King Pharmaceuticals Completes Review Of Returns Reserve
As previously announced on December 8, 2004, the Company will restate itspreviously reported financial results for 2002, 2003 and the first six monthsof 2004 due to methodological flaws concerning the timing of expenserecognition for product returns. Specifically, King determined that itsmethodology for reserving for product returns from the first quarter of 2000through the second quarter of 2004 contained errors, with the result thatestimated product returns were or would have been recorded in later periodsthan required under Generally Accepted Accounting Principles. The errors inKing's reserve for product returns resulted from policies adopted in goodfaith and after discussion with King's independent auditors, and are unrelatedto the ongoing investigations of King by the U.S. Securities and ExchangeCommission ("SEC") and the Office of the Inspector General of the Departmentof Health and Human Services.
Restated financial data for 2002 and 2003, including interim periods in2003, and the first two quarters of 2004 and other related financial data areprovided below. King plans to file with the SEC on or before March 16, 2005its Annual Report on Form 10-K for the year ended December 31, 2004 togetherwith its Quarterly Report on Form 10-Q for the quarter ended September 30,2004. The primary effect of the restatement is to shift to periods prior to2004 the recognition of product returns and other immaterial expense itemsthat were, or would have been, recognized during the first three quarters of2004.
The restatement will increase King's previously reported net sales for thefirst six months of 2004 by approximately $1.3 million, and preliminary netincome for the first six months of 2004 by approximately $7.6 million, or$0.03 per share. The restatement will also decrease previously reported netsales, net income, and earnings per share in 2003 by approximately $16.5million, $13.9 million, and $0.06, respectively; decrease previously reportednet sales and net income in 2002 by approximately $0.5 million and $0.1million, respectively, and have no effect on earnings per share; and result inapproximately a $23.7 million charge to retained earnings as of January 1,2002. The charge to retained earnings includes a $13.4 million adjustmentrelating to immaterial Medicaid errors that arose between 1998 and 2001 that were previously recorded in 2002 as a reduction of revenues and net income.The effect of errors that arose in periods prior to 2002 is not material.
As a result of the restatement of prior periods, King's previouslyannounced preliminary net sales, net income, and earnings per share for thethird quarter of 2004 increased by approximately $53.0 million, $28.9 million,and $0.12, respectively. However, events that have arisen subsequent to therelease of King's preliminary results for the third quarter of 2004 willresult in additional net charges in the third quarter of 2004. Morespecifically, subsequent events affecting the third quarter of 2004 areexpected to primarily include (i) an unanticipated product return discussedbelow, (ii) an impairment of intangible assets and write-off of excesspurchase commitments associated with Lorabid(R) (loracarbef), and, aspreviously disclosed, (iii) an impairment of intangible assets associated withTapazole(R) (methimazole tablets, USP) and Procanbid(R) (procainamidehydrochloride extended-release tablets). The Company currently believes thatthe increases in its preliminary results for the third quarter of 2004 arisingfrom the restatement of prior periods for product returns will besubstantially offset by the net charges resulting from these subsequentevents. Additional subsequent events affecting the third quarter of 2004 mayarise between now and the date the Company files its financial statements forthe third quarter.
In early January 2005, a major wholesale customer informed King that thecustomer had incorrectly omitted information it was contractually obligated toprovide to King under the Company's inventory management agreements. Theomitted information regarded inventory the customer was likely to return. As aresult, King received an unanticipated product return which is a subsequentevent affecting the Company's previously announced preliminary results for thethird quarter of 2004. With the exception of this unanticipated return, King'slevel of product returns since the conclusion of the third quarter of 2004 hasremained within the Company's expected rate.
During the fourth quarter of 2004 the Company began working to amend itsinventory management agreements with its key wholesale customers with theobjective of further reducing their inventory of King's products. As a result,the average wholesale inventory level of King's key products was reducedduring the fourth quarter of 2004. King anticipates that it should achieve anaverage wholesale inventory level for its key products that is no higher thanapproximately 1.5 months of end-user demand by March 31, 2005. Accordingly,the Company anticipates that wholesale channel inventory reductions of King'sproducts should be substantially complete by the end of the first quarter of2005.
As a result of Section 404 of the Sarbanes-Oxley Act of 2002 and the rulesissued thereunder, the Company will be required to include in its AnnualReport on Form 10-K for the year ended December 31, 2004 a report onmanagement's assessment of the effectiveness of the Company's internal controlover financial reporting. The Company's independent auditor will also berequired to attest to and report on management's assessment. Current auditingstandards provide that a restatement is a strong indicator of a materialweakness in the Company's internal control over financial reporting.Considering this guidance, the Company has evaluated these methodologicalerrors and has concluded that the restatement resulted from a materialweakness in the Company's internal control, which the Company believes it hassince remediated. In the course of its ongoing evaluation, the Company hasalso identified certain deficiencies which King is currently addressing. TheCompany may identify additional deficiencies in the course of completing itsSection 404 testing and evaluation. Management will consider all of thesematters when assessing the effectiveness of the Company's internal controlover financial reporting as of December 31, 2004.
The Company believes that it has taken remedial steps to address the material weakness identified above, including the adoption by the Company ofrevised methodologies for estimating its product returns. The Company cannotassure that the steps it has taken or is taking to address the materialweakness and other identified deficiencies will be adequate, that the otheridentified deficiencies will not ultimately result in material weaknesses,that additional material weaknesses or control deficiencies will not beidentified, and/or that management will be able to conclude on the basis ofits evaluation that its internal control over financial reporting waseffective as of December 31, 2004. Moreover, the Company cannot assure thatmanagement will complete its assessment of internal control over financialreporting in a timely fashion.
TRANSACTION WITH MYLAN
As previously reported, Mylan Laboratories Inc. and King are parties to amerger agreement pursuant to which Mylan agreed to acquire King in a stock-for-stock merger transaction. Pursuant to its terms, either King or Mylan mayterminate the merger agreement at any time on or after March 1, 2005. TheKing board of directors has not yet determined whether to proceed with atransaction with Mylan on or after March 1, 2005 and, if so, on what terms.The King board expects to evaluate its options in connection with the mergeragreement, and in that context will give appropriate consideration to anyproposals it may receive from Mylan. King intends to make a definitive decision regarding the outcome of the merger with Mylan as promptly aspracticable, but there can be no assurance as to whether a decision will bereached by February 28. King does not intend to make any further commentregarding Mylan until a definitive decision regarding the merger is reached.
Restated financial data for 2002 and 2003, including interim periods in2003, and the first two quarters of 2004 and other related financial data areprovided below. King plans to file with the SEC on or before March 16, 2005its Annual Report on Form 10-K for the year ended December 31, 2004 togetherwith its Quarterly Report on Form 10-Q for the quarter ended September 30,2004. The primary effect of the restatement is to shift to periods prior to2004 the recognition of product returns and other immaterial expense itemsthat were, or would have been, recognized during the first three quarters of2004.
The restatement will increase King's previously reported net sales for thefirst six months of 2004 by approximately $1.3 million, and preliminary netincome for the first six months of 2004 by approximately $7.6 million, or$0.03 per share. The restatement will also decrease previously reported netsales, net income, and earnings per share in 2003 by approximately $16.5million, $13.9 million, and $0.06, respectively; decrease previously reportednet sales and net income in 2002 by approximately $0.5 million and $0.1million, respectively, and have no effect on earnings per share; and result inapproximately a $23.7 million charge to retained earnings as of January 1,2002. The charge to retained earnings includes a $13.4 million adjustmentrelating to immaterial Medicaid errors that arose between 1998 and 2001 that were previously recorded in 2002 as a reduction of revenues and net income.The effect of errors that arose in periods prior to 2002 is not material.
As a result of the restatement of prior periods, King's previouslyannounced preliminary net sales, net income, and earnings per share for thethird quarter of 2004 increased by approximately $53.0 million, $28.9 million,and $0.12, respectively. However, events that have arisen subsequent to therelease of King's preliminary results for the third quarter of 2004 willresult in additional net charges in the third quarter of 2004. Morespecifically, subsequent events affecting the third quarter of 2004 areexpected to primarily include (i) an unanticipated product return discussedbelow, (ii) an impairment of intangible assets and write-off of excesspurchase commitments associated with Lorabid(R) (loracarbef), and, aspreviously disclosed, (iii) an impairment of intangible assets associated withTapazole(R) (methimazole tablets, USP) and Procanbid(R) (procainamidehydrochloride extended-release tablets). The Company currently believes thatthe increases in its preliminary results for the third quarter of 2004 arisingfrom the restatement of prior periods for product returns will besubstantially offset by the net charges resulting from these subsequentevents. Additional subsequent events affecting the third quarter of 2004 mayarise between now and the date the Company files its financial statements forthe third quarter.
In early January 2005, a major wholesale customer informed King that thecustomer had incorrectly omitted information it was contractually obligated toprovide to King under the Company's inventory management agreements. Theomitted information regarded inventory the customer was likely to return. As aresult, King received an unanticipated product return which is a subsequentevent affecting the Company's previously announced preliminary results for thethird quarter of 2004. With the exception of this unanticipated return, King'slevel of product returns since the conclusion of the third quarter of 2004 hasremained within the Company's expected rate.
During the fourth quarter of 2004 the Company began working to amend itsinventory management agreements with its key wholesale customers with theobjective of further reducing their inventory of King's products. As a result,the average wholesale inventory level of King's key products was reducedduring the fourth quarter of 2004. King anticipates that it should achieve anaverage wholesale inventory level for its key products that is no higher thanapproximately 1.5 months of end-user demand by March 31, 2005. Accordingly,the Company anticipates that wholesale channel inventory reductions of King'sproducts should be substantially complete by the end of the first quarter of2005.
As a result of Section 404 of the Sarbanes-Oxley Act of 2002 and the rulesissued thereunder, the Company will be required to include in its AnnualReport on Form 10-K for the year ended December 31, 2004 a report onmanagement's assessment of the effectiveness of the Company's internal controlover financial reporting. The Company's independent auditor will also berequired to attest to and report on management's assessment. Current auditingstandards provide that a restatement is a strong indicator of a materialweakness in the Company's internal control over financial reporting.Considering this guidance, the Company has evaluated these methodologicalerrors and has concluded that the restatement resulted from a materialweakness in the Company's internal control, which the Company believes it hassince remediated. In the course of its ongoing evaluation, the Company hasalso identified certain deficiencies which King is currently addressing. TheCompany may identify additional deficiencies in the course of completing itsSection 404 testing and evaluation. Management will consider all of thesematters when assessing the effectiveness of the Company's internal controlover financial reporting as of December 31, 2004.
The Company believes that it has taken remedial steps to address the material weakness identified above, including the adoption by the Company ofrevised methodologies for estimating its product returns. The Company cannotassure that the steps it has taken or is taking to address the materialweakness and other identified deficiencies will be adequate, that the otheridentified deficiencies will not ultimately result in material weaknesses,that additional material weaknesses or control deficiencies will not beidentified, and/or that management will be able to conclude on the basis ofits evaluation that its internal control over financial reporting waseffective as of December 31, 2004. Moreover, the Company cannot assure thatmanagement will complete its assessment of internal control over financialreporting in a timely fashion.
TRANSACTION WITH MYLAN
As previously reported, Mylan Laboratories Inc. and King are parties to amerger agreement pursuant to which Mylan agreed to acquire King in a stock-for-stock merger transaction. Pursuant to its terms, either King or Mylan mayterminate the merger agreement at any time on or after March 1, 2005. TheKing board of directors has not yet determined whether to proceed with atransaction with Mylan on or after March 1, 2005 and, if so, on what terms.The King board expects to evaluate its options in connection with the mergeragreement, and in that context will give appropriate consideration to anyproposals it may receive from Mylan. King intends to make a definitive decision regarding the outcome of the merger with Mylan as promptly aspracticable, but there can be no assurance as to whether a decision will bereached by February 28. King does not intend to make any further commentregarding Mylan until a definitive decision regarding the merger is reached.
