Case

KV Pharmaceutical Company (KVa and KVb)

Case outline

 

KV Pharmaceutical Company is a relatively small drug company (with 455 employees in 1999) manufacturing primarily generic drugs (i.e. 80% of revenue in 1999 and 1998) and concentrating in methods of delivery of medications (e.g. taste masking, ease of absorption, derma-patches). Sales growth has taken off at an annual compounded rate of 29% for the past four years, compared to the previous six years when sales grew by only 4.5% annually. The growth has produced record breaking profits for the past two years. The early years were difficult years marked by repeated losses, and accumulated deficits that were only extinguished in 1998. Debt to equity ratio deteriorated to two to one by 1995. KV had also accrued cumulative preferred stock dividends in excess of $ 2.2 millions, which remain undeclared in 1999.

In 1999, KV is changing its strategy by creating a Ther-Rx subsidiary which will handle branded rather than generic products. As part of this shift, KV acquired world rights to Micro-K, a potassium supplement capsule from American Home Products for $ 36 millions. Micro-K offers a promise of generating over $ 18 millions of revenue per year. Although the annual report puts great emphasis research into new products, the strategy shift seems also to indicate a decrease in own research and development at the expense of acquired products. R&D averaged 12% of revenues in the early years, peaking in 1994 at 15%. Since then, R&D declined to 6% of revenues for the last two years. The previously noted impressive profits are actually somewhat inflated by an arbitration award of $12 millions (for a supplier's failure to deliver certain products on time). Yet, notwithstanding the arbitration award, the 1999 profits are all the more impressive because prices on generic drugs have been dropping in the late 1990's. KV achieved its profit feat by selling a larger proportion of the higher priced product line.

To finance its difficult years, KV relied on a line of credit which was extinguished in 1996, preferred shares and two classes of stock. The preferred shares of $25 nominal carry a fixed cumulative dividend of 7%, and are convertible into common shares at an exercise price of $ 6.67 per share. Throughout the 1990's, KV issued Class A common shares which pay a dividend equal to 120% of the dividend paid to Class B common shares, but Class A common shares have only one-twentieth of a vote in elections of directors (and one vote in other matters). Class B stock is convertible into Class A stock. But, because no cash dividends have been paid for the past twelve years (i.e. only stock dividends were distributed in 1991 and 1998), and KV states that it does not anticipate paying dividends, it is unlikely that Class B shareholders are eager to convert into Class A stock. The number of Class A common shares grew to almost twice the number of Class B common shares by the end of 1999, as the number of Class B common shares decreased each year since 1992. The latest flotation of Class A stock was in 1998 when 200,000 Class A shares were sold to generate $ 3.5 millions of new capital. KV has also a number of stock options, amounting to about 10% of common shares outstanding, which were issued in connection with certain employment contracts and marketing or product development agreements.

The $ 36 millions needed for the acquisition of Micro-K were obtained from KV's own cash and from a revolving line of credit at LIBOR plus 200 basis points (or 6.94% in 1999) of up to $ 40 millions and expiring June 18, 2000 from LaSalle National Bank. KV used $ 25 millions as cash borrowing and $ 4.1 millions in open letter of credit from the line of credit.

Financial data:

Condensed financial statements without notes are presented for selected years in following tables:

 
Table T-KVa.1 - KV Pharmceutical Company Balance Sheets
Table T-KVa.2 - KV Pharmceutical Company Income Statements

Normalized statements and selected ratios based on above financial statements are presented in

Table T-KVa.3 - KV Pharmceutical Company Normalized Balance Sheets
Table T-KVa.4 - KV Pharmceutical Company Normalized Income Statements
Table T-KVa.5 - KV Pharmceutical Company Ratios

Information sources:

Apparently, as of mid 2000 KV Pharmeceutical Company does not have a web site.

SEC 10-K file available at http://www.sec.gov/cgi-bin/srch-edgar or http://www.edgar-online.com/

KV stock is traded on the NYSE exchange under the symbols KVa for Class A common shares and KVb for Class B common shares (note not KVA and KVB as indicated in annual reports). Find stock quotes and recent news from http://finance.yahoo.com/ or http://www.quote.com/ or from the exchange.