we must meet ongoing operating costs as well as costs related to the steps we
are currently taking to prepare for reintroducing our approved products to the market. If we are not able to obtain the FDAs clearance to resume manufacturing and distribution of our approved products in a timely manner and at a reasonable
cost, our financial position, results of operations, cash flows and liquidity will continue to be materially adversely affected. These conditions raise substantial doubt about our ability to continue as a going concern.
We believe that we are not in compliance with one or more of the requirements of our mortgage loan arrangement as of March 31, 2009 (see the 2009 Form
10-K). Failure by us to comply with the requirements of the mortgage loan arrangement or to otherwise receive a waiver from the mortgage lender for any noncompliance could result in our outstanding mortgage debt obligation accelerating and
immediately becoming due and payable. If the acceleration occurs and the mortgage debt is not immediately paid in full, an event of default could also be deemed to have occurred under the $200 million principal amount of 2.5% Contingent Convertible
Subordinated Notes. If an event of default is deemed to have occurred on the Notes, the principal amount plus any accrued and unpaid interest could also become immediately due and payable. The acceleration of these outstanding debt obligations would
materially adversely affect our business, financial condition and cash flows.
Based on current financial projections, we believe the
continuation of our company as a going concern is primarily dependent on our ability to address, among other factors: (i) our need to obtain additional capital; (ii) the suspension of shipment of all products manufactured by us and the
requirements under the consent decree with the FDA; (iii) the timing and number of approved products that will be reintroduced to the market and the related costs; (iv) the potential outcome with respect to the governmental inquiries,
litigation or other matters described in Note 19
ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q; and
(v) our ability to comply with debt covenants. While we address these matters, we must continue to meet expected near-term obligations, including normal course operating cash requirements and costs associated with reintroducing our approved
products to the market (such as costs related to our employees, facilities and FDA compliance), remaining payments associated with the acquisition of the rights to Gestiva (see the 2009 Form 10-K), the financial obligations pursuant to the
plea agreement (see Note 19
ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q), as well as the significant
costs, such as legal and consulting fees, associated with the steps taken by us in connection with the consent decree and the litigation and governmental inquiries. If we are not able to obtain the FDAs clearance to resume manufacturing and
distribution of our approved products in a timely manner and at a reasonable cost, and/or if we experience adverse outcomes with respect to any of the governmental inquiries or litigation described in Note
19
ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, our financial position, results of operations, cash
flows and liquidity will continue to be materially adversely affected. See Item 1ARisk Factors included in the 2009 Form 10-K regarding additional risks we face with respect to these matters.
50
In the near term, we are focused on meeting the requirements of the consent decree, which will allow our
approved products to be reintroduced to the market, and are pursuing various means to increase cash. Since March 31, 2009, we have generated non-recurring cash proceeds to support our on-going operating and compliance requirements from the
receipt of tax refunds, the monetization of our ARS and the sale of certain other assets (see the 2009 Form 10-K for more information regarding the cash received). We also generated cash from the sale of certain products not manufactured by us under
the distribution and supply agreement with Purdue (see Note 19ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q). While
these cash proceeds were sufficient to meet near-term cash requirements, we are pursuing ongoing efforts to increase cash including the continued implementation of cost savings, divestiture of PDI and other assets and the return of certain or many
of our approved products to market in a timely manner. In addition, in order to continue to meet the expected near-term obligations described above, we will still need to obtain additional capital through additional asset sales. Based on our
continuing assessment and identification of assets for future sale and the results of the currently proposed asset sales, we may elect to engage in external financing efforts. We currently do not anticipate issuing equity securities to raise
additional capital. However, we continue to evaluate our capital needs and availability of financing to assess and identify the best available external financing alternatives. We cannot provide assurance that we will be able to realize the cost
reductions we anticipate from reducing our operations or our employee base, that some or many of our approved products can be returned to the market in a timely manner, that our higher profit approved products will return to the market in the near
term, that we can obtain additional cash through asset sales, or that external financing can be obtained when needed, under acceptable terms or in the amounts required. If we are unsuccessful in our efforts to sell assets and raise additional
capital in the near term, we will be required to further reduce our operations, including further reductions of our employee base, or we may be required to cease operations in order to offset the lack of available funding.
Our ability to obtain capital has been and continues to be materially and negatively affected by a number of factors. The current and evolving credit market
condition and general adverse economic conditions have caused the cost of prospective debt and equity financings to increase considerably. These circumstances have materially adversely affected liquidity in the financial markets, making terms for
certain financings unattractive, and in some cases have resulted in the unavailability of financing. We also anticipate that the uncertainty created by the ongoing governmental inquiries and litigation described in Note
19ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, steps taken by us in connection with the nationwide recall and
suspension of shipment of all drug products manufactured by us, the consent decree and the uncertainty with respect to when we will resume shipment of our products, if at all, will affect our ability to obtain capital on a timely basis, or at all.
In light of the factors described above, we may not be able to obtain additional capital. Even if we are able to obtain additional financing or issue debt securities under these circumstances, the cost to us likely will be high and the terms and
conditions are likely to be onerous. In addition, if we were to issue equity securities, such securities likely would be priced at or below the current market price for our securities. As a result, sales of equity securities at or below current
market prices likely would result in substantial dilution for current shareholders who purchased our equity securities at or above current market prices.
We continue to evaluate the sale of certain of our assets, including the planned sale of our PDI subsidiary. However, due to the general economic slowdown, we will likely be exposed to risks related to
the overall macro-economic environment, including a lower rate of return than we have historically experienced on our invested assets and being limited in our ability to sell assets. In addition, we cannot provide any assurance that we will be
successful in finding suitable purchasers for the sale of such assets. Even if we are able to find purchasers, we may not be able to obtain attractive terms and conditions for such sales, including attractive pricing. In addition, divestitures of
businesses such as PDI may also involve a number of risks, including the diversion of management and employee attention, significant costs and expenses, the loss of customer relationships, a decrease in revenues and earnings associated with the
divested business, and the disruption of operations in the affected business. In addition, divestitures potentially involve significant post-closing separation activities, which could involve the expenditure of significant financial and employee
resources. Inability to consummate identified asset sales or manage the post-separation transition arrangements could adversely affect our business, financial condition, results of operations and cash flows.
51
Current and Anticipated Liquidity Position
At February 28, 2010, we had approximately $78.6 million in cash, cash equivalents and short-term investment securities. We realized approximately
$125.3 million of cash during the third quarter of fiscal year 2010 as a result of entering into a distribution and supply agreement with Purdue that allowed us to sell limited quantities of oxycodone hydrochloride tablets manufactured by them (see
Note 19ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for more information regarding the litigation with Purdue and
descriptions of the settlement agreement, the patent license agreement and the distribution and supply agreement). We also received tax refunds of approximately $81.9 million during the first two quarters of fiscal year 2010 and an additional tax
refund of approximately $23.8 million during the fourth quarter of fiscal year 2010. We received an additional $61.7 million related to the settlement agreement on our ARS during the fourth quarter of fiscal year 2010 (see the 2009 Form 10-K for
more information on the settlement agreement entered into on the ARS and the proceeds received thereon).
At February 28, 2010, we had $
236.2 million of outstanding debt, consisting of $200.0 million principal amount of Notes, the remaining principal balance of a $43.0 million mortgage loan and the remaining portion of a $2.0 million software financing arrangement. See
discussion above in this section for more information on our indebtedness.
We currently project that during the quarter ending March 31,
2010, our cash operating expenditures are approximately $122 million to $134 million. Of this amount, $70 million relates to a payment to Hologic, which payment was made in January 2010 in connection with the amendment to the asset purchase
agreement entered into in January 2010 to secure the rights to Gestiva, approximately $34 million to $38 million relates to on-going operating expenses, approximately $5 million relate to financial obligations pursuant to the plea agreement
and approximately $9 million to $13 million relate to debt service payments, inventory build and capital expenditures. The remainder of the projected cash expenditures totaling approximately $4 million to $8 million relates to costs related to our
FDA compliance consultants and other costs.
We currently project that during the quarter ending June 30, 2010, our cash operating
expenditures will be approximately $54 million to $66 million. Of this amount, approximately $36 million to $40 million relate to on-going operating expenses, approximately $7 million to $10 million relate to debt service payments and inventory
build, and approximately $7 million to $10 million relate to legal and customer settlement payments. The remainder of the projected cash expenditures totaling approximately $4 million to $6 million relates to costs related to our FDA compliance
consultants and other costs.
We are continuously reviewing our projected cash expenditures and are evaluating measures to reduce expenditures
on an ongoing basis. In addition, our top priority is to maintain and attempt to increase our limited cash and financial resources. As a result, if we determine that our current goal of meeting the consent decrees requirements and returning
our approved products to market is likely to be significantly delayed, we may decide to further reduce our operations, including further reductions of our employee base, and to significantly curtail some or all of our efforts to meet the consent
decrees requirements and return our approved products to market. Such decision would be made based on our ability to manage our near-term cash obligations, to obtain additional capital through asset sales and/or external financing and to
expeditiously meet the consent decrees requirements and return our approved products to market. If such decision were to be made, we currently anticipate that we would focus our efforts on developing product candidates in our development
portfolio that we believe have the highest potential return on investment, which we currently believe to be primarily Gestiva (17-alphahydroxyprogesterone caproate). We also expect to evaluate other alternatives available to us in order to
increase our cash balance.
Inflation
Inflation may apply upward pressure on the cost of goods and services used by us in the future. However, we believe that the net effect of inflation on our operations during the past three years has been
minimal. In addition, changes in the mix of products sold and the effect of competition has made a comparison of changes in selling prices less meaningful relative to changes in the overall rate of inflation over the past three years.
Critical Accounting Estimates
Our consolidated financial statements are presented on the basis of U.S. generally accepted accounting principles. Certain of our accounting policies are particularly important to the presentation of our
financial condition and results of operations and require the application of significant judgment by our management. As a result, amounts determined under 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 we believe to be reasonable and appropriate under the circumstances, the
52
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 Recognition and Provisions for Estimated Reductions to Gross
Revenues
Revenue is generally realized or realizable and earned when persuasive evidence of an arrangement exists, the sellers price
to the buyer is fixed or determinable, the customers payment ability has been reasonably assured and title and risk of ownership have been transferred to the customer.
Concurrently with the recognition of revenue, we record estimated provisions for product returns, sales rebates, payment discounts, chargebacks, and other sales allowances. These 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 and actual customer inventory levels, customer rebate arrangements
and current sales terms with wholesale and indirect customers. We record a liability for product returns related to recalls when their occurrence becomes estimable and probable.
From time to time, we provide incentives to our wholesale customers, such as trade show allowances or stocking allowances that they in turn use to accelerate distribution to their end customers. We
believe that such incentives are normal and customary in the industry. Sales allowances are accrued and revenue is recognized as sales are made pursuant to the terms of the allowances offered to the customer. Due to the nature of these allowances,
we believe we are able to accurately calculate the required provisions for the allowances based on the specific terms in each agreement. Additionally, customers will normally purchase additional product ahead of regular demand to take advantage of
the temporarily lower cost resulting from the sales allowances. This practice has been customary in the industry and we believe would be part of a customers ordinary course of business inventory level. We reserve the right, with our major
wholesale customers, to limit the amount of these forward buys. Sales made as a result of allowances offered on our specialty generics product line in conjunction with trade shows sponsored by our major wholesale customers and for other promotional
programs accounted for 14.3% and 16.6% of total gross revenues for the six months ended September 30, 2008 and 2007, respectively.
In
addition, we understand that certain of our wholesale customers may try to anticipate the timing of price increases and have made, and may continue to make, business decisions to buy additional product in anticipation of future price increases. This
practice has been customary in the industry and we believe would be part of a customers ordinary course of business inventory level.
We
evaluate inventory levels at our wholesale customers, which accounted for approximately 53% of our unit sales during the six months ended September 30, 2008, through an internal analysis that considers, among other things, wholesaler purchases,
wholesaler contract sales, available end consumer prescription information and inventory data received from our three largest wholesale customers. We believe that our evaluation of wholesaler inventory levels allows us to make reasonable estimates
of our reserve balances. Further, our products are typically sold with adequate shelf life to permit sufficient time for our wholesaler customers to sell our products in their inventory through to the end consumer.
53
The following table reflects the activity during the six months ended September 30, 2008 for each
accounts receivable reserve or related liability:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning
Balance
|
|
Current
Provision
Related to Shipments
Made in the
Current Period
|
|
Current
Provision
Related to Sales
Made in
Prior Periods
|
|
Actual Returns
or Credits
in
the
Current Period
|
|
|
Ending
Balance
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended September 30, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts Receivable Reserves:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chargebacks
|
|
$
|
18,103
|
|
$
|
96,145
|
|
$
|
|
|
$
|
(93,658
|
)
|
|
$
|
20,590
|
Cash discounts and other allowances
|
|
|
3,848
|
|
|
10,337
|
|
|
|
|
|
(9,390
|
)
|
|
|
4,795
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales rebates
|
|
|
12,585
|
|
|
29,039
|
|
|
2,528
|
|
|
(33,132
|
)
|
|
|
11,020
|
Sales returns
|
|
|
3,950
|
|
|
6,374
|
|
|
|
|
|
(8,014
|
)
|
|
|
2,310
|
Medicaid rebates
|
|
|
7,953
|
|
|
8,140
|
|
|
|
|
|
(4,002
|
)
|
|
|
12,091
|
Medicare and Medicaid restitution
|
|
|
|
|
|
|
|
|
2,275
|
|
|
|
|
|
|
2,275
|
Product recall returns
|
|
|
346
|
|
|
2,050
|
|
|
|
|
|
(346
|
)
|
|
|
2,050
|
Failure to supply claims
|
|
|
|
|
|
2,145
|
|
|
|
|
|
(645
|
)
|
|
|
1,500
|
Other
|
|
|
6,120
|
|
|
22,767
|
|
|
|
|
|
(20,418
|
)
|
|
|
8,469
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
52,905
|
|
$
|
176,997
|
|
$
|
4,803
|
|
$
|
(169,605
|
)
|
|
$
|
65,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The estimation process used to determine our reserve provisions has
been applied on a consistent basis and no material adjustments have been necessary to increase or decrease our reserves as a result of a significant change in underlying estimates. We use a variety of methods to assess the adequacy of our reserves
to ensure our financial statements are fairly stated. These include reviews of customer inventory data, customer contract programs and product pricing trends to analyze and validate the reserves.
The increase in the reserve for chargebacks at September 30, 2008 was primarily due to chargeback reserves established on the 25 mg and 50 mg strengths
of metoprolol, which were launched upon approval by the FDA in March 2008 and May 2008, respectively. The decrease in the reserve for sales rebates at September 30, 2008 was primarily due to the impact of certain rebates accrued at the end of
fiscal 2008 for customer agreements related to initial sales of the 25 mg strength of metoprolol. The current provision related to sales made in prior periods reflected the impact of the settlement of a disputed customer claim received during the
quarter for rebates related to sales of new products launched in the prior fiscal year. We had interpreted the rebate agreement with the customer to exclude certain new product sales that the customer claimed should have been included. Since there
were interpretive differences as to the intent of the language in the rebate agreement relative to the inclusion of new products, we decided to settle the claim with the customer. The increase in the reserve for cash discounts and other allowances
at September 30, 2008 was principally due to the impact of charges incurred by us for our failure to supply certain specialty generic products due to production backlogs coupled with an increased level of sales made as a result of allowances
offered on our specialty generic product line for trade shows sponsored by our major wholesale customers. The increase in the liability for Medicaid rebates at September 30, 2008 resulted primarily from the timing of when certain Medicaid
rebate payments were processed. The $2.3 million for Medicare and Medicaid restitution relates to the amount paid to these two programs in March 2010 pursuant to the plea agreement that ETHEX entered into with the Department of Justice on
March 2, 2010 (see Note 19
ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q).
The provisions for the reserves for chargebacks and sales returns are primarily a function of the estimated amount of inventory in the applicable
distribution channel (wholesale or retail) at the balance sheet date. We determine the amounts of these reserves at each balance sheet date based on customer inventory levels and record the
54
provisions as appropriate based on changes in the inventory balances. With the exception of sales rebates, there are no other current provisions related to sales made in prior periods for the six
months ended September 30, 2008 because of information constraints in the distribution channel, which have made it impractical for us to capture and quantify the impact of current versus prior year activity on the chargebacks or returns
provision. Information constraints within the distribution channel primarily relate to our inability to track product through the channel on a unit or specific lot basis. The lack of information on a specific lot basis precludes us from tracking
actual chargeback and return activity to the period of our initial sale.
We have not found it necessary to determine which specific lot a
product sale originated from in estimating the provision for chargebacks or returns because these reserves are based on the quantity of inventory held in the wholesale distribution channel at the balance sheet date. We assume the customers relieve
their inventory on a first-in, first-out basis, so that the quantities in inventory reflect their most recent purchases. For example, in determining the provision for chargebacks, we first estimate the reserve required at period end based on
customer inventory balances and certain assumptions (described above), add to that requirement the credits actually issued during the period and then subtract the beginning reserve balance, which is determined on the same basis as the ending
balance.
These reserves and their respective provisions are discussed in further detail below.
Chargebacks
We market and sell products directly to wholesalers, distributors, warehousing pharmacy chains, mail order pharmacies and other
direct purchasing groups. We also market products indirectly to independent pharmacies, non-warehousing chains, managed care organizations, and group purchasing organizations, collectively referred to as indirect customers. We enter into
agreements with some indirect customers to establish contract pricing for certain products. These indirect customers then independently select a wholesaler from which to purchase the products at these contracted prices. Alternatively, we may
pre-authorize wholesalers to offer specified contract pricing to other indirect customers. Under either arrangement, we provide credit to the wholesaler for any difference between the contracted price with the indirect customer and the
wholesalers invoice price. This credit is called a chargeback.
Chargeback transactions are almost exclusively related to our specialty
generics business segment. During the six months ended September 30, 2008 and 2007, the chargeback provision reduced the gross sales of our specialty generics segment by $95.5 million and $65.2 million, respectively. These amounts accounted for
99.3% of the total chargeback provisions recorded during the six months ended September 30, 2008 and 2007.
The provision for chargebacks
is the most significant and complex estimate used in the recognition of revenue. The primary factors we consider in developing and evaluating the reserve for chargebacks include:
|
|
|
The amount of inventory in the wholesale distribution channel.
We receive actual inventory information from our three major wholesale customers
and estimate the inventory position of the remaining wholesalers based on historical buying patterns. During the six months ended September 30, 2008, unit sales to our three major wholesale customers accounted for 82% of our total unit sales to
all wholesalers, and the aggregate inventory position of the three major wholesalers at September 30, 2008 was approximately equivalent to our last four weeks of shipments during the fiscal year. We currently use the last six weeks of our
shipments as an estimate of the inventory held by the remaining wholesalers where we do not receive actual inventory data, as our experience and buying patterns indicate that our smaller wholesale customers carry less inventory than our large
wholesale customers. As of September 30, 2008, each week of inventory for those remaining wholesalers represented approximately $0.3 million, or 1.2%, of the reported reserve for chargebacks.
|
|
|
|
The percentage of sales to our wholesale customers that will result in chargebacks
. Using our automated chargeback system we track, at the
product level, the percentage of sales units shipped to our wholesale customers that eventually result in chargebacks to us. The percentage for each product, which is based on actual historical experience, is applied to the respective inventory
units in the wholesale distribution channel. As of September 30, 2008, the aggregate weighted average percentage of sales to wholesalers assumed to result in chargebacks was approximately 91%, with each 1% representing approximately $0.2
million, or 0.9%, of the reported reserve for chargebacks.
|
55
|
|
|
Contract pricing and the resulting chargeback per unit
. The chargeback provision is based on the difference between our invoice price to the
wholesaler, or WAC, and the contract price negotiated with either our indirect customer or with the wholesaler for sales by the wholesaler to the indirect customers. We calculate the price difference, or chargeback per unit, for each
product and for each major wholesale customer using historical weighted average pricing, based on actual chargeback experience. Use of weighted average pricing over time compensates for changes in the mix of indirect customers and products from
period to period. As of September 30, 2008, a 5% shift in the calculated chargeback per unit in the same direction across all products and customers would result in a $0.8 million, or 3.9%, impact on the reported reserve for chargebacks.
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Our calculation of the chargeback accrual includes a quarterly review of the inventory reports from our largest wholesale
customers. This customer inventory information is used to verify the estimated liability for future chargeback claims based on historical contract and chargeback rates. We continually monitor pricing trends and sales to our indirect customers
through the wholesale distribution channel and wholesaler inventory levels. Specifically, to ensure the liability for future chargebacks is fairly stated, each of the primary factors we consider in developing and evaluating the reserve for
chargebacks, as described above, are validated on a quarterly basis as follows:
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Inventory in the wholesale distribution channel is validated through a review of reports of actual inventory on-hand at the end of a given quarter
received from our three major wholesale customers. These customers account for approximately 85% of chargebacks processed annually.
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The percentage of sales to our wholesale customers that will result in chargebacks is validated through an analysis of actual chargebacks received on a
product specific basis from all wholesale customers relative to their purchases from us over various historical timeframes.
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Contract pricing and the resulting chargeback per unit is validated through an analysis of actual contract pricing on a product specific basis to our
indirect and wholesale customers in the current period and over various historical timeframes.
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Shelf-Stock
Adjustments
These adjustments, which are included in the chargeback reserves, represent credits issued to our wholesale customers that result from a decrease in our wholesale acquisition cost (WAC). Decreases in our invoice
prices are discretionary decisions we make to reflect market conditions. These credits are customary in the industry and are intended to reduce a wholesale customers inventory cost to better reflect current market prices. Generally, we provide
credits to customers at the time the price reduction occurs based on the inventory that is owned by them on the effective date of the price reduction. Since a reduction in WAC reduces the chargeback per unit, or the difference between WAC and the
contract price, shelf-stock adjustments are typically included as part of the reserve for chargebacks because the price reduction credits act essentially as accelerated chargebacks. Although we have contractually agreed to provide price adjustment
credits to our major wholesale customers at the time they occur, the impact of any such price reductions not included in the reserve for chargebacks is immaterial to the amount of revenue recognized in any given period. As a result of WAC decreases
to certain specialty generic/non-branded products, we paid shelf-stock adjustments of $7.7 million to our wholesale customers during the six months ended September 30, 2008.
Sales Returns
Consistent with industry practice, we maintain a returns policy that allows our direct and indirect customers to return product six months prior to expiration and within one
year after expiration. This policy is applicable to both our branded and specialty generics business segments. Upon recognition of revenue from product sales to customers, we provide for an estimate of product to be returned. This estimate is
determined by applying a historical relationship of customer returns to gross sales. We evaluate the reserve for sales returns by calculating historical return rates using data from the last 12 months on a product specific basis and by class of
trade (wholesale versus retail chain). The calculated percentages are applied against estimates of inventory in the distribution channel on a product specific basis. To determine the inventory levels in the wholesale distribution channel, we utilize
actual inventory information from our major wholesale customers and estimate the inventory positions of the remaining wholesalers based on historical buying patterns. For inventory held by our non-wholesale customers, we use the last two months of
sales to the direct buying chains and the indirect buying retailers as an estimate. A 10% change in the product specific historical return rates used in the reserve analysis would have changed the reserve balance at September 30, 2008 by
approximately $0.1 million, or 6.1%, of the
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reported reserve for sales returns. A 10% change in the amount of estimated inventory in the distribution channel would have changed the reserve balance at September 30, 2008 by
approximately $0.2 million, or 7.6%, of the reported reserve for sales returns.
Medicaid Rebates
Federal law requires that a
pharmaceutical manufacturer, as a condition of having its products receive federal reimbursement under Medicaid and Medicare Part B, must pay rebates to state Medicaid programs for all units of its pharmaceuticals that are dispensed to Medicaid
beneficiaries and paid for by a state Medicaid program. Medicaid rebates apply to both our branded and specialty generic/non-branded segments. Individual states invoice us for Medicaid rebates on a quarterly basis using statutorily determined rates:
for noninnovator products, in general generic drugs marketed under ANDAs, the rebate amount is 11% of the Average Manufacturer Price (AMP) for the quarter; for innovator products, in general brand-name products marketed under NDAs, the
rebate amount is the greater of 15.1% of the AMP for the quarter or the difference between such AMP and the best price for that same quarter. An additional rebate for innovator products is payable in the amount by which, if any, the products
AMP has increased at a rate faster than inflation. The total rebate amount for each particular product is its Unit Rebate Amount, or URA. The amount owed is based on the number of units paid for by each state Medicaid program in a
quarter extended by the URA. At September 30, 2008, we evaluated the liabilities for Medicaid rebates by comparing them against the amount of payments made subsequent to the end of the second quarter. Prior to September 30, 2008, we
historically evaluated the reserve based on expected payments, which were affected by patient usage and estimated inventory in the distribution channel. We estimated patient usage by calculating a payment rate as a percentage of net sales, which was
then applied to an estimate of customer inventory. We used the last two months of our shipments to wholesalers and direct buying chains as an estimate of inventory in the wholesale and chain channels and an additional month of wholesale sales as an
estimate of inventory held by the indirect buying retailer.
Reserve for Failure to Supply Claims
We have historically entered
into product purchase arrangements with certain customers that include a provision that requires us to reimburse these customers for price differences on product orders that we are unable to fulfill. We are able to estimate provisions for supply
failures based on the specific terms in each arrangement. We incurred failure to supply claims in the second quarter due primarily to our failure to supply certain specialty generic products due to production backlogs coupled with an increased level
of sales made as a result of allowances offered on our specialty generic product line for trade shows sponsored by our major wholesale customers. Based on the specific terms of these arrangements, we recorded reductions to net revenues during the
quarter ended September 30, 2008 of $2.1 million for amounts owed to certain customers for price differences they incurred for procuring products we were unable to supply.
Liabilities for Product Returns Related to Recalls
Beginning in May 2008 through November 2008, we announced six separate voluntary recalls of certain tablet form generic products as a
precaution due to the potential existence of oversized tablets. Liabilities for product returns related to recalls are based on estimated and actual customer inventory levels at the time of the recall and actual contract pricing.
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 should 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 managements assessment of current product demand.
Inventories also include costs related to certain products that are pending regulatory approval. From time to time, we capitalize inventory costs associated
with products prior to regulatory approval based on managements judgment of probable future regulatory approval, commercial success and realizable value. Such judgment incorporates our knowledge and best estimate of where the product is in the
regulatory review process, our required investment in the product, market conditions, competing products and our economic expectations for the product post-approval relative to the risk of manufacturing the product prior to approval. If final
regulatory approval for such products is denied or delayed, we revise our estimates and judgments about the recoverability of the capitalized costs and, where required, provide reserves for such inventory in the period those estimates and judgments
change.
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Intangible and Other Long-Lived Assets
Our intangible assets principally 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 their estimated useful lives, which range from nine
to 20 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 products
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
assets useful life and an acceleration of related amortization expense.
We assess the impairment of intangible and other long-lived
assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. 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 or other long-lived 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 assets recoverability. Recoverability is determined by comparing the carrying amount of an 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 asset, an impairment loss is recognized based on the excess of the carrying amount over the
estimated fair value of the asset.
See the 2009 Form 10-K for disclosure of certain events and transactions that occurred after
September 30, 2008, including, but not limited to, the evaluation of impairment performed on each of our intangible assets subsequent to December 31, 2008 due to the nationwide recall and suspension of shipment of all products manufactured
by us and the consent decree with the FDA.
Stock-Based Compensation
We account for stock-based compensation expense in accordance with SFAS 123R, which requires the measurement and recognition of compensation expense, based
on estimated fair values, for all share-based compensation awards made to employees and directors over the vesting period of the awards. Determining the fair value of share-based awards at the grant date requires judgment to identify the appropriate
valuation model and estimate the assumptions, including the expected term of the stock options and expected stock-price volatility, to be used in the calculation. Judgment is also required in estimating the percentage of share-based awards that are
expected to be forfeited. We estimate the fair value of stock options granted using the Black-Scholes option-pricing model with assumptions based primarily on historical data. If actual results differ significantly from these estimates, stock-based
compensation expense and our results of operations could be materially impacted.
Income Taxes
Our deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax basis of assets and
liabilities. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. We record a valuation
allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. Management believes it is more likely than not that forecasted income, including income that may be generated as a result of certain tax
planning strategies, together with the tax effects of the deferred tax liabilities, will be sufficient to fully recover the remaining deferred tax assets. If all or part of the net deferred tax assets are determined not to be realizable in the
future, an adjustment to the valuation allowance would be charged to earnings in the period such determination is made. Similarly, if we subsequently realize deferred tax assets that were previously determined to be unrealizable, the respective
valuation allowance would be reversed, resulting in a positive adjustment to earnings in the period such determination is made.
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We compute our annual tax rate based on the statutory tax rates and tax planning opportunities available to
us in the various jurisdictions in which we earn income. Significant judgment is required in determining our annual tax rate and in evaluating tax positions. We establish reserves in accordance with FASB Interpretation No. 48, Accounting
for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109 (FIN 48), which provides that the tax effects from an uncertain tax position need only be recognized in an entitys financial statements if
the position is more likely than not to be sustained upon audit, based on the technical merits of the position. We adjust these reserves in light of changing facts and circumstances, such as the settlement of a tax audit. Our annual tax rate
includes the impact of reserve provisions and changes to reserves.
Management regularly evaluates our tax positions taken on filed tax
returns using information about recent court decisions and legislative activities. Many factors are considered in making these evaluations, including past history, recent interpretations of tax law, and the specific facts and circumstances of each
matter. Because tax regulations are subject to interpretation and tax litigation is inherently uncertain, these evaluations can involve a series of complex judgments about future events and can rely heavily on estimates and assumptions. The recorded
tax liabilities are based on estimates and assumptions that have been deemed reasonable by management. However, if our estimates are not representative of actual outcomes, recorded tax liabilities could be materially impacted.
Contingencies
We are
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 we determine 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 future outcome of litigation and because of the potential that an adverse outcome in legal
proceedings could have a material impact on our financial condition or results of operations, such estimates are considered to be critical accounting estimates. After completing a review of such matters, we determined that at September 30,
2008, there were certain legal proceedings in which we are involved that met the conditions described above. Accordingly, we have accrued a loss contingency relating to such legal proceedings.
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Item 3.
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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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Our exposure to market risk is limited to fluctuating interest rates associated with variable rate indebtedness and marketable securities that are subject to interest rate changes.
As of September 30, 2008, we had investments in taxable ARS. The rates on these securities reset at pre-determined intervals up to 35 days. As of
September 30, 2008, we had $83.5 million principal amount invested in ARS consisting of high quality (AAA-rated) bonds secured by student loans which are guaranteed by the U.S. Government. The maturity of these securities is greater than 10
years. During the fourth quarter of fiscal year 2008, certain developments in the capital and credit markets adversely affected the market for auction rate securities, which has resulted in a loss of liquidity for these investments. We have
evaluated these securities to determine if other-than-temporary impairment of the carrying value of the securities has occurred due to the loss of liquidity. At September 30, 2008, the fair value of auction rate securities was $77.2 million and
the resultant difference of $6.3 million was recorded in accumulated other comprehensive loss as the unrealized losses were considered to be temporary. (See Note 10Investment Securities of the Notes to the Consolidated Financial
Statements in this Quarterly Report on Form 10-Q.)
The annual favorable impact on our net income as a result of a 100 basis point (where 100
basis points equals 1%) increase in short-term interest rates would be approximately $2.2 million, based on our average cash, cash equivalents and short-term marketable investment balances during the six months ended September 30, 2008.
Advances to us under our credit facility were charged at an interest rate that varied 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 have significantly increased borrowing expenses. At September 30, 2008, we had $30.0 million of borrowings
outstanding under our credit facility. The annual unfavorable impact on our pre-tax income as a result of a 100 basis point (where 100 basis points equals 1%) increase in short-term interest rates would be approximately $0.3 million annually based
on the $30.0 million of borrowings that were outstanding under our line of credit at September 30, 2008. The $30.0 million borrowing was repaid in February 2009 and the credit agreement was subsequently terminated.
In May 2003, we issued $200.0 million principal amount of Convertible Subordinated Notes. The interest rate on the Notes is fixed at 2.50% and therefore not
subject to interest rate changes. Beginning May 16, 2006, we became 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 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. In November 2007, the average trading price of the Notes reached the threshold for the
applicable five-day trading period which resulted in the payment of contingent interest and beginning November 16, 2007 the Notes began to bear interest at a rate of 3.00% per annum. In May 2008, the average trading price of the Notes fell
below the contingent interest threshold for the five-day trading period and beginning May 16, 2008 the Notes began to pay interest at a rate of 2.50% per annum. Holders may require us to repurchase all or a portion of their Notes on
May 16, 2013, 2018, 2023 and 2028, or upon a change in control, as defined in the indenture governing the Notes, at 100% of the principal amount of the Notes, plus accrued and unpaid interest (including contingent interest, if any) to the date
of repurchase, payable in cash. Holders had the right to require us to repurchase all or a portion of their Notes on May 16, 2008 and, accordingly, we classified the Notes as a current liability as of March 31, 2008. Since no holders
required us to repurchase all or a portion of their Notes on that date and because the next occasion holders may require us to repurchase all or a portion of their Notes is May 16, 2013, the Notes were classified as a long-term liability as of
September 30, 2008.
In March 2006, we entered into a $43.0 million mortgage loan secured by three of our buildings that matures in April
2021. The interest rate on this loan is fixed at 5.91% per annum and not subject to market interest rate changes.
We entered into an
installment payment agreement in June 2007 and another in August 2007 with a financial institution related to the purchase of software products and the right to receive consulting or other services from the seller, respectively. For the two
agreements, we recorded debt in the amount of $2.0 million which will be paid ratably over 16 consecutive quarters. The two installment payment agreements were discounted using an imputed annual interest rate that approximated our borrowing rate for
similar debt instruments at the time of the borrowings.
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Item 4.
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CONTROLS AND PROCEDURES
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(a) Evaluation of Disclosure Controls and Procedures
An evaluation was conducted under the supervision and with the
participation of our management, including the Interim Chief Executive Officer (the CEO) and Interim Chief Financial Officer (the CFO), of the effectiveness of the design and operation of our disclosure controls and
procedures as of September 30, 2008. As a result of the material weaknesses in our internal control over financial reporting described below, our Interim CEO and Interim CFO have concluded that our disclosure controls and procedures were not
effective as of September 30, 2008.
As described in Item 9AControls and Procedures of our 2009 Form 10-K,
management determined that the following material weaknesses existed in our internal control over financial reporting.
Material
weaknesses in entity-level controls.
We did not maintain an effective control environment or entity-level controls with respect to the risk assessment, information and communications and monitoring components of internal control.
Specifically, the following individual material weaknesses were identified:
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We did not sufficiently promote an appropriate level of control awareness;
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We did not maintain a sufficient complement of adequately trained personnel with an appropriate level of knowledge, experience and training in the
application of GAAP and commensurate with our financial reporting requirements;
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We did not design adequate controls to identify and address risks critical to financial reporting, including noncompliance with applicable FDA rules
and regulations;
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We did not design adequate monitoring controls to determine the adequacy of, and to identify deficiencies with respect to, other controls;
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We did not design controls to ensure that identified deficiencies were remediated on a timely basis; and
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The operating effectiveness of our information and communication controls was inadequate to ensure that information was communicated to the appropriate
personnel across and within business activities.
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These deficiencies resulted in a reasonable possibility that a material
misstatement of our annual or interim consolidated financial statements will not be prevented or detected on a timely basis and contributed to the other material weaknesses and material errors described below.
Material weaknesses surrounding the financial statement preparation and review procedures.
Our policies and procedures did not adequately
address the financial reporting risks associated with the preparation and review of our financial statements. Specifically, the following individual material weaknesses were identified:
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Manual journal entries
. The operating effectiveness of our controls was inadequate to ensure that we identified, accumulated and documented
appropriate information necessary to support manual journal entries;
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Account reconciliations
. The operating effectiveness of our controls was inadequate to ensure that account reconciliations were reviewed and
approved for accuracy and completeness and that we identified, accumulated and documented appropriate information necessary to support account balances;
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Spreadsheets.
We did not design adequate controls over access, changes to and review of our spreadsheets used in the preparation of financial
statements;
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Customer and supplier agreements.
The design of our controls was inadequate to ensure that necessary information for new and modified agreements
was identified and communicated to those responsible for evaluating the accounting implications;
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Stock-based compensation.
The operating effectiveness of our controls was inadequate to ensure the proper grant dates and expected terms were
used to measure the fair values of the options and to ensure that necessary information resulting from the modification of options was identified and communicated to those responsible for evaluating the accounting implications;
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Medicaid rebates.
The operating effectiveness of our controls was inadequate to ensure that accurate information, including information related
to pricing of products and the exempt status of customers, was captured and communicated to those responsible for evaluating the accounting implications; and
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Income Taxes.
The operating effectiveness of our controls was inadequate to ensure that review and monitoring of the tax provision calculation
occurred and that the necessary information was captured and communicated to those responsible for the tax provision calculation.
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These deficiencies resulted in material errors related to net revenues, research and development expense, selling and administrative expense, accounts receivable, inventory, property and equipment, accrued liabilities, income taxes and
additional paid-in capital in our interim financial statements for fiscal year 2009. As a result, the interim financial statements for the first quarter of fiscal year 2009 were restated and the interim financial statements for the second and
third quarters of fiscal year 2009 and the year-end financial statements for fiscal year 2009 were adjusted prior to their issuance. These deficiencies also resulted in a reasonable possibility that a material misstatement of our annual
consolidated financial statements will not be prevented or detected on a timely basis.
Material weaknesses related to the application
of accounting principles.
Our policies and procedures did not adequately address the financial reporting risks associated with the application of certain accounting principles and standards. Specifically, the following individual material
weaknesses were identified:
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Inventories.
The operating effectiveness of our controls was inadequate to ensure that manufacturing variances were capitalized as inventory and
that purchases of raw materials to be used in research and development activities were expensed as incurred;
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Property and equipment
. The operating effectiveness of our controls was inadequate to ensure that maintenance and repairs of equipment were
expensed as incurred, asset costs were appropriately capitalized, depreciation expense was appropriately calculated and that the selection of useful lives of property and equipment was appropriately and consistently applied;
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Employee compensation
. The operating effectiveness of our controls was inadequate to ensure that costs for vacation pay, severance, and other
payroll related accruals were appropriately recorded;
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Reserves for sales allowances
. The operating effectiveness of our controls was inadequate to ensure that the process for estimating reserves for
sales allowances was reviewed and monitored; and
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Financing transactions
. The operating effectiveness of our controls was inadequate to ensure that vendor financing arrangements, including
financing costs, were properly reflected on the balance sheet.
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These deficiencies resulted in material errors related to
net revenues, research and development expense, selling and administrative expense, accounts receivable, inventory, property and equipment and accrued liabilities in our interim financial statements for fiscal year 2009. As a result, the
interim financial statements for the first quarter of fiscal year 2009 were restated and the interim financial statements for the second and third quarters of fiscal year 2009 and the year-end financial statements for fiscal year 2009 were adjusted
prior to their issuance. These deficiencies also resulted in a reasonable possibility that a material misstatement of our annual consolidated financial statements will not be prevented or detected on a timely basis.
Remediation Activities
As
disclosed in Item 9AControls and Procedures(d) Remediation Activities of our 2009 Form 10-K, during the fourth quarter of fiscal year 2009 and continuing after March 31, 2009, we began taking action, including
designing and implementing controls, in order to remediate the material weaknesses described above. We will continue our remediation efforts described below, including testing of operating effectiveness of new controls, during the fiscal year ending
March 31, 2010, and we plan to provide an update on the status of our remediation activities on a quarterly basis. While unremediated, these material weaknesses have the potential to result in our failure to prevent or detect material
misstatements in our annual or interim consolidated financial statements.
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As previously disclosed, in August 2008, the Audit Committee, with the assistance of legal counsel,
including FDA regulatory counsel with respect to FDA matters, and other advisers, conducted an internal investigation with respect to a range of specific allegations involving, among other items, FDA regulatory and other compliance matters and
management misconduct. The investigation was substantially completed in December 2008 and the investigation of all remaining matters was completed in June 2009.
The investigation focused on, among other areas, FDA and other healthcare regulatory and compliance matters, financial analysis and reporting, employment and labor issues, and corporate governance and
oversight. See Item 1Business(b) Significant Recent Developments of our 2009 Form 10-K for more information on the Audit Committee investigation. As a result of its findings from the investigation, the Audit Committee,
with the assistance of its legal counsel, including FDA regulatory counsel with respect to FDA matters, and other advisors, prepared and approved a remedial framework. The Board, either directly or through the special committee, has reviewed and
approved the remedial framework. Some of the measures included in the remedial framework are intended to remediate certain material weaknesses and are listed below.
The following actions have been taken or are expected to be taken to remediate one or more of the material weaknesses listed above:
1.
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Expand the membership of our disclosure committee to include executives with responsibilities over our operating divisions and regulatory affairs; and reviewing,
revising and updating existing corporate governance policies and procedures.
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2.
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Reorganize and relocate our legal department adjacent to the Interim CEOs office to facilitate greater access to the legal department and more extensive
involvement of the legal department in corporate governance and compliance matters.
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3.
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Adopt measures to strengthen and enhance compliance with FDA regulations and related regulatory compliance, including:
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retaining new outside consultants and counsel for FDA regulatory matters and, with their assistance, reviewing and revising our policies, procedures
and practices to enhance compliance with the FDAs current good manufacturing practice requirements;
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enhancing compliance with FDA drug application, approval and post-approval requirements;
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evaluating compliance with applicable foreign laws and regulations; and
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implementing internal reporting policies pursuant to which our chief compliance officer will report periodically to the non-management members of the
Board.
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4.
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Review the staffing levels, capabilities and experience of the members of the Finance department and add employees with appropriate financial statement closing and GAAP
expertise to the Finance department as necessary.
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5.
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Establish a monthly business review process to ensure an in-depth senior management review of business segment results on a regular basis.
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6.
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Develop and document comprehensive accounting policies and procedures, including documentation of the methods for applying accounting policies through detailed process
maps and procedural narratives.
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7.
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Define and document roles and responsibilities within the financial statement closing process including required reviews and approval of account reconciliations,
journal entries and methodologies used to analyze account balances.
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8.
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Identify and implement specific steps to improve information flow between the Finance department and business unit finance personnel, as well as other functional areas
within our company, to ensure that information that could affect the financial statements, including the effects of all material agreements, is identified, communicated and addressed on a timely basis.
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9.
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Identify and implement specific steps to improve communication, coordination and oversight with respect to the application of critical accounting policies and the
determination of estimates.
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10.
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Implement month-end, quarter-end and year-end closing schedules and closing checklists to ensure timely and documented completion of the financial statements.
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11.
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Develop and implement a policy and procedure to control the access, modification and review processes for spreadsheets that are used in the preparation of our financial
statements and other disclosures.
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12.
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Conduct training and education of the Finance department personnel on critical accounting policies and procedures, including account reconciliations and financial
statement closing procedures, to develop and maintain an appropriate level of skills for proper identification and application of accounting principles.
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13.
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Define specific roles and responsibilities within the Finance department to improve accounting research and implementation of accounting policies.
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14.
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Conduct training and education for personnel outside the Finance department on critical accounting policies and procedures to improve the level of control awareness at
our company and to ensure an appropriate level of understanding of the proper application of accounting principles that are critical to our financial reporting.
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15.
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Implement processes and procedures to (1) identify and assess whether certain entities are appropriately exempt from the Medicaid best price calculation and
(2) evaluate Public Health Service (PHS) pricing requests.
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16.
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Establish periodic meetings between the contracting functions and the Finance department to improve communication regarding the evaluation and reporting of PHS pricing
requests and related matters.
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Management believes these remediation measures will strengthen our internal control over
financial reporting and remediate the material weaknesses we have identified. However, we have not yet implemented all of these measures and have not completed testing the operating effectiveness of those measures that have been implemented to date.
We are committed to improving our internal control processes and will continue to diligently review our financial controls and procedures. However, any control system, regardless of how well designed, operated and evaluated, can provide only
reasonable, not absolute, assurance that the control objective will be met. As we continue to evaluate and work to improve our internal control over financial reporting, we may take additional measures to address control deficiencies and/or
determine not to complete certain of the remediation measures described above.
(b) Changes in Internal Control Over
Financial Reporting
There were no changes in our internal control over financial reporting (as such term is defined in Exchange Act
Rules 13a-15(f) and 15d-15(f)) during the quarter ended September 30, 2008 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1.
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LEGAL PROCEEDINGS
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The information set
forth under Note 19ContingenciesLitigation and Governmental Inquiries of the Notes to the Consolidated Financial Statements included in Part I, Item 1 in this Quarterly Report on Form 10-Q is incorporated in this Part
II, Item 1 by reference.
Please refer to the risk
factors that are included under the caption Item 1ARisk Factors in our 2009 Form 10-K.
Item 2.
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UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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Purchase of Equity Securities by the Company
The following table provides
information about purchases we made of our common stock during the quarter ended September 30, 2008:
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Period
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Total number
of shares
purchased (a)
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Average price
paid per share
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Total number of
shares purchased
as part of a
publicly announced
program
|
|
Maximum number
of shares that may
yet be purchased
under the program
|
July 131, 2008
|
|
191
|
|
$
|
20.96
|
|
|
|
|
August 131, 2008
|
|
1,048
|
|
$
|
21.96
|
|
|
|
|
September 130, 2008
|
|
772
|
|
$
|
22.95
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
2,011
|
|
$
|
22.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
Shares were purchased from employees upon their termination pursuant to the terms of our stock option plan.
|
65
Item 4.
|
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|
The following provides a summary of votes cast for the proposals on which our stockholders voted at our Annual Meeting of Stockholders held on September 5, 2008.
Proposal No. 1
To consider and approve an amendment to our Certificate of Incorporation to provide that members of the Board of
Directors be elected annually.
|
|
|
|
|
For
|
|
Against
|
|
Abstain
|
11,965,508
|
|
53,598
|
|
5,114
|
The proposal received the
affirmative vote of a majority of the issued and outstanding shares of our Class A Common Stock and Class B Common Stock, voting as a single class, and was approved.
Proposal No. 2
Election of Eight Directors.
|
|
|
|
|
Nominee
|
|
For
|
|
Withhold
|
Jean M. Bellin
|
|
11,907,676
|
|
12,483
|
Kevin S. Carlie
|
|
11,912,633
|
|
7,526
|
Terry B. Hatfield
|
|
11,892,514
|
|
12,645
|
David S. Hermelin
|
|
11,901,351
|
|
3,808
|
Marc S. Hermelin
|
|
11,900,587
|
|
4,572
|
Ronald J. Kanterman
|
|
11,897,627
|
|
7,532
|
Jonathon E. Killmer
|
|
11,892,267
|
|
12,892
|
Norman D. Schellenger
|
|
11,896,471
|
|
8,689
|
Each of the eight directors received
a plurality vote of the issued and outstanding shares of our Class A Common Stock and Class B Common Stock, as a single class, present or represented by proxy at the Annual Meeting and was elected.
Proposals 3 and 4 related to actions to be taken in the event that proposal 1 had not been approved. However, because proposal 1 was approved, proposals 3
and 4 were not acted upon.
Proposal No. 5
To approve an amendment to our Incentive Stock Option Plan to increase by
3,000,000 the number of shares of Class A Common Stock available for issuance upon exercise of stock options granted under the Plan.
|
|
|
|
|
For
|
|
Against
|
|
Abstain
|
8,996,225
|
|
228,059
|
|
8,432
|
The proposal received the
affirmative vote of a majority of the issued and outstanding shares of our Class A Common Stock and Class B Common Stock, as a single class, present or represented by proxy at the Annual Meeting and was approved.
Proposal No. 6
To ratify the selection of KPMG LLP as our independent registered public accounting firm for the fiscal year ending
March 31, 2009.
|
|
|
|
|
For
|
|
Against
|
|
Abstain
|
12,012,912
|
|
5,056
|
|
6,027
|
The proposal received the
affirmative vote of a majority of the issued and outstanding shares of our Class A Common Stock and Class B Common Stock, as a single class, present or represented by proxy at the Annual Meeting and was approved.
66
|
|
|
3.1
|
|
Certificate of Incorporation, as amended through September 5, 2008, incorporated herein by reference to Exhibit 3.1 filed with our Annual Report on Form 10-K for fiscal year
2009, filed March 25, 2010.
|
|
|
3.2
|
|
By-Laws, as amended through December 29, 2009, incorporated herein by reference to Exhibit 3.2 filed with our Current Report on Form 8-K, filed January 4, 2010.
|
|
|
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.*
|
|
|
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.*
|
|
|
32.1
|
|
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
|
|
|
32.2
|
|
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
|
67
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: March 25, 2010
|
|
|
|
By:
|
|
/s/ David A. Van Vliet
|
|
|
|
|
|
|
David A. Van Vliet
|
|
|
|
|
|
|
Interim President and
Interim Chief Executive Officer
|
|
|
|
|
|
|
(Principal Executive Officer)
|
|
|
|
|
Date: March 25, 2010
|
|
|
|
By:
|
|
/s/ Thomas S. McHugh
|
|
|
|
|
|
|
Thomas S. McHugh
|
|
|
|
|
|
|
Interim Chief Financial Officer, Interim
Treasurer, Chief Accounting Officer, Vice
President
of Finance and Corporate Controller
|
|
|
|
|
|
|
(Principal Financial Officer)
|
68
EXHIBIT INDEX
|
|
|
Exhibit
No.
|
|
Description
|
|
|
3.1
|
|
Certificate of Incorporation, as amended through September 5, 2008, incorporated herein by reference to Exhibit 3.1 filed with our Annual Report on Form 10-K for fiscal year 2009,
filed March 25, 2010.
|
|
|
3.2
|
|
By-Laws, as amended through December 29, 2009, incorporated herein by reference to Exhibit 3.2 filed with our Current Report on Form 8-K, filed January 4, 2010.
|
|
|
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.*
|
|
|
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.*
|
|
|
32.1
|
|
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
|
|
|
32.2
|
|
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
|
69
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