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SECURITIES AND EXCHANGE COMMISSION
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WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2002
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COMMISSION FILE NUMBER 1-9601
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K-V PHARMACEUTICAL COMPANY
- ----------------------------------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 43-0618919
- ------------------------------- ------------------------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
2503 SOUTH HANLEY ROAD, ST. LOUIS, MISSOURI 63144
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(ZIP CODE)
(314) 645-6600
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(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL
REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR SUCH SHORTER PERIOD
THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS) AND (2) HAS BEEN
SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
--- ---
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED
FILER (AS DEFINED IN RULE 12B-2 OF THE SECURITIES EXCHANGE ACT OF
1934). YES X NO
--- ---
TITLE OF CLASS OF NUMBER OF SHARES
COMMON STOCK OUTSTANDING AS OF FEBRUARY 4, 2003
------------ ----------------------------------
CLASS A COMMON STOCK, PAR VALUE $.01 PER SHARE 23,650,318
CLASS B COMMON STOCK, PAR VALUE $.01 PER SHARE 10,521,511
1
PART I. - FINANCIAL INFORMATION
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands, except per share data)
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------ --------------------------
2002 2001 2002 2001
------- ------- -------- --------
Net revenues $61,929 $51,553 $171,638 $147,431
Cost of sales 23,728 19,306 66,287 58,133
------- ------- -------- --------
Gross profit 38,201 32,247 105,351 89,298
------- ------- -------- --------
Operating expenses:
Research and development 5,689 3,019 14,244 7,977
Selling and administrative 16,569 15,848 49,390 46,887
Amortization of intangible assets 583 596 1,746 1,774
Litigation (Notes D and H) - - 16,500 -
------- ------- -------- --------
Total operating expenses 22,841 19,463 81,880 56,638
------- ------- -------- --------
Operating income 15,360 12,784 23,471 32,660
------- ------- -------- --------
Other income (expense):
Interest and other income 308 92 694 335
Interest expense (113) (94) (209) (303)
------- ------- -------- --------
Total other income (expense), net 195 (2) 485 32
------- ------- -------- --------
Income before income taxes 15,555 12,782 23,956 32,692
Provision for income taxes 5,409 4,634 8,492 11,851
------- ------- -------- --------
Net income $10,146 $ 8,148 $ 15,464 $ 20,841
======= ======= ======== ========
Net income per common share - basic $0.30 $0.26 $0.47 $0.69
===== ===== ===== =====
Net income per common share - diluted $0.29 $0.25 $0.45 $0.65
===== ===== ===== =====
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
2
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
DECEMBER 31, 2002 MARCH 31, 2002
----------------- --------------
(UNAUDITED)
ASSETS
- ------
Current Assets:
Cash and cash equivalents $ 98,107 $ 12,109
Receivables, less allowance for doubtful accounts of
$370 and $403 at December 31, 2002 and March 31, 2002, respectively 47,448 54,218
Inventories, net 43,288 35,097
Prepaid and other assets 2,224 2,102
Deferred tax asset, net 13,291 5,227
-------- --------
Total Current Assets 204,358 108,753
Property and equipment, less accumulated depreciation 50,117 41,224
Goodwill and other intangible assets, net 40,772 41,292
Other assets 4,453 3,923
-------- --------
TOTAL ASSETS $299,700 $195,192
======== ========
LIABILITIES
- -----------
Current Liabilities:
Accounts payable $ 11,693 $ 10,312
Accrued liabilities 30,373 16,332
Current maturities of long-term debt 712 712
-------- --------
Total Current Liabilities 42,778 27,356
Long-term debt 3,741 4,387
Other long-term liabilities 2,917 2,717
Deferred tax liability, net 2,319 1,940
-------- --------
TOTAL LIABILITIES 51,755 36,400
-------- --------
Commitments and Contingencies
SHAREHOLDERS' EQUITY
- --------------------
7% Cumulative Convertible Preferred Stock, $.01 par value; $25.00
stated and liquidation value; 840,000 shares authorized; issued and
outstanding - 40,000 shares at December 31, 2002 and March 31, 2002
(convertible into Class A shares at a ratio of 5.625-to-one) - -
Class A and Class B Common Stock, $.01 par value; 150,000,000 and
75,000,000 shares authorized, respectively;
Class A-issued 23,644,885 and 20,158,334 at December 31, 2002 and
March 31, 2002, respectively 236 201
Class B-issued 10,573,086 and 10,711,514 at December 31, 2002 and
March 31, 2002, respectively (convertible into Class A shares on a
one-for-one basis) 106 108
Additional paid-in capital 120,919 47,231
Retained earnings 126,712 111,301
Less: Treasury stock, 32 shares of Class A and 53,428 shares of Class B
Common Stock at December 31, 2002 and 40,493 shares of Class A and 53,428
shares of Class B Common Stock at March 31, 2002, at cost (28) (49)
-------- --------
TOTAL SHAREHOLDERS' EQUITY 247,945 158,792
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $299,700 $195,192
======== ========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
NINE MONTHS ENDED
DECEMBER 31,
-----------------------
2002 2001
---- ----
OPERATING ACTIVITIES
Net income $ 15,464 $ 20,841
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation, amortization and other non-cash charges 5,402 4,861
Change in deferred taxes (7,685) (3,076)
Change in deferred compensation 200 225
Changes in operating assets and liabilities:
Decrease (increase) in receivables, net 6,770 (12,417)
(Increase) decrease in inventories, net (8,191) 82
Decrease in prepaid and other assets 1,122 693
Increase in accounts payable and accrued liabilities 15,422 11,178
-------- --------
Net cash provided by operating activities 28,504 22,387
-------- --------
INVESTING ACTIVITIES
Purchase of stock and other intangible assets (3,000) -
Purchase of property and equipment, net (12,549) (5,518)
-------- --------
Net cash used in investing activities (15,549) (5,518)
-------- --------
FINANCING ACTIVITIES
Principal payments on long-term debt (646) (628)
Dividends paid on preferred stock (53) (53)
Proceeds from issuance of common stock 72,385 -
Sale of common stock to employee profit sharing plan 905 -
Exercise of common stock options 452 835
-------- --------
Net cash provided by financing activities 73,043 154
-------- --------
Increase in cash and cash equivalents 85,998 17,023
Cash and cash equivalents at:
Beginning of year 12,109 4,128
-------- --------
End of period $ 98,107 $ 21,151
======== ========
Supplemental information:
Income taxes paid $ 15,844 $ 1,201
Interest paid 321 363
Non-cash investing and financing activities:
Term loan refinanced $ 1,738 $ 2,450
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of K-V
Pharmaceutical Company ("KV" or the "Company") have been prepared in
accordance with generally accepted accounting principles 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 generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments
(consisting of only normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the three-month
and nine-month periods ended December 31, 2002 are not necessarily
indicative of the results that may be expected for the fiscal year ending
March 31, 2003. The interim consolidated financial statements should be read
in conjunction with the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K for the fiscal
year ended March 31, 2002. The balance sheet information as of March 31,
2002, has been derived from the Company's audited consolidated balance sheet
as of that date.
NOTE B - INVENTORIES
Inventories consist of the following:
DECEMBER 31, 2002 MARCH 31, 2002
----------------- --------------
Finished goods $27,539 $18,600
Work-in-process 4,075 4,702
Raw materials 12,249 12,903
------- -------
43,863 36,205
Reserve for obsolescence (575) (1,108)
------- -------
$43,288 $35,097
======= =======
Reserves for potentially obsolete or slow moving inventory are established
by management based on evaluation of inventory levels, estimated time
required to sell such inventory, remaining shelf life, and current and
expected market conditions.
NOTE C - REVENUE RECOGNITION
Revenue is recognized at the time product is shipped to customers. Net
revenues consist of gross sales to customers less provisions for expected
customer returns, rebates, discounts, chargebacks, and other sales
allowances which are established by the Company concurrently with the
recognition of revenue. Sales provisions totaled $24,075 and $20,216 for the
three months ended December 31, 2002 and 2001, respectively, and $68,342 and
$77,148 for the nine months ended December 31, 2002 and 2001, respectively.
The reserve balances related to the sales provisions totaled $26,016 and
$18,958 at December 31, 2002 and March 31, 2002, respectively, and are
included in "Receivables, less allowance for doubtful accounts" in the
accompanying consolidated balance sheets.
5
NOTE D - EARNINGS PER SHARE
Basic earnings per share is calculated by dividing net income available to
common shareholders for the period by the weighted average number of common
shares outstanding during the period. Diluted earnings per share is computed
by dividing net income by the weighted average common shares and common
share equivalents (based on the treasury stock method) outstanding during
the periods presented assuming the conversion of preferred shares and the
exercise of all in-the-money stock options. Common share equivalents have
been excluded from the computation of diluted earnings per share where their
inclusion would be anti-dilutive. The following table sets forth the
computation of basic and diluted earnings per share (in thousands, except
per share data):
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------- ---------------------
2002 2001 2002 2001
---- ---- ---- ----
Numerator:
Net income $10,146 $ 8,148 $15,464 $20,841
Preferred stock dividends (18) (18) (53) (53)
------- ------- ------- -------
Numerator for basic earnings per
share-income available to common
shareholders 10,128 8,130 15,411 20,788
Effect of dilutive securities:
Preferred stock dividends 18 18 53 53
------- ------- ------- -------
Numerator for diluted earnings per
share-income available to common
shareholders after assumed conversions $10,146 $ 8,148 $15,464 $20,841
======= ======= ======= =======
Denominator:
Denominator for basic earnings per
share-weighted-average shares 34,088 30,720 32,899 30,296
------- ------- ------- -------
Effect of dilutive securities:
Stock options 912 1,282 987 1,278
Convertible preferred stock 225 225 225 589
------- ------- ------- -------
Dilutive potential common shares 1,137 1,507 1,212 1,867
------- ------- ------- -------
Denominator for diluted earnings
per share-adjusted weighted-average
shares and assumed conversions 35,225 32,227 34,111 32,163
======= ======= ======= =======
Basic earnings per share (1)(3): $0.30 $0.26 $0.47 $0.69
===== ===== ===== =====
Diluted earnings per share (1)(2)(3): $0.29 $0.25 $0.45 $0.65
===== ===== ===== =====
- -----------------------------
(1) The two-class method for Class A and Class B Common Stock is not
presented because the earnings per share are equivalent to the if
converted method since dividends were not declared or paid and each
class of Common Stock has equal ownership of the Company.
(2) For the quarter and nine months ended December 31, 2002, there were
stock options to purchase 290 shares of Class A and Class B Common
Stock that were excluded from the computation of diluted earnings per
share because their effect would have been anti-dilutive. At December
31, 2001, there were no anti-dilutive shares.
6
(3) Net income for the nine-month period ended December 31, 2002 includes a
litigation reserve of $16,500 for potential damages associated with a
lawsuit (see Note H). The impact of the litigation reserve, net of the
applicable tax effect, is as follows:
NINE MONTHS ENDED
DECEMBER 31,
----------------------
2002 2001
---- ----
Net income:
Net income without litigation reserve $ 25,908 $20,841
Litigation reserve, net of tax (10,444) -
-------- -------
Total net income $ 15,464 $20,841
======== =======
Per basic share:
Net income without litigation reserve $ 0.79 $ 0.69
Litigation reserve, net of tax (0.32) -
-------- -------
Total net income $ 0.47 $ 0.69
======== =======
Per diluted share:
Net income without litigation reserve $ 0.76 $ 0.65
Litigation reserve, net of tax (0.31) -
-------- -------
Total net income $ 0.45 $ 0.65
======== =======
7
NOTE E - SEGMENT FINANCIAL INFORMATION
The reportable operating segments of the Company are branded products,
specialty generics and specialty materials. The operating segments are
distinguished by differences in products, marketing and regulatory approval.
Segment profits are measured based on income before taxes and are determined
based on each segment's direct revenues and expenses. The majority of
research and development expense, corporate general and administrative
expenses, amortization and interest expense, as well as interest and other
income, are not allocated to segments, but included in the "all other"
classification. Identifiable assets for the three reportable operating
segments primarily include receivables, inventory, and property and
equipment. For the "all other" classification, identifiable assets consist
of cash and cash equivalents, property and equipment, goodwill and other
intangible assets, other assets and all income tax related assets. The
accounting policies of the segments are the same as those described in the
Company's Annual Report on Form 10-K for the fiscal year ended March 31,
2002.
The following represents information for the Company's reportable operating
segments for the three and nine months ended December 31, 2002 and 2001.
THREE MONTHS
ENDED BRANDED SPECIALTY SPECIALTY ALL
DECEMBER 31 PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED
----------- -------- -------- --------- ----- ------------ ------------
- ----------------------------------------------------------------------------------------------------------------------------
Net revenues 2002 $12,079 $44,537 $3,865 $1,448 $ - $ 61,929
2001 10,645 35,349 4,540 1,019 - 51,553
- ----------------------------------------------------------------------------------------------------------------------------
Segment profit (loss) 2002 3,315 24,072 (5) (11,827) - 15,555
2001 2,234 19,502 929 (9,883) - 12,782
- ----------------------------------------------------------------------------------------------------------------------------
Identifiable assets 2002 7,962 60,565 9,199 223,132 (1,158) 299,700
2001 7,403 42,752 8,339 126,909 (1,158) 184,245
- ----------------------------------------------------------------------------------------------------------------------------
Property and 2002 4 - 14 2,821 - 2,839
equipment additions 2001 15 45 34 2,035 - 2,129
- ----------------------------------------------------------------------------------------------------------------------------
Depreciation and 2002 72 11 39 1,773 - 1,895
amortization 2001 17 19 35 1,619 - 1,690
- ----------------------------------------------------------------------------------------------------------------------------
NINE MONTHS
ENDED BRANDED SPECIALTY SPECIALTY ALL
DECEMBER 31 PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED
----------- -------- -------- --------- ----- ------------ ------------
- ----------------------------------------------------------------------------------------------------------------------------
Net revenues 2002 $30,499 $125,982 $12,781 $2,376 - $171,638
2001 27,667 102,982 14,394 2,388 - 147,431
- ----------------------------------------------------------------------------------------------------------------------------
Segment profit (loss) (1) 2002 4,401 67,477 1,448 (49,370) - 23,956
2001 3,164 54,570 2,914 (27,956) - 32,692
- ----------------------------------------------------------------------------------------------------------------------------
Property and 2002 625 20 71 11,833 - 12,549
equipment additions 2001 280 123 140 4,975 - 5,518
- ----------------------------------------------------------------------------------------------------------------------------
Depreciation and 2002 183 36 123 5,060 - 5,402
amortization 2001 50 61 109 4,641 - 4,861
- ----------------------------------------------------------------------------------------------------------------------------
- -----------------------------
(1) In the "all other" classification, segment profit (loss) for the
nine-month period ended December 31, 2002 includes a litigation reserve
of $16,500 for potential damages associated with a lawsuit (see Note
H). Excluding the effect of the litigation reserve for potential legal
damages, segment profit on a consolidated basis was $40,456 and segment
loss for the "all other" classification was $(32,870) for the nine
months ended December 31, 2002.
8
NOTE F - GOODWILL AND OTHER INTANGIBLE ASSETS - ADOPTION OF SFAS NO. 142
(Including Goodwill no longer subject to amortization)
Effective April 1, 2002, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets,
issued in June 2001. In accordance with SFAS 142, goodwill and
indefinite-lived intangible assets are no longer subject to amortization,
while the value of other identifiable intangible assets must be amortized
over their estimated useful life. SFAS 142 requires goodwill and
indefinite-lived intangible assets to be tested for impairment annually
using a two-step process, and written off when impaired. In addition,
goodwill and indefinite-lived intangible assets must be tested for
impairment as of the beginning of the fiscal year in which SFAS 142 is
adopted.
As of December 31, 2002, the net carrying amounts of goodwill and other
intangible assets were $556 and $40,216, respectively. With the adoption of
SFAS 142, the Company determined its other intangible assets had finite
useful lives and will continue to be amortized over their estimated useful
lives. Goodwill relates to the 1972 acquisition of the Company's specialty
materials segment. The Company's initial goodwill impairment test as of
April 1, 2002 for the applicable reporting unit resulted in no impairment of
goodwill. The adoption of SFAS 142 did not have a material effect on the
Company's financial condition or results of operations.
The following table reflects consolidated financial results adjusted as
though the adoption of SFAS 142 was applied retroactively:
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------- ---------------------
2002 2001 2002 2001
---- ---- ---- ----
Net income:
As reported $10,146 $8,148 $15,464 $20,841
Goodwill amortization - 14 - 42
------- ------ ------- -------
As adjusted $10,146 $8,162 $15,464 $20,883
======= ====== ======= =======
The retroactive application of the statement had no impact on earnings per
share as previously reported.
The following table reflects the components of intangible assets as of
December 31, 2002:
GROSS
CARRYING ACCUMULATED
AMOUNT AMORTIZATION
------ ------------
Product rights $44,573 $ 8,284
Trademarks and patents 4,217 290
Goodwill 2,138 1,582
------- -------
Total intangible assets $50,928 $10,156
======= =======
9
Amortization expense for the three and nine months ended December 31, 2002
was $579 and $1,732, respectively. Estimated annual amortization expense for
each of the five succeeding fiscal years is as follows:
Fiscal Year Ending March 31: AMOUNT
- ---------------------------- ------
2003 $2,317
2004 2,317
2005 2,317
2006 2,317
2007 2,317
NOTE G - RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2001, the Emerging Issues Task Force issued EITF 01-09,
Accounting for Consideration Given by a Vendor to a Customer or a Reseller
of the Vendor's Products. EITF 01-09 codified and reconciled the task
force's consensuses on prior issues and identified other issues related to
various aspects of the accounting for consideration given by a vendor to a
customer or a reseller of the vendor's products. EITF 01-09 requires certain
items previously reported as selling expenses to be reclassified as
reductions of net revenues in the income statement. EITF 01-09 was effective
for reporting periods beginning after December 15, 2001 and was adopted by
the Company for the fourth quarter of its fiscal year ended March 31, 2002.
In connection with the adoption and to conform to current period
presentation, the Company reclassified certain prior period items which had
been included in selling and administrative expenses to reduce net revenues.
However, the reclassification did not affect reported net income or net
sales growth rates.
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. This statement
is effective for fiscal years beginning after June 15, 2002. Management does
not believe the adoption of this statement will have a material impact on
the results of operations or financial position of the Company.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. SFAS 144 addresses financial accounting
and reporting for the impairment or disposal of long-lived assets. It
supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed of, and certain provisions of
Accounting Principles Board Opinion No. 30, Reporting the Effects of
Disposal of a Segment of a Business and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions, for the disposal of a
segment of a business. SFAS 144 establishes a single accounting model, based
on the framework established in SFAS 121, for long-lived assets to be
disposed of by sale and resolves other implementation issues related to SFAS
121. This statement was adopted by the Company effective April 1, 2002. The
adoption of SFAS 144 did not have a material impact on the Company's results
of operations or financial position.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS 145 rescinds, amends or makes various technical
corrections to certain existing authoritative pronouncements. Management
does not believe the adoption of this statement will have a material impact
on the results of operations or financial position of the Company.
10
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. SFAS 146 addresses the recognition,
measurement and reporting of costs associated with exit and disposal
activities, including costs related to terminating a contract that is not a
capital lease and termination benefits that employees who are involuntarily
terminated receive under the terms of a one-time benefit arrangement that is
not an ongoing benefit arrangement or an individual deferred-compensation
contract. SFAS 146 requires recording costs associated with exit or disposal
activities at their fair values when a liability has been incurred. Under
previous guidance, certain exit costs were accrued upon management's
commitment to an exit plan, which is generally before an actual liability
has been incurred. This statement will be effective for exit or disposal
activities that are initiated after December 31, 2002. Management does not
believe the adoption of this statement will have a material impact on the
results of operations or financial position of the Company.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and Disclosure - an amendment of FASB Statement
No. 123. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements
of SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
Company is required to follow the prescribed format and provide the
additional disclosures required by SFAS No. 148 in its annual financial
statements for the fiscal year ending March 31, 2003 and must also provide
the disclosures in its quarterly reports containing condensed financial
statements for interim periods beginning with the quarterly period ending
June 30, 2003.
NOTE H - CONTINGENCIES - RESERVE FOR POTENTIAL LEGAL DAMAGES
ETHEX Corporation, a wholly-owned subsidiary of the Company, is a defendant
in a lawsuit styled, Healthpoint, Ltd. v. ETHEX Corporation. On September
28, 2001, the jury returned verdicts, in the form of answers to special
interrogatories, against ETHEX on certain false advertising, unfair
competition and misappropriation claims and awarded approximately $16,500 in
damages to Healthpoint. On October 1, 2002, the U.S. District Court for the
Western District of Texas denied the Company's motion to set aside the
jury's verdicts. On December 17, 2002 the court entered a judgment awarding
attorney's fees to Healthpoint in an amount to be subsequently determined.
The Company intends to vigorously appeal the judgment entered by the court.
The Company and its counsel believe that the jury's recommended award is
excessive and is not sufficiently supported by the facts or the law. The
Company and its counsel are not presently able to predict the outcome of an
appeal. However, as a result of the court's decision, the Company's results
of operations for the nine months ended December 31, 2002 include a reserve
for potential damages of $16,500, which is reflected in accrued liabilities
in the Company's Consolidated Balance Sheet as of December 31, 2002.
From time to time, the Company becomes involved in various other legal
matters, in addition to the above-described matters, that the Company
considers to be in the ordinary course of business. For additional
information regarding legal proceedings in which the Company or its
subsidiaries are a party, see Item 1 of Part II of this report. While the
Company is not presently able to determine the potential liability, if any,
related to such matters, the Company believes none of such matters,
individually or in the aggregate, will have a material adverse effect on the
Company's financial position or operations.
NOTE I - SECONDARY STOCK OFFERING
During July 2002, the Company completed a secondary public offering of
approximately 3.3 million shares of Class A Common Stock. Net proceeds to
the Company were $72,385, after deducting underwriting discounts, commissions
and offering expenses.
11
NOTE J - SUPPLEMENTAL CREDIT LINE
During December 2002, the Company extended the expiration of the
supplemental credit line of $20 million for financing acquisitions to
December 2003.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
The materials in this Form 10-Q may contain various forward-looking
statements within the meaning of the Private Securities Litigation Reform
Act of 1995. Any statements about the Company's expectations, beliefs,
plans, objectives, assumptions or future events or performance are not
historical facts and may be forward-looking. These statements are often, but
not always, made through the use of words or phases such as "anticipate,"
"estimate," "plans," "projects," "continuing," "ongoing," "expects,"
"management believes," "the Company believes," "the Company intends" and
similar words or phrases. Accordingly, these statements involve estimates,
assumptions and uncertainties that could cause actual results to differ
materially from those expressed in them. Any forward-looking statements are
qualified in their entirety by reference to the factors discussed throughout
this Form 10-Q.
Factors that could cause actual results to differ materially from the
forward-looking statements include, but are not limited to, the following:
(1) the degree to which the Company is successful in developing new products
and commercializing products under development; (2) the degree to which the
Company is successful in acquiring new pharmaceutical products, drug
delivery technologies and/or companies that offer these properties; (3) the
difficulty of predicting FDA approvals; (4) acceptance and demand for new
pharmaceutical products; (5) the impact of competitive products and pricing;
(6) reliance on key strategic alliances; (7) the availability of raw
materials; (8) the regulatory environment; (9) fluctuations in operating
results; (10) the difficulty of predicting the pattern of inventory
movements by the Company's customers; (11) the impact of competitive
response to the Company's efforts to leverage its brand power with product
innovation, promotional programs, and new advertising; (12) the availability
of third-party reimbursement for the Company's products; (13) the Company's
dependence on sales to a limited number of large pharmacy chains and
wholesale drug distributors for a large portion of its total net sales; and
(14) the other risks detailed from time to time in the Company's filings
with the Securities and Exchange Commission.
Because the factors referred to above, as well as the statements included
under the caption "Management's Discussion and Analysis of Results of
Operations and Financial Condition," and elsewhere in this Form 10-Q, could
cause actual results or outcomes to differ materially from those expressed
in any forward-looking statements made by the Company or on its behalf, you
should not place undue reliance on any forward-looking statements. Further,
any forward-looking statement speaks only as of the date on which it is made
and, unless applicable law requires to the contrary, the Company undertakes
no obligation to update any forward-looking statement to reflect events or
circumstances after the date on which the statement is made or to reflect
the occurrence of unanticipated events. New factors emerge from time to
time, and it is not possible for the Company to predict which factors will
arise, when they will arise and/or their effects. In addition, the Company
cannot assess the impact of each factor on its business or financial
condition or the extent to which any factor, or combination of factors, may
cause actual results to differ materially from those contained in any
forward-looking statements.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Except for the historical information contained herein, the
following discussion contains forward-looking statements that are subject to
known and unknown risks, uncertainties, and other factors that may cause the
Company's actual results to differ materially from those expressed or
implied by those forward-looking statements. These risks, uncertainties and
other factors are discussed above under the caption "Cautionary Statement
Regarding Forward-Looking Information." In addition, the following
discussion and analysis of financial condition and results of operations
should be read in conjunction with the consolidated financial statements,
the related notes to consolidated financial statements and "Management's
Discussion and Analysis of Results of Operations and Financial Condition"
included in the Company's Annual Report on Form 10-K for the fiscal year
ended March 31, 2002, 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.
RESULTS OF OPERATIONS
- ---------------------
REVENUES. Net revenues for the quarter ended December 31, 2002
increased $10.4 million, or 20.1%, to $61.9 million from $51.6 million for
the third quarter in the prior fiscal year. For the nine months ended
December 31, 2002, net revenues increased $24.2 million, or 16.4%, to $171.6
million from $147.4 million for the corresponding period in the prior fiscal
year. The increase in net revenues for both the quarter and nine-month
periods was due to higher sales of branded and specialty generic products.
Branded product sales increased $1.4 million, or 13.5%, to $12.1
million for the quarter ended December 31, 2002 compared to $10.7 million
for the third quarter of the prior fiscal year. For the nine months ended
December 31, 2002, branded product sales increased $2.8 million, or 10.2%,
to $30.5 million compared to $27.7 million for the corresponding prior year
period. The increase in branded product sales for the quarter resulted from
increased sales volume in all product categories. The increase in branded
product sales for the nine-month period was due to continued growth in the
sales volume of the women's healthcare family of products. Sales from this
product line increased $0.8 million, or 9.7%, in the third quarter of fiscal
2003 and $3.7 million, or 19.2%, for the nine-month period ended December
31, 2002. Sales of Gynazole-1(R) continued to grow in the third quarter of
fiscal 2003 as its market share increased to 16.2% at the end of the
quarter, compared to 11.7% at the end of the third quarter of the prior
fiscal year. Due to its continued growth in market share, sales of
Gynazole-1(R) increased $0.4 million, or 15.5%, in the third quarter of
fiscal 2003 compared to the third quarter of the prior fiscal year and
increased $2.7 million, or 39.8%, for the nine months ended December 31,
2002 compared to the corresponding prior year period. Sales from the
cardiovascular product line increased $0.7 million for the quarter ended
December 31, 2002 and declined $0.8 million for the nine-month period ended
December 31, 2002.
Specialty generic product sales increased $9.2 million, or 26.0%,
to $44.5 million for the quarter ended December 31, 2002 compared to $35.3
million for the quarter ended December 31, 2001. For the nine months ended
December 31, 2002, specialty generic product sales increased $23.0 million,
or 22.3%, to $126.0 million compared to $103.0 million for the nine months
ended December 31, 2001. Specialty generic product sales comprised 71.9% and
73.4% of the Company's total net revenues for the quarter and nine months
ended December 31, 2002, respectively, compared to 68.6% and 69.9% for the
corresponding prior year quarter and nine-month periods, respectively. The
increase in sales for both the quarter and nine-month periods was primarily
attributable to an increase in sales volume in the cardiovascular, pain
management, and cough/cold product lines. In addition, during the first nine
months
13
of fiscal 2003, the Company introduced twelve new products into the
specialty generic product line. The increase in sales volume for the third
quarter of fiscal 2003 was comprised of a $6.9 million increase in sales
from existing products and $3.8 million of incremental sales from new
products. These increases were partially offset by $1.5 million of product
price erosion that resulted from normal and expected competitive pricing
pressures on certain products. For the nine-month period ended December 31,
2002, specialty generic sales were favorably impacted by a $16.6 million
increase in sales volume from existing products and $8.1 million of
incremental sales from new products. The volume growth experienced by
specialty generics during the nine months ended December 31, 2002 was
partially offset by $1.6 million of product price erosion. The
cardiovascular product line accounted for $4.6 million and $11.6 million of
the total sales growth for the quarter and nine-month periods ended December
31, 2002, respectively, which were favorably impacted by the April 2002 ANDA
approval and subsequent launch of Potassium Chloride 20 mg. tablets (generic
equivalent to K-Dur(R)).
Net revenues from specialty raw material products decreased $0.7
million, or 14.9%, to $3.9 million for the quarter ended December 31, 2002
compared to $4.5 million for the corresponding fiscal quarter in the prior
year. For the nine months ended December 31, 2002, specialty raw material
product sales decreased $1.6 million, or 11.2%, to $12.8 million compared to
$14.4 million for the first nine months of fiscal 2002. The decrease in
specialty raw material sales for both the quarter and nine-month periods was
primarily due to an unexpected softness in the nutritional supplement market
for which the specialty raw material segment is a supplier.
GROSS PROFIT. Gross profit increased $6.0 million, or 18.5%, to
$38.2 million for the quarter ended December 31, 2002 compared to $32.2
million for the quarter ended December 31, 2001. For the nine months ended
December 31, 2002, gross profit increased $16.1 million, or 18.0%, to $105.4
million compared to $89.3 million for the corresponding prior year period.
The increases in gross profit for both the quarter and nine-month periods
were attributable to the increased level of branded and specialty generic
product sales. Gross profit as a percentage of net revenues decreased to
61.7% for the quarter ended December 31, 2002 compared to 62.6% for the
corresponding prior year quarter. For the nine months ended December 31,
2002, gross profit as a percentage of net revenues increased to 61.4%
compared to 60.6% for the corresponding prior year period. The decrease in
the gross profit percentage for the quarter primarily resulted from a
decline in the gross profit percentage at the specialty raw materials
segment. The gross profit percentage for both the quarter and nine-month
periods was favorably impacted by price increases in the branded business,
coupled with the introduction of new higher margin specialty generic
products.
OPERATING EXPENSES. Research and development expense increased $2.7
million, or 88.4%, to $5.7 million for the quarter ended December 31, 2002
compared to $3.0 million for the quarter ended December 31, 2001. For the
nine months ended December 31, 2002, research and development expense
increased $6.3 million, or 78.6%, to $14.2 million compared to $8.0 million
for the corresponding period in the prior year. The increase in research and
development expense for both the quarter and nine-month periods was due to
an increase in costs associated with clinical testing related to the
Company's internal product development efforts, as well as costs related to
co-development projects. Research and development expense as a percentage of
net revenues increased to 9.2% and 8.3% for the quarter and nine months
ended December 31, 2002, respectively, from 5.9% and 5.4% in the
corresponding prior year quarter and nine-month periods, respectively. In
April 2002, the Company announced that it had received favorable results
from screening studies on a number of products utilizing one of its newest
drug delivery technologies, which, due to the significant revenue and profit
potential of these products, led to the initiation of phase III clinical
trials.
Selling and administrative expense increased $0.7 million, or 4.6%,
to $16.6 million for the quarter ended December 31, 2002 compared to $15.8
million for the quarter ended December 31, 2001. For the nine months ended
December 31, 2002, selling and administrative expense increased $2.5
million, or 5.3%, to $49.4 million compared to $46.9 million for the
corresponding prior year period. The
14
increases in selling and administrative expense were primarily the result of
an increase in specialty generic selling and marketing expenses, higher
insurance costs for all segments and an increase in personnel costs
associated with branded marketing, partially offset by a reduction in legal
expenses. Selling and administrative expense as a percentage of net revenues
decreased to 26.8% and 28.8% for the quarter and nine months ended December
31, 2002, respectively, compared to 30.7% and 31.8% for the corresponding
prior year quarter and nine-month periods, respectively.
In September 2002, the Company recorded a litigation reserve of
$16.5 million for potential damages associated with the adverse decision
made by a federal court in Texas to uphold a previously rendered jury
verdict in a lawsuit against ETHEX Corporation, a wholly-owned subsidiary of
the Company (see Note H in the accompanying Notes to Consolidated Financial
Statements in this Quarterly Report). Excluding the effect of this
litigation reserve, net income for the nine months ended December 31, 2002
increased $5.1 million, or 24.3%, to $25.9 million, or $0.76 per diluted
share.
OPERATING INCOME. As a result of the factors described above, the
Company had operating income of $15.4 million for the quarter ended December
31, 2002 compared to operating income of $12.8 million for the quarter ended
December 31, 2001. For the nine months ended December 31, 2002, operating
income decreased $9.2 million, or 28.1%, to $23.5 million compared to $32.7
million for the same period last year. Excluding the effect of the
litigation reserve for potential legal damages, operating income increased
$7.3 million, or 22.4%, to $40.0 million for the nine months ended December
31, 2002.
OTHER INCOME (EXPENSE). For the three and nine months ended
December 31, 2002, interest and other income increased $0.2 million and $0.4
million, respectively. The increase in interest and other income for both
the quarter and nine-month periods resulted from interest earned on $72.4
million of net proceeds from the Company's secondary public offering of
approximately 3.3 million shares of Class A common stock in July 2002. Since
the offering, the net proceeds have been deposited in short-term, highly
liquid investments.
PROVISION FOR INCOME TAXES. The effective tax rates for the quarter
and nine months ended December 31, 2002 were 34.8% and 35.4%, respectively,
compared to 36.3% for both of the corresponding prior year periods. The
decrease in the effective tax rate for both the quarter and nine-month
periods was primarily due to an increase in research and development
credits.
NET INCOME. As a result of the factors described above, the Company
had net income of $10.1 million, or $0.29 per diluted share, for the quarter
ended December 31, 2002 compared to net income of $8.1 million, or $0.25 per
diluted share, for the quarter ended December 31, 2001. For the nine months
ended December 31, 2002, net income decreased $5.4 million, or 25.8%, to
$15.5 million, or $0.45 per diluted share, compared to $20.8 million, or
$0.65 per diluted share, for the corresponding prior year period. Excluding
the effect of the litigation reserve for potential legal damages, net
income increased $5.1 million, or 24.3%, to $25.9 million, or $0.76 per
diluted share for the nine months ended December 31, 2002. The increases in
earnings per diluted share were partially impacted by an increase in
weighted average shares outstanding that resulted from the issuance of
approximately 3.3 million shares of Class A common stock in the secondary
public offering that was completed in July 2002.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The Company's cash and cash equivalents and working capital were
$98.1 million and $161.6 million, respectively, at December 31, 2002,
compared to $12.1 million and $81.4 million, respectively, at March 31,
2002. Internally generated funds from product sales growth continued to be
the
15
primary source of operating capital used to fund the Company's businesses.
The net cash flow from operating activities was $28.5 million for the nine
months ended December 31, 2002 compared to $22.4 million for the
corresponding period in the prior year. The 27.3% increase in operating cash
flow resulted primarily from a $6.8 million decrease in receivables for the
nine months ended December 31, 2002 compared to a $12.4 million increase in
receivables for the corresponding period in the prior year. The favorable
impact of the change in receivables was offset partially by an increase in
inventories during the nine months ended December 31, 2002. The decrease in
receivables was primarily due to the receipt of certain delayed customer
payments, which were due as of March 31, 2002 and collected during the
quarter ended June 30, 2002. The increase in inventories primarily resulted
from increased production of specialty generic products in anticipation of
continued sales growth and to support seasonal demand of the cough/cold
product line.
Net cash used in investing activities was $15.5 million for the
nine months ended December 31, 2002 compared to $5.5 million for the
corresponding period in the prior year. Capital expenditures of $12.5
million for the nine months ended December 31, 2002 were funded by net cash
flows from operating activities. The Company's investment in capital assets
was primarily for purchasing machinery and equipment to upgrade and expand
the Company's pharmaceutical manufacturing and distribution capabilities,
and for other building renovations. Investing activities for the period also
included $3.0 million related to the purchase of certain intangible rights
combined with an equity investment in a women's healthcare company.
Long-term debt decreased to $4.5 million at December 31, 2002
compared to $5.1 million at March 31, 2002. The decrease resulted from
principal payments made during the nine months ended December 31, 2002. In
December 2002, the Company refinanced a $1.7 million building mortgage that
was due in March 2004. The refinanced building mortgage bears interest at
6.27% and is due in December 2007.
The Company has a credit agreement with a bank that provides for a
revolving line of credit for borrowing up to $60 million. The credit
agreement provides for a $40 million unsecured revolving line of credit,
along with an unsecured supplemental credit line of $20 million for
financing acquisitions. The $40 million unsecured revolving line of credit
expires in October 2004. The unsecured supplemental credit line of $20
million, which was renewed in December 2002, expires in December 2003. At
December 31, 2002, the Company had no cash borrowings outstanding under either
credit facility.
During July 2002, the Company completed a secondary public offering
of approximately 3.3 million shares of Class A common stock. Net proceeds to
the Company were approximately $72.4 million, after deducting underwriting
discounts, commissions and offering expenses. The proceeds from the offering
will be used for general corporate purposes, including potential
acquisitions, research and development activities and working capital. At
December 31, 2002, the net proceeds were invested in short-term, highly
liquid instruments.
The Company believes its cash and cash equivalents balance, cash
flow from operations, funds available under its credit facilities and
proceeds received from its recently completed secondary public offering of
Class A common stock will be adequate to fund operating activities for the
presently foreseeable future, including the payment of short-term and
long-term debt obligations, capital improvements, product development
activities and expansion of marketing capabilities for the branded
pharmaceutical business. In addition, the Company continues to examine
opportunities to expand its business through the acquisition of or
investment in companies, technologies, product rights or other investments
that are compatible with its existing business. The Company intends to use
its available cash to help in funding any acquisitions or investments. As
such, cash has been invested in short-term, highly liquid instruments. The
Company may also use funds available under its credit facilities, or
financing sources that subsequently become available, including the issuance
of additional debt or equity securities,
16
to fund such acquisitions or investments. If the Company were to fund one or
more such acquisitions or investments, the Company's capital resources,
financial condition and results of operations could be materially impacted
in future periods.
INFLATION
- ---------
Although at reduced levels in recent years, inflation continues to
apply upward pressure on the cost of goods and services used by the Company.
However, the Company believes that the net effect of inflation on its
operations has been minimal during the past three years. In addition,
changes in the mix of products sold and the effect of competition has made a
comparison of changes in selling prices less meaningful relative to changes
in the overall rate of inflation over the past three years.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
- ------------------------------------------
The Company's consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires the Company
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent
liabilities. On an on-going basis, the Company evaluates its estimates
including those related to the allowance for inventories, sales allowances
and useful life or impairment of other intangibles. The Company bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form
the basis of judgments regarding the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or conditions.
The Company believes the following critical accounting policies
affect its more significant judgments and estimates used in the preparation
of its unaudited consolidated financial statements.
ALLOWANCE FOR INVENTORIES. Inventories are stated at the
lower of cost or market, with cost determined on the first-in, first-out
basis. In evaluating whether inventory is stated at the lower of cost or
market, management considers such factors as the amount of inventory on hand
and in the distribution channel, estimated time required to sell such
inventory, remaining shelf life and current and expected market conditions,
including levels of competition. As appropriate, provisions are made to
reduce inventories to their net realizable value. As of December 31, 2002,
the Company had an inventory reserve of $0.6 million.
REVENUE RECOGNITION AND SALES ALLOWANCES. Revenue is recognized at
the time product is shipped to customers. Sales provisions for estimated
chargebacks, discounts, rebates, returns, pricing adjustments and other
sales allowances are established by the Company concurrently with the
recognition of revenue. The sales provisions are established based upon
consideration of a variety of factors, including but not limited to, actual
return and historical experience by product type, the number and timing of
competitive products approved for sale, the expected market for the product,
estimated customer inventory levels by product, price declines and current
and projected economic conditions and levels of competition. Actual product
returns, chargebacks and other sales allowances incurred are, however,
dependent upon future events. 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. As of
December 31, 2002, reserve balances related to the sales allowances totaled
$26.0 million.
OTHER INTANGIBLE ASSETS. Effective April 1, 2002, the Company
adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill
and Other Intangible Assets, issued in June 2001. With the adoption of SFAS
142, the Company determined its Other Intangible Assets had finite useful
lives and will continue to be amortized over their estimated useful life.
(See Note F - Goodwill
17
and Other Intangible Assets - Adoption of SFAS No. 142 above for a
discussion on SFAS 142.) The adoption of SFAS 142 did not have a material
effect on the Company's financial condition or results of operations.
Other Intangible Assets consist primarily of brand product rights
purchased from other pharmaceutical companies, all of which are being
amortized over 20-year periods. The amortization periods for product rights
are based on the Company's assessment of various factors impacting estimated
useful lives and cash flows of the acquired products. Such factors include
the product's position in its life cycle, competitive positioning, the
existence or absence of like products in the market and various competitive
and technical issues. Other Intangible Assets also consist of patents and
trademarks, which are being amortized over periods ranging from five to 17
years. As of December 31, 2002, the net carrying amount of Other Intangibles
Assets was $40.2 million. Amortization is calculated using the straight-line
method over the estimated useful life. Intangible assets are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Advances to the Company under the Company's credit facilities bear
interest at a rate that varies consistent with increases or decreases in the
publicly-announced prime rate and/or the LIBOR rate with respect to
LIBOR-related loans, if any. A material increase in such rates could
significantly increase borrowing expenses. The Company did not have any cash
borrowings under the credit facilities at December 31, 2002.
ITEM 4. CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Company's
chief executive officer and chief financial officer have concluded that the
Company's disclosure controls and procedures (as defined in Rules
240.13a-14(c) and 15d-14(c) promulgated under the Securities Exchange Act of
1934) are sufficiently effective to ensure that the information required to
be disclosed by the Company in the reports it files under the Exchange Act
is gathered, analyzed and disclosed with adequate timeliness, accuracy and
completeness, based on an evaluation of such controls and procedures within
90 days prior to the date hereof.
(b) CHANGES IN INTERNAL CONTROLS. There have been no significant
changes in the Company's internal controls or in other factors that could
significantly affect these controls subsequent to the date of the evaluation
referred to above, nor were there any corrective actions with regard to
significant deficiencies or material weaknesses.
18
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ETHEX Corporation, a wholly-owned subsidiary of the Company, is a
defendant in a lawsuit styled, Healthpoint, Ltd. v. ETHEX Corporation,
pending in federal court in the Western District of Texas, San Antonio
Division. The suit was filed by Healthpoint on August 3, 2000, and later was
joined by companies affiliated with Healthpoint. In general, the plaintiffs
allege that ETHEX's promotion of its Ethezyme(TM) product as an alternative
to Healthpoint's Accuzyme(R) product resulted in false advertising and
misleading statements under various federal and state laws, and unfair
competition and misappropriation of trade secrets. In September 2001, the
jury returned verdicts against ETHEX on certain false advertising, unfair
competition and misappropriation claims. The jury awarded compensatory and
punitive damages totaling $16.5 million. On October 1, 2002, the U.S.
District Court for the Western District of Texas denied the Company's motion
to set aside the jury's verdicts. On December 17, 2002 the court entered a
judgment awarding attorney's fees to Healthpoint in an amount to be
subsequently determined. The Company intends to vigorously appeal the
judgment entered by the court. The Company and its counsel believe that the
jury's recommended award is excessive and is not sufficiently supported by
the facts or the law. The Company and its counsel are not presently able to
predict the outcome of an appeal, however, as a result of the court's
decision, the Company's results of operations for the nine months ended
December 31, 2002 include a reserve for potential damages of $16.5 million,
which is reflected in Accrued liabilities in the Company's Consolidated
Balance Sheet as of December 31, 2002.
The Company previously manufactured two low-volume pharmaceutical
products that contained phenylpropanolamine, or PPA, that were discontinued
and/or reformulated to exclude PPA in 2000 and 2001, respectively. The
Company was named as one of several defendants in two product liability
lawsuits in federal courts involving PPA. These two lawsuits have been
transferred to the nationwide, multi-district litigation for PPA claims now
pending in the U.S District Court for the Western District of Washington.
Each lawsuit alleges bodily injury, wrongful death, economic injury,
punitive damages, loss of consortium and/or loss of services from the use of
pharmaceuticals containing PPA. Discovery in these cases is ongoing. The
Company believes that it has substantial defenses to these claims, although
the ultimate outcome of these cases and the potential material effect on the
Company cannot be determined.
The Company is being defended and indemnified in these two PPA
lawsuits by its primary commercial general liability insurer subject to
aggregate products-completed operations policy limits in the amount of $10
million and subject to a reservation of rights. The Company's product
liability-completed operations coverage was obtained on a claims made basis
and provides coverage for judgments, settlements and defense costs arising
from product liability claims. Although the Company renewed its product
liability coverage for a policy term of June 15, 2002 through June 15, 2003,
that renewal policy excludes future PPA claims in accordance with the
standard industry exclusion. Consequently, as of June 15, 2002, the Company
must provide for legal defense costs and indemnity payments involving PPA
claims made after June 14, 2002, should they occur.
From time to time, the Company becomes involved in various legal
matters, in addition to the above-described matters, that the Company
considers to be in the ordinary course of business. While the Company is not
presently able to determine the potential liability, if any, related to such
matters, the Company believes none of such matters, individually or in the
aggregate, will have a material adverse effect on the Company's financial
position.
19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits 99.1 and 99.2 - Certifications of Chief
Executive Officer and Chief Financial Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
b) Reports on Form 8-K. The Company filed on October 8,
2002 a Current Report on Form 8-K to report pursuant
to Item 5 that the U.S. District Court for the Western
District of Texas had denied the motion of Ethex
Corporation, a wholly-owned subsidiary of the Company,
that would have had the effect of setting aside the
September 2001 jury verdict in the civil case of
Healthpoint, Ltd. v. Ethex Corporation.
20
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: January 17, 2003 By /s/ Marc S. Hermelin
-----------------------------------
Marc S. Hermelin
Vice Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: February 13, 2003 By /s/ Gerald R. Mitchell
-----------------------------------
Gerald R. Mitchell
Vice President, Treasurer and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
21
CERTIFICATIONS
I, Marc S. Hermelin, certify that:
1. I have reviewed this quarterly report on Form 10-Q of K-V
Pharmaceutical Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading
with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and we have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a. All significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b. Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were any significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of
our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: January 17, 2003 /s/ Marc S. Hermelin
------------------------------------------
Marc S. Hermelin
Vice Chairman and Chief Executive Officer
22
I, Gerald R. Mitchell, certify that:
1. I have reviewed this quarterly report on Form 10-Q of K-V
Pharmaceutical Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading
with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and we have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a. All significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b. Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were any significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of
our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: February 13, 2003 /s/ Gerald R. Mitchell
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Gerald R. Mitchell
Vice President, Treasurer and
Chief Financial Officer
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