KV Pharmaceutical's new CEO seeks to rebuild company's reputation | St. Louis Public Radio

KV Pharmaceutical's new CEO seeks to rebuild company's reputation

Dec 12, 2008

This article first appeared in the St. Louis Beacon, Dec.12, 2008 - On the job for barely two weeks, David Van Vliet faces the task of restoring KV Pharmaceutical's reputation on Wall Street and in Washington.

Named interim CEO on Dec. 5, Van Vliet is trying to mollify analysts, who have complained for years about insufficient corporate communication. And he's trying to satisfy regulators, who have periodically -- and emphatically -- chastised the practices of the Brentwood-based maker of generic drugs and brand-name medications.

In recent months, KV's board has launched an investigation into "management misconduct," the stock has dropped sharply and the company has withdrawn its fiscal-year financial projections.

KV also is in the midst of a managerial drama. Van Vliet took over when KV's board fired Marc Hermelin as chairman and CEO "for cause." On the same day, however, Hermelin said he had retired a few days earlier.

"Things can hardly get worse, and this could put the company in position to start putting the pieces together again," said Scott Henry, of Roth Capital Partners, in a Dec. 11 report.

"We believe the shares are near carcass value," said Henry, who recommends buying the stock.

An immediate KV priority is "building strong relationships with government agencies, especially the Food and Drug Administration," Van Vliet told analysts in a Dec. 8 conference call. "I will personally take the lead in this important area."

Van Vliet didn't provide many details. Still, it was a start. "When was the last conference call you had with KV?" he asked the analysts. They couldn't recall any conference calls with Hermelin. Neither could several long-time employees.

"I can assure you that the new management team is committed to developing a culture of openness and teamwork as we work to restore growth and public confidence in our company," said Van Vliet, who had worked for KV since 2006 and who had been in charge of its generic-drug unit. The new chairman is Terry Hatfield, a KV board member since 2004.

FIRED? OR RETIRED?

Hermelin was fired based on a recommendation of a special board-of-directors committee investigating allegations of "management misconduct," KV said in a Dec. 5 report to the Securities and Exchange Commission. The filing didn't mention specific allegations. The audit is scheduled to be completed by year-end.

Hermelin issued a press release on the same day, saying he had "notified the company" of his retirement on Dec. 1, adding that KV had hired an executive recruiter firm in late November to find a successor. Hermelin said his employment agreement with KV enables him to serve as a consultant if he chooses.

Investors cheered Hermelin's departure, which was announced one hour before the markets closed on Dec. 5; the company's two sets of stock climbed 15 percent and 17 percent that day. However, that's still about 80 percent below their value in late September.

If Hermelin's firing for cause is upheld, he probably will lose what analyst David Steinberg calls a "very generous" retirement package. That's why KV watchers, like Steinberg of Deutsche Bank Securities, temper their support for his departure with concern about legal and management turmoil.

"We view the management change as a net positive," said Steinberg in a Dec. 8 report to clients. "We think the outlook is very uncertain." Like most analysts, he has a hold rating.

"We do not expect this disagreement to go away quietly and (will) not be surprised if a legal dispute followed," added Adam Greene, of the Stanford Group, in a Dec. 8 research report. He has a hold rating.

Hermelin's relinquishing daily duties is complicated because he commands a majority vote of KV shares. KV has two sets of stock; one class has 20 times the voting power as the other. Both stocks trade in tandem but at slightly different prices. The stock with low voting power is more heavily traded.

Through direct ownership and through the control of three family trusts, Hermelin has enough of the super-voting stock and the other stock to hold about 60 percent of the total voting power, says a recent proxy. Although he is no longer chairman, he remains on the eight-member board.

"What does this mean?" asked Elliot Wilbur, of Needham & Co., in a recent research report. "If a $10 bid were put on the table today, Hermelin could effectively block a deal, though he couldn't block strategic moves by the board such as acquisitions."

Wilbur has a hold rating because he lacks a clear picture of the company. "We can of course look past a lot of future potential short-term softness, disappointing quarters, messy litigation and even potential state and federal investigations tied to securities and other matters," said Wilbur's Dec. 10 report.

"Where we draw the line," he added, "is blindly stepping into a situation where we aren't completely comfortable that the company won't be in the gun sights of increasingly pressured-to-respond FDA."

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REGULATORY PROBLEMS

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The company has a sometimes contentious relationship with the FDA. "KV management by its own actions seems to have almost invited increased regulatory scrutiny," Wilbur told clients recently.

The recent audit by KV's board of directors into alleged "management misconduct" also involves "FDA regulatory and other compliance matters," says a filing with the SEC.

The board is working with FDA lawyers and its own lawyers to examine unspecified issues. Three separate product recalls are part of the audit, says a November SEC filing.

In late July, the FDA seized $24.2 million worth of drugs, saying that KV violated an agency order to stop making and marketing certain drugs ranging from cough medications to narcotic products. KV said the FDA's action resulted from a "potential misunderstanding" by the company about FDA regulations.

The FDA acted after inspecting several KV plants. The agency said the seized drugs had been placed under embargo by Missouri regulators in April. "Since the time of the embargo, KV Pharmaceutical has been cooperating with FDA officials," the FDA said in July.

In the mid-1990s, relations with the FDA reached a point that the agency placed KV on a special penalty list, refusing to approve drug applications until KV fixed multiple problems, according to various SEC filings.

KV spent about five years on this list. After KV was removed from the list in April 1998, the FDA resumed reviewing applications for brand-name and generic drugs.

In 1993, KV had to recall some batches of two products. The FDA seized some drugs and charged that KV didn't correct many problems cited in previous FDA inspections. KV signed a consent decree to improve manufacturing practices. In 1995, KV pleaded guilty to four misdemeanor counts of violating federal drug laws, paying $600,000 in fines and costs.

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CHANGING NUMBERS

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In recent years, KV has had to address financial issues related to, and independent of, its making and selling products.

In October 2006, the board began investigating claims in a lawsuit that accused KV of improperly dating stock option grants for current and former employees and directors.

One year later, the board said there were accounting errors. KV had understated stock option expenses by $12 million for the 1996 fiscal year through the 2006 fiscal year, worth $14.5 million including taxes and penalties. The board also cited some accounting errors, unrelated to options, for the 2002 fiscal year through the 2006 fiscal year.

As a result, KV restated financial results from fiscal 1996 through fiscal 2006 to reflect the board's findings. The board asked Hermelin to pay back $1.4 million related to the options.

The stock options adjustments appear modest compared to the latest uncertainty caused by the internal audit over alleged management misconduct. The audit has prevented KV from issuing a formal financial report for the July-September quarter.

On Nov. 17, KV withdrew its financial forecast for the fiscal year ending March 31, 2009 due to the audit. KV offered a preliminary projection of a $3 million profit for the July-September quarter versus a $40.2 million profit for the same period last year. Projected sales of $144.3 million fell by 17 percent.

KV blamed the loss partly on "manufacturing interruptions and inefficiencies," reduced production for several generic drugs and higher-than-expected demand for certain products.

At the time, Hermelin said these problems represented "an interruption in our growth"; but these are the types of revelations that exasperate analysts.

Their frustration is heightened by the fact that despite its problems, KV had recorded a more-than-doubling of revenue to $602 million for the year ended March 31, 2008 from the year ended March 31, 2004.

"Under the Hermelins, KV has executed nicely on a diversification program from pure generics to a successful player in branded (drugs for) women's health care," wrote Steinberg of Deutsche Bank Securities, quickly adding that KV "remains a 'show me' situation."

Until there are "definitive signs" of improvement under new management, he added, KV's stock price "may remain undervalued for some time" and attractive only to investors "with a high tolerance for risk."

MORE ABOUT KV

Although KV Pharmaceutical is a public company, it has been a family business.

Just a few years ago, five members of the Hermelin family had been directors or top executives. Now, no family members are in active management of the company that was founded in 1942.

The Dec. 5 departure of Marc Hermelin preceded by a few days the departure of his wife, Sarah Weltscheff, and his son, David Hermelin, as executives. Their exit was first reported by the St. Louis Business Journal. KV declined to comment.

The latest proxy says Weltscheff was senior vice president of human resource management and corporate communications. For the fiscal year ended March 31, Weltscheff was paid $517,584 in salary, bonus and other compensation.

She exercised stock options with a realized value -- the difference between the market price when the options were exercised versus the original exercise price -- of $1.24 million.

David Hermelin was vice president for strategy and operations analysis. He was paid $378,752 in salary, bonus and other compensation.

He also is a director. It appears, like his father, that David Hermelin is still on the board. Companies must inform the Securities and Exchange Commission of changes in their boards of directors. KV hasn't made any filing.

The proxy also says Victor Hermelin, a KV founder and Marc's father, remains on the payroll at last through the fiscal year ended March 31. He received $313,669 in salary, consulting fees and other compensation.

Victor Hermelin had been chairman until June 2006 when the board elected him chairman emeritus. Another family member, Mitchell Kirschner, Marc Hermelin's brother-in-law, worked at KV from July 1974 until January 2006.

For the fiscal year ended March 31, Marc Hermelin received $8.66 million in total compensation, including salary, change in pension value and other payments. Hermelin was the 17th highest-paid executive among publicly traded companies in the St. Louis area, according to the latest Post-Dispatch survey of executive pay. KV's revenue ranked 36th in the Post-Dispatch's annual list of largest public companies.

Robert W. Steyer is a freelance business journalist living in New York.