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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. (Check one):

 

Large accelerated filer þ Accelerated filer o Non-accelerated filer o

 

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 7, 2007: 244,434,949

 

 

TABLE OF CONTENTS

 

 

PART I — FINANCIAL INFORMATION

 

 

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, 2007 and 2006

(Unaudited)

(In thousands, except share and per share data)

 

 

The accompanying unaudited interim 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, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of items of a normal recurring nature) considered necessary for a fair presentation are included. Operating results for the three and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. These unaudited interim 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, 2006. The year-end condensed balance sheet was derived from the audited consolidated financial statements but does not include all disclosures required by generally accepted accounting principles.

 

These unaudited interim 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 current presentation. For additional information, please see Note 6.

 

 

The basic and diluted income per common share was determined using the following share data:

 

 

For the three months ended September 30, 2007, the dilutive effect of options to purchase 259,346 shares of common stock and 827,200 share awards were not included in the computation of diluted (loss) income per share because their inclusion would have reduced the loss per share.

 

For the three months ended September 30, 2007, the weighted average shares that were anti-dilutive, and therefore excluded from the calculation of diluted income per share, included options to purchase 3,630,018 shares of common stock, 471,820 restricted stock awards (“RSAs”) and 274,621 long-term performance units (“LPUs”). For the nine months ended September 30, 2007, the weighted average shares that were anti-dilutive, and therefore excluded from the calculation of diluted income per share, included options to purchase 2,418,942 shares of common stock, 191,857 RSAs, and 478,546 LPUs. The 11/4% Convertible Senior Notes due April 1, 2026 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

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

from the calculation of diluted income per share because these notes are anti-dilutive since the conversion price of the notes was greater than the average market price of the Company’s common stock during the quarter.

 

For the three months ended September 30, 2006, the weighted average shares that were anti-dilutive, and therefore excluded from the calculation of diluted income per share, included options to purchase 5,694,787 shares of common stock and 1,111,690 LPUs. For the nine months ended September 30, 2006, the weighted average shares that were anti-dilutive, and therefore excluded from the calculation of diluted income per share included options to purchase 5,317,551 shares of common stock, 2,341 RSAs and 708,255 LPUs. As of September 30, 2006, the 23/4% Convertible Debentures due November 15, 2021 could also convert into 84,868 shares of common stock in the future, subject to certain contingencies outlined in the indenture. Since the convertible debentures were anti-dilutive, they were not included in the calculation of diluted income per common share. The 11/4% Convertible Senior Notes due April 1, 2026 could be converted into 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 calculation of diluted income per share because these notes were anti-dilutive since the conversion price of the notes was greater than the average market price of the Company’s common stock during the quarter.

 

 

Inventories consist of the following:

 

 

On September 11, 2007, the U.S. Circuit Court of Appeals for the Federal Circuit (the “Circuit Court”) declared invalid U.S. Patent No. 5,061,722 (the “722 Patent”) that covers the Company’s Altace^® product, overruling the decision of the U.S. District Court for the Eastern District of Virginia (the “District Court”), which had upheld the validity of the patent. The Company has filed with the Circuit Court a petition for rehearing and rehearing en banc, and Lupin Ltd. (“Lupin”) filed its responsive brief on November 7, 2007, but the Circuit Court has yet to issue a decision regarding the petition. Invalidation of the ‘722 Patent will likely lead to generic versions of Altace^® entering the market sooner than previously anticipated. The entry of generic products into the market would likely cause the Company’s net sales of Altace^® to decline significantly.

 

Following the Circuit Court’s decision on September 11, 2007, the Company undertook an analysis of its potential effect on future net sales of Altace^®. Based upon that analysis, the Company concluded that it has more Altace^® raw material inventory than is required to meet anticipated future demand for the product. Accordingly, during the third quarter of 2007 the Company recorded charges in the amount of (i) $17,274 for an inventory valuation allowance for a portion of the Altace^® raw material inventory on hand; (ii) $39,904 to write off prepaid Altace^® raw material inventory; and (iii) $24,794 for a portion of the Company’s estimated remaining minimum purchase requirements for excess Altace^® raw material. These charges are included in cost of revenues exclusive of depreciation, amortization and impairments on the Condensed Consolidated

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Statements of Operations. For additional information regarding the intangible assets associated with Altace^® and the Company’s minimum purchase commitments for Altace^® raw material, please see Notes 5 and 8.

 

Because the Company’s analysis of the potential effect of the Circuit Court’s decision includes probability-weighted estimated future demand for Altace^®, the Company could incur additional material charges, in the near term, if events, such as the failure of its petition for rehearing, occur that cause the Company to reduce its probability-weighted estimate of future demand for Altace^®. These charges would be associated with raw material inventories and minimum purchase requirements under the supply agreement to purchase raw material inventory associated with Altace^®.

 

4.  Acquisitions, Dispositions, Co-Promotions and Alliances

 

On October 30, 2007, King Pharmaceuticals Research and Development, Inc. (“King Research and Development”), a wholly owned subsidiary of the Company, and Acura Pharmaceuticals, Inc. (“Acura”) entered into a License, Development and Commercialization Agreement to develop and commercialize certain opioid analgesic products utilizing Acura’s proprietary Aversion^® (abuse deterrent) Technology in the United States, Canada and Mexico. The agreement provides King Research and Development an exclusive license for Acurox^tm (oxycodone HCl, niacin and a unique combination of other ingredients) tablets, formerly known as OxyADF, and another undisclosed opioid product utilizing Acura’s Aversion^® Technology. In addition, the agreement provides King Research and Development with an option to license all future opioid analgesic products developed utilizing Acura’s Aversion^® Technology.

 

Under the terms of the agreement, King Research and Development will make a non-refundable cash payment of $30,000 to Acura upon the satisfaction of closing conditions and the effectiveness of the agreement. King Research and Development will reimburse Acura for all research and development expenses incurred beginning from September 19, 2007 for Acurox^tm tablets and all research and development expenses related to future products after exercise of its option to an exclusive license for each future product. King Research and Development may make additional non-refundable cash milestone payments to Acura based on the successful achievement of certain clinical and regulatory milestones for Acurox^tm tablets and for each other product developed under the agreement. King Research and Development may also make an additional $50,000 non-refundable cash milestone payment to Acura when the aggregate net sales of all products developed under the agreement exceeds $750,000. In addition, King Research and Development will make royalty payments to Acura ranging from 5% to 25% based on the combined annual net sales of all products developed under the agreement.

 

The agreement will become effective upon the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.

 

On October 1, 2007, the Company sold its Rochester, Michigan sterile manufacturing facility, some of its legacy products that are manufactured there, and the related contract manufacturing business to JHP Pharmaceuticals, LLC, (“JHP”) for $91,524, subject to final inventory adjustments, less fees of $5,341. The Company retained its Bicillin^® (sterile penicillin products) manufacturing facility which is also located in Rochester, Michigan. For additional information, please see Note 6.

 

On August 12, 2004, the Company entered into a Collaborative Development and Marketing Agreement (the “Agreement”) with Palatin Technologies, Inc. (“Palatin”), to jointly develop and, on obtaining necessary regulatory approvals, commercialize Palatin’s bremelanotide compound, which was formerly known as PT-141, for the treatment of male and female sexual dysfunction, for $20,000 plus acquisition costs of $498. Pursuant to the terms of the Agreement, Palatin granted the Company a co-exclusive license with Palatin to bremelanotide in North America and an exclusive right to collaborate in the licensing or sublicensing of bremelanotide with Palatin outside North America. The Company agreed to pay potential milestone payments to or make investments in Palatin of up to $100,000 upon achieving certain development and regulatory approval targets, $10,000 of which was paid in September 2005 for the purchase of Palatin common stock and

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

warrants. In the event of regulatory approval and commercialization of bremelanotide, the Company would also pay potential milestone payments to Palatin of up to $130,000 upon achieving specified annual North American net sales thresholds.

 

In August 2007, representatives of the U.S. Food and Drug Administration (“FDA”) communicated serious concerns about the lack of an acceptable benefit/risk ratio to support the progression of the proposed bremelanotide program into Phase 3 studies for erectile dysfunction (“ED”). After reviewing the data generated in the Phase 1 and 2 studies, the FDA questioned the overall efficacy results and the clinical benefit of this product in both the general and diabetic ED populations, and cited blood pressure increases as its greatest safety concern.

 

In light of the of the FDA’s comments, and after discussions with Palatin, on September 6, 2007, the Company provided notice to Palatin that the Company is terminating the Agreement. The termination becomes effective on December 6, 2007, which is 90 days after Palatin’s receipt of the notice. The Company has no further obligation for payments related to milestones but has various immaterial obligations related to the wind-down of the collaboration.

 

The Company holds 5,675,461 shares of common stock of Palatin as well as 719,894 warrants to purchase Palatin common stock. For additional information, please see Note 13.

 

On May 18, 2007, the Company entered into a Product Development Agreement with Mutual Pharmaceutical Company (“Mutual”) and United Research Laboratories (“United”) to jointly research and develop one or more improved formulations of metaxalone. Under this agreement, the Company seeks Mutual’s expertise in developing improved formulations of metaxalone, including certain improved formulations Mutual developed prior to execution of this agreement and access to Mutual’s and United’s rights in intellectual property pertaining to these formulations. The success of this project depends on additional development activities and FDA approval. The Company paid $3,100 to Mutual for previously incurred development expenses, which was recorded as in-process research and development in the branded pharmaceutical segment. The estimated cost to complete the project at the execution of the agreement was approximately $5,000. In addition, the Company could be required to make additional milestone payments of up to $10,000.

 

On September 6, 2006, the Company entered into a definitive asset purchase agreement and related agreements with Ligand Pharmaceuticals Incorporated (“Ligand”) to acquire rights to Ligand’s product Avinza^® (morphine sulfate extended release). Avinza^® is an extended release 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. The Company completed its acquisition of Avinza^® on February 26, 2007, acquiring all the rights to Avinza^® in the United States, its territories and Canada. Under the terms of the asset purchase agreement the purchase price was $289,732, consisting of $289,332 in cash consideration and $400 for the assumption of a short-term liability. Additionally, the Company incurred acquisition costs of $6,760. Of the cash payments made to Ligand, $15,000 was set aside in an escrow account to fund potential liabilities Ligand could later owe the Company, of which $7,500 was released to Ligand in the third quarter of 2007.

 

As part of the transaction, the Company has agreed to pay Ligand an ongoing royalty and assume payment of Ligand’s royalty obligations to third parties. The royalty the Company will pay to Ligand consists of a 15% royalty during the first 20 months after the closing date. Subsequent royalty payments to Ligand will be based upon calendar year net sales of Avinza^® as follows:

 

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

In connection with the transaction, on October 12, 2006, the Company entered into a loan agreement with Ligand for the amount of $37,750. The principal amount of the loan was to be used solely for the purpose of paying a specific liability related to Avinza^®. The loan was subject to certain market terms, including a 9.5% interest rate and security interest in the assets that comprise Avinza^® and certain of the proceeds of Ligand’s sale of certain assets. On January 8, 2007, Ligand repaid the principal amount of the loan of $37,750 and accrued interest of $883. Pursuant to the terms of the loan agreement with Ligand, the Company forgave the interest on the loan and repaid Ligand the interest at the time of closing the transaction to acquire Avinza^®. Accordingly, the Company has not recognized interest income on the related note receivable.

 

The allocation of the initial purchase price and acquisition costs is as follows:

 

 

At the time of the acquisition, the intangible assets were assigned useful lives of 10.75 years. The acquisition is allocated to the branded pharmaceuticals segment. The goodwill recognized in this transaction is expected to be fully deductible for tax purposes. The Company financed the acquisition using available cash on hand.

 

On January 9, 2007, the Company obtained an exclusive license to certain hemostatic products owned by Vascular Solutions, Inc. (“Vascular Solutions”), including products which the Company markets as Thrombi-Pad^TM and Thrombi-Gel^®. The license also includes a product the Company expects to market as Thrombi-Paste^TM, which is currently in development. Each of these products includes the Company’s Thrombin-JMI^® topical hemostatic agent product as a component. Vascular Solutions will manufacture the products for the Company. Upon acquisition of the license, the Company made an initial payment to Vascular Solutions of $6,000, a portion of which is refundable in the event FDA approval for certain of these products is not received. During the second quarter of 2007, the Company made an additional milestone payment of $1,000. In addition, the Company could make additional milestone payments of up to a total of $1,000.

 

On March 1, 2006, the Company acquired the exclusive right to market and sell EpiPen^® throughout Canada and other specific assets from Allerex Laboratory LTD (“Allerex”). Under the terms of the agreements, the initial purchase price was $23,924, plus acquisition costs of $682. As an additional component of the purchase price, the Company will 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, the Company will increase intangible assets by the amount of the accrual. As of September 30, 2007, the Company has incurred a total of $4,656 for these earn-out payments. The aggregate of these payments will not exceed $13,164.

 

The allocation of the initial purchase price and acquisition costs is as follows:

 

 

At the time of the acquisition, the intangible assets were assigned useful lives of 9.8 years. The acquisition is allocated to the Meridian Medical Technologies segment. The Company financed the acquisition using available cash on hand.

 

On February 12, 2006, the Company entered into a collaboration with Arrow International Limited and certain of its affiliates, excluding Cobalt Pharmaceuticals, Inc. (collectively, “Arrow”), to commercialize one or

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

more novel formulations of ramipril, the active ingredient in the Company’s Altace^® product. Under a series of agreements, Arrow has granted King rights to certain current and future New Drug Applications regarding novel formulations of ramipril and intellectual property, including patent rights and technology licenses relating to these novel formulations. Arrow will have responsibility for the manufacture and supply of the new formulations of ramipril for King. However, under certain conditions King may manufacture and supply the formulations of ramipril.

 

Upon execution of the agreements, King made an initial payment to Arrow of $35,000. During the fourth quarter of 2006 and the first quarter and second quarters of 2007, the Company made additional payments of $25,000 in each of the three quarters to Arrow. Additionally, Arrow will earn fees for the manufacture and supply of the new formulations of ramipril.

 

In connection with the agreement with Arrow, the Company recognized the above payments and future payments totaling $110,000 as in-process research and development expense during 2006. This amount was expensed as in-process research and development as the project had not received regulatory approval and had no alternative future use. The in-process research and development project is part of the branded pharmaceutical segment. This project includes a New Drug Application (“NDA”) filed by Arrow for a tablet formulation of ramipril in January 2006 (the “Ramipril Application”). At the time of the acquisition, the success of the project was dependent on additional development activities and FDA approval. The estimated cost to complete the project at the execution of the agreement was approximately $3,500. The FDA approved the Ramipril Application on February 27, 2007. Arrow granted the Company an exclusive option to acquire their entire right, title and interest to the Ramipril Application or any future filed Amended Ramipril Application for the amount of $5,000. In April 2007, the Company exercised its option and paid $5,000 to Arrow. As a result, the Company owns the entire right, title and interest in and to the Ramipril Application. The Company expects to launch the tablet formulation during the fourth quarter of 2007.

 

On February 12, 2006, the Company entered into an agreement with Cobalt Pharmaceuticals, Inc. (“Cobalt”), an affiliate of Arrow International Limited, whereby Cobalt has the non-exclusive right to distribute a generic formulation of the Company’s currently marketed Altace^® product in the U.S. market, which generic product would be supplied by King. On October 12, 2007, Cobalt sent the Company 30-day written notice of its intent to launch its generic ramipril product, which product would not be supplied by the Company. The Company responded on October 19, 2007, informing Cobalt that the Company intends to vigorously enforce its rights under the ’722 and ’856 patents to the full extent of the law. For additional information, please see Note 8.

 

 

The following table reflects the components of intangible assets as of:

 

 

Amortization expense for the three months ended September 30, 2007 and 2006 was $26,749 and $26,836, respectively. Amortization expense for the nine months ended September 30, 2007 and 2006 was $81,044 and $79,380, respectively.

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

On September 11, 2007, the Circuit Court declared invalid the ‘722 Patent that covers the Company’s Altace^® product, overruling the decision of the District Court, which had upheld the validity of the patent. The Company has filed with the Circuit Court a petition for rehearing and rehearing en banc, and Lupin filed its responsive brief on November 7, 2007, but the Circuit Court has yet to issue a decision regarding the petition. Invalidation of the ‘722 Patent will likely lead to generic versions of Altace^® entering the market sooner than previously anticipated. The entry of generic products into the market would likely cause the Company’s net sales of Altace^® to decline significantly. For additional information, please see Note 8.

 

Following the Circuit Court’s decision on September 11, 2007, the Company undertook an analysis of its potential effect on future net sales of Altace^®. Based upon that analysis, the Company reduced the estimated remaining useful life of this product and forecasted net sales. This decrease in estimated remaining useful life and forecasted net sales reduced the probability-weighted estimated undiscounted future cash flows associated with the Altace^® intangible assets to a level below their carrying value. Accordingly, the Company recorded an intangible asset impairment charge of $146,444 during the third quarter of 2007 to reflect the estimated fair value of these assets. The Company determined the fair value of these assets based on probability-weighted estimated discounted future cash flows. If the petition for rehearing and rehearing en banc is unsuccessful, the Company’s current estimated probability-weighted cash flows associated with the remaining assets would be further materially adversely affected. In that case, the Company may have to further reduce the estimated remaining useful life and/or take an additional charge against a portion or all of the value of the remaining intangible assets.

 

During the second quarter of 2007, the Company made the decision to no longer pursue the development of a new formulation of Intal^® utilizing hydroflouroalkane as a propellant. As a result, the Company lowered its future sales forecast for this product in the second quarter of 2007 and decreased the estimated remaining useful life of the product. This decrease reduced the estimated undiscounted future cash flows associated with the Intal^® and Tilade^® intangible assets to a level below their carrying value. Accordingly, the Company recorded an intangible asset impairment charge of $29,259 during the second quarter of 2007 to adjust the carrying value of Intal^® and Tilade^® intangible assets on the Company’s balance sheet to reflect the estimated fair value of these assets. The Company determined the fair value of the intangible assets associated with Intal^® and Tilade^® based on estimated discounted future cash flows.

 

Altace^®, Intal^® and Tilade^® are included in the Company’s branded pharmaceuticals reporting segment.

 

As of September 30, 2007, the net intangible assets associated with Synercid^® totaled approximately $78,743. The Company believes that these intangible assets are not currently impaired based on estimated undiscounted cash flows associated with these assets. However, if the Company’s current estimates regarding future cash flows adversely change, the Company may have to reduce the estimated remaining useful life and/or write off a portion or all of these intangible assets.

 

Goodwill at September 30, 2007 and December 31, 2006 is as follows:

 

 

 

On July 14, 2007, the Company entered into an asset purchase agreement with JHP, pursuant to which JHP acquired the Company’s Rochester, Michigan sterile manufacturing facility, some of the Company’s legacy products that are manufactured there, and the related contract manufacturing business. The Company

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

retained its Bicillin^® (sterile penicillin products) manufacturing facility which is also located in Rochester Michigan.

 

The companies closed the transaction on October 1, 2007. JHP paid the Company $91,524, subject to final inventory adjustments. In addition, the Company incurred fees of approximately $5,341 related to the transaction. The companies also entered into a manufacturing and supply agreement pursuant to which JHP will provide certain fill and finish manufacturing activities with respect to the Company’s hemostatic product Thrombin-JMI^®.

 

As of September 30, 2007, the Company’s Rochester, Michigan sterile manufacturing facility and certain legacy branded pharmaceutical products were classified as held for sale. As a result, the Company recorded charges of $1,394 and $45,551 in the third and second quarters of 2007, respectively, based on the assets’ estimated fair value less cost to sell.

 

The assets classified as held for sale consist of the following:

 

 

 

Long-term debt consists of the following:

 

 

 

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

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 multi-district litigation (“MDL”) court has been established in Philadelphia, 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, is a defendant in approximately 90 multi-plaintiff (approximately 1,400 plaintiffs) lawsuits involving the manufacture and sale of dexfenfluramine, fenfluramine and phentermine. These lawsuits have been 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”), is 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 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.

 

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 many of these cases. As a result of these settlements, King Research and Development has routinely received voluntarily 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 many of these complaints are multi-party suits and do not state specific damage amounts. Rather, these claims

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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.

 

In addition, the Company is one of many defendants in six multi-plaintiff lawsuits that claim damages for personal injury arising from its production of the anorexigenic drug phentermine under contract for GlaxoSmithKline. While the Company cannot predict the outcome of these suits, the Company believes that the claims against it are without merit and the Company intends to pursue all defenses available to it. The Company is being indemnified in the six lawsuits by GlaxoSmithKline, for which the Company manufactured the anorexigenic product, provided that neither the lawsuits nor the associated liabilities are based upon the Company’s independent negligence or intentional acts. The Company intends to submit a claim for any unreimbursed costs to its product liability insurance carrier. However, in the event that GlaxoSmithKline is unable to satisfy or fulfill its obligations under the indemnity, 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. A reasonable estimate of possible losses related to these suits cannot be made.

 

Thimerosal / Children’s Vaccine Litigation

 

The Company and Parkedale Pharmaceuticals, Inc., a wholly-owned subsidiary of the Company (“Parkedale”), were named as defendants in lawsuits filed in California, Mississippi and Illinois (Madison County), along with other pharmaceutical companies. The first of these lawsuits was filed in November 2001. Most of the defendants manufactured or sold the mercury-based preservative thimerosal or manufactured or sold children’s vaccines containing thimerosal. The Company did not manufacture or sell thimerosal or a children’s vaccine that contained thimerosal. For two years the Company did manufacture and sell an influenza vaccine that contained thimerosal. None of the plaintiffs alleged taking the Company’s influenza vaccine.

 

All claims against the Company and Parkedale in the children’s vaccine litigation have been voluntarily dismissed without prejudice due, among other matters, to lack of product identification. These claims were dismissed without the payment of any settlement proceeds. Although these claims could be filed again, the Company does not believe that re-filing is likely.

 

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 800 plaintiffs, but most of those claims were voluntarily dismissed or dismissed by the Court for lack of product identification. These remaining 22 lawsuits were filed in Alabama, Arkansas, Missouri, Pennsylvania, Ohio, Florida, Maryland, Mississippi and Minnesota. A federal multidistrict litigation court (“MDL”) has been established in Little Rock, Arkansas, 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 and Pfizer. The MDL trials against Wyeth have resulted in verdicts for Wyeth. The Philadelphia trials have resulted in one verdict for and several verdicts adverse to Wyeth, all of which have been set aside based on post-trial motions,

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

except for one plaintiff’s verdict which is on appeal. Wyeth recently lost a large verdict in Nevada but the status of that verdict has not been fully determined. Pfizer’s only trial, in Philadelphia, Pennsylvania, resulted in a plaintiff’s verdict. 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.

 

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 United States District Court for the District of Massachusetts has been established as the MDL Court for the case, In re: Pharmaceutical Industry Average Wholesale Pricing Litigation.

 

Since the filing of the New York City case, forty eight New York counties have filed lawsuits against the pharmaceutical industry, including the Company and Monarch. All of these lawsuits are currently pending in the MDL Court in the District of Massachusetts except for the Erie, Oswego and Schenectady cases, which were removed in October 2006 and remanded to State Court in September 2007. The allegations in all of these cases are virtually the same as the allegations in the New York City case. A First Amended Consolidated Complaint was filed for most of the New York counties. Motions to dismiss were granted in part and denied in part for all defendants in all New York City and County cases pending in the MDL. 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.

 

In January 2005, the State of Alabama filed a lawsuit in State Court 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 did require an amended complaint to be filed. The Company filed an answer and counter-claim for return of rebates overpaid to the State. Alabama filed a motion to dismiss the counter-claim which was granted. The Company perfected its appeal of that ruling. Briefing in the appeal to the Alabama Supreme Court is complete. No oral argument date has been set. In a separate appeal of a motion to sever denied by the Court, the Alabama Supreme Court severed all defendants into single-defendant cases. The Trial Court consolidated AstraZeneca International, Novartis Pharmaceuticals and SmithKline Beecham Corporation for trial set to begin on February 11, 2008. The Company and Monarch have requested a stay pending their appeal.

 

In October 2005, the State of Mississippi filed a lawsuit in State Court against the Company, Monarch and eighty-four other defendants and alleged fourteen causes of action. Many of those causes of action allege that all defendants fraudulently inflated the AWPs and wholesale acquisition costs (“WACs”) of their products. A motion to dismiss the criminal statute counts and a motion for more definite statement were granted. Mississippi was required to file an amended complaint and in doing so dismissed the Company and Monarch from the lawsuit without prejudice. These claims could be refiled.

 

A co-defendant removed the Alabama and Mississippi cases to Federal Court on October 11, 2006. The Alabama case was remanded to State Court on November 2, 2006. The Mississippi case was remanded to State Court on September 17, 2007. Discovery is proceeding in the Alabama case and has begun in New York.

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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 recently filed. The Company has not been served with the Iowa complaint. The relief sought in all of these state cases is similar to the relief sought in the New York City lawsuit. The Company does not expect any of its trials to be set in the next year. 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, if any.

 

Settlement of Governmental Pricing Investigation

 

As previously reported, during the first quarter of 2006, the Company paid approximately $129,268, comprising (i) all amounts due under each of the settlement agreements resolving the governmental investigations related to the Company’s underpayment of rebates owed to Medicaid and other governmental pricing programs during the period from 1994 to 2002 (the “Settlement Agreements”) and (ii) all the Company’s obligations to reimburse other parties for expenses related to the settlement, including the previously disclosed legal fees of approximately $787 and the previously disclosed settlement costs of approximately $950.

 

The individual purportedly acting as a “relator” under the False Claims Act has appealed certain decisions of the District Court denying the relator’s request to be compensated out of the approximately $31,000 that was paid by the Company to those states that do not have legislation providing for a “relator’s share.” The purported relator asserted for the first time on appeal that the Company should be responsible for making such a payment to this individual. Oral argument of the appeal before the United States Court of Appeals for the Third Circuit was heard on May 8, 2007. On July 16, 2007, the Court of Appeals affirmed the District Court’s decision in all respects, and denied the relator’s assertions with respect to the Company. The relator has exercised his limited rights to appeal the Court of Appeals’ decision. The Company believes that the claim against it is without merit and does not expect the result of this appeal or any subsequent appeal to have a material effect on it.

 

In addition to the Settlement Agreements, on October 31, 2005, the Company entered into a five-year corporate integrity agreement with HHS/OIG (the “Corporate Integrity Agreement”) pursuant to which the Company is required, among other things, to keep in place the Company’s current compliance program, to provide periodic reports to HHS/OIG and to submit to audits relating to the Company’s Medicaid rebate calculations.

 

The Settlement Agreements do not resolve any of the previously disclosed civil suits that are pending against the Company and related individuals and entities discussed in the section entitled “Securities and Derivative Litigation” below. The Settlement Agreements have been asserted as defenses to the claims in the Average Wholesale Price litigation discussed above.

 

SEC Investigation

 

As previously reported, the Securities and Exchange Commission (the “SEC”) had also been conducting an investigation relating to the Company’s underpayments to governmental programs and to the Company’s previously disclosed errors relating to reserves for product returns. On October 25, 2007, the Company received a letter from the Staff of the SEC stating that the investigation has been completed, and no enforcement action has been recommended to the SEC. The Staff of the SEC notified the Company of its determination pursuant to the final paragraph of Securities Act Release No. 5310.

 

Securities and Derivative Litigation

 

Subsequent to the announcement of the SEC investigation described above, beginning in March 2003, 22 purported class action complaints were filed by holders of the Company’s securities against the Company, its directors, former directors, executive officers, former executive officers, a Company subsidiary, and a former

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

director of the subsidiary in the United States District Court for the Eastern District of Tennessee, alleging violations of the Securities Act of 1933 and/or the Securities Exchange Act of 1934, in connection with the Company’s underpayment of rebates owed to Medicaid and other governmental pricing programs, and certain transactions between the Company and the Benevolent Fund, a nonprofit organization affiliated with certain former members of the Company’s senior management. These 22 complaints were consolidated in the United States District Court for the Eastern District of Tennessee. In addition, holders of the Company’s securities filed two class action complaints alleging violations of the Securities Act of 1933 in Tennessee State Court. The Company removed these two cases to the United States District Court for the Eastern District of Tennessee, where these two cases were consolidated with the other class actions.

 

In November 2005, the parties agreed to submit the matter to non-binding mediation. After an extensive mediation process, an agreement in principle to settle the litigation was reached on April 26, 2006. On July 31, 2006, the parties entered into a stipulation of settlement and a supplemental agreement (together, the “Settlement Agreement”) to resolve the litigation. On January 9, 2007, the Court granted final approval of the Settlement Agreement. The Settlement Agreement provides for a settlement amount of $38,250 which has been fully funded by the Company’s insurance carriers on the Company’s behalf and placed into an escrow account controlled by the Court.

 

Beginning in March 2003, four purported shareholder derivative complaints were also filed in Tennessee State Court alleging a breach of fiduciary duty, among other things, by some of the Company’s current and former officers and directors, with respect to the same events at issue in the federal securities litigation described above. These cases have been consolidated. In June 2007, plaintiffs filed a motion to amend the complaint, seeking to name as defendants additional current and former officers and directors and the Company’s independent auditor and to add additional claims. Following negotiations among the parties, this motion was granted in part, but it was denied with respect to naming as defendants additional current and former officers and directors of the Company. Trial is scheduled to begin on September 22, 2008. The parties are scheduled to engage in non-binding mediation in December 2007.

 

Beginning in March 2003, three purported shareholder derivative complaints were likewise filed in Tennessee Federal Court, asserting claims similar to those alleged in the state derivative litigation. These cases have been consolidated, and on December 2, 2003 plaintiffs filed a consolidated amended complaint. On March 9, 2004, the Court entered an order indefinitely staying these cases in favor of the state derivative action.

 

During the third quarter of 2006 and the second quarter of 2007, the Company recorded an anticipated insurance recovery of legal fees in the amount of $6,750 and $3,398, respectively, for the class action and derivative suits described above. In November of 2006 and July of 2007, the Company received payment for the recovery of these legal fees.

 

The Company is currently unable to predict the outcome or reasonably estimate the range of potential loss, if any, except as noted above, in the pending litigation. If the Company were not to prevail in the pending litigation, which it cannot predict or reasonably estimate at this time, its business, financial condition, results of operations and cash flows could be materially adversely affected.

 

Other Legal Proceedings

 

Elan Corporation, plc (“Elan”) was working to develop a modified release formulation of Sonata^®, which the Company refers to as Sonata^® MR, pursuant to an agreement the Company had with Elan which the Company refers to as the Sonata^® MR Development Agreement. In early 2005, the Company advised Elan that it considered the Sonata^® MR Development Agreement terminated for failure to satisfy the target product profile required by the Company. Elan disputed the termination and initiated an arbitration proceeding. During December of 2006, the arbitration panel reached a decision in favor of Elan and ordered the Company to pay Elan certain milestone payments and other research and development related expenses of approximately

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

$49,800, plus interest from the date of the decision. The Company recorded approximately $45,100 in the fourth quarter of 2006 and had previously recorded $5,000 in 2004, related to this arbitration. In January 2007, the Company paid Elan approximately $50,100, which included interest of approximately $300.

 

Cobalt Pharmaceuticals, Inc. (“Cobalt”), a generic drug manufacturer located in Mississauga, Ontario, Canada, filed an Abbreviated New Drug Application (“ANDA”) with the U.S. Food and Drug Administration (the “FDA”) seeking permission to market a generic version of Altace^®. The following U.S. patents are listed for Altace^® in the FDA’s Approved Drug Products With Therapeutic Equivalence Evaluations (the “Orange Book”): United States Patent No. 5,061,722 (the “722 patent”), a composition of matter patent, and United States Patent No. 5,403,856 (the “856 patent”), a method-of-use patent, with expiration dates of October 2008 and April 2012, respectively. Under the federal Hatch-Waxman Act of 1984, any generic manufacturer may file an ANDA with a certification (a “Paragraph IV certification”) challenging the validity or infringement of a patent listed in the FDA’s Orange Book four years after the pioneer company obtains approval of its New Drug Application (“NDA”). Cobalt filed a Paragraph IV certification alleging invalidity of the ’722 patent, and Aventis Pharma Deutschland GmbH (“Aventis”) and the Company filed suit on March 14, 2003 in the District Court for the District of Massachusetts to enforce the rights under that patent. Pursuant to the Hatch-Waxman Act, the filing of that suit provided the Company an automatic stay of FDA approval of Cobalt’s ANDA for 30 months (unless the patents are held invalid, unenforceable, or not infringed) from no earlier than February 5, 2003. That 30-month stay expired in August 2005 and on October 24, 2005, the FDA granted final approval of Cobalt’s ANDA. In March 2004, Cobalt stipulated to infringement of the ’722 patent. Subsequent to filing its original complaint, the Company amended its complaint to add an allegation of infringement of the ’856 patent. The ’856 patent covers one of Altace^®’s three indications for use. In response to the amended complaint, Cobalt informed the FDA that it no longer seeks approval to market its proposed product for the indication covered by the ’856 patent. On this basis, the Court granted Cobalt summary judgment of non-infringement of the ’856 patent. The Court’s decision does not affect Cobalt’s infringement of the ’722 patent. The parties submitted a joint stipulation of dismissal on April 4, 2006, and the Court granted dismissal. Pursuant to the dismissal agreement, on October 12, 2007, Cobalt sent the Company 30-day written notice of its intent to launch its generic ramipril product which product would not be supplied by the Company. The Company responded on October 19, 2007, informing Cobalt that the Company intends to vigorously enforce its rights under the ’722 and ’856 patents to the full extent of the law.

 

The Company has received a civil investigative demand (“CID”) for information from the U.S. Federal Trade Commission (“FTC”). The CID requires the Company to provide information related to the Company’s collaboration with Arrow, the dismissal without prejudice of the Company’s patent infringement litigation against Cobalt under the Hatch-Waxman Act of 1984 and other information. The Company is cooperating with the FTC in this investigation.

 

Lupin filed an ANDA with the FDA seeking permission to market a generic version of Altace^® (“Lupin’s ANDA”). In addition to its ANDA, Lupin filed a Paragraph IV certification challenging the validity and infringement of the ’722 patent, and seeking to market its generic version of Altace^® before expiration of the ’722 patent. In July 2005, the Company filed civil actions for infringement of the ’722 patent against Lupin in the U.S. District Courts for the District of Maryland and the Eastern District of Virginia. Pursuant to the Hatch-Waxman Act, the filing of the lawsuit against Lupin provided the Company with an automatic stay of FDA approval of Lupin’s ANDA for up to 30 months (unless the patents are held invalid, unenforceable, or not infringed) from no earlier than June 8, 2005. On February 1, 2006, the Maryland and Virginia cases were consolidated into a single action in the Eastern District of Virginia. On June 5, 2006, the District Court granted King summary judgment and found Lupin to infringe the ’722 patent. On June 14, 2006, during the trial, the District Court dismissed Lupin’s unenforceability claims as a matter of law, finding the ’722 patent enforceable. On July 18, 2006, the District Court upheld the validity of the ’722 patent. Lupin filed a notice of appeal on July 19, 2006. All appellate briefing was completed as of March 19, 2007, and the Circuit Court heard oral arguments on July 12, 2007. On September 11, 2007, the Circuit Court reversed the decision of the

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

District Court and invalidated the Company’s ‘722 patent. The decision applied the recent U.S. Supreme Court decision in KSR International Co. v. Teleflex Inc. to invalidate the patent on the basis of obviousness. The Company has filed with the Circuit Court a petition for rehearing and rehearing en banc. Lupin filed its responsive brief on November 7, 2007. The Circuit Court has not yet issued a decision regarding this petition.

 

Teva Pharmaceuticals USA (“Teva USA”) filed an ANDA with the FDA seeking permission to market a generic version of Altace^®. On October 12, 2007, Teva USA informed the Company that Teva USA had filed a Paragraph IV certification challenging the validity and infringement of the ’722 patent.

 

Dr. Reddy’s Laboratories, Ltd. and Dr. Reddy’s Laboratories, Inc. (collectively, “Dr. Reddy’s”) filed an ANDA with the FDA seeking permission to market a generic version of Altace^®. On October 28, 2007, Dr. Reddy’s informed the Company that Dr. Reddy’s had filed a Paragraph IV certification challenging the validity and infringement of the ’722 Patent.

 

The Company intends to vigorously enforce its rights under the ’722 and ’856 patents. As of September 30, 2007, the Company had net intangible assets related to Altace^® of $59,375. If the Company’s petition for rehearing and rehearing en banc is unsuccessful and a generic version of Altace^® enters the market, the Company may have to write off a portion or all of the remaining intangible assets associated with this product, and the Company’s business, financial condition, results of operations and cash flows could otherwise be materially adversely affected.

 

Eon Labs, Inc. (“Eon Labs”), CorePharma, LLC (“CorePharma”) and Mutual Pharmaceutical Co., Inc. (“Mutual”) have each filed an ANDA with the 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, and are alleging noninfringement, invalidity and unenforceability of those patents. Mutual has filed a Paragraph IV certification against the ’102 patent alleging noninfringement and invalidity of that patent. A patent infringement suit was filed against Eon Labs on January 2, 2003 in the District Court for the Eastern District of New York; against CorePharma on March 7, 2003 in the District Court for the District of New Jersey (subsequently transferred to the District Court for the Eastern District of New York); and against Mutual on March 12, 2004 in the 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 District Court for the Eastern District of New York, concerning its proposed 800 mg Skelaxin^® product.

 

Pursuant to the Hatch-Waxman Act, the filing of the suit against CorePharma triggered an automatic stay of FDA approval of CorePharma’s ANDA for 30 months (unless the patents are held invalid, unenforceable, or not infringed) from no earlier than January 24, 2003. Also 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. The 30-month stay of FDA approval for Eon Labs’ 800 mg product was tolled by the Court and has not expired yet. The Court has reserved judgment on the length of the tolling period. On May 17, 2006, the 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 District Court for the Eastern District of New York consolidated the Eon Labs cases with the CorePharma case. 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. The Court also set a briefing schedule in the CorePharma case for the Company’s motion to dismiss for lack of case or controversy and for a CorePharma motion for summary

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

judgment of non-infringement. The motions were fully briefed by July 2007. On August 27, 2007, Eon also served a motion for summary judgment on the issue of non-infringement. The Court set a briefing schedule contingent on its decision in the CorePharma case. The Court heard oral arguments on September 11, 2007 on these motions, but reserved judgment and has yet to issue any decisions. The Company intends to vigorously enforce its rights under the ’128 and ’102 patents to the full extent of the law.

 

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 metaxalone 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 have 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. On July 27, 2007, Mutual filed another Citizen Petition in which it seeks a determination that Skelaxin^® labeling should be revised to reflect the previously submitted data in its earlier submissions.

 

If the Company’s Amended Citizen Petition is rejected, there is a substantial likelihood that a generic version of Skelaxin^® will enter the market, and the Company’s business, financial condition, results of operations and cash flows could be materially adversely affected. As of September 30, 2007, the Company had net intangible assets related to Skelaxin^® of $143,175. If demand for Skelaxin^® declines below current expectations, the Company may have to write off a portion or all of these intangible assets.

 

The Company has entered into an agreement with a generic pharmaceutical company to launch an authorized generic version of Skelaxin^® in the event the Company faces generic competition for Skelaxin^®. However, the Company cannot provide any assurance regarding the extent to which this strategy will be successful, if at all.

 

Actavis, Inc. (“Actavis”) filed an ANDA with the FDA, seeking permission to market a generic version of Avinza^®. U.S. Patent No. 6,066,339 (the “339 patent”), a composition of matter patent relating to Avinza^® that is listed in the Orange Book that expires on November 25, 2017. Actavis filed a paragraph IV certification challenging the validity and infringement of the ’339 patent, and the Company and Elan Pharma International LTD, the owner of the ’339 patent, filed suit on October 18, 2007 in the United States District Court for the District of New Jersey to enforce 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.

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The Company intends to vigorously enforce its rights under the ’339 patent to the full extent of the law. As of September 30, 2007, the Company had net intangible assets related to Avinza^® of $285,700. If a generic form of Avinza^® enters the market, 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.

 

Sicor Pharmaceuticals, Inc. (“Sicor Pharma”), a generic drug manufacturer located in Irvine California, filed an ANDA with the FDA seeking permission to market a generic version of Adenoscan^®. U.S. Patent No. 5,070,877 (the “877 patent”), a method-of-use patent with an expiration date of May 2009, is assigned to the Company and listed in the FDA’s Orange Book entry for Adenoscan^®. Astellas Pharma US, Inc. (“Astellas”) is the exclusive licensee of certain rights under the ’877 patent and has marketed Adenoscan^® in the U.S. since 1995. A substantial portion of the Company’s revenues from its royalties segment is derived from Astellas based on its net sales of Adenoscan^®. Sicor Pharma has filed a Paragraph IV certification alleging invalidity of the ’877 patent and non-infringement of certain claims of the ’877 patent. The Company and Astellas filed suit against Sicor Pharma and its parents/affiliates Sicor, Inc., Teva Pharmaceuticals USA, Inc. (“Teva”) and Teva Pharmaceutical Industries, Ltd., on May 26, 2005 in the United States District Court for the District of Delaware to enforce their rights under the ’877 patent. Pursuant to the Hatch-Waxman Act, the filing of that suit provided the Company an automatic stay of FDA approval of Sicor Pharma’s ANDA for 30 months (unless the patents are held invalid, unenforceable, or not infringed) from no earlier than April 16, 2005. On May 16, 2006, Sicor Pharma stipulated to infringement of the asserted claims of the ’877 patent. Trial in this action began on February 12, 2007 and concluded on February 28, 2007. Post-trial briefing concluded in June 2007. The Company intends to vigorously enforce its rights under the ’877 patent. Sicor is also involved in litigation with Item Development AB regarding U.S. Patent No. 5,731,296 (the “296 patent”), a method-of-use patent with an expiration date of March 2015, which is also listed in the Orange Book for Adenoscan^®. Trial of the ’296 patent occurred simultaneously with the ’877 patent. Post-trial briefing for the ’296 patent trial followed the same schedule as the ’877 patent trial. On August 31, 2007, the parties entered into an agreement to allow Sicor to launch their generic version of Adenoscan^® pursuant to a license in September 2012, or earlier under certain conditions. The parties also agreed to terminate both litigations. The agreement was subject to a 45-day review by the FTC and Department of Justice. That period ended October 20, 2007. On October 22, 2007, the parties submitted a stipulated entry of consent judgment to the Court, and on October 29, 2007 the consent judgement was entered and the cases were closed.

 

Teva filed an ANDA with the FDA seeking permission to market a generic version of Sonata^®. In addition to its ANDA, Teva filed a Paragraph IV certification challenging the enforceability of U.S. Patent 4,626,538 (the “538 patent”) listed in the Orange Book, a composition of matter patent which expires in June 2008. In August 2005, King filed suit against Teva in the United States District Court for the District of New Jersey to enforce its rights under the ’538 patent. Pursuant to the Hatch-Waxman Act, the filing of that suit provided the Company an automatic stay of FDA approval of Teva’s ANDA for 30 months (unless the patents are held invalid, unenforceable, or not infringed) from no earlier than June 21, 2005. On September 25, 2006, the parties filed a stipulation with the Court in which Teva admitted infringement of the ’538 patent. In October 2006, Teva filed a summary judgment motion on the grounds that the ’538 patent is unenforceable due to breach in the common ownership requirement for terminally disclaimed patents. The Company filed its opposition brief in November 2006. Oral argument was heard on January 10, 2007, and the Court subsequently denied Teva’s summary judgment motion. The Company has filed a motion for summary judgment to dispose of the case, and Teva filed a cross-motion for summary judgment. The Court granted the Company’s motion and denied Teva’s cross-motion on August 3, 2007. On August 14, 2007, judgment was entered declaring the validity of the ’538 patent and enjoining Teva from entering the market prior to the expiration of the ’538 patent. The parties entered into an agreement whereby the Company agreed not to pursue attorneys’ fees and Teva agreed not to appeal the decision.

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

In addition to the matters discussed above, the Company is involved in various other legal proceedings incident to the ordinary course of its business. The Company does not believe that unfavorable outcomes as a result of these other legal proceedings would have a material adverse effect on its financial position, results of operations and cash flows.

 

Other Contingencies

 

The Company has a supply agreement with a third party to produce ramipril, the active ingredient in Altace^®. This supply agreement requires the Company to purchase certain minimum levels of ramipril as long as the Company maintains market exclusivity for Altace^® in the United States, and thereafter the parties must negotiate in good faith the annual minimum purchase quantities. On September 11, 2007, the Circuit Court declared invalid the ’722 Patent that covers the Company’s Altace^® product, overruling the decision of the District Court, which had upheld the validity of the patent. The Company has filed with the Circuit Court a petition for rehearing and rehearing en banc, and Lupin filed its responsive brief on November 7, 2007, but the Circuit Court has yet to issue a decision regarding the petition. Invalidation of the ’722 Patent will likely lead to generic versions of Altace^® entering the market sooner than previously anticipated. The entry of generic products into the market would likely cause the Company’s net sales of Altace^® to decline significantly. Following the Circuit Court’s decision on September 11, 2007, the Company undertook an analysis of its potential effect on future net sales of Altace^®. Based upon that analysis, the Company concluded that it has more Altace^® raw material inventory than is required to meet anticipated future demand for the product. As a result, the Company recorded a charge of $24,794 for the Company’s estimated remaining minimum purchase requirements for excess Altace^® raw material associated with this supply agreement. This charge is included in cost of revenues, exclusive of depreciation, amortization and impairments on the Condensed Consolidated Statements of Operations. For additional information please see Note 3.

 

Because the Company’s analysis of the potential effect of the Circuit Court’s decision includes probability-weighted estimated future demand for Altace^®, the Company could incur additional material charges, in the near term, if events, such as the failure of its petition for rehearing, occur that cause the Company to reduce its probability-weighted estimate of future demand for Altace^®. These charges would be associated with minimum purchase requirements under the supply agreement to purchase raw material inventory associated with Altace^®.

 

The Company has supply agreements with two third parties to produce metaxalone, the active ingredient in Skelaxin^®. These supply agreements require the Company to purchase certain minimum levels of mataxalone and expire in 2008 and 2010. If sales of Skelaxin^® are not consistent with current forecasts, the Company could incur losses in connection with purchase commitments for metaxalone, which could have a material adverse effect upon the Company’s results of operations and cash flows.

 

 

Effective January 1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 is an interpretation of FASB Statement No. 109, Accounting for Income Taxes, that seeks to reduce the variability in practice associated with measurement and recognition of tax benefits. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position that an entity takes or expects to take in a tax return. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Under FIN 48, an entity may only recognize or continue to recognize tax positions that meet a “more likely than not” threshold. The Company recorded the cumulative effect of applying FIN 48 of $1,523 as a reduction to the opening balance of retained earnings. The total net liability under FIN 48 as of January 1, 2007 was $34,152. See Note 10, “Income Taxes,” for additional information.

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”). This statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is in the process of evaluating the effect of SFAS No. 157 on its financial statements and is planning to adopt this standard in the first quarter of 2008.

 

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the effect of SFAS No. 159 on its financial statements and is planning to adopt this standard in the first quarter of 2008.

 

In June 2007, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities (“Issue 07-3”). Issue 07-3 addresses nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities and requires these payments be deferred and capitalized. Under Issue 07-03, expense will be recognized as the related goods are delivered or the related services are performed. Issue 07-03 is effective for financial statements issued for fiscal years beginning after December 15, 2007 and is applied prospectively for new contracts entered into on or after the effective date. The Company is in the process of evaluating the effect of Issue 07-3 on its financial statements and is planning to adopt this standard in the first quarter of 2008.

 

 

The Company’s effective income tax rate varied from the statutory rate for the three and nine months ended September 30, 2007 primarily due to tax benefits related to tax-exempt interest income, research and experimentation tax credits and domestic production activities deductions, which benefits were partially offset by state taxes. Additionally, the 2007 effective income tax rate benefited from the release of reserves under FIN 48 as a result of the closing of the federal statute of limitations for the 2003 tax year. The Company’s effective tax rate varied from the statutory rate for the three and nine months ended September 30, 2006 primarily due to tax benefits related to charitable contributions of inventory, tax-exempt interest income, and domestic production activities deductions, which benefits were partially offset by state taxes.

 

The Company adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, the Company recorded a $1,523 increase to the net liability for unrecognized tax positions, which was recorded as a reduction to the opening balance of retained earnings as of January 1, 2007. The total liability recorded under FIN 48, as of January 1, 2007, was $34,152, net of federal tax benefits, including interest and penalties of $3,147 and $2,702, respectively.

 

As of September 30, 2007, the total liability recorded under FIN 48 was $35,229, net of federal tax benefits. The total amount of unrecognized tax benefits as of September 30, 2007, was $27,874, all of which would benefit the effective tax rate if recognized. In accordance with its accounting policy, the Company recognizes accrued interest and penalties related to unrecognized tax benefits as a component of tax expense. The Company’s Condensed Consolidated Balance Sheet as of September 30, 2007 includes interest and penalties of $4,476 and $2,879, respectively.

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Included in the balance of unrecognized tax benefits at September 30, 2007, was $4,225 related to tax positions for which it is reasonably possible that the total amounts could significantly change during the next twelve months. This amount is comprised primarily of items related to expiring statutes.

 

As of September 30, 2007, the Company is subject to U.S. Federal income tax examinations for the tax years 2004 through 2006, and to non-U.S. income tax examinations for the tax years of 2002 through 2006. In addition, the Company is subject to state and local income tax examinations for the tax years 2002 through 2006.

 

 

The Company’s business is classified into five reportable segments: branded pharmaceuticals, Meridian Medical Technologies (“Meridian”), royalties, contract manufacturing and other. Branded pharmaceuticals includes a variety of branded prescription products that are separately categorized into four therapeutic areas: cardiovascular/metabolic, neuroscience, hospital/acute care, and other. These branded prescription products are aggregated because of the similarity in regulatory environment, manufacturing processes, methods of distribution, and types of customer. Meridian develops, manufactures, and sells to both commercial and government markets pharmaceutical products that are administered with an auto-injector. 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 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. Contract manufacturing primarily includes pharmaceutical manufacturing services the Company provides to third-party pharmaceutical and biotechnology companies. Royalties include 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, segment profit (excluding depreciation and amortization) and total assets. Revenues among the segments are presented in the individual segments and removed through eliminations in the information below. Substantially all of the eliminations relate to sales from the contract manufacturing segment to the branded pharmaceuticals segment. The Company’s revenues are substantially all derived from activities within the United States and Puerto Rico. The Company’s assets are substantially all located within the United States and Puerto Rico.

 

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 pharmaceutical revenues by therapeutic area:

 

 

 

On September 11, 2007, the Circuit Court declared invalid the ‘722 Patent that covers the Company’s Altace^® product, overruling the decision of the District Court, which had upheld the validity of the patent. The Company has filed with the Circuit Court a petition for rehearing and rehearing en banc, and Lupin filed its responsive brief on November 7, 2007, but the Circuit Court has yet to issue a decision regarding the petition. Invalidation of the ‘722 Patent will likely lead to generic versions of Altace^® entering the market sooner than previously anticipated. The entry of generic products into the market would likely cause the Company’s net sales of Altace^® to decline significantly.

 

Following the Circuit Court’s decision, the Company developed a restructuring initiative designed to accelerate a planned strategic shift emphasizing its focus in neuroscience, hospital and acute care medicine. This initiative includes a reduction in personnel, staff leverage, expense reductions and additional controls over spending, reorganization of sales teams and a realignment of research and development priorities.

 

The Company estimates that it will incur total costs of approximately $70,000 associated with this initiative, including approximately $67,000 in restructuring charges, $1,000 in accelerated depreciation associated with general support assets and approximately $2,000 for implementation costs of reorganizing the sales teams.

 

The restructuring charges include employee termination costs associated with a workforce reduction of approximately 530 employees, including 440 people in our sales force. Restructuring charges also include contract termination costs, including the termination of the promotion agreement for Glumetza^tm discussed below, and other exit costs associated with this initiative.

 

During the third quarter of 2007, the Company recorded employee termination costs of approximately $15,655 and expects to incur additional employee termination costs of approximately $20,000 in the fourth quarter of 2007. Additionally, the Company expects to incur other exit costs of less than $2,000 in the fourth quarter of 2007 associated with this restructuring initiative. Substantially all of the employee termination costs and other exit costs are expected to be paid by the end of the first quarter of 2008.

 

On October 29, 2007, the Company and Depomed, Inc. announced the termination of their promotion agreement for Glumetza^tm. As a result, the Company will incur contract termination costs and other fees of approximately $30,000 in the fourth quarter of 2007, which were paid in October 2007. Under the terms of the termination agreement, the Company will fulfill its promotion obligations through the end of 2007 and Depomed, Inc. will not pay the Company a promotion fee for the fourth quarter of 2007.

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The implementation costs associated with reorganization of sales teams is expected to be incurred in the fourth quarter of 2007 and will be reported in selling, general and administrative, exclusive of co-promotion fees.

 

In July 2007, the Company entered into an asset purchase agreement with JHP, pursuant to which JHP acquired the Company’s Rochester, Michigan sterile manufacturing facility, some of the Company’s legacy products that are manufactured there, and the related contract manufacturing business. As a result of this sale, the Company incurred $4,619 in the third quarter of 2007 for employee termination costs upon notification of the sale to the approximately 300 affected employees. The Company accrued employee separation payments which are expected to be substantially paid during the fourth quarter of 2007. This transaction closed on October 1, 2007. For more information, please see Note 4.

 

During 2006, the Company decided to streamline 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 by the end of 2008. As a result of these steps, the Company expects to incur restructuring charges totaling approximately $13,000 through the end of 2008, of which approximately $11,000 is associated with accelerated depreciation and approximately $2,000 is associated with employee termination costs. The employee termination costs are expected to be paid by the end of 2008.

 

The types of costs accrued and incurred are summarized below:

 

 

 

 

The restructuring charges in 2007 primarily relate to the branded pharmaceutical segment.

 

 

As of December 31, 2006, the Company’s investment in Palatin Technologies, Inc. (“Palatin”) common stock had a cost basis of $12,242 and there were cumulative unrealized holding losses of $664. During the third quarter 2007, the Company determined that an other than temporary impairment had occurred on this investment and recorded a charge of $9,972, resulting in a cost basis of $2,270 as of September 30, 2007. The Company also recorded an other than temporary impairment of $481 on its investment in warrants to purchase Palatin common stock.

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

During the third quarter of 2007, under its Incentive Plan, the Company granted to employees 158,500 RSAs, and 9,000 nonqualified stock options.

 

During the second quarter of 2007, under its Incentive Plan, the Company granted to employees 175,600 RSAs, 5,400 LPUs with a three year performance cycle and 17,500 nonqualified stock options. In addition, the Company granted 41,069 Restricted Stock Units (“RSUs”) to non-employee directors.

 

During the first quarter of 2007, under its Incentive Plan, the Company granted to employees 179,210 RSAs, 655,840 LPUs with a one year performance cycle, 158,610 LPUs with a three year performance cycle and 352,510 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 over 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.

 

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 2007 operating targets. LPUs with a three-year performance cycle will be earned based on market-related performance targets over the years 2007 through 2009. At the end of the applicable performance period, the number of shares of common stock awarded is determined by adjusting upward or downward from the performance target in a range between 0% and 200%. 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.

 

 

The Company’s calculation of its product returns reserves is based on historical sales and return rates over the period during which customers have a right of return. The Company also considers current wholesale inventory levels of the Company’s products. Because actual returns related to sales in prior periods were lower than the Company’s original estimates, it recorded a decrease in its reserve for returns in each of the first quarter of 2007 and the first quarter of 2006. During the first quarter of 2007, the Company decreased its reserve for returns by approximately $8,000 and increased its net sales from branded pharmaceuticals, excluding the adjustment to sales classified as discontinued operations, by the same amount. The effect of the change in estimate on first quarter 2007 operating income was an increase of approximately $5,000. During the first quarter of 2006, the Company decreased its reserve for returns by approximately $8,000 and increased its net sales from branded pharmaceuticals, excluding the adjustment to sales classified as discontinued operations, by the same amount. The effect of the change in estimate on first quarter 2006 operating income was an increase of approximately $6,000.

 

During the third quarter of 2006, the Company reduced its rebate expense and increased net sales from branded pharmaceutical products by approximately $9,300 due to the determination that a liability established in 2005 for a government pricing program for military dependents and retirees was no longer probable.

 

KING PHARMACEUTICALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

On March 30, 2004, the Company’s Board of Directors approved management’s decision to market for divestiture some of the Company’s women’s health products. On November 22, 2004, the Company sold all of its rights in Prefest^® for approximately $15,000. On December 23, 2004, the Company sold all of its rights in Nordette^® for approximately $12,000.

 

The Prefest^® and Nordette^® product rights had identifiable cash flows that were largely independent of the cash flows of other groups of assets and liabilities and are classified as discontinued operations in the accompanying financial statements. Prefest^® and Nordette^® were formerly included in the Company’s branded pharmaceuticals segment.

 

Summarized financial information for the discontinued operations is as follows:

 

 

Discontinued operations during 2007 and 2006 are primarily due to changes in estimated reserves for returns and rebates.

 

 

On April 23, 2002, the Company established a $400,000 five-year Senior Secured Revolving Credit Facility which was scheduled to mature in April 2007 (the “2002 Credit Facility”). On April 19, 2007, this facility was terminated and replaced with a new $475,000 five-year Senior Secured Revolving Credit Facility which matures in April 2012 (the “2007 Credit Facility”).

 

Each of the Company’s subsidiaries, except Monarch Pharmaceuticals Ireland Limited (the “Guarantor Subsidiaries”), guaranteed on a full, unconditional and joint and several basis the Company’s performance under the $400,000 aggregate principal amount of the Notes and under the 2002 Credit Facility on a joint and several basis.

 

Four of the Guarantor Subsidiaries, King Pharmaceuticals Research and Development, Inc., Monarch Pharmaceuticals, Inc., Meridian Medical Technologies, Inc., and Parkedale Pharmaceuticals, Inc., have guaranteed on a full, unconditional and joint and several basis the Company’s performance under the 2007 Credit Facility.

 

There are no restrictions under the Company’s current financing arrangements, and there were no restrictions under the 2002 Credit Facility, 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 Notes and the 2002 Credit Facility (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