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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

 

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, 2009 was $2,372,491,300. The number of shares of Common Stock, no par value, outstanding at February 23, 2010 was 248,472,497.

 

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 2010 annual meeting of shareholders.

 

 

Table of Contents

 

 

 

King Pharmaceuticals, Inc. (“King” or the “Company”) was incorporated in the State of Tennessee in 1993. Our principal executive offices are located at 501 Fifth Street, Bristol, Tennessee 37620. Our telephone number is (423) 989-8000.

 

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

 

 

Branded prescription pharmaceutical products are innovative products sold under a brand name that have, or previously had, some degree of market exclusivity. Our branded prescription pharmaceuticals include neuroscience products (primarily pain medicines), hospital products, and legacy brands, all of which are for use in humans. Our auto-injector business manufactures acute care medicines for use in humans that are delivered using an auto-injector. Our animal health business is focused on medicated feed additives (“MFAs”) and water-soluble therapeutics primarily for poultry, cattle, and swine.

 

Our corporate strategy is focused on specialty markets, particularly specialty-driven branded prescription pharmaceutical markets. We believe our target markets have significant potential and our organization is aligned to focus on these markets. Our growth in specialty markets is achieved through both acquisitions and organic growth. Our strategy focuses on growth through the acquisition of novel branded prescription pharmaceutical products and technologies that we believe complement the commercial footprint we have established in the neuroscience and hospital markets. We strive to be a leader in developing and commercializing innovative, clinically-differentiated therapies and technologies in these target, specialty-driven markets. We may also seek company acquisitions that add commercialized products or products in development, technologies or sales and marketing capabilities to our existing platforms or that otherwise complement our operations. We also have a commitment to research and development and advancing the products and technologies in our development pipeline.

 

We work to achieve organic growth by maximizing the potential of our currently marketed products through sales and marketing and product life-cycle management. By “product life-cycle management,” we mean the extension of the economic life of products, including seeking and obtaining necessary governmental approvals, by securing from the U.S. Food and Drug Administration (“FDA”) additional approved uses (“indications”) for our products, developing and producing different strengths, producing different package sizes, developing new dosage forms, and developing new product formulations.

 

We market our branded prescription pharmaceutical products, primarily through a dedicated sales force, to general/family practitioners, internal medicine physicians, neurologists, pain specialists, surgeons and hospitals across the United States and in Puerto Rico.

 

Through a team of internal sales professionals, our auto-injector business markets a portfolio of acute care auto-injector products to the pre-hospital emergency services market, which includes U.S. federal, state and local governments, public health services, emergency medical personnel and first responders and approved foreign governments.

 

Our animal health products of our wholly-owned subsidiary Alpharma Inc. (“Alpharma”) are marketed through a staff of trained sales and technical service and marketing employees, many of whom are veterinarians and nutritionists. Sales offices are located in the U.S., Europe, Canada, Mexico, South America

and Asia. Elsewhere, our animal health products are sold primarily through the use of distributors and other third-party sales companies.

 

Business Segments

 

Our business consists of four segments: a specialty-driven branded prescription pharmaceuticals business, our global animal health business, our Meridian auto-injector business, and royalties and other.

 

Segment Revenues

 

The following table summarizes revenues by operating segment. Note that the table includes revenues for the animal health segment and the Flector^® Patch product within the branded prescription pharmaceuticals segment for 2009 only since these were part of Alpharma, a company we acquired at the end of December 2008.

 

 

For additional financial information regarding each segment and the geographic areas in which we conduct business, see Note 20, “Segment Information” in Part IV, Item 15(a)(1) “Financial Statements.”

 

Branded Prescription Pharmaceuticals Segment

 

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

 

 

Our branded prescription pharmaceutical products are generally in high-volume markets, and we believe they are well known for their treatment indications. Branded prescription pharmaceutical products represented approximately 63%, 81% and 87% of our total net revenues for the years ended December 31, 2009, 2008, and 2007, respectively.

Our significant branded prescription pharmaceutical products are described below:

 

Revenues of certain of our significant branded prescription pharmaceutical products for the year ended December 31, 2009 are set forth below.

 

 

Animal Health Segment

 

Our animal health business is a global leader in the development, registration, manufacture and marketing of MFAs and water soluble therapeutics, primarily for poultry, cattle and swine.

 

In this business, we make anti-infectives that are added to the feed and water of livestock and poultry. The anti-infective market is comprised of the following categories:

 

 

In addition to anti-infectives, we also sell water soluble vitamins, minerals and electrolytes that are used as nutritional supplements primarily for poultry, cattle and swine, and non-medicated feed additives, disinfectants/cleaners and insecticides. The animal health business was part of Alpharma. Because we acquired Alpharma at the end of December 2008, the animal health segment is included in the financial results only for 2009 in this report.

 

Meridian Auto-Injector Segment

 

Our Meridian Auto-Injector segment manufactures and markets pharmaceutical products that are delivered using an auto-injector. 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 sold to both commercial and government customers.

 

The commercial pharmaceutical business of our Meridian Auto-Injector 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. Demand for EpiPen^® is seasonal as a result of its use in the emergency treatment of allergic reactions for both insect stings or bites, more of which occur in the warmer months, and food allergies, for which demand increases in the months preceding the start of a new school year.

Our Meridian Auto-Injector segment also includes pharmaceutical products that are sold primarily to the U.S. Department of Defense (“DoD”) under a 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, (“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. Demand for these products is affected by the cyclical nature of procurements as well as the occurrence of domestic and international events.

 

Royalties and other Segment

 

We developed a currently marketed adenosine-based product, Adenoscan^®, 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. We are party to an agreement under which Astellas Pharma US, Inc. (“Astellas”) manufactures and markets Adenoscan^® 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^® in certain countries other than the United States and Canada in exchange for royalties.

 

Royalties received by us from sales of Adenoscan^® 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.”

 

Recent Developments

 

For information regarding recent developments, see “Recent Developments,” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Industries

 

The global human pharmaceutical and animal health industries are highly competitive and each includes a variety of participants, including large and small branded pharmaceutical companies, specialty and niche-market human pharmaceutical and/or animal health 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, clinical efficacy, safety, convenience or ease of administration and cost-effectiveness. In order to promote their products, industry participants devote considerable resources to, as applicable, advertising, marketing and sales force personnel, distribution mechanisms and relationships with medical and research centers, physicians, patient advocacy and support groups, veterinarians, commercial animal food manufacturers, wholesalers and integrated cattle, swine and poultry producers.

 

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

 

 

 

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

 

 

Sales and Marketing

 

Branded Prescription Pharmaceuticals

 

The commercial operations organization for our branded prescription pharmaceuticals business, which includes sales and marketing, is based in Bridgewater, New Jersey. We have a sales force consisting of approximately 720 employees in the United States and Puerto Rico. We distribute our branded prescription pharmaceutical products primarily through wholesale pharmaceutical distributors. These products are ordinarily dispensed to the public through pharmacies as a result of prescriptions written by physicians and other licensed practitioners. Our marketing and sales promotions for branded prescription 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 by advertising in trade publications and representation at regional and national medical conventions. We identify and target physicians using data available from suppliers of prescriber prescription data.

 

Similar to other pharmaceutical companies, our principal customers for our branded prescription pharmaceutical products are wholesale pharmaceutical distributors. In recent years, the wholesale distributor network for branded prescription pharmaceutical products has been subject to increasing consolidation, which has increased our customer concentration and that of other industry participants. In addition, the number of independent drug stores and small chains has decreased as retail consolidation has occurred. For the year ended December 31, 2009, approximately 61% of our gross sales were attributable to three key wholesalers: Cardinal/Bindley (27%), McKesson Corporation (20%), and Amerisource Bergen Corporation (14%).

 

Animal Health

 

Our animal health products of our wholly owned subsidiary Alpharma are marketed through a staff of over 100 sales and technical service and marketing employees, many of whom are veterinarians and

nutritionists. Sales offices are located in the U.S., Europe, Canada, Mexico, South America and Asia. Elsewhere, our animal health products are sold primarily through the use of distributors and other third-party sales companies. Sales are made principally to commercial animal feed manufacturers, wholesalers and integrated cattle, swine and poultry producers.

 

Although the customer base for our animal health products is not significantly concentrated, consolidation is taking place. Accordingly, as consolidation continues, our animal health business may become more dependent on certain individual customers.

 

Meridian Auto-Injector

 

We have a supply agreement with Dey, L.P., in which we granted Dey the exclusive right to market, distribute, and sell EpiPen^® worldwide. We manufacture and supply EpiPen^® products to Dey at prices established under the agreement. Dey may determine the prices at which the products are sold to third parties. The agreement provides for minimum quantities to be purchased by Dey based upon prior purchase quantities and upon certain minimum rates of growth. These minimum quantities are subject to adjustment in the event of competition entering the market. We are entitled to receive, in connection with the sale of certain products by Dey, royalty payments equal to a low single-digit percentage of Dey’s net sales of these products. Because the conditions under which we receive these royalty payments were met in the fourth quarter of 2009, we will receive these payments going forward. The supply agreement expires December 31, 2015.

 

We also maintain the exclusive rights to market and sell EpiPen^® in Canada through 2015. Accordingly, through a team of sales professionals, we market EpiPen^® to allergists, pediatricians, internal medicine physicians, general practitioners and pharmacists across Canada.

 

Through a team of internal sales professionals, we market a portfolio of acute care auto-injector products to the pre-hospital emergency services market, which includes U.S. federal, state and local governments, public health agencies, emergency medical personnel and first responders and approved foreign governments.

 

Competition

 

Branded Prescription Pharmaceuticals

 

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 prescription pharmaceutical products may be subject to competition from alternate therapies during the period of patent protection and thereafter from generic equivalents.

 

Some of our branded prescription 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 prescription pharmaceutical product and the generic substitute are therapeutically equivalent. The manufacturers of generic products typically do not bear the 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.

 

The FDA requires that generic applicants claiming invalidity or non-infringement of patents listed by a new drug application (“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 are issued 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.

 

Animal Health Segment

 

Our animal health products compete in a highly competitive global market under the Alpharma brand name, customer service and price. Some of our competitors in the animal health industry offer a wide range of products with various therapeutic and production enhancing qualities. Some of the principal global competitors include Eli Lilly and Company (Elanco), Pennfield, Phibro Animal Health, Novartis and Huvepharma. Given our strong market position in MFAs and experience in obtaining requisite FDA approvals for combination claims, we believe we have a competitive advantage in marketing MFAs under the FDA approved combination clearances. No assurances can be given, however, that third parties will continue to cooperate in seeking combination approval for our products, and we expect additional entrants in the generic MFA market in the future. More than half of our animal health net sales are derived from products sold in the U.S., and we have a growing presence in Europe, Mexico, Canada, South America and Asia.

 

Meridian Auto-Injector Segment

 

In the commercial business of our Meridian Auto-Injector segment, we compete directly with companies that manufacture drug injection devices, whether such devices are automatic or non-automatic, variable dose pen-like injection devices, reloadable injection devices or disposable needle-free injection systems. EpiPen^® competes with other approved devices which administer epinephrine intramuscularly. EpiPen^® has not experienced a significant decline in market share as new competitors have entered the market. Additional competitors are expected to enter the market in the future.

 

Meridian is the sole supplier of auto-injectors to the U.S. government for military use and faces limited competition for auto-injector devices in U.S. and approved foreign markets.

 

Research and Development

 

Branded Prescription Pharmaceuticals and Meridian Auto-Injector Segments

 

We are engaged in the development of chemical compounds, including new chemical entities, which provide us with 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 by improving 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 formulation scientists, clinical development experts, medical affairs personnel, regulatory affairs experts, data scientists/statisticians and project managers.

 

We outsource a substantial portion of our research and development activities. This approach provides us with substantial operational flexibility while minimizing internal fixed costs. Using 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 efficacy 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 frequently 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 used 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:

 

 

For additional information regarding certain research and development projects, see “Recent Developments” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Animal Health Segment

 

Our animal health business development efforts focus on activities complementary to in-licensing and co-developing technology through third parties and expanding the geographic reach of our current product line

with new registrations in new jurisdictions. In addition, we conduct technical product development activities at our Willow Island, West Virginia; Chicago Heights, Illinois and Bridgewater, New Jersey facilities, as well as through contract research organizations and independent research facilities. We presently employ approximately 20 regulatory and development professionals in our animal health business.

 

Research and Development Expenses

 

Our research and development expenses totaled $98.7 million in 2009 compared to $145.2 million in 2008 and $149.4 million in 2007, excluding research and development in process at the time of acquisition of a product. These amounts also exclude research and development expenses incurred by Alpharma in 2008 and 2007 since it was not acquired until the end of December 2008. In-process research and development expenses were $598.5 million for the year ended December 31, 2008 and $35.3 million for the year ended December 31, 2007. In-process research and development represents the actual cost of acquiring rights to branded prescription pharmaceutical projects in development from third parties, which costs were expensed during 2008 and 2007 at the time of acquisition. The in-process research and development expenses in 2008 relate primarily to our acquisition of Alpharma on December 29, 2008.

 

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. Certain generic companies have challenged patents on Skelaxin^®, Avinza^® and EpiPen^®. Please see Note 19, “Commitments and Contingencies” in Part IV, Item 15(a)(1), “Financial Statements” for additional information.

 

Skelaxin^® has three method-of-use patents listed in the FDA’s Orange Book, two of which expire in December 2021 and the last of which expires in February 2026. On January 20, 2009, the U.S. District Court for the Eastern District of New York issued an order ruling invalid United States Patent Nos. 6,407,128 and 6,683,102, two patents relating to Skelaxin^®, our branded muscle relaxant. On June 4, 2009, the court entered final judgment against us. On July 1, 2009, we filed a notice of appeal to the Federal Circuit, and we filed our appeal brief with the Federal Circuit on November 23, 2009. We intend to vigorously defend our interests. In addition, in January 2008, we entered into an agreement with CorePharma, LLC 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.

 

Flector^® Patch has a formulation patent listed in the FDA’s Orange Book that expires in April 2014.

 

Embeda^® has several formulation patent applications pending. We received two notices of allowance from the United States Patent and Trademark Office in pending applications covering the Embeda^® formulation and its method of use in treating pain. Issue fees have been paid and we expect the patents to issue in due course. Once issued, we intend to list these patents in the FDA’s Orange Book.

 

Our Meridian Auto-Injector segment has a patent covering the next generation auto-injector (“NGA”) for use with epinephrine to be sold under the EpiPen^® brand name listed in the FDA’s Orange Book that expires in September 2025.

 

We receive royalties on sales of Adenoscan^®, a product that we developed. We have certain rights tied to a 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. (“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.

 

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 pre-existing license rights granted by Pain Therapeutics) to certain intellectual property rights related to opioid formulations, including Remoxy^®, which is currently in development for the treatment of moderate to severe chronic pain. In connection with our collaborative agreement with Acura, we have acquired a license to intellectual property rights related to the Aversion^® Technology platform. We have exclusive rights to patents related to CorVue^tm. We acquired certain intellectual property rights from Mutual Pharmaceutical Company, Inc. (“Mutual”) related to metaxalone, the active pharmaceutical ingredient in Skelaxin^®. As part of our acquisition of Alpharma, we have acquired rights to intellectual property related to several products in development. Finally, in connection with a collaboration agreement with Durect Corporation, we obtained rights to a bupivacaine patch (Eladur^®).

 

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 prescription pharmaceutical and animal health products registered in the United States and selected foreign countries.

 

Government Regulation

 

Branded Prescription Pharmaceuticals and Meridian Auto-Injector Segments

 

Our business and our products are subject to extensive and rigorous regulation. Pharmaceutical 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, (“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 Drug Enforcement Agency (“DEA”), a division of the Department of Justice (“DOJ”), 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 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 branded prescription 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 limitations on indications or stringent 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 branded prescription 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 of marketing rights to us. 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 prescription pharmaceutical products to other manufacturing facilities, which

may include manufacturing assets we own, after regulatory requirements are satisfied. In order to transfer manufacturing of acquired products, the prospective 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 (“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 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 associated with the use of our products by patients 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, initiate enforcement actions based on promotional materials that are false or misleading, 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.

 

Certain of the branded prescription pharmaceutical products we manufacture and sell 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 DOJ. 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, and in several states distributing samples of controlled substances to licensed practitioners is prohibited. The PDMA also imposes extensive licensing, personnel record keeping, packaging, labeling, product handling, 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 and the federal government 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.

Animal Health Segment

 

Our animal health business and products are subject to extensive and rigorous regulation by federal, state, local and foreign agencies. Additionally, our operations are subject to complex federal, state, local and foreign laws and regulations concerning the environment and occupational and health safety.

 

Animal drugs must be reviewed by and registered with the FDA for marketing in the United States and approved or registered by similar regulatory agencies in other countries, most notably those in Canada, the European Union (“EU”), Asia, Mexico and South America. Regulatory approvals for products to be used in food-producing animals are complex due to, among other things, the possible impact on humans. Government regulation of our animal health products includes detailed inspections of, and controls over, testing, manufacturing, safety, efficacy, labeling, storage, record keeping, reporting, approval, advertising, promotion, sale and distribution.

 

Approval also must be granted in the United States for the use of an animal drug in combination with other animal drugs in feeds. Such combination approvals generally require the cooperation of other manufacturers to consent to authorize the FDA to refer to such manufacturer’s New Animal Drug Application (“NADA”) in support of our regulatory submissions. This consent is necessary to obtain approval from the FDA for the use of an animal drug in combination with other animal drugs in feeds. To date, we have been successful in obtaining the cooperation of third parties to seek combination approval for many products, which extends the reach and potential market share of such products.

 

Manufacturing

 

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.

 

Branded Prescription Pharmaceuticals and Meridian Auto-Injector Segments

 

We manufacture certain of our own branded prescription pharmaceutical products at facilities located in Bristol, Tennessee; Rochester, Michigan; Middleton, Wisconsin; and St. Petersburg, Florida. Our Meridian Auto-Injector manufacturing facility is located in St. Louis, Missouri. These facilities have manufacturing, packaging, laboratory, office and warehouse space. We are licensed by the DEA to procure and produce controlled substances at our Bristol, Tennessee facility. We maintain an operational excellence program utilizing Six Sigma and lean manufacturing techniques to identify and execute cost-saving and process-improvement initiatives.

 

We are capable of producing a broad range of dosage forms, including injectables, tablets and capsules, creams and ointments. We believe this manufacturing versatility allows us to pursue drug development and product line extensions more efficiently. However, currently many of our product lines, including Embeda^® Skelaxin^®, Thrombin-JMI^®, Avinza^®, and Flector^® Patch are manufactured for us by third parties and there is currently no secondary manufacturer with the required regulatory approvals to manufacture these products. Our branded prescription pharmaceutical and Meridian Auto-Injector facilities generally operate at moderate capacity utilization rates except for the Bristol facility that currently has a low level of capacity utilization. Although the capacity utilization at our Bristol facility was lower in 2009 and 2008 than in previous years, 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 the second half of 2010, we will close our St. Petersburg facility. In addition, we plan to increase some of the utilization at our Bristol facility by manufacturing some of the new products we expect to emerge from our pipeline in the near future.

 

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.

Animal Health Segment

 

We produce our animal health products in several manufacturing facilities, including those located in Chicago Heights, Illinois, which contains a modern fermentation and recovery plant; Shenzhou, China; Yantai, China; Longmont, Colorado, which produces the majority of our soluble antibiotics and vitamins; Willow Island, West Virginia, which produces chlortetracycline (“CTC”) and lasalocid; Van Buren, Arkansas, which blends Bio-Cox^®; Salisbury, Maryland, which blends Avatec^® and Bovatec^®; and Eagle Grove, Iowa, which blends Aureomycin^® products. Process improvement and manufacturing development is performed primarily at the Chicago Heights, Willow Island and Shenzhou facilities. In addition, we make significant use of third-party facilities. Our animal health facilities generally operate at moderate capacity utilization rates except the Chicago Heights and Willow Island facilities, which currently have a high level of capacity utilization, and the Yantai facility, which currently has a low level of capacity utilization.

 

Environmental Matters

 

Our operations are subject to numerous and increasingly stringent federal, state, local and foreign 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 2009 and 2008, 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.

 

For more information about pending environmental matters, please see Note 19. “Commitments and Contingencies,” in Part IV, Item 15(a)(1), “Financial Statements.”

 

Backlog

 

There was no material backlog as of February 25, 2010.

 

Executive Officers

 

 

Brian A. Markison was elected 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 Company 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 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 company. 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.

 

James W. Elrod has served as King’s Chief Legal Officer/General Counsel since February 2006 and 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.

 

Stephen J. Andrzejewski has served as King’s Chief Commercial Officer since October 2005. He was previously Corporate Head, Commercial Operations, a position he held since 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 was responsible 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 King’s 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 President, Alpharma Animal Health since February 2009. Previously he 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 held 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.

 

Employees

 

As of February 23, 2010, we employed approximately 2,640 full-time and 9 part-time persons.

 

Available Information

 

Our website is www.kingpharm.com, where you may view our Corporate Code of Conduct and Ethics (“Code of Conduct”). 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 of Conduct and any waivers from provisions of the Code of Conduct 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, 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.

 

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 Businesses

 

The uncertainty and expense of the drug development process, actions by our competitors and regulatory agencies 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 the acquisition or in-licensing of products, either in development or previously approved by the FDA, that complement our business and allow 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.

 

Branded prescription pharmaceutical 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.

 

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 prescription 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 not face 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.

 

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.

 

If we cannot successfully defend our rights under the patents relating to our key products, such as Skelaxin^®, or if we are unable to secure or defend 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 affected 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 of or claiming non-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), “Financial Statements,” other companies have filed Paragraph IV certifications challenging the patents associated with some of our key products. For example, in January 2009, a U.S. District Court ruled invalid two key patents related to Skelaxin^® based on Paragraph IV challenges. We have appealed the judgment, but the appeal may be unsuccessful. 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.

 

We may not be successful in securing or maintaining proprietary patent protection for products we currently market 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. The appearance in the market of products developed in this way could materially reduce our sales.

 

There is no proprietary protection for many of our branded prescription 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 defend 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, we have inventory purchase commitments related to purchase orders and certain supply agreements which 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 inventory we have committed to purchase, we may incur losses in connection with those supply agreements or purchase orders.

 

An expansion of restrictions on, or bans of, the use of antibiotics used in food-producing animals could result in a decrease in our sales.

 

The issue of the potential transfer of increased bacterial resistance to human pathogens due to the use of certain antibiotics in certain food-producing animals is the subject of discussions on a worldwide basis and, in certain instances, has led to government restrictions on the use of antibiotics in these food-producing animals. The sales of our animal health segment are principally antibiotic-based products for use with food-producing animals; therefore, future limitations in major markets, including the U.S., or negative publicity regarding this

use of antibiotic-based products, could have a negative impact on our business, financial condition, results of operations and cash flows.

 

While most of the government activity in this area has involved products other than those that we offer for sale, the EU and a number of non-EU countries, including Norway and Turkey, banned the use of zinc bacitracin, a feed antibiotic growth promoter manufactured by us and others that has been used in livestock feeds for over 40 years. We have not sold this product as a feed additive growth promoter in these countries since the bans took effect (initially in the EU in July 1999; in Turkey, Bulgaria and Romania (the latter two now part of the EU) in 2000; and in Norway in January 2006). The EU ban is based upon the “Precautionary Principle,” which states that a product may be withdrawn from the market based upon a finding of a potential threat of serious or irreversible damage even if such finding is not supported by scientific certainty.

 

Taiwan, South Korea and Brazil have implemented, or are expected to implement shortly, restrictions on the use of antibiotics in animal feed. We have marketed antibiotics for use in food-producing animals in these countries but will be required to curtail or discontinue those practices. The actions by these countries may negatively impact our business as a result of reduced sales. It is not yet known whether this reduction will be material to our financial position or results of operations.

 

Discussions of the antibiotic resistance issue continue actively in the U.S. Various sources have published reports concerning possible adverse human effects from the use of antibiotics in food animals. Some of these reports have asserted that major animal producers, some of whom are our customers or the end-users of our products, are reducing the use of antibiotics.

 

In July 2009, FDA officials expressed support for a phase-out of growth promotion/feed efficiency uses of antibiotics in food-producing animals. Legislation pending before Congress would, if it were to become law, require the FDA to withdraw the approval of such nontherapeutic uses of antibiotics unless the FDA determines, within two years of enactment, that “there is a reasonable certainty of no harm to human health due to the development of antimicrobial resistance that is attributable in whole or in part to the nontherapeutic use of the drug” in food-producing animals. Under the proposed legislation, this finding may be based on evidence submitted by the holder of the approved product application or developed by the FDA on its own initiative. We cannot predict whether this legislation will become law or, if it does, whether the FDA would agree that this standard has been satisfied for bacitracin-based products.

 

In July 2005, the FDA withdrew the approval of an antibiotic poultry water medication due to concerns regarding antibiotic resistance in humans. While we do not market this drug, this ruling could be significant if its conclusions were expanded to the MFAs sold by us. In the absence of new legislation, it is uncertain what additional actions, if any, the FDA may take for approved animal drug products. However, the FDA has established guidance for the industry on how to prepare assessments comparing the risks associated with the use of specific antibiotic products in food producing animals, including those sold by us. While we do not believe that the current guidance would have a materially adverse effect on our business, it is subject to change.

 

We cannot predict whether the present ban of zinc bacitracin products may be expanded or whether other antibiotic restrictions will be introduced. If any one of the following events occurs, the resulting loss of sales could be material to our financial condition, cash flows and results of operations:

 

 

Potential adverse effects on human health linked to the raising or consumption of food-producing animals using our products could result in a decrease in our sales.

 

Should the government find, or the public perceive, a risk to human health from consumption of food-producing animals which utilize our products (such as Avian flu) or as a by-product to the raising of such animals, such as the “Chicken Litter” litigation, there may be a decline in either the sale of these food products, which would result in a decrease in the use of our products, or a decrease in the use of our products in the growing of these food-producing animals. For additional information regarding the “Chicken Litter” litigation, please see Note 19, “Commitments and Contingencies”, in Part IV, Item 15(a)(1), “Financial Statements”.

 

Unfavorable results in pending and future claims and litigation matters could have a material adverse effect on our business, results of operations, financial condition and cash flows.

 

We are named as a party in various lawsuits. For information about our pending material litigation matters, please see Note 19, “Commitments and Contingencies,” in Part IV, Item 15(a)(1), “Financial Statements.” 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 the pending litigation could otherwise have a material adverse effect on our business, results of operations, financial condition 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 processes and systems meet applicable 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 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 appropriate processes in support of 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.

 

The terms of our Revolving Credit Facility restricts, and other borrowing arrangements in the future could similarly restrict, our activities in various ways.

 

The Senior Secured Revolving Credit Facility (“Revolving Credit Facility”) contains certain covenants that, among other things, restrict additional indebtedness, liens and encumbrances, sale and leaseback transactions, loans and investments, acquisitions and purchases, dividends and other restricted payments, transactions with affiliates, asset dispositions, mergers and consolidations, prepayments, redemptions and repurchases of other indebtedness and other matters customarily restricted in such agreements.

 

The Revolving Credit Facility also contains customary events of default, including, without limitation, payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to certain other material indebtedness in excess of specified amounts, certain events of bankruptcy and insolvency, certain ERISA events, judgments in excess of specified amounts, certain impairments to the guarantees, and change in control. The breach of any covenants or obligations under the Revolving Credit Facility could result in a default which could trigger acceleration of (or the right to accelerate) the related debt. In addition, our lenders would be entitled to proceed against the collateral securing the indebtedness. If any of our indebtedness were to be accelerated, it could adversely affect our ability to operate our business or we may be unable to repay such debt, and, therefore, such acceleration could adversely affect our results of operations, financial condition and, consequently, the price of our common stock.

We may enter into other borrowing arrangements in the future which impose restrictions on us similar to, or more restrictive than, the terms of the Revolving Credit Facility.

 

For more information about the terms of the Revolving Credit Facility, please see Note 13, “Long Term Debt,” in Part IV, Item 15(a)(1), “Financial Statements”.

 

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 products, including Embeda^®, Skelaxin^®, the Flector^® Patch, Thrombin-JMI^®, Avinza^® and certain animal health products and ingredients, are currently manufactured in part or entirely by third parties. In addition, many of these products are produced by manufacturers for which there is no secondary manufacturer with the required regulatory approvals. Our dependence upon third parties for the manufacture of certain 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 is 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.

 

Further, if we encounter other delays or difficulties in producing or packaging products either handled by third parties or by us, 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 third-party 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.

 

We are subject to the risks of doing business outside of the United States.

 

Future growth rates and success of our animal health and auto-injector businesses depend in part on continued growth in our operations outside of the United States. In the case of animal health, we have both sales and manufacturing operations outside the United States and numerous risks and uncertainties affect those operations. These risks and uncertainties include political and economic instability, changes in local governmental laws, regulations and policies, including those related to tariffs, investments, taxation, employment regulations, repatriation of earnings, enforcement of contract and intellectual property rights and currency exchange fluctuations and restrictions.

 

International transactions may also involve increased financial and legal risks due to differing legal systems and customs, including risks of non-compliance with U.S. and local laws such as the U.S. Foreign Corrupt Practices Act, the U.S. Arms Export Control Act and the International Traffic in Arms Regulations.

 

While the impact of these factors is difficult to predict, any of them could adversely affect our business, financial condition, operating results or cash flows. If we were to violate U.S. or local laws, we may be subject to fines, penalties, other costs, loss of ability to do business with the U.S. government or other business-related effects which could adversely affect our business, financial condition, results of operations and cash flows.

 

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, which could result in a material adverse effect on our business, financial condition and results of operations.

 

As of December 31, 2009, we had approximately $1.3 billion 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 federal or state anti-trust laws. Alternatively, courts could interpret these laws in a manner contrary to current understandings of and past rulings relating to 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 materially 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 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.

 

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, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

For the year ended December 31, 2009, our product Thrombin-JMI^® accounted for 10.3% of our total revenues. 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 about 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 that potential extraneous viral contaminants are removed 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.

 

Our charter and bylaws and applicable state laws discourage unsolicited takeover proposals and could prevent shareholders from realizing a premium on their common stock.

 

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 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.

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 a 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), “Financial Statements.” 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 corporate 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 noncompliance. In addition, flagrant or repeated violations of the CIA could result in our being excluded from participating in government health care programs, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Risks Related to Our Industries

 

New legislation or regulatory proposals may adversely affect our revenues, our business, financial condition, results of operations and cash flows.

 

A number of legislative and regulatory proposals have been proposed and could be proposed in the future that are broadly aimed at health care reform. Such reform could involve easing safeguards that limit importation and reimportation of prescription products from countries outside the United States, providing preferential treatment to manufacturers of generic pharmaceutical products, imposing additional and possibly conflicting reporting requirements on prescription pharmaceutical companies, reducing the level at which pharmaceutical companies are reimbursed for sales of their products, altering the requirements applicable to health care insurance, and requiring significant monitoring initiatives by manufacturers in an attempt to reduce the misuse and abuse of controlled substances.

 

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 and other similar 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.

 

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 U.S. federal and state statutes and government agencies as well as laws and agencies in foreign countries. The manufacturing, processing, formulation, packaging, labeling, distribution and marketing 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 DEA, the FTC, the Consumer Product Safety Commission, the Department of Agriculture, the Occupational Safety and Health

Administration, and the EPA, as well as by foreign governments in countries where we manufacture or distribute 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 DoD.

 

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 problems with a drug’s safety or efficacy. All drugs must be manufactured in conformity with cGMPs 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.

 

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.

 

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 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.

 

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.

 

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 healthcare 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 healthcare 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.

 

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 majority 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 branded prescription pharmaceutical products in larger than normal quantities. The ordering of excess quantities in any quarter could cause sales of some of our branded prescription pharmaceutical products to be lower in subsequent quarters than they would have been otherwise. We have inventory management and data services agreements with each of the three key branded prescription pharmaceutical products wholesale customers and other wholesale customers who purchase our branded prescription pharmaceutical products. 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, interruptions in our internal manufacturing processes, 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.

 

An increase in product liability claims or product recalls could harm our business and our financial condition, results of operations and cash flows could be materially adversely affected.

 

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, but 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.

 

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 prescription pharmaceutical products or the therapeutic areas in which our products compete, sales of these products may be materially adversely affected.

 

The insolvency of, or decreased purchasing by, 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, the primary customers for our branded prescription pharmaceutical products 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. Accordingly, three key customers accounted for approximately 61% of our gross sales and a significant portion of our accounts receivable for the fiscal year ended December 31, 2009. The insolvency of or decreased purchasing by any of our principal customers could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

 

None.

 

 

Our primary facilities, which serve the principal purposes and business segments indicated below are as follows:

 

 

We own each of these primary facilities, with the exception of the facility in Van Buren, Arkansas, which is leased, the facility in Willow Island, West Virginia, which is subject to a ground lease, and a portion of the facilities in St. Louis, Missouri, which is leased. For information regarding production capacity and extent of utilization, please see “Manufacturing” in Part I, Item 1, “Business.”

 

Our principal executive offices and centralized branded prescription pharmaceuticals 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 branded prescription pharmaceutical commercial operations organization and our animal health operations located in Bridgewater, New Jersey, our branded prescription pharmaceutical research and development organization located in Cary, North Carolina, and our Meridian Auto-Injector business located in Columbia, Maryland. We also lease office space and warehouse facilities for the use of our animal health operations in the U.S. and elsewhere.

 

 

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

 

 

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 NYSE, where it trades under the symbol “KG.” There were approximately 795 shareholders of record on February 23, 2010.

 

 

 

On February 24, 2010, the closing price of our common stock as reported on the NYSE was $11.56. For information regarding our equity compensation plans, please see Note 21, “Stock-Based Compensation,” in Part IV, Item 15(a)(1), “Financial Statements.”

PERFORMANCE GRAPH

 

COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN

 

The following graph compares the cumulative five-year total return provided shareholders on King’s common stock relative to the cumulative total returns of the S&P 500 Index and the NYSE US SIC Code 2830-2839, Drug index. An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our common stock and in each of the indexes on December 31, 2004 and its relative performance is tracked through December 31, 2009.

 

COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN

Among King, the S&P 500 Index

and NYSE US SIC Code 2830-2839, Drug

 

 

 

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

 

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 Revolving 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.

 

 

 

 

 

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. You should not unduly rely on our forward-looking statements.

 

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.

 

 

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 and animal health products. By “vertically integrated,” we mean that we have the following capabilities:

 

 

Branded prescription pharmaceutical products are innovative products sold under a brand name that have, or previously had, some degree of market exclusivity. Our branded prescription pharmaceuticals include neuroscience products (primarily pain medicines), hospital products, and legacy brands, all of which are for use in humans. Our auto-injector business manufactures acute care medicines for use in humans that are delivered using an auto-injector. Our animal health business is focused on medicated feed additives (“MFAs”) and water-soluble therapeutics primarily for poultry, cattle, and swine.

 

Our corporate strategy is focused on specialty markets, particularly specialty-driven branded prescription pharmaceutical markets. We believe our target markets have significant potential, and our organization is aligned to focus on these markets. Our growth in specialty markets is achieved through both acquisitions and organic growth. Our strategy focuses on growth through the acquisition of novel branded prescription pharmaceutical products and technologies that we believe complement the commercial footprint we have established in the neuroscience and hospital markets. We strive to be a leader in developing and commercializing innovative, clinically-differentiated therapies and technologies in these target, specialty-driven markets. We may also seek company acquisitions that add commercialized products or products in development, technologies or sales and marketing capabilities to our existing platforms or that otherwise complement our operations. We also have a commitment to research and development and advancing the products and technologies in our development pipeline.

 

We work to achieve organic growth by maximizing the potential of our currently marketed products through sales and marketing and product life-cycle management. By “product life-cycle management,” we mean the extension of the economic life of products, including seeking and obtaining necessary governmental approvals, by securing from the U.S. Food and Drug Administration (“FDA”) additional approved uses for our products, developing and producing different strengths, producing different package sizes, developing new dosage forms, and developing new product formulations.

 

We market our branded prescription pharmaceutical products, primarily through a dedicated sales force, to general/family practitioners, internal medicine physicians, neurologists, pain specialists, surgeons and hospitals across the United States and in Puerto Rico.

 

Through a team of internal sales professionals, our auto-injector business markets a portfolio of acute care auto-injector products to the pre-hospital emergency services market, which includes U.S. federal, state and local governments, public health services, emergency medical personnel and first responders and approved foreign governments.

 

Our animal health products of our wholly-owned subsidiary Alpharma Inc. (“Alpharma”) are marketed through a staff of trained sales and technical service and marketing employees, many of whom are veterinarians and nutritionists. Sales offices are located in the U.S., Europe, Canada, Mexico, South America and Asia. Elsewhere, our animal health products are sold primarily through the use of distributors and other third-party sales companies.

 

Recent Developments

 

Embeda^®

 

In August 2009, the FDA approved Embeda^® (morphine sulfate and naltrexone hydrochloride) Extended Release Capsules, a long-acting Schedule II opioid analgesic for the management of moderate to severe pain when a continuous, around-the-clock opioid analgesic is needed for an extended period of time. Embeda^® contains pellets of an extended-release oral formulation of morphine sulfate, an opioid receptor agonist, surrounding an inner core of naltrexone hydrochloride, an opioid receptor antagonist. When Embeda^® is used as directed, the inner core of naltrexone remains sequestered and passes through the body without any clinical effect. When Embeda^® is tampered by crushing or chewing, the naltrexone is released and can antagonize the effects of the morphine. Embeda^® is the first FDA-approved long-acting opioid designed to reduce drug liking and euphoria when tampered with by crushing or chewing. However, the clinical significance of the degree of reduction in drug liking and euphoria reported in clinical studies has not yet been established. There is no evidence that the naltrexone in Embeda^® reduces the abuse liability of Embeda^®. Embeda^® became commercially available in late September 2009.

 

On October 8, 2009, we received a warning letter from the FDA, Division of Drug Marketing, Advertising, and Communications (“DDMAC”) regarding certain materials used to announce the commercial launch of Embeda^®. The letter indicated these materials were false or misleading because they omitted and minimized the risks associated with the use of Embeda^®, failed to present the limitations to its approved indication, and presented misleading claims. We ceased the dissemination of these materials and took steps to conform other materials we currently utilize with Embeda^® to the guidance set forth in the warning letter. On October 16, 2009, we responded to the warning letter, providing DDMAC with a list of materials that were discontinued and a comprehensive plan of action to appropriately disseminate corrective messages to those that received the original materials. We continue to cooperate fully with DDMAC in this matter. We met with members of the FDA on December 22, 2009 to discuss the warning letter. During January 2010 we submitted to DDMAC for pre-approval proposed revised marketing materials, as well as certain corrective materials.

 

Remoxy^®

 

In early July 2009, we met with the FDA to discuss the Complete Response Letter received by us in December 2008 regarding our New Drug Application (“NDA”) for Remoxy^®. The outcome of this meeting provided us with a clearer path forward to resubmit the Remoxy^® NDA and to address all FDA comments in the Complete Response Letter. We believe the timing of the resubmission will be determined principally by the generation of six-month stability data. We are not required by the FDA to conduct clinical trials in order to provide additional safety or efficacy data in patients with moderate to severe chronic pain. As part of the resubmission plan, and in order to strengthen the NDA, we have undertaken a likeability study and a pharmacokinetic trial in volunteers. We plan to resubmit the NDA in the fourth quarter of 2010.

Remoxy^® is a unique long-acting formulation of oral oxycodone with a proposed indication for the management of moderate to severe pain when a continuous, around-the-clock, opioid analgesic is needed for an extended period of time. This formulation uses the Oradur^tm platform technology, which provides a unique physical barrier that is designed to provide controlled pain relief and at the same time resist certain common methods used to extract the opioid more rapidly than intended as can occur with products currently on the market that are abused in this way for non-medical purposes. Common methods used to cause a rapid extraction of an opioid include crushing, chewing and dissolution in alcohol. These methods are typically used to cause failure of the controlled release dosage form, resulting in “dose dumping” of oxycodone, or the immediate release of the active drug so as to achieve a state of euphoria.

 

Acurox^® Tablets

 

On June 30, 2009, the FDA issued a Complete Response Letter regarding the NDA for Acurox^® Tablets. The Complete Response Letter raises issues regarding the potential abuse deterrent benefits of Acurox^®. In early September 2009, we and Acura Pharmaceuticals, Inc. (“Acura”) met with the FDA to discuss the Complete Response Letter. The FDA, Acura and we agreed to submit the NDA to an FDA advisory committee to consider the evidence to support the potential abuse deterrent effects of Acurox^® Tablets when compared to other currently marketed short-acting oxycodone opioid products. While the FDA indicated that no new clinical trials are required at this time, we and Acura are conducting an additional clinical study in volunteers to further assess the abuse deterrent features of Acurox^®. The FDA has set a meeting date for the Advisory Committee’s review of the NDA in the second quarter of 2010.

 

Acurox^® Tablets, a patented, orally administered, immediate release tablet containing oxycodone HCl as its sole active analgesic ingredient, has a proposed indication for the relief of moderate to severe pain. Acurox^® uses Acura’s patented Aversion^® Technology, which is designed to deter misuse and abuse by intentional swallowing of excess quantities of tablets, intravenous injection of dissolved tablets and nasal snorting of crushed tablets. Attempts to extract oxycodone from an Acurox^® Tablet by dissolving it in liquid result in the formation of a viscous gel which is intended to limit the ability to inject the drug intravenously. Crushing an Acurox^® Tablet for the purposes of nasal snorting releases an ingredient that is intended to cause nasal irritation and thereby discourage this method of misuse and abuse. Swallowing excessive numbers of Acurox^® Tablets releases niacin in quantities that are intended to cause unpleasant and undesirable side effects.

 

CorVue^tm (binodenoson) for Injection

 

In December 2008, we submitted an NDA for CorVue^tm to the FDA. On October 19, 2009, we received a Complete Response Letter from the FDA with respect to the NDA for Corvue^tm. We are currently working on our reply to the FDA’s Complete Response Letter. CorVue^tm is a cardiac pharmacologic stress agent for use as an adjunct in SPECT (single-photon-emission computed tomographic) cardiac imaging intended for use in patients with or at risk for coronary artery disease who are unable to perform a cardiac exercise stress test.

 

Department of Justice Investigation

 

As previously disclosed, Alpharma, acquired by us in December 2008, received a subpoena from Department of Justice (“DOJ”) in February 2007 in connection with its investigation of alleged improper sales and marketing practices related to the sale of the pain medicine Kadian^®. We divested Alpharma’s Kadian^® assets to Actavis LLC simultaneously with the closing of the acquisition of Alpharma.

 

In September 2009, we reached an agreement in principle with the U.S. Attorney’s Office and DOJ which would, if completed, resolve this investigation. We recorded a reserve of $42.5 million in connection with this development in the third quarter of 2009 as an adjustment to the goodwill associated with the purchase of Alpharma because evaluation of the DOJ investigation and the allocation period associated with this preacquisition contingency was still in progress through that time. Final agreement is subject to the execution of a definitive settlement agreement.

OPERATING RESULTS

 

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

 

 

The following table summarizes our deductions from gross revenues.

 

 

Gross revenues increased in 2009 compared to 2008, primarily due to additional sales from Alpharma, which we acquired at the end of December 2008; gross revenues of Embeda^®, which we began selling in late September 2009 after the product received FDA approval in August 2009; and an increase in revenues in the Meridian Auto-Injector segment. Gross revenues of several key branded prescription pharmaceuticals products decreased due to market competition, as discussed below. We anticipate gross revenues in 2010 will be similar to those in 2009.

 

Gross revenues were lower in 2008 compared to 2007 primarily due to a decrease in gross revenues of Altace^®, partially offset by increases in gross revenues of Avinza^®, which we acquired on February 26, 2007, and the Meridian Auto-Injector segment. During December 2007, a competitor entered the market with a generic substitute for Altace^® and additional generic competitors entered the market in June 2008.

 

We maintain inventory management and data services agreements (“IMAs”) with each of our three key branded prescription 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 affected.

 

Based on inventory data provided by our key customers under the IMAs, we believe that wholesale inventory levels of Skelaxin^®, Thrombin-JMI^®, Flector^® Patch, Avinza^®, and Levoxyl^®, as of December 31, 2009, are at or below levels we consider normal. We estimate that the wholesale and retail inventories of all our products as of December 31, 2009 represent gross revenues of approximately $125.0 million to $135.0 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 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 use these overpayments. 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. 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. In 2009, 2008 and 2007, the utilization of overpayments reduced our rebate payments by approximately $20.7 million, $25.3 million, and $6.5 million, respectively. The utilization of the overpayment has therefore reduced “Rebates paid” in the table above.

 

A competitor entered the market with a generic substitute for Altace^® during December 2007 and additional competitors entered the market in June 2008. As a result of this competition, sales of Altace^® and use of Altace^® by rebate-eligible customers decreased in 2008 and 2009. The decrease in use of Altace^® by rebate-eligible customers has, in turn, significantly decreased the “current provision related to sales made in the current period” and “rebates paid” in the table above. For a discussion regarding Altace^® net sales, please see “Altace^®” within the “Sales of Key Products” section below.

 

Accrual for Returns

 

Our calculation for product return 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.

 

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 the first quarter of 2007. During the first quarter of 2007, we decreased our reserve for returns by approximately $8.0 million and increased our net sales from branded prescription 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. The “Accrual for Returns” table above reflects this adjustment as a reduction in the current provision.

 

Accrual for Chargebacks

 

 

Branded Prescription Pharmaceuticals Segment

 

 

Net sales from branded prescription pharmaceutical products were lower in 2009 than in 2008 primarily due to lower net sales of Altace^®, Thrombin-JMI^® and Skelaxin^®, discussed below, partially offset by sales of Flector^® Patch and Embeda^®. Flector^® Patch was part of the acquisition of Alpharma at the end of 2008. Embeda^® was approved by the FDA in August 2009, and we began selling the product in late September 2009. We expect net sales from branded prescription pharmaceutical products to decrease in 2010 from 2009 levels primarily due to anticipated decreases in sales of several of our key products, discussed below, partially offset by an anticipated increase in net sales of Embeda^® and Flector^® Patch.

Net sales from branded prescription pharmaceutical products were lower in 2008 than in 2007 primarily due to a decrease in net sales of Altace^®, partially offset by increases in net sales of Avinza^®, which we acquired on February 26, 2007. During December 2007, a competitor entered the market with a generic substitute for Altace^® and additional competitors entered the market in June 2008.

 

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), “Financial Statements.”

 

Sales of Key Products

 

Skelaxin^®

 

On January 20, 2009, the U.S. District Court for the Eastern District of New York issued an order ruling invalid two patents related to Skelaxin^®. In June 2009, the Court entered judgment against King. We have appealed the judgment and plan to vigorously defend our interests. The entry of the Court’s order may lead to generic versions of Skelaxin^® entering the market sooner than previously anticipated, which would likely cause net sales of Skelaxin^® to decline significantly.

 

Net sales of Skelaxin^® decreased in 2009 from 2008 primarily due to a decrease in prescriptions, partially offset by price increases taken in the fourth quarter of 2008 and the second quarter of 2009. Primarily due to a decrease in promotional efforts, total prescriptions for Skelaxin^® decreased approximately 19.8% in 2009 from 2008, according to IMS America, Ltd. (“IMS”) monthly prescription data. Following the January 2009 court order, we completed a restructuring initiative that reduced our promotional efforts. For additional information regarding the restructuring initiative, please see “Skelaxin^®” within the “Liquidity and Capital Resources” section below. We expect net sales of Skelaxin^® will continue to decrease during 2010 as a result of the decrease in promotional efforts. We anticipate significant decreases in net sales if generic competition enters the market.

 

Net sales of Skelaxin^® increased in 2008 from 2007 primarily due to a price increase taken in the fourth quarter of 2007 and decreases in wholesale inventory levels during 2007, partially offset by a decrease in prescriptions. During 2007, net sales of Skelaxin^® benefited from a favorable change in estimate during the first quarter of 2007 in the product’s reserve for returns as discussed above. Due to increased competition, total prescriptions for Skelaxin^® decreased approximately 11.9% in 2008 compared to 2007 according to IMS monthly prescription data.

 

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.

 

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), “Financial Statements.”

 

Thrombin-JMI^®

 

Net sales of Thrombin-JMI^® decreased in 2009 compared to 2008 and in 2008 compared to 2007 primarily due to price concessions and the market entry of two competing products which caused a decrease in gross sales. The first competing product entered the market in the fourth quarter of 2007 and another entered the market in the first quarter of 2008. We expect net sales of our Thrombin-JMI^® product to decrease in 2010 as a result of competition.

 

Flector^® Patch

 

Flector^® Patch was part of the acquisition of Alpharma at the end of December 2008. Alpharma began selling Flector^® Patch in January 2008. Total prescriptions for Flector^® Patch increased approximately 42.6% in 2009 compared to the launch year of 2008, according to IMS monthly prescription data. We anticipate prescriptions to increase in 2010 from 2009; however, we do not believe prescriptions will increase at the rate experienced in 2009. At the time of acquisition, the wholesale inventory level of Flector^® Patch exceeded our

normal levels. During the first quarter of 2009, we reduced these inventories to a level consistent with our other promoted products. As a result, net sales of Flector^® Patch were lower than prescription demand in 2009.

 

Avinza^®

 

Net sales of Avinza^® decreased in 2009 compared to 2008 primarily due to a decrease in prescriptions, partially offset by price increases taken in the first and fourth quarters of 2009. Total prescriptions for Avinza^® decreased approximately 9.7% in 2009 compared to 2008 according to IMS monthly prescription data. We expect net sales of Avinza^® to decrease at a higher rate in 2010 than in 2009.

 

Net sales of Avinza^® increased in 2008 compared to 2007 primarily due to a price increase taken in the fourth quarter of 2007, an increase in prescriptions and the fact that net sales of Avinza^® in 2007 only reflect sales occurring from February 26, 2007 through December 31, 2007. We acquired all rights to Avinza^® in the United States, its territories and Canada on February 26, 2007. Total prescriptions for Avinza^® increased approximately 3.4% in 2008 compared to 2007 according to IMS monthly prescription data.

 

On March 24, 2008, we received a letter from DDMAC regarding promotional material for Avinza^® that was created and submitted to the DDMAC by Ligand Pharmaceuticals Incorporated (“Ligand”) (the company from which we acquired Avinza^® in late February 2007). The letter expressed concern with the balance of the described risks and benefits associated with the use of the product and the justification for certain statements made in the promotional material. We had already discontinued the use of promotional materials created by Ligand prior to receiving the letter and communicated this information to DDMAC. In addition, DDMAC requested support for certain statements included in Avinza^® promotional materials which were then in use. We promptly responded to this request and asked for a meeting with DDMAC to discuss this matter.

 

Our request resulted in a teleconference with DDMAC representatives on January 6, 2009. After this call, we immediately ceased the dissemination of promotional materials for Avinza^® that included any statements with which DDMAC took issue in its March 24, 2008 letter. Further, we directed our sales representatives to discontinue the use of such materials and ceased all advertising containing the statements discussed in that letter. We have taken the additional corrective actions agreed upon with DDMAC.

 

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), “Financial Statements.”

 

Embeda^®

 

In August 2009, the FDA approved Embeda^® (morphine sulfate and naltrexone hydrochloride) Extended Release Capsules, a long-acting Schedule II opioid analgesic for the management of moderate to severe pain when a continuous, around-the-clock opioid analgesic is needed for an extended period of time. We began selling Embeda^® in late September 2009, and we anticipate net sales of Embeda^® to increase significantly in 2010.

 

Sales of Other Products

 

Levoxyl^®

 

Net sales of Levoxyl^® decreased in 2009 compared to 2008 primarily due to a decrease in prescriptions, partially offset by price increases taken in the fourth quarter of 2008. In addition, net sales of Levoxyl^® in 2008 were decreased as a result of decreases in the wholesale inventory levels in the first quarter of 2008. Total prescriptions for Levoxyl^® decreased approximately 11.5% in 2009 compared to 2008 according to IMS monthly prescription data. We anticipate net sales for Levoxyl^® will decline in 2010 due to decreasing prescriptions.

Net sales of Levoxyl^® decreased in 2008 compared to 2007 primarily due to a decrease in prescriptions as a result of generic competition. In addition, net sales of Levoxyl^® decreased as a result of decreases in the wholesale inventory levels in the first quarter 2008. These decreases in 2008 were partially offset by a price increase taken in the fourth quarter of 2007. Total prescriptions for Levoxyl^® decreased approximately 11.1% in 2008 compared to 2007 according to IMS monthly prescription data.

 

Altace^®

 

Net sales of Altace^® decreased significantly in 2009 from 2008 and in 2008 from 2007 primarily due to a competitor entering the market in December 2007, and additional competitors entering the market in June 2008, with generic substitutes for Altace^®. As a result of the entry of generic competition, we expect net sales of Altace^® to continue to decline in the future. Total prescriptions for Altace^® decreased approximately 82.3% in 2009 compared to 2008 and 74.5% in 2008 compared to 2007 according to IMS monthly prescription data.

 

For a discussion regarding the generic competition for Altace^®, please see Note 3, “Invalidation of Altace^® Patent” in Part IV, Item 15(a)(1), “Financial Statements.”

 

Other

 

Other branded prescription pharmaceutical products are not promoted through our sales force, and prescriptions for many of our products included in this category are declining. Net sales of other branded pharmaceutical products were lower in 2009 compared to 2008 primarily due to lower net sales of Sonata^® and Cytomel^® and a decrease in prescriptions. Net sales of other branded prescription pharmaceutical products were lower in 2008 compared to 2007 primarily due to the sale of several of our other branded prescription pharmaceutical products to JHP Pharmaceuticals LLC (“JHP”) on October 1, 2007, and lower net sales of Sonata^® and Bicillin^®.

 

Net sales of Sonata^® were lower in 2009 compared to 2008 and in 2008 compared to 2007 primarily due to competition entering the market with generic substitutes for Sonata^®. The composition of matter patent covering Sonata^® expired in June 2008, at which time several competitors entered the market with generic substitutes. Net sales of Sonata decreased to $4.0 million in 2009 from $31.2 million in 2008 and $78.7 million in 2007.

 

In April 2009, a third party entered the market with a generic substitute for Cytomel^®. As a result of the entry of generic competition, net sales declined in 2009 and we expect net sales of Cytomel^® to continue to decline in the future. Net sales of Cytomel^® decreased from $51.1 million in 2008 to $34.1 million in 2009.

 

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. As a result of this replenishment, we believe that net sales of Bicillin^® in 2007 exceeded demand. Prior to the first quarter of 2007, Bicillin^® was in short supply.

 

As a result of generic competition for Cytomel^® and declining demand for many other products included in this category, we anticipate net sales of other branded prescription pharmaceutical products will continue to decline in 2010.

 

Cost of Revenues

 

Cost of revenues from branded prescription pharmaceutical products decreased in 2009 compared to 2008 primarily due to a decrease in unit sales of several key products, as discussed above, partially offset by additional cost of revenues for Flector^® Patch, which was part of the acquisition of Alpharma at the end of December 2008 and the addition of Embeda^®, which we began selling in late September 2009.

 

The royalty rate on Skelaxin^® increased in the second quarter of 2009 due to the achievement of certain regulatory milestones under our agreement with Mutual. For additional information on the Mutual agreement, please see “Other” within the “Liquidity and Capital Resources” section below.

Cost of revenues from branded prescription pharmaceutical products decreased in 2008 from 2007 primarily due to lower unit sales of Altace^® and the sale of several of our other branded prescription pharmaceutical products to JHP on October 1, 2007, partially offset by an increase in unit sales of Avinza^® due to the acquisition of this product on February 26, 2007.

 

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, 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 prescription pharmaceuticals during 2009, 2008 and 2007 included the following:

 

 

We anticipate cost of revenues will decrease in 2010 compared to 2009 primarily due to a decrease in unit sales of several branded prescription pharmaceutical products, as discussed above.

 

Animal Health

 

 

The Animal Health segment was part of the acquisition of Alpharma at the end of December 2008.

 

At the time of the acquisition of Alpharma, we valued the inventory that was acquired based on the accounting requirements for business combinations. As a result, we increased the carrying value of the Animal Health inventory by approximately $34 million. During 2009, the cost of revenues for the Animal Health segment reflect charges of $34.1 million related to the sale of this marked-up inventory.

Meridian Auto-Injector

 

 

Revenues and cost of revenues from our Meridian Auto-Injector segment increased in 2009 compared to 2008 primarily due to higher unit sales of EpiPen^®, as well as higher unit sales of product sold to various government agencies. Revenues and cost of revenues from our Meridian Auto-Injector segment increased in 2008 compared to 2007 primarily due to higher unit sales of products sold to various government agencies and higher unit sales of EpiPen^®.

 

Revenues from government entities were unusually high in 2008 and 2009. With respect to auto-injector products sold to government entities, demand for these products is affected by the timing of procurements which can be affected by preparedness initiatives and responses to domestic and international events.

 

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 for both insect stings or bites, more of which occur in the warmer months, and food allergies, for which demand increases in the months preceding the start of a new school year. Most of our EpiPen^® sales are based on our supply agreement with Dey, L.P., which markets, distributes and sells the product worldwide, except for Canada, where it is marketed, distributed and sold by us. Revenues from Epipen^® in the United States increased in 2009 from 2008 and from 2008 compared to 2007 primarily due to an increase in prescriptions. Total prescriptions for Epipen^® in the United States increased approximately 9.5% in 2009 compared to 2008 and increased approximately 6.4% in 2008 compared to 2007 according to IMS monthly prescription data.

 

We anticipate revenues from our Meridian Auto-Injector segment in 2010 will approximate revenues in 2009.

 

Royalties and other 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.

 

On April 10, 2008, CV Therapeutics, Inc. and Astellas Pharma US, Inc. (“Astellas”) announced that the FDA approved regadenoson injection, an A2A adenosine receptor agonist product that competes with Adenoscan^®. Regadenoson has been commercialized by Astellas. Astellas is also responsible for the marketing and sale of Adenoscan^® pursuant to agreements we have with Astellas. With the commercial launch of regadenoson, sales of Adenoscan and our royalty revenue have declined and may continue to decline.

However, our agreements with Astellas provide for minimum royalty payments to King of $40.0 million per year for three years (beginning June 1, 2008 and ending May 31, 2011). Therefore, we will continue to receive royalties on the sale of Adenoscan^® through expiration of the patents covering the product, although the minimum guaranteed portion of the royalty payments would terminate upon certain events, including a finding of invalidity or unenforceability of the patents related to Adenoscan^®.

 

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.

 

Operating Costs and Expenses

 

 

Selling, General and Administrative Expenses

 

 

As a percentage of total revenues, total selling, general, and administrative expenses were 30.9%, 28.6% and 32.3% during 2009, 2008 and 2007, respectively.

 

Total selling, general and administrative expenses increased in 2009 compared to 2008 primarily due to the acquisition of Alpharma in late December of 2008, partially offset by a decrease in co-promotion expenses for fees that we pay to Wyeth under our Amended and Restated Co-Promotion Agreement (the “Amended Co-Promotion Agreement”) and a decrease in expenses due to a restructuring initiative related to Skelaxin^®. The decrease in co-promotion expense is due to a decrease in Altace^® net sales and the lower percentage of net sales of Altace^® that we paid Wyeth in 2009 compared to 2008 under the Amended Co-Promotion Agreement. The decrease in expenses resulted from our restructuring initiative following the January 2009

court order ruling invalid two patents relating to Skelaxin^®. Our senior management team conducted an extensive examination of our company and developed a restructuring initiative following this ruling. The initiative included, based on an analysis of our strategic needs: a reduction in sales, marketing and other personnel; leveraging of staff; expense reductions and additional controls over spending; and reorganization of sales teams.

 

Total selling, general and administrative expenses decreased in 2008 compared to 2007, primarily due to a decrease in co-promotion expenses for fees that we pay to Wyeth under our Amended Co-Promotion Agreement and a decrease in operating expenses. The decrease in co-promotion expenses is due to a decrease in Altace^® net sales and the lower percentage of net sales of Altace^® that we paid Wyeth in 2008 compared to 2007 under the Amended Co-Promotion Agreement. Following a court’s decision in September 2007 invalidating a patent that covered Altace^®, our senior management team conducted an extensive examination of our company and developed a restructuring initiative. 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. As a result of these actions, we reduced selling, general and administrative expenses, exclusive of co-promotion fees in 2008 compared to 2007.

 

For additional discussion regarding the Amended Co-Promotion Agreement, please see “Other” within the “Liquidity and Capital Resources” section below. For a discussion regarding net sales of Altace^®, please see “Altace^®” within the “Sales of Other Products” section above.

 

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

 

 

Research and Development Expense

 

 

Research and development represents expenses associated with the ongoing development of investigational drugs and product life-cycle management projects in our research and development pipeline, which primarily consists of branded prescription pharmaceutical products. These expenses decreased in 2009 compared to 2008 primarily due to milestone payments made in 2008. During 2008, we recorded as an expense and paid to Pain Therapeutics, milestone payments of $5.1 million associated with the acceptance of an investigational new drug application and $15.8 million associated with the acceptance of the NDA filing for Remoxy^® by the FDA. We also recorded as an expense and paid a $5 million milestone to Acura associated with positive top-line results from the Phase III clinical trial evaluating Acurox^® Tablets. For a discussion regarding recent research and development activities, please see “Recent Developments” above.

Research and development — in-process upon acquisition represents the actual cost of acquiring rights to novel branded prescription pharmaceutical projects in development from third parties, which costs were expensed during 2008 and 2007 at the time of acquisition. Each of the in-process research and development projects are part of the branded prescription pharmaceuticals segment. We classified these costs as special items, and in 2008 and 2007, special items included the following:

 

 

The $32.0 million of payments made to Acura were recognized as in-process research and development expense during 2007. This amount was expensed because the in-process research and development project had not received regulatory approval and had no alternative future use. An NDA for Acurox^® Tablets was submitted to the FDA in December 2008. On June 30, 2009, the FDA issued a Complete Response Letter regarding the NDA for Acurox^® Tablets. The Complete Response Letter raises issues

regarding the potential abuse deterrent benefits of Acurox^®. The success of the project depends on approval by the FDA. We anticipate resubmitting the NDA following the FDA Advisory Committee meeting expected to be held in the second quarter of 2010. The estimated cost to complete the project at the execution of the agreement was approximately $9.0 million.

 

 

Depreciation and Amortization Expense

 

Depreciation and amortization expense increased in 2009 compared to 2008 primarily due to an increase in amortization expense associated with Skelaxin^® and an increase in depreciation and amortization expense associated with Alpharma, which we acquired in late December 2008, partially offset by a decrease in amortization expense associated with Altace^®.

 

Following the U.S. District Court’s order ruling invalid two Skelaxin^® patents on January 20, 2009, we estimated the potential effect on future net sales of the product. We believe that the intangible assets associated with Skelaxin^® are not currently impaired based on estimated undiscounted cash flows associated with these assets. However, as a result of the order described above, we reduced the estimated remaining useful life of the intangible assets of Skelaxin^® during 2009. The amortization expense associated with Skelaxin^® increased to $82.9 million in 2009 from $23.6 million in 2008. If our current estimates regarding future cash flows adversely change, we may have to further reduce the estimated remaining useful life and/or write off a portion or all of these intangible assets. As of December 31, 2009, the net intangible assets associated with Skelaxin^® total approximately $42.4 million.

 

Following a court’s decision in September 2007 invalidating our ‘722 patent that covered Altace^®, we undertook an analysis of the potential effect on future net sales of the product. Based upon this analysis, we reduced the estimated remaining useful life of Altace^®. Accordingly, amortization of the remaining intangibles associated with Altace^® was completed during the first quarter of 2008. The amortization expense associated with Altace^® during the first quarter of 2008 was $29.7 million.

 

Depreciation and amortization expense decreased in 2008 compared to 2007 primarily due to a decrease in amortization associated with Altace^®, partially offset by increases in amortization associated with Skelaxin^® and Avinza^®, as discussed below. In addition, the decrease in depreciation and amortization expense during 2008 was partially attributable to the cessation of depreciation and amortization associated with the Rochester, Michigan sterile manufacturing facility that we sold in October 2007.

 

In January 2008, we entered into an agreement with CorePharma providing CorePharma with the right to launch an authorized generic version of Skelaxin^® pursuant to a license in December 2012, or earlier under certain conditions. As a result, we decreased the estimated useful life of Skelaxin^®, which had the effect of increasing amortization in 2008 compared to 2007. Additionally, on February 26, 2007, we completed our acquisition of Avinza^® and began amortizing the associated intangible assets as of that date. On June 30, 2007, the assets associated with the sale of the Rochester, Michigan sterile manufacturing facility were classified as held for sale, and accordingly the depreciation and amortization was discontinued as of that date.

 

For additional information about the sale of the Rochester, Michigan facility and the acquisition of Avinza^®, please see Note 9, “Acquisitions, Dispositions, Co-Promotions and Alliances,” in Part IV, Item 15(a)(1), “Financial Statements.” For additional information relating to the Altace^® intangible assets, please see Note 10, “Intangible Assets and Goodwill,” in Part IV, Item 15(a)(1), “Financial Statements.”

 

Depreciation and amortization expense in 2009, 2008 and 2007 includes a special item consisting of $1.0 million, $2.6 million and $7.0 million, respectively, associated with accelerated depreciation on certain assets, including those associated with our decision to transfer the production of Levoxyl^® from our