More Pain Ahead for KV Pharma Shareholders

The share price of KV Pharmaceutical (KV.A-$20.49) is close to a two year low and fetches a scant 10.9 times FY 2010 earnings. Nonetheless, the 10Q Detective opines that the stock of the integrated specialty drug company, home to brand name products, such as the anti-infective Clindesse and the prescription prenatal PrimaCare ONE, and a host of generic products, is not a value play.

The company grew consolidated net revenues at a compounded annual growth rate of 19.4% in the last five years. Similar forward growth could easily lead to a doubling in the current market capitalization of $1.02 billion, save for an excess of problems distracting management.

Talking Points

• Relations with the FDA have soured, which could adversely impact marketing approval of new submissions. Federal authorities seized more than $24 million of unapproved new drugs (to treat coughs, colds and gastrointestinal conditions) on Tuesday.
• Generic morphine tablets were recalled in Canada after some were found to contain too much of the painkiller.
• The company disclosed a material weakness in its internal controls related to the accounting of some customer rebate programs. Remedial actions are being implemented, including a procedure to verify actual customer receipt dates.

Stuffing the channels
Perception of sales growing
Watch out for chargebacks. ~ 10Q Detective Haiku poem

• In the fourth-quarter of fiscal 2008 ended March 31, the company took a $1.6 million unrealized loss due to the reduced value of the auction rate securities (ARS). Albeit this was a non-cash charge, the company holds $83.9 million in principal amount of such "illiquid" securities.

Of interest, management had said the adjustment to its ARS holdings were but "a temporary decline in value." If so, why did the company subsequently reclassify this portfolio of student loans as non-current investment securities? This signals to us that actual market value losses could be much larger, for such an accounting maneuver keeps the value declines of the income statement (unrealized losses are reported in a contra stockholders' equity account on the balance sheet) until ultimate sale.

Corporate Governance

The Hermelin family, through the family trusts, controls about 11.5% of Class A shares and 68.6% of Class B shares, according to the recent Proxy Statement filed with the SEC. Both classes of stock trade for about the same price, but Class A shares have only one-20th the voting power of Class B shares.

This explains why KV founder Victor Hermelin, 94, who retired more than thirty years ago, still receives a salary and other compensation (which totaled $142,970 in 2008) "in consideration of continuing valuable services as a consultant to the company, ongoing role as confidante, and contributions that could not be contemplated."

Current management includes his son, Chairman and CEO Marc S. Hermelin, 66; daughter-in-law, Sarah R. Weltscheff, employed as Senior Vice President, Human Resource; and, his grandson, Vice President of Corporate Strategy David S. Hermelin, 41.

Even in death, shareholders remain indebted to Marc Hermelin. His employment contract provides that upon his demise the company will make a $500,000 donation to the charity of his choice!

A constant battle for the ultimate state of control
After you've heard lie upon lie
There can hardly be a question of why
Some love is just a lie of the heart.

As if common stockholders did not have enough to worry about—another distraction at KV is familial infighting, for Victor is struggling to wrest control of the company from his son Marc—something to do with Victor’s second wife and her two daughters, whom he adopted in 2005.

The cold remains of what began with a passionate start
But that can't happen to us
Because it's always been a matter of trust. ~ singer/songwriter Billy Joel

That said, if Marc can get dad off his back, there is a huge incentive to sell the company—$39.6 million worth of motivation.

Editor David J Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.