e10vq
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
Form 10-Q
 
     
(Mark One)    
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the quarterly period ended June 30, 2010
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to          
 
Commission File No. 001-15875
 
 
King Pharmaceuticals, Inc.
(Exact name of registrant as specified in its charter)
 
     
Tennessee
  54-1684963
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
501 Fifth Street,
Bristol, TN
(Address of principal executive offices)
  37620
(Zip Code)
(423) 989-8000
(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 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 þ     No o
 
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 þ     No o
 
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):
 
             
Large accelerated filer þ
       Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
    (Do not check if a smaller reporting company)     
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
Number of shares outstanding of Registrant’s common stock as of August 4, 2010: 249,662,593
 


 

 
Table of Contents
 
             
        Page
 
PART I — Financial Information        
Item 1.   Financial Statements     2  
    Condensed Consolidated Balance Sheets     2  
    Condensed Consolidated Statements of Operations     3  
    Condensed Consolidated Statements of Changes in Shareholders’ Equity and Other Comprehensive Income     4  
    Condensed Consolidated Statements of Cash Flows     5  
    Notes to Condensed Consolidated Financial Statements     6  
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations     33  
Item 3.   Quantitative and Qualitative Disclosures about Market Risk     57  
Item 4.   Controls and Procedures     57  
       
PART II — Other Information        
Item 1.   Legal Proceedings     58  
Item 1A.   Risk Factors     58  
Item 6.   Exhibits     58  
Signatures     59  
 EX-3.1
 EX-3.2
 EX-10.1
 EX-10.2
 EX-10.3
 EX-10.4
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT


Table of Contents

 
PART I — FINANCIAL INFORMATION
 
Item 1.   Financial Statements
 
KING PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
 
                 
    June 30,
    December 31,
 
    2010     2009  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 573,062     $ 545,312  
Investments in debt securities
    16,346       29,258  
Marketable securities
    1,022       2,100  
Accounts receivable, net of allowance of $3,338 and $3,401
    209,585       210,256  
Inventories
    195,614       182,291  
Deferred income tax assets
    72,494       83,675  
Income taxes receivable
    13,341       16,091  
Prepaid expenses and other current assets
    29,323       60,860  
                 
Total current assets
    1,110,787       1,129,843  
                 
Property, plant and equipment, net
    377,298       391,839  
Intangible assets, net
    719,862       794,139  
Goodwill
    466,283       467,613  
Deferred income tax assets
    259,579       264,162  
Investments in debt securities
    169,777       218,608  
Other assets (includes restricted cash of $15,905 and $15,900)
    58,748       56,496  
Assets held for sale
    5,890       5,890  
                 
Total assets
  $ 3,168,224     $ 3,328,590  
                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 74,176     $ 86,692  
Accrued expenses
    228,747       320,992  
Short-term debt
    3,506       3,662  
Current portion of long-term debt
          85,550  
                 
Total current liabilities
    306,429       496,896  
                 
Long-term debt
    341,735       339,016  
Other liabilities
    126,604       123,371  
                 
Total liabilities
    774,768       959,283  
                 
Commitments and contingencies (Note 9)
               
Shareholders’ equity
    2,393,456       2,369,307  
                 
Total liabilities and shareholders’ equity
  $ 3,168,224     $ 3,328,590  
                 
 
See accompanying notes.


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KING PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2010     2009     2010     2009  
 
Revenues:
                               
Net sales
  $ 332,853     $ 430,299     $ 705,931     $ 844,631  
Royalties
    38,050       14,689       45,827       29,414  
                                 
Total revenues
    370,903       444,988       751,758       874,045  
                                 
Operating costs and expenses:
                               
Cost of revenues, exclusive of depreciation and amortization shown below
    119,027       156,093       246,081       307,032  
                                 
Selling, general and administrative
    131,829       120,631       272,304       259,165  
Acquisition related costs
          2,944             6,733  
                                 
Total selling, general and administrative expense
    131,829       123,575       272,304       265,898  
                                 
Research and development
    33,174       21,202       61,498       48,458  
Depreciation and amortization
    53,903       52,862       111,178       106,211  
Restructuring charges (Note 13)
    4,852       1,475       5,114       49,525  
                                 
Total operating costs and expenses
    342,785       355,207       696,175       777,124  
                                 
Operating income
    28,118       89,781       55,583       96,921  
                                 
Other income (expense):
                               
Interest income
    487       1,506       896       4,294  
Interest expense
    (7,479 )     (27,592 )     (16,215 )     (50,695 )
Gain on Kadian® (Note 6)
    12,500             12,500        
Gain (loss) on investments
    249       (524 )     (623 )     (1,347 )
Loss on early extinguishment of debt
    (2,252 )           (2,252 )      
Other, net
    (1,753 )     4,112       (1,956 )     1,333  
                                 
Total other income (expense)
    1,752       (22,498 )     (7,650 )     (46,415 )
                                 
Income before income taxes
    29,870       67,283       47,933       50,506  
Income tax expense
    11,882       29,348       25,476       23,293  
                                 
Net income
  $ 17,988     $ 37,935     $ 22,457     $ 27,213  
                                 
Net income per common share:
                               
Basic net income per common share
  $ 0.07     $ 0.16     $ 0.09     $ 0.11  
                                 
Diluted net income per common share
  $ 0.07     $ 0.15     $ 0.09     $ 0.11  
                                 
 
See accompanying notes.


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KING PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
AND OTHER COMPREHENSIVE INCOME
(In thousands, except share data)
(Unaudited)
 
                                         
                      Accumulated
       
                      Other
       
    Common Stock     Retained
    Comprehensive
       
    Shares     Amount     Earnings     Income (Loss)     Total  
 
Balance at December 31, 2008
    246,487,232     $ 1,391,065     $ 871,021     $ (28,287 )   $ 2,233,799  
Adoption of new accounting standard, net of taxes of $396 (Note 3)
                646       (646 )      
Comprehensive income:
                                       
Net income
                27,213             27,213  
Reclassification of unrealized losses on investments in debt securities, net of taxes of $542
                      885       885  
Net unrealized gain on marketable securities, net of taxes of $345
                      563       563  
Net unrealized loss on interest rate swap, net of taxes of $88
                      (144 )     (144 )
Net unrealized gain on investments in debt securities, net of taxes of $2,518
                      4,108       4,108  
Foreign currency translation
                      (235 )     (235 )
                                         
Total comprehensive income
                                    32,390  
Stock-based award activity
    1,642,536       13,641                   13,641  
                                         
Balance at June 30, 2009
    248,129,768     $ 1,404,706     $ 898,880     $ (23,756 )   $ 2,279,830  
                                         
Balance at December 31, 2009
    248,444,711     $ 1,421,489     $ 963,620     $ (15,802 )   $ 2,369,307  
Comprehensive income:
                                       
Net income
                22,457             22,457  
Reclassification of unrealized losses on investments in debt securities, net of taxes of $268
                      428       428  
Net unrealized loss on marketable securities, net of taxes of $305
                      (773 )     (773 )
Net unrealized gain on investments in debt securities, net of taxes of $1,798
                      2,875       2,875  
Foreign currency translation
                      (12,882 )     (12,882 )
                                         
Total comprehensive income
                                    12,105  
Stock-based award activity
    1,219,802       12,044                   12,044  
                                         
Balance at June 30, 2010
    249,664,513     $ 1,433,533     $ 986,077     $ (26,154 )   $ 2,393,456  
                                         
 
See accompanying notes.


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KING PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
                 
    Six Months Ended June 30,  
    2010     2009  
 
Cash flows provided by operating activities
  $ 48,875     $ 117,566  
                 
Cash flows from investing activities:
               
Transfers to restricted cash
    (5 )     (55 )
Proceeds from maturities and sales of investments in debt securities
    67,860       32,223  
Purchases of property, plant and equipment
    (17,299 )     (18,832 )
Proceeds from sale of property and equipment
    235        
Proceeds from sale of Kadian®
    40,000       34,800  
Acquisition of Alpharma
          (70,374 )
Forward foreign exchange contracts
          (3,117 )
Purchases of intellectual property and product rights
    (1,280 )     (1,207 )
                 
Net cash provided by (used in) investing activities
    89,511       (26,562 )
                 
Cash flows from financing activities:
               
Proceeds from exercise of stock options
    963       1,286  
Net payments related to stock-based award activity
    (4,979 )     (3,123 )
Payments on debt
    (92,417 )     (585,227 )
Debt issuance costs
    (4,315 )     (1,313 )
                 
Net cash used in financing activities
    (100,748 )     (588,377 )
                 
Effect of exchange rate changes on cash
    (9,888 )     (647 )
                 
Increase (decrease) in cash and cash equivalents
    27,750       (498,020 )
Cash and cash equivalents, beginning of period
    545,312       940,212  
                 
Cash and cash equivalents, end of period
  $ 573,062     $ 442,192  
                 
 
See accompanying notes.


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010 and 2009
(In thousands, except share and per share data)
(Unaudited)
 
1.   General
 
The accompanying unaudited Condensed Consolidated Financial Statements of King Pharmaceuticals, Inc. (“King” or the “Company”) were prepared by the Company in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X and, accordingly, 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 items of a normal recurring nature) considered necessary for a fair presentation are included. Operating results for the six months ended June 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. The year-end Condensed Consolidated Balance Sheet included in this Form 10-Q was derived from the audited Consolidated Financial Statements, but does not include all disclosures required by generally accepted accounting principles.
 
These unaudited Condensed Consolidated Financial Statements include the accounts of King and all of its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
 
Certain amounts from the prior Condensed Consolidated Financial Statements have been reclassified to conform to the presentation adopted in 2010.
 
2.   Earnings Per Share
 
Basic and diluted income per common share were determined using the following share data:
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2010     2009     2010     2009  
 
Basic net income per common share:
                               
Weighted average common shares
    245,786,855       244,693,041       245,496,207       244,290,940  
                                 
Diluted net income per common share:
                               
Weighted average common shares
    245,786,855       244,693,041       245,496,207       244,290,940  
Effect of stock options
    263,519       20,242       463,708       12,709  
Effect of dilutive share awards
    3,324,536       2,493,266       3,660,933       2,618,332  
                                 
Weighted average common shares
    249,374,910       247,206,549       249,620,848       246,921,981  
                                 
 
For the three months ended June 30, 2010, the weighted average shares that were anti-dilutive, and therefore excluded from the calculation of diluted income per common share, included options to purchase 5,525,900 shares of common stock, 795,260 restricted stock awards (“RSAs”) and 878,690 long-term performance units (“LPUs”). For the six months ended June 30, 2010, the weighted average shares that were anti-dilutive, and therefore excluded from the calculation of diluted income per common share, included options to purchase 4,359,163 shares of common stock, 448,807 RSAs and 492,449 LPUs. For the three months ended June 30, 2009, the weighted average shares that were anti-dilutive, and therefore excluded from the calculation of diluted income per common share, included options to purchase 7,902,942 shares of common stock, 286,368 RSAs and 371,840 LPUs. For the six months ended June 30, 2009, the weighted average shares that were anti-dilutive, and therefore excluded from the calculation of diluted income per common share included options to purchase 7,029,986 shares of common stock, 303,948 RSAs and 262,723 LPUs. The 11/4% Convertible Senior Notes due April 1, 2026, the “Convertible Senior Notes”, could be converted into the Company’s common stock in the future, subject to certain contingencies. Shares of the Company’s common stock associated with this right of conversion were excluded from the calculations of


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
diluted income per common share because the conversion price of the notes was greater than the average market price of the Company’s common stock during the three and six months ended June 30, 2009 and 2010.
 
3.   Fair Value Measurements
 
Cash and Cash Equivalents.  The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The Company’s cash and cash equivalents consisted of institutional money market funds. There were no cumulative unrealized holding gains or losses associated with these money market funds as of June 30, 2010 and December 31, 2009.
 
Derivatives.  During 2009, the Company had forward foreign exchange contracts outstanding on certain non-U.S. cash balances. The forward exchange contracts were not designated as hedges. The Company recorded these contracts at fair value and changes in fair value were recognized in current earnings. All foreign exchange contracts expired during 2009.
 
The terms of certain credit agreements required the Company to maintain hedging agreements that fix the interest rates on 50% of the Company’s total outstanding long-term debt. Accordingly, in March 2009 the Company entered into an interest rate swap agreement with an aggregate notional amount of $112,500, which was scheduled to expire in March 2011. The interest rate swap was designated as a cash flow hedge and was being used to offset the overall variability of cash flows. For a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the period during which the hedged transaction affects earnings. As a result of the reduction of its variable rate long-term debt beginning in the third quarter of 2009, more than 50% of the Company’s outstanding long-term debt was at fixed rates and therefore an interest rate swap was no longer required. The Company terminated the interest rate swap in the third quarter of 2009.
 
The following tables summarize the effect of derivative instruments on the Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2009:
 
                                                 
    Three Months Ended June 30, 2009   Six Months Ended June 30, 2009
        Gain or (Loss)
          Gain or (Loss)
   
    Gain or (Loss)
  Reclassified from
          Reclassified from
   
    in Other
  Accumulated
      Gain or (Loss)
  Accumulated
   
    Comprehensive
  Other
      in Other
  Other
   
    Income
  Comprehensive
  Gain or (Loss)
  Comprehensive
  Comprehensive
  Gain or (Loss)
    on
  Income into
  Recorded
  Income on
  Income into
  Recorded
    Derivative
  Income
  in Income
  Derivative
  Income
  in Income
Derivatives in Cash Flow
  (Effective
  (Effective
  (Ineffective
  (Effective
  (Effective
  (Ineffective
Hedging Relationships   Portion)   Portion)   Portion)   Portion)   Portion)   Portion)
 
Interest rate swap
  $ 299     $     $     $ (232 )   $     $  
 
                     
        Three Months Ended June 30, 2009   Six Months Ended June 30, 2009
Derivatives not Designated as
      Gain or (Loss) Recognized
  Gain or (Loss) Recognized
Hedging Instruments       in Income on Derivative   in Income on Derivative
 
Foreign currency contracts
  Other Income   $ (8,523 )   $ 429  
 
Marketable Securities.  As of June 30, 2010 and December 31, 2009, the Company’s investment in marketable securities consisted solely of Palatin Technologies, Inc. common stock with a cost basis of $511. The cumulative unrealized holding gain in this investment was $511 and $1,589, respectively, as of June 30, 2010 and December 31, 2009.
 
Investments in Debt Securities.  The Company undertook investments in auction rate securities prior to the end of the first quarter of 2008. Tax-exempt auction rate securities are long-term variable rate bonds tied to short-term interest rates that are intended to reset through an auction process generally every 7, 28 or 35 days. On February 11, 2008, the Company began to experience auction failures with respect to its investments in auction rate securities. In the event of an auction failure, the interest rate on the security is reset according to the contractual terms in the underlying indenture. The Company will not be able to liquidate these securities until a successful


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
auction occurs, the issuer calls or restructures the underlying security, the underlying security matures or it is purchased by a buyer outside the auction process.
 
The Company classified auction rate securities as available-for-sale at the time of purchase. Temporary gains or losses are included in accumulated other comprehensive income (loss). Other-than-temporary credit losses are included in Gain (loss) on investments in the Condensed Consolidated Statements of Operations. Non-credit related other-than-temporary losses are recorded in accumulated other comprehensive income (loss), as the Company has no intent to sell the securities and believes that it is more likely than not that it will not be required to sell the securities prior to recovery.
 
As of June 30, 2010 and December 31, 2009, the par value of the Company’s investments in debt securities was $213,025 and $281,525, respectively, and consisted solely of tax-exempt auction rate securities associated with municipal bonds and student loans. The Company has not invested in any mortgage-backed securities or any securities backed by corporate debt obligations. The Company’s investment policy requires it to maintain an investment portfolio with a high credit quality. Accordingly, the Company’s investments in debt securities were limited to issues which were rated AA or higher at the time of purchase.
 
Excluding the municipal bond discussed below, as of June 30, 2010, there were cumulative unrealized holding losses of $21,195 recorded in accumulated other comprehensive income (loss) on the Condensed Consolidated Balance Sheet associated with investments in debt securities with a par value of $179,825, which were classified as available for sale. All of these investments in debt securities have been in continuous unrealized loss positions for greater than 12 months. As of June 30, 2010, the Company believed the decline associated with the underlying securities was temporary and it was probable that the par amount of these auction rate securities would be collectible under their contractual terms.
 
As of April 1, 2009, the Company adopted a new statement of the Financial Accounting Standards Board (“FASB”) that provides guidance in determining whether impairments in debt securities are other-than-temporary, and modifies the presentation and disclosures surrounding such instruments. During the fourth quarter of 2008, the Company recognized unrealized losses of $6,832 in other (expense) income for a municipal bond with a par value of $15,000 for which the holding losses were determined to be other-than-temporary. The Company determined that $1,042 (or $646 net-of-tax) of this previously recognized loss was non-credit related. Upon the adoption of this statement, the Company was required to reclassify this non-credit related loss from retained earnings to accumulated other comprehensive income (loss). As of June 30, 2010, there were cumulative unrealized holding gains of $1,936 associated with this security recorded in accumulated other comprehensive income (loss) on the Condensed Consolidated Balance Sheet. For the three and six months ended June 30, 2010, no other-than-temporary impairment losses associated with available for sale investments in debt securities were recognized.
 
During the first quarter of 2010, the Company sold certain auction rate securities associated with student loans with a par value of $8,000 for $7,360 to the issuer and realized a loss of $640 in the Condensed Consolidated Statements of Operations. During the second quarter of 2009, the Company sold certain auction rate securities associated with student loans with a par value of $20,350 for $18,923 to the issuer and realized a loss of $1,427 in the Condensed Consolidated Statements of Operations. The Company has not sold any other investments in debt securities below par value during the periods presented in the accompanying Condensed Consolidated Statements of Operations.
 
During the fourth quarter of 2008, the Company accepted an offer from UBS Financial Services, Inc. (“UBS”) providing the Company the right to sell to UBS at par value certain auction rate securities during the period from June 30, 2010 to July 2, 2012 (the “right”). During the second quarter of 2010, the Company notified UBS of its intent to sell the auction rate securities related to this offer. At June 30, 2010 and December 31, 2009, the Company held auction rate securities related to this offer with a par value of $18,200 and $32,500, respectively. The Company has elected the fair value option to account for this right. As a result, gains and losses associated with this right are recorded in Other income (expense) in the Condensed Consolidated Statements of Operations. The value of the right to sell certain auction rate securities to UBS was estimated considering the present value of future cash flows, the


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
fair value of the auction rate security and counterparty risk. As of June 30, 2010 and December 31, 2009, the fair value of the right to sell the auction rate securities to UBS at par was $1,854 and $3,226, respectively. With respect to this right, the Company recognized unrealized losses of $571 and $1,372 during the second quarter and first six months of 2010, respectively, and an unrealized gain of $108 and an unrealized loss of $457 during the second quarter and first six months of 2009, respectively, in Other income (expense) in the accompanying Condensed Consolidated Statements of Operations.
 
In addition, during the fourth quarter of 2008, the Company reclassified the auction rate securities that are included in this right from available-for-sale securities to trading securities. As of June 30, 2010 and December 31, 2009, the fair value of the investments in debt securities classified as trading was $16,346 and $29,258, respectively. The Company recognized unrealized gains related to these securities of $819 and $1,388 during the second quarter and first six months of 2010, respectively, and $795 and $537 during the second quarter and first six months of 2009, respectively, in Other income (expense) in the accompanying Condensed Consolidated Statements of Operations.
 
During July 2010, the Company sold the auction rate securities that were included in the UBS right for par value of $18,200, recognizing no gain or loss on the exercise of the right and the sale of the securities.
 
As of June 30, 2010, the Company had classified $16,346 of its auction rate securities as current assets and $169,777 as long-term assets.
 
The following tables summarize the Company’s assets that are measured at fair value on a recurring basis:
 
                                 
          Fair Value Measurements at June 30, 2010 Using  
          Quoted Prices in
    Significant Other
    Significant
 
    Total
    Active Markets for
    Observable
    Unobservable
 
    Fair Value at
    Identical Assets
    Inputs
    Inputs
 
Description   06/30/2010     (Level 1)     (Level 2)     (Level 3)  
 
Assets:
                               
Money Market Funds
  $ 561,347     $ 561,347     $     $  
U.S. Government Securities
    4,136       4,136              
Marketable Securities
    1,022       1,022              
Investments in Debt Securities
    186,123                   186,123  
Right to Sell Debt Securities
    1,854                   1,854  
                                 
Total Assets
  $ 754,482     $ 566,505     $     $ 187,977  
                                 
 
                                 
          Fair Value Measurements at December 31, 2009 Using  
          Quoted Prices in
    Significant Other
    Significant
 
    Total
    Active Markets for
    Observable
    Unobservable
 
    Fair Value at
    Identical Assets
    Inputs
    Inputs
 
Description   12/31/2009     (Level 1)     (Level 2)     (Level 3)  
 
Assets:
                               
Money Market Funds
  $ 518,950     $ 518,950     $     $  
U.S. Government Securities
    4,138       4,138              
Marketable Securities
    2,100       2,100              
Investments in Debt Securities
    247,866                   247,866  
Right to Sell Debt Securities
    3,226                   3,226  
                                 
Total Assets
  $ 776,280     $ 525,188     $     $ 251,092  
                                 
 
The fair value of marketable securities within the Level 1 classification is based on the quoted price for identical securities in an active market as of the valuation date.


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The fair value of investments in debt securities within the Level 3 classification is based on a trinomial discount model. This model considers the probability at the valuation date of three potential occurrences for each auction event through the maturity date of the security. The three potential outcomes for each auction are (i) successful auction/early redemption, (ii) failed auction and (iii) issuer default. Inputs in determining the probabilities of the potential outcomes include, but are not limited to, the security’s collateral, credit rating, insurance, issuer’s financial standing, contractual restrictions on disposition and the liquidity in the market. The fair value of each security is determined by summing the present value of the probability-weighted future principal and interest payments determined by the model. As of June 30, 2010, the Company assumed a weighted average discount rate of 4.7% and expected terms which are generally less than five years. The discount rate was determined as the loss-adjusted required rate of return using public information such as spreads on near risk-free to risk-free assets. The expected term is based on the Company’s estimate of future liquidity as of June 30, 2010. Transfers out of Level 3 classification occur only when public call notices have been announced by the issuer prior to the date of the valuation.
 
The following table provides a reconciliation of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3):
 
                 
    2010     2009  
 
Beginning balance, January 1
  $ 251,092     $ 361,913  
Total gains (losses) (realized/unrealized)
               
Included in earnings
    (872 )     (823 )
Included in other comprehensive income (loss)
    927       (4,300 )
Settlements
    (16,810 )     (8,000 )
Transfers into (out of) Level 3
    (3,750 )     1,700  
                 
Ending balance, March 31
  $ 230,587     $ 350,490  
                 
Total gains (losses) (realized/unrealized)
               
Included in earnings
    249       (524 )
Included in other comprehensive income (loss)
    4,441       13,781  
Settlements
    (51,050 )     (25,650 )
Transfers into (out of) Level 3
    3,750       700  
                 
Ending balance, June 30
  $ 187,977     $ 338,797  
                 
 
4.   Inventories
 
Inventories consist of the following:
 
                 
    June 30,
    December 31,
 
    2010     2009  
 
Raw materials
  $ 65,193     $ 62,054  
Work-in-process
    37,147       29,979  
Finished goods (including $1,920 and $3,908 of sample inventory, respectively)
    136,538       126,705  
                 
      238,878       218,738  
Inventory valuation allowance
    (43,264 )     (36,447 )
                 
Total inventories
  $ 195,614     $ 182,291  
                 


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
5.   Property, Plant and Equipment
 
During the first quarter of 2009, the Company classified as held for sale a pharmaceutical facility which was acquired as a result of the acquisition of Alpharma Inc., now Alpharma LLC (“Alpharma”). The facility is recorded at estimated fair value less cost to sell. The Company finalized its determination of fair value of this asset in the first quarter of 2009, reduced the value by $3,600 and adjusted goodwill accordingly. During the fourth quarter of 2009, the Company further reduced the fair value of this asset based on management’s estimate of current market conditions and incurred an asset impairment charge of $2,010.
 
The net book value of some of the Company’s manufacturing facilities currently exceeds fair market value. Management currently believes that the long-term assets associated with these facilities are not impaired based on estimated undiscounted future cash flows. However, if the Company were to approve a plan to sell or close any of the facilities for which the carrying value exceeds fair market value, the Company would have to write off a portion of the assets or reduce the estimated useful life of the assets, which would accelerate depreciation.
 
6.   Acquisitions, Dispositions, Co-Promotions and Alliances
 
Kadian®
 
On December 29, 2008, the Company completed its acquisition of Alpharma. In connection with the acquisition of Alpharma, the Company and Alpharma executed a consent order (the “Consent Order”) with the U.S. Federal Trade Commission (“FTC”). The Consent Order required the Company to divest the assets related to Alpharma’s branded oral long-acting opioid analgesic drug Kadian® to Actavis Elizabeth, L.L.C. (“Actavis LLC”). In accordance with the Consent Order, effective upon the acquisition of Alpharma on December 29, 2008, the Company divested the Kadian® product to Actavis LLC. Actavis LLC is entitled to sell Kadian® as a branded or generic product. Prior to the divestiture, Actavis LLC supplied Kadian® to Alpharma.
 
Actavis LLC paid a purchase price of $127,500 in cash based on the achievement of certain Kadian® quarterly gross profit-related milestones for the period beginning January 1, 2009 and ending June 30, 2010. The purchase price payment associated with each calendar quarter is as follows:
 
         
    Purchase
    Price Payment
 
First Quarter 2009
  $ 30,000  
Second Quarter 2009
  $ 25,000  
Third Quarter 2009
  $ 25,000  
Fourth Quarter 2009
  $ 20,000  
First Quarter 2010
  $ 20,000  
Second Quarter 2010
  $ 7,500  
 
The Company recorded a receivable of $115,000 at the time of the divestiture, reflecting the present value of the estimated future purchase price payments from Actavis LLC. The Company recorded a gain of $12,500 in the second quarter of 2010 as a result of the divestiture. In accordance with the agreement, quarterly payments are received one quarter in arrears. During the second quarter and first six months of 2010, the Company received $20,000 and $40,000, respectively, from Actavis LLC related to gross profit from sales during the fourth quarter of 2009 and the first quarter of 2010. In July 2010, the Company received the final payment of $7,500.
 
Skelaxin® Authorized Generic
 
In January 2008, the Company entered into an agreement with CorePharma, LLC (“CorePharma”) granting CorePharma a license to launch an authorized generic version of Skelaxin® under certain conditions. In accordance with this agreement, the Company receives a fee based on CorePharma’s gross profit, as defined by the agreement, of the authorized generic product. During the second quarter of 2010, the Company recognized revenue of $25,624


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
related to the gross profit of the CorePharma Skelaxin® authorized generic which is recorded in royalties. In addition, the Company sells the related active pharmaceutical ingredient to CorePharma for their manufacture of the authorized generic.
 
7.   Intangible Assets and Goodwill
 
Intangible assets consist primarily of patents, licenses, trademarks and product rights. A summary of the gross carrying amount and accumulated amortization is as follows:
 
                                 
    June 30, 2010     December 31, 2009  
    Gross
          Gross
       
    Carrying
    Accumulated
    Carrying
    Accumulated
 
    Amount     Amortization     Amount     Amortization  
 
Branded prescription pharmaceuticals
  $ 1,266,163     $ 834,766     $ 1,264,250     $ 764,327  
Alpharma Animal Health
    169,945       14,446       170,000       9,633  
Meridian Auto-Injector
    186,764       53,997       183,249       49,621  
Royalties and other
    3,731       3,532       3,731       3,510  
                                 
Total intangible assets
  $ 1,626,603     $ 906,741     $ 1,621,230     $ 827,091  
                                 
 
Amortization expense for the three months ended June 30, 2010 and 2009 was $38,213 and $38,149, respectively. Amortization expense for the six months ended June 30, 2010 and 2009 was $79,650 and $76,327, respectively.
 
In January 2009, the U.S. District Court for the Eastern District of New York issued an order ruling invalid two Skelaxin® patents. In June 2009, the Court entered judgment against the Company. In August 2010, the Court of Appeals for the Federal Circuit affirmed the actions of the District Court. Generic versions of Skelaxin® entered the market early in the second quarter of 2010. The Company’s sales of Skelaxin® have declined significantly and will continue to decline as a result of generic competition. Net sales of Skelaxin® were $400,998 in 2009 and $5,319 and $96,236, respectively, in the three and six months ended June 30, 2010. According to IMS America, Ltd. weekly prescription data, for the week ending July 23, 2010, generic competitors have garnered approximately 90% of the prescriptions in the metaxalone market. The intangible assets associated with Skelaxin® were fully amortized in the second quarter of 2010. The amortization expense associated with Skelaxin® in the second quarter and first six months of 2010 was $19,979 and $43,226, respectively.
 
For additional information regarding Skelaxin® litigation, please see Note 9.
 
Goodwill at June 30, 2010 and December 31, 2009 is as follows:
 
                                 
    Branded
    Animal Health
    Meridian
       
    Segment     Segment     Segment     Total  
 
Goodwill at December 31, 2009
  $ 267,024     $ 92,179     $ 108,410     $ 467,613  
Adjustment to Alpharma acquisition
          (1,330 )           (1,330 )
                                 
Goodwill at June 30, 2010
  $ 267,024     $ 90,849     $ 108,410     $ 466,283  
                                 


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
8.   Long-Term Debt
 
Long-term debt consists of the following:
 
                 
    June 30,
    December 31,
 
    2010     2009  
 
Convertible senior notes
  $ 341,735     $ 332,305  
Senior secured revolving credit facility
          92,261  
                 
Total long-term debt
    341,735       424,566  
Less current portion
          85,550  
                 
Long-term portion
  $ 341,735     $ 339,016  
                 
 
Convertible Senior Notes
 
At June 30, 2010, the Company has $400,000 of Convertible Senior Notes outstanding. The liability and equity components of the Convertible Senior Notes have been separately accounted for in a manner that reflects the Company’s nonconvertible debt borrowing rate at the date of issuance. The debt component is being amortized through March 31, 2013.
 
A summary of the gross carrying amount, unamortized debt cost and the net carrying amount of the liability component is as follows:
 
                 
    June 30,
    December 31,
 
    2010     2009  
 
Gross carrying amount
  $ 400,000     $ 400,000  
Unamortized debt discount
    58,265       67,695  
                 
Net carrying amount
  $ 341,735     $ 332,305  
                 
 
Senior Secured Revolving Credit Facility
 
On May 11, 2010, the Company entered into a new $500,000 five-year Senior Secured Revolving Credit Facility (“2010 Revolving Credit Facility”) with Credit Suisse AG, as Administrative Agent (the “Administrative Agent”) and terminated the existing $475,000 Senior Secured Revolving Credit Facility (“2008 Revolving Credit Facility”) entered into April 19, 2007 and amended December 5, 2008, which was scheduled to mature in April 2012. The 2010 Revolving Credit Facility provides the Company with aggregate revolving credit commitments of $500,000, with a $50,000 sublimit for the issuance of letters of credit. The 2010 Revolving Credit Agreement also provides for an incremental term loan facility in an aggregate amount of up to $500,000. The 2010 Revolving Credit Facility matures on May 11, 2015.
 
The undrawn commitment amount under the 2010 Revolving Credit Facility on June 30, 2010 totals $496,291 after giving effect to letters of credit totaling $3,709.
 
Prior to the termination of the 2008 Revolving Credit Facility, the Company made payments of $92,261 on this facility in the first quarter of 2010, which represented full payment on all outstanding borrowings under the facility. During the three and six months ended June 30, 2009, the Company made payments of $102,092 and $134,185, respectively, on the 2008 Revolving Credit Facility.
 
In connection with the establishment of the 2010 Revolving Credit Facility, the Company incurred approximately $4,615 of new deferred financing costs. During the second quarter of 2010, the Company expensed $2,252 of the $4,287 of deferred financing costs that remained outstanding at the time of the termination of the 2008 Revolving Credit Facility. Therefore, deferred financing costs associated with the 2010 Revolving Credit Facility total $6,651 and are being amortized over five years.


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The Company’s borrowings under the 2010 Revolving Credit Facility will bear interest at annual rates that, at the Company’s option, will be either:
 
  •  a base rate generally defined as the sum of (i) the greatest of (a) the prime rate of the Administrative Agent, (b) the federal funds effective rate plus 0.5% and (c) the one-month adjusted LIBO rate (by reference to the British Bankers’ Association Interest Settlement Rates for deposits in dollars) plus 1.0% and (ii) an applicable percentage of 1.50%, 1.75% or 2.00%, depending on the Company’s corporate credit rating; or
 
  •  an adjusted LIBO rate generally defined as the sum of (i) the product of (a) the LIBO rate (by reference to the British Bankers’ Association Interest Settlement Rates for deposits in dollars) in effect for the relevant interest period and (b) a fraction, the numerator of which is one and the denominator of which is one minus certain maximum statutory reserves for eurocurrency liabilities and (ii) an applicable percentage of 2.50%, 2.75% or 3.00%, depending on the Company’s corporate credit rating.
 
If the Company makes any borrowings under the incremental term loan facility, those borrowings will bear interest at annual rates established at the time of the borrowings.
 
The Company is required to pay an unused commitment fee on the difference between committed amounts and amounts actually borrowed under the 2010 Revolving Credit Facility equal to an applicable percentage of 0.375% or 0.5% per annum, depending on the Company’s corporate credit rating. The Company is required to pay a letter of credit participation fee based upon the aggregate face amount of outstanding letters of credit equal to an applicable percentage of 2.5%, 2.75% or 3.0% per annum, depending on the Company’s corporate credit rating.
 
The 2010 Revolving Credit Facility contains customary representations and warranties and affirmative covenants. The 2010 Revolving Credit Facility also contains certain covenants that restrict, among other things, the ability of the Company and its subsidiaries to incur additional indebtedness, permit certain liens to exist on its respective assets, enter into sale and leaseback transactions, make investments, loans and advances, undertake acquisitions, mergers and consolidations, sell assets, make dividend and other restricted payments, enter into transactions with affiliates, prepay, redeem or repurchase other indebtedness and make capital expenditures, in each case, subject to certain exceptions.
 
The 2010 Revolving Credit Facility also requires the Company to meet the following financial tests:
 
  •  maintenance of a minimum consolidated EBITDA to consolidated interest expense ratio for periods of four consecutive fiscal quarters of 3.50 to 1; and
 
  •  maintenance of a maximum total funded debt to consolidated EBITDA ratio of 3.0 to 1.
 
The 2010 Revolving Credit Facility also contains customary events of default, including events of default based on failures to make payments as and when required under the 2010 Revolving Credit Facility, breaches of representations, warranties and covenants, defaults under certain other material indebtedness, the occurrence of certain bankruptcy and insolvency events related to the Company and certain of its subsidiaries, the levy of judgments in excess of specified amounts, the occurrence of certain ERISA events, certain impairments to the guarantees of the Company’s obligations under the credit facility, certain impairments of the security interests granted by the Company and the subsidiary guarantors in connection with the 2010 Revolving Credit Facility and a change in control.
 
The Company’s obligations under the 2010 Revolving Credit Facility are guaranteed by each of the Company’s domestic subsidiaries and secured by pledges by the Company of certain of its assets, including equity interests in certain of the Company’s subsidiaries and intellectual property.
 
Senior Secured Term Facility
 
In connection with the acquisition of Alpharma on December 29, 2008, the Company entered into a $200,000 Senior Secured Term Facility with a maturity date of December 28, 2012. The Company borrowed $200,000 under


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
the Senior Secured Term Facility and received proceeds of $192,000, net of the discount at issuance. During the three and six months ended June 30, 2009, the Company made payments of $49,886 and $65,815, respectively, on its Senior Secured Term Facility. During the fourth quarter of 2009, the Company completed its repayment obligations under the facility.
 
Alpharma Convertible Senior Notes
 
At the time of the acquisition of Alpharma by the Company, Alpharma had $300,000 of Convertible Senior Notes outstanding (“Alpharma Notes”). The Alpharma Notes were convertible into shares of Alpharma’s Class A common stock at an initial conversion rate of 30.6725 Alpharma common shares per $1,000 principal amount. The conversion rate of the Alpharma Notes was subject to adjustment upon the direct or indirect sale of all or substantially all of Alpharma’s assets or more than 50% of the outstanding shares of the Alpharma common stock to a third party (a “Fundamental Change”). In the event of a Fundamental Change, the Alpharma Notes included a make-whole provision that adjusted the conversion rate by a predetermined number of additional shares of Alpharma’s common stock based on (1) the effective date of the Fundamental Change; and (2) Alpharma’s common stock market price as of the effective date. The acquisition of Alpharma by the Company was a Fundamental Change. As a result, any Alpharma Notes converted in connection with the acquisition of Alpharma were entitled to be converted at an increased rate equal to the value of 34.7053 Alpharma common shares, at the acquisition price of $37 per share, per $1,000 principal amount of Alpharma Notes, at a date no later than 35 trading days after the occurrence of the Fundamental Change. During the first quarter of 2009, the Company paid $385,227 to redeem the Alpharma Convertible Senior Notes.
 
9.   Commitments and Contingencies
 
Intellectual Property Matters
 
Skelaxin®
 
Eon Labs, Inc. (“Eon Labs”), CorePharma and Mutual Pharmaceutical Company, Inc. (“Mutual”) each filed an Abbreviated New Drug Application (“ANDA”) with the U.S. Food and Drug Administration (“FDA”) seeking permission to market a generic version of Skelaxin® 400 mg tablets. Additionally, Eon Labs’ ANDA seeks permission to market a generic version of Skelaxin® 800 mg tablets. United States Patent Nos. 6,407,128 (the ‘‘ ‘128 patent”) and 6,683,102 (the ‘‘ ‘102 patent”), two method-of-use patents relating to Skelaxin®, are listed in the FDA’s Orange Book and do not expire until December 3, 2021. Eon Labs and CorePharma each filed Paragraph IV certifications against the ‘128 and ‘102 patents alleging non-infringement, invalidity and unenforceability of those patents. Mutual has filed a Paragraph IV certification against the ‘102 patent alleging non-infringement and invalidity of that patent. A patent infringement suit was filed against Eon Labs on January 2, 2003 in the U.S. District Court for the Eastern District of New York; against CorePharma on March 7, 2003 in the U.S. District Court for the District of New Jersey (subsequently transferred to the U.S. District Court for the Eastern District of New York); and against Mutual on March 12, 2004 in the U.S. District Court for the Eastern District of Pennsylvania, concerning their proposed 400 mg products. Additionally, the Company filed a separate suit against Eon Labs on December 17, 2004 in the U.S. District Court for the Eastern District of New York, concerning its proposed generic version of the 800 mg Skelaxin® product. On May 17, 2006, the U.S. District Court for the Eastern District of Pennsylvania placed the Mutual case on the Civil Suspense Calendar pending the outcome of the FDA activity described below. On June 16, 2006, the U.S. District Court for the Eastern District of New York consolidated the Eon Labs cases with the CorePharma case. In January 2008, the Company entered into an agreement with CorePharma providing it with, among other things, the right to launch an authorized generic version of Skelaxin® pursuant to a license in December 2012 or earlier under certain conditions. On January 8, 2008, the Company and CorePharma submitted a joint stipulation of dismissal without prejudice. On January 15, 2008, the Court entered an order dismissing the case without prejudice.
 
The Company believes that CorePharma began shipping a generic form of Skelaxin® in early April 2010. On April 13, 2010, the Company brought suit against CorePharma in the U.S. District Court for New Jersey asserting


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
certain of the Company’s rights under the January 2008 agreement. The parties appeared at a District Court hearing on April 14, 2010, at which the Company sought, and was denied, a temporary restraining order (“TRO”) against CorePharma to prevent further sales of generic product. On May 6, 2010, the Court granted a preliminary injunction against CorePharma. On May 19, 2010, the Court entered a consent order from the parties vacating the preliminary injunction, and CorePharma resumed selling the authorized generic form of Skelaxin®.
 
Pursuant to the Hatch-Waxman Act, the filing of the suits against Eon Labs provided the Company with an automatic stay of FDA approval of Eon Labs’ ANDA for its proposed 400 mg and 800 mg products for 30 months (unless the patents are held invalid, unenforceable or not infringed) from no earlier than November 18, 2002 and November 3, 2004, respectively. The 30-month stay of FDA approval for Eon Labs’ ANDA for its proposed 400 mg product expired in May 2005 and Eon Labs subsequently withdrew its 400 mg ANDA in September 2006. The 30-month stay of FDA approval for Eon Labs’ 800 mg product was tolled by the Court from January 10, 2005 to April 30, 2007, and the stay expired in early August 2009. On April 30, 2007, Eon Labs’ 400 mg case was dismissed without prejudice, although Eon Labs’ claim for fees and expenses was severed and consolidated with Eon Labs’ 800 mg case. On August 27, 2007, Eon Labs served a motion for summary judgment on the issue of infringement. The Court granted the Company discovery for purposes of responding to Eon’s motion until March 14, 2008 and set a briefing schedule. On March 7, 2008, the Company filed a letter with the Court regarding Eon Labs’ inability to adhere to the discovery schedule and the Court took Eon Labs’ motion for summary judgment on the issue of infringement off the calendar. Subsequently, Eon Labs filed an amended motion for summary judgment on the issue of infringement on April 4, 2008. Eon Labs also filed a motion for summary judgment on the issue of validity on April 16, 2008. On May 8, 2008, Eon Labs filed amended pleadings. On May 22, 2008, the Company moved to dismiss certain defenses and counterclaims. On June 6, 2008, the Company responded to Eon Labs’ motion for summary judgment on the issue of validity. On January 20, 2009, the Court issued an order ruling invalid the ‘128 and ‘102 patents. The order was issued without the benefit of a hearing in response to Eon Labs’ motion for summary judgment. The order also allowed Eon Labs to pursue its claim for exceptional case, and on March 31, 2009, Eon Labs filed its motion for this purpose, which was opposed by the Company and Elan Pharmaceuticals, Inc. (“Elan”). Eon Labs has replied and the motion remains pending before the Court. On May 20, 2009, Eon Labs asked for entry of final judgment, and on June 4, 2009, the Court granted this request. On July 1, 2009, the Company filed a notice of appeal to the Court of Appeals for the Federal Circuit of the Court’s entry of judgment. On July 2, 2009, Elan did the same. The appeals were docketed by the Federal Circuit on July 10, 2009. In late July 2009, the companies moved to dismiss the appeals for lack of jurisdiction. On September 30, 2009, the Federal Circuit denied the motions to dismiss. The Company and Elan filed opening briefs on November 23, 2009. Eon filed its opposition brief on January 19, 2010. The Company and Elan filed reply briefs on February 19, 2010. Oral argument of the appeal was heard by the Federal Circuit on May 7, 2010. On August 2, 2010, the Federal Circuit affirmed the district court’s grant of summary judgment and vacated the order against Elan for lack of subject matter jurisdiction. Any petition for a rehearing is due September 1, 2010. The Company intends to vigorously defend its interests.
 
On December 5, 2008, the Company, along with co-plaintiff Pharmaceutical IP Holding, Inc. (“PIH”) initiated suit in the U.S. District Court of New Jersey against Sandoz, Inc. (“Sandoz”) for infringement of U.S. Patent No. 7,122,566 (the “ ‘566 patent”). The ‘566 patent is a method-of-use patent relating to Skelaxin® that is listed in the FDA’s Orange Book; it expires on February 6, 2026. The ‘566 patent is owned by PIH and licensed to the Company. The Company and PIH sued Sandoz, alleging that Eon Labs’ submission of its ANDA seeking approval to sell a generic version of a 800 mg Skelaxin® tablet prior to the expiration of the ‘566 patent constitutes infringement of the patent. Sandoz, which acquired Eon Labs, is the named owner of Eon Labs’ ANDA and filed a Paragraph IV certification challenging the validity and alleging non-infringement of the ‘566 patent. On January 13, 2009, Sandoz answered the complaint and filed counterclaims of invalidity and non-infringement. The Company filed a reply on February 5, 2009.
 
On March 31, 2010, Sandoz received approval from the FDA to commercialize a generic product containing metaxalone. On April 1, 2010, the Company sought, and the United States District Court of New Jersey granted, a TRO enjoining Sandoz from using, offering to sell, or selling within the United States its generic metaxalone


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product. On April 9, 2010, the TRO was vacated. On April 14 and May 5, 2010, the District Court heard the Company’s arguments in support of a preliminary injunction against Sandoz. The preliminary injunction motion was denied on May 17, 2010. On June 1, 2010, the Company filed an amended complaint to include claims for monetary damages. On June 15, 2010, Sandoz answered the amended complaint and filed amended counterclaims. The Company’s request for a jury trial was also granted and the trial date for the patent litigation against Sandoz is set for September 7, 2010.
 
On March 9, 2004, the Company received a copy of a letter from the FDA to all ANDA applicants for Skelaxin® stating that the use listed in the FDA’s Orange Book for the ‘128 patent may be deleted from the ANDA applicants’ product labeling. The Company believes that this decision is arbitrary, capricious and inconsistent with the FDA’s previous position on this issue. The Company filed a Citizen Petition on March 18, 2004 (supplemented on April 15, 2004 and on July 21, 2004), requesting the FDA to rescind that letter, require generic applicants to submit Paragraph IV certifications for the ’128 patent and prohibit the removal of information corresponding to the use listed in the Orange Book. The Company concurrently filed a petition for stay of action requesting the FDA to stay approval of any generic Skelaxin® products until the FDA has fully evaluated the Company’s Citizen Petition.
 
On March 12, 2004, the FDA sent a letter to the Company explaining that the Company’s proposed labeling revision for Skelaxin®, which includes references to additional clinical studies relating to food, age and gender effects, was approvable and only required certain formatting changes. On April 5, 2004, the Company submitted amended labeling text that incorporated those changes. On April 5, 2004, Mutual filed a petition for stay of action requesting the FDA to stay approval of the Company’s proposed labeling revision until the FDA has fully evaluated and ruled upon the Company’s Citizen Petition, as well as all comments submitted in response to that petition. The Company, CorePharma and Mutual filed responses and supplements to their pending Citizen Petitions and responses. On December 8, 2005, Mutual filed another supplement with the FDA in which it withdrew its prior petition for stay, supplement and opposition to the Company’s Citizen Petition. On November 24, 2006, the FDA approved the revision to the Skelaxin® labeling. On February 13, 2007, the Company filed another supplement to the Company’s Citizen Petition to reflect FDA approval of the revision to the Skelaxin® labeling. On May 2, 2007, Mutual filed comments in connection with the Company’s supplemental submission. These issues are pending. On July 27, 2007 and January 24, 2008, Mutual filed two other Citizen Petitions in which it seeks a determination that Skelaxin® labeling should be revised to reflect the data provided in its earlier submissions. These petitions were denied on July 18, 2008.
 
Avinza®
 
Actavis, Inc. (“Actavis”) filed an ANDA with the FDA seeking permission to market generic versions of Avinza® at the 30 mg, 45 mg, 60 mg and 120 mg dosages. U.S. Patent No. 6,066,339 (the ‘‘ ‘339 patent”) is a formulation patent relating to Avinza® that is listed in the Orange Book and expires on November 25, 2017. Actavis filed a Paragraph IV certification challenging the validity and alleging non-infringement of the ‘339 patent, and the Company and Elan Pharma International LTD (“EPI”), the owner of the ‘339 patent, filed suit on October 18, 2007 in the U.S. District Court for the District of New Jersey to defend the rights under the patent. Pursuant to the Hatch-Waxman Act, the filing of the lawsuit against Actavis provided the Company with an automatic stay of FDA approval of Actavis’ ANDA for up to 30 months (unless the patent is held invalid, unenforceable or not infringed) from no earlier than September 4, 2007. On November 18, 2007, Actavis answered the complaint and filed counterclaims of non-infringement and invalidity. The Company and EPI filed a reply on December 7, 2007. The initial scheduling conference was held on March 11, 2008.
 
In November 2009, Actavis sent the Company and EPI a second Paragraph IV certification adding the 75 mg and 90 mg dosages. The Company and EPI initiated another suit against Actavis in New Jersey on December 15, 2009. On January 12, 2010, Actavis answered the complaint and filed counterclaims of non-infringement and invalidity. On February 23, 2010, this case was consolidated with the earlier-initiated suit.


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The Court held a claim construction hearing on March 19, 2010 and issued a ruling. No trial date has been set. The close of all discovery is currently set for December 17, 2010.
 
Sandoz filed an ANDA with the FDA seeking permission to market generic versions of Avinza® at the 30 mg and 120 mg dosages and provided the Company with a Paragraph IV certification challenging the validity and alleging non-infringement of the ‘339 patent. The Company and EPI filed suit on July 21, 2009 in the U.S. District Court for the District of New Jersey to defend the rights under the patent. Pursuant to the Hatch-Waxman Act, the filing of the lawsuit against Sandoz provided the Company with an automatic stay of FDA approval of Sandoz’s ANDA for up to 30 months (unless the patent is held invalid, unenforceable or not infringed) from no earlier than June 11, 2009. Sandoz subsequently sent the Company and EPI a second Paragraph IV certification adding the 45 mg, 60 mg, 75 mg and 90 mg dosages. The Company and EPI initiated another suit against Sandoz in New Jersey on September 1, 2009. On October 2, 2009, Sandoz answered the complaints and filed counterclaims of non-infringement and invalidity. The Company and EPI filed a reply on October 22, 2009. The two cases were consolidated on January 4, 2010. The parties are in the midst of fact discovery. A claim construction hearing is set for September 27, 2010 and trial is currently set for May 9, 2011.
 
The Company intends to vigorously defend its rights under the ‘339 patent. Net sales of Avinza® were $131,148 in 2009 and $24,740 and $47,936, respectively, in the three and six months ended June 30, 2010. As of June 30, 2010, the Company had net intangible assets related to Avinza® of $201,213. If a generic form of Avinza® enters the market or if the Company’s current estimates regarding future cash flows adversely change, the Company may have to write off a portion or all of these intangible assets, and the Company’s business, financial condition, results of operations and cash flows could be otherwise materially adversely affected.
 
EpiPen®
 
On November 11, 2008, the Company was granted U.S. Patent 7,449,012 (the ‘‘ ‘012 patent”) covering the next generation autoinjector (“NGA”) for use with epinephrine to be sold under the EpiPen® brand name. The ‘012 patent expires September 11, 2025. The ‘012 patent was listed in FDA’s Orange Book on July 17, 2009 under the EpiPen® NDA. On July 21, 2009, the Company received a Paragraph IV certification from Teva Pharmaceutical Industries Ltd. (“Teva”) giving notice that it had filed an ANDA to commercialize an epinephrine injectable product and challenging the validity and alleging non-infringement of the ’012 patent. On August 28, 2009, the Company filed suit against Teva in the U.S. District Court for the District of Delaware to defend its rights under the ‘012 patent. On October 21, 2009, Teva filed its answer asserting non-infringement and invalidity of the ‘012 patent.
 
On June 4, 2010, the Company received a Paragraph IV certification from Sandoz giving notice that it had filed an ANDA to commercialize an epinephrine injectable product and challenging the validity and alleging non-infringement of the ‘012 patent. On July 14, 2010, the Company filed suit against Sandoz in the U.S. District Court for District of New Jersey to defend its rights under the ‘012 patent.
 
Embeda®
 
On November 17, 2008, Alpharma filed a declaratory judgment action against Purdue Pharma L.P. (“Purdue”) in the U.S. District Court for the Western District of Virginia, seeking an order declaring that nine of Purdue’s patents are invalid and/or would not be infringed by the commercialization of Embeda®. The complaint was served on March 12, 2009, and on April 22, 2009, Purdue filed a motion requesting that the court dismiss the action for lack of subject matter jurisdiction or, alternatively, to transfer the action to the District of Connecticut. On July 9, 2009, the court denied Purdue’s motion to dismiss or transfer. On August 6, 2009, Purdue filed its answer and counterclaims, and filed a motion for an order certifying the court’s July 9 order for immediate appeal. On August 26, 2009, the court denied Purdue’s motion to certify for immediate appeal and issued an order scheduling certain discovery and hearing dates. On December 4, 2009, the Company was added as a plaintiff to the lawsuit. On December 23, 2009, Purdue delivered an unconditional and irrevocable covenant not to sue the Company (or any of its affiliates, subsidiaries, parents, divisions, successors and assigns) for infringement of eight of the nine patents in


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the suit. On that day, the parties also filed a Stipulation with the Court to dismiss the lawsuit with prejudice with respect to these eight patents. The only patent remaining in the case was U.S. Patent No. 6,696,088 (the ‘‘ ‘088 patent”). On February 4, 2010, after extensive briefing, the Court held a claim construction hearing.
 
On February 9, 2010, the United States Patent & Trademark Office issued U.S. Patent No. 7,658,939 (“the ‘939 patent”) to Purdue. The ‘939 patent is a continuation of the ‘088 patent. On the same day, Purdue filed a patent infringement action against the Company in the U.S. District Court for the District of New Jersey, alleging infringement of the ‘939 patent by the commercialization of Embeda®. On February 10, 2010, the Company filed a motion in the U.S. District Court for the Western District of Virginia seeking leave to amend its complaint to add declaratory judgment counts of non-infringement and invalidity against the ‘939 patent.
 
On March 19, 2010, the Court in the Western District of Virginia granted the Company’s motion for leave to amend its complaint adding the ‘939 patent to the existing litigation. A trial date was set for August 18, 2010, for both the ’088 and the ‘939 patents. On April 2, 2010, Purdue’s action brought in the U.S. District Court for the District of New Jersey was dismissed. On June 22, 2010, the Court issued its opinion and order regarding claim construction.
 
On July 23, 2010, the Company and Alpharma (collectively “the King Parties”) entered into a settlement agreement with Purdue. Pursuant to the terms of the agreement, Purdue agreed not to sue the King Parties or their affiliates in the United States with regard to the manufacture, use or sale of Embeda®. The King Parties are obligated to pay to Purdue an up-front payment, which is accrued as of June 30, 2010, and a quarterly royalty on net sales of Embeda® for the duration of any valid claims in the ’088 and ‘939 patents, or other patents in the same family that cover the Embeda® product beginning on August 1, 2010. In addition, the King Parties agreed not to challenge certain of Purdue’s patents, including the ’088 and ‘939 patents, as they may relate to Embeda®. The agreement also obligates the parties to dismiss the civil action pending in the District Court for the Western District of Virginia.
 
Average Wholesale Price Litigation
 
In August 2004, the Company and Monarch Pharmaceuticals, Inc. (“Monarch”), a wholly-owned subsidiary of the Company, were named as defendants along with 44 other pharmaceutical manufacturers in an action brought by the City of New York (“NYC”) in Federal court in the State of New York. NYC claims that the defendants fraudulently inflated their average wholesale prices (“AWP”) and fraudulently failed to accurately report their “best prices” and their average manufacturer’s prices and failed to pay proper rebates pursuant to federal law. Additional claims allege violations of federal and New York statutes, fraud and unjust enrichment. For the period from 1992 to the present, NYC is requesting money damages, civil penalties, declaratory and injunctive relief, restitution, disgorgement of profits and treble and punitive damages. The U.S. District Court for the District of Massachusetts has been established as the multidistrict litigation court for the case, In re: Pharmaceutical Industry Average Wholesale Pricing Litigation (the “MDL Court”).
 
Since the filing of the NYC case, 48 New York counties have filed lawsuits against the pharmaceutical industry, including the Company and Monarch. The allegations in all of these cases are virtually the same as the allegations in the NYC case. All of these lawsuits are currently pending in the MDL Court, except for the Erie, Oswego and Schenectady County cases, which were removed in October 2006 and remanded to the state of New York Supreme Court in Erie County, New York state court in September 2007. Motions to dismiss were granted in part and denied in part for all defendants in all NYC and county cases pending in the MDL Court. The Erie motion to dismiss was granted in part and denied in part by the state court before removal. Motions to dismiss were filed in October 2007 in the Oswego and Schenectady cases, and these cases were subsequently transferred to Erie County for coordination with the Erie County case. A hearing on these motions to dismiss occurred on March 15, 2010, and the Court has taken the motions under advisement. It is not anticipated that any trials involving the Company will be set in any of these cases in 2010. On January 27, 2010, the MDL Court granted partial summary judgment for the plaintiffs in a case involving other pharmaceutical company defendants.
 
In January 2005, the State of Alabama filed a lawsuit in the Circuit Court for Montgomery County, Alabama against 79 defendants, including the Company and Monarch. The four causes of action center on the allegation that


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all defendants fraudulently inflated the AWPs of their products. A motion to dismiss was filed and denied by the Court, but the Court required an amended complaint to be filed. The Company filed an answer and counterclaim for return of rebates overpaid to the state. Alabama filed a motion to dismiss the counterclaim, which was granted. The Company appealed the dismissal. The Alabama Supreme Court affirmed the dismissal. In a separate appeal of a motion to sever denied by the trial court, the Alabama Supreme Court severed all defendants into single-defendant cases. Trials against AstraZeneca International, Novartis Pharmaceuticals, SmithKline Beecham Corporation and Sandoz resulted in verdicts for the State. These defendants appealed their verdicts. On October 16, 2009, the Alabama Supreme Court reversed all of the verdicts against AstraZeneca, Novartis and SmithKline Beecham and rendered judgment in favor of these companies. Alabama filed a petition to rehear in the Alabama Supreme Court, which was denied in January 2010. Trials scheduled to begin in 2010 have been stayed or continued pending a ruling on the Sandoz appeal. A trial against Watson Pharmaceuticals, Inc. in June 2009 resulted in a deadlocked jury. In April 2009, the Court established various trial dates for all defendants. The Company is scheduled for trial in January 2011 but other scheduled cases have been continued or reset for later dates following the Alabama Supreme Court decision.
 
In October 2005, the State of Mississippi filed a lawsuit in the Chancery Court of Rankin County, Mississippi against the Company, Monarch and 84 other defendants, alleging fourteen causes of action. Many of those causes of action allege that all defendants fraudulently inflated the AWPs and wholesale acquisition costs of their products. A motion to dismiss the criminal statute counts and a motion for more definite statement were granted. Mississippi filed an amended complaint dismissing the Company and Monarch from the lawsuit without prejudice. These claims could be refiled.
 
Over half of the states have filed similar lawsuits but the Company has not been named in any other case except Iowa’s, which was instituted in October 2007. The Company filed a motion to dismiss the Iowa complaint. On February 20, 2008, the Iowa case was transferred to the MDL Court. The relief sought in all of these cases is similar to the relief sought in the NYC lawsuit. The MDL Court granted in part and denied in part the Company’s motion to dismiss, and the Company has filed its answer. Discovery is proceeding in these cases. The Company intends to defend all of the AWP lawsuits vigorously, but is currently unable to predict the outcome or reasonably estimate the range of potential loss.
 
See also “AWP Litigation” under the section “Alpharma Matters” below.
 
Fen-Phen Litigation
 
Many distributors, marketers and manufacturers of anorexigenic drugs have been subject to claims relating to the use of these drugs. Generally, the lawsuits allege that the defendants (1) misled users of the products with respect to the dangers associated with them, (2) failed to adequately test the products and (3) knew or should have known about the negative effects of the drugs, and should have informed the public about the risks of such negative effects. Claims include product liability, breach of warranty, misrepresentation and negligence. The actions have been filed in various state and federal jurisdictions throughout the United States. A multidistrict litigation court has been established in the U.S. District Court for the Eastern District of Pennsylvania, In re: Fen-Phen Litigation. The plaintiffs seek, among other things, compensatory and punitive damages and/or court-supervised medical monitoring of persons who have ingested these products.
 
The Company’s wholly-owned subsidiary, King Research and Development, was originally a defendant in numerous cases. These lawsuits were filed in various jurisdictions throughout the United States and in each of these lawsuits King Research and Development, as the successor to Jones Pharma Incorporated (“Jones”), was one of many defendants, including manufacturers and other distributors of these drugs. Although Jones did not at any time manufacture dexfenfluramine, fenfluramine or phentermine, Jones was a distributor of a generic phentermine product and, after its acquisition of Abana Pharmaceuticals, was a distributor of Obenix®, Abana’s branded phentermine product. The manufacturer of the phentermine, purchased by Jones, filed for bankruptcy protection and is no longer in business. The plaintiffs in these cases, in addition to the claims described above, claim injury as a result of ingesting a combination of these weight-loss drugs and are seeking compensatory and punitive damages as


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well as medical care and court-supervised medical monitoring. The plaintiffs claim liability based on a variety of theories, including, but not limited to, product liability, strict liability, negligence, breach of warranty, fraud and misrepresentation. All of the cases involving King Research and Development have been dismissed, except for two. The Company expects these cases to be dismissed as well.
 
King Research and Development denies any liability incident to Jones’ distribution and sale of Obenix® or Jones’ generic phentermine product. King Research and Development’s insurance carriers are currently defending King Research and Development in these lawsuits. The manufacturers of fenfluramine and dexfenfluramine have settled nearly all of these cases. As a result of these settlements, King Research and Development has routinely received voluntary dismissals without the payment of settlement proceeds. In the event that King Research and Development’s insurance coverage is inadequate to satisfy any resulting liability, King Research and Development will have to assume defense of these lawsuits and be responsible for the damages, if any, that are awarded against it.
 
While the Company cannot predict the outcome of these lawsuits, management believes that the claims against King Research and Development are without merit and intends to vigorously pursue all defenses available. The Company is unable to disclose an aggregate dollar amount of damages claimed because these complaints are multi-party suits and do not state specific damage amounts. Rather, these claims typically state damages as may be determined by the court or similar language and state no specific amount of damages against King Research and Development. Consequently, the Company cannot reasonably estimate possible losses related to the lawsuits.
 
Hormone Replacement Therapy
 
Currently, the Company is named as a defendant by 22 plaintiffs in lawsuits involving the manufacture and sale of hormone replacement therapy drugs. The first of these lawsuits was filed in July 2004. Numerous other pharmaceutical companies have also been sued. The Company was sued by approximately 1,000 plaintiffs, but most of those claims were voluntarily dismissed or dismissed for lack of product identification. The remaining 22 lawsuits were filed in Alabama, Arkansas, California, Missouri, Pennsylvania, Ohio, Florida, Maryland, Mississippi and Minnesota. A federal multidistrict litigation court has been established in the U.S. District Court for the Eastern District of Arkansas, Western Division, In re: Prempro Products Liability Litigation, and all of the plaintiffs’ claims have been transferred and are pending in that Court except for one lawsuit pending in Philadelphia, Pennsylvania state court. Many of these plaintiffs allege that the Company and other defendants failed to conduct adequate research and testing before the sale of the products and post-sale monitoring to establish the safety and efficacy of the long-term hormone therapy regimen and, as a result, misled consumers when marketing their products. Plaintiffs also allege negligence, strict liability, design defect, breach of implied warranty, breach of express warranty, fraud and misrepresentation. Discovery of the plaintiffs’ claims against the Company has begun but is limited to document discovery. No trial has occurred in the hormone replacement therapy litigation against the Company or any other defendants except Wyeth/Pfizer/Upjohn. The trials against Pfizer/Wyeth have resulted in verdicts for and against Pfizer/Wyeth, with several verdicts against Wyeth reversed on post-trial motions. Pfizer/Wyeth lost appeals in the Eighth Circuit from an adverse jury verdict in the federal multidistrict litigation court and in the Pennsylvania Court of Appeals. Pfizer/Upjohn has lost several jury verdicts. One of these verdicts was later reversed, and one other was partially reversed. The Company does not expect to have any trials set in the next year. The Company intends to defend these lawsuits vigorously but is currently unable to predict the outcome or to reasonably estimate the range of potential loss, if any. The Company may have limited insurance for these claims. The Company would have to assume defense of the lawsuits and be responsible for damages, fees and expenses, if any, that are awarded against it or for amounts in excess of the Company’s product liability coverage.
 
Alpharma Matters
 
The following matters relate to our Alpharma subsidiary and/or certain of its subsidiaries.


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Department of Justice Investigation
 
As previously disclosed, Alpharma, acquired by the Company in December 2008, received a subpoena from the U.S. Department of Justice (“DOJ”) in February 2007 in connection with its investigation of alleged improper sales and marketing practices related to the sale of the pain medicine Kadian®. The Company divested Alpharma’s Kadian® assets to Actavis LLC simultaneously with the closing of the acquisition of Alpharma.
 
In September 2009, the Company reached an agreement in principle with the U.S. Attorney’s Office and DOJ which would resolve this investigation. The Company recorded a reserve of $42,500 in connection with this development in the third quarter of 2009 as an adjustment to the goodwill associated with the purchase of Alpharma. Under the terms of the agreement in principle, the Company began accruing interest on October 1, 2009 at a rate of 3.125% per annum. During the first quarter of 2010, Alpharma entered into a definitive settlement agreement and paid $42,500 plus interest of $648 to the DOJ, of which $8,876 plus interest of $161 is related to certain states.
 
Chicken Litter Litigation
 
Alpharma and one of its subsidiaries are two of multiple defendants that have been named in several lawsuits that allege that one of its animal health products causes chickens to produce manure that contains an arsenical compound which, when used as agricultural fertilizer by chicken farmers, degrades into inorganic arsenic and may have caused a variety of diseases in the plaintiffs (who allegedly live in close proximity to such farm fields). These lawsuits were filed beginning on December 16, 2003. Alpharma provided notice to its insurance carriers and its primary insurance carriers have responded by accepting their obligations to defend or pay Alpharma’s defense costs, subject to reservation of rights to later reject coverage for these lawsuits. One of the carriers has filed a declaratory judgment action in state court in which it has sought a ruling concerning the allocation of its coverage obligations to Alpharma among the several insurance carriers and, to the extent Alpharma does not have full insurance coverage, to Alpharma. Further, this declaratory judgment action requests that the Court rule that certain of the carrier’s policies provide no coverage because certain policy exclusions allegedly operate to limit its coverage obligations under said policies. The insurance carriers may take the position that some, or all, of the applicable insurance policies contain certain provisions that could limit coverage for future product liability claims arising in connection with product sold on and after December 16, 2003.
 
In addition to the potential for personal injury damages to the approximately 155 plaintiffs, the plaintiffs are asking for punitive damages and requesting that Alpharma be enjoined from the future sale of the product at issue. In September 2006, in the first trial, which was brought by three plaintiffs, the Circuit Court of Washington County, Arkansas, Second Division entered a jury verdict in favor of Alpharma. The plaintiffs appealed the verdict, challenging certain pretrial expert rulings; however, in May 2008, the Supreme Court of Arkansas denied plaintiffs’ challenges. In its ruling, the Supreme Court of Arkansas also overturned the trial court’s grant of summary judgment that had the effect of dismissing certain poultry company co-defendants from the case. The case was tried against the poultry company co-defendants in April and May 2009, resulting in a verdict for the defendants. In July 2009, the plaintiffs filed a notice of appeal of that verdict. It is expected that the appeal of the case will be heard in 2010. No additional cases have been set for trial. Subsequent cases may be tried against both the poultry companies and Alpharma together.
 
While the Company can give no assurance of the outcome of any future trial in this litigation, it believes that it will be able to continue to present credible scientific evidence that its product is not the cause of any injuries the plaintiffs may have suffered. There is also the possibility of an adverse customer reaction to the allegations in these lawsuits, as well as additional lawsuits in other jurisdictions where the product has been sold. Worldwide sales of this product were approximately $23,606 in 2009 and approximately $7,059 and $14,235, respectively, in the three and six months ended June 30, 2010.


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AWP Litigation
 
Alpharma, and in certain instances one of its subsidiaries, are defendants in connection with various elements of the litigation described above under the heading “Average Wholesale Price Litigation”, primarily related to sale of Kadian® capsules. At present, Alpharma is involved in proceedings in the following courts:
 
  •  Superior Court for the State of Alaska, Third Judicial District of Anchorage;
 
  •  Second Judicial Court in and for Leon County, Florida;
 
  •  Circuit Court of Cook County, Illinois, County Department, Chancery Division; and
 
  •  Court of Common Pleas, for the Fifth Judicial District, State of South Carolina, County of Richland.
 
In addition, Alpharma’s New York and Iowa cases are pending in the MDL Court discussed above. Mississippi and Texas cases against Alpharma were dismissed without prejudice. The Company expects the Florida case will be dismissed voluntarily.
 
These lawsuits vary with respect to the particular causes of action and relief sought. The relief sought in these lawsuits includes statutory causes of action including civil penalties and treble damages, common law causes of action, declaratory and injunctive relief, and punitive damages, including, in certain lawsuits, disgorgement of profits. The Company believes it has meritorious defenses and intends to vigorously defend its positions in these lawsuits. Numerous other pharmaceutical companies are defendants in similar lawsuits.
 
Environmental Matters
 
In 2006, the Company contacted the U.S. Environmental Protection Agency (“EPA”) to report past deviations from the requirements of the state conditional major air emissions operating permit relating to the Company’s operation of certain pollution control equipment at its Bristol, Tennessee facility. In May 2009, the Company received an information request from EPA pursuant to section 114 of the Clean Air Act regarding the Company’s historic air emissions and its operation of certain pollution control equipment (“Information Request”). In June 2009, the Company provided EPA with its initial response to the Information Request. The Company has subsequently provided additional information to, and met with, EPA and the Tennessee Department of Environment and Conservation. At this time, the Company cannot predict or determine the outcome of this matter or reasonably estimate the amount or range of amounts of fines or penalties, if any, that might result from an adverse outcome.
 
10.   Accounting Developments
 
In April 2010, the FASB issued a standard that provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for certain research and development transactions. Under this new standard, a company can recognize as revenue consideration that is contingent upon achievement of a milestone in the period in which it is achieved, if the milestone meets all criteria to be considered substantive. This standard will be effective for us on a prospective basis for periods beginning after January 1, 2011. The Company does not anticipate the standard will have a material effect on its financial statements.
 
In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for transfers of financial assets. This amendment requires greater transparency and additional disclosures for transfers of financial assets and the entity’s continuing involvement with them and changes the requirements for derecognizing financial assets. In addition, this amendment eliminates the concept of a qualifying special-purpose entity (“QSPE”). This amendment is effective for financial statements issued for fiscal years beginning after November 15, 2009. The Company’s adoption of this amendment did not have a material effect on its financial statements.
 
In June 2009, the FASB also issued an amendment to the accounting and disclosure requirements for the consolidation of variable interest entities (“VIEs”). The elimination of the concept of a QSPE, as discussed above,


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
removes the exception from applying the consolidation guidance within this amendment. This amendment requires an enterprise to perform a qualitative analysis when determining whether or not it must consolidate a VIE. The amendment also requires an enterprise to continuously reassess whether it must consolidate a VIE. Additionally, the amendment requires enhanced disclosures about an enterprise’s involvement with VIEs and any significant change in risk exposure due to that involvement, as well as how its involvement with VIEs impacts the enterprise’s financial statements. Finally, an enterprise will be required to disclose significant judgments and assumptions used to determine whether or not to consolidate a VIE. This amendment is effective for financial statements issued for fiscal years beginning after November 15, 2009. The Company’s adoption of this amendment did not have a material effect on its financial statements.
 
11.   Income Taxes
 
During the three months and six months ended June 30, 2010, the Company’s effective income tax rate was 39.8% and 53.1%, respectively. During the three months and six months ended June 30, 2009, the Company’s effective income tax was 43.6% and 46.1%, respectively. These rates are higher than the statutory rate of 35% primarily due to losses from foreign subsidiaries with no tax benefit, taxes related to stock compensation and state taxes.
 
12.   Segment Information
 
The Company’s business is classified into four reportable segments: branded prescription pharmaceuticals, Alpharma animal health, Meridian Auto-Injector, and royalties and other. The branded prescription pharmaceuticals segment includes a variety of branded prescription products that are separately categorized into neuroscience, hospital and legacy products. These branded prescription products are aggregated because of the similarity in regulatory environment, manufacturing processes, methods of distribution and types of customer. The Alpharma animal health business is a global leader in the development, registration, manufacture and marketing of medicated feed additives and water soluble therapeutics primarily for poultry, cattle and swine. Meridian Auto-Injector products are sold to both commercial and government markets. The principal source of revenues in the commercial market is the EpiPen® product, an epinephrine filled auto-injector which is primarily prescribed for the treatment of severe allergic reactions and which is primarily marketed, distributed and sold by Dey, L.P. Government revenues in the Meridian Auto-Injector segment are principally derived from the sale of nerve agent antidotes and other emergency medicine auto-injector products marketed to the U.S. Department of Defense and other federal, state and local agencies, particularly those involved in homeland security, as well as to approved foreign governments. Royalties and other primarily includes revenues the Company derives from pharmaceutical products after the Company has transferred the manufacturing or marketing rights to third parties in exchange for licensing fees or royalty payments.
 
The Company primarily evaluates its segments based on segment profit. Reportable segments were separately identified based on revenues and segment profit. Segment profit is defined as operating income (loss) before other expenses such as depreciation, amortization, restructuring charges and expenses associated with the acquisition of Alpharma. Additionally, segment profit does not include general corporate expenses, which are included in “Corporate costs” in the table below. Prior year results have been conformed to the current presentation.


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following represents selected information for the Company’s reportable segments for the periods indicated.
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2010     2009     2010     2009  
 
Total revenues:
                               
Branded prescription pharmaceuticals(1)
  $ 162,243     $ 275,110     $ 403,784     $ 552,814  
Alpharma Animal Health
    84,673       82,824       165,987       162,659  
Meridian Auto-Injector
    82,702       72,091       132,529       128,698  
Royalties and other
    42,415       15,739       51,059       31,886  
Eliminations
    (1,130 )     (776 )     (1,601 )     (2,012 )
                                 
Total revenues
  $ 370,903     $ 444,988     $ 751,758     $ 874,045  
                                 
Segment profit:
                               
Branded prescription pharmaceuticals(1)(2)
  $ 8,598     $ 117,656     $ 71,775     $ 222,973  
Alpharma Animal Health(2)
    21,816       5,126       39,279       5,159  
Meridian Auto-Injector
    51,096       38,224       74,937       65,109  
Royalties and other
    28,346       13,640       35,715       26,858  
Corporate costs
    (22,983 )     (27,584 )     (49,831 )     (60,709 )
Acquisition related costs
          (2,944 )           (6,733 )
Depreciation and amortization
    (53,903 )     (52,862 )     (111,178 )     (106,211 )
Restructuring charges
    (4,852 )     (1,475 )     (5,114 )     (49,525 )
Other income (expense)
    1,752       (22,498 )     (7,650 )     (46,415 )
                                 
Income before income taxes
  $ 29,870     $ 67,283     $ 47,933     $ 50,506  
                                 
 
 
(1) Branded prescription pharmaceuticals revenues and segment profit does not include the revenue recognized related to the Company’s agreement with CorePharma providing it with a license to launch an authorized generic version of Skelaxin®. In accordance with the agreement, the Company receives a fee based on CorePharma’s gross profit, as defined in the agreement, of the authorized generic product. This revenue is recorded in royalties and other.
 
(2) The segment profit for branded prescription pharmaceuticals and Alpharma animal health for the three months ended June 30, 2009 includes charges of $2,440 and $13,618, respectively, related to the mark up of inventory upon acquisition of Alpharma, which the Company recognized as the related inventory was sold. The segment profit for branded prescription pharmaceuticals and Alpharma animal health for the six months ended June 30, 2009 includes charges of $3,455 and $34,128, respectively.


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
The following represents branded prescription pharmaceutical revenues by the Company’s target markets:
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2010     2009     2010     2009  
 
Total revenues:
                               
Neuroscience
  $ 77,906     $ 170,853     $ 233,603     $ 327,954  
Hospital
    40,005       52,698       79,960       104,657  
Legacy:
                               
Cardiovascular/metabolic
    27,626       32,818       55,776       77,786  
Other
    16,706       18,741       34,445       42,417  
                                 
Branded prescription pharmaceutical revenues
  $ 162,243     $ 275,110     $ 403,784     $ 552,814  
                                 
 
13.   Restructuring Activities
 
Second Quarter of 2010 Action
 
During the second quarter of 2010, management completed an evaluation of the commercial operations organization within the branded prescription pharmaceuticals segment. As a result of this evaluation, the Company made changes in the management of its commercial operations organization, and a number of employees departed the Company, including the Chief Commercial Officer. The Company also eliminated certain sales territories to better focus on higher potential territories.
 
The Company has estimated that the total costs associated with this restructuring plan will be approximately $4,946 for severance pay and other employee related costs, which include approximately $1,119 of cash expenditures paid in the second quarter of 2010. The remaining severance pay is expected to be fully paid in the third quarter of 2010.
 
The restructuring charges include employee termination costs associated with a workforce reduction of approximately 30 employees, all of which were members of the commercial operations organization.
 
First Quarter of 2009 Action
 
On January 20, 2009, the U.S. District Court for the Eastern District of New York issued an order ruling invalid two patents relating to the Company’s product Skelaxin®. In June 2009, the Court entered judgment against the Company. In August 2010, the Court of Appeals for the Federal Circuit affirmed the actions of the District Court. Generic versions of Skelaxin® entered the market early in the second quarter of 2010. The Company’s sales of Skelaxin® have declined significantly and are expected to continue to decline as a result of generic competition. For additional information regarding Skelaxin® litigation, please see Note 9.
 
Following the decision of the District Court, the Company’s senior management team conducted an extensive examination of the Company and developed a restructuring initiative. Based on an analysis of the Company’s strategic needs, this initiative included a reduction in sales, marketing and other personnel; leveraging of staff; expense reductions and additional controls over spending; and reorganization of sales teams.
 
The Company incurred restructuring charges of approximately $50,000 associated with this restructuring plan related to severance pay and other employee termination expenses. Almost all of the restructuring charges were cash expenditures and were substantially paid in the second quarter of 2009. The remaining severance pay and other employee termination costs are expected to be fully paid by the third quarter of 2010.
 
The restructuring charges include employee termination costs associated with a workforce reduction of approximately 520 employees, including approximately 380 members of our sales force.


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Fourth Quarter of 2008 Action
 
As part of the acquisition of Alpharma, management developed a restructuring plan to eliminate redundancies in operations created by the acquisition. This plan includes a reduction in personnel, staff leverage, reductions in duplicate expenses and a realignment of research and development priorities.
 
The Company has estimated total costs of $70,928 associated with this restructuring plan, $64,516 of which was included in the liabilities assumed in the purchase price of Alpharma. The restructuring plan includes employee termination costs associated with a workforce reduction of 250 employees. The restructuring plan also includes contract termination costs of $16,458 as a result of the acquisition. All employee termination costs are expected to be paid by the end of 2012. All contract termination costs are expected to be paid by the end of 2018.
 
Third Quarter of 2006 Action
 
During 2006, the Company decided to streamline its manufacturing activities in order to improve operating efficiency and reduce costs, including the decision to transfer the production of Levoxyl® from its St. Petersburg, Florida facility to its Bristol, Tennessee facility, which the Company expects to complete in 2011. As a result of these steps, the Company incurred restructuring charges totaling approximately $16,500, of which approximately $12,000 are associated with accelerated depreciation and approximately $4,500 are associated with employee termination costs. The employee termination costs are expected to be fully paid in the first quarter of 2011.
 
A summary of the types of costs accrued and incurred are summarized below:
 
                                         
    Accrued
                      Accrued
 
    Balance at
    Income
                Balance at
 
    December 31,
    Statement
    Cash
    Non-Cash
    June 30,
 
    2009     Impact     Payments     Costs     2010  
 
Second quarter of 2010 Action
                                       
Employee separation payments
  $     $ 4,900     $ 1,119     $ 1,640     $ 2,141  
Contract termination
          46                   46  
Third quarter of 2009 action
                                       
Employee separation payments
    1,080       59       1,129             10  
First quarter of 2009 action
                                       
Employee separation payments
    314       23       303             34  
Accelerated depreciation(1)
          (45 )           (45 )      
Fourth quarter of 2008 action
                                       
Employee separation payments
    16,177       (79 )     8,399       (576 )     8,275  
Contract termination
    9,193       265       2,700       (463 )     7,221  
Other
    182       (182 )                  
Third quarter of 2006 action
                                       
Employee separation payments
    1,185       82       22       12       1,233  
                                         
    $ 28,131     $ 5,069     $ 13,672     $ 568     $ 18,960  
                                         
 
 
(1) Included in depreciation and amortization on the Condensed Consolidated Statements of Operations.
 
The restructuring charges in 2010 relate primarily to the branded prescription pharmaceutical segment.
 
14.   Stock-Based Compensation
 
During the second quarter of 2010, the Company granted 9,500 RSAs to certain employees, pursuant to its Incentive Plan, and 145,809 restricted stock units (“RSUs”) were granted to non-employee directors.


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
During the first quarter of 2010, the Company granted to certain employees, pursuant to its Incentive Plan, 650,370 RSAs, 452,530 LPUs with a one-year performance cycle, 193,930 LPUs with a three-year performance cycle, 16,550 RSUs and 1,770,260 nonqualified stock options.
 
The RSAs are grants of shares of common stock restricted from sale or transfer for three years from grant date.
 
RSUs represent the right to receive a share of common stock at the expiration of a restriction period, generally three years from grant, but may be restricted for other designated periods as determined by the Company’s Board of Directors or a committee of the Board. The RSUs granted to non-employee directors under the current Compensation Policy for Non-Employee Directors have a restriction period that generally ends one year after the date of the grant, unless a deferral election is made in advance.
 
The LPUs are rights to receive common stock of the Company in which the number of shares ultimately received depends on the Company’s performance over time. LPUs with a one-year performance cycle, followed by a two-year restriction period, will be earned based on 2010 operating targets. LPUs with a three-year performance cycle will be earned based on market-related performance targets over the years 2010 through 2012. At the end of the applicable performance period, the number of shares of common stock awarded is either 0% or between 50% and 200% of a target number. The final performance percentage on which the number of shares of common stock issued is based, considering performance metrics established for the performance period, will be determined by the Company’s Board of Directors or a committee of the Board at its sole discretion.
 
The nonqualified stock options were granted at option prices equal to the fair market value of the common stock at the date of grant and vest approximately in one-third increments on each of the first three anniversaries of the grant date.
 
15.   Guarantor Financial Statements
 
Each of the Company’s U.S. subsidiaries (the “Guarantor Subsidiaries”) guarantees on a full, unconditional and joint and several basis the Company’s performance under the $400,000 aggregate principal amount of the Convertible Senior Notes.
 
There are no restrictions under the Company’s current financing arrangements on the ability of the Guarantor Subsidiaries to distribute funds to the Company in the form of cash dividends, loans or advances. The following combined financial data provides information regarding the financial position, results of operations and cash flows of the Guarantor Subsidiaries for the $400,000 aggregate principal amount of the Convertible Senior Notes (condensed consolidating financial data). Separate financial statements and other disclosures concerning the Guarantor Subsidiaries are not presented because management has determined that such information would not be material to the holders of the debt.


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
GUARANTOR SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEETS
(In thousands)
(Unaudited)
 
                                                                                 
    June 30, 2010     December 31, 2009  
                Non-
                            Non-
             
          Guarantor
    Guarantor
    Eliminating
    King
          Guarantor
    Guarantor
    Eliminating
    King
 
    King     Subsidiaries     Subsidiaries     Entries     Consolidated     King     Subsidiaries     Subsidiaries     Entries     Consolidated  
 
ASSETS
Current assets:
                                                                               
Cash and cash equivalents
  $ 303,425     $ 40,637     $ 229,000     $     $ 573,062     $ 277,603     $ 30,779     $ 236,930     $     $ 545,312  
Investments in debt securities
    16,346                         16,346       29,258                         29,258  
Marketable securities
    1,022                         1,022       2,100                         2,100  
Accounts receivable, net
    29,174       143,753       36,658             209,585       2,467       174,713       33,076             210,256  
Inventories
    44,533       120,651       32,600       (2,170 )     195,614       43,834       111,242       28,642       (1,427 )     182,291  
Deferred income tax assets
    31,296       40,739       459             72,494       30,828       52,597       250             83,675  
Income taxes receivable
    13,147       472       (278 )           13,341       17,983       (1,865 )     (27 )           16,091  
Prepaid expenses and other current assets
    11,565       16,637       1,121             29,323       14,972       44,384       1,504             60,860  
                                                                                 
Total current assets
    450,508       362,889       299,560       (2,170 )     1,110,787       419,045       411,850       300,375       (1,427 )     1,129,843  
                                                                                 
Property, plant and equipment, net
    143,290       225,840       8,168             377,298       148,399       234,233       9,207             391,839  
Intangible assets, net
          686,452       33,410             719,862             759,583       34,556             794,139  
Goodwill
          466,283                   466,283             467,613                   467,613  
Deferred income tax assets
    (29,626 )     288,633       572             259,579       (26,551 )     290,104       609             264,162  
Investments in debt securities
    169,777                         169,777       218,608                         218,608  
Other assets
    37,232       21,206       310             58,748       32,368       23,795       333             56,496  
Assets held for sale
          5,890                   5,890             5,890                   5,890  
Investments in subsidiaries
    3,038,414       873,349       (115 )     (3,911,648 )           3,027,491       938,020       (88 )     (3,965,423 )      
                                                                                 
Total assets
  $ 3,809,595     $ 2,930,542     $ 341,905     $ (3,913,818 )   $ 3,168,224     $ 3,819,360     $ 3,131,088     $ 344,992     $ (3,966,850 )   $ 3,328,590  
                                                                                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
                                                                               
Accounts payable
  $ 25,772     $ 41,836     $ 6,568     $     $ 74,176     $ 27,377     $ 53,966     $ 5,349     $     $ 86,692  
Accrued expenses
    24,281       196,218       8,248             228,747       31,541       279,662       9,789             320,992  
Short-term debt
                3,506             3,506                   3,662             3,662  
Current portion of long-term debt
                                  85,550                         85,550  
                                                                                 
Total current liabilities
    50,053       238,054       18,322             306,429       144,468       333,628       18,800             496,896  
                                                                                 
Long-term debt
    341,735                         341,735       339,016                         339,016  
Other liabilities
    67,508       45,764       13,332             126,604       59,884       48,579       14,908             123,371  
Intercompany (receivable) payable
    956,843       (998,019 )     41,176                   906,685       (932,193 )     25,508              
                                                                                 
Total liabilities
    1,416,139       (714,201 )     72,830             774,768       1,450,053       (549,986 )     59,216             959,283  
                                                                                 
Shareholders’ equity
    2,393,456       3,644,743       269,075       (3,913,818 )     2,393,456       2,369,307       3,681,074       285,776       (3,966,850 )     2,369,307  
                                                                                 
Total liabilities and shareholders’ equity
  $ 3,809,595     $ 2,930,542     $ 341,905     $ (3,913,818 )   $ 3,168,224     $ 3,819,360     $ 3,131,088     $ 344,992     $ (3,966,850 )   $ 3,328,590  
                                                                                 


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
GUARANTOR SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
(In thousands)
(Unaudited)
 
                                                                                 
    Three Months Ended June 30, 2010     Three Months Ended June 30, 2009  
                Non-
                            Non-
             
          Guarantor
    Guarantor
          King
          Guarantor
    Guarantor
          King
 
    King     Subsidiaries     Subsidiaries     Eliminations     Consolidated     King     Subsidiaries     Subsidiaries     Eliminations     Consolidated  
 
Revenues:
                                                                               
Net sales
  $ 75,045     $ 302,432     $ 46,257     $ (90,881 )   $ 332,853     $ 83,593     $ 528,701     $ 39,362     $ (221,357 )   $ 430,299  
Royalties
    25,630       12,420                   38,050       (20 )     14,709                   14,689  
                                                                                 
Total revenues
    100,675       314,852       46,257       (90,881 )     370,903       83,573       543,410       39,362       (221,357 )     444,988  
                                                                                 
Operating costs and expenses:
                                                                               
Cost of revenues
    32,293       151,225       26,142       (90,633 )     119,027       31,163       320,858       26,465       (222,393 )     156,093  
Selling, general and administrative
    49,360       74,253       8,216             131,829       46,453       70,101       7,021             123,575  
Research and development
    2,720       29,493       961             33,174       985       17,835       2,382             21,202  
Depreciation and amortization
    5,527       47,484       892             53,903       4,793       46,763       1,306             52,862  
Restructuring charges
    2,754       2,098                   4,852       803       672                   1,475  
                                                                                 
Total operating costs and expenses
    92,654       304,553       36,211       (90,633 )     342,785       84,197       456,229       37,174       (222,393 )     355,207  
                                                                                 
Operating income (loss)
    8,021       10,299       10,046       (248 )     28,118       (624 )     87,181       2,188       1,036       89,781  
Other income (expense):
                                                                               
Interest income
    361       16       110             487       979       10       517             1,506  
Interest expense
    (6,818 )     (612 )     (49 )           (7,479 )     (26,402 )     (1,116 )     (74 )           (27,592 )
Gain on Kadian®
          12,500                   12,500                                
Gain (loss) on investments
    249                         249       (524 )                       (524 )
Loss on early extinguishment of debt
    (2,252 )                       (2,252 )                              
Other, net
    (145 )     (334 )     (1,274 )           (1,753 )     482       2,046       1,584             4,112  
Equity in earnings (loss) of subsidiaries
    19,343       2,641       (7 )     (21,977 )           58,932       4,238       60       (63,230 )      
Intercompany interest income (expense)
    (2,309 )     11,139       (8,830 )                 (1,296 )     5,725       (4,429 )            
                                                                                 
Total other income (expense)
    8,429       25,350       (10,050 )     (21,977 )     1,752       32,171       10,903       (2,342 )     (63,230 )     (22,498 )
                                                                                 
Income (loss) before income taxes
    16,450       35,649       (4 )     (22,225 )     29,870       31,547       98,084       (154 )     (62,194 )     67,283  
                                                                                 
Income tax expense (benefit)
    (1,538 )     12,564       856             11,882       (6,388 )     35,852       (116 )           29,348  
                                                                                 
Net income (loss)
  $ 17,988     $ 23,085     $ (860 )   $ (22,225 )   $ 17,988     $ 37,935     $ 62,232     $ (38 )   $ (62,194 )   $ 37,935  
                                                                                 


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
GUARANTOR SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS — (Continued)
(In thousands)
(Unaudited)
 
                                                                                 
    Six Months Ended June 30, 2010     Six Months Ended June 30, 2009  
                Non-
                            Non-
             
          Guarantor
    Guarantor
          King
          Guarantor
    Guarantor
          King
 
    King     Subsidiaries     Subsidiaries     Eliminations     Consolidated     King     Subsidiaries     Subsidiaries     Eliminations     Consolidated  
 
Revenues:
                                                                               
Net sales
  $ 167,996     $ 659,226     $ 83,699     $ (204,990 )   $ 705,931     $ 178,775     $ 926,057     $ 69,839     $ (330,040 )   $ 844,631  
Royalties
    25,617       20,210                   45,827       (53 )     29,467                   29,414  
                                                                                 
Total revenues
    193,613       679,436       83,699       (204,990 )     751,758       178,722       955,524       69,839       (330,040 )     874,045  
                                                                                 
Operating costs and expenses:
                                                                               
Cost of revenues
    52,030       348,800       48,186       (202,935 )     246,081       58,093       530,253       49,566       (330,880 )     307,032  
Selling, general and administrative
    99,124       157,091       16,089             272,304       105,872       146,320       13,706             265,898  
Research and development
    4,904       54,207       2,387             61,498       2,594       42,162       3,702             48,458  
Depreciation and amortization
    11,701       97,684       1,793             111,178       9,650       94,709       1,852             106,211  
Restructuring charges
    2,756       2,358                   5,114       14,307       35,218                   49,525  
                                                                                 
Total operating costs and expenses
    170,515       660,140       68,455       (202,935 )     696,175       190,516       848,662       68,826       (330,880 )     777,124  
                                                                                 
Operating income (loss)
    23,098       19,296       15,244       (2,055 )     55,583       (11,794 )     106,862       1,013       840       96,921  
Other income (expense):
                                                                               
Interest income
    640       66       190             896       2,428       277       1,589             4,294  
Interest expense
    (14,519 )     (1,600 )     (96 )           (16,215 )     (48,468 )     (2,077 )     (150 )           (50,695 )
Gain on Kadian®
          12,500                   12,500                                
Gain (loss) on investments
    (623 )                       (623 )     (1,347 )                       (1,347 )
Loss on early extinguishment of debt
    (2,252 )                       (2,252 )                              
Other, net
    (52 )     (197 )     (1,707 )           (1,956 )     41       1,947       (655 )           1,333  
Equity in earnings (loss) of subsidiaries
    23,804       5,401       (27 )     (29,178 )           71,550       12,048       40       (83,638 )      
Intercompany interest income (expense)
    (4,402 )     18,696       (14,294 )                 (2,687 )     9,473       (6,786 )            
                                                                                 
Total other income (expenses)
    2,596       34,866       (15,934 )     (29,178 )     (7,650 )     21,517       21,668       (5,962 )     (83,638 )     (46,415 )
                                                                                 
Income (loss) before income taxes
    25,694       54,162       (690 )     (31,233 )     47,933       9,723       128,530       (4,949 )     (82,798 )     50,506  
                                                                                 
Income tax expense (benefit)
    3,237       20,435       1,804             25,476       (17,490 )     41,836       (1,053 )           23,293  
                                                                                 
Net income (loss)
  $ 22,457     $ 33,727     $ (2,494 )   $ (31,233 )   $ 22,457     $ 27,213     $ 86,694     $ (3,896 )   $ (82,798 )   $ 27,213  
                                                                                 


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KING PHARMACEUTICALS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
GUARANTOR SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
                                                                 
    Six Months Ended June 30, 2010     Six Months Ended June 30, 2009  
                Non-
                      Non-
       
          Guarantor
    Guarantor
    King
          Guarantor
    Guarantor
    King
 
    King     Subsidiaries     Subsidiaries     Consolidated     King     Subsidiaries     Subsidiaries     Consolidated  
 
Cash flows provided by operating activities
  $ 12,798     $ 49,270     $ (13,193 )   $ 48,875     $ (74,351 )   $ 190,727     $ 1,190     $ 117,566  
                                                                 
Cash flows from investing activities:
                                                               
Transfers to restricted cash
    (5 )                 (5 )     (28 )     (27 )           (55 )
Proceeds from maturities and sales of investments in debt securities
    67,860                   67,860       32,223                   32,223  
Purchases of property, plant and equipment
    (8,925 )     (8,058 )     (316 )     (17,299 )     (13,492 )     (5,168 )     (172 )     (18,832 )
Proceeds from sale of property and equipment
    162       73             235                          
Proceeds from sale of Kadian®
          40,000             40,000             34,800             34,800  
Acquisition of Alpharma
                            (13,677 )     (56,697 )           (70,374 )
Forward foreign exchange contracts
                                        (3,117 )     (3,117 )
Purchases of intellectual property and product rights
          (1,280 )           (1,280 )     (1 )     (1,206 )           (1,207 )
                                                                 
Net cash provided by (used in) investing activities
    59,092       30,735       (316 )     89,511       5,025       (28,298 )     (3,289 )     (26,562 )
                                                                 
Cash flows from financing activities:
                                                               
Proceeds from exercise of stock options
    963                   963       1,286                   1,286  
Net payments related to stock-based award activity
    (4,979 )                 (4,979 )     (3,123 )                 (3,123 )
Payments on debt
    (92,261 )           (156 )     (92,417 )     (200,000 )     (385,227 )           (585,227 )
Debt issuance costs
    (4,315 )                 (4,315 )     (1,313 )                 (1,313 )
Intercompany
    54,524       (70,147 )     15,623             56,517       (49,179 )     (7,338 )      
                                                                 
Net cash (used in) provided by financing activities
    (46,068 )     (70,147 )     15,467       (100,748 )     (146,633 )     (434,406 )     (7,338 )     (588,377 )
                                                                 
Effect of exchange rate changes on cash
                (9,888 )     (9,888 )                 (647 )     (647 )
Increase (decrease) in cash and cash equivalents
    25,822       9,858       (7,930 )     27,750       (215,959 )     (271,977 )     (10,084 )     (498,020 )
Cash and cash equivalents, beginning of period
    277,603       30,779       236,930       545,312       401,657       289,996       248,559       940,212  
                                                                 
Cash and cash equivalents, end of period
  $ 303,425     $ 40,637     $ 229,000     $ 573,062     $ 185,698     $ 18,019     $ 238,475     $ 442,192  
                                                                 


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion contains certain forward-looking statements that reflect management’s current views of future events and our business, financial condition and results of operations. This discussion should be read in conjunction with the following: (a) our audited consolidated financial statements and related notes which are included in our Annual Report on Form 10-K for the year ended December 31, 2009; and (b) our unaudited condensed consolidated financial statements and related notes which are included in this Quarterly Report on Form 10-Q. Please see the sections entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009, and “Risk Factors” and “A Warning About Forward-Looking Statements” in this Quarterly Report on Form 10-Q for a discussion of the uncertainties, risks and assumptions associated with these statements.
 
I.   OVERVIEW
 
Our Business
 
We are a vertically integrated pharmaceutical company that performs basic research and develops, manufactures, markets and sells branded prescription pharmaceutical products and animal health products. By “vertically integrated,” we mean that we have the following capabilities:
 
  •  research and development
 
  •  manufacturing
 
  •  packaging
 
  •  quality control and assurance
 
  •  distribution
 
  •  sales and marketing
 
  •  business development
 
  •  regulatory management
 
Branded prescription pharmaceutical products are innovative products sold under a brand name that have, or previously had, some degree of market exclusivity. Our branded prescription pharmaceuticals include neuroscience products (primarily pain medicines), hospital products, and legacy brands, all of which are for use in humans. Our auto-injector business manufactures acute care medicines for use in humans that are delivered using an auto-injector. Our Alpharma animal health business is focused on medicated feed additives (“MFAs”) and water-soluble therapeutics primarily for poultry, cattle, and swine.
 
Our corporate strategy is focused on specialty markets, particularly specialty-driven branded prescription pharmaceutical markets. We believe our target markets have significant potential, and our organization is aligned to focus on these markets. Our growth in specialty markets is achieved through both acquisitions and organic growth. Our strategy focuses on growth through the acquisition of novel branded prescription pharmaceutical products and technologies that we believe complement the commercial footprint we have established in the neuroscience and hospital markets. We strive to be a leader in developing and commercializing innovative, clinically-differentiated therapies and technologies in these target, specialty-driven markets. We may also seek company acquisitions that add commercialized products or products in development, technologies or sales and marketing capabilities to our existing platforms or that otherwise complement our operations. We also have a commitment to research and development and advancing the products and technologies in our development pipeline.
 
We work to achieve organic growth by maximizing the potential of our currently marketed products through sales and marketing and product life-cycle management. By “product life-cycle management,” we mean the extension of the economic life of products, including seeking and obtaining necessary governmental approvals, by securing from the U.S. Food and Drug Administration (“FDA”) additional approved uses for our products, developing and producing different strengths, producing different package sizes, developing new dosage forms, and developing new product formulations.
 
We market our branded prescription pharmaceutical products, primarily through a dedicated sales force, to general/family practitioners, internal medicine physicians, neurologists, pain specialists, surgeons and hospitals across the United States and in Puerto Rico.
 
Through a team of internal sales professionals, our auto-injector business markets a portfolio of acute care auto-injector products to the pre-hospital emergency services market, which includes U.S. federal, state and local governments, public health services, emergency medical personnel and first responders and approved foreign governments.


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The animal health products of our wholly-owned subsidiary Alpharma, LLC (“Alpharma”) are marketed through a staff of trained sales and technical service and marketing employees, many of whom are veterinarians and nutritionists. Sales offices are located in the U.S., Europe, Canada, Mexico, South America and Asia. Elsewhere, our Alpharma animal health products are sold primarily through distributors and other third-party sales companies.
 
Recent Developments
 
Acurox® Tablets (with niacin)
 
Acurox® Tablets, a patented, orally administered, immediate release tablet containing oxycodone HCl as its sole active analgesic ingredient, has a proposed indication for the relief of moderate to severe pain. Acurox® uses Acura Pharmaceuticals Inc.’s (“Acura”) patented Aversion® Technology, which is designed to deter misuse and abuse by intentional swallowing of excess quantities of tablets, intravenous injection of dissolved tablets and nasal snorting of crushed tablets. Attempts to extract oxycodone from an Acurox® Tablet by dissolving it in liquid result in the formation of a viscous gel which is intended to limit the ability to inject the drug intravenously. Crushing an Acurox® Tablet for the purposes of nasal snorting releases an ingredient that is intended to cause nasal irritation and thereby discourage this method of misuse and abuse. Swallowing excessive numbers of Acurox® Tablets releases niacin in quantities that are intended to cause unpleasant and undesirable side effects.
 
On June 30, 2009, the FDA issued a Complete Response Letter regarding the New Drug Application (“NDA”) for Acurox® Tablets. The Complete Response Letter raises issues regarding the potential abuse deterrent benefits of Acurox®. In early September 2009, we and Acura met with the FDA to discuss the Complete Response Letter. The FDA, Acura and we agreed to submit the NDA to an FDA advisory committee. On April 22, 2010, the FDA held an advisory committee meeting to review the NDA related to Acurox®. The advisory committee voted that they did not have sufficient evidence to support the approval of the NDA for Acurox® Tablets for the treatment of moderate to severe pain. The presence of niacin in Acurox® was central to the deliberations. The advisory committee did not believe that the benefits of niacin outweighed the potential risks for a broad treatment population. The FDA is not bound by the advisory committee’s recommendation, but may take its advice into consideration when evaluating the NDA for Acurox® Tablets. We continue to evaluate our plans regarding the NDA.
 
Acurox® Tablets (without niacin)
 
Acura and King plan to develop and submit an NDA for Acurox® (oxycodone HCl) Tablets (without niacin) intended to relieve moderate to severe pain and introduce limits and impediments to potential abuse via nasal snorting of crushed tablets and intravenous injection of dissolved tablets. At the April 22, 2010 advisory committee meeting, the FDA cited no concerns with the snorting and intravenous abuse limiting features of the original Acurox® Tablets formulation. The Companies expect to submit an NDA for Acurox® Tablets (without niacin) in early 2011.
 
Acura and King also plan to develop and submit NDAs for two additional immediate release opioid analgesic products utilizing Acura’s proprietary Aversion® Technology: Vycavert® (hydrocodone bitartrate/acetaminophen) Tablets and Acuracet® (oxycodone HCl/acetaminophen) Tablets. Like Acurox® Tablets (without niacin), these additional product candidates are patent protected compositions comprising a mixture of active and inactive ingredients intended to relieve pain and introduce limits and impediments to nasal and intravenous abuse.
 
Skelaxin®
 
On January 20, 2009, the U.S. District Court for the Eastern District of New York issued an order ruling invalid two patents related to Skelaxin®. In June 2009, the Court entered judgment against King. In August 2010, the Court of Appeals for the Federal Circuit affirmed the actions of the District Court. Generic versions of Skelaxin® entered the market early in the second quarter of 2010, one of which is an authorized generic product sold by CorePharma, LLC (“CorePharma”) under a license from us. Net sales of Skelaxin® have declined significantly and will continue to decline as a result of generic competition. According to IMS America, Ltd. (“IMS”) weekly prescription data, for the week ending July 23, 2010, generic competitors have garnered approximately 90% of the prescriptions in the metaxalone market.


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For additional information on the Skelaxin® litigation, please see Note 9, “Commitments and Contingencies”, in Part I, Item 1, “Financial Statements.”
 
II.   RESULTS OF OPERATIONS
 
Three and Six Months Ended June 30, 2010 and 2009
 
Revenues
 
The following table summarizes total revenue by operating segment:
 
                                 
    For the Three Months
    For the Six Months
 
    Ended June 30,     Ended June 30,  
    2010     2009     2010     2009  
          (In thousands)        
 
Total Revenues
                               
Branded prescription pharmaceuticals
  $ 162,243     $ 275,110     $ 403,784     $ 552,814  
Alpharma Animal Health
    84,673       82,824       165,987       162,659  
Meridian Auto-Injector
    82,702       72,091       132,529       128,698  
Royalties and other
    41,285       14,963       49,458       29,874  
                                 
Total revenues
  $ 370,903     $ 444,988     $ 751,758     $ 874,045  
                                 
 
The following table summarizes our deductions from gross revenues:
 
                                 
    For the Three Months
    For the Six Months
 
    Ended June 30,     Ended June 30,  
    2010     2009     2010     2009  
          (In thousands)        
 
Gross Revenues
  $ 451,547     $ 522,833     $ 921,692     $ 1,029,877  
Commercial Rebates
    13,290       14,386       29,219       29,845  
Medicare Part D Rebates
    2,364       3,099       6,129       5,638  
Medicaid Rebates
    6,864       11,400       17,804       23,023  
Chargebacks
    29,406       26,704       57,628       54,880  
Returns
    9,730       5,345       20,487       8,228  
Trade Discounts/Other
    18,990       16,911       38,667       34,218  
                                 
Total revenues
  $ 370,903     $ 444,988     $ 751,758     $ 874,045  
                                 
 
Gross revenues decreased in the second quarter of 2010 compared to the second quarter of 2009, and in the first six months of 2010 compared to the first six months of 2009, primarily due to Skelaxin® and market competition with several other key products in the branded prescription pharmaceuticals segment, partially offset by increased revenues in our Meridian Auto-Injector and Royalties and other segments discussed below.
 
Based on inventory data provided to us by our customers, we believe that wholesale inventory levels of Thrombin-JMI®, Flector® Patch, Avinza®, Embeda®, Levoxyl®, and Skelaxin® are at or below normalized levels as of June 30, 2010. As of June 30, 2010, we estimate that wholesale and retail inventories of our products represent gross sales of approximately $90.0 million to $100.0 million.


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Accrual for Rebates, including Administrative Fees (in thousands):
 
                 
    2010     2009  
 
Balance at January 1, net of prepaid amounts
  $ 44,439     $ 58,129  
Current provision related to sales made in current period
    30,431       28,512  
Current provision related to sales made in prior periods
    203       1,109  
Alpharma acquisition
    (124 )     1,772  
Rebates paid
    (29,580 )     (34,482 )
                 
Balance at March 31, net of prepaid amounts
  $ 45,369     $ 55,040  
                 
Current provision related to sales made in current period
    21,027       31,219  
Current provision related to sales made in prior periods
    1,491       (2,334 )
Alpharma acquisition
    99       885  
Rebates paid
    (30,575 )     (35,474 )
                 
Balance at June 30, net of prepaid amounts
  $ 37,411     $ 49,336  
                 
 
Rebates include commercial, Medicaid and Medicare rebates.
 
Accrual for Returns (in thousands):
 
                 
    2010     2009  
 
Balance at January 1
  $ 30,345     $ 33,471  
Current provision
    10,757       2,883  
Actual returns
    (9,729 )     (4,646 )
                 
Ending balance at March 31
  $ 31,373     $ 31,708  
                 
Current provision
    9,730       5,345  
Actual returns
    (9,073 )     (6,062 )
                 
Ending balance at June 30
  $ 32,030     $ 30,991  
                 
 
Accrual for Chargebacks (in thousands):
 
                 
    2010     2009  
 
Balance at January 1
  $ 10,593     $ 9,965  
Current provision
    28,222       28,176  
Actual chargebacks
    (28,589 )     (27,244 )
                 
Ending balance at March 31
  $ 10,226     $ 10,897  
                 
Current provision
    29,406       26,704  
Actual chargebacks
    (29,178 )     (27,958 )
                 
Ending balance at June 30
  $ 10,454     $ 9,643  
                 


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Branded Prescription Pharmaceuticals Segment
 
                                                                 
    For the Three Months
    Change
    For the Six Months
    Change
 
    Ended June 30,     2010 vs. 2009     Ended June 30,     2010 vs. 2009  
    2010     2009     $     %     2010     2009     $     %  
    (In thousands)     (In thousands)  
 
Branded Prescription Pharmaceutical revenue:
                                                               
Skelaxin®
  $ 5,319     $ 102,178     $ (96,859 )     (94.8 )%   $ 96,236     $ 202,777     $ (106,541 )     (52.5 )%
Thrombin-JMI®
    36,955       48,562       (11,607 )     (23.9 )     73,887       95,901       (22,014 )     (23.0 )
Flector® Patch
    35,261       38,621       (3,360 )     (8.7 )     68,793       55,397       13,396       24.2  
Avinza®
    24,740       28,892       (4,152 )     (14.4 )     47,936       67,872       (19,936 )     (29.4 )
Embeda®
    14,641             14,641             23,716             23,716        
Levoxyl®
    16,103       15,280       823       5.4       31,458       34,852       (3,394 )     (9.7 )
Other
    29,224       41,577       (12,353 )     (29.7 )     61,758       96,015       (34,257 )     (35.7 )
                                                                 
Total revenue
  $ 162,243     $ 275,110     $ (112,867 )     (41.0 )%   $ 403,784     $ 552,814     $ (149,030 )     (27.0 )%
                                                                 
 
Skelaxin®
 
Net sales of Skelaxin® decreased significantly in the second quarter and first six months of 2010 from the second quarter and first six months of 2009 primarily due to the entry of two competitors in the market early in the second quarter of 2010 with generic substitutes for Skelaxin®. Total prescriptions for Skelaxin® decreased approximately 83.9% and 53.6% in the second quarter and first six months of 2010, respectively, from the second quarter and first six months of 2009, respectively, according to IMS monthly prescription data. As a result of generic competition, net sales of Skelaxin® will continue to decrease significantly in 2010 compared to 2009.
 
For additional information on Skelaxin® generic competition, please see Note 9, “Commitments and Contingencies”, in Part I, Item 1, “Financial Statements.”
 
Thrombin-JMI®
 
Net sales of Thrombin-JMI® decreased in the second quarter and first six months of 2010 compared to the second quarter and first six months of 2009 primarily due to market competition. The first competing product entered the market in the fourth quarter of 2007 and another entered the market in the first quarter of 2008. We expect net sales of our Thrombin-JMI® product to decrease in 2010 compared to 2009, as a result of competition.
 
Flector® Patch
 
Net sales of Flector® Patch decreased in the second quarter of 2010 from the second quarter of 2009 primarily due to a decrease in prescriptions, partially offset by a price increase taken in the first quarter of 2010. Net sales of Flector® Patch increased in the first six months of 2010 from the first six months of 2009 primarily due to a significant reduction in wholesale inventory levels in the first quarter of 2009, and price increases taken in the second quarter of 2009 and the first quarter of 2010, partially offset by a decrease in prescriptions. Flector® Patch was part of the acquisition of Alpharma at the end of December 2008. At the time of acquisition, the wholesale inventory level of Flector® Patch exceeded our normal levels. During the first quarter of 2009, we reduced these inventories to a level consistent with our other promoted products. As a result, net sales of Flector® Patch were lower than prescription demand in the first quarter of 2009. Alpharma began selling the Flector® Patch in January 2008. Total prescriptions for Flector® Patch decreased approximately 8.9% and 6.2% in the second quarter and first six months of 2010, respectively, compared to the second quarter and first six months of 2009, respectively, according to IMS monthly prescription data. While we expect net sales of Flector® Patch to increase in the second half of 2010 compared to the first half of 2010, we anticipate lower net sales of Flector® Patch during both the third and fourth quarters of 2010 compared to the third and fourth quarters of 2009.
 
Avinza®
 
Net sales of Avinza® decreased in the second quarter of 2010 compared to the second quarter of 2009 primarily due to a decrease in prescriptions, partially offset by a price increase taken in the fourth quarter of 2009 and a decrease in wholesale inventory levels in the second quarter of 2009. Net sales of Avinza® decreased in the first six months of 2010


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compared to the first six months of 2009 primarily due to a decrease in prescriptions, partially offset by a price increase taken in the fourth quarter of 2009. Total prescriptions for Avinza® decreased approximately 29.9% and 28.3% in the second quarter and first six months of 2010, respectively, compared to the second quarter and first six months of 2009, respectively, according to IMS monthly prescription data. We expect net sales of Avinza® to decrease in 2010 compared to 2009.
 
For a discussion regarding the risk of potential generic competition for Avinza®, please see Note 9, “Commitments and Contingencies”, in Part I, Item 1, “Financial Statements.”
 
Embeda®
 
In August 2009, the FDA approved Embeda® (morphine sulfate and naltrexone hydrochloride) Extended Release Capsules, a long-acting Schedule II opioid analgesic for the management of moderate to severe pain when a continuous, around-the-clock opioid analgesic is needed for an extended period of time. We began selling Embeda® in late September 2009, and we anticipate net sales of Embeda® will increase significantly in 2010 compared to 2009. During the first quarter of 2010, we received approval of two patents on the product and listed these in the FDA’s Orange Book. These patents expire in June 2027.
 
On October 8, 2009, we received a warning letter from the FDA, Division of Drug Marketing, Advertising, and Communications (“DDMAC”) regarding certain materials used to announce the commercial launch of Embeda®. The letter indicated these materials were false or misleading because they omitted and minimized the risks associated with the use of Embeda®, failed to present the limitations to its approved indication, and presented misleading claims. We ceased the dissemination of these materials and took steps to conform other materials we currently utilize with Embeda® to the guidance set forth in the warning letter. On October 16, 2009, we responded to the warning letter, providing DDMAC with a list of materials that were discontinued and a comprehensive plan of action to appropriately disseminate corrective messages to those that received the original materials. We met with members of the FDA on December 22, 2009 to discuss the warning letter. On March 26, 2010, we issued a corrective press release to address the issues raised in the warning letter and DDMAC closed the case.
 
During January 2010, we submitted to DDMAC for pre-approval proposed revised marketing materials for Embeda®. In late March 2010, we received DDMAC’s reply to our submission and, during the third quarter of 2010, we expect to begin using modified materials which are responsive to its comments.
 
On March 23, 2010 and April 30, 2010, we voluntarily recalled certain lots of Embeda® as a result of issues noted in standard post-manufacturing testing that were not related to patient safety. We believe the recalls caused some disruption in the market that could have negatively affected the prescriptions of Embeda®. The recalls did not have a significant effect on the results of operations during the first or second quarters of 2010.
 
Levoxyl®
 
Net sales of Levoxyl® increased in the second quarter of 2010 compared to the second quarter of 2009 primarily due to greater decreases in wholesale inventory levels in the second quarter of 2009 than in the second quarter of 2010, partially offset by a decrease in prescriptions. Net sales of Levoxyl® decreased in the first six months of 2010 compared to the first six months of 2009 primarily due to decreases in wholesale inventory levels in 2010 and a decrease in prescriptions. Total prescriptions for Levoxyl® decreased approximately 13.1% and 11.4% in the second quarter and first six months of 2010, respectively, compared to the second quarter and first six months of 2009, according to IMS monthly prescription data. We anticipate net sales for this product will decline in 2010 due to decreasing prescriptions.
 
Other
 
Our other branded prescription pharmaceutical products are not promoted through our sales force, and prescriptions for many of our products included in this category are declining. Net sales of other branded pharmaceutical products were lower in the second quarter and first six months of 2010 compared to the second quarter and first six months of 2009 primarily due to lower net sales of Cytomel®, increases in returns of certain products, and a decrease in prescriptions.


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In April 2009, a third party entered the market with a generic substitute for Cytomel®. As a result of the entry of generic competition, net sales of Cytomel® declined in the second quarter of 2010 and we expect net sales of Cytomel® to continue to decline in the future. Net sales of Cytomel® decreased from $7.4 million and $21.3 million in the second quarter and first six months of 2009, respectively, to $4.5 million and $9.8 million in the second quarter and first six months of 2010, respectively.
 
As a result of generic competition for Cytomel® and declining demand for many other products included in this category, we anticipate net sales of other branded prescription pharmaceutical products will continue to decline in 2010.
 
Alpharma Animal Health
 
Revenues of the Alpharma animal health segment were consistent in the second quarter and first six months of 2010 compared to the second quarter and first six months of 2009.
 
Meridian Auto-Injector
 
Revenues from our Meridian Auto-Injector segment increased in the second quarter and first six months of 2010 compared to the second quarter and first six months of 2009, primarily due to price increases and higher unit sales of EpiPen®, partially offset by lower sales to government entities.
 
Revenues from the Meridian Auto-Injector segment fluctuate based on the buying patterns of Dey, L.P. and government customers. With respect to auto-injector products sold to government entities, demand for these products is affected by the cyclical nature of procurements as well as response to domestic and international events. Demand for EpiPen® is seasonal as a result of its use in the emergency treatment of allergic reactions for both insect stings or bites, more of which occur in the warmer months, and food allergies, for which demand increases in the months preceding the start of a new school year. Most of our EpiPen® sales are based on our supply agreement with Dey, L.P., which markets, distributes and sells the product worldwide, except for Canada where it is marketed, distributed and sold by us. Total prescriptions for EpiPen® in the United States increased approximately 9.7% and 8.4% in the second quarter and first six months of 2010, respectively, compared to the second quarter and first six months of 2009, according to IMS monthly prescription data.
 
During the second quarter of 2010, we entered into a new supply agreement with Dey, L.P. which extends the term through December 31, 2020.
 
Royalties and other
 
Skelaxin® Authorized Generic
 
During the second quarter of 2010, we recognized revenue of $25.6 million related to our agreement with CorePharma providing it with a license to launch an authorized generic version of Skelaxin® under certain conditions. In accordance with this agreement, we receive a fee based on gross profit, as defined in the agreement, of the authorized generic product.
 
Adenoscan®
 
We receive royalty revenue based on sales of Adenoscan®. We are not responsible for the marketing of this product. On April 10, 2008, CV Therapeutics, Inc. and Astellas Pharma US, Inc. (“Astellas US”) announced that the FDA approved regadenoson injection, an A2A adenosine receptor agonist product that competes with Adenoscan®. Regadenoson has been commercialized by Astellas US. Astellas US is also responsible for the marketing and sale of Adenoscan® pursuant to agreements we have with Astellas US. With the commercial launch of regadenoson, sales of Adenoscan and our royalty revenue have declined and may continue to decline. However, our agreements with Astellas US provide for minimum royalty revenue payments to us of $40.0 million per year for three years (beginning June 1, 2008 and ending May 31, 2011). Therefore, we will continue to receive royalties on the sale of Adenoscan® through expiration of the patents covering the product, although the minimum guaranteed portion of the royalty payments would terminate upon certain events, including a finding of invalidity or unenforceability of the patents related to Adenoscan®. During the second quarter of 2010, we recorded royalty revenue related to Adenoscan of


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$10.1 million, of which $2.8 million is as a result of the minimum royalty agreement we have with Astellas US for the contract year ended May 30, 2010.
 
In October 2007, we entered into an agreement with Astellas US and a subsidiary of Teva Pharmaceutical Industries Ltd. providing Teva with the right to launch a generic version of Adenoscan® pursuant to a license in September 2012 or earlier under certain conditions.
 
Operating Costs and Expenses
 
                                                                 
    For the Three
          For the Six
       
    Months Ended
    Change
    Months Ended
    Change
 
    June 30,     2010 vs. 2009     June 30,     2010 vs. 2009  
    2010     2009     $     %     2010     2009     $     %  
    (In thousands)     (In thousands)  
 
Cost of revenues, exclusive of depreciation and amortization shown below
  $ 119,027     $ 156,093     $ (37,066 )     (23.7 )%   $ 246,081     $ 307,032     $ (60,951 )     (19.9 )%
Selling, general and administrative
    131,829       123,575       8,254       6.7       272,304       265,898       6,406       2.4  
Research and development
    33,174       21,202       11,972       56.5       61,498       48,458       13,040       26.9  
Depreciation and amortization
    53,903       52,862       1,041       2.0       111,178       106,211       4,967       4.7  
Restructuring charges
    4,852       1,475       3,377       >100       5,114       49,525       (44,411 )     (89.7 )
                                                                 
Total operating costs and expenses
  $ 342,785     $ 355,207     $ (12,422 )     (3.5 )%   $ 696,175     $ 777,124     $ (80,949 )     (10.4 )%
                                                                 
 
Cost of Revenues
 
Cost of revenues decreased in the second quarter and first six months of 2010 versus the second quarter and first six months of 2009 primarily due to the decrease of a special item related to the acquisition of Alpharma, as described below, and a decrease in Skelaxin® revenues, partially offset by costs associated with the addition of Embeda®, which we began selling in late September 2009, and an increase in the Skelaxin® royalty rate.
 
Special items are those particular material income or expense items that our management believes are not related to our ongoing, underlying business, are not recurring, or are not generally predictable. These items include, but are not limited to, merger and restructuring expenses; non-capitalized expenses associated with acquisitions, such as in-process research and development charges and inventory valuation adjustment charges; charges resulting from the early extinguishments of debt; asset impairment charges; and gains and losses resulting from the divestiture of assets. We believe the identification of special items enhances an analysis of our ongoing, underlying business and an analysis of our financial results when comparing those results to that of a previous or subsequent like period. However, it should be noted that the determination of whether to classify an item as a special item involves judgments by us.
 
At the time of the acquisition of Alpharma, we valued the inventory that was acquired based on the accounting requirements for business combinations. As a result, we increased the carrying value of the Flector® Patch and Alpharma animal health inventory by approximately $42.1 million. During the second quarter and first six months of 2009, the cost of revenues reflects a charge of $16.1 million and $37.6 million, respectively, related to the sale of this marked up inventory.
 
The royalty rate on Skelaxin® increased in the second quarter of 2009 due to the achievement of certain regulatory milestones under our agreement with Mutual Pharmaceutical Company, Inc. (“Mutual”). For additional information on the Mutual agreement, please see “Other” within the “Liquidity and Capital Resources” section below.


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Selling, General and Administrative Expenses
 
                                                                 
    For the Three
          For the Six
       
    Months Ended
    Change
    Months Ended
    Change
 
    June 30,     2010 vs. 2009     June 30,     2010 vs. 2009  
    2010     2009     $     %     2010     2009     $     %  
    (In thousands)     (In thousands)  
 
Selling, general and administrative
  $ 131,829     $ 120,631     $ 11,198       9.3 %   $ 272,304     $ 259,165     $ 13,139       5.1 %
Acquisition related costs
          2,944       (2,944 )     (100 )           6,733       (6,733 )     (100 )
                                                                 
Total selling, general and administrative
  $ 131,829     $ 123,575     $ 8,254       6.7 %   $ 272,304     $ 265,898     $ 6,406       2.4 %
                                                                 
 
As a percentage of total revenues, total selling, general, and administrative expenses were 35.5% and 36.2% in the second quarter and first six months of 2010, respectively. As a percentage of total revenues, total selling, general and administrative expenses were 27.8% and 30.4% in the second quarter and first six months of 2009, respectively.
 
Total selling, general and administrative expenses increased in the second quarter and first six months of 2010 compared to the second quarter and first six months of 2009 primarily due to an increase in marketing due to the launch of Embeda®. The increase in the first six months of 2010 compared to the first six months of 2009 was partially offset by a decrease in expenses resulting from the integration of Alpharma and a restructuring initiative related to Skelaxin®.
 
Alpharma was purchased on December 29, 2008. The integration of Alpharma was substantially completed by the end of the first quarter of 2009. During the first quarter of 2009, therefore, selling, general and administrative costs included costs associated with Alpharma corporate and pharmaceutical management division employees and related activities.
 
Following the January 2009 court order ruling invalid two patents relating to Skelaxin®, our senior management team conducted an extensive examination of our company and implemented a restructuring initiative. The initiative included, based on an analysis of our strategic needs: a reduction in sales, marketing and other personnel; leveraging of staff; expense reductions and additional controls over spending; and reorganization of sales teams.
 
We incurred special charges of $2.9 million and $6.7 million in the second quarter and first six months of 2009, respectfully, for costs related to the acquisition and integration of Alpharma. In addition, we incurred net special charges in the second quarter and first six months of 2010 of $1.9 million and $3.5 million, respectively, related to litigation settlements.
 
Research and Development Expense
 
                                                                 
    For the Three
      For the Six
   
    Months Ended
  Change
  Months Ended
  Change
    June 30,   2010 vs. 2009   June 30,   2010 vs. 2009
    2010   2009   $   %   2010   2009   $   %
    (In thousands)   (In thousands)
 
Research and development
  $ 33,174     $ 21,202     $ 11,972       56.5 %   $ 61,498     $ 48,458     $ 13,040       26.9 %
 
Research and development represents expense associated with the ongoing development of investigational drugs and product life-cycle management projects in our research and development pipeline. These expenses increased in the second quarter and first six months of 2010 compared to the second quarter and first six months of 2009 due to the timing of costs incurred on our current research and development projects. During the second quarter of 2010, we incurred a $5.0 million expense associated with the modification of our strategic alliance with Pain Therapeutics, Inc. (“Pain Therapeutics”) for Remoxy® and other opioid products. During the second quarter of 2010, we modified the strategic alliance with Pain Therapeutics to provide a royalty rate of 10% on net sales outside the U.S. The original agreement called for a royalty rate of 15% of net sales and included a provision to increase the royalty rate to 20% should certain net sales benchmarks be met. We also gained certain rights to the development of other opioid products covered by the collaboration agreement. The U.S. royalty rate and potential milestone payments under the strategic alliance with Pain Therapeutics remain unchanged.


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For a discussion regarding recent research and development activities, please see “Recent Developments” above.
 
Depreciation and Amortization Expense
 
Amortization expense associated with Skelaxin® was completed during the second quarter of 2010. As a result, we anticipate a significant decrease in amortization expense in the second half of 2010. The amortization expense associated with Skelaxin® in the second quarter and first six months of 2010 was $20.0 million and $43.2 million, respectively.
 
Depreciation and amortization expense in the second quarter and first six months of 2009 includes special items of $0.3 million and $1.3 million, respectively, due to accelerated depreciation on certain assets.
 
In addition, certain manufacturers of generic pharmaceutical products have challenged the patents covering Avinza® and EpiPen®. For additional information, please see Note 9, “Commitments and Contingencies”, in Part I, Item 1, “Financial Statements.” If a generic version of Avinza® or EpiPen® enters the market or if our current estimates regarding future cash flows adversely change, we may have to write off a portion or all of the intangible assets associated with these products.
 
Other Operating Expenses
 
We incurred restructuring charges of $4.9 million and $5.1 million in the second quarter and first six months of 2010, respectively, primarily due to a restructuring of our commercial operations organization in the second quarter of 2010.
 
We incurred restructuring charges of $1.5 million and $49.5 million in the second quarter and first six months of 2009, respectively, primarily due to our restructuring initiative related to Skelaxin®.
 
For additional information on restructuring events, please see Note 13, “Restructuring Activities”, in Part I, Item 1, “Financial Statements.”
 
Non-Operating Items
 
                                 
    For the Three Months
    For the Six Months
 
    Ended June 30,     Ended June 30,  
    2010     2009     2010     2009  
    (In thousands)     (In thousands)  
 
Interest income
  $ 487     $ 1,506     $ 896     $ 4,294  
Interest expense
    (7,479 )     (27,592 )     (16,215 )     (50,695 )
Gain on Kadian®
    12,500             12,500        
Gain (loss) on investments
    249       (524 )     (623 )     (1,347 )
Loss on early extinguishment of debt
    (2,252 )           (2,252 )      
Other, net
    (1,753 )     4,112       (1,956 )     1,333  
                                 
Total other income (expense)
  $ 1,752     $ (22,498 )   $ (7,650 )   $ (46,415 )
Income tax expense
    11,882       29,348       25,476       23,293  
 
Interest Income
 
Interest income decreased during the second quarter and first six months of 2010 compared to the second quarter and first six months of 2009, primarily due to a lower average balance of investments in debt securities and a decrease in interest rates. Cash and cash equivalents decreased in the first quarter of 2009 due to the payment of the Alpharma Convertible Senior Notes. In addition, cash received through redemptions of our auction rate securities of approximately $145.9 million during 2009 and the first quarter of 2010 was used to reduce long-term debt.
 
Interest Expense
 
Interest expense decreased in the second quarter and first six months of 2010 compared to the second quarter and first six months of 2009 primarily due to a decrease in borrowings. Our December 29, 2008 acquisition of


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Alpharma was funded with available cash on hand, borrowings of $425.0 million under our Senior Secured Revolving Credit Facility (the “2008 Revolving Credit Facility”) entered into April 19, 2007 and amended December 5, 2008, and borrowings of $200.0 million under a Senior Secured Term Facility. We made payments of $918.0 million related to long-term debt during 2009, which consisted of $200.0 million related to the Senior Secured Term Facility, $332.7 million related to the 2008 Revolving Credit Facility, and $385.2 million related to the Alpharma Convertible Senior Notes. In addition, during the first quarter of 2010, the remaining outstanding borrowings of $92.3 million under the 2008 Revolving Credit Facility were paid in full.
 
Special items affecting other income (expense) included the following:
 
  •  The liability and equity components of the $400,000 11/4% Convertible Senior Notes due April 1, 2026 (the “Convertible Senior Notes”) have been separately accounted for in a manner that reflects our nonconvertible debt borrowing rate at the date of issuance. The debt component is being amortized through March 31, 2013, which is reflected as an increase in interest expense. Interest expense in the second quarter of 2010 and 2009 reflects non-cash interest of $4.8 million and $4.4 million, respectively, and $9.4 million and $8.8 million in the first six months of 2010 and 2009, respectively, due to the accretion of the debt component of the Convertible Senior Notes.
 
  •  During the second quarter of 2010, we recorded a gain of $12.5 million as a result of the divestiture of Kadian®. For additional information regarding the Kadian® divestiture, please see “Kadian®” within the “Liquidity and Capital Resources” section below.
 
  •  A gain of $0.2 million and a loss of $0.5 million in the second quarter of 2010 and 2009, respectively, and a loss of $0.6 million and $1.3 million in the first six months of 2010 and 2009, respectively, related to our investments in debt securities.
 
  •  A loss of $2.3 million in the second quarter of 2010 resulting from the early extinguishment of our 2008 Revolving Credit Facility. On May 11, 2010, we entered into a new $500.0 million five-year Senior Secured Revolving Credit Facility (“2010 Revolving Credit Facility”) with Credit Suisse AG, as Administrative Agent (the “Administrative Agent”) and terminated the 2008 Revolving Credit Facility that was scheduled to mature April 2012. As a result, we wrote off a portion of the deferred financing costs associated with the 2008 Revolving Credit Facility.
 
Income Tax Expense
 
During the second quarter and first six months of 2010, our effective income tax rate was 39.8% and 53.1%, respectively. During the second quarter and first six months of 2009, our effective income tax rate was 43.6% and 46.1%, respectively. These rates are greater than the statutory rate of 35% primarily due to losses from foreign subsidiaries with no tax benefit, taxes related to stock compensation and state taxes.
 
Liquidity and Capital Resources
 
General
 
We believe that existing balances of cash, cash equivalents, cash generated from operations and our existing revolving credit facility are sufficient to finance our current operations and working capital requirements on both a short-term and long-term basis. However, we cannot predict the amount or timing of our need for additional funds. We cannot provide assurance that funds will be available to us when needed on favorable terms, or at all.
 
Investments in Debt Securities
 
As of June 30, 2010, our investments in debt securities consisted solely of tax-exempt auction rate securities and did not include any mortgage-backed securities or any securities backed by corporate debt obligations. The tax-exempt auction rate securities that we hold are long-term variable rate bonds tied to short-term interest rates that are intended to reset through an auction process generally every 7, 28 or 35 days. Our investment policy requires us to maintain an investment portfolio with a high credit quality. Accordingly, our investments in debt securities were limited to issues which were rated AA or higher at the time of purchase.


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In the event that we attempt to liquidate a portion of our holdings through an auction and are unable to do so, we term it an “auction failure.” On February 11, 2008, we began to experience auction failures. As of June 30, 2010, all our investments in auction rate securities, with a total par value of $213.0 million, have experienced multiple failed auctions. In the event of an auction failure, the interest rate on the security is reset according to the contractual terms in the underlying indenture. As of August 3, 2010, we have received all scheduled interest payments associated with these securities.
 
We will be unable to liquidate these securities until a successful auction occurs, the issuer calls or restructures the underlying security, the underlying security matures or is purchased by a buyer outside the auction process. Based on the frequency of auction failures and the lack of market activity, current market prices are not available for determining the fair value of these investments. As a result, we have measured $213.0 million in par value of our investments in debt securities and the UBS put right discussed below, or 27.5% of the assets that we have measured at fair value, using unobservable inputs, which are classified as Level 3 measurements. For additional information regarding this, please see Note 3, “Fair Value Measurements”, in Part I, Item 1, “Financial Statements.”
 
As of June 30, 2010, there were cumulative unrealized holding losses of $21.2 million recorded in accumulated other comprehensive income (loss) on the Condensed Consolidated Balance Sheet associated with investments in debt securities with a par value of $179.8 million classified as available for sale. All of these investments in debt securities have been in continuous unrealized loss positions for greater than twelve months. As of June 30, 2010, we believed the decline was temporary and it was probable that the par amount of these auction rate securities would be collectible under their contractual terms.
 
During the first quarter of 2010, we sold certain auction rate securities associated with student loans with a par value of $8.0 million for $7.4 million to the issuer and realized a loss of $0.6 million in the Condensed Consolidated Statements of Operations. During the second quarter of 2009, we sold certain auction rate securities associated with student loans with a par value of $20.4 million for $18.9 million to the issuer and realized a loss of $1.4 million in the Condensed Consolidated Statements of Operations. We have not sold any other investments in debt securities below par value during the periods presented in the accompanying Condensed Consolidated Statements of Operations.
 
During the fourth quarter of 2008, we accepted an offer from UBS Financial Services, Inc. (“UBS”) providing us the right to sell to UBS at par value certain auction rate securities during the period from June 30, 2010 to July 2, 2012 (the “right”). During the second quarter of 2010, we notified UBS of our intent to sell the auction rate securities related to this offer. At June 30, 2010 and December 31, 2009, we held auction rate securities related to this offer with a par value of $18.2 million and $32.5 million, respectively. We have elected the fair value option to account for this right. As a result, gains and losses associated with this right are recorded in other income (expense) in the Condensed Consolidated Statements of Operations. The value of the right to sell certain auction rate securities to UBS was estimated considering the present value of future cash flows, the fair value of the auction rate security and counterparty risk. As of June 30, 2010 and December 31, 2009, the fair value of the right to sell the auction rate securities to UBS at par was $1.9 million and $3.2 million, respectively. With respect to this right, we recognized unrealized losses of $0.6 million and $1.4 million during the second quarter and first six months of 2010, respectively, and an unrealized gain of $0.1 million and an unrealized loss of $0.5 million during the second quarter and first six months of 2009, respectively, in Other income (expense) in the Condensed Consolidated Statements of Operations.
 
In addition, during the fourth quarter of 2008, we reclassified the auction rate securities that are included in this right from available-for-sale securities to trading securities. As of June 30, 2010 and December 31, 2009, the fair value of the investments in debt securities classified as trading was $16.3 million and $29.3 million, respectively. We recognized unrealized gains related to these securities of $0.8 million and $1.4 million during the second quarter and first six months of 2010, respectively, and $0.8 million and $0.5 million during the second quarter and first six months of 2009, respectively, in Other income (expense) in the accompanying Condensed Consolidated Statements of Operations.
 
During July 2010, we sold the auction rate securities that were included in the UBS right for par value of $18.2 million, recognizing no gain or loss on the exercise of the right and the sale of the securities.


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As of June 30, 2010, we had unrealized holding gains of $1.9 million associated with a security that was previously impaired, as it was determined that the losses in previous periods were other-than-temporary.
 
As of June 30, 2010, we had approximately $213.0 million, in par value, invested in tax-exempt auction rate securities which consisted of $107.2 million associated with student loans backed by the Federal Family Education Loan Program (FFELP), $87.6 million associated with municipal bonds in which performance is supported by bond insurers and $18.2 million associated with student loans collateralized by loan pools that equal at least 200% of the bond issue.
 
As of June 30, 2010, we classified $16.3 million of auction rate securities as current assets and $169.8 million as long-term assets.
 
Skelaxin®
 
As previously disclosed, we are involved in multiple legal proceedings over patents relating to our product Skelaxin®. In January 2009, the U.S. District Court for the Eastern District of New York issued an order ruling invalid two of these patents. In June 2009, the Court entered judgment against us. In August 2010, the Court of Appeals for the Federal Circuit affirmed the actions of the District Court. Generic versions of Skelaxin® entered the market early in the second quarter of 2010. Net sales of Skelaxin® have declined significantly and will continue to decline as a result of generic competition. For additional information regarding Skelaxin® litigation, please see Note 9, “Commitments and Contingencies”, in Part I, Item 1, “Financial Statements.”
 
Following the decision of the District Court in January 2009, we conducted an extensive examination of the company and developed a restructuring initiative. Based on an analysis of our strategic needs, this initiative included: a reduction in branded prescription pharmaceutical sales, marketing and other personnel; leveraging of staff; expense reductions and additional controls over spending; and reorganization of sales teams.
 
We incurred total restructuring costs of approximately $50.0 million, almost all of which was paid during the second quarter of 2009. These costs relate to severance pay and other employee termination expenses. For additional information, please see Note 13, “Restructuring Activities”, in Part I, Item 1, “Financial Statements.”
 
Kadian®
 
In connection with the acquisition of Alpharma, we and Alpharma executed a consent order (the “Consent Order”) with the U.S. Federal Trade Commission. The Consent Order required us to divest the assets related to Alpharma’s branded oral long-acting opioid analgesic drug Kadian® to Actavis Elizabeth, L.L.C., (“Actavis LLC”). In accordance with the Consent Order, effective upon the acquisition of Alpharma, on December 29, 2008, we divested the Kadian® product to Actavis LLC. Actavis LLC is entitled to sell Kadian® as a branded or generic product. Prior to this divestiture, Actavis LLC supplied Kadian® to Alpharma.
 
Actavis LLC paid a purchase price of $127.5 million in cash based on the achievement of certain Kadian® quarterly gross profit-related milestones for the period beginning January 1, 2009 and ending June 30, 2010. The purchase price payment associated with each calendar quarter is as follows:
 
         
    Purchase
    Price Payment
 
First Quarter 2009
  $ 30.0 million  
Second Quarter 2009
    25.0 million  
Third Quarter 2009
    25.0 million  
Fourth Quarter 2009
    20.0 million  
First Quarter 2010
    20.0 million  
Second Quarter 2010
    7.5 million  
 
At the time of the divestiture, we recorded a receivable of $115.0 million reflecting the present value of the estimated future purchase price payments from Actavis LLC. We recorded a gain of $12.5 million in the second quarter of 2010 as a result of the divestiture. In accordance with the agreement, quarterly payments are received one quarter in arrears. During the second quarter and first six months of 2010, we received $20.0 million and


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$40.0 million, respectively, from Actavis LLC related to gross profit from sales during the fourth quarter of 2009 and the first quarter of 2010. In July 2010, we received the final payment of $7.5 million for the sale of Kadian® from Actavis LLC.
 
Alpharma
 
As part of the integration of Alpharma, management developed a restructuring initiative to eliminate redundancies in operations created by the acquisition. This initiative included, based on an analysis of our strategic needs: a reduction in sales, marketing and other personnel; leveraging of staff; expense reductions and additional controls over spending; and reorganization of sales teams.
 
We estimated total costs of approximately $70.9 million associated with this restructuring plan, almost all of which are cash-related costs. All employee termination costs are expected to be paid by the end of 2012. All contract termination costs are expected to be paid by the end of 2018. For additional information, please see Note 13, “Restructuring Activities”, in Part I, Item 1, “Financial Statements.”
 
During the first quarter of 2009, we paid $385.2 million to redeem the Convertible Senior Notes of Alpharma outstanding at the time of the acquisition and at December 31, 2008. For additional information, please see “Alpharma Convertible Senior Notes” in Note 8, “Long-Term Debt”, in Part I, Item 1, “Financial Statements.”
 
Senior Secured Revolving Credit Facility
 
On May 11, 2010, we entered into the $500.0 million 2010 Revolving Credit Facility and terminated the existing $475.0 million 2008 Revolving Credit Facility, which was scheduled to mature in April 2012. The 2010 Revolving Credit Facility matures on May 11, 2015.
 
In connection with the acquisition of Alpharma on December 29, 2008, we borrowed $425.0 million in principal amount under the 2008 Revolving Credit Facility. During 2009 and the first quarter of 2010, we made payments of $332.7 million and $92.3 million, respectively, on the 2008 Revolving Credit Facility, $203.2 million in excess of the required amounts, which represented full payment of all borrowings under the 2008 Revolving Credit Facility.
 
As of June 30, 2010, the remaining undrawn commitment amount under the 2010 Revolving Credit Facility totals approximately $496.3 million after giving effect to outstanding letters of credit totaling approximately $3.7 million.
 
For additional discussion regarding the 2010 Revolving Credit Facility, please see “Senior Secured Revolving Credit Facility” within the “Certain Indebtedness and Other Matters” section below.
 
CorePharma, LLC
 
In June 2008, we entered into a Product Development Agreement with CorePharma to collaborate in the development of new formulations of metaxalone that we currently market under the brand name Skelaxin®. Under the agreement, we and CorePharma granted each other non-exclusive cross-licenses to certain pre-existing intellectual property. Any intellectual property created as a result of the agreement will belong to us and we will grant CorePharma a non-exclusive, royalty-free license to use this newly created intellectual property with any product not containing metaxalone. In the second quarter of 2008, we made a non-refundable cash payment of $2.5 million to CorePharma. Under the terms of the agreement, we will reimburse CorePharma for the cost to complete the development activities incurred under the agreement, subject to a cap. In addition, we could be required to make milestone payments based on the achievement and success of specified development activities and the achievement of specified net sales thresholds of such formulations, as well as royalty payments based on net sales.
 
Acura Pharmaceuticals, Inc.
 
In October 2007, we entered into a License, Development and Commercialization Agreement with Acura to develop and commercialize certain opioid analgesic products utilizing Acura’s Aversion® Technology in the


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United States, Canada and Mexico. The agreement provides us with an exclusive license for Acurox® Tablets and another opioid product utilizing Acura’s Aversion® Technology. In addition, the agreement provides us with an option to license all future opioid analgesic products developed utilizing Acura’s Aversion® Technology. In May 2008 and December 2008, we exercised our options for third and fourth immediate-release opioid products under the agreement. In connection with the exercise of the options, we paid non-refundable option exercise fees to Acura of $3.0 million for each option.
 
Under the terms of the agreement, we made a non-refundable cash payment of $30.0 million to Acura in December 2007. In addition, we will reimburse Acura for all research and development expenses incurred beginning from September 19, 2007 for Acurox® Tablets and all research and development expenses related to future products after the exercise of our option to an exclusive license for each future product. We may make additional non-refundable cash milestone payments to Acura based on the successful achievement of certain clinical and regulatory milestones for Acurox® Tablets and for each other product developed under the agreement. In June 2008, we made a milestone payment of $5.0 million associated with positive top-line results from the Phase III clinical trial evaluating Acurox® Tablets. We will also make an additional $50.0 million non-refundable cash milestone payment to Acura in the first year that the aggregate net sales of all products developed under the agreement exceeds $750.0 million. In addition, we will make royalty payments to Acura ranging from 5% to 25% based on the level of combined annual net sales of all products developed under the agreement.
 
Avinza®
 
In September 2006, we entered into a definitive asset purchase agreement and related agreements with Ligand to acquire rights to Avinza® (morphine sulfate long-acting). Avinza® is a long-acting formulation of morphine and is indicated as a once-daily treatment for moderate to severe pain in patients who require continuous opioid therapy for an extended period of time.
 
As part of the transaction, we agreed to pay Ligand an ongoing royalty through November 2017 and assume payment of Ligand’s royalty obligations to third parties. We paid Ligand a royalty of 15% of net sales of Avinza® until October 2008. Subsequent royalty payments to Ligand are based upon calendar year net sales of Avinza® as follows:
 
  •  If calendar year net sales are less than $200.0 million, the royalty payment will be 5% of all net sales.
 
  •  If calendar year net sales are greater than $200.0 million, then the royalty payment will be 10% of all net sales up to $250.0 million, plus 15% of net sales greater than $250.0 million.
 
Patient Protection and Affordable Care Act
 
On March 23, 2010, the Patient Protection and Affordable Care Act (“PPACA”) was signed into law. We expect that the new legislation will increase Medicaid rebates paid by us in the future, primarily due to an increase in Medicaid rebate rates, changes to the calculation of Medicaid rebates for new formulations of existing products, and an expansion of Medicaid rebates to products supplied to enrollees of Medicaid managed care organizations. For the full year of 2010, we expect rebates to increase by approximately $10.0 million as a result of the PPACA.
 
In addition, the PPACA will impose an annual fee on pharmaceutical manufacturers beginning in 2011. The fee will be payable no later than September 30 of each applicable year and will be allocated to pharmaceutical manufacturers based on relative market share.
 
Other
 
In March 2006, we acquired the exclusive right to market, distribute and sell EpiPen® throughout Canada and certain other assets from Allerex Laboratory LTD (“Allerex”). Under the terms of the agreements, the initial purchase price was approximately $23.9 million, plus acquisition costs of approximately $0.7 million. As an additional component of the purchase price, we pay Allerex an earn-out equal to a percentage of future sales of EpiPen® in Canada over a fixed period of time. As these additional payments accrue, we increase intangible assets by the amount of the accrual. As of June 30, 2010, we have incurred a total of $13.5 million for these earn-out payments. The aggregate amount of these payments will be approximately $14.2 million and are expected to be incurred by the end of third quarter of 2010.


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In December 2005, we entered into a cross-license agreement with Mutual related to Skelaxin®. Under the terms of the agreement, each of the parties has granted the other a worldwide license to certain intellectual property, including patent rights and know-how, relating to metaxalone. As of January 1, 2006, we began paying royalties to Mutual on net sales of products containing metaxalone. This royalty increased in the fourth quarter of 2006 and the second quarter of 2009 due to the achievement of certain milestones. The royalty percentage we pay to Mutual is currently in the low-double-digit and could potentially increase by an additional 10% depending on the achievement of certain regulatory and commercial milestones in the future. In the event certain specified net sales levels are not achieved, the royalty could be reduced to a lower double-digit or single-digit rate. No increases in the royalty rate are presently anticipated. The royalty we pay to Mutual is in addition to the royalty we pay to Elan Corporation, plc on our current formulation of metaxalone, Skelaxin®.
 
During the fourth quarter of 2005, we entered into a strategic alliance with Pain Therapeutics to develop and commercialize Remoxy® and other opioid painkillers. Under the strategic alliance, we made an upfront cash payment of $150.0 million in December 2005 and made a milestone payment of $5.0 million in July 2006 to Pain Therapeutics. In August 2008, we made milestone payments totaling $20.0 million. In addition, we may pay additional milestone payments of up to $125.0 million in cash based on the successful clinical and regulatory development of Remoxy® and other opioid products. This amount includes $15.0 million upon FDA approval of Remoxy®. In March 2009, we exercised rights under our Collaboration Agreement with Pain Therapeutics and assumed sole control and responsibility for the development of Remoxy®. This includes all communications with the FDA regarding Remoxy® and ownership of the Remoxy® NDA. During the second quarter of 2010, we incurred a $5.0 million expense associated with the modification of our strategic alliance with Pain Therapeutics for Remoxy® and other opioid painkillers which was paid in the third quarter of 2010. The modification reduced the royalty rate on net sales of Remoxy® and other products developed through this alliance for net sales outside the U.S to 10%. We also gained certain rights to the development of other opioid products covered by the collaboration agreement. After regulatory approval and commercialization of Remoxy® or other products developed through this alliance, we will pay a royalty of 15% of the cumulative net sales in the U.S. up to $1.0 billion and 20% of the cumulative net sales in the U.S. over $1.0 billion. We are responsible for research and development expenses related to this alliance, subject to certain limitations set forth in the agreement.
 
Patent Challenges
 
Certain generic companies have challenged patents on Skelaxin®, Avinza® and EpiPen®. For additional information, please see Note 9, “Commitments and Contingencies”, in Part I, Item 1, “Financial Statements.” Generic versions of Skelaxin® entered the market early in the second quarter of 2010. Net sales of Skelaxin® have declined significantly and will continue to decline as a result of generic competition. If a generic version of Avinza® or EpiPen® enters the market, our business, financial condition, results of operations and cash flows could be materially adversely affected.
 
Cash Flows
 
Operating Activities
 
                 
    For the Six Months
    Ended June 30,
    2010   2009
    (In thousands)
 
Net cash provided by operating activities
  $ 48,875     $ 117,566  
 
Our net cash from operations was lower in the first six months of 2010 than in the first six months of 2009 primarily due to a decrease in net sales of several key branded prescription pharmaceutical products and payment of $42.5 million to the DOJ. Please see the section above entitled “Results of Operations” for a discussion of net sales.
 
In March 2010, we made a payment of $42.5 million, plus interest of $0.6 million, to the DOJ. For additional information related to the DOJ settlement, please see Note 9, “Commitments and Contingencies”, in Part I, Item 1, “Financial Statements.”


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In addition, we made cash payments related to the Skelaxin® and Alpharma restructuring actions during the first six months of 2009 and 2010 which reduced operating cash flows. For information regarding the restructuring actions, please see Note 13, “Restructuring Activities”, in Part I, Item 1, “Financial Statements.”
 
The following table summarizes the changes in operating assets and liabilities and deferred taxes for the six months ended June 30, 2010 and 2009:
 
                 
    For the Six Months
 
    Ended June 30,  
    2010     2009  
    (In thousands)  
 
Accounts receivable, net of allowance
  $ (2,384 )   $ 35,832  
Inventories
    (16,447 )     (3,026 )
Prepaid expenses and other current assets
    2,604       (9,563 )
Accounts payable
    (10,253 )     (79,475 )
Accrued expenses and other liabilities
    (89,381 )     (48,422 )
Income taxes payable
    5,553       (17,047 )
Deferred revenue
    (2,340 )     (2,340 )
Other assets
    (2,142 )     734  
Deferred taxes
    13,102       17,663  
                 
Total changes in operating assets and liabilities and deferred taxes
  $ (101,688 )   $ (105,644 )
                 
 
Investing Activities
 
                 
    For the Six Months Ended June 30,
    2010   2009
    (In thousands)
 
Net cash provided by (used in) investing activities
  $ 89,511     $ (26,562 )
 
Our cash flows from investing activities for the first six months of 2010 were primarily due to net sales of our investments in debt securities of $67.9 million and proceeds related to the sale of Kadian® of $40.0 million, partially offset by capital expenditures of $17.3 million. Our cash flows from investing activities for the first six months of 2009 were primarily due to payments made in connection with our acquisition of Alpharma of $70.4 million and capital expenditures of $18.8 million, partially offset by proceeds related to the sale of Kadian® of $34.8 million and proceeds from the sale of debt securities of $32.2 million.
 
We anticipate capital expenditures, including capital lease obligations, for the year ending December 31, 2010 of approximately $35.0 million to $45.0 million, which will be funded with cash from operations. The principal capital expenditures are anticipated to include costs associated with the preparation of our facilities to manufacture new products as they emerge from our research and development pipeline.
 
Financing Activities
 
                 
    For the Six Months Ended June 30,
    2010   2009
    (In thousands)
 
Net cash used in financing activities
  $ (100,748 )   $ (588,377 )
 
Our cash flows from financing activities for the first six months of 2010 are primarily related to payments on long-term debt. During the first quarter of 2010, we made payments of $92.3 million on the 2008 Revolving Credit Facility, which represented full payment of all outstanding borrowings. During the first six months of 2009, we made payments on debt of $585.2 million, which included $385.2 million to redeem the Alpharma Convertible Senior Notes, $134.2 million on the 2008 Revolving Credit Facility and $65.8 million on the Senior Secured Term Facility.


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Certain Indebtedness and Other Matters
 
Convertible Senior Notes
 
The Convertible Senior Notes, issued in 2006, are unsecured obligations and are guaranteed by each of our domestic subsidiaries on a joint and several basis. The Convertible Senior Notes accrue interest at an initial rate of 11/4%. Beginning with the six-month interest period that commences on April 1, 2013, we will pay additional interest during any six-month interest period if the average trading price of the Convertible Senior Notes during the five consecutive trading days ending on the second trading day immediately preceding the first day of such six-month period equals 120% or more of the principal amount of the Convertible Senior Notes. Interest is payable on April 1 and October 1 of each year.
 
On or after April 5, 2013, we may redeem for cash some or all of the Convertible Senior Notes at any time at a price equal to 100% of the principal amount of the Convertible Senior Notes to be redeemed, plus any accrued and unpaid interest, and liquidated damages, if any, up to but excluding the date fixed for redemption. Holders may require us to purchase for cash some or all of their Convertible Senior Notes on April 1, 2013, April 1, 2016 and April 1, 2021, or upon the occurrence of a fundamental change, at 100% of the principal amount of the Convertible Senior Notes to be purchased, plus any accrued and unpaid interest, and liquidated damages, if any, up to but excluding the purchase date.
 
Senior Secured Revolving Credit Facility
 
The 2010 Revolving Credit Facility provides us with aggregate revolving credit commitments of $500.0 million, with a $50.0 million sublimit for the issuance of letters of credit. The 2010 Revolving Credit Agreement also provides for an incremental term loan facility in an aggregate amount of up to $500.0 million. The 2010 Revolving Credit Facility matures on May 11, 2015.
 
As of June 30, 2010, there were no outstanding borrowings under the 2010 Revolving Credit Facility and letters of credit totaled $3.7 million. The undrawn commitment amount under the 2010 Revolving Credit Facility on June 30, 2010 totals $496.3 million after giving effect to letters of credit.
 
In connection with our acquisition of Alpharma on December 29, 2008, we borrowed $425.0 million in principal under the 2008 Revolving Credit Facility. Prior to the termination of the 2008 Revolving Credit Facility, we made payments of $92.3 million on this facility in the first quarter of 2010, which represented full payment on all outstanding borrowings under the facility. During the three and six months ended June 30, 2009, we made payments of $102.1 million and $134.2 million, respectively, on the 2008 Revolving Credit Facility.
 
In connection with the establishment of the 2010 Revolving Credit Facility, we incurred approximately $4.6 million of new deferred financing costs. During the second quarter of 2010, we expensed $2.3 million of the $4.3 million of deferred financing costs that remained outstanding at the time of the termination of the 2008 Revolving Credit Facility. Therefore, deferred financing costs associated with the 2010 Revolving Credit Facility total $6.7 million and are being amortized over five years.
 
Our borrowings under the 2010 Revolving Credit Facility will bear interest at annual rates that, at our option, will be either:
 
  •  a base rate generally defined as the sum of (i) the greatest of (a) the prime rate of the Administrative Agent, (b) the federal funds effective rate plus 0.5% and (c) the one-month adjusted LIBO rate (by reference to the British Bankers’ Association Interest Settlement Rates for deposits in dollars) plus 1.0% and (ii) an applicable percentage of 1.50%, 1.75% or 2.00%, depending on our corporate credit rating; or
 
  •  an adjusted LIBO rate generally defined as the sum of (i) the product of (a) the LIBO rate (by reference to the British Bankers’ Association Interest Settlement Rates for deposits in dollars) in effect for the relevant interest period and (b) a fraction, the numerator of which is one and the denominator of which is one minus certain maximum statutory reserves for eurocurrency liabilities and (ii) an applicable percentage of 2.50%, 2.75% or 3.00%, depending on the our corporate credit rating.


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If we make any borrowings under the incremental term loan facility, those borrowings will bear interest at annual rates established at the time of such borrowings.
 
We are required to pay an unused commitment fee on the difference between committed amounts and amounts actually borrowed under the 2010 Revolving Credit Facility equal to an applicable percentage of 0.375% or 0.5% per annum, depending on our corporate credit rating. We are required to pay a letter of credit participation fee based upon the aggregate face amount of outstanding letters of credit equal to an applicable percentage of 2.5%, 2.75% or 3.0% per annum, depending on our corporate credit rating.
 
The 2010 Revolving Credit Facility contains customary representations and warranties and affirmative covenants. The 2010 Revolving Credit Facility also contains certain covenants that restrict, among other things, our and our subsidiaries’ ability to incur additional indebtedness, permit certain liens to exist on assets, enter into sale and leaseback transactions, make investments, loans and advances, undertake acquisitions, mergers and consolidations, sell assets, make dividend and other restricted payments, enter into transactions with affiliates, prepay, redeem or repurchase other indebtedness and make capital expenditures, in each case, subject to certain exceptions.
 
The 2010 Revolving Credit Facility also requires us to meet the following financial tests:
 
  •  maintenance of a minimum consolidated EBITDA to consolidated interest expense ratio for periods of four consecutive fiscal quarters of 3.50 to 1; and
 
  •  maintenance of a maximum total funded debt to consolidated EBITDA ratio of 3.0 to 1.
 
As of June 30, 2010, we were in compliance with these covenants.
 
The 2010 Revolving Credit Facility also contains customary events of default, including events of default based on failures to make payments as and when required under the 2010 Revolving Credit Facility, breaches of representations, warranties and covenants, defaults under certain other material indebtedness, the occurrence of certain bankruptcy and insolvency events related to us and certain of our subsidiaries, the levy of judgments in excess of specified amounts, the occurrence of certain ERISA events, certain impairments to the guarantees of our obligations under the credit facility, certain impairments of the security interests granted by us and the subsidiary guarantors in connection with the 2010 Revolving Credit Facility and a change in control.
 
Our obligations under the 2010 Revolving Credit Facility are guaranteed by each of our domestic subsidiaries and secured by pledges by us of certain of our assets, including equity interests in certain of our subsidiaries and intellectual property.
 
Impact of Inflation
 
We have experienced only moderate raw material and labor price increases in recent years. In general, the price increases we have passed along to our customers have offset inflationary pressures.
 
Recently Issued Accounting Standards
 
For information regarding recently issued accounting standards, please see Note 10, “Accounting Developments”, in Part I, Item 1, “Financial Statements.”
 
Critical Accounting Policies and Estimates
 
We have chosen accounting policies that we believe are appropriate to accurately and fairly report our operating results and financial position, and apply those accounting policies in a consistent manner.
 
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.


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Significant estimates for which it is reasonably possible that a material change in estimate could occur in the near term include forecasted future cash flows used in testing for impairments of intangible and tangible assets and loss accruals for excess inventory and fixed purchase commitments under our supply contracts. Forecasted future cash flows in particular require considerable judgment and are subject to inherent imprecision. In the case of impairment testing, changes in estimates of future cash flows could result in a material impairment charge and, whether they result in an immediate impairment charge, could result prospectively in a reduction in the estimated remaining useful life of tangible or intangible assets, which could be material to the financial statements.
 
Other significant estimates include accruals for Medicaid, Medicare, and other rebates, returns and chargebacks, allowances for doubtful accounts, the fair value of our investments in debt securities, and estimates used in applying the revenue recognition policy.
 
We are subject to risks and uncertainties that may cause actual results to differ from the related estimates, and our estimates may change from time to time in response to actual developments and new information.
 
The significant accounting estimates that we believe are important to aid in fully understanding our reported financial results include the following:
 
  •  Intangible assets, goodwill, and other long-lived assets.  When we acquire product rights in conjunction with either business or asset acquisitions, we allocate an appropriate portion of the purchase price to intangible assets, goodwill and other long-lived assets. The purchase price is allocated to products, acquired research and development, if any, and other intangibles using the assistance of valuation consultants. We estimate the useful lives of the assets by factoring in the characteristics of the products such as: patent protection, competition by products prescribed for similar indications, estimated future introductions of competing products, and other issues. The factors that drive the estimate of the life of the asset are inherently uncertain. We use a straight-line method of amortization for our intangible assets.
 
We review our property, plant and equipment and intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. We review our goodwill for possible impairment annually, during the first quarter, or whenever events or circumstances indicate that the carrying amount may not be recoverable. In any event, we evaluate the remaining useful lives of our intangible assets each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization. This evaluation is performed through our quarterly evaluation of intangibles for impairment. We review our intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. In evaluating goodwill for impairment, we estimate the fair value of our individual business reporting units on a discounted cash flow basis. Assumptions and estimates used in the evaluation of impairment may affect the carrying value of long-lived assets, which could result in impairment charges in future periods. Such assumptions include projections of future cash flows and, in some cases, the current fair value of the asset. In addition, our depreciation and amortization policies reflect judgments on the estimated useful lives of assets.
 
We may incur impairment charges in the future if prescriptions for, or sales of, our products are less than current expectations and result in a reduction of our estimated undiscounted future cash flows. This may be caused by many factors, including competition from generic substitutes, significant delays in the manufacture or supply of materials, the publication of negative results of studies or clinical trials, new legislation or regulatory proposals.


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The gross carrying amount and accumulated amortization as of June 30, 2010 are as follows:
 
                         
    Gross
             
    Carrying
    Accumulated
    Net Book
 
    Amount     Amortization     Value  
    (In thousands)  
 
Branded Prescription Pharmaceuticals
                       
Avinza®
  $ 290,367     $ 89,154     $ 201,213  
Skelaxin®
    288,049       288,049        
Sonata®
    61,961       61,961        
Flector® Patch
    130,000       17,727       112,273  
                         
Neuroscience
    770,377       456,891       313,486  
                         
Synercid®
    70,959       50,773       20,186  
Other hospital
    8,442       6,883       1,559  
                         
Hospital
    79,401       57,656       21,745  
                         
Bicillin®
    92,350       36,823       55,527  
Other legacy products
    324,035       283,396       40,639  
                         
Legacy products
    416,385       320,219       96,166  
                         
Total Branded
    1,266,163       834,766       431,397  
                         
Alpharma Animal Health
    169,945       14,446       155,499  
Meridian Auto-Injector
    186,764       53,997       132,767  
Royalties and other
    3,731       3,532       199  
                         
Total intangible assets
  $ 1,626,603     $ 906,741     $ 719,862  
                         
 
The amounts of impairments and amortization expense for the three months ended June 30, 2010 and 2009 are as follows:
 
                                 
    Three Months Ended
    Three Months Ended
 
    June 30, 2010     June 30, 2009  
          Amortization
          Amortization
 
    Impairments     Expense     Impairments     Expense  
    (In thousands)     (In thousands)  
 
Branded Prescription Pharmaceuticals
                               
Avinza®
  $     $ 6,782     $     $ 6,638  
Skelaxin®
          19,979             20,041  
Flector® Patch
          2,954             2,955  
                                 
Neuroscience
          29,715             29,634  
                                 
Synercid®
          1,443             1,484  
Other hospital
          75             76  
                                 
Hospital
          1,518             1,560  
                                 
Bicillin®
          926             925  
Other legacy products
          1,430             1,430  
                                 
Legacy products
          2,356             2,355  
                                 
Total Branded
          33,589             33,549  
                                 
Alpharma Animal Health
          2,405             2,411  
Meridian Auto-Injector
          2,208             2,062  
Royalties and other
          11             127  
                                 
Total
  $     $ 38,213     $     $ 38,149  
                                 


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The amounts of impairments and amortization expense for the six months ended June 30, 2010 and 2009 are as follows:
 
                                 
    Six Months Ended
    Six Months Ended
 
    June 30, 2010     June 30, 2009  
          Amortization
          Amortization
 
    Impairments     Expense     Impairments     Expense  
    (In thousands)     (In thousands)  
 
Branded Prescription Pharmaceuticals
                               
Avinza®
  $     $ 13,557     $     $ 13,276  
Skelaxin®
          43,226             40,082  
Flector® Patch
          5,909             5,910  
                                 
Neuroscience
          62,692             59,268  
                                 
Synercid®
            2,885             2,968  
Other hospital
          151             152  
                                 
Hospital
          3,036             3,120  
                                 
Bicillin®
            1,851             1,850  
Other legacy products
          2,860             2,860  
                                 
Legacy products
          4,711             4,710  
                                 
Total Branded
          70,439             67,098  
                                 
Alpharma Animal Health
          4,813             4,819  
Meridian Auto-Injector
          4,376             4,097  
Royalties and other
          22             313  
                                 
Total
  $     $ 79,650     $     $ 76,327  
                                 
 
     
    Remaining Life at
    June 30, 2010
 
Skelaxin®
 
Avinza®
  7 years 5 months
Synercid®
  3 years 6 months
Bicillin®
  15 years
Flector® Patch
  9 years 6 months
 
  •  Inventories.  Our inventories are valued at the lower of cost or market value. We evaluate our entire inventory for short-dated or slow-moving product and inventory commitments under supply agreements based on projections of future demand and market conditions. For those units in inventory that are so identified, we estimate their market value or net sales value based on current realization trends. If the projected net realizable value is less than cost, on a product basis, we make a provision to reflect the lower value of that inventory. This methodology recognizes projected inventory losses at the time such losses are evident rather than at the time goods are actually sold. We maintain supply agreements with some of our vendors which contain minimum purchase requirements. We estimate future inventory requirements based on current facts and trends. Should our minimum purchase requirements under supply agreements, or if our estimated future inventory requirements exceed actual inventory quantities that we will be able to sell to our customers, we record a charge in costs of revenues.
 
  •  Accruals for rebates, returns and chargebacks.  We establish accruals for returns, chargebacks, Medicaid, Medicare and commercial rebates in the same period we recognize the related sales. The accruals reduce revenues and are included in accrued expenses. At the time a rebate or chargeback payment is made or a product return is received, which occurs with a delay after the related sale, we record a reduction to accrued expenses and, at the end of each quarter, adjust accrued expenses for differences between estimated and actual payments. Due to estimates and assumptions inherent in determining the amount of returns,


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  chargebacks and rebates, the actual amount of product returns and claims for chargebacks and rebates may be different from our estimates.
 
Our product returns accrual is primarily based on estimates of future product returns over the period during which customers have a right of return which is in turn based in part on estimates of the remaining shelf life of our products when sold to customers. Future product returns are estimated primarily on historical sales and return rates. We also consider the level of inventory of our products in the distribution channel. We base our estimate of our Medicaid rebate, Medicare rebate and commercial rebate accruals on estimates of usage by rebate-eligible customers, estimates of the level of inventory of our products in the distribution channel that remain potentially subject to those rebates, and the terms of our commercial and regulatory rebate obligations. We base our estimate of our chargeback accrual on our estimates of the level of inventory of our products in the distribution channel that remain subject to chargebacks, and specific contractual and historical chargeback rates. The estimate of the level of our products in the distribution channel is based primarily on data provided by our three key wholesalers under inventory management agreements.
 
Our accruals for returns, chargebacks and rebates are adjusted as appropriate for specific known developments that may result in a change in our product returns or our rebate and chargeback obligations. In the case of product returns, we monitor demand levels for our products and the effects of the introduction of competing products and other factors on this demand. When we identify decreases in demand for products or experience higher than historical rates of returns caused by unexpected discrete events, we further analyze these products for potential additional supplemental reserves.
 
  •  Investments in debt securities.  Prior to the end of the first quarter of 2008, we undertook investments in debt securities. Tax-exempt auction rate securities are long-term variable rate bonds tied to short-term interest rates that are reset through an auction process generally every 7, 28 or 35 days. On February 11, 2008, we began to experience auction failures with respect to our investments in auction rate securities. All of our investments in auction rate securities have experienced multiple failed auctions. We will not be able to liquidate these securities until a successful auction occurs, the issuer calls or restructures the underlying security, the underlying security matures or it is purchased by a buyer outside the auction process. Based on the frequency of auction failures and the lack of market activity, current market prices are not available for determining the fair value of these investments. As a result, we measure these investments using unobservable inputs.
 
The fair value of investments in debt securities is based on a trinomial discount model. This model considers the probability at the valuation date of three potential occurrences for each auction event through the maturity date of the security. The three potential outcomes for each auction are (i) successful auction/early redemption, (ii) failed auction and (iii) issuer default. Inputs in determining the probabilities of the potential outcomes include, but are not limited to, the security’s collateral, credit rating, insurance, issuer’s financial standing, contractual restrictions on disposition and the liquidity in the market. The fair value of each security is determined by summing the present value of the probability-weighted future principal and interest payments determined by the model. The discount rate is determined as the loss-adjusted required rate of return using public information such as spreads or near risk-free to risk-free assets. The expected term is based on our estimate of future liquidity as of the balance sheet date.
 
  •  Revenue recognition.  Revenue is recognized when title and risk of loss are transferred to customers, collection of sales is reasonably assured, and we have no further performance obligations. This is generally at the time products are received by the customer. Accruals for estimated returns, rebates and chargebacks, determined based on historical experience, reduce revenues at the time of sale and are included in accrued expenses. Medicaid and certain other governmental pricing programs involve particularly difficult interpretations of relevant statutes and regulatory guidance, which are complex and, in certain respects, ambiguous. Moreover, prevailing interpretations of these statutes and guidance can change over time. We launched Embeda® in late September 2009. We have recognized revenue on Embeda® in a manner consistent with our other products, as described above, which is generally at the time the product is received by the customer. We believe Embeda® has similar characteristics of certain of our other pharmaceutical products such that we can reliably estimate expected returns of the product. Royalty revenue is recognized based on a percentage of sales (namely, contractually agreed-upon royalty rates) reported by third parties.


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A WARNING ABOUT FORWARD-LOOKING STATEMENTS
 
This report includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to analyses and other information which are based on forecasts of future results and estimates of amounts that are not yet determinable. These statements also relate to our future prospects, developments and business strategies.
 
These forward-looking statements are identified by their use of terms and phrases, such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will” and other similar terms and phrases, including references to assumptions. These statements are contained in the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections, as well as other sections of this report. You should not unduly rely on our forward-looking statements.
 
Forward-looking statements in this report include, but are not limited to, those regarding:
 
  •  expectations regarding the outcome of various pending legal proceedings including the Skelaxin®, Avinza® and EpiPen® patent challenges and litigation, and other legal proceedings described in this report;
 
  •  expectations regarding the enforceability and effectiveness of product-related patents, including, in particular, patents related to Skelaxin®, Avinza®, EpiPen® and Adenoscan®;
 
  •  the potential of, including anticipated net sales and prescription trends for, our branded prescription pharmaceutical products, particularly Skelaxin®, Avinza®, Thrombin-JMI®, Flector® Patch, Embeda®, Levoxyl® and Cytomel®;
 
  •  expected trends and projections with respect to particular products, reportable segment and income and expense line items;
 
  •  the adequacy of our liquidity and capital resources and our ability to enter into borrowing arrangements in the future;
 
  •  anticipated capital expenditures;
 
  •  the development, approval and successful commercialization of Remoxy®, Acurox® Tablets, CorVuetm and other products;
 
  •  the cost of and the successful execution of our growth and restructuring strategies;
 
  •  anticipated developments and expansions of our business;
 
  •  our plans for the manufacture of some of our products, including products manufactured by third parties;
 
  •  the potential costs, outcomes and timing of research, clinical trials and other development activities involving pharmaceutical products, including, but not limited to, the timing or outcomes of regulatory processes or the magnitude and timing of potential payments to third parties in connection with development activities;
 
  •  the development of product line extensions;
 
  •  the expected timing of the initial marketing of certain products;
 
  •  products developed, acquired or in-licensed that may be commercialized;
 
  •  our intent, beliefs or current expectations, primarily with respect to our future operating performance;
 
  •  expectations regarding sales growth, gross margins, manufacturing productivity, capital expenditures and effective tax rates;
 
  •  expectations regarding our financial condition and liquidity as well as future cash flows and earnings; and
 
  •  expectations regarding our ability to liquidate our holdings of auction rate securities and the temporary nature of unrealized losses recorded in connection with some of those securities.


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These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from those contemplated by our forward-looking statements. These known and unknown risks, uncertainties and other factors are described in detail in the “Risk Factors” section and in other sections of this report.
 
Item 3.   Quantitative and Qualitative Disclosures about Market Risk
 
We are exposed to market risk for changes in the market values of some of our investments (“Investment Risk”), the effect of interest rate changes (“Interest Rate Risk”) and the effect of changes in foreign currency exchange rates (“Foreign Currency Exchange Rate Risk”). At June 30, 2010, we held derivative financial instruments associated with the Convertible Senior Notes. There have been no material changes in our exposure to these items since our disclosure under Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2009, except that (i) we fully repaid all borrowings under the 2008 Revolving Credit Facility in the first quarter of 2010, which carried a variable rate of interest, and (ii) we terminated the 2008 Revolving Credit Facility and entered into the 2010 Revolving Credit Facility in the second quarter of 2010. For additional information, please see “Senior Secured Revolving Credit Facility” within “Certain Indebtedness and Other Matters”, in Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
Item 4.   Controls and Procedures
 
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to reasonably ensure that information required to be disclosed and filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified, and that management will be timely alerted to material information required to be included in our periodic reports filed with the SEC.
 
There were no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2010 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.   Legal Proceedings
 
The information required by this Item is incorporated by reference to Note 9, “Commitments and Contingencies”, in Part I, Item 1, “Financial Statements.”
 
Item 1A.   Risk Factors
 
We have disclosed a number of material risks under Item 1A of our annual report on Form 10-K for the year ended December 31, 2009, which we filed with the Securities and Exchange Commission on February 26, 2010. Please also see the additional risk factor below.
 
Net sales of Skelaxin® will decline significantly as the result of competition from generic products.
 
In January 2009, the U.S. District Court for the Eastern District of New York issued an order ruling invalid two Skelaxin® patents, and the Court entered judgment against the Company in June 2009. In August 2010, the Court of Appeals for the Federal Circuit affirmed the actions of the District Court. Generic versions of Skelaxin® entered the market early in the second quarter of 2010, including an authorized generic sold by CorePharma. The Company’s net sales of Skelaxin® have declined significantly and will continue to decline as a result of this competition from generic products.
 
Item 6.   Exhibits
 
         
Exhibit
   
Number   Description
 
  3 .1   Third Amended and Restated Charter of King Pharmaceuticals, Inc., as amended June 2, 2010
  3 .2   Second Amended and Restated Bylaws of King Pharmaceuticals, Inc., as amended June 29, 2010
  10 .1   Credit Agreement, dated as of May 11, 2010, among King Pharmaceuticals, Inc., the Lenders Named Therein, Credit Suisse AG, as Administrative Agent, as Collateral Agent and as Swingline Lender, Credit Suisse Securities (USA) LLC, Bank of America, N.A., DnBNOR Bank ASA, SunTrust Bank and U.S. Bank National Association, as Co-Syndication Agents, Credit Suisse Securities (USA) LLC, as Sole Arranger and Sole Bookrunner
  10 .2*   Letter Amendment to License and Collaboration Agreements, dated June 25, 2010, between Pain Therapeutics, Inc. and King Pharmaceuticals, Inc.
  10 .3   King Pharmaceuticals, Inc. Form of Indemnification Agreement for Directors
  10 .4   King Pharmaceuticals, Inc. Form of Indemnification Agreement for Officers
  31 .1   Certificate of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  31 .2   Certificate of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  32 .1   Certificate of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
  32 .2   Certificate of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
  101 .INS**   XBRL Instance Document
  101 .SCH**   XBRL Taxonomy Extension Schema Document
  101 .CAL**   XBRL Taxonomy Extension Calculation Linkbase Document
  101 .DEF**   XBRL Taxonomy Definition Linkbase Document
  101 .LAB**   XBRL Taxonomy Extension Label Linkbase Document
  101 .PRE**   XBRL Taxonomy Extension Presentation Linkbase Document
 
 
* Portions of this Exhibit have been omitted and filed separately with the Securities and Exchange Commission pursuant to a confidential treatment request under Rule 24b-2 of the Securities Exchange Act of 1934, as amended.
 
** XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.


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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
KING PHARMACEUTICALS, INC.
 
  By: 
/s/  Brian A. Markison
Brian A. Markison
President and Chief Executive Officer
 
Date: August 9, 2010
 
  By: 
/s/  Joseph Squicciarino
Joseph Squicciarino
Chief Financial Officer
 
Date: August 9, 2010


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