UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

Commission File No. 001-15875

 

 

King Pharmaceuticals, Inc.

(Exact name of registrant as specified in its charter)

 

(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):

 

 

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 November 2, 2010: 249,968,580

 

 

Table of Contents

 

 

 

KING PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)

 

 

See accompanying notes.

KING PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

 

 

See accompanying notes.

KING PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
AND OTHER COMPREHENSIVE INCOME
(In thousands, except share data)
(Unaudited)

 

 

See accompanying notes.

KING PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

 

 

See accompanying notes.

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2010 and 2009

(In thousands, except share and per share data)

(Unaudited)

 

 

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 nine months ended September 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.

 

 

Basic and diluted income per common share were determined using the following share data:

 

 

For the three months ended September 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 6,532,380 shares of common stock, 616,614 restricted stock awards (“RSAs”) and 872,720 long-term performance units (“LPUs”). For the nine months ended September 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 5,083,569 shares of common stock, 504,743 RSAs and 619,206 LPUs. For the three months ended September 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 5,010,109 shares of common stock and 138,640 LPUs. For the nine months ended September 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 6,356,694 shares of common stock, 202,632 RSAs and 221,362 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 diluted

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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 nine months ended September 30, 2009 and 2010.

 

 

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 September 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 of the Company’s prior credit agreements required the Company to maintain hedging agreements that fixed 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 for $838 and recognized the cost as interest expense in the accompanying Condensed Consolidated Statement of Operations.

 

The following tables summarize the effect of derivative instruments on the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2009:

 

 

 

Marketable Securities.  As of September 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 $408 and $1,589, respectively, as of September 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

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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 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 (Loss) gain 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 September 30, 2010 and December 31, 2009, the par value of the Company’s investments in debt securities was $184,975 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 September 30, 2010, there were cumulative unrealized holding losses of $21,388 recorded in accumulated other comprehensive income (loss) on the Condensed Consolidated Balance Sheet associated with investments in debt securities with a par value of $169,975, 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 September 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 income (expense) 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). During the third quarter of 2010, the Company recognized $2,460 of additional other-than-temporary credit losses related to this municipal bond.

 

During the third quarter of 2010, the Company sold an auction rate security associated with student loans with a par value of $500 for $485 to the issuer and realized a loss of $15 in the Condensed Consolidated Statements of Operations. 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. During the third quarter of 2010, the Company sold all the auction rate securities that were included in the UBS right for par value of $18,200. The Company did not

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

recognize any gain or loss on the exercise of the right and the sale of the securities. At December 31, 2009, the Company held auction rate securities related to this offer with a par value of $32,500. The Company elected the fair value option to account for this right. As a result, gains and losses associated with this right were 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 December 31, 2009, the fair value of the right to sell the auction rate securities to UBS at par was $3,226. With respect to this right, the Company recognized unrealized losses of $1,854 and $3,226 during the third quarter and first nine months of 2010, respectively, and an unrealized gain of $44 and an unrealized loss of $413 during the third quarter and first nine 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 December 31, 2009, the fair value of the investments in debt securities classified as trading was $29,258. The Company recognized unrealized gains related to these securities of $1,854 and $3,242 during the third quarter and first nine months of 2010, respectively, and $477 and $1,014 during the third quarter and first nine months of 2009, respectively, in Other income (expense) in the accompanying Condensed Consolidated Statements of Operations.

 

As of September 30, 2010, the Company had classified all of its auction rate securities as long-term assets.

 

The following tables summarize the Company’s assets that are measured at fair value on a recurring basis:

 

 

 

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.

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The fair value of investments in debt securities within the Level 2 classification is based on observed market trading activity for securities with similar terms and characteristics.

 

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 September 30, 2010, the Company assumed a weighted average discount rate of 3.9% 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 September 30, 2010. Transfers out of Level 3 classification occur when public call notices have been announced by the issuer prior to the date of the valuation or when observable market trading activity for securities with similar terms and characteristics is available.

 

The following table provides a reconciliation of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3):

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Inventories consist of the following:

 

 

 

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. During the third quarter of 2010, the Company recorded a gain of $677 based on the estimated fair value of this asset at September 30, 2010. During October 2010, the Company sold this facility for $6,567.

 

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.

 

 

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.

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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:

 

 

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 were received one quarter in arrears. During the third quarter and first nine months of 2010, the Company received $7,500 and $47,500, respectively, from Actavis LLC related to gross profit from sales during the fourth quarter of 2009 and the first six months of 2010.

 

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 and third quarters of 2010, the Company recognized revenue of $25,624 and $25,223, respectively, 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.

 

 

Intangible assets consist primarily of patents, licenses, trademarks and product rights. A summary of the gross carrying amount and accumulated amortization is as follows:

 

 

Amortization expense for the three months ended September 30, 2010 and 2009 was $18,335 and $38,011, respectively. Amortization expense for the nine months ended September 30, 2010 and 2009 was $97,985 and $114,338, 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

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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 $6,781 and $103,017, respectively, in the three and nine months ended September 30, 2010. According to IMS America, Ltd. weekly prescription data, for the week ending October 22, 2010, generic competitors have garnered approximately 85% 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 first six months of 2010 was $43,226.

 

For additional information regarding Skelaxin^® litigation, please see Note 9.

 

Goodwill at September 30, 2010 and December 31, 2009 is as follows:

 

 

 

Long-term debt consists of the following:

 

 

Convertible Senior Notes

 

At September 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:

 

 

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

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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 Facility 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 September 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 nine months ended September 30, 2009, the Company made payments of $18,584 and $152,769, respectively, on the 2008 Revolving Credit Facility.

 

In connection with the establishment of the 2010 Revolving Credit Facility, the Company incurred approximately $4,622 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 $6,657 and are being amortized over five years.

 

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:

 

 

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.

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The 2010 Revolving Credit Facility also requires the Company to meet the following financial tests:

 

 

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 of the Company.

 

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 the Senior Secured Term Facility and received proceeds of $192,000, net of the discount at issuance. During the three and nine months ended September 30, 2009, the Company made payments of $105,489 and $171,305, 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.

 

 

Legal Proceedings Related to the Pfizer Transaction

 

Since the announcement on October 12, 2010 of the Company’s entry into an agreement and plan of merger with Pfizer Inc. and a wholly-owned subsidiary of Pfizer Inc. (“Pfizer”) (see Note 15, “Subsequent Event”), a

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

number of putative class action lawsuits have been filed in federal and state court in Tennessee by purported shareholders of the Company on behalf of themselves and other shareholders of the Company. The complaints name as defendants the Company and its directors and, in certain cases, Pfizer.

 

The complaints variously allege, among other things, that the Company’s directors breached their fiduciary duties to shareholders of the Company in connection with the Company’s entry into the agreement and plan of merger with Pfizer. Certain of the complaints also allege that the Company and/or Pfizer aided and abetted the directors’ purported breaches of fiduciary duties. The complaints seek, among other things, class action status, an order enjoining the proposed transaction, and attorneys’ fees and expenses.

 

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 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

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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 fully briefed by the parties. On September 2, 2010, the Court dismissed all of Eon Labs’ pending counterclaims. On September 10, 2010, the Court denied Eon Labs’ motion for exceptional case. 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. A petition for panel rehearing and rehearing en banc was filed on September 21, 2010. The Federal Circuit Court denied the petition on October 14, 2010. On October 26, 2010, Eon filed a Notice of Appeal to the Federal Circuit to appeal the district court’s decision on its motion for exceptional case.

 

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 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 was set for September 7, 2010. The trial concluded on September 16, 2010. The jury found the ‘566 patent invalid and not infringed. On October 18, 2010, the plaintiffs filed post-trial motions.

 

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

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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.

 

The Court held a claim construction hearing on March 19, 2010 and issued a ruling. The Court scheduled trial to begin on February 7, 2011. The close of all discovery is currently set for January 7, 2011.

 

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

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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 was held on September 30, 2010 and the Court issued a ruling on October 1, 2010. 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 $27,281 and $75,218, respectively, in the three and nine months ended September 30, 2010. As of September 30, 2010, the Company had net intangible assets related to Avinza^® of $195,178. 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. A claim construction hearing is set for September 15, 2011 and trial is currently set for February 16, 2012. The parties are in the midst of fact discovery.

 

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.

 

On September 13, 2010, Sandoz answered the complaint and filed counterclaims of noninfringement and invalidity. The Company filed a reply on October 7, 2010. An initial scheduling conference is set for December 2, 2010.

 

On September 14, 2010, the U.S. Patent and Trademark Office issued U.S. Patent No. 7,794,432 (“the ‘432 patent”) covering the NGA for use with epinephrine sold under the EpiPen^® brand name. The ‘432 patent expires September 11, 2025. The ‘432 patent was listed in FDA’s Orange Book on September 15, 2010 under the EpiPen^® NDA. On September 17, 2010, the Company sent notice to Teva and Sandoz that it had added the ‘432 patent to the FDA Orange Book.

 

On November 2, 2010, the Company received a Paragraph IV certification from Teva challenging the validity and alleging non-infringement of the ‘432 patent. The Company is evaluating the certification and intends to vigorously enforce its intellectual property related to EpiPen^®.

 

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

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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 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 was paid in the third quarter of 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

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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 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 was scheduled for trial in January 2011 but, as with other scheduled cases, this trial date was continued as a result of 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, Oklahoma’s, filed in September 2010 and Louisiana’s, filed in October 2010. The Company expects the Oklahoma case to be voluntarily dismissed. 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

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manufacture dexfenfluramine, fenfluramine or phentermine, Jones was a distributor of a generic phentermine product and, after its acquisition of Abana Pharmaceuticals (“Abana”), 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 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.

 

Hormone Replacement Therapy

 

Currently, the Company is named as a defendant by 20 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 20 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. Most of the trials have involved 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.

 

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

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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 138 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 $8,231 and $22,466, respectively, in the three and nine months ended September 30, 2010.

 

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:

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

In addition, Alpharma’s New York and Iowa cases are pending in the MDL Court discussed above, and the Oklahoma case is pending in the District Court of Pottawotomie County, Oklahoma. 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.

 

 

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, 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.

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

During the three and nine months ended September 30, 2010, the Company’s effective income tax rate was 36.3% and 43.7%, respectively. During the three months and nine months ended September 30, 2009, the Company’s effective income tax was 37.5% and 41.2%, 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.

 

 

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 merger and acquisition related costs. 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.

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.

 

 

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The following represents branded prescription pharmaceutical revenues by the Company’s target markets:

 

 

 

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 $5,176 for severance pay and other employee related costs, which includes approximately $3,341 of cash expenditures and $1,651 of non-cash costs incurred in the second and third quarters of 2010. The remaining severance pay is expected to be fully paid by the third quarter of 2011.

 

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 within the branded prescription pharmaceuticals segment.

 

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 fourth quarter of 2010.

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The restructuring charges include employee termination costs associated with a workforce reduction of approximately 520 employees, including approximately 380 members of our sales force.

 

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 $70,711 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 substantially paid by the first quarter of 2011.

 

A summary of the types of costs accrued and incurred are summarized below:

 

 

 

 

The restructuring charges in 2010 relate primarily to the branded prescription pharmaceutical segment.

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

During the third quarter of 2010, the Company granted to certain employees 176,200 RSAs and 40,000 nonqualified stock options pursuant to its Incentive Plan.

 

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.

 

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 achievement of 2010 operating targets. LPUs with a three-year performance cycle will be earned based on achievement of 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. Subsequent Event

 

On October 11, 2010, King entered into an agreement and plan of merger (the “Merger Agreement”) with Pfizer pursuant to which Pfizer has agreed to commence a tender offer to purchase all of the outstanding shares of common stock, no par value per share, of King (the “Shares”) for $14.25 per Share net to the seller in cash (the “Offer”). Pfizer commenced the Offer on October 22, 2010. The Offer expires on November 19, 2010, unless extended in accordance with the terms of the Merger Agreement. Completion of the Offer is subject to customary conditions including, among others, (i) a majority of the Shares issued and outstanding (on a fully-diluted basis, without giving effect to compensatory equity awards that may be validly cancelled under the Merger Agreement upon completion of the Offer) being validly tendered and not validly withdrawn and (ii) the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, expiring and all other authorizations, consents, and approvals of or notices or filings with any foreign antitrust or competition regulatory authority having been made or obtained.

 

Subject to the terms and conditions of the Merger Agreement, King has granted Pfizer an irrevocable option (the “Top-Up Option”) to purchase an aggregate number of newly-issued shares of King common stock that, at the time of such exercise, and when added to the Shares owned by Pfizer or any of its subsidiaries, constitutes one Share more than 90% of the Shares that would be outstanding immediately after the issuance of Shares pursuant to such exercise (on a fully diluted basis), subject to there being authorized Shares available for issuance. The Top-Up Option is exercisable only after Shares have been purchased by Pfizer pursuant to the Offer. The consideration for each Share acquired upon exercise of the Top-Up Option will be the Offer price.

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The Merger Agreement prohibits King from soliciting or initiating discussions with third parties regarding other proposals to acquire King and King has agreed to restrictions on its ability to respond to such proposals, subject to certain exceptions. The Merger Agreement also contains customary termination provisions for King and Pfizer. Upon termination of the Merger Agreement, under specified circumstances King will be required to pay to Pfizer a termination fee of $110 million (or $75 million if the basis for the actions giving rise to such termination was King’s receipt, within 30 days of the date of the Merger Agreement, of an alternative acquisition proposal that King’s Board of Directors determines in good faith constitutes or could be reasonably expected to result in a superior proposal). In addition, the Merger Agreement contains representations, warranties and covenants of the parties customary for transactions of this type.

 

In connection with the Merger Agreement, in October 2010 the Board of Directors approved payments of awards under certain of King’s employee incentive award plans for the 2010 performance period, which will be recognized and paid in the fourth quarter of 2010. In addition, the Company expects to incur fees for its legal and financial advisors related to the merger with Pfizer. In the aggregate, the costs described in this paragraph are estimated to approximate $50 to $60 million.

 

 

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.

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

GUARANTOR SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEETS
(In thousands)
(Unaudited)