KV Pharmaceutical: Surging Revenue and New Product Launch May Signal Turnaround

Jun.24.11 | About: K-V Pharmaceutical (KVPBQ)

Last week, KV Pharmaceutical (KV.A)(NYSE:KV.B) announced that it has reached an agreement to divest its generic business and assets, including its generics subsidiary Nesher Pharmaceuticals. Zydus Pharmaceuticals will pay $60 million in cash to acquire the assets, and the deal should close during the second quarter of KV's 2012 fiscal year (July – September 2011).

The announcement comes just days after the company filed its annual report with the Securities Exchange Commission, reporting a 200% increase in net revenue (from $9.1 million in fiscal 2010 to $27.3 million in fiscal 2011). Although KV still posted a loss of $174 million, this is a significant decline from the previous fiscal year's loss of $285.6 million. Both of these facts, along with the launch of its new drug, Makena, suggest that management is successfully moving towards turning around the company, as KV Pharmaceutical continues to transform itself into a branded specialty pharmaceutical company specializing in women's health.

KV Pharmaceutical is a specialty pharmaceutical company that develops, manufactures, acquires and markets branded and generic prescription drugs. The company operates two wholly-owned subsidiaries: (1) Ther-Rx Corporation ("Ther-Rx"), which handles KV's branded pharmaceutical products, including its new drug Makena; and (2) Nesher Pharmaceuticals, the generics arm of KV Pharmaceutical that is in the process of being sold. In addition, KV previously owned two additional subsidiaries. The first was Particle Dynamics, Inc., which was sold in June 2010 in order to help KV raise money after the FDA shutdown its manufacturing facilities. The other was ETHEX Corporation ("ETHEX"), which was the generics arm of KV Pharmaceutical.

ETHEX was dissolved in December 2010, after pleading guilty to two felony counts for failing to report manufacturing problems to the FDA that resulted in oversized pills for two drugs, dextroamphetamine and propafenone. Pursuant to the plea agreement, ETHEX agreed to pay a criminal fine in the amount of $23.4 million in installments through December 2013. In exchange, the Department of Justice agreed that no further federal prosecution will be brought against ETHEX, KV and Ther-Rx regarding this matter.

In March of 2009, the FDA announced a consent decree barring KV Pharmaceutical and its subsidiaries from manufacturing and distributing drugs until both an independent expert and FDA officials inspect their facilities and certify that they are in compliance with the current Good Manufacturing Practice (cGMP). KV's independent cGMP expert, Lachman Consultants, certified the company as being compliant with all cGMP systems requirements in April 2010.

The FDA conducted an inspection in February, focused on KV's product Clindesse, and issued a Form 483 Report with certain observations. Later that month, KV Pharmaceutical filed its responses with the FDA with respect to such observations. The FDA conducted another inspection a month later, focused on adverse drug experience reporting. The inspection was completed without any observations being issued by the FDA. KV expects to re-launch Clindesse and Gynazole-1 (their vaginal anti-infective products for bacterial vaginosis and vaginal yeast infections, respectively) in the second half of fiscal 2012. When these products were removed from the market in 2009, they generated combined revenue of ~$60 million, and were leading products in the marketplace.

The biggest game changer for KV is the launch of its new drug Makena, which was approved by the FDA in February. Makena is the first and only FDA-approved treatment indicated to reduce the risk of preterm birth in women with a singleton pregnancy who have a history of singleton spontaneous preterm birth. KV Pharmaceutical received a lot of resistance and negative publicity from the March of Dimes, several physician organizations, and even the media, over their initial pricing of Makena. Even the U.S. government seemed to be coming after them, as Senators Klobuchar and Brown posed questions about potential price gouging, and the FDA said it would not stop pharmacies from compounding the active ingredient in Makena.

KV has since agreed to lower the price from $1,500 to $690 per injection, and has also initiated a comprehensive patient assistance program and patient access program. According to company's annual report, KV began shipping Makena in March, and so far over 100 commercial and Medicaid insurance plans have already reimbursed for prescriptions.

On the most recent company conference call, KV's management team agreed with analysts' assumption that they would need to generate ~$140,000 annually in order to cover their costs. Based on the clinical literature, 130,000-140,000 patients annually may medically qualify for treatment with Makena, so the potential market opportunity for Makena could be over $1.9B at the high end. Realistically, the potential will be much less once you take into account the number of patients who lack medical insurance or choose not to seek treatment, the payer-mix of the population that does receive Makena (Medicaid receives a 23% rebate), and a host of additional factors. However, if KV can capture even a fraction of the total market potential the company could break even from Makena sales alone.

It is important to keep in mind that KV's balance sheet has been severely weakened by the FDA shutdown and the resulting plunge in revenue for the past few years. Although the company has been able to restructuring its debt on more favorable terms and raise additional capital through a private placement, KV still has a high liquidity risk given its working capital deficiency and high debt load. This risk is highlighted by KV's management team in its annual report. So far KV has been able to renegotiate the timing of debt payments, DOJ settlement payments, and milestone payments related to Makena, but this is clearly a major risk that investors should be aware of.

Despite the risk mentioned above, I believe the upside could be worth it. Investing in a drug company as it transitions into a profitable business can be extremely rewarding to investors, especially as they become more widely followed by Wall Street analysts and the general investment community. If KV is able to launch Makena successfully, reintroduce Clindesse and Gynazole-1 to the market, and continue to grow sales for Evamist ($13 million in fiscal year 2011), the current management team could be well on their way to turning the company around.

Disclosure: I am long KV.A.