UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

Form 10-K

 

 

 

Commission File Number 001-15875

 

King Pharmaceuticals, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code: (423) 989-8000

 

Securities registered under Section 12(b) of the Exchange Act:

 

 

 

 

Securities registered under Section 12(g) of the Exchange Act:
None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of ‘‘large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of June 30, 2007 was $4,980,295,452. The number of shares of Common Stock, no par value, outstanding at February 26, 2008 was 246,050,574.

 

Documents Incorporated by Reference:
Certain information required in Part III of this Annual Report on Form 10-K is incorporated
by reference from the registrant’s Proxy Statement for its 2008 annual meeting of shareholders.

 

 

Table of Contents

 

 

 

King Pharmaceuticals, Inc. was incorporated in the State of Tennessee in 1993. Our wholly owned subsidiaries are Monarch Pharmaceuticals, Inc.; King Pharmaceuticals Research and Development, Inc.; Meridian Medical Technologies, Inc.; Parkedale Pharmaceuticals, Inc.; King Pharmaceuticals Canada Inc.; and Monarch Pharmaceuticals Ireland Limited.

 

Our principal executive offices are located at 501 Fifth Street, Bristol, Tennessee 37620. Our telephone number is (423) 989-8000 and our facsimile number is (423) 274-8677. Our website is www.kingpharm.com where you may view our Corporate Code of Conduct and Ethics (“Code”). To the extent permitted by U.S. Securities and Exchange Commission (“SEC”) and New York Stock Exchange (“NYSE”) regulations, we intend to disclose information as to any amendments to the Code and any waivers from provisions of the Code for our principal executive officer, principal financial officer, and certain other officers by posting the information on our website, to the extent such matters arise. We make available through our website, free of charge, our annual reports on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments, as well as other documents, as soon as reasonably practicable after their filing with the SEC. These filings are also available to the public through the Internet at the website of the SEC, at www.sec.gov. You may also read and copy any document that we file at the SEC’s Public Reference Room located at 100 F Street, NE, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room.

 

Our Chief Executive Officer, Brian A. Markison, submitted to the NYSE an Annual Chief Executive Officer Certification on June 12, 2007, pursuant to Section 303A.12 of the NYSE’s listing standards, certifying that he was not aware of any violation by King of the NYSE’s corporate governance listing standards as of that date.

 

King is a vertically integrated pharmaceutical company that performs basic research and develops, manufactures, markets and sells branded prescription pharmaceutical products. By “vertically integrated,” we mean that we have the following capabilities:

 

 

Through our national sales force we market our branded prescription pharmaceutical products to general/family practitioners, internal medicine physicians, neurologists, pain specialists, surgeons and hospitals across the United States and in Puerto Rico. Branded pharmaceutical products are innovative products sold under a brand name that enjoy, or previously enjoyed, some degree of market exclusivity.

 

Our corporate strategy is focused on target, specialty-driven markets, particularly neuroscience, hospital and acute care. We believe each of these target markets has significant market potential and our organization is aligned accordingly.

 

Under our corporate strategy we work to achieve organic growth by maximizing the potential of our currently marketed products through sales and marketing and prudent product life-cycle management. By “product life-cycle management,” we mean the extension of the economic life of a product, including seeking and gaining necessary related governmental approvals, by such means as:

 

 

 

Our strategy also focuses on growth through the acquisition of novel branded pharmaceutical products in various stages of development and the acquisition of pharmaceutical technologies, particularly those products and technologies that we believe have significant market potential and complement our neuroscience, hospital and acute care medicine platforms. Using our internal resources and a disciplined business development process, we strive to be a leader and partner of choice in developing and commercializing innovative, clinically-differentiated therapies and technologies in our target, specialty-driven markets. We may also seek company acquisitions that add products or products in development, technologies or sales and marketing capabilities to our existing platforms or that otherwise complement our operations. We also work to achieve organic growth by continuing to develop investigational drugs, as we have a strong commitment to research and development and advancing the products and technologies in our development pipeline.

 

Business Segments

 

Our branded pharmaceutical products are divided into the following categories:

 

 

Our Meridian Auto-Injector segment consists of EpiPen^® and nerve gas antidotes which we provide to the U.S. Military. Royalties, another of our business segments, are derived from products we successfully developed and have licensed to third parties.

 

The following table summarizes net revenues by operating segment (in thousands), almost all of which are derived from activities within the United States.

 

 

For information regarding profit and loss and total assets associated with each segment, see Note 20, “Segment Information” in Part IV, Item 15(a)(1) “Exhibits and Financial Statement Schedules.”

 

Recent Developments

 

Accelerated Strategic Shift

 

Following the Circuit Court’s decision in September 2007 invalidating our Altace^® patent, our senior management team conducted an extensive examination of our company and developed a restructuring initiative designed to accelerate a previously planned strategic shift emphasizing our focus on neuroscience, hospital and acute care markets. This initiative included 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. Pursuant to this initiative, we terminated approximately 20% of our workforce, primarily through a reduction in our sales force.

New Generic Competition

 

In December 2007, a third party entered the market with a generic substitute for our Altace^® capsules. This followed the decision of the U.S. Circuit Court of Appeals for the Federal Circuit (the “Circuit Court”) in September 2007 which declared invalid U.S. Patent No. 5,061,722 (the “722 Patent”) that covered our 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. We filed with the Circuit Court a petition for rehearing and rehearing en banc, but this petition was denied in December 2007. As a result of the entry of a generic substitute, our sales of Altace^® have begun to decline. We launched a tablet formulation of Altace^® in February 2008.

 

In January 2008, we entered into an agreement with CorePharma, LLC (“CorePharma”) granting CorePharma a license to launch an authorized generic version of Skelaxin^® in December 2012, or earlier under certain conditions.

 

New Branded^® Competition

 

Beginning in 2008, Thrombin-JMI^®, our bovine thrombin product, has new competition from recombinant human thrombin and human thrombin. Omrix Biopharmaceuticals, Inc.’s Biologics Licensing Application (“BLA”) for its human thrombin product was approved in September 2007. Zymogenetics, Inc. received approval of its BLA for recombinant human thrombin in January 2008. The presence of these competing products in the marketplace may reduce net sales of Thrombin-JMI^® materially.

 

Clinical Trial Results

 

In December 2007, we, together with Pain Therapeutics Inc., announced positive results from the pivotal Phase III clinical trial for Remoxy^tm. The Phase III trial was conducted in accordance with a Special Protocol Assessment (“SPA”) from the FDA. The top-line data indicates that the Phase III trial achieved a statistically significant result in its primary endpoint, defined by the SPA as a mean decrease in pain intensity scores during the 12-week treatment period. In addition, the Phase III trial achieved statistically significant results in secondary endpoints. Remoxy^tm, an investigational novel formulation of extended release, long-acting oxycodone for moderate to severe pain, is designed to resist common methods of abuse, such as crushing, heating, or dissolution in alcohol, that are reported with respect to other long-acting opioids.

 

We entered into a series of agreements with Pain Therapeutics in November 2005 to develop and commercialize Remoxy^tm and other extended release, long-acting opioid painkillers that resist common methods of abuse. We have worldwide exclusive rights to commercialize Remoxy^tm and the other abuse-resistant opioid drugs that are developed pursuant to the collaboration, other than in Australia and New Zealand.

 

In early 2008, we received positive results from our Phase III clinical trials with CorVue^tm (binodenoson) our next generation cardiac pharmacologic stress-imaging agent. We expect to file a new drug application (“NDA”) for CorVue^tm with the FDA by early 2009. The Phase II clinical trial for Sonedenoson, formerly MRE-0094, an adenosine A2a receptor agonist for the topical treatment of chronic, neuropathic, diabetic foot ulcers, did not meet its primary endpoint. We are continuing to evaluate the data from this trial.

 

Expanded Product Portfolio and Development Pipeline

 

In October 2007, we entered into a License, Development and Commercialization Agreement with Acura Pharmaceuticals, Inc. (“Acura”) to develop and commercialize certain immediate release opioid analgesic products utilizing Acura’s proprietary Aversion^® (abuse-deterrent/abuse-resistant) Technology in the United States, Canada and Mexico. The agreement provides us with an exclusive license for Acurox^tm (oxycodone HCl, niacin and a unique combination of other ingredients) tablets and another undisclosed opioid product utilizing Acura’s Aversion^® Technology. In addition, the agreement provides us with an option to license all future opioid analgesic products developed utilizing Acura’s Aversion^® Technology. Acurox^tm tablets are intended to effectively treat moderate to moderately severe pain while deterring or resisting common methods

of abuse, including intravenous injection or oral consumption of tablets dissolved in liquids, nasal inhalation of crushed tablets and intentional swallowing of excessive numbers of tablets.

 

On February 26, 2007, we acquired all the rights to Avinza^® in the United States, its territories and Canada from Ligand Pharmaceuticals Incorporated (“Ligand”). 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.

 

Other

 

In October 2007, we sold our Rochester, Michigan sterile manufacturing facility, some of our legacy products that are manufactured there and the related contract manufacturing business to JHP Pharmaceuticals, LLC (“JHP”) for $91.7 million less selling costs of $5.4 million. This transaction resulted in a loss of $46.4 million. The companies also entered into a manufacturing and supply agreement pursuant to which JHP will provide to us certain filling and finishing manufacturing activities with respect to Thrombin-JMI^®. The sale did not include our stand-alone sterile penicillin production facility that is also located in Rochester, Michigan.

 

In September 2007, we provided Palatin Technologies, Inc. (“Palatin”) with notice of termination of our Collaborative Development and Marketing Agreement to jointly develop and commercialize Palatin’s bremelanotide compound, which was formerly known as PT-141, for the treatment of male and female sexual dysfunction. Our decision to terminate the agreement followed communications from representatives of the FDA of serious concerns about the lack of an acceptable benefit/risk ratio to support the progression of the proposed bremelanotide program into Phase III studies for erectile dysfunction (“ED”). After reviewing the data generated in the Phase I and II 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. The termination was effective in December 2007.

 

Industry

 

The pharmaceutical industry is a highly competitive global business composed of a variety of participants, including large and small branded pharmaceutical companies, specialty and niche-market pharmaceutical companies, biotechnology firms, large and small research and drug development organizations, and generic drug manufacturers. These participants compete on a number of bases, including technological innovation or novelty, clinical efficacy, safety, convenience or ease of administration and cost-effectiveness. In order to promote their products to physicians and consumers, industry participants devote considerable resources to advertising, marketing and sales force personnel, distribution mechanisms and relationships with medical and research centers, physicians and patient advocacy and support groups.

 

The industry is affected by the following factors, among others:

 

 

 

Branded Pharmaceuticals Segment

 

We market a variety of branded prescription products that are divided into the following categories:

 

 

Our branded pharmaceutical products are generally in high-volume target markets and we believe they are well known for their treatment indications. Branded pharmaceutical products represented approximately 87% of our total net revenues for each of the years ended December 31, 2007, 2006 and 2005.

Some of our branded prescription products are described below:

 

 

 

Net sales of certain of our branded prescription products for the year ended December 31, 2007 are set forth in the tables below.

 

 

Meridian Auto-Injector Segment

 

Our Meridian Auto-Injector segment consists of our auto-injector business. An auto-injector is a pre-filled, pen-like device that allows a patient or caregiver to automatically inject a precise drug dosage quickly, easily, safely and reliably. Auto-injectors are a convenient, disposable, one-time use drug delivery system designed to improve the medical and economic value of injectable drug therapies. We pioneered the development and are a manufacturer of auto-injectors for the self-administration of injectable drugs. Our auto-injector products currently consist of a variety of acute care medicines.

 

The commercial pharmaceutical business of our Meridian segment consists of EpiPen^®, an auto-injector filled with epinephrine for the emergency treatment of anaphylaxis resulting from severe or allergic reactions to insect stings or bites, foods, drugs and other allergens, as well as idiopathic or exercise-induced anaphylaxis. We have a supply agreement with Dey, L.P., in which we granted Dey the exclusive right to market, distribute, and sell EpiPen^® worldwide. The supply agreement expires December 31, 2015.

 

In March 2006, we acquired substantially all of the assets of Allerex Laboratory LTD. The primary asset purchased from Allerex was the exclusive right to market and sell EpiPen^® throughout Canada. We also obtained from Dey, L.P., an extension of those exclusive rights to market and sell EpiPen^® in Canada through 2015.

 

Our Meridian Auto-Injector segment also includes pharmaceutical products that are presently sold primarily to the U.S. Department of Defense (“DoD”) under an Industrial Base Maintenance Contract which is terminable by the DoD at its convenience. These products include the nerve agent antidotes AtroPen^® and ComboPen^®, and the Antidote Treatment Nerve Agent Auto-injector, which we refer to as the “ATNAA.” AtroPen^® is an atropine-filled auto-injector and ComboPen^® consists of an atropine-filled auto-injector and a pralidoxime-filled auto-injector. The ATNAA utilizes a dual chambered auto-injector and injection process to administer atropine and pralidoxime, providing an improved, more efficient means of delivering these nerve agent antidotes. Other products sold to the DoD include a diazepam-filled auto-injector for the treatment of seizures and a morphine-filled auto-injector for pain management.

Royalties Segment

 

We have successfully developed two currently marketed adenosine-based products, Adenoscan^® and Adenocard^®, for which we receive royalty revenues. Adenoscan^® is a sterile, intravenous solution of adenosine administered intravenously as an adjunct to imaging agents used in cardiac stress testing of patients who are unable to exercise adequately. Adenocard^® is a sterile solution of adenosine administered intravenously in emergency situations to convert certain irregular heart rhythms to normal sinus rhythms. Specifically, we are party to an agreement under which Astellas Pharma US, Inc. (“Astellas”) manufactures and markets Adenoscan^® and Adenocard^® in the United States and Canada in exchange for royalties through the duration of the patents. We have licensed exclusive rights to other third-party pharmaceutical companies to manufacture and market Adenoscan^® and Adenocard^® in certain countries other than the United States and Canada in exchange for royalties.

 

Royalties received by us from sales of Adenoscan^® and Adenocard^® outside of the United States and Canada are shared equally with Astellas. Astellas, on its own behalf and ours, obtained a license to additional intellectual property rights for intravenous adenosine in cardiac imaging and the right to use intravenous adenosine as a cardioprotectant in combination with thrombolytic therapy, balloon angioplasty and coronary bypass surgery. For additional information on our royalty agreements, please see the section below entitled “Intellectual Property.”

 

Sales and Marketing

 

Our commercial operations organization, which includes sales and marketing, is based in Bridgewater, New Jersey. We have a sales force consisting of over 600 employees in the United States and Puerto Rico. We distribute our branded pharmaceutical products primarily through wholesale pharmaceutical distributors. These products are ordinarily dispensed to the public through pharmacies by prescription. Our marketing and sales promotions for branded pharmaceutical products principally target general/family practitioners, internal medicine physicians, neurologists, pain specialists, surgeons and hospitals through detailing and sampling to encourage physicians to prescribe our products. The sales force is supported by telemarketing and direct mail, as well as through advertising in trade publications and representation at regional and national medical conventions. We identify and target physicians through data available from IMS America, Ltd., a supplier of prescriber prescription data. The marketing and distribution of these products in foreign countries generally requires the prior registration of the products in those countries. We generally seek to enter into distribution agreements with companies with established foreign marketing and distribution capabilities since we do not have a distribution network in place for distribution outside the United States and Puerto Rico.

 

Similar to other pharmaceutical companies, our principal customers are wholesale pharmaceutical distributors. The wholesale distributor network for pharmaceutical products has in recent years been subject to increasing consolidation, which has increased our, and other industry participants’, customer concentration. In addition, the number of independent drug stores and small chains has decreased as retail consolidation has occurred. For the year ended December 31, 2007, approximately 75% of our gross sales were attributable to three key wholesalers: McKesson Corporation (35%), Cardinal/Bindley (27%), and Amerisource Bergen Corporation (13%).

 

Manufacturing

 

Our manufacturing facilities are located in Bristol, Tennessee; Rochester, Michigan; Middleton, Wisconsin; St. Petersburg, Florida; and St. Louis, Missouri. These facilities have manufacturing, packaging, laboratory, office and warehouse space. We are licensed by the Drug Enforcement Agency, which we refer to as the “DEA,” a division of the Department of Justice, to procure and produce controlled substances. We manufacture certain of our own branded pharmaceutical products. In 2007, we maintained an operational excellence program utilizing Six Sigma and lean manufacturing techniques to identify and execute cost-saving and process-improvement initiatives.

 

We can produce a broad range of dosage forms, including sterile solutions, lyophylized (freeze-dried) products, injectables, tablets and capsules, creams and ointments, suppositories and powders. We believe our

manufacturing capabilities allow us to pursue drug development and product line extensions more efficiently. However, currently many of our product lines, including Skelaxin^®, Thrombin-JMI^®, Avinza^®, Sonata^® and Synercid^® are manufactured for us by third parties. As of December 31, 2007, we estimate capacity utilization was approximately 35% at the Bristol facility, approximately 60% at the Rochester facility, approximately 85% at the Middleton facility, approximately 70% at the St. Petersburg facility and approximately 70% at the St. Louis facility. Although the capacity utilization at our Bristol facility will be lower in 2008 as a result of the anticipated decline in Altace^® sales, we expect that the capacity utilization at that location will increase in future years. We are transferring the production of Levoxyl^® from our St. Petersburg facility to our Bristol facility. Following the transfer, which we expect to complete in early 2009, we will close our St. Petersburg facility. During the fourth quarter of 2007, we sold our Rochester, Michigan sterile manufacturing facility to JHP Pharmaceuticals, LLC. This sale did not include our stand-alone manufacturing and production facility for our Bicillin^® product line, also located in Rochester, Michigan, which the FDA approved in early 2007.

 

In addition to manufacturing, we have fully integrated manufacturing support systems including quality assurance, quality control, regulatory management and logistics. We believe that these support systems enable us to maintain high standards of quality for our products and simultaneously deliver reliable goods to our customers on a timely basis.

 

We require a supply of quality raw materials and components to manufacture and package drug products. Generally, we have not had difficulty obtaining raw materials and components from suppliers. Currently, we rely on more than 500 suppliers to deliver the necessary raw materials and components for our products.

 

Research and Development

 

We are engaged in the development of chemical compounds, including new chemical entities, which provide us with strategic pipeline opportunities for the commercialization of new branded prescription pharmaceutical products. In addition to developing new chemical compounds, we pursue strategies to enhance the value of existing products by developing new uses, formulations, and drug delivery technology that may provide additional benefits to patients and improvements in the quality and efficiency of our manufacturing processes.

 

We invest in research and development because we believe it is important to our long-term growth. We presently employ approximately 100 people in research and development, including pre-clinical and toxicology experts, pharmaceutical formulations scientists, clinical development experts, medical affairs personnel, regulatory affairs experts, data scientists/statisticians and project managers.

 

In the context of our research and development, we outsource a substantial amount of our non-critical activities. This provides us with substantial flexibility and allows high efficiency while minimizing internal fixed costs. Utilizing this approach, we supplement our internal efforts by collaborating with independent research organizations, including educational institutions and research-based pharmaceutical and biotechnology companies, and contracting with other parties to perform research in their facilities. We use the services of physicians, hospitals, medical schools, universities, and other research organizations worldwide to conduct clinical trials to establish the safety and effectiveness of new products. We seek investments in external research and technologies that hold the promise to complement and strengthen our own research efforts. These investments can take many forms, including in-licensing arrangements, development agreements, joint ventures and the acquisition of products in development.

 

Drug development is time-consuming and expensive. Only a small percentage of chemical compounds discovered by researchers prove to be both medically effective and safe enough to become an approved medicine. The process from discovery to regulatory approval typically takes 10 to 15 years or longer. Drug candidates can fail at any stage of the process, and even late-stage product candidates sometimes fail to receive regulatory approval.

 

Clinical trials are conducted in a series of sequential phases, with each phase designed to address a specific research question. In Phase I clinical trials, researchers test a new drug or treatment in a small group of people to evaluate the drug’s safety, determine a safe dosage range and identify side effects. In Phase II

clinical trials, researchers give the drug or treatment to a larger population to assess effectiveness and to further evaluate safety. In Phase III clinical trials, researchers give the drug or treatment to an even larger population to confirm its effectiveness, monitor side effects, compare it to commonly used treatments and collect information that will allow the drug or treatment to be used safely. The results of Phase III clinical trials are pivotal for purposes of obtaining FDA approval of a new product. Phase IV clinical trials are typically conducted after FDA approval in order to broaden the understanding of the safety and efficacy of a drug as utilized in actual clinical practice or to explore alternative or additional uses.

 

Our development projects, including those for which we have collaboration agreements with third parties, include the following:

 

 

Our research and development expenses totaled $149.4 million in 2007 compared to $143.6 million in 2006 and $74.0 million in 2005, excluding research and development in-process at the time of acquisition of a product. In-process research and development expenses were $35.3 million for the year ended December 31, 2007, $110.0 million for the year ended December 31, 2006 and $188.7 million for the year ended December 31, 2005. In-process research and development represents the actual cost of acquiring rights to branded pharmaceutical projects in development from third parties, which costs we expense at the time of acquisition.

 

Government Regulation

 

Our business and our products are subject to extensive and rigorous regulation at both the federal and state levels. Nearly all of our products are subject to pre-market approval requirements. New drugs are approved under, and are subject to, the Food, Drug and Cosmetics Act (“FDC Act”) and related regulations. Biological drugs are subject to both the FDC Act and the Public Health Service Act, which we refer to as the “PHS Act,” and related regulations. Biological drugs are licensed under the PHS Act.

 

At the federal level, we are principally regulated by the FDA as well as by the DEA, the Consumer Product Safety Commission, the Federal Trade Commission (“FTC”), the Occupational Safety and Health Administration, and the U.S. Environmental Protection Agency (“EPA”). The FDC Act, the regulations promulgated thereunder, and other federal and state statutes and regulations, govern, among other things, the

development, testing, manufacture, safety, effectiveness, labeling, storage, record keeping, approval, advertising and promotion of pharmaceutical products.

 

The processes by which regulatory approvals are obtained from the FDA to market and sell a new product are complex, require a number of years and involve the expenditure of substantial resources. Compounds or potential new products that appear promising in development can prove unsuccessful and fail to receive FDA approval, fail to receive approval of specific anticipated indications, be substantially delayed, or receive unfavorable product labeling (including indications or safety warnings), each of which can materially affect the commercial value of the product. Additional factors that may materially affect the success and/or timing of regulatory approval of a new product, and its commercial potential, include the regulatory filing strategies employed, the timing of and delays in FDA review, and the intervention by third parties in the approval process through administrative or judicial means.

 

When we acquire the right to market an existing approved pharmaceutical product, both we and the former application holder are required to submit certain information to the FDA. This information, if adequate, results in the transfer to us of marketing rights to the pharmaceutical product. We are also required to report to the FDA, and sometimes acquire prior approval from the FDA for, certain changes in an approved NDA or Biologics Licensing Application, as set forth in the FDA’s regulations. When advantageous, we transfer the manufacture of acquired branded pharmaceutical products to other manufacturing facilities, which may include manufacturing facilities we own, after regulatory requirements are satisfied. In order to transfer manufacturing of acquired products, the new manufacturing facility must demonstrate, through the filing of information with the FDA, that it can manufacture the product in accordance with current Good Manufacturing Practices, referred to as “cGMPs,” and the specifications and conditions of the approved marketing application. There can be no assurance that the FDA will grant necessary approvals in a timely manner, if at all.

 

The FDA also mandates that drugs be manufactured, packaged and labeled in conformity with cGMPs at all times. In complying with cGMPs, manufacturers must continue to expend time, money and effort in production, record keeping and quality control to ensure that the products meet applicable specifications and other requirements to ensure product safety and efficacy.

 

The FDA and other government agencies periodically inspect drug manufacturing facilities to ensure compliance with applicable cGMP and other regulatory requirements. Failure to comply with these statutory and regulatory requirements subjects the manufacturer to possible legal or regulatory action, such as suspension of manufacturing, recall of product or seizure of product. We must report adverse experiences with the use of our products to the FDA. The FDA could impose market restrictions on us such as labeling changes or product removal as a result of significant reports of unexpected, severe adverse experiences. Product approvals may be withdrawn if we fail to comply with regulatory requirements or if there are problems with the safety or efficacy of the product.

 

The federal government has extensive enforcement powers over the activities of pharmaceutical manufacturers, including the authority to withdraw product approvals at any time, commence actions to seize and prohibit the sale of unapproved or non-complying products, halt manufacturing operations that are not in compliance with cGMPs, and impose or seek injunctions, voluntary or involuntary recalls, and civil monetary and criminal penalties. A restriction or prohibition on sales or withdrawal of approval of products marketed by us could materially adversely affect our business, financial condition or results of operations.

 

We also manufacture and sell pharmaceutical products which are “controlled substances” as defined in the Controlled Substances Act and related federal and state laws. These laws establish certain security, licensing, record keeping, reporting and personnel requirements administered by the DEA and state authorities. The DEA has dual missions of law enforcement and regulation. The former deals with the illicit aspects of the control of abusable substances and the equipment and raw materials used in making them. The DEA shares enforcement authority with the Federal Bureau of Investigation, another division of the Department of Justice. The DEA’s regulatory responsibilities are concerned with the control of licensed manufacturers, distributors and dispensers of controlled substances, the substances themselves and the equipment and raw materials used in their manufacture and packaging in order to prevent these articles from being diverted into illicit channels

of commerce. We maintain appropriate licenses and certificates with the DEA and applicable state authorities in order to engage in the development, manufacturing and distribution of pharmaceutical products containing controlled substances.

 

The distribution and promotion of pharmaceutical products is subject to the Prescription Drug Marketing Act (“PDMA”), a part of the FDC Act, which regulates distribution activities at both the federal and state levels. Under the PDMA and its implementing regulations, states are permitted to require registration of manufacturers and distributors who provide pharmaceuticals even if these manufacturers or distributors have no place of business within the state. States are also permitted to adopt regulations limiting the distribution of product samples to licensed practitioners. The PDMA also imposes extensive licensing, personnel record keeping, packaging, quantity, labeling, product handling and facility storage and security requirements intended to prevent the sale of pharmaceutical product samples or other diversions of samples.

 

A number of states have passed laws specifically designed to track and regulate specified activities of pharmaceutical companies. Other states presently have pending legislation that will have similar effects. Some of these state laws require the tracking and reporting of advertising or marketing activities and spending within the state. Others limit spending on items provided to healthcare providers or state officials.

 

Environmental Matters

 

Our operations are subject to numerous and increasingly stringent federal, state and local environmental laws and regulations concerning, among other things, the generation, handling, storage, transportation, treatment and disposal of toxic and hazardous substances and the discharge of pollutants into the air and water. Environmental permits and controls are required for some of our operations and these permits are subject to modification, renewal and revocation by the issuing authorities. We believe that our facilities are in substantial compliance with our permits and environmental laws and regulations and do not believe that future compliance with current environmental laws will have a material adverse effect on our business, financial condition or results of operations. Our environmental capital expenditures and costs for environmental compliance were immaterial in 2007 and 2006, but may increase in the future as a result of changes in environmental laws and regulations or as a result of increased manufacturing activities at any of our facilities.

 

Competition

 

General

 

We compete with numerous other pharmaceutical companies, including large, global pharmaceutical companies, for the acquisition of products and technologies in later stages of development. We also compete with other pharmaceutical companies for currently marketed products and product line acquisitions. Additionally, our products are subject to competition from products with similar qualities. Our branded pharmaceutical products may be subject to competition from alternate therapies during the period of patent protection and thereafter from generic equivalents. The manufacturers of generic products typically do not bear the related research and development costs and consequently are able to offer such products at considerably lower prices than the branded equivalents. There are, however, a number of factors which enable some products to remain profitable once patent protection has ceased. These include the establishment of a strong brand image with the prescriber or the consumer, supported by the development of a broader range of alternative formulations than the manufacturers of generic products typically supply.

 

Generic Substitutes

 

Some of our branded pharmaceutical products currently face competition from generic substitutes, and others may face competition from generic substitutes in the future. For a manufacturer to launch a generic substitute, it must prove to the FDA that the branded pharmaceutical product and the generic substitute are therapeutically equivalent.

 

The FDA requires that generic applicants claiming invalidity or non-infringement of patents listed by a NDA holder give the NDA holder notice each time an abbreviated new drug application (“ANDA”) which

claims invalidity or non-infringement of listed patents is either submitted or amended. If the NDA holder files a patent infringement suit against the generic applicant within 45 days of receiving such notice, the FDA is barred (or stayed) from approving the ANDA for 30 months unless specific events occur sooner. To avoid multiple 30-month stays for the same branded drug, the relevant provisions of the Hatch-Waxman Act (21 U.S.C. §§ 355(j)(2) and (5)) indicate that a 30-month stay will only attach to patents that are listed in the FDA’s Approved Drug Products with Therapeutic Equivalence Evaluations, which we refer to as the “FDA’s Orange Book,” at the time an ANDA is originally filed. Although the ANDA filer is still required to certify against a newly-listed patent, and the NDA holder can still bring suit based upon infringement of that patent, such a suit will not trigger an additional 30-month stay of FDA approval of the ANDA.

 

Patents that claim a composition of matter relating to a drug or certain methods of using a drug are required to be listed in the FDA’s Orange Book. The FDA’s regulations prohibit listing of certain types of patents. Thus, some patents that may issue are not eligible for listing in the FDA’s Orange Book and thus not eligible for protection by a 30-month stay of FDA approval of the ANDA.

 

Intellectual Property

 

Patents, Licenses and Proprietary Rights

 

The protection of discoveries in connection with our development activities is critical to our business. The patent positions of pharmaceutical companies, including ours, are uncertain and involve legal and factual questions which can be difficult to resolve. We seek patent protection in the United States and selected foreign countries where and when appropriate.

 

Skelaxin^® has two method-of-use patents listed in the FDA’s Orange Book which expire in December 2021. In January 2008, we entered into an agreement with CorePharma providing it with a license to launch an authorized generic version of Skelaxin^® in December 2012 or earlier under certain conditions.

 

Avinza^® has a formulation patent listed in the FDA’s Orange Book that expires in November 2017.

 

Sonata^® has a composition of matter patent listed in the FDA’s Orange Book that expires in June 2008. In 2007, we entered into an agreement with CorePharma providing it with a license to launch an authorized generic version of Sonata^® in April 2008.

 

Synercid^® has a formulation patent that expires in November 2017.

 

We own the intellectual property rights associated with Meridian’s dual-chambered auto-injector and injection process, which include a patent in the United States that expires in April 2010.

 

We receive royalties on sales of Adenoscan^®, a product that we developed. We own one patent on Adenoscan^® with an expiration date of May 2009. We also have certain rights tied to another patent covering this product which does not expire until 2015. In October 2007, we entered into an agreement with Astellas and a subsidiary of Teva Pharmaceutical Industries Ltd. providing Teva with the right to launch a generic version of Adenoscan^® pursuant to a license in September 2012 or earlier under certain conditions.

 

In addition to the intellectual property for the currently marketed products described above, we also have created, acquired or licensed intellectual property related to various products currently under development. For example, in connection with our collaborative agreement with Pain Therapeutics, Inc., we have acquired an exclusive license (subject to preexisting license rights granted by Pain Therapeutics) to certain intellectual property rights related to opioid formulations, including Remoxy^tm, which is currently in development for the treatment of moderate to severe chronic pain. In connection with our collaborative agreement with Acura Pharmaceuticals, Inc., we have acquired a license to intellectual property rights related to the Aversion^® Technology platform. Furthermore, in connection with the development of Sonedenoson, we have acquired exclusive licenses to composition and method patents related to adenosine receptor agonists for the topical treatment of chronic diabetic foot ulcers. Also, we have acquired exclusive rights to patents related to CorVue^tm, the pharmacologic stress agent specific to the adenosine receptor necessary for increased cardiac blood flow. Also, we have acquired certain intellectual property rights from Mutual Pharmaceutical Company, Inc. related to metaxalone, the active pharmaceutical ingredient in Skelaxin^®.

We also rely upon trade secrets, unpatented proprietary know-how and continuing technological innovation to develop and sustain our competitive position. There can be no assurance that others will not independently develop substantially equivalent proprietary technology and techniques or otherwise gain access to our trade secrets or disclose the technology or that we can adequately protect our trade secrets.

 

Trademarks

 

We sell our branded products under a variety of trademarks. We believe that we have valid proprietary interests in all currently used trademarks, including those for our principal branded pharmaceutical products registered in the United States.

 

Backlog

 

There was no material backlog as of February 27, 2008.

 

Executive Officers

 

 

Brian A. Markison was elected as Chairman of the Board in May 2007. He has been President and Chief Executive Officer and a director since July 2004. He joined King as Chief Operating Officer in March 2004. Mr. Markison served in various positions with Bristol-Myers Squibb beginning in 1982. Most recently as President of Bristol-Myers Squibb’s Oncology, Virology and Oncology Therapeutics Network businesses. Between 1998 and 2001, he served variously as Senior Vice President, Neuroscience/Infectious Disease; President, Neuroscience/Infectious Disease/Dermatology; and Vice President, Operational Excellence and Productivity. He also held various sales and marketing positions. Mr. Markison is a member of the Board of Directors of Immunomedics, Inc., a publicly-held corporation. He graduated from Iona College in 1982 with a Bachelor of Science degree.

 

Joseph Squicciarino has served as King’s Chief Financial Officer since June 2005. Prior to joining King, he was Chief Financial Officer — North America for Revlon, Inc. since March 2005. From February 2003 until March 2005 he served as Chief Financial Officer — International for Revlon International, Inc. He held the position of Group Controller Pharmaceuticals — Europe, Middle East, Africa with Johnson & Johnson from October 2001 until October 2002. He held a variety of positions with the Bristol-Myers Squibb Company and its predecessor, the Squibb Corporation, from 1979 until 2001, including Vice President Finance, International Medicines; Vice President Finance, Europe Pharmaceuticals & Worldwide Consumer Medicines; Vice President Finance, Technical Operations; and Vice President Finance, U.S. Pharmaceutical Group. Mr. Squicciarino also serves on the Board of Directors of Zep, Inc., a publicly-held company. He is a Certified Public Accountant, a member of the New Jersey Society of Certified Public Accountants and a member of the American Institute of Certified Public Accountants. Mr. Squicciarino graduated from Adelphi University in 1978 with a Bachelor of Science degree in Accounting.

 

Stephen J. Andrzejewski has served as Chief Commercial Officer since October 2005. He was previously Corporate Head, Commercial Operations commencing in May 2004. Prior to joining King, Mr. Andrzejewski was Senior Vice President, Commercial Business at Endo Pharmaceuticals Inc. since June 2003. He previously served in various positions with Schering-Plough Corporation beginning in 1987, including Vice President of

New Products and Vice President of Marketing, and had responsibility for launching the Claritin^® product. Mr. Andrzejewski graduated cum laude from Hamilton College with a Bachelor of Arts degree in 1987 and in 1992 graduated from New York University’s Stern School of Business with a Master of Business Administration degree.

 

Frederick Brouillette, Jr. has served as Corporate Compliance Officer since August 2003. He served as Executive Vice President, Finance from January 2003 until August 2003 and prior to that as Vice President, Risk Management beginning in February 2001. Before joining King, Mr. Brouillette, a Certified Public Accountant, was with PricewaterhouseCoopers for 4 years, serving most recently in that firm’s Richmond, Virginia office providing internal audit outsourcing and internal control consulting services. He was formerly a chief internal audit executive for two major public corporations and served for 12 years in the public accounting audit practice of Peat, Marwick Mitchell & Co., the predecessor firm to KPMG. Mr. Brouillette is a member of the Virginia Society of Certified Public Accountants, the American Institute of Certified Public Accountants, and the Institute of Internal Auditors. He graduated with honors from the University of Virginia’s McIntire School of Commerce in 1973 with a Bachelor of Science degree in accounting.

 

Eric J. Bruce has served as Chief Technical Operations Officer since June 2005. Prior to joining King, Mr. Bruce was Vice President of Operations for Mallinckrodt Pharmaceuticals, a position he had occupied since 2000. Previously, he was Vice President of Manufacturing for Kendall Health Care from 1997 until 2000, and from 1996 until 1997 he held various positions with INBRAND, including that of Senior Vice President of Manufacturing. Mr. Bruce graduated from the Georgia Institute of Technology in 1978 with a Bachelor of Science degree in Industrial Management.

 

Eric G. Carter, M.D., Ph.D., has served as King’s Chief Science Officer since January 2007. Prior to joining King, he held several positions with GlaxoSmithKline commencing in 1999, most recently as Vice President and Global Head, Clinical Development and Medical Affairs, Gastroenterology, R&D. Dr. Carter has served as a Clinical Associate Professor at the University of North Carolina for the Division of Digestive Diseases and Nutrition, School of Medicine. He previously held academic positions with the University of California, where he was responsible for establishing and directing many research programs. After earning a bachelor’s degree in Biochemistry from the University of London, Dr. Carter received his medical degree from the University of Miami and a doctor of philosophy degree from the University of Cambridge. He obtained board certification from the American Board of Internal Medicine, Gastroenterology and Clinical Nutrition and has authored or co-authored more than 50 scientific publications.

 

James W. Elrod has served as General Counsel since February 2006 and Corporate Secretary since May 2005. He was Acting General Counsel from February 2005 to February 2006. He has worked in various positions with King since September 2003, including Vice President, Legal Affairs. Prior to joining King he served in various capacities at Service Merchandise Company, Inc. including Vice President, Legal Department. He previously practiced law in Nashville, Tennessee. Mr. Elrod earned a Juris Doctor degree from the University of Tennessee and a Bachelor of Arts degree from Berea College.

 

James E. Green has served as Executive Vice President, Corporate Affairs since April 2003. He was Vice President, Corporate Affairs commencing in June 2002 and was Senior Director, Corporate Affairs beginning in September 2000. Prior to joining King, he was engaged in the private practice of law for 15 years as a commercial transactions and commercial litigation attorney, having most recently served as the senior member of Green & Hale, a Professional Corporation, in Bristol, Tennessee. Mr. Green graduated from Southern Methodist University School of Law with a Juris Doctor degree in 1985 and Milligan College with a Bachelor of Science degree, cum laude, in 1982. He is licensed to practice law in Tennessee, Texas and Virginia.

Employees

 

As of February 27, 2008, we employed approximately 2,050 full-time and 2 part-time persons. Twenty-nine employees of the Rochester facility are covered by a collective bargaining agreement with United Steelworkers, Local 6-176. Approximately 240 employees of the St. Louis facility are covered by a collective bargaining agreement with the International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America Union, Local No. 688. We believe our employee relations are good.

 

You should carefully consider the risks described below and the other information contained in this report, including our audited consolidated financial statements and related notes. The risks described below are not the only ones facing our company. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the adverse events described in this “Risk Factors” section or other sections of this report actually occurs, our business, results of operations and financial condition could be materially adversely affected, the trading price, if any, of our securities could decline and you might lose all or part of your investment.

 

Risks Related to our Business

 

If we cannot successfully enforce our rights under the patents relating to two of our largest products, Skelaxin^® and Avinza^®, or if we are unable to secure or enforce our rights under other patents and trademarks and protect our trade secrets and other intellectual property, additional competitors could enter the market, and sales of these products may decline materially.

 

Under the Hatch-Waxman Act, any generic pharmaceutical manufacturer may file an ANDA with a certification, known as a “Paragraph IV certification,” challenging the validity or infringement of a patent listed in the FDA’s Approved Drug Products with Therapeutic Equivalence Evaluations, which is known as the “FDA’s Orange Book,” four years after the pioneer company obtains approval of its NDA.

 

As more fully described in Note 19, “Commitments and Contingencies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules,” other companies have filed Paragraph IV certifications challenging the patents associated with some of our key products. If any of these Paragraph IV challenges succeeds, our affected product would face generic competition and its sales would likely decline materially. Should sales decline, we may have to write off a portion or all of the intangible assets associated with the affected product as we did with Altace^® as described below.

 

We may not be successful in securing or maintaining proprietary patent protection for other of our products or for products and technologies we develop or license. In addition, our competitors may develop products similar to ours, including generic products, using methods and technologies that are beyond the scope of our intellectual property protection, which could materially reduce our sales.

 

Although most of our revenue is generated by products not currently subject to competition from generic products, there is no proprietary protection for many of our branded pharmaceutical products, and generic substitutes for many of these products are sold by other pharmaceutical companies. Further, we also rely upon trade secrets, unpatented proprietary know-how and continuing technological innovation in order to maintain our competitive position with respect to some products. Our sales could be materially reduced if our competitors independently develop equivalent proprietary technology and techniques or gain access to our trade secrets, know-how and technology.

 

If we are unable to enforce our patents and trademarks or protect our trade secrets and other intellectual property, our results of operations and cash flows could be materially and adversely affected.

 

Additionally, certain of our supply agreements and purchase orders for raw materials contain minimum purchase commitments. If loss of market exclusivity or other factors cause sales of our products to fall below amounts necessary to use the raw materials we have committed to purchase, we may incur losses in connection with those supply agreements or purchase orders.

 

In late 2007, the key patent associated with Altace^® was invalidated by a federal court, and we expect net sales of Altace^® to decrease significantly as a result. Our related restructuring initiative might not succeed, and, in any event, the benefits of the initiative will not be sufficient to offset the loss of revenues from decreased Altace^® sales.

 

In late 2007, following the Circuit Court’s decision invalidating our ‘722 Altace^® patent, we undertook an analysis of its potential effects on future sales of Altace^®. As a result of this analysis, we concluded that our

actual and estimated future net sales of Altace^® are likely to decrease significantly because of competition from generic products. We therefore reduced our estimate of future net sales of Altace^® and recorded charges associated with (1) minimum purchase requirements under our supply agreement to purchase Altace^® raw material, (2) inventories associated with Altace^® and (3) an impairment of our Altace^® intangible assets.

 

In addition, following the Circuit Court’s invalidation of our ‘722 patent relating to Altace^®, we began a restructuring initiative designed to accelerate our planned strategic shift emphasizing our focus in neuroscience, hospital and acute care medicine. This initiative includes, based on an analysis of our strategic needs, 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. If we are unable to complete the objectives of this initiative, our business and results of operations may be materially adversely affected. Moreover, the anticipated benefits of the restructuring initiative will not be sufficient to offset the loss of revenues from decreased product sales following the invalidation of our Altace^® patent. We expect this loss of revenues to be material.

 

The uncertainty and expense of the drug development process, actions by our competitors and other factors may adversely affect our ability to implement our strategy to grow our business through increased sales, acquisitions, development and in-licensing, and, as a result, our business or competitive position in the pharmaceutical industry may suffer.

 

Drug development is time-consuming and expensive. Only a small percentage of chemical compounds discovered by researchers prove to be both medically effective and safe enough to become an approved medicine. The process from discovery to regulatory approval typically takes 10 to 15 years or longer. Drug candidates can fail at any stage of the process, and even late-stage product candidates sometimes fail to receive regulatory approval.

 

Clinical trials are conducted in a series of sequential phases, with each phase designed to address a specific research question. In Phase I clinical trials, researchers test a new drug or treatment in a small group of people to evaluate the drug’s safety, determine a safe dosage range, and identify side effects. In Phase II clinical trials, researchers give the drug or treatment to a larger population to assess effectiveness and to further evaluate safety. In Phase III clinical trials, researchers give the drug or treatment to an even larger population to confirm its effectiveness, monitor side effects, compare it to commonly used treatments, and collect information that will allow the drug or treatment to be used safely. The results of Phase III clinical trials are pivotal for purposes of obtaining FDA approval of a new product.

 

The processes by which regulatory approvals are obtained from the FDA to market and sell a new product are complex, require a number of years and involve the expenditure of substantial resources. Compounds or potential new products that appear promising in development can prove unsuccessful and fail to receive FDA approval, fail to receive approval of specific anticipated indications, be substantially delayed, or receive unfavorable product labeling (including indications or safety warnings), each of which can materially affect the commercial value of the product. Additional factors that may materially affect the success and/or timing of regulatory approval of a new product, and its commercial potential, include the regulatory filing strategies employed, the timing of and delays in FDA review, and the intervention by third parties in the approval process through administrative or judicial means. As a result, there can be no assurance that we will receive regulatory approval of our products in development, or of new dosage forms for existing products, that our products or dosage forms will receive approval for specific indications or that the labeling of these products will be as we would prefer.

 

Our current strategy is to increase sales of certain of our existing products and to enhance our competitive standing through acquisitions or in-licensing of products, either in development or previously approved by the FDA, that complement our business and enable us to promote and sell new products through existing marketing and distribution channels. Moreover, since we engage in limited proprietary research activity with respect to the development of new chemical entities, we rely heavily on purchasing or licensing products in development and FDA-approved products from other companies.

Development projects, including those for which we have collaboration agreements with third parties, include the following:

 

 

We compete with other pharmaceutical companies, including large pharmaceutical companies with financial, human and other resources substantially greater than ours, in the development and licensing of new products. We cannot assure you that we will be able to:

 

 

If we are not successful in the development or licensing of new products already in development, including obtaining any necessary FDA approvals, our business, financial condition, and results of operations could be materially adversely affected.

 

Further, other companies may license or develop products or may acquire technologies for the development of products that are the same as or similar to the products we have in development or that we license. Because there is rapid technological change in the industry and because many other companies may have more financial resources than we do, other companies may:

 

 

Any of these events would thereby have a negative effect on the sales of our existing, newly developed or licensed products. The inability to effect acquisitions or licenses of additional branded products in development and FDA-approved products could limit the overall growth of our business. Furthermore, even if we obtain rights to a pharmaceutical product or acquire a company, we may not be able to generate sales sufficient to create a profit or otherwise avoid a loss. Technological developments or the FDA’s approval of new products or of new therapeutic indications for existing products may make our existing products or those products we are licensing or developing obsolete or may make them more difficult to market successfully, which could have a material adverse effect on results of operations and cash flows.

Seven of our products and our royalty segment accounted for 86.4% of our revenues from continuing operations in 2007 and a decrease in sales of these products or royalty income or an increase in competition in the future would have a material adverse effect on our results of operations.

 

Revenues.  Altace^®, Skelaxin^®, Thrombin-JMI^®, EpiPen^®, Levoxyl^®, Sonata^®, Avinza^® and royalty revenues for the last twelve months ended December 31, 2007 accounted for 30.2%, 20.6%, 12.5%, 5.7%, 4.7%, 3.7%, 5.1% and 3.9% of our total revenues from continuing operations, respectively, or 86.4% in total. Accordingly, any factor adversely affecting sales of any of these products or products for which we receive royalty payments could have a material adverse effect on our results of operations and cash flows. For example, on September 11, 2007, the Circuit Court invalidated our ‘722 patent, related to Altace^®. Invalidation of this patent has led to a generic version of Altace^® entering the market. Additional third parties will likely enter the market with their own generic substitutes for Altace^® in 2008. As a result of the entry of generic competition, we expect net sales of Altace^® to decline significantly.

 

Product Competition.  Additionally, since our currently marketed products are generally established and commonly sold, they are subject to competition from products with similar qualities. For example:

 

 

Other of our branded pharmaceutical products also face competition from generic substitutes.

 

The manufacturers of generic products typically do not bear the related research and development costs and, consequently, are able to offer such products at considerably lower prices than the branded equivalents. We cannot assure you that any of our products will remain without generic competition, or maintain their market share, gross margins and cash flows, the failure of which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

EpiPen.  Dey, L.P. markets our EpiPen^® auto-injector through a supply agreement with us that expires on December 31, 2015. Under the terms of the agreement, we grant Dey the exclusive right and license to market, distribute and sell EpiPen^®, either directly or through subdistributors. A failure by Dey to successfully market and distribute EpiPen^® or an increase in competition could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Royalty Revenue. We receive royalties on sales of Adenoscan^®, a product that we developed. Adenoscan^® is manufactured, marketed and distributed by Astellas. In October 2007, we entered into an agreement with Astellas and a subsidiary of Teva Pharmaceutical Industries Ltd. (“Teva”) providing Teva with the right to launch a generic version of Adenoscan^® pursuant to a license in September 2012, or earlier under certain conditions. A failure by Astellas to successfully manufacture, market and distribute Adenoscan^®

or an increase in competition could have a material adverse effect on our business, financial condition, results of operations and cash flows.

If we cannot integrate the business of companies or products we acquire, or appropriately and successfully manage and coordinate third-party collaborative development activities, our business may suffer.

 

The integration into our business of in-licensed or acquired assets or businesses, as well as the coordination and collaboration of research and development, sales and marketing efforts with third parties, requires significant management attention, maintenance of adequate operational, financial and management information systems, integration of systems that we acquire into our existing systems, and verification that the acquired systems meet our standards for internal control over financial reporting. Our future results will also depend in part on our ability to hire, retain and motivate qualified employees to manage expanded operations efficiently and in accordance with applicable regulatory standards. If we cannot manage our third-party collaborations and integrate in-licensed and acquired assets successfully, or, if we do not establish and maintain an appropriate administrative, support and control infrastructure to support these activities, this could have a material adverse effect on our business, financial condition, results of operations and cash flows and on our ability to make the necessary certifications with respect to our internal controls.

 

We are required annually, or on an interim basis as needed, to review the carrying value of our intangible assets and goodwill for impairment. If sales of our products decline because of, for example, generic competition or an inability to manufacture or obtain sufficient supply of product, the intangible asset value of any declining product could become impaired.

 

As of December 31, 2007, we had approximately $910.1 million of net intangible assets and goodwill. Intangible assets primarily include the net book value of various product rights, trademarks, patents and other intangible rights. If a change in circumstances causes us to lower our future sales forecast for a product, we may be required to write off a portion of the net book value of the intangible assets associated with that product. In evaluating goodwill for impairment, we estimate the fair value of our individual business reporting units on a discounted cash flow basis. In the event the value of an individual business reporting unit declines significantly, it could result in a non-cash impairment charge. Any impairment of the net book value of any intangible asset or goodwill, depending on the size, could result in a material adverse effect on our business, financial condition and results of operations.

 

We have entered into agreements with manufacturers and/or distributors of generic pharmaceutical products with whom we are presently engaged, or have previously been engaged, in litigation, and these agreements could subject us to claims that we have violated federal and/or state anti-trust laws.

 

We have negotiated and entered into a number of agreements with manufacturers and/or distributors of generic pharmaceutical products, some of whom are presently engaged or have previously been engaged in litigation with us. Governmental and/or private parties may allege that these arrangements and activities in furtherance of the success of these arrangements violate applicable state or federal anti-trust laws. Alternatively, courts could interpret these laws in a manner contrary to current understandings of such laws. If a court or other governmental body were to conclude that a violation of these laws had occurred, any liability based on such a finding could be material and adverse and could be preceded or followed by private litigation such as class action litigation.

 

For example, we have received civil investigative demands (“CIDs”) for information from the U.S. Federal Trade Commission (“FTC”). The CIDs require us to provide information related to our collaboration with Arrow, the dismissal without prejudice of our patent infringement litigation against Cobalt under the Hatch-Waxman Act of 1984 and other information. We are cooperating with the FTC in this investigation.

 

Unfavorable results in pending and future claims and litigation matters could have an adverse impact on us.

 

We are named as a party in various lawsuits, as are certain of our current and former directors and certain of our former officers. For information about our pending material litigation matters, please see Note 19, “Commitments and Contingencies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.” While we intend to vigorously defend ourselves in these actions, we are generally unable to predict the

outcome or reasonably estimate the range of potential loss, if any, in the pending litigation. If we were not to prevail in the pending litigation, we could be required to pay material sums in connection with judgments or settlements related to these matters, or they could otherwise have a material adverse effect on our business, results of operations and financial condition.

 

Any significant delays or difficulties in the manufacture of, or supply of materials for, our products may reduce our profit margins and revenues, limit the sales of our products, or harm our products’ reputations.

 

Many of our product lines, including Skelaxin^®, Thrombin-JMI^®, Avinza^®, Sonata^® and Synercid^®, are currently manufactured in part or entirely by third parties. Our dependence upon third parties for the manufacture of our products may adversely affect our profit margins or may result in unforeseen delays or other problems beyond our control. For example, if any of these third parties are not in compliance with applicable regulations, the manufacture of our products could be delayed, halted or otherwise adversely affected. If for any reason we are unable to obtain or retain third-party manufacturers on commercially acceptable terms, we may not be able to distribute our products as planned. If we encounter delays or difficulties with contract manufacturers in producing or packaging our products, the distribution, marketing and subsequent sales of these products could be adversely affected, and we may have to seek alternative sources of supply or abandon product lines or sell them on unsatisfactory terms. We might not be able to enter into alternative supply arrangements in a timely manner or at commercially acceptable rates, if at all. We also cannot assure you that the manufacturers we use will be able to provide us with sufficient quantities of our products or that the products supplied to us will meet our specifications.

 

Sales of Thrombin-JMI^® may be affected by the perception of risks associated with some of the raw materials used in its manufacture. If we are unable to maintain purification procedures at our facilities that are in accordance with the FDA’s expectations for biological products generally, the FDA could limit our ability to manufacture biological products at those facilities.

 

For the twelve months ended December 31, 2007, our product Thrombin-JMI^® accounted for 12.5% of our total revenues from continuing operations. The source material for Thrombin-JMI^® comes from bovine plasma and lung tissue which has been certified by the United States Department of Agriculture for use in the manufacture of pharmaceutical products. Bovine-sourced materials, particularly those from outside the United States, may be of some concern because of potential transmission of bovine spongiform encephalopathy, or “BSE.” However, we have taken precautions to minimize the risks of contamination from BSE in our source materials and process. Our principal precaution is the use of bovine materials only from FDA-approved sources in the United States. Accordingly, all source animals used in our production of Thrombin-JMI^® are of United States origin. Additionally, source animals used in production of Thrombin-JMI^® are generally less than 18 months of age (BSE has not been identified in animals less than 30 months of age).

 

There is currently no alternative to the bovine-sourced materials for the manufacture of Thrombin-JMI^®. We have two approved vendors as sources of supply of the bovine raw materials. Any interruption or delay in the supply of these materials could adversely affect the sales of Thrombin-JMI^®. We will continue surveillance of the source and believe that the risk of BSE contamination in the source materials for Thrombin-JMI^® is very low. While we believe that our procedures and those of our vendor for the supply, testing and handling of the bovine material comply with all federal, state, and local regulations, we cannot eliminate the risk of contamination or injury from these materials. There are high levels of global public concern about BSE. Physicians could determine not to administer Thrombin-JMI^® because of the perceived risk, which could adversely affect our sales of the product. Any injuries resulting from BSE contamination could expose us to extensive liability. If public concern for the risk of BSE infection in the United States should increase, the manufacture and sale of Thrombin-JMI^® and our business, financial condition, results of operations and cash flows could be materially and adversely affected.

 

The FDA expects manufacturers of biological products to have validated processes capable of removing extraneous viral contaminants to a high level of assurance. We have developed and implemented appropriate processing steps to achieve maximum assurance for the removal of potential extraneous viral contaminants

from Thrombin-JMI^®, which does not include BSE because it is not a viral contaminant, and we gained FDA approval for these processes. If we are unable to successfully maintain these processing steps or obtain the necessary supplies to do so in accordance with the FDA’s expectations, the manufacture and sale of Thrombin-JMI^® and our business, financial condition, results of operations and cash flows could be materially and adversely affected.

 

Wholesaler and distributor buying patterns and other factors may cause our quarterly results to fluctuate, and these fluctuations may adversely affect our short-term results. Further, our access to wholesaler and distributor inventory levels and sales data affects our ability to estimate certain reserves included in our financial statements.

 

Our results of operations, including, in particular, product sales revenue, may vary from quarter to quarter due to many factors. Sales to wholesalers and distributors represent a substantial portion of our total sales. Buying patterns of our wholesalers and distributors may vary from time to time. In the event wholesalers and distributors with whom we do business determine to limit their purchases of our products, sales of our products could be adversely affected. For example, in advance of an anticipated price increase, customers may order pharmaceutical products in larger than normal quantities. The ordering of excess quantities in any quarter could cause sales of some of our branded pharmaceutical products to be lower in subsequent quarters than they would have been otherwise. As part of our ongoing efforts to facilitate improved management of wholesale inventory levels of our branded pharmaceutical products, we have entered into inventory management and data services agreements with each of our three key wholesale customers and other wholesale customers. These agreements provide wholesalers incentives to manage inventory levels and provide timely and accurate data with respect to inventory levels held, and valuable data regarding sales and marketplace activity. We rely on the timeliness and accuracy of the data that each customer provides to us on a regular basis pursuant to these agreements. If our wholesalers fail to provide us with timely and accurate data in accordance with the agreements, our estimates for certain reserves included in our financial statements could be materially and adversely affected.

 

Other factors that may affect quarterly results include, but are not limited to, expenditures related to the acquisition, sale and promotion of pharmaceutical products, a changing customer base, the availability and cost of raw materials, interruptions in supply by third-party manufacturers, new products introduced by us or our competitors, the mix of products we sell, sales and marketing expenditures, product recalls, competitive pricing pressures and general economic and industry conditions that may affect customer demand. We cannot assure you that we will be successful in maintaining or improving our profitability or avoiding losses in any future period.

 

Our relationships with the U.S. Department of Defense and other government entities subject us to risks associated with doing business with the government.

 

All U.S. government contracts provide that they may be terminated for the convenience of the government as well as for default. Our Meridian Auto-Injector segment has pharmaceutical products that are presently sold primarily to the U.S. Department of Defense (“DoD”) under an Industrial Base Maintenance Contract (“IBMC”). The current IBMC expires in July 2008. Although we have reason to believe the DoD will renew the IBMC based on our relationship of many years, we cannot assure you that it will do so. In the event the DoD does not renew the IBMC, our business, financial condition, results of operations and cash flows could be materially adversely affected. Additionally, the unexpected termination of one or more of our significant government contracts could result in a material adverse effect on our business, financial condition, results of operations and cash flows. A surge capability provision allows for the coverage of defense mobilization requirements in the event of rapid military deployment. If this surge capability provision becomes operative, we may be required to devote more of our Meridian Auto-Injector segment manufacturing capacity to the production of products for the government, which could result in less manufacturing capacity being devoted to products in this segment with higher profit margins.

Our supply contracts with the DoD are subject to post-award audit and potential price determination. These audits may include a review of our performance on the contract, our pricing practices, our cost structure and our compliance with applicable laws, regulations and standards. Any costs found to be improperly allocated to a specific contract will not be reimbursed, while costs already reimbursed must be refunded. Therefore, a post-award audit or price redetermination could result in an adjustment to our revenues. From time to time the DoD makes claims for pricing adjustments with respect to completed contracts. If a government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeitures of profits, suspension of payments, fines and suspension or disqualification from doing business with the government.

 

Other risks involved in government sales include the unpredictability in funding for various government programs and the risks associated with changes in procurement policies and priorities. Reductions in defense budgets may result in reductions in our revenues. We also provide our nerve agent antidote auto-injectors to a number of state agencies and local communities for homeland defense against chemical agent terrorist attacks. Changes in governmental and agency procurement policies and priorities may also result in a reduction in government funding for programs involving our auto-injectors. A loss in government funding of these programs could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Compliance with the terms and conditions of our corporate integrity agreement with the Office of Inspector General of the United States Department of Health and Human Services requires significant resources and management time and, if we fail to comply, we could be subject to penalties or, under certain circumstances, excluded from government health care programs, which could materially reduce our sales.

 

In October 2005, as part of our settlement of the government pricing investigation of our company we entered into a five-year corporate integrity agreement (“CIA”) with the Office of Inspector General of the United States Department of Health and Human Services (“HHS/OIG”). For additional information, please see Note 19, “Commitments and Contingencies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.” The purpose of the CIA, which applies to all of our U.S. subsidiaries and employees, is to promote compliance with the federal health care and procurement programs in which we participate, including the Medicaid Drug Rebate Program, the Medicare Program, the 340B Drug Pricing Program, and the Veterans Administration Pricing Program.

 

In addition to the challenges associated with complying with the regulations applicable to each of these programs (as discussed below), we are required, among other things, to keep in place our current compliance program, provide specified training to employees, retain an independent review organization to conduct periodic audits of our Medicaid Rebate calculations and our automated systems, processes, policies and practices related to government pricing calculations, and to provide periodic reports to HHS/OIG.

 

Maintaining the broad array of processes, policies, and procedures necessary to comply with the CIA is expected to continue to require a significant portion of management’s attention as well as the application of significant resources. Failing to meet the CIA obligations could have serious consequences for us including stipulated monetary penalties for each instance of non-compliance. In addition, flagrant or repeated violations of the CIA could result in our being excluded from participating in government health care programs, which could materially reduce our sales.

 

Our shareholder rights plan, charter and bylaws discourage unsolicited takeover proposals and could prevent shareholders from realizing a premium on their common stock.

 

We have a shareholder rights plan that may have the effect of discouraging unsolicited takeover proposals. The rights issued under the shareholder rights plan would cause substantial dilution to a person or group which attempts to acquire us on terms not approved in advance by our Board of Directors. In addition, our charter

and bylaws contain provisions that may discourage unsolicited takeover proposals that shareholders may consider to be in their best interests. These provisions include:

 

 

We are also subject to anti-takeover provisions under Tennessee law, each of which could delay or prevent a change of control. Together these provisions and the rights plan may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock.

 

At times, our stock price has been volatile, and such volatility in the future could result in substantial losses for our investors.

 

The trading price of our common stock has at times been volatile. The stock market in general and the market for the securities of emerging pharmaceutical companies such as King, in particular, have experienced extreme volatility. Many factors contribute to this volatility, including:

 

 

The volatility of our common stock imposes a greater risk of capital losses on our shareholders than would a less volatile stock. In addition, such volatility makes it difficult to ascribe a stable valuation to a shareholder’s holdings of our common stock.

 

Risks Related to Our Industry

 

Failure to comply with laws and government regulations could adversely affect our ability to operate our business.

 

Virtually all of our activities are regulated by federal and state statutes and government agencies. The manufacturing, processing, formulation, packaging, labeling, distribution and advertising of our products, and

disposal of waste products arising from these activities, are subject to regulation by one or more federal agencies, including the FDA, the Drug Enforcement Agency, or “DEA,” the Federal Trade Commission, the Consumer Product Safety Commission, the Department of Agriculture, the Occupational Safety and Health Administration, and the Environmental Protection Agency (“EPA”), as well as by foreign governments in countries where we distribute some of our products.

 

Failure to comply with the policies or requirements established by these agencies could subject us to enforcement actions or other consequences. For example, noncompliance with applicable FDA policies or requirements could subject us to suspensions of manufacturing or distribution, seizure of products, product recalls, fines, criminal penalties, injunctions, failure to approve pending drug product applications or withdrawal of product marketing approvals. Similar civil or criminal penalties could be imposed by other government agencies, such as the DEA, the EPA or various agencies of the states and localities in which our products are manufactured, sold or distributed, and could have ramifications for our contracts with government agencies such as the Department of Veterans Affairs or the Department of Defense.

 

The FDA has the authority and discretion to withdraw existing marketing approvals and to review the regulatory status of marketed products at any time. For example, the FDA may require withdrawal of an approved marketing application for any drug product marketed if new information reveals questions about a drug’s safety or efficacy. All drugs must be manufactured in conformity with current Good Manufacturing Practices and drug products subject to an approved application must be manufactured, processed, packaged, held and labeled in accordance with information contained in the approved application.

 

While we believe that all of our currently marketed pharmaceutical products comply with FDA enforcement policies, have approval pending or have received the requisite agency approvals, our marketing is subject to challenge by the FDA at any time. Through various enforcement mechanisms, the FDA can ensure that noncomplying drugs are no longer marketed and that advertising and marketing materials and campaigns are in compliance with FDA regulations. In addition, modifications, enhancements, or changes in manufacturing sites of approved products are in many circumstances subject to additional FDA approvals which may or may not be received and which may be subject to a lengthy FDA review process. Our manufacturing facilities and those of our third-party manufacturers are continually subject to inspection by governmental agencies. Manufacturing operations could be interrupted or halted in any of those facilities if a government or regulatory authority is unsatisfied with the results of an inspection. Any interruptions of this type could result in materially reduced sales of our products or increased manufacturing costs. For additional information please see the section entitled “Government Regulation” in Item 1, “Business” in Part I.

 

Under the Comprehensive Environmental Response, Compensation, and Liability Act, “CERCLA,” the EPA can impose liability for the entire cost of cleanup of contaminated properties upon each or any of the current and former site owners, site operators or parties who sent waste to the site, regardless of fault or the legality of the original disposal activity. In addition, many states, including Tennessee, Michigan, Wisconsin, Florida and Missouri, have statutes and regulatory authorities similar to CERCLA and to the EPA. We have entered into hazardous waste hauling agreements with licensed third parties to properly dispose of hazardous wastes. We cannot assure you that we will not be found liable under CERCLA or other applicable state statutes or regulations for the costs of undertaking a cleanup at a site to which our wastes were transported.

 

We cannot determine what effect changes in regulations, enforcement positions, statutes or legal interpretations, when and if promulgated, adopted or enacted, may have on our business in the future. These changes could, among other things, require modifications to our manufacturing methods or facilities, expanded or different labeling, new approvals, the recall, replacement or discontinuance of certain products, additional record keeping and expanded documentation of the properties of certain products and scientific substantiation. These changes, new legislation, or failure to comply with existing laws and regulations could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

An increase in product liability claims or product recalls could harm our business.

 

We face an inherent business risk of exposure to product liability claims in the event that the use of our technologies or products is alleged to have resulted in adverse effects. These risks exist for products in clinical

development and with respect to products that have received regulatory approval for commercial sale. While we have taken, and will continue to take, what we believe are appropriate precautions, we may not be able to avoid significant product liability exposure. We currently have product liability insurance covering all of our significant products, however, we cannot assure you that the level or breadth of any insurance coverage will be sufficient to cover fully all potential claims. Also, adequate insurance coverage might not be available in the future at acceptable costs, if at all. With respect to any product liability claims that are not covered by insurance, we could be responsible for any monetary damages awarded by any court or any voluntary monetary settlements. Significant judgments against us for product liability for which we have no insurance could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Product recalls or product field alerts may be issued at our discretion or at the discretion of the FDA, other government agencies or other companies having regulatory authority for pharmaceutical product sales. From time to time, we may recall products for various reasons, including failure of our products to maintain their stability through their expiration dates. Any recall or product field alert has the potential of damaging the reputation of the product or our reputation. To date, these recalls have not been significant and have not had a material adverse effect on our business, financial condition, results of operations or cash flows. However, we cannot assure you that the number and significance of recalls will not increase in the future. Any significant recalls could materially affect our sales and the prescription trends for the products and damage the reputation of the products or our reputation. In these cases, our business, financial condition, results of operations and cash flows could be materially adversely affected.

 

If we fail to comply with our reporting and payment obligations under the Medicaid rebate program or other governmental pricing programs, we could be required to reimburse government programs for underpayments and could be required to pay penalties, sanctions and fines which could have a material adverse effect on our business.

 

Medicaid reporting and payment obligations are highly complex and in certain respects ambiguous. If we fail to comply with these obligations, we could be subject to additional reimbursements, penalties, sanctions and fines which could have a material adverse effect on our business. Our processes for estimating amounts due under Medicaid and other governmental pricing programs involve subjective decisions, and, as a result, these calculations will remain subject to the risk of errors.

 

The insolvency of any of our principal customers, who are wholesale pharmaceutical distributors, could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

As with most other pharmaceutical companies, our principal customers are primarily wholesale pharmaceutical distributors. The wholesale distributor network for pharmaceutical products has in recent years been subject to increasing consolidation, which has increased our, and other industry participants’, customer concentration. Accordingly, three key customers accounted for approximately 75% of our gross sales and a significant portion of our accounts receivable for the fiscal year ended December 31, 2007. The insolvency of any of our principal customers could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Any reduction in reimbursement levels by managed care organizations or other third-party payors may have an adverse effect on our revenues.

 

Commercial success in producing, marketing and selling branded prescription pharmaceutical products depends, in part, on the availability of adequate reimbursement from third-party health care payors, such as the government, private health insurers and managed care organizations. Third-party payors are increasingly challenging whether to reimburse certain pharmaceutical products and medical services. For example, many managed health care organizations limit reimbursement of pharmaceutical products. These limits may take the form of formularies with differential co-pay tiers. The resulting competition among pharmaceutical companies to maximize their product reimbursement has generally reduced growth in average selling prices across the industry. We cannot assure you that our products will be appropriately reimbursed or included on the formulary lists of managed care organizations or any or all Medicare Part D plans, or that downward pricing pressures in the industry generally will not negatively impact our operations.

We establish accruals for the estimated amounts of rebates we will pay to managed care and government organizations each quarter. Any increased usage of our products through Medicaid, Medicare, or managed care programs will increase the amount of rebates that we owe. We cannot assure you that our products will be included on the formulary lists of managed care or Medicare organizations or that adverse reimbursement issues will not result in materially lower revenues.

 

If we fail to comply with the safe harbors provided under various federal and state laws, our business could be adversely affected.

 

We are subject to various federal and state laws pertaining to health care “fraud and abuse,” including anti-kickback laws and false claims laws. Anti-kickback laws make it illegal for a prescription drug manufacturer to solicit, offer, receive, or pay any remuneration in exchange for, or to include, the referral of business, including the purchase or prescription of a particular drug. The federal government has published regulations that identify “safe harbors” or exemptions for certain payment arrangements that do not violate the anti-kickback statutes. We seek to comply with these safe harbors. Due to the breadth of the statutory provisions and the absence of guidance in the form of regulations or court decisions addressing some of our practices, it is possible that our practices might be challenged under anti-kickback or similar laws. False claims laws prohibit anyone from knowingly (in the civil context), or knowingly and willfully (in the criminal context), presenting, or causing to be presented for payment to third-party payors (including Medicaid and Medicare) claims for reimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed, or claims for medically unnecessary items or services.

 

Violations of fraud and abuse laws may be punishable by civil and/or criminal sanctions, including fines and civil monetary penalties, as well as the possibility of exclusion from federal health care programs, including Medicaid and Medicare. Any such violations could have a material adverse effect on our financial results.

 

In the future, the publication of negative results of studies or clinical trials may adversely affect the sales of our products or the values of the intangible assets associated with them.

 

From time to time studies or clinical trials on various aspects of pharmaceutical products are conducted by academics or others, including government agencies, the results of which, when published, may have dramatic effects on the markets for the pharmaceutical products that are the subject of the study, or those of related or similar products. The publication of negative results of studies or clinical trials related to our products or the therapeutic areas in which our products compete could adversely affect our sales, the prescription trends for our products and the reputation of our products. In the event of the publication of negative results of studies or clinical trials related to our branded pharmaceutical products or the therapeutic areas in which our products compete, sales of these products may be materially adversely affected. Additionally, potential write-offs of the intangible assets associated with the affected products could materially adversely affect our results of operations.

 

New legislation or regulatory proposals may adversely affect our revenues.

 

A number of legislative and regulatory proposals aimed at changing the health care system, including the cost of prescription products, importation and reimportation of prescription products from countries outside the United States and changes in the levels at which pharmaceutical companies are reimbursed for sales of their products, have been proposed and could be proposed in the future. While we cannot predict when or whether any of these proposals will be adopted or the effect these proposals may have on our business, these proposals, as well as the adoption of any other proposals, may exacerbate industry-wide pricing pressures and could have a material adverse effect on our business, financial condition, results of operations and cash flows. We are unable at this time to predict or estimate the effect of any such regulations, if any.

A WARNING ABOUT FORWARD-LOOKING STATEMENTS

 

This report includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to analyses and other information which are based on forecasts of future results and estimates of amounts that are not yet determinable. These statements also relate to our future prospects, developments and business strategies.

 

These forward-looking statements are identified by their use of terms and phrases, such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will” and other similar terms and phrases, including references to assumptions. These statements are contained in the “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections, as well as other sections of this report.

 

Forward-looking statements in this report include, but are not limited to, those regarding:

 

 

These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from those contemplated by our forward-looking statements. These known and unknown risks, uncertainties and other factors are described in detail in the “Risk Factors” section and in other sections of this report.

 

None.

 

 

The location and business segments served by our primary facilities are as follows:

 

 

We own each of these primary facilities, with the exception of a portion of the facilities in St. Louis, Missouri, which is leased. For information regarding production capacity and extent of utilization, please see Item 1, “Manufacturing.”

 

Our corporate headquarters and centralized distribution center are located in Bristol, Tennessee. We consider our properties to be generally in good condition, well maintained, and generally suitable and adequate to carry on our business.

 

We currently lease office space for our commercial operations organization located in Bridgewater, New Jersey, our research and development organization located in Cary, North Carolina, and our Meridian Auto-Injector business located in Columbia, Maryland.

 

 

Please see Note 19 “Commitments and Contingencies” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules” for information regarding material legal proceedings in which we are involved.

 

 

None.

 

 

 

The following table sets forth the range of high and low sales prices per share of our common stock for the periods indicated. Our common stock is listed on the New York Stock Exchange, where it trades under the symbol “KG.” There were approximately 954 shareholders of record on February 26, 2008.

 

 

 

On February 26, 2008 the closing price of our common stock as reported on the New York Stock Exchange was $11.03. For information regarding our equity compensation plans, please see Note 21, “Stock Based Compensation,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”

PERFORMANCE GRAPH

 

COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN

 

The graph below compares the cumulative total return of King’s common stock with the Standard & Poor’s 500 Index and a peer group index since December 31, 2002. It shows an investment of $100 on December 31, 2002. The peer group index includes United States pharmaceutical companies which trade on the NYSE.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
Among King Pharmaceuticals, Inc., The S&P 500 Index
And NYSE US SIC Code 2830-2839, Drugs

 

 

We have never paid cash dividends on our common stock. The payment of cash dividends is subject to the discretion of the Board of Directors and is limited by the terms of our credit facility. We currently anticipate that for the foreseeable future we will retain our earnings.

 

 

The table below should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our audited consolidated financial statements and related notes included elsewhere in this report.

 

 

 

 

 

 

The following discussion should be read in conjunction with the other parts of this report, including the audited consolidated financial statements and related notes. Historical results and percentage relationships set forth in the statement of income, including trends that might appear, are not necessarily indicative of future operations. Please see the “Risk Factors” and “Forward-Looking Statements” sections for a discussion of the uncertainties, risks and assumptions associated with these statements.

 

OVERVIEW

 

Our Business

 

We are a vertically integrated pharmaceutical company that performs basic research and develops, manufactures, markets and sells branded prescription pharmaceutical products. To capitalize on opportunities in the pharmaceutical industry, we seek to develop, in-license, acquire or obtain commercialization rights to novel branded prescription pharmaceutical products in attractive markets.

 

Our corporate strategy is focused on specialty-driven markets, particularly neuroscience, hospital and acute care. We believe each of our targeted markets has significant market potential and our organization is aligned accordingly. We work to achieve organic growth by maximizing the potential of our currently marketed products through sales and marketing and product life-cycle management. We also work to achieve organic growth through the successful development of new branded pharmaceutical products. Additionally, we seek to achieve growth through the acquisition or in-licensing of novel branded pharmaceutical products in various stages of development and technologies that have significant market potential that complement our neuroscience, hospital and acute care medicine platforms. We may also seek company acquisitions which add products or products in development, technologies or sales and marketing capabilities in our target markets or that otherwise complement our operations.

Utilizing our internal resources and a disciplined business development process, we strive to be a leader and partner of choice in developing and commercializing innovative, clinically-differentiated therapies and technologies in our target, specialty-driven markets.

 

Our business consists of five segments which include branded pharmaceuticals, Meridian Auto-Injector, royalties, contract manufacturing, and other. Our branded pharmaceutical products are divided into the following categories:

 

 

Our Meridian Auto-Injector segment includes EpiPen^®, a commercial product, and nerve gas antidotes which we provide to the U.S. Military. Our royalties segment relates to revenues we derive from successfully developed products that we have licensed to third parties.

 

Executive Summary

 

During 2007, we took many steps to better position us for long-term growth. With the unexpected early entry of generic competition for Altace^®, we accelerated the implementation of our planned strategic shift to focus on specialty-driven markets where we have core capabilities and assets. We also expanded our portfolio of marketed products and development pipeline and advanced projects in our development pipeline, with an emphasis in these markets.

 

Accelerated Strategic Shift

 

Following the Circuit Court’s decision in September 2007 invalidating our Altace^® patent, we conducted an extensive examination of our company and developed a restructuring initiative designed to accelerate a previously planned strategic shift emphasizing our focus on specialty-driven markets where we have core capabilities and assets, specifically the neuroscience, hospital and acute care markets. This initiative included 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. Pursuant to this initiative, we terminated approximately 20% of our workforce, primarily through a reduction in our sales force. We have incurred total costs of approximately $65.0 million associated with this initiative. We estimate that the 2008 selling, general and administrative expense savings from these actions will range from $75.0 million to $90.0 million.

 

New Generic Competition

 

In December 2007, a third party launched a generic substitute for our Altace^® capsules. This followed the decision of the U.S. Circuit Court of Appeals for the Federal Circuit (the “Circuit Court”) in September 2007 which declared invalid U.S. Patent No. 5,061,722 (the “722 Patent”) that covered our 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. We filed with the Circuit Court a petition for rehearing and rehearing en banc, but this petition was denied in December 2007. The Circuit Court issued the mandate to the District Court on December 10, 2007, beginning the 180-day Hatch-Waxman exclusive marketing period for the first generic competitor that has entered the market. Following this 180-day period of exclusivity, we anticipate additional competitors will enter the market. We launched a tablet formulation of Altace^® in February 2008.

Expanded Product Portfolio and Development Pipeline

 

Neuroscience

 

On February 26, 2007, we acquired all the rights to Avinza^® in the United States, its territories and Canada from Ligand Pharmaceuticals Incorporated (“Ligand”). 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.

 

In October 2007, we entered into a License, Development and Commercialization Agreement with Acura Pharmaceuticals, Inc. (“Acura”) to develop and commercialize certain immediate release opioid analgesic products utilizing Acura’s proprietary Aversion^® (abuse-deterrent/abuse-resistant) Technology in the United States, Canada and Mexico. The agreement provides us with an exclusive license for Acurox^tm (oxycodone HCl, niacin and a unique combination of other ingredients) tablets, and another undisclosed immediate release opioid product utilizing Acura’s Aversion^® Technology. In addition, the agreement provides us with an option to license all future opioid analgesic products developed utilizing Acura’s Aversion^® Technology. Acurox^TM tablets are intended to effectively treat moderate to moderately severe pain while discouraging common methods of abuse, including intravenous injection or oral consumption of tablets dissolved in liquids, nasal inhalation of crushed tablets and intentional swallowing of excessive numbers of tablets.

 

The agreement with Acura, which provides us with a wide range of immediate release opioids utilizing the Aversion^® Technology platform, complements our collaborative agreement with Pain Therapeutics, Inc. to develop and commercialize Remoxy^tm and other extended release, long-acting opioid painkillers that are also designed to resist common methods of abuse.

 

Hospital

 

Our product Thrombin-JMI^® is the market leading topical hemostat used to control bleeding during surgery. To better meet the needs of our customers and in anticipation of the recent entry of two new competitors, we introduced new Thrombin-JMI^® based products in 2007, broadening the range of delivery options.

 

In January 2007, we obtained an exclusive license to the hemostatic products designed by Vascular Solutions, Inc. for use outside catheterization and electrophysiology laboratories. This license includes products which we market as Thrombi-Pad^tm (3x3 hemostatic pad), the only composite of Thrombin-JMI^® and gauze pad, offering healthcare professionals in the emergency department a convenient option to achieve active hemostasis at bleeding sites where they would typically use trauma dressing, and Thrombi-Gel^® (thrombin/gelatin foam hemostat) which provides a convenient topical hemostat option. The license also includes a product we expect to market as Thrombi-Paste^tm, which is currently in development. Each of these products includes Thrombin-JMI^® as a component.

 

In June 2007, the U.S. Food and Drug Administration (“FDA”) approved our Thrombin-JMI^® Epistaxis Kit, a new intranasal spray delivery device for Thrombin-JMI^® for use to aid in stopping epistaxes (nosebleeds). The kit offers healthcare professionals in the emergency department and trauma center a convenient new option to achieve fast, active hemostasis during epistaxes. We began marketing the Thrombin-JMI^® Epistaxis Kit in the United States in the third quarter of 2007.

 

Beginning in 2008, Thrombin-JMI^®, our bovine thrombin, has new competition from human thrombin and recombinant human thrombin. Omrix Biopharmaceuticals, Inc.’s Biologics Licensing Application (“BLA”) for its human thrombin product was approved in September 2007. Zymogenetics, Inc. received approval of its BLA for recombinant human thrombin in January 2008. The presence of competing products in the marketplace may reduce net sales of Thrombin-JMI materially.

Our Research and Development Projects

 

Our current research and development pipeline includes several products in Phase III and late Phase II clinical trials, including immediate release and long-acting opioid products utilizing abuse-deterrent/abuse-resistant platform technologies pursuant to our collaborations with Pain Therapeutics and Acura.

 

Remoxy^tm and CorVue^tm have completed Phase III clinical trials. Remoxy^tm, a novel formulation of extended release, long-acting oxycodone for the treatment of moderate to severe chronic pain, is designed to resist common methods of abuse, such as crushing, heating, or dissolution in alcohol, that are reported with respect to currently available formulations of long-acting oxycodone. In December 2007, we, together with Pain Therapeutics, announced positive results from the pivotal Phase III clinical trial for Remoxy^tm. This trial met its primary endpoint, pain relief versus placebo, as prospectively defined by the FDA during the Special Protocal Assessment process. Pain Therapeutics plans to file a New Drug Application for Remoxy^tm with the FDA in the second quarter of 2008.

 

CorVue^tm (binodenoson) is a pharmacologic cardiac stress imaging agent intended to provide a reduced side effects profile compared to the currently approved product Adenoscan^®. We received positive results from our Phase III clinical trials for CorVue^tm and expect to file an NDA by early 2009.

 

Our products in Phase III of development include Acurox^tm and Vanquix^tm. Acurox^tm tablets are intended to effectively treat moderate to moderately severe acute pain while deterring or resisting common methods of prescription drug abuse, including intravenous injection or oral consumption of tablets dissolved in liquids, nasal inhalation of crushed tablets and intentional swallowing of excessive numbers of tablets. In early 2007, Acurox^tm tablets successfully completed a Special Protocol Assessment with the FDA. As a result, the pivotal Phase III clinical trial with Acurox^tm tablets in patients with moderate to severe pain commenced in September 2007 and we expect to report results in the second half of 2008.

 

Vanquix^tm is our diazepam-filled auto-injector that is currently under development as the only therapy of its kind for the treatment of acute, repetitive epileptic seizures.

 

Our Phase II compounds include Sonedenoson, formerly MRE-0094, an adenosine A2a receptor agonist for the topical treatment of chronic, neuropathic, diabetic foot ulcers, and T-62, an adenosine A1 allosteric enhancer that we are developing for the treatment of neuropathic pain. The Phase II clinical trial for Sonedenoson did not meet its primary endpoint. We are continuing to evaluate the data from this trial. We expect enrollment of patients in the Phase II clinical trial for T-62 to begin in the middle of 2008.

 

Rochester, Michigan Sterile Manufacturing Facility

 

In October 2007, we sold our Rochester, Michigan sterile manufacturing facility, some of our legacy products that are manufactured there and the related contract manufacturing business to JHP Pharmaceuticals, LLC (“JHP”) for $91.7 million, less selling costs of $5.4 million. This transaction resulted in a loss of $46.4 million. The companies also entered into a manufacturing and supply agreement pursuant to which JHP will provide to us certain filling and finishing manufacturing activities with respect to Thrombin-JMI^®. The sale did not include our stand-alone sterile penicillin production facility that is also located in Rochester, Michigan.

OPERATING RESULTS

 

The following table summarizes total revenues and cost of revenues by operating segment.

 

 

The following table summarizes our deductions from gross sales.

 

 

Gross sales were higher in 2007 compared to 2006 primarily due to the acquisition of Avinza^® on February 26, 2007, price increases taken during 2007 and an increase in gross sales of our Meridian Auto-Injector segment. These increases in gross sales were partially offset by a decline in prescriptions of certain of our branded pharmaceutical products during 2007.

 

Gross sales were higher in 2006 compared to 2005 primarily due to price increases, higher unit sales as a result of the effect of wholesale inventory reductions of some of our branded pharmaceutical products during 2005, particularly Altace^®, and an increase in gross sales of our Meridian Auto-Injector segment. These increases in gross sales were partially offset by a decline in prescriptions of certain of our branded pharmaceutical products during 2006.

Medicaid rebate expense was lower in 2006 than in 2005 primarily due to the Federal government shifting persons who were covered by the Medicaid Program to the Medicare Part D Program. During January 2006, the Medicare Prescription Drug Improvement and Modernization Act became effective, which provides outpatient prescription drug coverage to senior citizens and certain disabled citizens in the United States. We have contracts with organizations that administer the Medicare Part D Program, which require us to pay rebates based on contractual pricing and actual utilization under the plans. Initial enrollment in the Medicare Part D Program was open through the middle of the second quarter of 2006.

 

As part of our ongoing efforts to facilitate improved management of wholesale inventory levels of our branded pharmaceutical products, we have entered into inventory management and data services agreements with each of our three key wholesale customers and other wholesale customers. These agreements provide wholesalers incentives to manage inventory levels and provide timely and accurate data with respect to inventory levels held, and valuable data regarding sales and marketplace activity. We rely on the timeliness and accuracy of the data that each customer provides to us on a regular basis pursuant to these agreements. If our wholesalers fail to provide us with timely and accurate data in accordance with the agreements, our estimates for certain reserves included in our financial statements could be materially and adversely affected.

 

Based on inventory data provided by our key customers under the IMAs, we believe that wholesale inventory levels of Altace^®, Skelaxin^®, Thrombin-JMI^®, Avinza^® and Sonata^®, as of December 31, 2007, are at or below normalized levels. We estimate that the wholesale and retail inventories of our products as of December 31, 2007 represent gross sales of approximately $150.0 million to $160.0 million.

 

The following tables provide the activity and ending balances for our significant deductions from gross sales.

 

Accrual for Rebates, including Administrative Fees

 

 

Rebates include commercial rebates and Medicaid and Medicare rebates.

 

During the third quarter of 2005, we began reporting to the Centers for Medicare and Medicaid Services using a refined calculation to compute our Average Manufacturer’s Price (“AMP”) and Best Price. In addition, during the third quarter of 2005, we recalculated rebates due with respect to prior quarters utilizing the refined AMP and Best Price Calculations. As a result of this updated information, during the third quarter of 2005, we decreased our reserve for estimated Medicaid and other government pricing program obligations and increased net sales from branded pharmaceutical products by approximately $21.0 million, approximately $8.0 million of which related to years prior to 2005. This does not include the adjustment to sales classified as discontinued operations. As a result of the increase in net sales, the co-promotion expense related to net sales of Altace^® increased by approximately $6.0 million, approximately $4.0 million of which related to years prior to 2005. The effect of this change in estimate on operating income was, therefore, approximately $15.0 million, approximately $4.0 million of which related to years prior to 2005.

 

During the first quarter of 2006, we paid approximately $129.3 million related to (i) the settlement agreements with the Office of Inspector General of the United States Department of Health and Human Services (“HHS/OIG”) and the Department of Veterans Affairs, to resolve the governmental investigations related to our underpayment of rebates owed to Medicaid and other governmental pricing programs during the period from 1994 to 2002 and (ii) similar state settlement agreements. For a discussion regarding this settlement, please see “Settlement of Governmental Pricing Investigation” included in Note 19, “Commitments

and Contingencies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.” Of the $129.3 million paid in the first quarter of 2006, approximately $64.0 million reduced the rebate accrual and is reflected in “Rebates paid” in the table above.

 

In addition, during the first quarter of 2006, we delayed our regular periodic Medicaid rebate payments as a result of prior overpayments. During the second quarter of 2006, we began reducing our payments for Medicaid rebates to utilize overpayments made to the government related to Medicaid during the government pricing investigation in 2003, 2004 and 2005. During the period of the investigation, we made actual Medicaid payments in excess of estimated expense to avoid any underpayments to the government. As a result of refining the AMP and Best Price calculations in the third quarter of 2005, we discontinued the practice of making payments in excess of the amounts expensed. We expect to recover the remaining overpayments to the government and will continue to reduce cash payments in the future until this overpayment is fully recovered. For a discussion regarding this investigation, please see Note 19, “Commitments and Contingencies”, in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.” In 2007 and 2006, the utilization of overpayments reduced our rebate payments by approximately $6.5 million and $25.0 million, respectively. The utilization of the overpayment has therefore reduced “Rebates paid” in the table above.

 

During the third quarter of 2006, we reduced our Medicaid rebate expense and increased net sales from branded pharmaceutical products by approximately $9.3 million due to the determination that a liability established in 2005 for a government pricing program for military dependents and retirees was no longer probable.

 

Accrual for Returns

 

 

Our calculation for returns reserves is based on historical sales and return rates over the period during which customers have a right of return. We also consider current wholesale and retail inventory levels of our products. Based on data received from our inventory management agreements with our three key wholesale customers, there was a significant reduction of wholesale inventory levels of our products during the first quarter of 2005. This reduction resulted in a change in estimate during the first quarter of 2005 that decreased the reserve for returns by approximately $20.0 million and increased net sales from branded pharmaceuticals, excluding the adjustment to sales classified as discontinued operations, by the same amount. During the second quarter of 2005, we decreased our reserve for returns by approximately $5.0 million and increased our net sales from branded pharmaceuticals, excluding the adjustment for sales classified as discontinued operations, by the same amount as a result of an additional reduction in wholesale inventory levels of our branded products. These adjustments are reflected in the table above as a reduction in the current provision.

 

During the third quarter of 2005, our actual returns of branded pharmaceutical products continued to decrease significantly compared to actual returns during the quarterly periods in 2004 and the first quarter of 2005. Additionally, based on data received pursuant to our inventory management agreements with key wholesale customers, we continued to experience normalized wholesale inventory levels of our branded pharmaceutical products during the third quarter of 2005. Accordingly, we believed that the rate of returns experienced during the second and third quarters of 2005 was more indicative of what we expected in future quarters and adjusted our returns reserve accordingly. This change in estimate resulted in a decrease of approximately $15.0 million in the returns reserve in the third quarter of 2005 and a corresponding increase in net sales from branded pharmaceutical products. As a result of this increase in net sales, the co-promotion expense related to net sales of Altace^® increased by approximately $5.0 million. The effect of the change in estimate on operating income was, therefore, approximately $10.0 million.

Because actual returns related to sales in prior periods were lower than our original estimates, we recorded a decrease in our reserve for returns in each of the first quarter of 2007 and the first quarter of 2006. During the first quarter of 2007, we decreased our reserve for returns by approximately $8.0 million and increased our 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 $5.0 million. During the first quarter of 2006, we decreased our reserve for returns by approximately $8.0 million and increased our 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 $6.0 million. The “Accrual for Returns” table above reflects these adjustments as a reduction in the current provision.

 

Accrual for Chargebacks

 

 

Branded Pharmaceuticals Segment

 

 

Net sales from branded pharmaceutical products were higher in 2007 than in 2006 primarily due to the acquisition of Avinza^® on February 26, 2007 and price increases taken on various products. These increases in net sales were partially offset by a decline in prescriptions of certain of our branded pharmaceutical products during 2007. We expect net sales from branded pharmaceutical products in 2008 will be significantly lower than that experienced in 2007 primarily due to lower net sales of Altace^® for the reason discussed below.

 

Net sales from branded pharmaceutical products were higher in 2006 compared to 2005 primarily due to higher unit sales in 2006 as a result of the effects of wholesale inventory reductions in 2005 and price

increases taken in the fourth quarter of 2005, partially offset by a decrease in prescriptions in 2006 from 2005. In addition, net sales during 2005 reflect a reduction in reserves for returns and rebates as discussed above.

 

For a discussion regarding the potential risk of generic competition for Skelaxin^® and Avinza^®, please see Note 19 “Commitments and Contingencies” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”

 

Sales of Key Products

 

Altace^®

 

Net sales of Altace^® decreased in 2007 from 2006 primarily due to decreases in prescriptions, partially offset by price increases taken in the fourth quarter of 2006 and the third quarter and fourth quarters of 2007. Total prescriptions for Altace^® decreased approximately 7.1% in 2007 compared to the same period of the prior year according to IMS America, Ltd. (“IMS”) monthly prescription data.

 

In December 2007, a third party entered the market with a generic substitute for Altace^® capsules. Additional third parties will likely enter the market with their own generic substitutes for Altace^® capsules in 2008. As a result of the entry of generic competition, we expect net sales of Altace^® will decline significantly during 2008. We launched a tablet formulation of Altace^® in February 2008. For a discussion regarding the generic competition for Altace^®, please see Note 19, “Commitments and Contingencies” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”

 

Net sales of Altace^® were higher in 2006 than in 2005 primarily due to higher unit sales in 2006 as a result of the effects of wholesale inventory reductions of Altace^® in 2005 and a price increase taken in the fourth quarter of 2005 partially offset by a decrease in prescriptions in 2006 compared to 2005. In addition, net sales during 2005 reflect a reduction in reserves for returns and rebates as discussed above. Total prescriptions for Altace^® decreased approximately 2.2% in 2006 from 2005 according to IMS monthly prescription data.

 

Skelaxin^®

 

Net sales of Skelaxin^® increased in 2007 from 2006 primarily due to a price increase taken in the fourth quarter of 2006. During 2006, net sales of Skelaxin^® benefited from a reduction in the rebate reserve for a government pricing program for military dependents and retirees. During 2007, net sales of Skelaxin^® benefited from a favorable change in estimate in the products reserve for returns as discussed above. Total prescriptions for Skelaxin^® decreased approximately 1.6% in 2007 compared to 2006, according to IMS monthly prescription data. We do not anticipate that net sales of Skelaxin^® in 2008 will increase at the same rate experienced in 2007.

 

Net sales of Skelaxin^® increased in 2006 from 2005 primarily due to a price increase taken in the fourth quarter of 2005, higher unit sales in 2006 as a result of the effect of wholesale inventory reductions of Skelaxin^® in 2005 and a reduction in government rebates partially offset by a decline in prescriptions in 2006 compared to 2005. In addition, net sales during 2005 reflect a reduction in reserves for returns and rebates as discussed above. Total prescriptions for Skelaxin^® decreased approximately 2.1% in 2006 from 2005 according to IMS monthly prescription data.

 

For a discussion regarding the risk of potential generic competition for Skelaxin^®, please see Note 19 “Commitments and Contingencies” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”

 

Thrombin-JMI^®

 

Net sales of Thrombin-JMI^® increased in 2007 compared to 2006 primarily due to a price increase taken in the fourth quarter of 2006. A competing product entered the market in the fourth quarter of 2007 and another entered the market in the first quarter of 2008. It is likely that net sales of Thrombin-JMI^® will decrease as a result of the entry of these competing products.

Net sales of Thrombin-JMI^® increased in 2006 compared to 2005 primarily due to increases in wholesale inventory levels, a price increase taken in the second half of 2005 and an increase in demand by end users, partially offset by an increase in chargebacks during 2006 compared to 2005.

 

Avinza^®

 

We acquired all rights to Avinza^® in the United States, its territories and Canada on February 26, 2007. Net sales of Avinza^® in 2007 reflect sales occurring from February 26, 2007 through December 31, 2007. Total prescriptions for Avinza^® decreased approximately 16.4% in 2007 compared to 2006 according to IMS monthly prescription data. Due to an increase in promotion of Avinza^®, we do not believe prescriptions in 2008 for this product will decline from the level of prescriptions experienced in the fourth quarter of 2007 and we believe they may increase slightly.

 

For a discussion regarding the risk of potential generic competition for Avinza^®, please see Note 19, “Commitments and Contingencies” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”

 

Levoxyl^®

 

Net sales of Levoxyl^® decreased in 2007 compared to 2006 primarily due to a decrease in prescriptions in 2007 as a result of generic competition partially offset by the effect of an increase in wholesale inventory levels during 2007. During 2006, net sales of Levoxyl^® benefited from a favorable change in estimate of approximately $7.0 million in the product’s reserve for Medicaid rebates as a result of the government pricing investigation settlement, partially offset by a decrease in wholesale inventory levels. This benefit was substantially offset by increases in Medicaid rebate reserves for other products as a result of the settlement. Total prescriptions for Levoxyl^® were approximately 12.4% lower in 2007 compared to 2006 according to IMS monthly prescription data.          

 

Net sales of Levoxyl^® decreased in 2006 compared to 2005 primarily due to a decrease in prescriptions in 2006, partially offset by price increases taken in the fourth quarter of 2005 and changes in wholesale inventory levels. During 2005, net sales of Levoxyl^® benefited from the reduction in the reserve for returns described above and a reduction in the reserve for rebates. As noted above, 2006 net sales of Levoxyl^® benefited from a favorable change in estimate related to Medicaid rebates. Total prescriptions for Levoxyl^® were approximately 16.0% lower in 2006 than in 2005 according to IMS monthly prescription data.

 

Sonata^®

 

Net sales of Sonata^® were lower in 2007 than in 2006 primarily due to a decrease in prescriptions partially offset by a price increase taken in the fourth quarter of 2006. Total prescriptions for Sonata^® decreased approximately 20.4% compared to 2006 according to IMS monthly prescription data. The decrease in prescriptions during 2007 was primarily due to new competitors that entered the market in 2005 and a decrease in our promotional efforts. We believe net sales of Sonata^® will decline significantly in future periods due to the anticipated market entry of a generic substitute in the second quarter of 2008.

 

Net sales of Sonata^® were higher in 2006 than in 2005 primarily due to higher unit sales as a result of wholesale inventory reductions of Sonata^® in 2005 and price increases taken in the fourth quarter of 2005 and the third quarter of 2006, partially offset by a decrease in prescriptions during 2006 compared to 2005. Total prescriptions for Sonata^® decreased approximately 19.6% in 2006 from 2005 according to IMS monthly prescription data. The decrease in prescriptions during 2006 was primarily due to new competitors that entered the market in 2005.

 

Other

 

Net sales of other branded pharmaceutical products were higher in 2007 compared to 2006 primarily due to an increase in net sales of Bicillin^® and price increases which were partially offset by decreases in prescriptions. We completed construction of facilities to produce Bicillin^® at our Rochester, Michigan location, began commercial production in the fourth quarter of 2006, and replenished wholesale inventories of the

product during the first quarter of 2007. Our other branded pharmaceutical products are not promoted through our sales force and prescriptions for many of these products are declining. We completed the sale of several of our other branded pharmaceutical products to JHP Pharmaceuticals LLC on October 1, 2007. Considering all of these factors, we anticipate net sales of other branded pharmaceutical products will significantly decrease in 2008.

 

Net sales of other branded pharmaceutical products were higher in 2006 compared to 2005 primarily due to the effects of wholesale inventory reductions in 2005 and price increases which were partially offset by decreases in prescriptions.

 

Cost of Revenues

 

Cost of revenues from branded pharmaceutical products increased in 2007 from 2006 primarily due to an increase in royalties associated with Skelaxin^® and Avinza^® and the effects of special items in 2007 associated with Altace^® as discussed below.

 

Cost of revenues from branded pharmaceutical products increased in 2006 from 2005 primarily due to an increase in royalties associated with Skelaxin^®, the cost of revenues associated with higher unit sales of branded pharmaceutical products in 2006 compared to 2005, and differences in special items which benefited 2005 compared to 2006 as discussed below.

 

Special items are those particular material income or expense items that our management believes are not related to our ongoing, underlying business, are not recurring, or are not generally predictable. These items include, but are not limited to, merger and restructuring expenses; non-capitalized expenses associated with acquisitions, such as in-process research and development charges and inventory valuation adjustment charges; charges resulting from the early extinguishments of debt; asset impairment charges; expenses of drug recalls; and gains and losses resulting from the divestiture of assets. We believe the identification of special items enhances an analysis of our ongoing, underlying business and an analysis of our financial results when comparing those results to that of a previous or subsequent like period. However, it should be noted that the determination of whether to classify an item as a special item involves judgments by us.

 

Special items affecting cost of revenues from branded pharmaceuticals during 2007, 2006 and 2005 included the following:

 

 

We anticipate cost of revenues will decrease in 2008 compared to 2007 due to the launch of a generic substitute for Altace^® in December 2007 by a third party.

Meridian Auto-Injector Segment

 

 

Revenues from our Meridian Auto-Injector segment increased in 2007 compared to 2006 primarily due to increases in unit sales of Epipen^® to Dey, L.P., an increase in revenues derived from our acquisition of the rights to market and sell Epipen^® in Canada that we purchased from Allerex Laboratory LTD in March 2006 and a price increase taken in the first quarter of 2007. Most of our Epipen^® sales are based on our supply agreement with Dey, L.P., which markets, distributes and sells the product worldwide, except for Canada where it is marketed, distributed and sold by us. Revenues from the Meridian Auto-Injector segment fluctuate based on the buying patterns of Dey, L.P. and government customers. Demand for Epipen^® is seasonal as a result of its use in the emergency treatment of allergic reactions to insect stings or bites, more of which occur in the warmer months. With respect to auto-injector products sold to government entities, demand for these products is affected by the cyclical nature of procurements as well as response to domestic and international events. Total prescriptions for Epipen^® in the United States increased approximately 9.5% during 2007 compared to 2006 according to IMS monthly prescription data. We do not believe revenues from the Meridian Auto-Injector segment will increase at the rate experienced in 2007.

 

Revenues from the Meridian Auto-Injector segment increased in 2006 compared to 2005 primarily due to increases in unit sales of Epipen^® to Dey, L.P., as well as revenues derived from our acquisition of the rights to market and sell Epipen^® in Canada that we purchased from Allerex Laboratory LTD in March 2006. Total prescriptions for Epipen^® in the United States increased approximately 3.6% in 2006 compared to 2005 according to IMS monthly prescription data.

 

Cost of revenues from the Meridian Auto-Injector segment increased in 2007 compared to 2006 and in 2006 compared to 2005 primarily due to higher unit sales.

 

Royalties Segment

 

 

Revenues from royalties are derived primarily from payments we receive based on sales of Adenoscan^®. We are not responsible for the marketing of this product and, thus, are not able to predict whether revenue from royalties will increase or decrease in future periods. Additional branded competition may enter the market in 2008.

Contract Manufacturing Segment

 

 

Revenues and cost of revenues from contract manufacturing decreased in 2007 compared to 2006 due to a lower volume of units manufactured for third parties. As discussed above, we completed the sale of substantially all of our contract manufacturing business to JHP on October 1, 2007. Therefore, we anticipate a significant decrease in contract manufacturing revenue in 2008.

 

Revenues from contract manufacturing decreased in 2006 compared to 2005 due to a lower volume of units manufactured for third parties.

 

Cost of revenues associated with contract manufacturing decreased in 2007 compared to 2006 and in 2006 compared to 2005 primarily due to decreased unit production of products we manufacture for third parties.

 

Operating Costs and Expenses

 

Selling, General and Administrative Expenses

 

 

As a percentage of total revenues, total selling, general, and administrative expenses were 32.3% during 2007 and 35.9% in 2006 and 2005.

 

Total selling, general and administrative expenses decreased in 2007 compared to 2006, primarily due to a decrease in co-promotion fees we pay to Wyeth under our co-promotion agreement, partially offset by an increase in operating expenses associated with sales and marketing. The increases in sales and marketing expenses are driven by an increase in the size of our sales force and marketing costs primarily associated with Altace^® and Avinza^®. For the full year 2008, we expect selling, general and administrative expenses, exclusive of co-promotion fees, to decline by approximately $75.0 million to $90.0 million compared to full year 2007 as a result of the accelerated strategic shift discussed above. The co-promotion fee decreased in 2007 compared to 2006 due to a lower co-promotion fee average rate during 2007 as a result of the Amended Co-Promotion Agreement. For additional discussion regarding the Amended Co-Promotion Agreement, please see “General” within the “Liquidity and Capital Resources” section below. For a discussion regarding net sales of Altace^®, please see the section entitled “Altace^®” within the “Sales of Key Products” section above.

 

Total selling, general and administrative expenses increased in 2006 compared to 2005 primarily due to an increase in special items, stock-based compensation costs and an increase in operating expenses associated with sales and marketing. While Altace^® net sales were higher in 2006 compared to 2005, the co-promotion fee remained consistent due to a lower co-promotion fee average rate during 2006 as a result of the Amended Co-Promotion Agreement.

 

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment, using the modified prospective application transition method. Our prior period condensed consolidated financial statements have not been restated and therefore do not reflect the recognition of stock-based compensation costs. During 2007, we incurred stock-based compensation costs of $27.7 million, $19.8 million of which is included in selling, general and administrative expenses. During 2006, we incurred stock-based compensation costs of $21.1 million, $15.4 million of which is included in selling, general and administrative expenses.

 

In addition to the stock-based compensation costs discussed above, we recorded a charge of $3.6 million in the third quarter of 2006 to correct immaterial understatements of compensation expense identified in our voluntary review of our practices with respect to granting equity-based compensation. For additional information, please see Note 21, “Stock-Based Compensation,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”

 

Selling, general and administrative expense includes the following special items:

 

 

 

Research and Development Expense