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KV Pharmaceutical recalls products, halts production, faces uncertain future

This article first appeared in the St. Louis Beacon, Jan. 27, 2009 -Five weeks ago, one Wall Street analyst said "things can hardly get worse" for KV Pharmaceutical, the Brentwood-based maker of brand-name and generic drugs. He was commenting on a six-month period in which KV fired its chairman and CEO; launched an investigation into alleged management misconduct; failed to file timely quarterly financial results, withdrew fiscal-year predictions; was raided by federal regulators; and conducted three separate product recalls.

He may have underestimated the problem.

In a series of stunning announcements Monday, KV said it was recalling most products, halting all manufacturing and stopping shipments of all products that it makes. KV said it took these actions Jan. 22. (It continues to distribute a handful of drugs made by other companies.)

And that's just the beginning:

  • KV also said it may default on a loan unless it can negotiate with lenders.
  • It is the subject of an informal inquiry from the Securities and Exchange Commission, and it is cooperating with investigators from the Justice Department and the Food and Drug Administration's office of criminal investigations.
  • KV also said it had fired its senior vice president and general counsel.
  • And the company announced that Gestiva, a drug that prevents pre-term births, would again be delayed because the FDA wants more data and another clinical trial. KV acquired worldwide rights to this drug in January 2008 from another drugmaker. Gestiva has experienced regulatory delays since October 2006.

"Can it get any worse?" another analyst said Monday.

Danger Ahead

Yes, it can. Aside from the potential regulatory issues and possible penalties, the destruction of shareholder value, the prospects of Justice Department involvement and the flow of investor lawsuits, KV faces damage to its reputation and its ability to continue doing business.

"There may well be a lasting adverse impact on business," says David Steinberg, a Deutsche Bank Securities analyst in a note to clients. "KV may not be able to maintain all its customer relationships when its resumes product distribution."

Steinberg had been neutral on KV, but he has suspended coverage "given the severity of this situation."

Even for a company that hasn't been very communicative with Wall Street in the past, analysts are stunned at how KV could fall so far and so fast.

The longer KV is forced to wait, the greater the chance it could be permanently crippled. "This necessitates dramatic restructuring in a timely fashion to preserve the company viability," says Scott Henry, of Roth Capital Partners, in a Monday report to clients. "Our investment thesis assumed [there would be] manufacturing violations and management misconduct," he says. "However, the criminal aspects and removal of all products makes this the tail end of the negative expectations."

Henry wrote the "things-can-hardly-get-worse" remarks in December. He had a buy rating then; he has a hold rating now.

Unhappy Investors

There isn't much to hold. KV's Class A stock fell 77 percent on Monday to 51 cents. In September, it was trading in the low $20s.

The Class B stock, which has 20 times the voting power versus Class A, dropped 74 percent on Monday to 58 cents. It, too, was trading in the low $20s in September. On Tuesday, the Class A stock was down a few pennies and the Class B stock was up a few pennies by mid-day.

KV hasn't offered a timetable for resolving the problems or resuming manufacturing and shipping. The FDA continues to inspect KV's operations; the latest inspection started in December.

KV told the SEC on Monday that it "expects to incur significant costs resulting from, among other causes, the product recall, write-off of inventory and activities related to reentering the marketplace."

KV also told the SEC that it "may not be in compliance with one or more covenants included in a credit agreement with its lenders." The outstanding balance was $30 million by the end of 2008.

KV said it isn't sure if it violated the loan agreement because it hasn't completed tallying its financial results for the quarter ended Dec. 31.

Unless KV gets a waiver from its lenders, failure to comply with the terms of the loan could put KV into default and force an immediate payment of the loan.

The company also reported that Gregory Bentley, senior vice president and general counsel, was given a 120-day termination notice on Jan. 16 under the terms of his employment contract. He was removed immediately.

In early December, KV said Marc Hermelin, the chairman and CEO, was fired for cause. Hermelin said he retired.

In addition, Sarah Weltscheff, Marc Hermelin’s wife, and David Hermelin, his son, have left the company. Weltscheff was senior vice president for human resource management and corporate communications. David Hermelin was vice president for strategy and operations analysis.

David Hermelin and Marc Hermelin remain on KV's board of directors. Marc Hermelin, through his own holdings and through control of three family trusts, holds a majority of the voting power in the company.

Robert W.  Steyer is a reporter based in New York who specializes in business issues. 

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