10-K 1 g11456e10vk.htm KING PHARMACEUTICALS, INC. King Pharmaceuticals, Inc.
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
Form 10-K
 
     
(Mark One)    
 
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended December 31, 2007
OR
o
  TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
Commission File Number 001-15875
 
King Pharmaceuticals, Inc.
(Exact name of registrant as specified in its charter)
 
 
     
Tennessee
(State or other jurisdiction of
incorporation or organization)
  54-1684963
(I.R.S. Employer
Identification No.)
     
501 Fifth Street
Bristol, Tennessee
(Address of Principal Executive Offices)
  37620
(Zip Code)
 
Registrant’s telephone number, including area code: (423) 989-8000
 
Securities registered under Section 12(b) of the Exchange Act:
 
 
     
(Title of Each Class)
 
(Name of Each Exchange on Which Registered)
 
Common Stock and Associated
Preferred Stock Purchase Rights
  New York Stock Exchange
 
 
Securities registered under Section 12(g) of the Exchange Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  Yes o     No þ
 
Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of ‘‘large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
  Large accelerated filer  þ     Accelerated filer  o      Non-accelerated filer  o     Smaller reporting company  o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of June 30, 2007 was $4,980,295,452. The number of shares of Common Stock, no par value, outstanding at February 26, 2008 was 246,050,574.
 
Documents Incorporated by Reference:
Certain information required in Part III of this Annual Report on Form 10-K is incorporated
by reference from the registrant’s Proxy Statement for its 2008 annual meeting of shareholders.
 


 

 
Table of Contents
 
                 
    2  
      Business     2  
      Risk Factors     18  
      Unresolved Staff Comments     31  
      Properties     31  
      Legal Proceedings     31  
      Submission of Matters to a Vote of Security Holders     31  
       
    31  
      Market for Common Equity and Related Stockholder Matters     31  
      Selected Financial Data     33  
      Management’s Discussion and Analysis of Financial Condition and Results of Operations     34  
      Quantitative and Qualitative Disclosures About Market Risk     67  
      Financial Statements and Supplementary Data     67  
      Changes in Accountants and Disagreements with Accountants on Accounting and Financial Disclosure     67  
      Controls and Procedures     67  
      Other Information     68  
       
    68  
       
    69  
      Exhibits and Financial Statement Schedules     69  
 Ex-21.1 Subsidiaries of the Registrant
 Ex-23.1 Consent of PricewaterhouseCoopers LLP
 Ex-31.1 Section 302 Certification of the CEO
 Ex-31.2 Section 302 Certification of the CFO
 Ex-32.1 Section 906 Certification of the CEO
 Ex-32.2 Section 906 Certification of the CFO


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PART I
 
Item 1.   Business
 
King Pharmaceuticals, Inc. was incorporated in the State of Tennessee in 1993. Our wholly owned subsidiaries are Monarch Pharmaceuticals, Inc.; King Pharmaceuticals Research and Development, Inc.; Meridian Medical Technologies, Inc.; Parkedale Pharmaceuticals, Inc.; King Pharmaceuticals Canada Inc.; and Monarch Pharmaceuticals Ireland Limited.
 
Our principal executive offices are located at 501 Fifth Street, Bristol, Tennessee 37620. Our telephone number is (423) 989-8000 and our facsimile number is (423) 274-8677. Our website is www.kingpharm.com where you may view our Corporate Code of Conduct and Ethics (“Code”). To the extent permitted by U.S. Securities and Exchange Commission (“SEC”) and New York Stock Exchange (“NYSE”) regulations, we intend to disclose information as to any amendments to the Code and any waivers from provisions of the Code for our principal executive officer, principal financial officer, and certain other officers by posting the information on our website, to the extent such matters arise. We make available through our website, free of charge, our annual reports on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments, as well as other documents, as soon as reasonably practicable after their filing with the SEC. These filings are also available to the public through the Internet at the website of the SEC, at www.sec.gov. You may also read and copy any document that we file at the SEC’s Public Reference Room located at 100 F Street, NE, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room.
 
Our Chief Executive Officer, Brian A. Markison, submitted to the NYSE an Annual Chief Executive Officer Certification on June 12, 2007, pursuant to Section 303A.12 of the NYSE’s listing standards, certifying that he was not aware of any violation by King of the NYSE’s corporate governance listing standards as of that date.
 
King is a vertically integrated pharmaceutical company that performs basic research and develops, manufactures, markets and sells branded prescription pharmaceutical products. By “vertically integrated,” we mean that we have the following capabilities:
 
     
     

•   research and development
  •   distribution
     
•   manufacturing
  •   sales and marketing
     
•   packaging
  •   business development
     
•   quality control and assurance
  •   regulatory management
 
Through our national sales force we market our branded prescription pharmaceutical products to general/family practitioners, internal medicine physicians, neurologists, pain specialists, surgeons and hospitals across the United States and in Puerto Rico. Branded pharmaceutical products are innovative products sold under a brand name that enjoy, or previously enjoyed, some degree of market exclusivity.
 
Our corporate strategy is focused on target, specialty-driven markets, particularly neuroscience, hospital and acute care. We believe each of these target markets has significant market potential and our organization is aligned accordingly.
 
Under our corporate strategy we work to achieve organic growth by maximizing the potential of our currently marketed products through sales and marketing and prudent product life-cycle management. By “product life-cycle management,” we mean the extension of the economic life of a product, including seeking and gaining necessary related governmental approvals, by such means as:
 
  •  securing from the U.S. Food and Drug Administration, which we refer to as the “FDA,” additional approved uses (“indications”) for our branded pharmaceutical products;
 
  •  developing and producing different strengths;


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  •  producing different package sizes;
 
  •  developing new dosage forms; and
 
  •  developing new product formulations.
 
Our strategy also focuses on growth through the acquisition of novel branded pharmaceutical products in various stages of development and the acquisition of pharmaceutical technologies, particularly those products and technologies that we believe have significant market potential and complement our neuroscience, hospital and acute care medicine platforms. Using our internal resources and a disciplined business development process, we strive to be a leader and partner of choice in developing and commercializing innovative, clinically-differentiated therapies and technologies in our target, specialty-driven markets. We may also seek company acquisitions that add products or products in development, technologies or sales and marketing capabilities to our existing platforms or that otherwise complement our operations. We also work to achieve organic growth by continuing to develop investigational drugs, as we have a strong commitment to research and development and advancing the products and technologies in our development pipeline.
 
Business Segments
 
Our branded pharmaceutical products are divided into the following categories:
 
  •  neuroscience
 
  •  hospital
 
  •  acute care
 
  •  legacy products (including cardiovascular/metabolic and other)
 
Our Meridian Auto-Injector segment consists of EpiPen® and nerve gas antidotes which we provide to the U.S. Military. Royalties, another of our business segments, are derived from products we successfully developed and have licensed to third parties.
 
The following table summarizes net revenues by operating segment (in thousands), almost all of which are derived from activities within the United States.
 
                         
    For the Years Ended December 31,  
    2007     2006     2005  
 
Branded pharmaceuticals
  $ 1,857,813     $ 1,724,701     $ 1,542,124  
Meridian Auto-Injector
    183,860       164,760       129,261  
Royalties
    82,589       80,357       78,128  
Contract manufacturing
    9,201       16,501       22,167  
Other
    3,419       2,181       1,201  
                         
Total
  $ 2,136,882     $ 1,988,500     $ 1,772,881  
                         
 
For information regarding profit and loss and total assets associated with each segment, see Note 20, “Segment Information” in Part IV, Item 15(a)(1) “Exhibits and Financial Statement Schedules.”
 
Recent Developments
 
Accelerated Strategic Shift
 
Following the Circuit Court’s decision in September 2007 invalidating our Altace® patent, our senior management team conducted an extensive examination of our company and developed a restructuring initiative designed to accelerate a previously planned strategic shift emphasizing our focus on neuroscience, hospital and acute care markets. This initiative included a reduction in personnel, staff leverage, expense reductions and additional controls over spending, reorganization of sales teams and a realignment of research and development priorities. Pursuant to this initiative, we terminated approximately 20% of our workforce, primarily through a reduction in our sales force.


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New Generic Competition
 
In December 2007, a third party entered the market with a generic substitute for our Altace® capsules. This followed the decision of the U.S. Circuit Court of Appeals for the Federal Circuit (the “Circuit Court”) in September 2007 which declared invalid U.S. Patent No. 5,061,722 (the “722 Patent”) that covered our Altace® product, overruling the decision of the U.S. District Court for the Eastern District of Virginia (the “District Court”), which had upheld the validity of the patent. We filed with the Circuit Court a petition for rehearing and rehearing en banc, but this petition was denied in December 2007. As a result of the entry of a generic substitute, our sales of Altace® have begun to decline. We launched a tablet formulation of Altace® in February 2008.
 
In January 2008, we entered into an agreement with CorePharma, LLC (“CorePharma”) granting CorePharma a license to launch an authorized generic version of Skelaxin® in December 2012, or earlier under certain conditions.
 
New Branded® Competition
 
Beginning in 2008, Thrombin-JMI®, our bovine thrombin product, has new competition from recombinant human thrombin and human thrombin. Omrix Biopharmaceuticals, Inc.’s Biologics Licensing Application (“BLA”) for its human thrombin product was approved in September 2007. Zymogenetics, Inc. received approval of its BLA for recombinant human thrombin in January 2008. The presence of these competing products in the marketplace may reduce net sales of Thrombin-JMI® materially.
 
Clinical Trial Results
 
In December 2007, we, together with Pain Therapeutics Inc., announced positive results from the pivotal Phase III clinical trial for Remoxytm. The Phase III trial was conducted in accordance with a Special Protocol Assessment (“SPA”) from the FDA. The top-line data indicates that the Phase III trial achieved a statistically significant result in its primary endpoint, defined by the SPA as a mean decrease in pain intensity scores during the 12-week treatment period. In addition, the Phase III trial achieved statistically significant results in secondary endpoints. Remoxytm, an investigational novel formulation of extended release, long-acting oxycodone for moderate to severe pain, is designed to resist common methods of abuse, such as crushing, heating, or dissolution in alcohol, that are reported with respect to other long-acting opioids.
 
We entered into a series of agreements with Pain Therapeutics in November 2005 to develop and commercialize Remoxytm and other extended release, long-acting opioid painkillers that resist common methods of abuse. We have worldwide exclusive rights to commercialize Remoxytm and the other abuse-resistant opioid drugs that are developed pursuant to the collaboration, other than in Australia and New Zealand.
 
In early 2008, we received positive results from our Phase III clinical trials with CorVuetm (binodenoson) our next generation cardiac pharmacologic stress-imaging agent. We expect to file a new drug application (“NDA”) for CorVuetm with the FDA by early 2009. The Phase II clinical trial for Sonedenoson, formerly MRE-0094, an adenosine A2a receptor agonist for the topical treatment of chronic, neuropathic, diabetic foot ulcers, did not meet its primary endpoint. We are continuing to evaluate the data from this trial.
 
Expanded Product Portfolio and Development Pipeline
 
In October 2007, we entered into a License, Development and Commercialization Agreement with Acura Pharmaceuticals, Inc. (“Acura”) to develop and commercialize certain immediate release opioid analgesic products utilizing Acura’s proprietary Aversion® (abuse-deterrent/abuse-resistant) Technology in the United States, Canada and Mexico. The agreement provides us with an exclusive license for Acuroxtm (oxycodone HCl, niacin and a unique combination of other ingredients) tablets and another undisclosed opioid product utilizing Acura’s Aversion® Technology. In addition, the agreement provides us with an option to license all future opioid analgesic products developed utilizing Acura’s Aversion® Technology. Acuroxtm tablets are intended to effectively treat moderate to moderately severe pain while deterring or resisting common methods


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of abuse, including intravenous injection or oral consumption of tablets dissolved in liquids, nasal inhalation of crushed tablets and intentional swallowing of excessive numbers of tablets.
 
On February 26, 2007, we acquired all the rights to Avinza® in the United States, its territories and Canada from Ligand Pharmaceuticals Incorporated (“Ligand”). Avinza® is an extended release formulation of morphine and is indicated as a once-daily treatment for moderate to severe pain in patients who require continuous opioid therapy for an extended period of time.
 
Other
 
In October 2007, we sold our Rochester, Michigan sterile manufacturing facility, some of our legacy products that are manufactured there and the related contract manufacturing business to JHP Pharmaceuticals, LLC (“JHP”) for $91.7 million less selling costs of $5.4 million. This transaction resulted in a loss of $46.4 million. The companies also entered into a manufacturing and supply agreement pursuant to which JHP will provide to us certain filling and finishing manufacturing activities with respect to Thrombin-JMI®. The sale did not include our stand-alone sterile penicillin production facility that is also located in Rochester, Michigan.
 
In September 2007, we provided Palatin Technologies, Inc. (“Palatin”) with notice of termination of our Collaborative Development and Marketing Agreement to jointly develop and commercialize Palatin’s bremelanotide compound, which was formerly known as PT-141, for the treatment of male and female sexual dysfunction. Our decision to terminate the agreement followed communications from representatives of the FDA of serious concerns about the lack of an acceptable benefit/risk ratio to support the progression of the proposed bremelanotide program into Phase III studies for erectile dysfunction (“ED”). After reviewing the data generated in the Phase I and II studies, the FDA questioned the overall efficacy results and the clinical benefit of this product in both the general and diabetic ED populations, and cited blood pressure increases as its greatest safety concern. The termination was effective in December 2007.
 
Industry
 
The pharmaceutical industry is a highly competitive global business composed of a variety of participants, including large and small branded pharmaceutical companies, specialty and niche-market pharmaceutical companies, biotechnology firms, large and small research and drug development organizations, and generic drug manufacturers. These participants compete on a number of bases, including technological innovation or novelty, clinical efficacy, safety, convenience or ease of administration and cost-effectiveness. In order to promote their products to physicians and consumers, industry participants devote considerable resources to advertising, marketing and sales force personnel, distribution mechanisms and relationships with medical and research centers, physicians and patient advocacy and support groups.
 
The industry is affected by the following factors, among others:
 
  •  the aging of the patient population, including diseases specific to the aging process and demographic factors, including obesity, diabetes, cardiovascular disease, and patient and physician demand for products that meet chronic or unmet medical needs;
 
  •  technological innovation, both in drug discovery and corporate processes;
 
  •  merger and acquisition activity whereby pharmaceutical companies are acquiring one another or smaller biotechnology companies, and divestitures of products deemed “non-strategic”;
 
  •  cost containment and downward price pressure from managed care organizations and governmental entities, both in the United States and overseas;
 
  •  increased drug development, manufacturing and compliance costs for pharmaceutical producers;
 
  •  the rise of generic pharmaceutical companies and challenges to patent protection and sales exclusivity;
 
  •  more frequent product liability litigation;


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  •  increased governmental scrutiny of the healthcare sector, including issues of patient safety, cost, efficacy and reimbursement/insurance matters; and
 
  •  the cost of advertising and marketing, including direct-to-consumer advertising on television and in print.
 
Branded Pharmaceuticals Segment
 
We market a variety of branded prescription products that are divided into the following categories:
 
  •  neuroscience (including Skelaxin®, Avinza® and Sonata®),
 
  •  hospital (including Thrombin-JMI® and Synercid®),
 
  •  acute care (including Bicillin® and Intal®), and
 
  •  legacy products (including Altace®, Levoxyl® and Cytomel®).
 
Our branded pharmaceutical products are generally in high-volume target markets and we believe they are well known for their treatment indications. Branded pharmaceutical products represented approximately 87% of our total net revenues for each of the years ended December 31, 2007, 2006 and 2005.


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Some of our branded prescription products are described below:
 
     
Product
 
Product Description and Indication
 
Neuroscience
  Products in this category are primarily marketed to primary care physicians, neurologists, orthopedic surgeons and pain specialists.
Skelaxin®
 
  A muscle relaxant tablet indicated for the relief of discomforts associated with acute, painful musculoskeletal conditions.
Avinza®
 
  An extended-release formulation of morphine indicated as a once-daily treatment for moderate to severe pain in patients who require continuous opioid therapy for an extended period of time.
Sonata®
 
  A nonbenzodiazepine capsule treatment for insomnia.
     
Hospital
  Products in this category are primarily marketed to hospitals.
Thrombin-JMI®
 
  A chromatographically purified topical (bovine) thrombin solution indicated as an aid to hemostasis whenever oozing blood and minor bleeding from capillaries and small venules is accessible.
Synercid®
 
  An injectable antibiotic indicated for treatment of certain complicated skin and skin structure infections.
     
Acute Care
  Products in this category are primarily marketed to primary care physicians, internal medicine physicians, allergists and pediatricians.
Bicillin®
 
  A penicillin-based antibiotic suspension for deep muscular injection indicated for the treatment of infections due to penicillin-G-susceptible microorganisms that are susceptible to serum levels common to this particular dosage form.
Intal®
 
  An oral multi-dose inhaler of a non-steroidal anti-inflammatory agent for the preventive management of asthma.
     
Legacy Products
  Products in this category are not actively promoted through our sales force and many have generic competition.
Cardiovascular/Metabolic
   
Altace®(1)
 
  An oral administration indicated for the treatment of hypertension and reduction of the risk of stroke, myocardial infarction (heart attack) and death from cardiovascular causes in patients 55 and over with either a history of coronary artery disease, stroke or peripheral vascular disease or with diabetes and one other cardiovascular risk factor (such as elevated cholesterol levels or cigarette smoking). Altace® is also indicated in stable patients who have demonstrated clinical signs of congestive heart failure after sustaining acute myocardial infarction.
Levoxyl®
 
  Color-coded, potency-marked tablets indicated for thyroid hormone replacement or supplemental therapy for hypothyroidism.
Cytomel®
 
  A tablet indicated in the medical treatment of hypothyroidism.
 
 
(1) We acquired licenses for the exclusive rights in the United States under various patents to the active ingredient in Altace®.


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Net sales of certain of our branded prescription products for the year ended December 31, 2007 are set forth in the tables below.
 
         
    Net Sales  
    (In millions)  
 
Neuroscience
       
Skelaxin®
  $ 440.0  
Avinza®
    108.5  
Sonata®
    78.7  
Hospital
       
Thrombin-JMI®
  $ 267.4  
Synercid®
    11.6  
Acute Care
       
Bicillin®
  $ 58.6  
Intal®
    14.0  
Legacy Products
       
Cardiovascular/Metabolic
       
Altace®
  $ 646.0  
Levoxyl®
    100.1  
Cytomel®
    47.5  
 
Meridian Auto-Injector Segment
 
Our Meridian Auto-Injector segment consists of our auto-injector business. An auto-injector is a pre-filled, pen-like device that allows a patient or caregiver to automatically inject a precise drug dosage quickly, easily, safely and reliably. Auto-injectors are a convenient, disposable, one-time use drug delivery system designed to improve the medical and economic value of injectable drug therapies. We pioneered the development and are a manufacturer of auto-injectors for the self-administration of injectable drugs. Our auto-injector products currently consist of a variety of acute care medicines.
 
The commercial pharmaceutical business of our Meridian segment consists of EpiPen®, an auto-injector filled with epinephrine for the emergency treatment of anaphylaxis resulting from severe or allergic reactions to insect stings or bites, foods, drugs and other allergens, as well as idiopathic or exercise-induced anaphylaxis. We have a supply agreement with Dey, L.P., in which we granted Dey the exclusive right to market, distribute, and sell EpiPen® worldwide. The supply agreement expires December 31, 2015.
 
In March 2006, we acquired substantially all of the assets of Allerex Laboratory LTD. The primary asset purchased from Allerex was the exclusive right to market and sell EpiPen® throughout Canada. We also obtained from Dey, L.P., an extension of those exclusive rights to market and sell EpiPen® in Canada through 2015.
 
Our Meridian Auto-Injector segment also includes pharmaceutical products that are presently sold primarily to the U.S. Department of Defense (“DoD”) under an Industrial Base Maintenance Contract which is terminable by the DoD at its convenience. These products include the nerve agent antidotes AtroPen® and ComboPen®, and the Antidote Treatment Nerve Agent Auto-injector, which we refer to as the “ATNAA.” AtroPen® is an atropine-filled auto-injector and ComboPen® consists of an atropine-filled auto-injector and a pralidoxime-filled auto-injector. The ATNAA utilizes a dual chambered auto-injector and injection process to administer atropine and pralidoxime, providing an improved, more efficient means of delivering these nerve agent antidotes. Other products sold to the DoD include a diazepam-filled auto-injector for the treatment of seizures and a morphine-filled auto-injector for pain management.


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Royalties Segment
 
We have successfully developed two currently marketed adenosine-based products, Adenoscan® and Adenocard®, for which we receive royalty revenues. Adenoscan® is a sterile, intravenous solution of adenosine administered intravenously as an adjunct to imaging agents used in cardiac stress testing of patients who are unable to exercise adequately. Adenocard® is a sterile solution of adenosine administered intravenously in emergency situations to convert certain irregular heart rhythms to normal sinus rhythms. Specifically, we are party to an agreement under which Astellas Pharma US, Inc. (“Astellas”) manufactures and markets Adenoscan® and Adenocard® in the United States and Canada in exchange for royalties through the duration of the patents. We have licensed exclusive rights to other third-party pharmaceutical companies to manufacture and market Adenoscan® and Adenocard® in certain countries other than the United States and Canada in exchange for royalties.
 
Royalties received by us from sales of Adenoscan® and Adenocard® outside of the United States and Canada are shared equally with Astellas. Astellas, on its own behalf and ours, obtained a license to additional intellectual property rights for intravenous adenosine in cardiac imaging and the right to use intravenous adenosine as a cardioprotectant in combination with thrombolytic therapy, balloon angioplasty and coronary bypass surgery. For additional information on our royalty agreements, please see the section below entitled “Intellectual Property.”
 
Sales and Marketing
 
Our commercial operations organization, which includes sales and marketing, is based in Bridgewater, New Jersey. We have a sales force consisting of over 600 employees in the United States and Puerto Rico. We distribute our branded pharmaceutical products primarily through wholesale pharmaceutical distributors. These products are ordinarily dispensed to the public through pharmacies by prescription. Our marketing and sales promotions for branded pharmaceutical products principally target general/family practitioners, internal medicine physicians, neurologists, pain specialists, surgeons and hospitals through detailing and sampling to encourage physicians to prescribe our products. The sales force is supported by telemarketing and direct mail, as well as through advertising in trade publications and representation at regional and national medical conventions. We identify and target physicians through data available from IMS America, Ltd., a supplier of prescriber prescription data. The marketing and distribution of these products in foreign countries generally requires the prior registration of the products in those countries. We generally seek to enter into distribution agreements with companies with established foreign marketing and distribution capabilities since we do not have a distribution network in place for distribution outside the United States and Puerto Rico.
 
Similar to other pharmaceutical companies, our principal customers are wholesale pharmaceutical distributors. The wholesale distributor network for pharmaceutical products has in recent years been subject to increasing consolidation, which has increased our, and other industry participants’, customer concentration. In addition, the number of independent drug stores and small chains has decreased as retail consolidation has occurred. For the year ended December 31, 2007, approximately 75% of our gross sales were attributable to three key wholesalers: McKesson Corporation (35%), Cardinal/Bindley (27%), and Amerisource Bergen Corporation (13%).
 
Manufacturing
 
Our manufacturing facilities are located in Bristol, Tennessee; Rochester, Michigan; Middleton, Wisconsin; St. Petersburg, Florida; and St. Louis, Missouri. These facilities have manufacturing, packaging, laboratory, office and warehouse space. We are licensed by the Drug Enforcement Agency, which we refer to as the “DEA,” a division of the Department of Justice, to procure and produce controlled substances. We manufacture certain of our own branded pharmaceutical products. In 2007, we maintained an operational excellence program utilizing Six Sigma and lean manufacturing techniques to identify and execute cost-saving and process-improvement initiatives.
 
We can produce a broad range of dosage forms, including sterile solutions, lyophylized (freeze-dried) products, injectables, tablets and capsules, creams and ointments, suppositories and powders. We believe our


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manufacturing capabilities allow us to pursue drug development and product line extensions more efficiently. However, currently many of our product lines, including Skelaxin®, Thrombin-JMI®, Avinza®, Sonata® and Synercid® are manufactured for us by third parties. As of December 31, 2007, we estimate capacity utilization was approximately 35% at the Bristol facility, approximately 60% at the Rochester facility, approximately 85% at the Middleton facility, approximately 70% at the St. Petersburg facility and approximately 70% at the St. Louis facility. Although the capacity utilization at our Bristol facility will be lower in 2008 as a result of the anticipated decline in Altace® sales, we expect that the capacity utilization at that location will increase in future years. We are transferring the production of Levoxyl® from our St. Petersburg facility to our Bristol facility. Following the transfer, which we expect to complete in early 2009, we will close our St. Petersburg facility. During the fourth quarter of 2007, we sold our Rochester, Michigan sterile manufacturing facility to JHP Pharmaceuticals, LLC. This sale did not include our stand-alone manufacturing and production facility for our Bicillin® product line, also located in Rochester, Michigan, which the FDA approved in early 2007.
 
In addition to manufacturing, we have fully integrated manufacturing support systems including quality assurance, quality control, regulatory management and logistics. We believe that these support systems enable us to maintain high standards of quality for our products and simultaneously deliver reliable goods to our customers on a timely basis.
 
We require a supply of quality raw materials and components to manufacture and package drug products. Generally, we have not had difficulty obtaining raw materials and components from suppliers. Currently, we rely on more than 500 suppliers to deliver the necessary raw materials and components for our products.
 
Research and Development
 
We are engaged in the development of chemical compounds, including new chemical entities, which provide us with strategic pipeline opportunities for the commercialization of new branded prescription pharmaceutical products. In addition to developing new chemical compounds, we pursue strategies to enhance the value of existing products by developing new uses, formulations, and drug delivery technology that may provide additional benefits to patients and improvements in the quality and efficiency of our manufacturing processes.
 
We invest in research and development because we believe it is important to our long-term growth. We presently employ approximately 100 people in research and development, including pre-clinical and toxicology experts, pharmaceutical formulations scientists, clinical development experts, medical affairs personnel, regulatory affairs experts, data scientists/statisticians and project managers.
 
In the context of our research and development, we outsource a substantial amount of our non-critical activities. This provides us with substantial flexibility and allows high efficiency while minimizing internal fixed costs. Utilizing this approach, we supplement our internal efforts by collaborating with independent research organizations, including educational institutions and research-based pharmaceutical and biotechnology companies, and contracting with other parties to perform research in their facilities. We use the services of physicians, hospitals, medical schools, universities, and other research organizations worldwide to conduct clinical trials to establish the safety and effectiveness of new products. We seek investments in external research and technologies that hold the promise to complement and strengthen our own research efforts. These investments can take many forms, including in-licensing arrangements, development agreements, joint ventures and the acquisition of products in development.
 
Drug development is time-consuming and expensive. Only a small percentage of chemical compounds discovered by researchers prove to be both medically effective and safe enough to become an approved medicine. The process from discovery to regulatory approval typically takes 10 to 15 years or longer. Drug candidates can fail at any stage of the process, and even late-stage product candidates sometimes fail to receive regulatory approval.
 
Clinical trials are conducted in a series of sequential phases, with each phase designed to address a specific research question. In Phase I clinical trials, researchers test a new drug or treatment in a small group of people to evaluate the drug’s safety, determine a safe dosage range and identify side effects. In Phase II


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clinical trials, researchers give the drug or treatment to a larger population to assess effectiveness and to further evaluate safety. In Phase III clinical trials, researchers give the drug or treatment to an even larger population to confirm its effectiveness, monitor side effects, compare it to commonly used treatments and collect information that will allow the drug or treatment to be used safely. The results of Phase III clinical trials are pivotal for purposes of obtaining FDA approval of a new product. Phase IV clinical trials are typically conducted after FDA approval in order to broaden the understanding of the safety and efficacy of a drug as utilized in actual clinical practice or to explore alternative or additional uses.
 
Our development projects, including those for which we have collaboration agreements with third parties, include the following:
 
  •  Remoxytm, a novel formulation of long-acting oxycodone for the treatment of moderate to severe chronic pain, which has successfully completed Phase III clinical trials and our partner, Pain Therapeutics, Inc., is preparing to file an NDA with the FDA. Remoxytm is specifically designed to resist common methods of abuse associated with long-acting oxycodone products that are currently available.
 
  •  CorVuetm (binodenoson) our next generation cardiac pharmacologic stress-imaging agent, has successfully completed Phase III clinical trials and we are preparing to file an NDA with the FDA.
 
  •  Acuroxtm tablets, a novel formulation of immediate release oxycodone for the treatment of acute pain, which is currently in Phase III clinical trials. Acuroxtm is specifically designed to deter or resist common methods of abuse associated with immediate release oxycodone products that are currently available.
 
  •  Vanquixtm, a diazepam-filled auto-injector for the treatment of acute, repetitive epileptic seizures, is currently in Phase III clinical trials.
 
  •  Sonedenoson, formerly known as MRE0094, is an investigational drug for the topical treatment of chronic diabetic neuropathic foot ulcers. The Phase II clinical trial with Sonedenoson did not meet its primary endpoint. We are continuing to evaluate the data from this trial.
 
  •  T-62, an investigational drug for the treatment of neuropathic pain, has completed Phase I clinical trials and expect to begin patient enrollment in Phase II clinical trials in the middle of 2008.
 
Our research and development expenses totaled $149.4 million in 2007 compared to $143.6 million in 2006 and $74.0 million in 2005, excluding research and development in-process at the time of acquisition of a product. In-process research and development expenses were $35.3 million for the year ended December 31, 2007, $110.0 million for the year ended December 31, 2006 and $188.7 million for the year ended December 31, 2005. In-process research and development represents the actual cost of acquiring rights to branded pharmaceutical projects in development from third parties, which costs we expense at the time of acquisition.
 
Government Regulation
 
Our business and our products are subject to extensive and rigorous regulation at both the federal and state levels. Nearly all of our products are subject to pre-market approval requirements. New drugs are approved under, and are subject to, the Food, Drug and Cosmetics Act (“FDC Act”) and related regulations. Biological drugs are subject to both the FDC Act and the Public Health Service Act, which we refer to as the “PHS Act,” and related regulations. Biological drugs are licensed under the PHS Act.
 
At the federal level, we are principally regulated by the FDA as well as by the DEA, the Consumer Product Safety Commission, the Federal Trade Commission (“FTC”), the Occupational Safety and Health Administration, and the U.S. Environmental Protection Agency (“EPA”). The FDC Act, the regulations promulgated thereunder, and other federal and state statutes and regulations, govern, among other things, the


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development, testing, manufacture, safety, effectiveness, labeling, storage, record keeping, approval, advertising and promotion of pharmaceutical products.
 
The processes by which regulatory approvals are obtained from the FDA to market and sell a new product are complex, require a number of years and involve the expenditure of substantial resources. Compounds or potential new products that appear promising in development can prove unsuccessful and fail to receive FDA approval, fail to receive approval of specific anticipated indications, be substantially delayed, or receive unfavorable product labeling (including indications or safety warnings), each of which can materially affect the commercial value of the product. Additional factors that may materially affect the success and/or timing of regulatory approval of a new product, and its commercial potential, include the regulatory filing strategies employed, the timing of and delays in FDA review, and the intervention by third parties in the approval process through administrative or judicial means.
 
When we acquire the right to market an existing approved pharmaceutical product, both we and the former application holder are required to submit certain information to the FDA. This information, if adequate, results in the transfer to us of marketing rights to the pharmaceutical product. We are also required to report to the FDA, and sometimes acquire prior approval from the FDA for, certain changes in an approved NDA or Biologics Licensing Application, as set forth in the FDA’s regulations. When advantageous, we transfer the manufacture of acquired branded pharmaceutical products to other manufacturing facilities, which may include manufacturing facilities we own, after regulatory requirements are satisfied. In order to transfer manufacturing of acquired products, the new manufacturing facility must demonstrate, through the filing of information with the FDA, that it can manufacture the product in accordance with current Good Manufacturing Practices, referred to as “cGMPs,” and the specifications and conditions of the approved marketing application. There can be no assurance that the FDA will grant necessary approvals in a timely manner, if at all.
 
The FDA also mandates that drugs be manufactured, packaged and labeled in conformity with cGMPs at all times. In complying with cGMPs, manufacturers must continue to expend time, money and effort in production, record keeping and quality control to ensure that the products meet applicable specifications and other requirements to ensure product safety and efficacy.
 
The FDA and other government agencies periodically inspect drug manufacturing facilities to ensure compliance with applicable cGMP and other regulatory requirements. Failure to comply with these statutory and regulatory requirements subjects the manufacturer to possible legal or regulatory action, such as suspension of manufacturing, recall of product or seizure of product. We must report adverse experiences with the use of our products to the FDA. The FDA could impose market restrictions on us such as labeling changes or product removal as a result of significant reports of unexpected, severe adverse experiences. Product approvals may be withdrawn if we fail to comply with regulatory requirements or if there are problems with the safety or efficacy of the product.
 
The federal government has extensive enforcement powers over the activities of pharmaceutical manufacturers, including the authority to withdraw product approvals at any time, commence actions to seize and prohibit the sale of unapproved or non-complying products, halt manufacturing operations that are not in compliance with cGMPs, and impose or seek injunctions, voluntary or involuntary recalls, and civil monetary and criminal penalties. A restriction or prohibition on sales or withdrawal of approval of products marketed by us could materially adversely affect our business, financial condition or results of operations.
 
We also manufacture and sell pharmaceutical products which are “controlled substances” as defined in the Controlled Substances Act and related federal and state laws. These laws establish certain security, licensing, record keeping, reporting and personnel requirements administered by the DEA and state authorities. The DEA has dual missions of law enforcement and regulation. The former deals with the illicit aspects of the control of abusable substances and the equipment and raw materials used in making them. The DEA shares enforcement authority with the Federal Bureau of Investigation, another division of the Department of Justice. The DEA’s regulatory responsibilities are concerned with the control of licensed manufacturers, distributors and dispensers of controlled substances, the substances themselves and the equipment and raw materials used in their manufacture and packaging in order to prevent these articles from being diverted into illicit channels


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of commerce. We maintain appropriate licenses and certificates with the DEA and applicable state authorities in order to engage in the development, manufacturing and distribution of pharmaceutical products containing controlled substances.
 
The distribution and promotion of pharmaceutical products is subject to the Prescription Drug Marketing Act (“PDMA”), a part of the FDC Act, which regulates distribution activities at both the federal and state levels. Under the PDMA and its implementing regulations, states are permitted to require registration of manufacturers and distributors who provide pharmaceuticals even if these manufacturers or distributors have no place of business within the state. States are also permitted to adopt regulations limiting the distribution of product samples to licensed practitioners. The PDMA also imposes extensive licensing, personnel record keeping, packaging, quantity, labeling, product handling and facility storage and security requirements intended to prevent the sale of pharmaceutical product samples or other diversions of samples.
 
A number of states have passed laws specifically designed to track and regulate specified activities of pharmaceutical companies. Other states presently have pending legislation that will have similar effects. Some of these state laws require the tracking and reporting of advertising or marketing activities and spending within the state. Others limit spending on items provided to healthcare providers or state officials.
 
Environmental Matters
 
Our operations are subject to numerous and increasingly stringent federal, state and local environmental laws and regulations concerning, among other things, the generation, handling, storage, transportation, treatment and disposal of toxic and hazardous substances and the discharge of pollutants into the air and water. Environmental permits and controls are required for some of our operations and these permits are subject to modification, renewal and revocation by the issuing authorities. We believe that our facilities are in substantial compliance with our permits and environmental laws and regulations and do not believe that future compliance with current environmental laws will have a material adverse effect on our business, financial condition or results of operations. Our environmental capital expenditures and costs for environmental compliance were immaterial in 2007 and 2006, but may increase in the future as a result of changes in environmental laws and regulations or as a result of increased manufacturing activities at any of our facilities.
 
Competition
 
General
 
We compete with numerous other pharmaceutical companies, including large, global pharmaceutical companies, for the acquisition of products and technologies in later stages of development. We also compete with other pharmaceutical companies for currently marketed products and product line acquisitions. Additionally, our products are subject to competition from products with similar qualities. Our branded pharmaceutical products may be subject to competition from alternate therapies during the period of patent protection and thereafter from generic equivalents. The manufacturers of generic products typically do not bear the related research and development costs and consequently are able to offer such products at considerably lower prices than the branded equivalents. There are, however, a number of factors which enable some products to remain profitable once patent protection has ceased. These include the establishment of a strong brand image with the prescriber or the consumer, supported by the development of a broader range of alternative formulations than the manufacturers of generic products typically supply.
 
Generic Substitutes
 
Some of our branded pharmaceutical products currently face competition from generic substitutes, and others may face competition from generic substitutes in the future. For a manufacturer to launch a generic substitute, it must prove to the FDA that the branded pharmaceutical product and the generic substitute are therapeutically equivalent.
 
The FDA requires that generic applicants claiming invalidity or non-infringement of patents listed by a NDA holder give the NDA holder notice each time an abbreviated new drug application (“ANDA”) which


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claims invalidity or non-infringement of listed patents is either submitted or amended. If the NDA holder files a patent infringement suit against the generic applicant within 45 days of receiving such notice, the FDA is barred (or stayed) from approving the ANDA for 30 months unless specific events occur sooner. To avoid multiple 30-month stays for the same branded drug, the relevant provisions of the Hatch-Waxman Act (21 U.S.C. §§ 355(j)(2) and (5)) indicate that a 30-month stay will only attach to patents that are listed in the FDA’s Approved Drug Products with Therapeutic Equivalence Evaluations, which we refer to as the “FDA’s Orange Book,” at the time an ANDA is originally filed. Although the ANDA filer is still required to certify against a newly-listed patent, and the NDA holder can still bring suit based upon infringement of that patent, such a suit will not trigger an additional 30-month stay of FDA approval of the ANDA.
 
Patents that claim a composition of matter relating to a drug or certain methods of using a drug are required to be listed in the FDA’s Orange Book. The FDA’s regulations prohibit listing of certain types of patents. Thus, some patents that may issue are not eligible for listing in the FDA’s Orange Book and thus not eligible for protection by a 30-month stay of FDA approval of the ANDA.
 
Intellectual Property
 
Patents, Licenses and Proprietary Rights
 
The protection of discoveries in connection with our development activities is critical to our business. The patent positions of pharmaceutical companies, including ours, are uncertain and involve legal and factual questions which can be difficult to resolve. We seek patent protection in the United States and selected foreign countries where and when appropriate.
 
Skelaxin® has two method-of-use patents listed in the FDA’s Orange Book which expire in December 2021. In January 2008, we entered into an agreement with CorePharma providing it with a license to launch an authorized generic version of Skelaxin® in December 2012 or earlier under certain conditions.
 
Avinza® has a formulation patent listed in the FDA’s Orange Book that expires in November 2017.
 
Sonata® has a composition of matter patent listed in the FDA’s Orange Book that expires in June 2008. In 2007, we entered into an agreement with CorePharma providing it with a license to launch an authorized generic version of Sonata® in April 2008.
 
Synercid® has a formulation patent that expires in November 2017.
 
We own the intellectual property rights associated with Meridian’s dual-chambered auto-injector and injection process, which include a patent in the United States that expires in April 2010.
 
We receive royalties on sales of Adenoscan®, a product that we developed. We own one patent on Adenoscan® with an expiration date of May 2009. We also have certain rights tied to another patent covering this product which does not expire until 2015. In October 2007, we entered into an agreement with Astellas and a subsidiary of Teva Pharmaceutical Industries Ltd. providing Teva with the right to launch a generic version of Adenoscan® pursuant to a license in September 2012 or earlier under certain conditions.
 
In addition to the intellectual property for the currently marketed products described above, we also have created, acquired or licensed intellectual property related to various products currently under development. For example, in connection with our collaborative agreement with Pain Therapeutics, Inc., we have acquired an exclusive license (subject to preexisting license rights granted by Pain Therapeutics) to certain intellectual property rights related to opioid formulations, including Remoxytm, which is currently in development for the treatment of moderate to severe chronic pain. In connection with our collaborative agreement with Acura Pharmaceuticals, Inc., we have acquired a license to intellectual property rights related to the Aversion® Technology platform. Furthermore, in connection with the development of Sonedenoson, we have acquired exclusive licenses to composition and method patents related to adenosine receptor agonists for the topical treatment of chronic diabetic foot ulcers. Also, we have acquired exclusive rights to patents related to CorVuetm, the pharmacologic stress agent specific to the adenosine receptor necessary for increased cardiac blood flow. Also, we have acquired certain intellectual property rights from Mutual Pharmaceutical Company, Inc. related to metaxalone, the active pharmaceutical ingredient in Skelaxin®.


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We also rely upon trade secrets, unpatented proprietary know-how and continuing technological innovation to develop and sustain our competitive position. There can be no assurance that others will not independently develop substantially equivalent proprietary technology and techniques or otherwise gain access to our trade secrets or disclose the technology or that we can adequately protect our trade secrets.
 
Trademarks
 
We sell our branded products under a variety of trademarks. We believe that we have valid proprietary interests in all currently used trademarks, including those for our principal branded pharmaceutical products registered in the United States.
 
Backlog
 
There was no material backlog as of February 27, 2008.
 
Executive Officers
 
             
Name
 
Age
 
Position with the Company
 
Brian A. Markison
    48     President, Chief Executive Officer and Chairman of the Board of Directors
Joseph Squicciarino
    51     Chief Financial Officer
Stephen J. Andrzejewski
    42     Chief Commercial Officer
Frederick Brouillette, Jr. 
    56     Corporate Compliance Officer
Eric J. Bruce
    51     Chief Technical Operations Officer
Dr. Eric G. Carter
    56     Chief Science Officer
James W. Elrod
    47     General Counsel
James E. Green
    48     Executive Vice President, Corporate Affairs
 
Brian A. Markison was elected as Chairman of the Board in May 2007. He has been President and Chief Executive Officer and a director since July 2004. He joined King as Chief Operating Officer in March 2004. Mr. Markison served in various positions with Bristol-Myers Squibb beginning in 1982. Most recently as President of Bristol-Myers Squibb’s Oncology, Virology and Oncology Therapeutics Network businesses. Between 1998 and 2001, he served variously as Senior Vice President, Neuroscience/Infectious Disease; President, Neuroscience/Infectious Disease/Dermatology; and Vice President, Operational Excellence and Productivity. He also held various sales and marketing positions. Mr. Markison is a member of the Board of Directors of Immunomedics, Inc., a publicly-held corporation. He graduated from Iona College in 1982 with a Bachelor of Science degree.
 
Joseph Squicciarino has served as King’s Chief Financial Officer since June 2005. Prior to joining King, he was Chief Financial Officer — North America for Revlon, Inc. since March 2005. From February 2003 until March 2005 he served as Chief Financial Officer — International for Revlon International, Inc. He held the position of Group Controller Pharmaceuticals — Europe, Middle East, Africa with Johnson & Johnson from October 2001 until October 2002. He held a variety of positions with the Bristol-Myers Squibb Company and its predecessor, the Squibb Corporation, from 1979 until 2001, including Vice President Finance, International Medicines; Vice President Finance, Europe Pharmaceuticals & Worldwide Consumer Medicines; Vice President Finance, Technical Operations; and Vice President Finance, U.S. Pharmaceutical Group. Mr. Squicciarino also serves on the Board of Directors of Zep, Inc., a publicly-held company. He is a Certified Public Accountant, a member of the New Jersey Society of Certified Public Accountants and a member of the American Institute of Certified Public Accountants. Mr. Squicciarino graduated from Adelphi University in 1978 with a Bachelor of Science degree in Accounting.
 
Stephen J. Andrzejewski has served as Chief Commercial Officer since October 2005. He was previously Corporate Head, Commercial Operations commencing in May 2004. Prior to joining King, Mr. Andrzejewski was Senior Vice President, Commercial Business at Endo Pharmaceuticals Inc. since June 2003. He previously served in various positions with Schering-Plough Corporation beginning in 1987, including Vice President of


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New Products and Vice President of Marketing, and had responsibility for launching the Claritin® product. Mr. Andrzejewski graduated cum laude from Hamilton College with a Bachelor of Arts degree in 1987 and in 1992 graduated from New York University’s Stern School of Business with a Master of Business Administration degree.
 
Frederick Brouillette, Jr. has served as Corporate Compliance Officer since August 2003. He served as Executive Vice President, Finance from January 2003 until August 2003 and prior to that as Vice President, Risk Management beginning in February 2001. Before joining King, Mr. Brouillette, a Certified Public Accountant, was with PricewaterhouseCoopers for 4 years, serving most recently in that firm’s Richmond, Virginia office providing internal audit outsourcing and internal control consulting services. He was formerly a chief internal audit executive for two major public corporations and served for 12 years in the public accounting audit practice of Peat, Marwick Mitchell & Co., the predecessor firm to KPMG. Mr. Brouillette is a member of the Virginia Society of Certified Public Accountants, the American Institute of Certified Public Accountants, and the Institute of Internal Auditors. He graduated with honors from the University of Virginia’s McIntire School of Commerce in 1973 with a Bachelor of Science degree in accounting.
 
Eric J. Bruce has served as Chief Technical Operations Officer since June 2005. Prior to joining King, Mr. Bruce was Vice President of Operations for Mallinckrodt Pharmaceuticals, a position he had occupied since 2000. Previously, he was Vice President of Manufacturing for Kendall Health Care from 1997 until 2000, and from 1996 until 1997 he held various positions with INBRAND, including that of Senior Vice President of Manufacturing. Mr. Bruce graduated from the Georgia Institute of Technology in 1978 with a Bachelor of Science degree in Industrial Management.
 
Eric G. Carter, M.D., Ph.D., has served as King’s Chief Science Officer since January 2007. Prior to joining King, he held several positions with GlaxoSmithKline commencing in 1999, most recently as Vice President and Global Head, Clinical Development and Medical Affairs, Gastroenterology, R&D. Dr. Carter has served as a Clinical Associate Professor at the University of North Carolina for the Division of Digestive Diseases and Nutrition, School of Medicine. He previously held academic positions with the University of California, where he was responsible for establishing and directing many research programs. After earning a bachelor’s degree in Biochemistry from the University of London, Dr. Carter received his medical degree from the University of Miami and a doctor of philosophy degree from the University of Cambridge. He obtained board certification from the American Board of Internal Medicine, Gastroenterology and Clinical Nutrition and has authored or co-authored more than 50 scientific publications.
 
James W. Elrod has served as General Counsel since February 2006 and Corporate Secretary since May 2005. He was Acting General Counsel from February 2005 to February 2006. He has worked in various positions with King since September 2003, including Vice President, Legal Affairs. Prior to joining King he served in various capacities at Service Merchandise Company, Inc. including Vice President, Legal Department. He previously practiced law in Nashville, Tennessee. Mr. Elrod earned a Juris Doctor degree from the University of Tennessee and a Bachelor of Arts degree from Berea College.
 
James E. Green has served as Executive Vice President, Corporate Affairs since April 2003. He was Vice President, Corporate Affairs commencing in June 2002 and was Senior Director, Corporate Affairs beginning in September 2000. Prior to joining King, he was engaged in the private practice of law for 15 years as a commercial transactions and commercial litigation attorney, having most recently served as the senior member of Green & Hale, a Professional Corporation, in Bristol, Tennessee. Mr. Green graduated from Southern Methodist University School of Law with a Juris Doctor degree in 1985 and Milligan College with a Bachelor of Science degree, cum laude, in 1982. He is licensed to practice law in Tennessee, Texas and Virginia.


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Employees
 
As of February 27, 2008, we employed approximately 2,050 full-time and 2 part-time persons. Twenty-nine employees of the Rochester facility are covered by a collective bargaining agreement with United Steelworkers, Local 6-176. Approximately 240 employees of the St. Louis facility are covered by a collective bargaining agreement with the International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America Union, Local No. 688. We believe our employee relations are good.


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Item 1A.   Risk Factors
 
You should carefully consider the risks described below and the other information contained in this report, including our audited consolidated financial statements and related notes. The risks described below are not the only ones facing our company. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the adverse events described in this “Risk Factors” section or other sections of this report actually occurs, our business, results of operations and financial condition could be materially adversely affected, the trading price, if any, of our securities could decline and you might lose all or part of your investment.
 
Risks Related to our Business
 
If we cannot successfully enforce our rights under the patents relating to two of our largest products, Skelaxin® and Avinza®, or if we are unable to secure or enforce our rights under other patents and trademarks and protect our trade secrets and other intellectual property, additional competitors could enter the market, and sales of these products may decline materially.
 
Under the Hatch-Waxman Act, any generic pharmaceutical manufacturer may file an ANDA with a certification, known as a “Paragraph IV certification,” challenging the validity or infringement of a patent listed in the FDA’s Approved Drug Products with Therapeutic Equivalence Evaluations, which is known as the “FDA’s Orange Book,” four years after the pioneer company obtains approval of its NDA.
 
As more fully described in Note 19, “Commitments and Contingencies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules,” other companies have filed Paragraph IV certifications challenging the patents associated with some of our key products. If any of these Paragraph IV challenges succeeds, our affected product would face generic competition and its sales would likely decline materially. Should sales decline, we may have to write off a portion or all of the intangible assets associated with the affected product as we did with Altace® as described below.
 
We may not be successful in securing or maintaining proprietary patent protection for other of our products or for products and technologies we develop or license. In addition, our competitors may develop products similar to ours, including generic products, using methods and technologies that are beyond the scope of our intellectual property protection, which could materially reduce our sales.
 
Although most of our revenue is generated by products not currently subject to competition from generic products, there is no proprietary protection for many of our branded pharmaceutical products, and generic substitutes for many of these products are sold by other pharmaceutical companies. Further, we also rely upon trade secrets, unpatented proprietary know-how and continuing technological innovation in order to maintain our competitive position with respect to some products. Our sales could be materially reduced if our competitors independently develop equivalent proprietary technology and techniques or gain access to our trade secrets, know-how and technology.
 
If we are unable to enforce our patents and trademarks or protect our trade secrets and other intellectual property, our results of operations and cash flows could be materially and adversely affected.
 
Additionally, certain of our supply agreements and purchase orders for raw materials contain minimum purchase commitments. If loss of market exclusivity or other factors cause sales of our products to fall below amounts necessary to use the raw materials we have committed to purchase, we may incur losses in connection with those supply agreements or purchase orders.
 
In late 2007, the key patent associated with Altace® was invalidated by a federal court, and we expect net sales of Altace® to decrease significantly as a result. Our related restructuring initiative might not succeed, and, in any event, the benefits of the initiative will not be sufficient to offset the loss of revenues from decreased Altace® sales.
 
In late 2007, following the Circuit Court’s decision invalidating our ‘722 Altace® patent, we undertook an analysis of its potential effects on future sales of Altace®. As a result of this analysis, we concluded that our


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actual and estimated future net sales of Altace® are likely to decrease significantly because of competition from generic products. We therefore reduced our estimate of future net sales of Altace® and recorded charges associated with (1) minimum purchase requirements under our supply agreement to purchase Altace® raw material, (2) inventories associated with Altace® and (3) an impairment of our Altace® intangible assets.
 
In addition, following the Circuit Court’s invalidation of our ‘722 patent relating to Altace®, we began a restructuring initiative designed to accelerate our planned strategic shift emphasizing our focus in neuroscience, hospital and acute care medicine. This initiative includes, based on an analysis of our strategic needs, a reduction in personnel, staff leverage, expense reductions and additional controls over spending, reorganization of sales teams and a realignment of research and development priorities. If we are unable to complete the objectives of this initiative, our business and results of operations may be materially adversely affected. Moreover, the anticipated benefits of the restructuring initiative will not be sufficient to offset the loss of revenues from decreased product sales following the invalidation of our Altace® patent. We expect this loss of revenues to be material.
 
The uncertainty and expense of the drug development process, actions by our competitors and other factors may adversely affect our ability to implement our strategy to grow our business through increased sales, acquisitions, development and in-licensing, and, as a result, our business or competitive position in the pharmaceutical industry may suffer.
 
Drug development is time-consuming and expensive. Only a small percentage of chemical compounds discovered by researchers prove to be both medically effective and safe enough to become an approved medicine. The process from discovery to regulatory approval typically takes 10 to 15 years or longer. Drug candidates can fail at any stage of the process, and even late-stage product candidates sometimes fail to receive regulatory approval.
 
Clinical trials are conducted in a series of sequential phases, with each phase designed to address a specific research question. In Phase I clinical trials, researchers test a new drug or treatment in a small group of people to evaluate the drug’s safety, determine a safe dosage range, and identify side effects. In Phase II clinical trials, researchers give the drug or treatment to a larger population to assess effectiveness and to further evaluate safety. In Phase III clinical trials, researchers give the drug or treatment to an even larger population to confirm its effectiveness, monitor side effects, compare it to commonly used treatments, and collect information that will allow the drug or treatment to be used safely. The results of Phase III clinical trials are pivotal for purposes of obtaining FDA approval of a new product.
 
The processes by which regulatory approvals are obtained from the FDA to market and sell a new product are complex, require a number of years and involve the expenditure of substantial resources. Compounds or potential new products that appear promising in development can prove unsuccessful and fail to receive FDA approval, fail to receive approval of specific anticipated indications, be substantially delayed, or receive unfavorable product labeling (including indications or safety warnings), each of which can materially affect the commercial value of the product. Additional factors that may materially affect the success and/or timing of regulatory approval of a new product, and its commercial potential, include the regulatory filing strategies employed, the timing of and delays in FDA review, and the intervention by third parties in the approval process through administrative or judicial means. As a result, there can be no assurance that we will receive regulatory approval of our products in development, or of new dosage forms for existing products, that our products or dosage forms will receive approval for specific indications or that the labeling of these products will be as we would prefer.
 
Our current strategy is to increase sales of certain of our existing products and to enhance our competitive standing through acquisitions or in-licensing of products, either in development or previously approved by the FDA, that complement our business and enable us to promote and sell new products through existing marketing and distribution channels. Moreover, since we engage in limited proprietary research activity with respect to the development of new chemical entities, we rely heavily on purchasing or licensing products in development and FDA-approved products from other companies.


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Development projects, including those for which we have collaboration agreements with third parties, include the following:
 
  •  Remoxytm, an investigational drug for the treatment of moderate to severe chronic pain that we are developing with Pain Therapeutics, Inc.;
 
  •  Acuroxtm tablets, an investigational drug for the treatment of acute pain that we are developing with Acura Pharmaceuticals, Inc.;
 
  •  CorVuetm (binodenoson) a myocardial pharmacologic stress imaging agent;
 
  •  Vanquixtm, a diazepam-filled auto-injector;
 
  •  Sonedenoson, formerly known as MRE0094, an investigational drug for the topical treatment of chronic diabetic foot ulcers; and
 
  •  T-62, an investigational drug for the treatment of neuropathic pain.
 
We compete with other pharmaceutical companies, including large pharmaceutical companies with financial, human and other resources substantially greater than ours, in the development and licensing of new products. We cannot assure you that we will be able to:
 
  •  engage in product life-cycle management to develop new indications and line extensions for existing and acquired products,
 
  •  successfully develop, license or commercialize new products on a timely basis or at all,
 
  •  continue to develop products already in development in a cost effective manner, or
 
  •  obtain any FDA approvals necessary to successfully implement the strategies described above.
 
If we are not successful in the development or licensing of new products already in development, including obtaining any necessary FDA approvals, our business, financial condition, and results of operations could be materially adversely affected.
 
Further, other companies may license or develop products or may acquire technologies for the development of products that are the same as or similar to the products we have in development or that we license. Because there is rapid technological change in the industry and because many other companies may have more financial resources than we do, other companies may:
 
  •  develop or license their products more rapidly than we can,
 
  •  complete any applicable regulatory approval process sooner than we can,
 
  •  market or license their products before we can market or license our products, or
 
  •  offer their newly developed or licensed products at prices lower than our prices.
 
Any of these events would thereby have a negative effect on the sales of our existing, newly developed or licensed products. The inability to effect acquisitions or licenses of additional branded products in development and FDA-approved products could limit the overall growth of our business. Furthermore, even if we obtain rights to a pharmaceutical product or acquire a company, we may not be able to generate sales sufficient to create a profit or otherwise avoid a loss. Technological developments or the FDA’s approval of new products or of new therapeutic indications for existing products may make our existing products or those products we are licensing or developing obsolete or may make them more difficult to market successfully, which could have a material adverse effect on results of operations and cash flows.


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Seven of our products and our royalty segment accounted for 86.4% of our revenues from continuing operations in 2007 and a decrease in sales of these products or royalty income or an increase in competition in the future would have a material adverse effect on our results of operations.
 
Revenues.  Altace®, Skelaxin®, Thrombin-JMI®, EpiPen®, Levoxyl®, Sonata®, Avinza® and royalty revenues for the last twelve months ended December 31, 2007 accounted for 30.2%, 20.6%, 12.5%, 5.7%, 4.7%, 3.7%, 5.1% and 3.9% of our total revenues from continuing operations, respectively, or 86.4% in total. Accordingly, any factor adversely affecting sales of any of these products or products for which we receive royalty payments could have a material adverse effect on our results of operations and cash flows. For example, on September 11, 2007, the Circuit Court invalidated our ‘722 patent, related to Altace®. Invalidation of this patent has led to a generic version of Altace® entering the market. Additional third parties will likely enter the market with their own generic substitutes for Altace® in 2008. As a result of the entry of generic competition, we expect net sales of Altace® to decline significantly.
 
Product Competition.  Additionally, since our currently marketed products are generally established and commonly sold, they are subject to competition from products with similar qualities. For example:
 
  •  Altace® has a generic substitute that entered the market in December 2007.
 
  •  Skelaxin® competes in a highly genericized market with other muscle relaxants.
 
  •  Sonata® competes with other insomnia treatments in a highly competitive market. We anticipate a generic substitute will enter the market in the second quarter of 2008, and we expect the entry of generic products to cause our net sales of Sonata® to decline significantly.
 
  •  Levoxyl® competes in a competitive and highly genericized market with other levothyroxine sodium products.
 
  •  Beginning in 2008, Thrombin-JMI®, our bovine thrombin product, will face new competition from human thrombin and recombinant human thrombin. Omrix Biopharmaceuticals, Inc.’s Biologics Licensing Application (“BLA”) for its human thrombin product was approved in September 2007. Zymogenetics, Inc. received approval of its BLA for recombinant human thrombin product in January 2008.
 
Other of our branded pharmaceutical products also face competition from generic substitutes.
 
The manufacturers of generic products typically do not bear the related research and development costs and, consequently, are able to offer such products at considerably lower prices than the branded equivalents. We cannot assure you that any of our products will remain without generic competition, or maintain their market share, gross margins and cash flows, the failure of which could have a material adverse effect on our business, financial condition, results of operations and cash flows.
 
EpiPen.  Dey, L.P. markets our EpiPen® auto-injector through a supply agreement with us that expires on December 31, 2015. Under the terms of the agreement, we grant Dey the exclusive right and license to market, distribute and sell EpiPen®, either directly or through subdistributors. A failure by Dey to successfully market and distribute EpiPen® or an increase in competition could have a material adverse effect on our business, financial condition, results of operations and cash flows.
 
Royalty Revenue. We receive royalties on sales of Adenoscan®, a product that we developed. Adenoscan® is manufactured, marketed and distributed by Astellas. In October 2007, we entered into an agreement with Astellas and a subsidiary of Teva Pharmaceutical Industries Ltd. (“Teva”) providing Teva with the right to launch a generic version of Adenoscan® pursuant to a license in September 2012, or earlier under certain conditions. A failure by Astellas to successfully manufacture, market and distribute Adenoscan®
or an increase in competition could have a material adverse effect on our business, financial condition, results of operations and cash flows.


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If we cannot integrate the business of companies or products we acquire, or appropriately and successfully manage and coordinate third-party collaborative development activities, our business may suffer.
 
The integration into our business of in-licensed or acquired assets or businesses, as well as the coordination and collaboration of research and development, sales and marketing efforts with third parties, requires significant management attention, maintenance of adequate operational, financial and management information systems, integration of systems that we acquire into our existing systems, and verification that the acquired systems meet our standards for internal control over financial reporting. Our future results will also depend in part on our ability to hire, retain and motivate qualified employees to manage expanded operations efficiently and in accordance with applicable regulatory standards. If we cannot manage our third-party collaborations and integrate in-licensed and acquired assets successfully, or, if we do not establish and maintain an appropriate administrative, support and control infrastructure to support these activities, this could have a material adverse effect on our business, financial condition, results of operations and cash flows and on our ability to make the necessary certifications with respect to our internal controls.
 
We are required annually, or on an interim basis as needed, to review the carrying value of our intangible assets and goodwill for impairment. If sales of our products decline because of, for example, generic competition or an inability to manufacture or obtain sufficient supply of product, the intangible asset value of any declining product could become impaired.
 
As of December 31, 2007, we had approximately $910.1 million of net intangible assets and goodwill. Intangible assets primarily include the net book value of various product rights, trademarks, patents and other intangible rights. If a change in circumstances causes us to lower our future sales forecast for a product, we may be required to write off a portion of the net book value of the intangible assets associated with that product. In evaluating goodwill for impairment, we estimate the fair value of our individual business reporting units on a discounted cash flow basis. In the event the value of an individual business reporting unit declines significantly, it could result in a non-cash impairment charge. Any impairment of the net book value of any intangible asset or goodwill, depending on the size, could result in a material adverse effect on our business, financial condition and results of operations.
 
We have entered into agreements with manufacturers and/or distributors of generic pharmaceutical products with whom we are presently engaged, or have previously been engaged, in litigation, and these agreements could subject us to claims that we have violated federal and/or state anti-trust laws.
 
We have negotiated and entered into a number of agreements with manufacturers and/or distributors of generic pharmaceutical products, some of whom are presently engaged or have previously been engaged in litigation with us. Governmental and/or private parties may allege that these arrangements and activities in furtherance of the success of these arrangements violate applicable state or federal anti-trust laws. Alternatively, courts could interpret these laws in a manner contrary to current understandings of such laws. If a court or other governmental body were to conclude that a violation of these laws had occurred, any liability based on such a finding could be material and adverse and could be preceded or followed by private litigation such as class action litigation.
 
For example, we have received civil investigative demands (“CIDs”) for information from the U.S. Federal Trade Commission (“FTC”). The CIDs require us to provide information related to our collaboration with Arrow, the dismissal without prejudice of our patent infringement litigation against Cobalt under the Hatch-Waxman Act of 1984 and other information. We are cooperating with the FTC in this investigation.
 
Unfavorable results in pending and future claims and litigation matters could have an adverse impact on us.
 
We are named as a party in various lawsuits, as are certain of our current and former directors and certain of our former officers. For information about our pending material litigation matters, please see Note 19, “Commitments and Contingencies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.” While we intend to vigorously defend ourselves in these actions, we are generally unable to predict the


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outcome or reasonably estimate the range of potential loss, if any, in the pending litigation. If we were not to prevail in the pending litigation, we could be required to pay material sums in connection with judgments or settlements related to these matters, or they could otherwise have a material adverse effect on our business, results of operations and financial condition.
 
Any significant delays or difficulties in the manufacture of, or supply of materials for, our products may reduce our profit margins and revenues, limit the sales of our products, or harm our products’ reputations.
 
Many of our product lines, including Skelaxin®, Thrombin-JMI®, Avinza®, Sonata® and Synercid®, are currently manufactured in part or entirely by third parties. Our dependence upon third parties for the manufacture of our products may adversely affect our profit margins or may result in unforeseen delays or other problems beyond our control. For example, if any of these third parties are not in compliance with applicable regulations, the manufacture of our products could be delayed, halted or otherwise adversely affected. If for any reason we are unable to obtain or retain third-party manufacturers on commercially acceptable terms, we may not be able to distribute our products as planned. If we encounter delays or difficulties with contract manufacturers in producing or packaging our products, the distribution, marketing and subsequent sales of these products could be adversely affected, and we may have to seek alternative sources of supply or abandon product lines or sell them on unsatisfactory terms. We might not be able to enter into alternative supply arrangements in a timely manner or at commercially acceptable rates, if at all. We also cannot assure you that the manufacturers we use will be able to provide us with sufficient quantities of our products or that the products supplied to us will meet our specifications.
 
Sales of Thrombin-JMI® may be affected by the perception of risks associated with some of the raw materials used in its manufacture. If we are unable to maintain purification procedures at our facilities that are in accordance with the FDA’s expectations for biological products generally, the FDA could limit our ability to manufacture biological products at those facilities.
 
For the twelve months ended December 31, 2007, our product Thrombin-JMI® accounted for 12.5% of our total revenues from continuing operations. The source material for Thrombin-JMI® comes from bovine plasma and lung tissue which has been certified by the United States Department of Agriculture for use in the manufacture of pharmaceutical products. Bovine-sourced materials, particularly those from outside the United States, may be of some concern because of potential transmission of bovine spongiform encephalopathy, or “BSE.” However, we have taken precautions to minimize the risks of contamination from BSE in our source materials and process. Our principal precaution is the use of bovine materials only from FDA-approved sources in the United States. Accordingly, all source animals used in our production of Thrombin-JMI® are of United States origin. Additionally, source animals used in production of Thrombin-JMI® are generally less than 18 months of age (BSE has not been identified in animals less than 30 months of age).
 
There is currently no alternative to the bovine-sourced materials for the manufacture of Thrombin-JMI®. We have two approved vendors as sources of supply of the bovine raw materials. Any interruption or delay in the supply of these materials could adversely affect the sales of Thrombin-JMI®. We will continue surveillance of the source and believe that the risk of BSE contamination in the source materials for Thrombin-JMI® is very low. While we believe that our procedures and those of our vendor for the supply, testing and handling of the bovine material comply with all federal, state, and local regulations, we cannot eliminate the risk of contamination or injury from these materials. There are high levels of global public concern about BSE. Physicians could determine not to administer Thrombin-JMI® because of the perceived risk, which could adversely affect our sales of the product. Any injuries resulting from BSE contamination could expose us to extensive liability. If public concern for the risk of BSE infection in the United States should increase, the manufacture and sale of Thrombin-JMI® and our business, financial condition, results of operations and cash flows could be materially and adversely affected.
 
The FDA expects manufacturers of biological products to have validated processes capable of removing extraneous viral contaminants to a high level of assurance. We have developed and implemented appropriate processing steps to achieve maximum assurance for the removal of potential extraneous viral contaminants


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from Thrombin-JMI®, which does not include BSE because it is not a viral contaminant, and we gained FDA approval for these processes. If we are unable to successfully maintain these processing steps or obtain the necessary supplies to do so in accordance with the FDA’s expectations, the manufacture and sale of Thrombin-JMI® and our business, financial condition, results of operations and cash flows could be materially and adversely affected.
 
Wholesaler and distributor buying patterns and other factors may cause our quarterly results to fluctuate, and these fluctuations may adversely affect our short-term results. Further, our access to wholesaler and distributor inventory levels and sales data affects our ability to estimate certain reserves included in our financial statements.
 
Our results of operations, including, in particular, product sales revenue, may vary from quarter to quarter due to many factors. Sales to wholesalers and distributors represent a substantial portion of our total sales. Buying patterns of our wholesalers and distributors may vary from time to time. In the event wholesalers and distributors with whom we do business determine to limit their purchases of our products, sales of our products could be adversely affected. For example, in advance of an anticipated price increase, customers may order pharmaceutical products in larger than normal quantities. The ordering of excess quantities in any quarter could cause sales of some of our branded pharmaceutical products to be lower in subsequent quarters than they would have been otherwise. As part of our ongoing efforts to facilitate improved management of wholesale inventory levels of our branded pharmaceutical products, we have entered into inventory management and data services agreements with each of our three key wholesale customers and other wholesale customers. These agreements provide wholesalers incentives to manage inventory levels and provide timely and accurate data with respect to inventory levels held, and valuable data regarding sales and marketplace activity. We rely on the timeliness and accuracy of the data that each customer provides to us on a regular basis pursuant to these agreements. If our wholesalers fail to provide us with timely and accurate data in accordance with the agreements, our estimates for certain reserves included in our financial statements could be materially and adversely affected.
 
Other factors that may affect quarterly results include, but are not limited to, expenditures related to the acquisition, sale and promotion of pharmaceutical products, a changing customer base, the availability and cost of raw materials, interruptions in supply by third-party manufacturers, new products introduced by us or our competitors, the mix of products we sell, sales and marketing expenditures, product recalls, competitive pricing pressures and general economic and industry conditions that may affect customer demand. We cannot assure you that we will be successful in maintaining or improving our profitability or avoiding losses in any future period.
 
Our relationships with the U.S. Department of Defense and other government entities subject us to risks associated with doing business with the government.
 
All U.S. government contracts provide that they may be terminated for the convenience of the government as well as for default. Our Meridian Auto-Injector segment has pharmaceutical products that are presently sold primarily to the U.S. Department of Defense (“DoD”) under an Industrial Base Maintenance Contract (“IBMC”). The current IBMC expires in July 2008. Although we have reason to believe the DoD will renew the IBMC based on our relationship of many years, we cannot assure you that it will do so. In the event the DoD does not renew the IBMC, our business, financial condition, results of operations and cash flows could be materially adversely affected. Additionally, the unexpected termination of one or more of our significant government contracts could result in a material adverse effect on our business, financial condition, results of operations and cash flows. A surge capability provision allows for the coverage of defense mobilization requirements in the event of rapid military deployment. If this surge capability provision becomes operative, we may be required to devote more of our Meridian Auto-Injector segment manufacturing capacity to the production of products for the government, which could result in less manufacturing capacity being devoted to products in this segment with higher profit margins.


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Our supply contracts with the DoD are subject to post-award audit and potential price determination. These audits may include a review of our performance on the contract, our pricing practices, our cost structure and our compliance with applicable laws, regulations and standards. Any costs found to be improperly allocated to a specific contract will not be reimbursed, while costs already reimbursed must be refunded. Therefore, a post-award audit or price redetermination could result in an adjustment to our revenues. From time to time the DoD makes claims for pricing adjustments with respect to completed contracts. If a government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeitures of profits, suspension of payments, fines and suspension or disqualification from doing business with the government.
 
Other risks involved in government sales include the unpredictability in funding for various government programs and the risks associated with changes in procurement policies and priorities. Reductions in defense budgets may result in reductions in our revenues. We also provide our nerve agent antidote auto-injectors to a number of state agencies and local communities for homeland defense against chemical agent terrorist attacks. Changes in governmental and agency procurement policies and priorities may also result in a reduction in government funding for programs involving our auto-injectors. A loss in government funding of these programs could have a material adverse effect on our business, financial condition, results of operations and cash flows.
 
Compliance with the terms and conditions of our corporate integrity agreement with the Office of Inspector General of the United States Department of Health and Human Services requires significant resources and management time and, if we fail to comply, we could be subject to penalties or, under certain circumstances, excluded from government health care programs, which could materially reduce our sales.
 
In October 2005, as part of our settlement of the government pricing investigation of our company we entered into a five-year corporate integrity agreement (“CIA”) with the Office of Inspector General of the United States Department of Health and Human Services (“HHS/OIG”). For additional information, please see Note 19, “Commitments and Contingencies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.” The purpose of the CIA, which applies to all of our U.S. subsidiaries and employees, is to promote compliance with the federal health care and procurement programs in which we participate, including the Medicaid Drug Rebate Program, the Medicare Program, the 340B Drug Pricing Program, and the Veterans Administration Pricing Program.
 
In addition to the challenges associated with complying with the regulations applicable to each of these programs (as discussed below), we are required, among other things, to keep in place our current compliance program, provide specified training to employees, retain an independent review organization to conduct periodic audits of our Medicaid Rebate calculations and our automated systems, processes, policies and practices related to government pricing calculations, and to provide periodic reports to HHS/OIG.
 
Maintaining the broad array of processes, policies, and procedures necessary to comply with the CIA is expected to continue to require a significant portion of management’s attention as well as the application of significant resources. Failing to meet the CIA obligations could have serious consequences for us including stipulated monetary penalties for each instance of non-compliance. In addition, flagrant or repeated violations of the CIA could result in our being excluded from participating in government health care programs, which could materially reduce our sales.
 
Our shareholder rights plan, charter and bylaws discourage unsolicited takeover proposals and could prevent shareholders from realizing a premium on their common stock.
 
We have a shareholder rights plan that may have the effect of discouraging unsolicited takeover proposals. The rights issued under the shareholder rights plan would cause substantial dilution to a person or group which attempts to acquire us on terms not approved in advance by our Board of Directors. In addition, our charter


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and bylaws contain provisions that may discourage unsolicited takeover proposals that shareholders may consider to be in their best interests. These provisions include:
 
  •  a classified Board of Directors, although the classification of the Board is being phased out and will be eliminated in 2010;
 
  •  the ability of our Board of Directors to designate the terms of and issue new series of preferred stock;
 
  •  advance notice requirements for nominations for election to our Board of Directors; and
 
  •  special voting requirements for the amendment of our charter and bylaws.
 
We are also subject to anti-takeover provisions under Tennessee law, each of which could delay or prevent a change of control. Together these provisions and the rights plan may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock.
 
At times, our stock price has been volatile, and such volatility in the future could result in substantial losses for our investors.
 
The trading price of our common stock has at times been volatile. The stock market in general and the market for the securities of emerging pharmaceutical companies such as King, in particular, have experienced extreme volatility. Many factors contribute to this volatility, including:
 
  •  variations in our results of operations;
 
  •  perceived risks and uncertainties concerning our business;
 
  •  announcements of earnings;
 
  •  developments in the governmental investigations or derivative litigation;
 
  •  the commencement of, or adverse developments in, any material litigation;
 
  •  failure to meet timelines for product development or other projections or forward-looking statements we may make to the public;
 
  •  failure to meet or exceed security analysts’ financial projections for our company;
 
  •  comments or recommendations made by securities analysts;
 
  •  general market conditions;
 
  •  perceptions about market conditions in the pharmaceutical industry;
 
  •  announcements of technological innovations or the results of clinical trials or studies;
 
  •  changes in marketing, product pricing and sales strategies or development of new products by us or our competitors;
 
  •  changes in domestic or foreign governmental regulations or regulatory approval processes; and
 
  •  announcements concerning regulatory compliance and government agency reviews.
 
The volatility of our common stock imposes a greater risk of capital losses on our shareholders than would a less volatile stock. In addition, such volatility makes it difficult to ascribe a stable valuation to a shareholder’s holdings of our common stock.
 
Risks Related to Our Industry
 
Failure to comply with laws and government regulations could adversely affect our ability to operate our business.
 
Virtually all of our activities are regulated by federal and state statutes and government agencies. The manufacturing, processing, formulation, packaging, labeling, distribution and advertising of our products, and


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disposal of waste products arising from these activities, are subject to regulation by one or more federal agencies, including the FDA, the Drug Enforcement Agency, or “DEA,” the Federal Trade Commission, the Consumer Product Safety Commission, the Department of Agriculture, the Occupational Safety and Health Administration, and the Environmental Protection Agency (“EPA”), as well as by foreign governments in countries where we distribute some of our products.
 
Failure to comply with the policies or requirements established by these agencies could subject us to enforcement actions or other consequences. For example, noncompliance with applicable FDA policies or requirements could subject us to suspensions of manufacturing or distribution, seizure of products, product recalls, fines, criminal penalties, injunctions, failure to approve pending drug product applications or withdrawal of product marketing approvals. Similar civil or criminal penalties could be imposed by other government agencies, such as the DEA, the EPA or various agencies of the states and localities in which our products are manufactured, sold or distributed, and could have ramifications for our contracts with government agencies such as the Department of Veterans Affairs or the Department of Defense.
 
The FDA has the authority and discretion to withdraw existing marketing approvals and to review the regulatory status of marketed products at any time. For example, the FDA may require withdrawal of an approved marketing application for any drug product marketed if new information reveals questions about a drug’s safety or efficacy. All drugs must be manufactured in conformity with current Good Manufacturing Practices and drug products subject to an approved application must be manufactured, processed, packaged, held and labeled in accordance with information contained in the approved application.
 
While we believe that all of our currently marketed pharmaceutical products comply with FDA enforcement policies, have approval pending or have received the requisite agency approvals, our marketing is subject to challenge by the FDA at any time. Through various enforcement mechanisms, the FDA can ensure that noncomplying drugs are no longer marketed and that advertising and marketing materials and campaigns are in compliance with FDA regulations. In addition, modifications, enhancements, or changes in manufacturing sites of approved products are in many circumstances subject to additional FDA approvals which may or may not be received and which may be subject to a lengthy FDA review process. Our manufacturing facilities and those of our third-party manufacturers are continually subject to inspection by governmental agencies. Manufacturing operations could be interrupted or halted in any of those facilities if a government or regulatory authority is unsatisfied with the results of an inspection. Any interruptions of this type could result in materially reduced sales of our products or increased manufacturing costs. For additional information please see the section entitled “Government Regulation” in Item 1, “Business” in Part I.
 
Under the Comprehensive Environmental Response, Compensation, and Liability Act, “CERCLA,” the EPA can impose liability for the entire cost of cleanup of contaminated properties upon each or any of the current and former site owners, site operators or parties who sent waste to the site, regardless of fault or the legality of the original disposal activity. In addition, many states, including Tennessee, Michigan, Wisconsin, Florida and Missouri, have statutes and regulatory authorities similar to CERCLA and to the EPA. We have entered into hazardous waste hauling agreements with licensed third parties to properly dispose of hazardous wastes. We cannot assure you that we will not be found liable under CERCLA or other applicable state statutes or regulations for the costs of undertaking a cleanup at a site to which our wastes were transported.
 
We cannot determine what effect changes in regulations, enforcement positions, statutes or legal interpretations, when and if promulgated, adopted or enacted, may have on our business in the future. These changes could, among other things, require modifications to our manufacturing methods or facilities, expanded or different labeling, new approvals, the recall, replacement or discontinuance of certain products, additional record keeping and expanded documentation of the properties of certain products and scientific substantiation. These changes, new legislation, or failure to comply with existing laws and regulations could have a material adverse effect on our business, financial condition, results of operations and cash flows.
 
An increase in product liability claims or product recalls could harm our business.
 
We face an inherent business risk of exposure to product liability claims in the event that the use of our technologies or products is alleged to have resulted in adverse effects. These risks exist for products in clinical


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development and with respect to products that have received regulatory approval for commercial sale. While we have taken, and will continue to take, what we believe are appropriate precautions, we may not be able to avoid significant product liability exposure. We currently have product liability insurance covering all of our significant products, however, we cannot assure you that the level or breadth of any insurance coverage will be sufficient to cover fully all potential claims. Also, adequate insurance coverage might not be available in the future at acceptable costs, if at all. With respect to any product liability claims that are not covered by insurance, we could be responsible for any monetary damages awarded by any court or any voluntary monetary settlements. Significant judgments against us for product liability for which we have no insurance could have a material adverse effect on our business, financial condition, results of operations and cash flows.
 
Product recalls or product field alerts may be issued at our discretion or at the discretion of the FDA, other government agencies or other companies having regulatory authority for pharmaceutical product sales. From time to time, we may recall products for various reasons, including failure of our products to maintain their stability through their expiration dates. Any recall or product field alert has the potential of damaging the reputation of the product or our reputation. To date, these recalls have not been significant and have not had a material adverse effect on our business, financial condition, results of operations or cash flows. However, we cannot assure you that the number and significance of recalls will not increase in the future. Any significant recalls could materially affect our sales and the prescription trends for the products and damage the reputation of the products or our reputation. In these cases, our business, financial condition, results of operations and cash flows could be materially adversely affected.
 
If we fail to comply with our reporting and payment obligations under the Medicaid rebate program or other governmental pricing programs, we could be required to reimburse government programs for underpayments and could be required to pay penalties, sanctions and fines which could have a material adverse effect on our business.
 
Medicaid reporting and payment obligations are highly complex and in certain respects ambiguous. If we fail to comply with these obligations, we could be subject to additional reimbursements, penalties, sanctions and fines which could have a material adverse effect on our business. Our processes for estimating amounts due under Medicaid and other governmental pricing programs involve subjective decisions, and, as a result, these calculations will remain subject to the risk of errors.
 
The insolvency of any of our principal customers, who are wholesale pharmaceutical distributors, could have a material adverse effect on our business, financial condition, results of operations and cash flows.
 
As with most other pharmaceutical companies, our principal customers are primarily wholesale pharmaceutical distributors. The wholesale distributor network for pharmaceutical products has in recent years been subject to increasing consolidation, which has increased our, and other industry participants’, customer concentration. Accordingly, three key customers accounted for approximately 75% of our gross sales and a significant portion of our accounts receivable for the fiscal year ended December 31, 2007. The insolvency of any of our principal customers could have a material adverse effect on our business, financial condition, results of operations and cash flows.
 
Any reduction in reimbursement levels by managed care organizations or other third-party payors may have an adverse effect on our revenues.
 
Commercial success in producing, marketing and selling branded prescription pharmaceutical products depends, in part, on the availability of adequate reimbursement from third-party health care payors, such as the government, private health insurers and managed care organizations. Third-party payors are increasingly challenging whether to reimburse certain pharmaceutical products and medical services. For example, many managed health care organizations limit reimbursement of pharmaceutical products. These limits may take the form of formularies with differential co-pay tiers. The resulting competition among pharmaceutical companies to maximize their product reimbursement has generally reduced growth in average selling prices across the industry. We cannot assure you that our products will be appropriately reimbursed or included on the formulary lists of managed care organizations or any or all Medicare Part D plans, or that downward pricing pressures in the industry generally will not negatively impact our operations.


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We establish accruals for the estimated amounts of rebates we will pay to managed care and government organizations each quarter. Any increased usage of our products through Medicaid, Medicare, or managed care programs will increase the amount of rebates that we owe. We cannot assure you that our products will be included on the formulary lists of managed care or Medicare organizations or that adverse reimbursement issues will not result in materially lower revenues.
 
If we fail to comply with the safe harbors provided under various federal and state laws, our business could be adversely affected.
 
We are subject to various federal and state laws pertaining to health care “fraud and abuse,” including anti-kickback laws and false claims laws. Anti-kickback laws make it illegal for a prescription drug manufacturer to solicit, offer, receive, or pay any remuneration in exchange for, or to include, the referral of business, including the purchase or prescription of a particular drug. The federal government has published regulations that identify “safe harbors” or exemptions for certain payment arrangements that do not violate the anti-kickback statutes. We seek to comply with these safe harbors. Due to the breadth of the statutory provisions and the absence of guidance in the form of regulations or court decisions addressing some of our practices, it is possible that our practices might be challenged under anti-kickback or similar laws. False claims laws prohibit anyone from knowingly (in the civil context), or knowingly and willfully (in the criminal context), presenting, or causing to be presented for payment to third-party payors (including Medicaid and Medicare) claims for reimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed, or claims for medically unnecessary items or services.
 
Violations of fraud and abuse laws may be punishable by civil and/or criminal sanctions, including fines and civil monetary penalties, as well as the possibility of exclusion from federal health care programs, including Medicaid and Medicare. Any such violations could have a material adverse effect on our financial results.
 
In the future, the publication of negative results of studies or clinical trials may adversely affect the sales of our products or the values of the intangible assets associated with them.
 
From time to time studies or clinical trials on various aspects of pharmaceutical products are conducted by academics or others, including government agencies, the results of which, when published, may have dramatic effects on the markets for the pharmaceutical products that are the subject of the study, or those of related or similar products. The publication of negative results of studies or clinical trials related to our products or the therapeutic areas in which our products compete could adversely affect our sales, the prescription trends for our products and the reputation of our products. In the event of the publication of negative results of studies or clinical trials related to our branded pharmaceutical products or the therapeutic areas in which our products compete, sales of these products may be materially adversely affected. Additionally, potential write-offs of the intangible assets associated with the affected products could materially adversely affect our results of operations.
 
New legislation or regulatory proposals may adversely affect our revenues.
 
A number of legislative and regulatory proposals aimed at changing the health care system, including the cost of prescription products, importation and reimportation of prescription products from countries outside the United States and changes in the levels at which pharmaceutical companies are reimbursed for sales of their products, have been proposed and could be proposed in the future. While we cannot predict when or whether any of these proposals will be adopted or the effect these proposals may have on our business, these proposals, as well as the adoption of any other proposals, may exacerbate industry-wide pricing pressures and could have a material adverse effect on our business, financial condition, results of operations and cash flows. We are unable at this time to predict or estimate the effect of any such regulations, if any.


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A WARNING ABOUT FORWARD-LOOKING STATEMENTS
 
This report includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to analyses and other information which are based on forecasts of future results and estimates of amounts that are not yet determinable. These statements also relate to our future prospects, developments and business strategies.
 
These forward-looking statements are identified by their use of terms and phrases, such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will” and other similar terms and phrases, including references to assumptions. These statements are contained in the “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections, as well as other sections of this report.
 
Forward-looking statements in this report include, but are not limited to, those regarding:
 
  •  the potential of, including anticipated net sales and prescription trends for, our branded pharmaceutical products, particularly Altace®, Skelaxin®, Avinza®, Thrombin-JMI®, Levoxyl® and Sonata®;
 
  •  expectations regarding the enforceability and effectiveness of product-related patents, including in particular patents related to Skelaxin®, Avinza®, Sonata® and Adenoscan®;
 
  •  expected trends and projections with respect to particular products, reportable segment and income and expense line items;
 
  •  the adequacy of our liquidity and capital resources;
 
  •  anticipated capital expenditures;
 
  •  the development, approval and successful commercialization of Remoxytm, Acuroxtm, CorVuetm and other products;
 
  •  the successful execution of our growth and restructuring strategies, including our accelerated strategic shift;
 
  •  anticipated developments and expansions of our business;
 
  •  our plans for the manufacture of some of our products, including products manufactured by third parties;
 
  •  the potential costs, outcomes and timing of research, clinical trials and other development activities involving pharmaceutical products, including, but not limited to, the magnitude and timing of potential payments to third parties in connection with development activities;
 
  •  the development of product line extensions;
 
  •  the expected timing of the initial marketing of certain products;
 
  •  products developed, acquired or in-licensed that may be commercialized;
 
  •  our intent, beliefs or current expectations, primarily with respect to our future operating performance;
 
  •  expectations regarding sales growth, gross margins, manufacturing productivity, capital expenditures and effective tax rates;
 
  •  expectations regarding the outcome of various pending legal proceedings including the Skelaxin® and Avinza® patent challenges, securities litigation, and other legal proceedings described in this report; and
 
  •  expectations regarding our financial condition and liquidity as well as future cash flows and earnings.
 
These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from those contemplated by our forward-looking statements. These known and unknown risks, uncertainties and other factors are described in detail in the “Risk Factors” section and in other sections of this report.


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Item 1B.   Unresolved Staff Comments
 
None.
 
Item 2.   Properties
 
The location and business segments served by our primary facilities are as follows:
 
         
Location
 
Principal Purposes
 
Business Segment(s)
 
Bristol, Tennessee
  Manufacturing and Administration   Branded Pharmaceuticals
Rochester, Michigan
  Manufacturing   Branded Pharmaceuticals
St. Louis, Missouri
  Manufacturing   Meridian Auto-Injector
St. Petersburg, Florida
  Manufacturing   Branded Pharmaceuticals
Middleton, Wisconsin
  Manufacturing   Branded Pharmaceuticals
 
We own each of these primary facilities, with the exception of a portion of the facilities in St. Louis, Missouri, which is leased. For information regarding production capacity and extent of utilization, please see Item 1, “Manufacturing.”
 
Our corporate headquarters and centralized distribution center are located in Bristol, Tennessee. We consider our properties to be generally in good condition, well maintained, and generally suitable and adequate to carry on our business.
 
We currently lease office space for our commercial operations organization located in Bridgewater, New Jersey, our research and development organization located in Cary, North Carolina, and our Meridian Auto-Injector business located in Columbia, Maryland.
 
Item 3.   Legal Proceedings
 
Please see Note 19 “Commitments and Contingencies” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules” for information regarding material legal proceedings in which we are involved.
 
Item 4.   Submission of Matters to a Vote of Security Holders
 
None.
 
PART II
 
Item 5.   Market for Common Equity and Related Stockholder Matters
 
The following table sets forth the range of high and low sales prices per share of our common stock for the periods indicated. Our common stock is listed on the New York Stock Exchange, where it trades under the symbol “KG.” There were approximately 954 shareholders of record on February 26, 2008.
 
                 
    2007  
    High     Low  
 
First quarter
  $ 19.67     $ 16.05  
Second quarter
    21.67       19.56  
Third quarter
    21.08       11.58  
Fourth quarter
    11.65       9.93  
 
                 
    2006  
    High     Low  
 
First quarter
  $ 19.87     $ 16.25  
Second quarter
    18.48       15.83  
Third quarter
    17.31       15.93  
Fourth quarter
    17.46       15.74  
 
On February 26, 2008 the closing price of our common stock as reported on the New York Stock Exchange was $11.03. For information regarding our equity compensation plans, please see Note 21, “Stock Based Compensation,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”


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PERFORMANCE GRAPH
 
COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN
 
The graph below compares the cumulative total return of King’s common stock with the Standard & Poor’s 500 Index and a peer group index since December 31, 2002. It shows an investment of $100 on December 31, 2002. The peer group index includes United States pharmaceutical companies which trade on the NYSE.
 
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
Among King Pharmaceuticals, Inc., The S&P 500 Index
And NYSE US SIC Code 2830-2839, Drugs
 
PERFORMANCE GRAPH
 
                                                 
    12/02   12/03   12/04   12/05   12/06   12/07
 
King Pharmaceuticals, Inc. 
    100.00       88.77       72.13       98.43       92.61       59.57  
Standard & Poor’s 500 Stocks
    100.00       128.68       142.69       149.70       173.34       182.87  
NYSE Stocks (SIC 2830-2839 U.S. Companies) Drugs
    100.00       112.64       105.70       107.62       120.84       123.83  


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We have never paid cash dividends on our common stock. The payment of cash dividends is subject to the discretion of the Board of Directors and is limited by the terms of our credit facility. We currently anticipate that for the foreseeable future we will retain our earnings.
 
Item 6.   Selected Financial Data
 
The table below should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our audited consolidated financial statements and related notes included elsewhere in this report.
 
                                         
    For the Year Ended December 31,  
    2007     2006     2005     2004     2003  
    (In thousands, except per share data)  
 
Statement of Income Data:
                                       
Total revenues
  $ 2,136,882     $ 1,988,500     $ 1,772,881     $ 1,304,364     $ 1,492,789  
                                         
Operating income (loss)(1)(2)
    227,513       402,546       180,079       (41,264 )     151,952  
Income (loss) from continuing operations before income taxes and discontinued operations
    250,818       424,312       178,115       (58,034 )     163,327  
Income tax expense (benefit)
    67,600       135,730       61,485       (7,412 )     65,884  
                                         
Income (loss) from continuing operations
    183,218       288,582       116,630       (50,622 )     97,443  
(Loss) income from discontinued operations(3)
    (237 )     367       1,203       (109,666 )     (5,489 )
                                         
Net income (loss)
  $ 182,981     $ 288,949     $ 117,833     $ (160,288 )   $ 91,954  
                                         
Income per common share:
                                       
Basic:
                                       
Income (loss) from continuing operations
  $ 0.75     $ 1.19     $ 0.48     $ (0.21 )   $ 0.40  
Income (loss) from discontinued operations
                0.01       (0.45 )     (0.02 )
                                         
Net income (loss)
  $ 0.75     $ 1.19     $ 0.49     $ (0.66 )   $ 0.38  
                                         
Diluted:
                                       
Income (loss) from continuing operations
  $ 0.75     $ 1.19     $ 0.48     $ (0.21 )   $ 0.40  
Income (loss) from discontinued operations
                0.01       (0.45 )     (0.02 )
                                         
Net income (loss)
  $ 0.75     $ 1.19     $ 0.49     $ (0.66 )   $ 0.38  
                                         
Dividends declared per share of common stock
  $ 0.00     $ 0.00     $ 0.00     $ 0.00     $ 0.00  
                                         
 


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    December 31,  
    2007     2006     2005     2004     2003  
    (In thousands)  
 
Balance Sheet Data:
                                       
Working capital
  $ 1,366,569     $ 1,055,677     $ 276,329     $ 438,133     $ 241,762  
Total assets
    3,426,822       3,329,531       2,965,242       2,924,156       3,201,530  
Total debt
    400,000       400,000       345,000       345,000       345,097  
Shareholders’ equity
    2,510,757       2,288,606       1,973,422       1,848,790       2,004,491  
 
 
(1) Results for 2003 reflect a $15,212 reduction in the co-promotion fees paid to our Altace® co-promotion partner as a result of charges for amounts due under Medicaid and other governmental pricing programs for the years 1998 to 2002. Specifically (a) we recovered on a pre-tax basis $9,514 in fees we previously accrued during the fourth quarter of 2002 and reduced the accrual for these fees by this amount in the fourth quarter of 2003 and (b) fees under our Co-Promotion Agreement for Altace® in the fourth quarter of 2003 were reduced on a pre-tax basis by an additional $5,698 as a result of the Medicaid accrual adjustment recorded in that quarter.
 
(2) Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R), “Share Based Payment,” which requires the recognition of the fair value of stock-based compensation in earnings. This statement was adopted using the modified prospective application method and therefore our prior periods have not been restated and do not reflect the recognition of stock-based compensation costs. During 2007 and 2006, we incurred on a pre-tax basis $27,652 and $24,718, respectively, of compensation costs related to our stock-based compensation arrangements.
 
(3) Reflects the classification of Nordette® and Prefest® product lines as discontinued operations. See Note 27, “Discontinued Operations,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion should be read in conjunction with the other parts of this report, including the audited consolidated financial statements and related notes. Historical results and percentage relationships set forth in the statement of income, including trends that might appear, are not necessarily indicative of future operations. Please see the “Risk Factors” and “Forward-Looking Statements” sections for a discussion of the uncertainties, risks and assumptions associated with these statements.
 
OVERVIEW
 
Our Business
 
We are a vertically integrated pharmaceutical company that performs basic research and develops, manufactures, markets and sells branded prescription pharmaceutical products. To capitalize on opportunities in the pharmaceutical industry, we seek to develop, in-license, acquire or obtain commercialization rights to novel branded prescription pharmaceutical products in attractive markets.
 
Our corporate strategy is focused on specialty-driven markets, particularly neuroscience, hospital and acute care. We believe each of our targeted markets has significant market potential and our organization is aligned accordingly. We work to achieve organic growth by maximizing the potential of our currently marketed products through sales and marketing and product life-cycle management. We also work to achieve organic growth through the successful development of new branded pharmaceutical products. Additionally, we seek to achieve growth through the acquisition or in-licensing of novel branded pharmaceutical products in various stages of development and technologies that have significant market potential that complement our neuroscience, hospital and acute care medicine platforms. We may also seek company acquisitions which add products or products in development, technologies or sales and marketing capabilities in our target markets or that otherwise complement our operations.

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Utilizing our internal resources and a disciplined business development process, we strive to be a leader and partner of choice in developing and commercializing innovative, clinically-differentiated therapies and technologies in our target, specialty-driven markets.
 
Our business consists of five segments which include branded pharmaceuticals, Meridian Auto-Injector, royalties, contract manufacturing, and other. Our branded pharmaceutical products are divided into the following categories:
 
  •  neuroscience (including Skelaxin®, Avinza® and Sonata®),
 
  •  hospital (including Thrombin-JMI® and Synercid®),
 
  •  acute care (including Bicillin® and Intal®), and
 
  •  legacy products (including Altace®, Levoxyl® and Cytomel®).
 
Our Meridian Auto-Injector segment includes EpiPen®, a commercial product, and nerve gas antidotes which we provide to the U.S. Military. Our royalties segment relates to revenues we derive from successfully developed products that we have licensed to third parties.
 
Executive Summary
 
During 2007, we took many steps to better position us for long-term growth. With the unexpected early entry of generic competition for Altace®, we accelerated the implementation of our planned strategic shift to focus on specialty-driven markets where we have core capabilities and assets. We also expanded our portfolio of marketed products and development pipeline and advanced projects in our development pipeline, with an emphasis in these markets.
 
Accelerated Strategic Shift
 
Following the Circuit Court’s decision in September 2007 invalidating our Altace® patent, we conducted an extensive examination of our company and developed a restructuring initiative designed to accelerate a previously planned strategic shift emphasizing our focus on specialty-driven markets where we have core capabilities and assets, specifically the neuroscience, hospital and acute care markets. This initiative included a reduction in personnel, staff leverage, expense reductions and additional controls over spending, reorganization of sales teams and a realignment of research and development priorities. Pursuant to this initiative, we terminated approximately 20% of our workforce, primarily through a reduction in our sales force. We have incurred total costs of approximately $65.0 million associated with this initiative. We estimate that the 2008 selling, general and administrative expense savings from these actions will range from $75.0 million to $90.0 million.
 
New Generic Competition
 
In December 2007, a third party launched a generic substitute for our Altace® capsules. This followed the decision of the U.S. Circuit Court of Appeals for the Federal Circuit (the “Circuit Court”) in September 2007 which declared invalid U.S. Patent No. 5,061,722 (the “722 Patent”) that covered our Altace® product, overruling the decision of the U.S. District Court for the Eastern District of Virginia (the “District Court”), which had upheld the validity of the patent. We filed with the Circuit Court a petition for rehearing and rehearing en banc, but this petition was denied in December 2007. The Circuit Court issued the mandate to the District Court on December 10, 2007, beginning the 180-day Hatch-Waxman exclusive marketing period for the first generic competitor that has entered the market. Following this 180-day period of exclusivity, we anticipate additional competitors will enter the market. We launched a tablet formulation of Altace® in February 2008.


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Expanded Product Portfolio and Development Pipeline
 
Neuroscience
 
On February 26, 2007, we acquired all the rights to Avinza® in the United States, its territories and Canada from Ligand Pharmaceuticals Incorporated (“Ligand”). Avinza® is an extended release formulation of morphine and is indicated as a once-daily treatment for moderate to severe pain in patients who require continuous opioid therapy for an extended period of time.
 
In October 2007, we entered into a License, Development and Commercialization Agreement with Acura Pharmaceuticals, Inc. (“Acura”) to develop and commercialize certain immediate release opioid analgesic products utilizing Acura’s proprietary Aversion® (abuse-deterrent/abuse-resistant) Technology in the United States, Canada and Mexico. The agreement provides us with an exclusive license for Acuroxtm (oxycodone HCl, niacin and a unique combination of other ingredients) tablets, and another undisclosed immediate release opioid product utilizing Acura’s Aversion® Technology. In addition, the agreement provides us with an option to license all future opioid analgesic products developed utilizing Acura’s Aversion® Technology. AcuroxTM tablets are intended to effectively treat moderate to moderately severe pain while discouraging common methods of abuse, including intravenous injection or oral consumption of tablets dissolved in liquids, nasal inhalation of crushed tablets and intentional swallowing of excessive numbers of tablets.
 
The agreement with Acura, which provides us with a wide range of immediate release opioids utilizing the Aversion® Technology platform, complements our collaborative agreement with Pain Therapeutics, Inc. to develop and commercialize Remoxytm and other extended release, long-acting opioid painkillers that are also designed to resist common methods of abuse.
 
Hospital
 
Our product Thrombin-JMI® is the market leading topical hemostat used to control bleeding during surgery. To better meet the needs of our customers and in anticipation of the recent entry of two new competitors, we introduced new Thrombin-JMI® based products in 2007, broadening the range of delivery options.
 
In January 2007, we obtained an exclusive license to the hemostatic products designed by Vascular Solutions, Inc. for use outside catheterization and electrophysiology laboratories. This license includes products which we market as Thrombi-Padtm (3x3 hemostatic pad), the only composite of Thrombin-JMI® and gauze pad, offering healthcare professionals in the emergency department a convenient option to achieve active hemostasis at bleeding sites where they would typically use trauma dressing, and Thrombi-Gel® (thrombin/gelatin foam hemostat) which provides a convenient topical hemostat option. The license also includes a product we expect to market as Thrombi-Pastetm, which is currently in development. Each of these products includes Thrombin-JMI® as a component.
 
In June 2007, the U.S. Food and Drug Administration (“FDA”) approved our Thrombin-JMI® Epistaxis Kit, a new intranasal spray delivery device for Thrombin-JMI® for use to aid in stopping epistaxes (nosebleeds). The kit offers healthcare professionals in the emergency department and trauma center a convenient new option to achieve fast, active hemostasis during epistaxes. We began marketing the Thrombin-JMI® Epistaxis Kit in the United States in the third quarter of 2007.
 
Beginning in 2008, Thrombin-JMI®, our bovine thrombin, has new competition from human thrombin and recombinant human thrombin. Omrix Biopharmaceuticals, Inc.’s Biologics Licensing Application (“BLA”) for its human thrombin product was approved in September 2007. Zymogenetics, Inc. received approval of its BLA for recombinant human thrombin in January 2008. The presence of competing products in the marketplace may reduce net sales of Thrombin-JMI materially.


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Our Research and Development Projects
 
Our current research and development pipeline includes several products in Phase III and late Phase II clinical trials, including immediate release and long-acting opioid products utilizing abuse-deterrent/abuse-resistant platform technologies pursuant to our collaborations with Pain Therapeutics and Acura.
 
Remoxytm and CorVuetm have completed Phase III clinical trials. Remoxytm, a novel formulation of extended release, long-acting oxycodone for the treatment of moderate to severe chronic pain, is designed to resist common methods of abuse, such as crushing, heating, or dissolution in alcohol, that are reported with respect to currently available formulations of long-acting oxycodone. In December 2007, we, together with Pain Therapeutics, announced positive results from the pivotal Phase III clinical trial for Remoxytm. This trial met its primary endpoint, pain relief versus placebo, as prospectively defined by the FDA during the Special Protocal Assessment process. Pain Therapeutics plans to file a New Drug Application for Remoxytm with the FDA in the second quarter of 2008.
 
CorVuetm (binodenoson) is a pharmacologic cardiac stress imaging agent intended to provide a reduced side effects profile compared to the currently approved product Adenoscan®. We received positive results from our Phase III clinical trials for CorVuetm and expect to file an NDA by early 2009.
 
Our products in Phase III of development include Acuroxtm and Vanquixtm. Acuroxtm tablets are intended to effectively treat moderate to moderately severe acute pain while deterring or resisting common methods of prescription drug abuse, including intravenous injection or oral consumption of tablets dissolved in liquids, nasal inhalation of crushed tablets and intentional swallowing of excessive numbers of tablets. In early 2007, Acuroxtm tablets successfully completed a Special Protocol Assessment with the FDA. As a result, the pivotal Phase III clinical trial with Acuroxtm tablets in patients with moderate to severe pain commenced in September 2007 and we expect to report results in the second half of 2008.
 
Vanquixtm is our diazepam-filled auto-injector that is currently under development as the only therapy of its kind for the treatment of acute, repetitive epileptic seizures.
 
Our Phase II compounds include Sonedenoson, formerly MRE-0094, an adenosine A2a receptor agonist for the topical treatment of chronic, neuropathic, diabetic foot ulcers, and T-62, an adenosine A1 allosteric enhancer that we are developing for the treatment of neuropathic pain. The Phase II clinical trial for Sonedenoson did not meet its primary endpoint. We are continuing to evaluate the data from this trial. We expect enrollment of patients in the Phase II clinical trial for T-62 to begin in the middle of 2008.
 
Rochester, Michigan Sterile Manufacturing Facility
 
In October 2007, we sold our Rochester, Michigan sterile manufacturing facility, some of our legacy products that are manufactured there and the related contract manufacturing business to JHP Pharmaceuticals, LLC (“JHP”) for $91.7 million, less selling costs of $5.4 million. This transaction resulted in a loss of $46.4 million. The companies also entered into a manufacturing and supply agreement pursuant to which JHP will provide to us certain filling and finishing manufacturing activities with respect to Thrombin-JMI®. The sale did not include our stand-alone sterile penicillin production facility that is also located in Rochester, Michigan.


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OPERATING RESULTS
 
The following table summarizes total revenues and cost of revenues by operating segment.
 
                         
    For the Years Ended December 31,  
    2007     2006     2005  
    (In thousands)  
 
Total Revenues
                       
Branded pharmaceuticals
  $ 1,857,813     $ 1,724,701     $ 1,542,124  
Meridian Auto-Injector
    183,860       164,760       129,261  
Royalties
    82,589       80,357       78,128  
Contract manufacturing
    9,201       16,501       22,167  
Other
    3,419       2,181       1,201  
                         
Total revenues
  $ 2,136,882     $ 1,988,500     $ 1,772,881  
                         
Cost of Revenues, exclusive of depreciation, amortization and impairments
                       
Branded pharmaceuticals
  $ 467,507     $ 317,677     $ 222,924  
Meridian Auto-Injector
    76,050       74,576       62,958  
Royalties
    10,158       9,748       9,003  
Contract manufacturing
    9,434       17,636       27,055  
Other
    3,385       171       1,045  
                         
Total cost of revenues
  $ 566,534     $ 419,808     $ 322,985  
                         
 
The following table summarizes our deductions from gross sales.
 
                         
    For the Years Ended December 31,  
    2007     2006     2005  
    (In thousands)  
 
Gross Sales
  $ 2,623,330     $ 2,461,588     $ 2,240,852  
Commercial Rebates
    188,966       188,652       192,203  
Medicare Part D Rebates
    59,103       54,221        
Medicaid Rebates
    39,608       27,219       78,753  
Chargebacks
    97,251       102,876       99,057  
Returns
    11,679       14,832       5,012  
Trade Discounts/Other
    90,211       84,720       91,090  
                         
    $ 2,136,512     $ 1,989,068     $ 1,774,737  
Discontinued Operations
    (370 )     568       1,856  
                         
Net Sales
  $ 2,136,882     $ 1,988,500     $ 1,772,881  
                         
 
Gross sales were higher in 2007 compared to 2006 primarily due to the acquisition of Avinza® on February 26, 2007, price increases taken during 2007 and an increase in gross sales of our Meridian Auto-Injector segment. These increases in gross sales were partially offset by a decline in prescriptions of certain of our branded pharmaceutical products during 2007.
 
Gross sales were higher in 2006 compared to 2005 primarily due to price increases, higher unit sales as a result of the effect of wholesale inventory reductions of some of our branded pharmaceutical products during 2005, particularly Altace®, and an increase in gross sales of our Meridian Auto-Injector segment. These increases in gross sales were partially offset by a decline in prescriptions of certain of our branded pharmaceutical products during 2006.


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Medicaid rebate expense was lower in 2006 than in 2005 primarily due to the Federal government shifting persons who were covered by the Medicaid Program to the Medicare Part D Program. During January 2006, the Medicare Prescription Drug Improvement and Modernization Act became effective, which provides outpatient prescription drug coverage to senior citizens and certain disabled citizens in the United States. We have contracts with organizations that administer the Medicare Part D Program, which require us to pay rebates based on contractual pricing and actual utilization under the plans. Initial enrollment in the Medicare Part D Program was open through the middle of the second quarter of 2006.
 
As part of our ongoing efforts to facilitate improved management of wholesale inventory levels of our branded pharmaceutical products, we have entered into inventory management and data services agreements with each of our three key wholesale customers and other wholesale customers. These agreements provide wholesalers incentives to manage inventory levels and provide timely and accurate data with respect to inventory levels held, and valuable data regarding sales and marketplace activity. We rely on the timeliness and accuracy of the data that each customer provides to us on a regular basis pursuant to these agreements. If our wholesalers fail to provide us with timely and accurate data in accordance with the agreements, our estimates for certain reserves included in our financial statements could be materially and adversely affected.
 
Based on inventory data provided by our key customers under the IMAs, we believe that wholesale inventory levels of Altace®, Skelaxin®, Thrombin-JMI®, Avinza® and Sonata®, as of December 31, 2007, are at or below normalized levels. We estimate that the wholesale and retail inventories of our products as of December 31, 2007 represent gross sales of approximately $150.0 million to $160.0 million.
 
The following tables provide the activity and ending balances for our significant deductions from gross sales.
 
Accrual for Rebates, including Administrative Fees
 
                         
    2007     2006     2005  
    (In thousands)  
 
Balance at January 1, net of prepaid amounts
  $ 53,765     $ 126,240     $ 179,062  
Current provision related to sales made in current period
    285,253       282,603       294,964  
Current provision related to sales made in prior periods
    2,424       (12,511 )     (24,008 )
Rebates paid
    (276,141 )     (342,567 )     (323,778 )
                         
Balance at December 31, net of prepaid amounts
  $ 65,301     $ 53,765     $ 126,240  
                         
 
Rebates include commercial rebates and Medicaid and Medicare rebates.
 
During the third quarter of 2005, we began reporting to the Centers for Medicare and Medicaid Services using a refined calculation to compute our Average Manufacturer’s Price (“AMP”) and Best Price. In addition, during the third quarter of 2005, we recalculated rebates due with respect to prior quarters utilizing the refined AMP and Best Price Calculations. As a result of this updated information, during the third quarter of 2005, we decreased our reserve for estimated Medicaid and other government pricing program obligations and increased net sales from branded pharmaceutical products by approximately $21.0 million, approximately $8.0 million of which related to years prior to 2005. This does not include the adjustment to sales classified as discontinued operations. As a result of the increase in net sales, the co-promotion expense related to net sales of Altace® increased by approximately $6.0 million, approximately $4.0 million of which related to years prior to 2005. The effect of this change in estimate on operating income was, therefore, approximately $15.0 million, approximately $4.0 million of which related to years prior to 2005.
 
During the first quarter of 2006, we paid approximately $129.3 million related to (i) the settlement agreements with the Office of Inspector General of the United States Department of Health and Human Services (“HHS/OIG”) and the Department of Veterans Affairs, to resolve the governmental investigations related to our underpayment of rebates owed to Medicaid and other governmental pricing programs during the period from 1994 to 2002 and (ii) similar state settlement agreements. For a discussion regarding this settlement, please see “Settlement of Governmental Pricing Investigation” included in Note 19, “Commitments


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and Contingencies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.” Of the $129.3 million paid in the first quarter of 2006, approximately $64.0 million reduced the rebate accrual and is reflected in “Rebates paid” in the table above.
 
In addition, during the first quarter of 2006, we delayed our regular periodic Medicaid rebate payments as a result of prior overpayments. During the second quarter of 2006, we began reducing our payments for Medicaid rebates to utilize overpayments made to the government related to Medicaid during the government pricing investigation in 2003, 2004 and 2005. During the period of the investigation, we made actual Medicaid payments in excess of estimated expense to avoid any underpayments to the government. As a result of refining the AMP and Best Price calculations in the third quarter of 2005, we discontinued the practice of making payments in excess of the amounts expensed. We expect to recover the remaining overpayments to the government and will continue to reduce cash payments in the future until this overpayment is fully recovered. For a discussion regarding this investigation, please see Note 19, “Commitments and Contingencies”, in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.” In 2007 and 2006, the utilization of overpayments reduced our rebate payments by approximately $6.5 million and $25.0 million, respectively. The utilization of the overpayment has therefore reduced “Rebates paid” in the table above.
 
During the third quarter of 2006, we reduced our Medicaid rebate expense and increased net sales from branded pharmaceutical products by approximately $9.3 million due to the determination that a liability established in 2005 for a government pricing program for military dependents and retirees was no longer probable.
 
Accrual for Returns
 
                         
    2007     2006     2005  
    (In thousands)  
 
Balance at January 1
  $ 42,001     $ 50,902     $ 122,863  
Current provision
    11,679       14,832       5,012  
Actual returns
    (20,820 )     (23,733 )     (76,973 )
                         
Ending balance at December 31
  $ 32,860     $ 42,001     $ 50,902  
                         
 
Our calculation for returns reserves is based on historical sales and return rates over the period during which customers have a right of return. We also consider current wholesale and retail inventory levels of our products. Based on data received from our inventory management agreements with our three key wholesale customers, there was a significant reduction of wholesale inventory levels of our products during the first quarter of 2005. This reduction resulted in a change in estimate during the first quarter of 2005 that decreased the reserve for returns by approximately $20.0 million and increased net sales from branded pharmaceuticals, excluding the adjustment to sales classified as discontinued operations, by the same amount. During the second quarter of 2005, we decreased our reserve for returns by approximately $5.0 million and increased our net sales from branded pharmaceuticals, excluding the adjustment for sales classified as discontinued operations, by the same amount as a result of an additional reduction in wholesale inventory levels of our branded products. These adjustments are reflected in the table above as a reduction in the current provision.
 
During the third quarter of 2005, our actual returns of branded pharmaceutical products continued to decrease significantly compared to actual returns during the quarterly periods in 2004 and the first quarter of 2005. Additionally, based on data received pursuant to our inventory management agreements with key wholesale customers, we continued to experience normalized wholesale inventory levels of our branded pharmaceutical products during the third quarter of 2005. Accordingly, we believed that the rate of returns experienced during the second and third quarters of 2005 was more indicative of what we expected in future quarters and adjusted our returns reserve accordingly. This change in estimate resulted in a decrease of approximately $15.0 million in the returns reserve in the third quarter of 2005 and a corresponding increase in net sales from branded pharmaceutical products. As a result of this increase in net sales, the co-promotion expense related to net sales of Altace® increased by approximately $5.0 million. The effect of the change in estimate on operating income was, therefore, approximately $10.0 million.


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Because actual returns related to sales in prior periods were lower than our original estimates, we recorded a decrease in our reserve for returns in each of the first quarter of 2007 and the first quarter of 2006. During the first quarter of 2007, we decreased our reserve for returns by approximately $8.0 million and increased our net sales from branded pharmaceuticals, excluding the adjustment to sales classified as discontinued operations, by the same amount. The effect of the change in estimate on first quarter 2007 operating income was an increase of approximately $5.0 million. During the first quarter of 2006, we decreased our reserve for returns by approximately $8.0 million and increased our net sales from branded pharmaceuticals, excluding the adjustment to sales classified as discontinued operations, by the same amount. The effect of the change in estimate on first quarter 2006 operating income was an increase of approximately $6.0 million. The “Accrual for Returns” table above reflects these adjustments as a reduction in the current provision.
 
Accrual for Chargebacks
 
                         
    2007     2006     2005  
    (In thousands)  
 
Balance at January 1
  $ 13,939     $ 13,153     $ 27,953  
Current provision
    97,251       102,876       99,057  
Actual chargebacks
    (100,070 )     (102,090 )     (113,857 )
                         
Ending balance at December 31
  $ 11,120     $ 13,939     $ 13,153  
                         
 
Branded Pharmaceuticals Segment
 
                                                         
                      Change  
    For the Years Ended December 31,     2007 vs. 2006     2006 vs. 2005  
    2007     2006     2005     $     %     $     %  
    (In thousands)                          
 
Branded
pharmaceutical revenue:
                                                       
Altace®
  $ 645,989     $ 652,962     $ 554,353     $ (6,973 )     (1.1 )%   $ 98,609       17.8 %
Skelaxin®
    440,003       415,173       344,605       24,830       6.0       70,568       20.5  
Thrombin-JMI®
    267,354       246,520       220,617       20,834       8.5       25,903       11.7  
Avinza®
    108,546                   108,546                    
Levoxyl®
    100,102       111,771       139,513       (11,669 )     (10.4 )     (27,742 )     (19.9 )
Sonata®
    78,695       85,809       83,162       (7,114 )     (8.3 )     2,647       3.2  
Other
    217,124       212,466       199,874       4,658       2.2       12,592       6.3  
                                                         
Total revenue
  $ 1,857,813     $ 1,724,701     $ 1,542,124     $ 133,112       7.7 %   $ 182,577       11.8 %
                                                         
Cost of Revenues,
exclusive of depreciation, amortization and impairments
  $ 467,507     $ 317,677     $ 222,924     $ 149,830       47.2 %   $ 94,753       42.5 %
                                                         
 
Net sales from branded pharmaceutical products were higher in 2007 than in 2006 primarily due to the acquisition of Avinza® on February 26, 2007 and price increases taken on various products. These increases in net sales were partially offset by a decline in prescriptions of certain of our branded pharmaceutical products during 2007. We expect net sales from branded pharmaceutical products in 2008 will be significantly lower than that experienced in 2007 primarily due to lower net sales of Altace® for the reason discussed below.
 
Net sales from branded pharmaceutical products were higher in 2006 compared to 2005 primarily due to higher unit sales in 2006 as a result of the effects of wholesale inventory reductions in 2005 and price


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increases taken in the fourth quarter of 2005, partially offset by a decrease in prescriptions in 2006 from 2005. In addition, net sales during 2005 reflect a reduction in reserves for returns and rebates as discussed above.
 
For a discussion regarding the potential risk of generic competition for Skelaxin® and Avinza®, please see Note 19 “Commitments and Contingencies” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
Sales of Key Products
 
Altace®
 
Net sales of Altace® decreased in 2007 from 2006 primarily due to decreases in prescriptions, partially offset by price increases taken in the fourth quarter of 2006 and the third quarter and fourth quarters of 2007. Total prescriptions for Altace® decreased approximately 7.1% in 2007 compared to the same period of the prior year according to IMS America, Ltd. (“IMS”) monthly prescription data.
 
In December 2007, a third party entered the market with a generic substitute for Altace® capsules. Additional third parties will likely enter the market with their own generic substitutes for Altace® capsules in 2008. As a result of the entry of generic competition, we expect net sales of Altace® will decline significantly during 2008. We launched a tablet formulation of Altace® in February 2008. For a discussion regarding the generic competition for Altace®, please see Note 19, “Commitments and Contingencies” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
Net sales of Altace® were higher in 2006 than in 2005 primarily due to higher unit sales in 2006 as a result of the effects of wholesale inventory reductions of Altace® in 2005 and a price increase taken in the fourth quarter of 2005 partially offset by a decrease in prescriptions in 2006 compared to 2005. In addition, net sales during 2005 reflect a reduction in reserves for returns and rebates as discussed above. Total prescriptions for Altace® decreased approximately 2.2% in 2006 from 2005 according to IMS monthly prescription data.
 
Skelaxin®
 
Net sales of Skelaxin® increased in 2007 from 2006 primarily due to a price increase taken in the fourth quarter of 2006. During 2006, net sales of Skelaxin® benefited from a reduction in the rebate reserve for a government pricing program for military dependents and retirees. During 2007, net sales of Skelaxin® benefited from a favorable change in estimate in the products reserve for returns as discussed above. Total prescriptions for Skelaxin® decreased approximately 1.6% in 2007 compared to 2006, according to IMS monthly prescription data. We do not anticipate that net sales of Skelaxin® in 2008 will increase at the same rate experienced in 2007.
 
Net sales of Skelaxin® increased in 2006 from 2005 primarily due to a price increase taken in the fourth quarter of 2005, higher unit sales in 2006 as a result of the effect of wholesale inventory reductions of Skelaxin® in 2005 and a reduction in government rebates partially offset by a decline in prescriptions in 2006 compared to 2005. In addition, net sales during 2005 reflect a reduction in reserves for returns and rebates as discussed above. Total prescriptions for Skelaxin® decreased approximately 2.1% in 2006 from 2005 according to IMS monthly prescription data.
 
For a discussion regarding the risk of potential generic competition for Skelaxin®, please see Note 19 “Commitments and Contingencies” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
Thrombin-JMI®
 
Net sales of Thrombin-JMI® increased in 2007 compared to 2006 primarily due to a price increase taken in the fourth quarter of 2006. A competing product entered the market in the fourth quarter of 2007 and another entered the market in the first quarter of 2008. It is likely that net sales of Thrombin-JMI® will decrease as a result of the entry of these competing products.


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Net sales of Thrombin-JMI® increased in 2006 compared to 2005 primarily due to increases in wholesale inventory levels, a price increase taken in the second half of 2005 and an increase in demand by end users, partially offset by an increase in chargebacks during 2006 compared to 2005.
 
Avinza®
 
We acquired all rights to Avinza® in the United States, its territories and Canada on February 26, 2007. Net sales of Avinza® in 2007 reflect sales occurring from February 26, 2007 through December 31, 2007. Total prescriptions for Avinza® decreased approximately 16.4% in 2007 compared to 2006 according to IMS monthly prescription data. Due to an increase in promotion of Avinza®, we do not believe prescriptions in 2008 for this product will decline from the level of prescriptions experienced in the fourth quarter of 2007 and we believe they may increase slightly.
 
For a discussion regarding the risk of potential generic competition for Avinza®, please see Note 19, “Commitments and Contingencies” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
Levoxyl®
 
Net sales of Levoxyl® decreased in 2007 compared to 2006 primarily due to a decrease in prescriptions in 2007 as a result of generic competition partially offset by the effect of an increase in wholesale inventory levels during 2007. During 2006, net sales of Levoxyl® benefited from a favorable change in estimate of approximately $7.0 million in the product’s reserve for Medicaid rebates as a result of the government pricing investigation settlement, partially offset by a decrease in wholesale inventory levels. This benefit was substantially offset by increases in Medicaid rebate reserves for other products as a result of the settlement. Total prescriptions for Levoxyl® were approximately 12.4% lower in 2007 compared to 2006 according to IMS monthly prescription data.          
 
Net sales of Levoxyl® decreased in 2006 compared to 2005 primarily due to a decrease in prescriptions in 2006, partially offset by price increases taken in the fourth quarter of 2005 and changes in wholesale inventory levels. During 2005, net sales of Levoxyl® benefited from the reduction in the reserve for returns described above and a reduction in the reserve for rebates. As noted above, 2006 net sales of Levoxyl® benefited from a favorable change in estimate related to Medicaid rebates. Total prescriptions for Levoxyl® were approximately 16.0% lower in 2006 than in 2005 according to IMS monthly prescription data.
 
Sonata®
 
Net sales of Sonata® were lower in 2007 than in 2006 primarily due to a decrease in prescriptions partially offset by a price increase taken in the fourth quarter of 2006. Total prescriptions for Sonata® decreased approximately 20.4% compared to 2006 according to IMS monthly prescription data. The decrease in prescriptions during 2007 was primarily due to new competitors that entered the market in 2005 and a decrease in our promotional efforts. We believe net sales of Sonata® will decline significantly in future periods due to the anticipated market entry of a generic substitute in the second quarter of 2008.
 
Net sales of Sonata® were higher in 2006 than in 2005 primarily due to higher unit sales as a result of wholesale inventory reductions of Sonata® in 2005 and price increases taken in the fourth quarter of 2005 and the third quarter of 2006, partially offset by a decrease in prescriptions during 2006 compared to 2005. Total prescriptions for Sonata® decreased approximately 19.6% in 2006 from 2005 according to IMS monthly prescription data. The decrease in prescriptions during 2006 was primarily due to new competitors that entered the market in 2005.
 
Other
 
Net sales of other branded pharmaceutical products were higher in 2007 compared to 2006 primarily due to an increase in net sales of Bicillin® and price increases which were partially offset by decreases in prescriptions. We completed construction of facilities to produce Bicillin® at our Rochester, Michigan location, began commercial production in the fourth quarter of 2006, and replenished wholesale inventories of the


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product during the first quarter of 2007. Our other branded pharmaceutical products are not promoted through our sales force and prescriptions for many of these products are declining. We completed the sale of several of our other branded pharmaceutical products to JHP Pharmaceuticals LLC on October 1, 2007. Considering all of these factors, we anticipate net sales of other branded pharmaceutical products will significantly decrease in 2008.
 
Net sales of other branded pharmaceutical products were higher in 2006 compared to 2005 primarily due to the effects of wholesale inventory reductions in 2005 and price increases which were partially offset by decreases in prescriptions.
 
Cost of Revenues
 
Cost of revenues from branded pharmaceutical products increased in 2007 from 2006 primarily due to an increase in royalties associated with Skelaxin® and Avinza® and the effects of special items in 2007 associated with Altace® as discussed below.
 
Cost of revenues from branded pharmaceutical products increased in 2006 from 2005 primarily due to an increase in royalties associated with Skelaxin®, the cost of revenues associated with higher unit sales of branded pharmaceutical products in 2006 compared to 2005, and differences in special items which benefited 2005 compared to 2006 as discussed below.
 
Special items are those particular material income or expense items that our management believes are not related to our ongoing, underlying business, are not recurring, or are not generally predictable. These items include, but are not limited to, merger and restructuring expenses; non-capitalized expenses associated with acquisitions, such as in-process research and development charges and inventory valuation adjustment charges; charges resulting from the early extinguishments of debt; asset impairment charges; expenses of drug recalls; and gains and losses resulting from the divestiture of assets. We believe the identification of special items enhances an analysis of our ongoing, underlying business and an analysis of our financial results when comparing those results to that of a previous or subsequent like period. However, it should be noted that the determination of whether to classify an item as a special item involves judgments by us.
 
Special items affecting cost of revenues from branded pharmaceuticals during 2007, 2006 and 2005 included the following:
 
  •  An inventory valuation allowance that resulted in a charge of $78.8 million for inventories associated with Altace® in 2007. For additional information please see Note 8, “Inventory,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
  •  A charge of $25.4 million primarily associated with minimum purchase requirements under a supply agreement to purchase raw material inventory associated with Altace® in 2007. For additional information please see Note 8, “Inventory,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
  •  A contract termination that resulted in a charge of $3.8 million in 2007.
 
  •  A benefit of approximately $6.1 million resulting from the termination of purchase commitments for some of our smaller products which reduced our cost of revenues from branded pharmaceutical products in 2005.
 
  •  Product returned as a result of a Levoxyl® voluntary recall was less than originally estimated. Accordingly, cost of revenues from branded pharmaceutical products in 2005 was reduced by approximately $2.5 million.
 
We anticipate cost of revenues will decrease in 2008 compared to 2007 due to the launch of a generic substitute for Altace® in December 2007 by a third party.


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Meridian Auto-Injector Segment
 
                                                         
                      Change  
    For the Years Ended December 31,     2007-2006     2006-2005  
    2007     2006     2005     $     %     $     %  
    (In thousands)                          
 
Meridian Auto-Injector revenue
  $ 183,860     $ 164,760     $ 129,261     $ 19,100       11.6 %   $ 35,499       27.5 %
Cost of Revenues, exclusive of depreciation, amortization and impairments
    76,050       74,576       62,958       1,474       2.0       11,618       18.5  
                                                         
    $ 107,810     $ 90,184     $ 66,303     $ 17,626       19.5 %   $ 23,881       36.0 %
                                                         
 
Revenues from our Meridian Auto-Injector segment increased in 2007 compared to 2006 primarily due to increases in unit sales of Epipen® to Dey, L.P., an increase in revenues derived from our acquisition of the rights to market and sell Epipen® in Canada that we purchased from Allerex Laboratory LTD in March 2006 and a price increase taken in the first quarter of 2007. Most of our Epipen® sales are based on our supply agreement with Dey, L.P., which markets, distributes and sells the product worldwide, except for Canada where it is marketed, distributed and sold by us. Revenues from the Meridian Auto-Injector segment fluctuate based on the buying patterns of Dey, L.P. and government customers. Demand for Epipen® is seasonal as a result of its use in the emergency treatment of allergic reactions to insect stings or bites, more of which occur in the warmer months. With respect to auto-injector products sold to government entities, demand for these products is affected by the cyclical nature of procurements as well as response to domestic and international events. Total prescriptions for Epipen® in the United States increased approximately 9.5% during 2007 compared to 2006 according to IMS monthly prescription data. We do not believe revenues from the Meridian Auto-Injector segment will increase at the rate experienced in 2007.
 
Revenues from the Meridian Auto-Injector segment increased in 2006 compared to 2005 primarily due to increases in unit sales of Epipen® to Dey, L.P., as well as revenues derived from our acquisition of the rights to market and sell Epipen® in Canada that we purchased from Allerex Laboratory LTD in March 2006. Total prescriptions for Epipen® in the United States increased approximately 3.6% in 2006 compared to 2005 according to IMS monthly prescription data.
 
Cost of revenues from the Meridian Auto-Injector segment increased in 2007 compared to 2006 and in 2006 compared to 2005 primarily due to higher unit sales.
 
Royalties Segment
 
                                                         
                      Change  
    For the Years Ended December 31     2007-2006     2006-2005  
    2007     2006     2005     $     %     $     %  
    (In thousands)                          
 
Royalty revenue
  $ 82,589     $ 80,357     $ 78,128     $ 2,232       2.8 %   $ 2,229       2.9 %
Cost of Revenues, exclusive of depreciation, amortization and impairments
    10,158       9,748       9,003       410       4.2       745       8.3  
                                                         
    $ 72,431     $ 70,609     $ 69,125     $ 1,822       2.6 %   $ 1,484       2.1 %
                                                         
 
Revenues from royalties are derived primarily from payments we receive based on sales of Adenoscan®. We are not responsible for the marketing of this product and, thus, are not able to predict whether revenue from royalties will increase or decrease in future periods. Additional branded competition may enter the market in 2008.


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Contract Manufacturing Segment
 
                                                         
                      Change  
    For the Years Ended December 31,     2007-2006     2006-2005  
    2007     2006     2005     $     %     $     %  
    (In thousands)                          
 
Contract manufacturing revenue
  $ 9,201     $ 16,501     $ 22,167     $ (7,300 )     (44.2 )%   $ (5,666 )     (25.6 )%
Cost of Revenues, exclusive of depreciation, amortization and impairments
    9,434       17,636       27,055       (8,202 )     (46.5 )     (9,419 )     (34.8 )
                                                         
    $ (233 )   $ (1,135 )   $ (4,888 )   $ 902       79.5 %   $ 3,753       76.8 %
                                                         
 
Revenues and cost of revenues from contract manufacturing decreased in 2007 compared to 2006 due to a lower volume of units manufactured for third parties. As discussed above, we completed the sale of substantially all of our contract manufacturing business to JHP on October 1, 2007. Therefore, we anticipate a significant decrease in contract manufacturing revenue in 2008.
 
Revenues from contract manufacturing decreased in 2006 compared to 2005 due to a lower volume of units manufactured for third parties.
 
Cost of revenues associated with contract manufacturing decreased in 2007 compared to 2006 and in 2006 compared to 2005 primarily due to decreased unit production of products we manufacture for third parties.
 
Operating Costs and Expenses
 
                                                         
                      Change  
    For the Years Ended December 31,     2007-2006     2006-2005  
    2007     2006     2005     $     %     $     %  
    (In thousands)                          
 
Cost of revenues, exclusive of depreciation, amortization and impairments
  $ 566,534     $ 419,808     $ 322,985     $ 146,726       35.0 %   $ 96,823       30.0 %
Selling, general and administrative
    691,034       713,965       636,483       (22,931 )     (3.2 )     77,482       12.2  
Research and development
    184,735       253,596       262,726       (68,861 )     (27.2 )     (9,130 )     (3.5 )
Depreciation and amortization
    173,863       147,549       147,049       26,314       17.8       500       <1.0  
Asset impairments
    223,025       47,842       221,054       175,183       >100       (173,212 )     (78.4 )
Restructuring charges
    70,178       3,194       4,180       66,984       >100       (986 )     (23.6 )
Gain on sale of products
                (1,675 )                 1,675       100.0  
                                                         
Total operating costs and expenses
  $ 1,909,369     $ 1,585,954     $ 1,592,802     $ 323,415       20.4 %   $ (6,848 )     (0.4 )%
                                                         


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Selling, General and Administrative Expenses
 
                                                         
                      Change  
    For the Years Ended December 31,     2007-2006     2006-2005  
    2007     2006     2005     $     %     $     %  
    (In thousands)                          
 
Selling, general and administrative, exclusive of co-promotion fees
  $ 511,303     $ 496,215     $ 409,451     $ 15,088       3.0 %   $ 86,764       21.2 %
Mylan transaction costs
                3,898                   (3,898 )     (100.0 )
Co-promotion fees
    179,731       217,750       223,134       (38,019 )     (17.5 )     (5,384 )     (2.4 )
                                                         
Total selling, general and administrative
  $ 691,034     $ 713,965     $ 636,483     $ (22,931 )     (3.2 )%   $ 77,482       12.2 %
                                                         
 
As a percentage of total revenues, total selling, general, and administrative expenses were 32.3% during 2007 and 35.9% in 2006 and 2005.
 
Total selling, general and administrative expenses decreased in 2007 compared to 2006, primarily due to a decrease in co-promotion fees we pay to Wyeth under our co-promotion agreement, partially offset by an increase in operating expenses associated with sales and marketing. The increases in sales and marketing expenses are driven by an increase in the size of our sales force and marketing costs primarily associated with Altace® and Avinza®. For the full year 2008, we expect selling, general and administrative expenses, exclusive of co-promotion fees, to decline by approximately $75.0 million to $90.0 million compared to full year 2007 as a result of the accelerated strategic shift discussed above. The co-promotion fee decreased in 2007 compared to 2006 due to a lower co-promotion fee average rate during 2007 as a result of the Amended Co-Promotion Agreement. For additional discussion regarding the Amended Co-Promotion Agreement, please see “General” within the “Liquidity and Capital Resources” section below. For a discussion regarding net sales of Altace®, please see the section entitled “Altace®” within the “Sales of Key Products” section above.
 
Total selling, general and administrative expenses increased in 2006 compared to 2005 primarily due to an increase in special items, stock-based compensation costs and an increase in operating expenses associated with sales and marketing. While Altace® net sales were higher in 2006 compared to 2005, the co-promotion fee remained consistent due to a lower co-promotion fee average rate during 2006 as a result of the Amended Co-Promotion Agreement.
 
Effective January 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment, using the modified prospective application transition method. Our prior period condensed consolidated financial statements have not been restated and therefore do not reflect the recognition of stock-based compensation costs. During 2007, we incurred stock-based compensation costs of $27.7 million, $19.8 million of which is included in selling, general and administrative expenses. During 2006, we incurred stock-based compensation costs of $21.1 million, $15.4 million of which is included in selling, general and administrative expenses.
 
In addition to the stock-based compensation costs discussed above, we recorded a charge of $3.6 million in the third quarter of 2006 to correct immaterial understatements of compensation expense identified in our voluntary review of our practices with respect to granting equity-based compensation. For additional information, please see Note 21, “Stock-Based Compensation,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
Selling, general and administrative expense includes the following special items:
 
  •  Charges of $2.1 million, $0.1 million, and $19.8 million during 2007, 2006 and 2005, respectively, primarily due to professional fees related to the now-completed investigation of our company by the HHS/OIG, and the SEC, and on-going private plaintiff securities litigation. During 2007 and 2006, we


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  received payment from our insurance carriers for the recovery of legal fees in the amount of $3.4 million and $6.8 million, respectively, related to the securities litigation. These recoveries have been reflected as reductions of professional fees in 2007 and 2006. For additional information, please see Note 19, “Commitments and Contingencies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
  •  A charge of $45.1 million during 2006 related to the results of a binding arbitration proceeding with Elan Corporation, plc regarding an agreement concerning the development of a modified release formulation of Sonata®. During 2004, we incurred a charge of $5.0 million as estimated settlement costs related to the termination of this agreement. For additional information please see Note 13, “Accrued Expenses,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
  •  Charges in the amount of $3.9 million in 2005 for professional fees and expenses related to the terminated merger agreement with Mylan Laboratories, Inc.
 
Research and Development Expense
 
                                         
    For the Years Ended
    Change  
    December 31,     2007-2006     2006-2005  
    2007     2006     2005     $     $  
    (In thousands)              
 
Research and development
  $ 149,425     $ 143,596     $ 74,015     $ 5,829     $ 69,581  
Research and development — in-process upon acquisition
    35,310       110,000       188,711       (74,690 )     (78,711 )
                                         
Total research and development
  $ 184,735     $ 253,596     $ 262,726     $ (68,861 )   $ (9,130 )
                                         
 
Research and development represents expenses associated with the ongoing development of investigational drugs and product life-cycle management projects in our research and development pipeline. These expenses have continued to increase over time as our development programs have progressed to later stages of clinical development, which later stages are much more expensive than earlier stages, and as we have continued to add late-stage products in development to our portfolio. Our business model continues to focus on adding to our research and development pipeline through the acquisition of novel branded pharmaceutical products and technologies in later stages of development.
 
Research and development — in-process upon acquisition represents the actual cost of acquiring rights to novel branded pharmaceutical projects in development from third parties, which costs we expense at the time of acquisition. We classify these costs as special items, and in 2007, 2006, and 2005 special items included the following:
 
  •  A charge equaling $32.0 million during 2007 associated with our collaborative agreement with Acura Pharmaceuticals, Inc. (“Acura”) to develop and commercialize certain immediate release opioid analgesic products utilizing Acura’s proprietary Aversion® (abuse-deterrent/abuse-resistant) Technology in the United States, Canada and Mexico. The agreement provides us with an exclusive license for Acuroxtm (oxycodone HCl, niacin and a unique combination of other ingredients) tablets and another undisclosed immediate release opioid product utilizing Acura’s Aversion® Technology. In addition, the agreement provides us with an option to license all future opioid analgesic products developed utilizing Acura’s Aversion® Technology. Acuroxtm tablets are intended to effectively treat moderate to moderately severe acute pain while resisting or deterring common methods of abuse, including intravenous injection or oral consumption of tablets dissolved in liquids, nasal inhalation of crushed tablets and intentional swallowing of excessive numbers of tablets.
 
     In connection with the agreement with Acura, we recognized the above payments of $32.0 million as in-process research and development expense during 2007. This amount was expensed as the in-process research and development project had not received regulatory approval and had no alternative future use. The in-process research and development project is part of the branded pharmaceutical segment. Acuroxtm is currently in Phase III of clinical development. We believe there is a reasonable probability


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  of completing the project successfully. However, the success of the project depends on the outcome of the Phase III clinical trial program and approval by the FDA. The estimated cost to complete the project at the execution of the agreement was approximately $9.0 million. If the Phase III clinical trials are successful, we would expect to obtain FDA approval in 2009 or 2010.
 
  •  A charge equaling $3.1 million during 2007 for a payment to Mutual Pharmaceutical Company (“Mutual”) to jointly research and develop one or more improved formulations of metaxalone. Under the agreement with Mutual, we sought Mutual’s expertise in developing improved formulations of metaxalone, including improved formulations Mutual developed prior to execution of this agreement and access to Mutual’s and United Research Laboratories’ rights in intellectual property pertaining to these formulations. Development activities under this agreement ceased in December 2007.
 
  •  A charge equaling $110.0 million during 2006 for our acquisition of in-process research and development associated with our collaboration with Arrow to commercialize one or more novel formulations of ramipril, the active ingredient in our Altace® product. Under a series of agreements, Arrow has granted us rights to certain current and future NDAs regarding novel formulations of ramipril and intellectual property, including patent rights and technology licenses relating to these novel formulations. Arrow will have responsibility for the manufacture and supply of new formulations of ramipril for us. However, under certain conditions, we may manufacture and supply the formulations of ramipril instead of Arrow. Arrow will earn fees for the manufacture and supply of the new formulations of ramipril. Arrow filed an NDA for a tablet formulation of ramipril in January 2006 (the “Ramipril Application”). At the time of our acquisition of this project, its success was dependent on additional development activities and FDA approval. The estimated cost to complete the project at the execution of these agreements was approximately $3.5 million. The FDA approved the NDA on February 27, 2007. Arrow granted us an exclusive option to acquire their entire right, title and interest to the Ramipril Application or any future filed Amended Ramipril Application for the amount of $5.0 million. In April 2007, we exercised our option and paid $5.0 million to Arrow. As a result, we own the entire right, title and interest in the Ramipril Application. We launched the tablet formulation in February 2008.
 
  •  A charge equaling $153.7 million during 2005 for our acquisition of in-process research and development associated with our strategic alliance with Pain Therapeutics to develop and commercialize Remoxytm and other opioid painkillers that resist common methods of abuse. Remoxytm is an investigational drug in late-stage clinical development by Pain Therapeutics for the treatment of moderate to severe chronic pain. We are responsible for all research and development expenses related to this alliance. The value of the in-process research and development project was expensed on the date of acquisition as it had not received regulatory approval and had no alternative future use. Remoxytm has successfully completed Phase III of clinical development and Pain Therapeutics expects to file the NDA in the second quarter of 2008. We currently anticipate obtaining FDA approval in 2009. We believe there is a reasonable probability of completing the project successfully. However, the success of the project depends on regulatory approval and our ability to successfully manufacture the product.
 
  •  A charge of $35.0 million during 2005 for our acquisition of in-process research and development due to our co-exclusive license agreement with Mutual Pharmaceutical Company whereby we obtained a license to certain intellectual property relating to metaxalone. The intellectual property licensed to us relates to the potential for improved dosing and administration of metaxalone. The value of the in-process research and development project was expensed on the date of acquisition as it had not received regulatory approval and had no alternative future use.
 
Depreciation and Amortization Expense
 
Depreciation and amortization expense increased in 2007 compared to 2006 primarily due to increased amortization expense related to Avinza® and Altace® partially offset by a decrease in depreciation and amortization expense associated with the sale of the Rochester, Michigan sterile manufacturing facility. On February 26, 2007, we completed our acquisition of Avinza® and began amortizing the associated intangible assets as of that date. During 2007, following the Circuit Court’s decision invalidating our Altace® patent as


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discussed above, we decreased the estimated useful life of our Altace® intangible assets. On June 30, 2007, the assets associated with the sale of the Rochester, Michigan sterile manufacturing facility were classified as held for sale, and accordingly the depreciation and amortization was discontinued as of that date.
 
For additional information relating to the acquisition of Avinza® and the sale of the Rochester, Michigan facility please see Note 10, “Acquisitions, Dispositions, Co-Promotions and Alliances,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.” For additional information relating to the Altace® intangible assets please see Note 11, “Intangible Assets and Goodwill,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
Depreciation and amortization expense in 2007 includes a special item consisting of a $7.0 million charge associated with accelerated depreciation on certain assets, including those associated with our decision to transfer the production of Levoxyl® from our St. Petersburg, Florida facility to our Bristol, Tennessee facility, which we expect to complete in early 2009. Depreciation and amortization expense in 2006 includes a charge of $3.0 million associated with accelerated depreciation of these assets.
 
We expect depreciation and amortization expense to decrease in 2008. For additional information relating to 2008 amortization expense please see Note 11, “Intangible Assets and Goodwill,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
Other Operating Expenses
 
In addition to the special items described above, we incurred other special items affecting operating costs and expenses resulting in a net charge totaling $293.2 million in 2007 compared to a net charge totaling $51.0 million during 2006 and $223.6 million during 2005. These other special items included the following:
 
  •  An intangible asset impairment charge of $146.4 million in 2007 related to our Altace® product as a result of the invalidation of the ‘722 patent which covered the Altace® product. Following the Circuit Court’s decision, we reduced the estimated useful life of this product and forecasted net sales. This decrease in estimated remaining useful life and forecasted net sales reduced the probability-weighted estimated undiscounted future cash flows associated with Altace® intangible assets to a level below their carrying value. We determined the fair value of these assets based on probability-weighted estimated discounted future cash flows.
 
  •  A charge of $46.4 million in 2007 related to the write-down of our Rochester, Michigan sterile manufacturing facility and certain legacy branded pharmaceutical products which we classified as held for sale. On October 1, 2007, we closed the asset purchase agreement with JHP, pursuant to which JHP acquired our Rochester, Michigan sterile manufacturing facility, some of our legacy products that are manufactured there and the related contract manufacturing business. For additional information, please see Note 11, “Intangible Assets and Goodwill,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
  •  Intangible asset impairment charges of $30.2 million in 2007 primarily related to our decision to no longer pursue the development of a new formulation of Intal® utilizing hydroflouroalkane as a propellant. An intangible asset impairment charge in 2006 of $47.8 million, which is primarily related to lower than expected prescription growth for Intal® and Tilade®. An intangible asset impairment charge in 2005 of $221.1 million, which primarily related to a greater than expected decline in prescriptions for Sonata® and an anticipated decline in prescriptions for Corzide®. These charges were recorded in order to adjust the carrying value of the intangible assets on our balance sheet associated with these products so as to reflect the estimated fair value of these assets at the time the charges were incurred.
 
  •  Restructuring charges in the amount of $68.6 million in 2007 primarily due to our restructuring initiative designed to accelerate a planned strategic shift emphasizing our focus in neuroscience, hospital and acute care medicine and separation payments associated with the sale of the Rochester, Michigan sterile manufacturing facility discussed above. Restructuring charges of $1.3 million and $3.2 million during 2007 and 2006, respectively for separation payments that primarily arose in


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  connection with our decision to transfer the production of Levoxyl® from our St. Petersburg, Florida facility to the Bristol, Tennessee facility. Restructuring charges of $0.3 million in 2007 and $2.3 million in 2005 due to a decision to reduce our workforce in order to improve efficiencies in our operations. Restructuring charges of $1.9 million in 2005 primarily as a result of separation agreements with several of our executives, the relocation of our sales and marketing operations from Bristol, Tennessee to New Jersey and our decision to discontinue some relatively insignificant products associated with our Meridian Auto-Injector business.
 
  •  Income of $1.7 million in 2005 primarily due to a gain on the termination of our co-promotion and license agreements with Novavax, Inc. regarding Estrasorbtm and the repurchase by Novavax of all of its convertible notes which we held.
 
As of December 31, 2007, the net intangible assets associated with Synercid® totaled approximately $76.4 million. We believe that these intangible assets are not currently impaired based on estimated undiscounted cash flows associated with these assets. However, if our estimates regarding future cash flows prove to be incorrect or adversely change, we may have to reduce the estimated remaining useful life and/or write off a portion or all of these intangible assets.
 
In addition, certain generic companies have challenged patents on Skelaxin® and Avinza®. For additional information, please see Note 19, “Commitments and Contingencies” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.” If a generic version of Skelaxin® or Avinza® enters the market, we may have to write off a portion or all of the intangible assets associated with these products.
 
The net book value of some of our manufacturing facilities currently exceeds fair market value. Management currently believes that the long-term assets associated with these facilities are not impaired based on estimated undiscounted future cash flows. However, if we were to approve a plan to sell or close any of the facilities for which the carrying value exceeds fair market value, we would have to write off a portion of the assets or reduce the estimated useful life of the assets which would accelerate depreciation.
 
NON-OPERATING ITEMS
 
                         
    For the Years Ended December 31,  
    2007     2006     2005  
    (In thousands)  
 
Interest income
  $ 42,491     $ 32,152     $ 18,175  
Interest expense
    (7,818 )     (9,857 )     (11,931 )
Loss on investment
    (11,591 )           (6,182 )
Gain on early extinguishment of debt
          628        
Other, net
    223       (1,157 )     (2,026 )
Income tax expense
    67,600       135,730       61,485  
Discontinued operations
    (237 )     367       1,203  
 
Other Income (Expense)
 
Interest income increased during 2007 compared to 2006 and in 2006 compared to 2005 primarily due to an increase in interest rates and a higher average balance of cash, cash equivalents and investments in debt securities in 2007 compared to 2006 and in 2006 compared to 2005. We believe interest income will decrease in 2008 compared to 2007 due to a diversification of our investments in 2008. For additional information related to the diversification of our investments in 2008 please see “Liquidity and Capital Resources” below.
 
Special items affecting other income (expense) included the following:
 
  •  A loss of $11.6 million in 2007 related to our investment in Palatin.
 
  •  Income of $0.6 million during 2006 resulting from the early retirement of our 23/4% Convertible Debentures due November 15, 2021.


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  •  A charge of $6.2 million in 2005 in order to writedown our investment in Novavax common stock to fair value. During the third quarter of 2005, we sold our investment in Novavax.
 
Income Tax Expense
 
During 2007 our effective income tax rate on our income from continuing operations was 27.0%. This rate differed from the statutory rate of 35% primarily due to tax benefits relating to tax-exempt interest income and domestic production activities deductions, which benefits were partially offset by state taxes. Additionally, the 2007 rate benefited from the release of reserves under FIN 48 as a result of the expiration of certain federal and state statutes of limitations for the 2002 and 2003 tax years. We believe our effective tax rate in 2008 will be higher than the 2007 effective tax rate.
 
During 2006, our effective tax rate for continuing operations was 32.0%. This rate differed from the federal statutory rate of 35% primarily due to benefits related to charitable contributions of inventory, tax-exempt interest income and domestic manufacturing activities deductions, which benefits were partially offset by state taxes.
 
During 2005, our effective income tax rate for continuing operations was 34.5%. This rate differed from the federal statutory rate of 35% primarily due to tax benefits related to charitable contributions of inventory, tax-exempt interest income and domestic manufacturing activities deductions, which benefits were partially offset by state taxes.
 
For additional information relating to income taxes please see Note 17, “Income Taxes,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
Off-Balance Sheet Arrangements, Contractual Obligations and Commercial Commitments
 
We do not have any off-balance sheet arrangements, except for operating leases in the normal course of business as described in Note 12 “Lease Obligations” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules” to our audited consolidated financial statements included in this report and as reflected in the table below.
 
The following table summarizes contractual obligations and commitments as of December 31, 2007 (in thousands):
 
                                         
    Payment Due by Period  
          Less Than
    One to
    Four to
    More Than
 
    Total     One Year     Three Years     Five Years     Five Years  
    (In thousands)  
 
Contractual Obligations:
                                       
Long-term debt
  $ 400,000     $     $     $     $ 400,000  
Operating leases
    72,366       11,846       21,952       20,562       18,006  
Unconditional purchase obligations
    304,141       151,499       93,824       23,998       34,820  
Interest on long-term debt
    26,306       5,000       10,000       10,000       1,306  
                                         
Total
  $ 802,813     $ 168,345     $ 125,776     $ 54,560     $ 454,132  
                                         
 
Our unconditional purchase obligations are primarily related to minimum purchase requirements under contracts with suppliers to purchase raw materials and finished goods related to our branded pharmaceutical products and commitments associated with research and development projects. The above table does not reflect any potential milestone payments in connection with research and development projects or acquisitions.
 
We have a supply agreement with a third party to produce ramipril, the active ingredient in Altace®. This supply agreement is reflected in the unconditional purchase obligations above. This supply agreement requires us to purchase certain minimum levels of ramipril as long as we maintain market exclusivity on Altace® in the United States, and thereafter the parties must negotiate in good faith the annual minimum purchase quantities. In September 2007, our ’722 Patent that covered our Altace® product was invalidated by the Circuit Court as discussed above. As a result of the invalidation of the ’722 Patent, we concluded that we have more Altace®


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raw material than is required to meet anticipated future demand for the product. As a result, we recorded a charge of $25.8 million in 2007 for our estimated remaining minimum purchase requirements for excess Altace® raw material associated with this supply agreement. If prescriptions for, or sales of, Altace® are less than current expectations, we may incur additional losses in connection with the purchase commitments under the supply agreement. In the event we incur additional losses in connection with the purchase commitments under the supply agreement, there may be a material adverse effect upon our results of operations and cash flows.
 
We have supply agreements with two third parties to produce metaxalone, the active ingredient in Skelaxin®. These supply agreements require us to purchase certain minimum levels of metaxalone and expire in 2008 and 2010. If sales of Skelaxin® are not consistent with current forecasts, we could incur losses in connection with purchase commitments for metaxalone, which could have a material adverse effect upon our results of operations and cash flows.
 
As of December 31, 2007, we had a liability for unrecognized tax benefits of $34.5 million. Due to the high degree of uncertainty regarding the timing of future cash outflows of liabilities for unrecognized tax benefits beyond one year, a reasonable estimate of the period of cash settlement for years beyond 2008 can not be made.
 
Liquidity and Capital Resources
 
General
 
We believe that existing balances of cash, cash equivalents, investments in debt securities and marketable securities, cash generated from operations, our existing revolving credit facility and funds potentially available to us under our universal shelf registration are sufficient to finance our current operations and working capital requirements on both a short-term and long-term basis. However, we cannot predict the amount or timing of our need for additional funds under various circumstances, which could include a significant acquisition of a business or assets, new product development projects, expansion opportunities, or other factors that may require us to raise additional funds in the future. We cannot provide assurance that funds will be available to us when needed on favorable terms, or at all.
 
As of December 31, 2007, our investments in debt securities of $1,345.0 million consisted solely of tax-exempt auction rate securities, and we were not invested in any mortgage-backed securities or any securities backed by corporate debt obligations. The tax-exempt auction rate securities that we hold are long-term variable rate bonds tied to short-term interest rates that are reset through an auction process generally every seven, 28 or 35 days. All of our investments in debt securities as of December 31, 2007, have experienced at least one successful auction since that time. Our investment policy requires us to maintain an investment portfolio with a high credit quality. Accordingly, our investments in debt securities are limited to issues which are rated AA or higher at the time of purchase. We have realized no loss of principal with respect to these investments.
 
During the first quarter of 2008 we diversified our portfolio of short-term investments. As of February 27, 2008, we had approximately $624.4 million invested in tax-exempt auction rate securities and $823.3 million in money market funds supported by U.S. Treasury obligations. As of February 27, 2008, our investments in tax-exempt auction rate securities consisted of $258.6 million associated with student loans backed by the federal family education loan program (FFELP), $244.3 million associated with municipal bonds in which performance is supported by bond insurers and $21.1 million associated with student loans collateralized by loan pools which equal at least 200% of the bond issue.
 
In the event that we attempt to liquidate a portion of our holdings through an auction and are unable to do so, we term it an “auction failure.” On February 11, 2008, we began to experience auction failures. Since that date and as of February 27, 2008, 78% of the auctions through which we have attempted to liquidate investments in tax-exempt auction rate securities totaling $524.0 million have failed. In the event of an auction failure, the interest rate on the security is reset according to the contractual terms in the underlying indenture. As of February 27, 2008, we have received all scheduled interest payments associated with these securities.


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The current instability in the credit markets may affect our ability to liquidate these securities. The funds associated with failed auctions will not be accessible until a successful auction occurs, the issuer calls or restructures the underlying security, the underlying security matures or a buyer outside the auction process emerges. At this point in time, we believe that the failed auctions experienced to date are not a result of the deterioration of the underlying credit quality of the securities and any unrealized gain or loss associated with these securities will be temporary and will be recorded in accumulated other comprehensive income (loss) in our Consolidated Financial Statements.
 
On April 23, 2002, we established a $400.0 million five-year Senior Secured Revolving Credit Facility which was scheduled to mature in April 2007. On April 19, 2007, this facility was terminated and replaced with a new $475.0 million five-year Senior Secured Revolving Credit Facility which matures in April 2012.
 
In October 2007, we entered into a License, Development and Commercialization Agreement with Acura to develop and commercialize certain opioid analgesic products utilizing Acura’s proprietary Aversion® (abuse-deterrent/abuse-resistant) Technology in the United States, Canada and Mexico. The agreement provides us with an exclusive license for Acuroxtm (oxycodone HCl, niacin and a unique combination of other ingredients) tablets, formerly known as OxyADF, and another undisclosed opioid product utilizing Acura’s Aversion® Technology. In addition, the agreement provides us with an option to license all future opioid analgesic products developed utilizing Acura’s Aversion® Technology.
 
In December 2007, we made a non-refundable cash payment of $30.0 million to Acura. Under the terms of the agreement, we will reimburse Acura for all research and development expenses incurred beginning from September 19, 2007 for Acuroxtm tablets and all research and development expenses related to future products after the exercise of our option to an exclusive license for each future product. During January 2008, we made an additional payment of $2.0 million to Acura for certain research and development expenses incurred by Acura prior to the closing date. We may make additional non-refundable cash milestone payments to Acura based on the successful achievement of certain clinical and regulatory milestones for Acuroxtm tablets and for each other product developed under the agreement. We may also make an additional $50.0 million non-refundable cash milestone payment to Acura when the aggregate net sales of all products developed under the agreement exceeds $750.0 million. In addition, we will make royalty payments to Acura ranging from 5% to 25% based on the combined annual net sales of all products developed under the agreement.
 
In December 2007, a third party launched a generic substitute for Altace® capsules. Additional third parties will likely launch their own generic substitutes for Altace® capsules in 2008. As a result of the entry of generic competition, we expect net sales of Altace® will decline significantly during 2008. For a discussion regarding the generic competition for Altace®, please see Note 19, “Commitments and Contingencies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
Following the Circuit Court’s decision in September 2007 invalidating our ‘722 Patent that covered Altace®, our senior management team conducted an extensive examination of our company and developed a restructuring initiative designed to accelerate a planned strategic shift emphasizing its focus in neuroscience, hospital and acute care. This initiative includes a reduction in personnel, staff leverage, expense reductions and additional controls over spending, reorganization of sales teams and a realignment of research and development priorities. We incurred total costs of approximately $65.0 million in connection with this initiative. This includes the contract termination payment paid to Depomed, Inc. in October of 2007 of approximately $29.7 million, as discussed below. The remaining cash payments are expected to be completed during the first quarter of 2008. We estimate that the 2008 selling, general and administrative expense savings from these actions will range from $75.0 million to $90.0 million. For additional information, please see Note 25, “Restructuring Activities,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
In October 2007, we sold our Rochester, Michigan sterile manufacturing facility, some of our legacy products that are manufactured there and the related contract manufacturing business to JHP Pharmaceuticals, LLC for $91.7 million, less fees of $5.4 million. We retained our stand-alone Bicillin (sterile penicillin products) manufacturing facility which is also located in Rochester, Michigan. For additional information, please see Note 10, “Acquisitions, Dispositions, Co-Promotions and Alliances,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”


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In May 2007, we entered into a Product Development Agreement with Mutual Pharmaceutical Company (“Mutual”) and United Research Laboratories (“United”) to jointly research and develop one or more improved formulations of metaxalone. Under this agreement, we sought Mutual’s expertise in developing improved formulations of metaxalone, including certain improved formulations Mutual developed prior to execution of this agreement and access to Mutual’s and United’s rights in intellectual property pertaining to such formulations. We paid $3.1 million to Mutual for development expenses, and this was recorded as in-process research and development. Development activities under this agreement ceased in December 2007.
 
In September 2006, we entered into a definitive asset purchase agreement and related agreements with Ligand Pharmaceuticals Incorporated (“Ligand”) to acquire rights to Avinza® (morphine sulfate extended release). Avinza® is an extended release formulation of morphine and is indicated as a once-daily treatment for moderate to severe pain in patients who require continuous opioid therapy for an extended period of time. We completed the acquisition of Avinza® on February 26, 2007, acquiring all the rights to Avinza® in the United States, its territories and Canada. Under the terms of the asset purchase agreement the purchase price was $289.7 million, consisting of $289.3 million in cash consideration and $0.4 million for the assumption of a short-term liability. Additionally, we incurred acquisition costs of $6.8 million. Of the cash payments made to Ligand, $15.0 million was set aside in an escrow account to fund potential liabilities that Ligand could later owe us, of which $7.5 million was released to Ligand in each of the third quarter of 2007 and the first quarter of 2008.
 
As part of the transaction, we have agreed to pay Ligand an ongoing royalty and assume payment of Ligand’s royalty obligations to third parties. The royalty we will pay to Ligand consists of a 15% royalty during the first 20 months after the closing date. Subsequent royalty payments to Ligand will be based upon calendar year net sales of Avinza® as follows:
 
  •  If calendar year net sales are less than $200.0 million, the royalty payment will be 5% of all net sales.
 
  •  If calendar year net sales are greater than $200.0 million, then the royalty payment will be 10% of all net sales up to $250.0 million, plus 15% of net sales greater than $250.0 million.
 
In connection with the transaction, in October 2006, we entered into a loan agreement with Ligand for the amount of $37.8 million. The principal amount of the loan was to be used solely for the purpose of paying a specific liability related to Avinza®. The loan was subject to certain market terms, including a 9.5% interest rate and security interest in the assets that comprise Avinza® and certain of the proceeds of Ligand’s sale of certain assets. On January 8, 2007, Ligand repaid the principal amount of the loan of $37.8 million and accrued interest of $0.9 million. Pursuant to the terms of the loan agreement with Ligand, we forgave the interest on the loan and repaid Ligand the interest at the time of closing the transaction to acquire Avinza®. Accordingly, we have not recognized interest income on the note receivable.
 
In January 2007, we obtained an exclusive license to certain hemostatic products owned by Vascular Solutions, Inc. (“Vascular Solutions”), including products which we market as Thrombi-Padtm and Thrombi-Gel®. The license also includes a product we expect to market as Thrombi-Pastetm, which is currently in development. Each of these products includes our Thrombin-JMI® topical hemostatic agent as a component. Vascular Solutions will manufacture and supply the products for us. Upon execution of the agreements, we made an initial payment to Vascular Solutions of $6.0 million, a portion of which is refundable in the event FDA approval for certain of these products is not received. During the second quarter of 2007, we made an additional milestone payment of $1.0 million. We could make additional milestone payments of up to $1.0 million in cash.
 
In June 2000, we entered into a Co-Promotion Agreement with Wyeth to promote Altace® in the United States and Puerto Rico through October 29, 2008, with possible extensions as outlined in the Co-Promotion Agreement. Under the agreement, Wyeth paid an upfront fee to us of $75.0 million. In connection with the Co-Promotion Agreement, we agreed to pay Wyeth a promotional fee based on annual net sales of Altace®. In July 2006, we entered into an Amended and Restated Co-Promotion Agreement with Wyeth regarding Altace®. Effective January 1, 2007, we assumed full responsibility for selling and marketing Altace®. For all of 2006,


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the Wyeth sales force promoted the product with us and Wyeth shared marketing expenses. We have paid or will pay Wyeth a reduced annual fee as follows:
 
  •  For 2006, 15% of Altace® net sales up to $165.0 million, 42.5% of Altace® net sales in excess of $165.0 million and less than or equal to $465.0 million, and 52.5% of Altace® net sales that are in excess of $465.0 million and less than or equal to $585.0 million.
 
  •  For 2007, 30% of Altace® net sales, with the fee not to exceed $178.5 million.
 
  •  For 2008, 22.5% of Altace® net sales, with the fee not to exceed $134.0 million.
 
  •  For 2009, 14.2% of Altace® net sales, with the fee not to exceed $84.5 million.
 
  •  For 2010, 25% of Altace® net sales, with the fee not to exceed $5.0 million.
 
The annual fee is accrued quarterly based on a percentage of Altace® net sales at a rate equal to the expected relationship of the expected fee for the year to applicable expected Altace® net sales for the year.
 
 
In June 2006, we entered into a co-exclusive agreement with Depomed, Inc. (“Depomed”) to commercialize Depomed’s Glumetzatm product. On October 29, 2007, we announced the termination of this agreement. We paid Depomed a termination fee of approximately $29.7 million and Depomed was not required to pay us a promotion fee for the fourth quarter of 2007. We fulfilled our promotion obligations through the end of 2007.
 
In March 2006, we acquired the exclusive right to market, distribute, and sell EpiPen® throughout Canada and other specific assets from Allerex Laboratory LTD (“Allerex”). Under the terms of the agreements, the initial purchase price was approximately $23.9 million, plus acquisition costs of approximately $0.7 million. As an additional component of the purchase price, we pay Allerex an earn-out equal to a percentage of future sales of EpiPen® in Canada over a fixed period of time. As these additional payments accrue, we will increase intangible assets by the amount of the accrual. The aggregate amount of these payments will not exceed $13.2 million.
 
In February 2006, we entered into a collaboration with Arrow to commercialize one or more novel formulations of ramipril, the active ingredient in our Altace® product. Under a series of agreements, Arrow granted us rights to certain current and future New Drug Applications (“NDAs”) regarding novel formulations of ramipril and intellectual property, including patent rights and technology licenses relating to these novel formulations. On February 27, 2007, the FDA approved an NDA arising from this collaboration for an Altace® tablet formulation. Arrow granted us an exclusive option to acquire their entire right, title and interest to the Ramipril Application or any future filed amended ramipril application for the amount of $5.0 million. In April 2007, we exercised this option and paid $5.0 million to Arrow. As a result, we own the entire right, title and interest in and to the Ramipril Application. Arrow will have responsibility for the manufacture and supply of the new formulations of ramipril for us. However, under certain conditions we may manufacture and supply new formulations of ramipril.
 
Upon execution of the agreements, we made an initial payment to Arrow of $35.0 million. During the fourth quarter of 2006 and the first and second quarters of 2007, we made additional payments of $25.0 million in each of the three quarters to Arrow. We classified these payments as in-process research and development expense in 2006. Additionally, Arrow will earn fees for the manufacture and supply of the new formulations of ramipril.
 
In December 2005, we entered into a cross-license agreement with Mutual. Under the terms of the agreement, each of the parties has granted the other a worldwide license to certain intellectual property, including patent rights and know-how, relating to metaxalone. As of January 1, 2006, we began paying royalties on net sales of products containing metaxalone to Mutual. This royalty increased in the fourth quarter of 2006 due to the achievement of a certain milestone and may continue to increase depending on the achievement of certain regulatory and commercial milestones in the future. The royalty we pay to Mutual is in addition to the royalty we pay to Elan Corporation, plc (“Elan”) on our current formulation of metaxalone, which we refer to as “Skelaxin®.”


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During the fourth quarter of 2005, we entered into a strategic alliance with Pain Therapeutics, Inc. to develop and commercialize Remoxytm and other opioid painkillers. Remoxytm, an investigational novel formulation of extended release oxycodone for the treatment of moderate to severe chronic pain, is designed to resist common methods of abuse, such as crushing, heating, or dissolution in alcohol that are reported with respect to other long-acting opioids. Under the strategic alliance, we made an upfront cash payment of $150.0 million in December 2005 and made a milestone payment of $5.0 million in July 2006 to Pain Therapeutics. In addition, we may pay additional milestone payments of up to $145.0 million in cash based on the successful clinical and regulatory development of Remoxytm and other opioid products. This amount includes a $15.0 million cash payment upon acceptance of a regulatory filing for Remoxytm and an additional $15.0 million upon its approval. We are responsible for all research and development expenses related to this alliance. After regulatory approval and commercialization of Remoxytm or other products developed through this alliance, we will pay a royalty of 15% of the cumulative net sales up to $1.0 billion and 20% of the cumulative net sales over $1.0 billion.
 
Elan was working to develop a modified release formulation of Sonata®, which we refer to as Sonata® MR, pursuant to an agreement we had with them which we refer to as the Sonata® MR Development Agreement. In early 2005, we advised Elan that we considered the Sonata® MR Development Agreement terminated for failure to satisfy the target product profile required by us. Elan disputed the termination and initiated an arbitration proceeding. During December of 2006, the arbitration panel reached a decision in favor of Elan and ordered us to pay Elan certain milestone payments and other research and development-related expenses of approximately $49.8 million, plus interest from the date of the decision. In January 2007, we paid Elan $50.1 million, which included interest of $0.4 million.
 
Settlement of Governmental Pricing Investigation
 
As previously reported, during the first quarter of 2006, we paid approximately $129.3 million, comprising (i) all amounts due under the settlement agreements resolving the governmental investigations related to our underpayment of rebates owed to Medicaid and other governmental pricing programs during the period from 1994 to 2002 (the “Settlement Agreements”) and (ii) all our obligations to reimburse other parties for expenses related to the settlement, including the previously disclosed legal fees of approximately $0.8 million and the previously disclosed settlement costs of approximately $1.0 million.
 
The individual purportedly acting as a “relator” under the False Claims Act appealed certain decisions of the District Court denying the relator’s request to be compensated out of the approximately $31.0 million that was paid by us to those states that do not have legislation providing for a “relator’s share.” On July 16, 2007, the Court of Appeals affirmed the District Court’s decision in all respects, and denied the relator’s assertions with respect to us. The relator exhausted his limited rights to appeal the Court of Appeals’ decision and we consider this matter concluded.
 
In addition to the Settlement Agreements, we have entered into a five-year corporate integrity agreement with HHS/OIG (the “Corporate Integrity Agreement”) pursuant to which we are required, among other things, to keep in place our current compliance program, to provide periodic reports to HHS/OIG and to submit to audits relating to our Medicaid rebate calculations.
 
The Settlement Agreements do not resolve any of the previously disclosed civil suits that are pending against us and related individuals and entities discussed in the section “Securities and Derivative Litigation” below.
 
The foregoing description of the settlement, the Settlement Agreements and the Corporate Integrity Agreement is qualified in its entirety by our Current Report on Form 8-K filed November 4, 2005, which is incorporated herein by reference.
 
SEC Investigation
 
As previously reported, the Securities and Exchange Commission (the “SEC”) had also been conducting an investigation relating to our underpayments to governmental programs and to our previously disclosed errors relating to reserves for product returns. On December 12, 2007, we received notice from the Staff of the SEC that the investigation was closed.


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Securities and Derivative Litigation
 
As previously reported, on July 31, 2006 a stipulation of settlement and a supplemental agreement (together, the “Settlement Agreement”) were entered into to resolve the federal securities litigation related to our underpayments of rebates owed to Medicaid and other governmental pricing programs and certain other matters. On January 9, 2007, the court granted final approval of the Settlement Agreement. The Settlement Agreement provides for a settlement amount of $38.3 million, which has been fully funded by our insurance carriers on our behalf.
 
Beginning in March 2003, four purported shareholder derivative complaints were also filed in Tennessee state court alleging a breach of fiduciary duty, among other things, by some of our current and former officers and directors, with respect to the same events at issue in the federal securities litigation described above. These cases have been consolidated. In June 2007, plaintiffs filed a motion to amend the complaint, seeking to name as defendants additional current and former officers and directors and our independent auditors and to add additional claims. Following negotiations among the parties, this motion was granted in part, but it was denied with respect to naming as defendants additional current and former officers and directors. Trial is scheduled to begin on September 22, 2008. The parties engaged in non-binding mediation in January 2008 but were not able to reach a resolution. Discussions between the parties continue.
 
Beginning in March 2003, three purported shareholder derivative complaints were likewise filed in Tennessee Federal Court, asserting claims similar to those alleged in the state derivative litigation. These cases have been consolidated, and on December 2, 2003 plaintiffs filed a consolidated amended complaint. On March 9, 2004, the Court entered an order indefinitely staying these cases in favor of the state derivative action.
 
During the third quarter of 2006 and the second quarter of 2007, we recorded an anticipated insurance recovery of legal fees in the amount of $6.8 million and $3.4 million, respectively, for the class action and derivative suits described above. In November of 2006 and July of 2007, we received payment for the recovery of these legal fees.
 
For additional information, please see Note 19, “Commitments and Contingencies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”
 
We are currently unable to predict the outcome of the pending litigation. If we were not to prevail in the pending litigation, our business, financial condition, results of operations and cash flows could be materially adversely affected.
 
Patent Challenges
 
Certain generic companies have challenged patents on Skelaxin® and Avinza®. For additional information, please see Note 19, “Commitments and Contingencies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.” If a generic version of Skelaxin® or Avinza®, enters the market, our business, financial condition, results of operations and cash flows could be materially adversely affected.
 
Cash Flows
 
Operating Activities
 
                         
    For the Years Ended December 31,  
    2007     2006     2005  
    (In thousands)  
 
Net cash provided by operating activities
  $ 672,649     $ 465,627     $ 519,508  
 
Our net cash from operations was higher in 2007 than in 2006 primarily due to our payment in 2006 of $129.3 million pursuant to the “Settlement Agreements” described in the section entitled “Settlement of Government Pricing Investigation” above, an increase in net sales and a lower co-promotion fee rate in 2007 compared to 2006. Our net cash flows from operations in 2007 benefited from an $80.1 million reduction in


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accounts receivable during 2007 which is discussed below, that was partially offset by the effect of a $50.1 million payment we made in 2007 as a result of a binding arbitration proceeding with Elan in 2006.
 
In December 2007, a third party launched a generic substitute for Altace® capsules. Additional third parties will likely launch their own generic substitutes for Altace® capsules in 2008. As a result of the entry of generic competition, we expect net cash flows from operations will decline significantly in 2008.
 
Our net cash from operations was lower in 2006 than in 2005 primarily due to our payment in 2006 of $129.3 million pursuant to the “Settlement Agreements” described in the section entitled “Settlement of Government Pricing Investigation” above and an increase in our investment in research and development partially offset by an increase in net sales and a lower co-promotion fee rate in 2006.
 
Please see the section entitled “Operating Results” for a discussion of net sales, selling, general and administrative expenses and co-promotion fees.
 
The following table summarizes the changes in operating assets and liabilities and deferred taxes for the periods ending December 31, 2007, 2006 and 2005 and the resulting cash provided by (used in) operating activities:
 
                         
    2007     2006     2005  
    (In thousands)  
 
Accounts receivable, net of allowance
  $ 80,106     $ (41,746 )   $ (43,407 )
Inventories
    55,056       48,275       46,349  
Prepaid expenses and other current assets
    (43,555 )     (45,796 )     (47,544 )
Accounts payable
    (16,276 )     (8,568 )     (7,713 )
Accrued expenses and other liabilities
    (33,408 )     (50,458 )     (52,544 )
Income taxes payable
    (9,009 )     8,479       22,161  
Deferred revenue
    (4,680 )     (6,886 )     (9,092 )
Other assets
    (3,470 )     (20,173 )     (4,471 )
Deferred taxes
    (91,229 )     (39,010 )     (68,047 )
                         
Total changes from operating assets and liabilities and deferred taxes
  $ (66,465 )   $ (155,883 )   $ (164,308 )
 
The significant decrease in accounts receivable at December 31, 2007 from December 31, 2006 is primarily due to the timing of sales within the year. Gross sales in December 2007 and December 2006 were $124.7 million and $189.7 million, respectively. Sales to our three major pharmaceutical wholesale customers represented approximately 75% of total gross sales in 2007. The timing of orders from these customers can vary within a quarter and can have a material effect on our accounts receivable balance and cash flows from operations.
 
Investing Activities
 
                         
    For the Years Ended December 31,  
    2007     2006     2005  
    (In thousands)  
 
Net cash used in investing activities
  $ (776,251 )   $ (436,315 )   $ (683,007 )
 
Investing activities in 2007 include the acquisition of Avinza® for $296.4 million, purchases of product rights and intellectual property for $98.9 million and net investments in debt securities of $454.8 million. Capital expenditures during 2007 totaled $49.6 million, which included property, plant and equipment purchases, building improvements for facility upgrades and costs associated with improving our production capabilities. These payments were partially offset by the collection of the loan to Ligand in the amount of $37.8 million and the net proceeds received of $86.3 million from the sale of the Company’s Rochester, Michigan sterile manufacturing facility.
 
Investing activities in 2006 primarily relate to our net investments in debt securities of $395.5 million. We transferred $129.3 million from restricted cash for payments associated with the “Settlement Agreements” noted


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above in cash flows from operating activities. Additionally we made payments totaling $85.8 million for our collaboration agreement with Arrow and our acquisition from Allerex Laboratory LTD of the exclusive right to market Epipen® in Canada. Capital expenditures during 2006 totaled $45.8 million which included property, plant and equipment purchases, building improvements for facility upgrades and costs associated with improving our production capabilities, as well as costs associated with moving production of some of our pharmaceutical products to our facilities in St. Louis, Bristol and Rochester. Additionally, in the fourth quarter of 2006, in connection with our pending acquisition from Ligand of all of Ligand’s assets related to Avinza®, we entered into a Loan Agreement with Ligand pursuant to which we loaned Ligand $37.8 million. The principal amount of the Loan was to be used solely for the purpose of paying certain obligations of Ligand to Organon USA Inc., which obligations we assumed as part of the acquisition.
 
Investing activities in 2005 were driven by payments totaling $217.3 for purchases of product rights and intellectual property. Capital expenditures during 2005 totaled $53.3 million which included property, plant and equipment purchases, building improvements for facility upgrades and costs associated with improving our production capabilities, and costs associated with moving production of some of our pharmaceutical products to our facilities in St. Louis, Bristol and Rochester. Additionally in 2005, we transferred $73.6 million to restricted cash primarily related to the now completed investigation of our company by the HHS/OIG. We increased our investments in debt securities by $345.2 million.
 
We anticipate capital expenditures, including capital lease obligations, for the year ending December 31, 2008 of approximately $55.0 to $65.0 million, which we expect to fund with cash from operations. The principal capital expenditures are anticipated to include property and equipment purchases, information technology systems and hardware, building improvements for facility upgrades, costs associated with improving our production capabilities, and costs associated with moving production of some of our pharmaceutical products to our facility in Bristol.
 
Financing Activities
 
                         
    2007     2006     2005  
    (In thousands)  
 
Net cash provided by financing activities
  $ 9,834     $ 54,451     $ 857  
 
During 2006, we issued $400.0 million of 11/4% Convertible Senior Notes due April 1, 2026 and repurchased all of our outstanding 23/4% Convertible Debentures due November 15, 2021 for $342.7 million.
 
Certain Indebtedness and Other Matters
 
During 2006, we issued $400.0 million of 11/4% Convertible Senior Notes due April 1, 2026 (“Notes”). The Notes are unsecured obligations and are guaranteed by each of our domestic subsidiaries on a joint and several basis. The Notes accrue interest at an initial rate of 11/4%. Beginning with the six-month interest period that commences on April 1, 2013, we will pay additional interest during any six-month interest period if the average trading price of the Notes during the five consecutive trading days ending on the second trading day immediately preceding the first day of such six-month period equals 120% or more of the principal amount of the Notes. Interest is payable on April 1 and October 1 of each year, beginning October 1, 2006.
 
On or after April 5, 2013, we may redeem for cash some or all of the Notes at any time at a price equal to 100% of the principal amount of the Notes to be redeemed, plus any accrued and unpaid interest, and liquidated damages, if any, to but excluding the date fixed for redemption. Holders may require us to purchase for cash some or all of their Notes on April 1, 2013, April 1, 2016 and April 1, 2021, or upon the occurrence of a fundamental change, at 100% of the principal amount of the Notes to be purchased, plus any accrued and unpaid interest, and liquidated damages, if any, to but excluding the purchase date.
 
During the fourth quarter of 2001, we issued $345.0 million of 23/4% Convertible Debentures due November 15, 2021 (“Debentures”). On March 29, 2006, we repurchased $165.0 million of the Debentures prior to maturity. On May 16, 2006, the interest rate on the Debentures reset to 3.5%. On June 2, 2006, we completed a tender offer, repurchasing $175.7 million of the Debentures. On November 20, 2006, we redeemed the remaining Debentures of $4.3 million.


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In April 2002, we established a $400.0 million five-year senior secured revolving credit facility that was scheduled to mature in April 2007. On April 19, 2007, this facility was terminated and replaced with a new $475.0 million five-year Senior Secured Revolving Credit Facility which is scheduled to mature in April 2012 (the “2007 Credit Facility”). As of December 31, 2007, up to $474.0 million is available to us under the 2007 Credit Facility.
 
The 2007 Credit Facility is collateralized by a pledge of 100% of the equity of most of our domestic subsidiaries and by a pledge of 65% of the equity of our foreign subsidiaries. Our obligations under this facility are unconditionally guaranteed on a senior basis by four of our subsidiaries, King Pharmaceuticals Research and Development, Inc., Monarch Pharmaceuticals, Inc., Meridian Medical Technologies, Inc., and Parkedale Pharmaceuticals, Inc. The 2007 Credit Facility accrues interest at either, at our option, (a) the base rate, which is based on the greater of (1) the prime rate or (2) the federal funds rate plus one-half of 1%, plus an applicable spread ranging from 0.0% to 0.5% (based on a leverage ratio) or (b) the applicable LIBOR rate plus an applicable spread ranging from 0.875% to 1.50% (based on a leverage ratio). In addition, the lenders under the 2007 Credit Facility are entitled to customary facility fees based on (x) unused commitments under the facility and (y) letters of credit outstanding. The facility provides availability for the issuance of up to $30.0 million in letters of credit. We incurred $1.5 million of deferred financing costs in connection with the establishment of this facility, which we will amortize over five years, the life of the facility. This facility requires us to maintain a minimum net worth of no less than $1.5 billion plus 50% of our consolidated net income for each fiscal quarter after April 19, 2007, excluding any fiscal quarter for which consolidated income is negative; an EBITDA (earnings before interest, taxes, depreciation and amortization) to interest expense ratio of no less than 3.00 to 1.00; and a funded debt to EBITDA ratio of no greater than 3.50 to 1.00. As of December 31, 2007, we were in compliance with these covenants. As of December 31, 2007, we had $1.0 million outstanding for letters of credit.
 
On September 20, 2001, our universal shelf registration statement on Form S-3 was declared effective by the Securities and Exchange Commission. This universal shelf registration statement registered a total of $1.3 billion of our securities for future offers and sales in one or more transactions and in any combination of debt and/or equity. During November 2001, we completed the sale of 17,992,000 newly issued shares of common stock for $38.00 per share ($36.67 per share net of commissions and expenses) resulting in net proceeds of $659.8 million. As of December 31, 2007, there was $616.3 million of securities remaining registered for future offers and sales under the shelf registration statement.
 
Impact of Inflation
 
We have experienced only moderate raw material and labor price increases in recent years. While we have passed some price increases along to our customers, we have primarily benefited from sales growth negating most inflationary pressures.
 
Critical Accounting Policies and Estimates
 
We have chosen accounting policies that we believe are appropriate to accurately and fairly report our operating results and financial position, and apply those accounting policies in a consistent manner.
 
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.
 
Significant estimates for which it is reasonably possible that a material change in estimate could occur in the near term include forecasted future cash flows used in testing for impairments of intangible and tangible assets and loss accruals for excess inventory and fixed purchase commitments under our supply contracts. Forecasted future cash flows in particular require considerable judgment and are subject to inherent imprecision. In the case of impairment testing, changes in estimates of future cash flows could result in a material impairment charge and, whether they result in an immediate impairment charge, could result prospectively in a


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reduction in the estimated remaining useful life of tangible or intangible assets, which could be material to the financial statements.
 
Other significant estimates include accruals for Medicaid and other rebates, returns and chargebacks, allowances for doubtful accounts and estimates used in applying the revenue recognition policy and accounting for the Amended and Restated Co-Promotion Agreement with Wyeth.
 
We are subject to risks and uncertainties that may cause actual results to differ from the related estimates, and our estimates may change from time to time in response to actual developments and new information.
 
The significant accounting estimates that we believe are important to aid in fully understanding our reported financial results include the following:
 
  •  Intangible assets, goodwill, and other long-lived assets.  When we acquire product rights in conjunction with either business or asset acquisitions, we allocate an appropriate portion of the purchase price to intangible assets, goodwill and other long-lived assets. The purchase price is allocated to product rights and trademarks, patents, acquired research and development, if any, and other intangibles using the assistance of valuation consultants. We estimate the useful lives of the assets by factoring in the characteristics of the products such as: patent protection, competition by products prescribed for similar indications, estimated future introductions of competing products, and other issues. The factors that drive the estimate of the life of the asset are inherently uncertain. However, patents have specific legal lives over which they are amortized. Conversely, trademarks and product rights have no specific legal lives. Trademarks and product rights will continue to be an asset to us after the expiration of the patent, as their economic value is not tied exclusively to the patent. We believe that by establishing separate lives for the patent versus the trademark and product rights, we are in essence using an accelerated method of amortization for the product as a whole. This results in greater amortization in earlier years when the product is under patent protection, as we are amortizing both the patent and the trademark and product rights, and less amortization when the product faces potential generic competition, as the amortization on the patent is eliminated. Because we have no discernible evidence to show a decline in cash flows for trademarks and product rights, or for patents, we use the straight-line method of amortization for both intangibles.
 
We review our property, plant and equipment and intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. We review our goodwill for possible impairment annually, or whenever events or circumstances indicate that the carrying amount may not be recoverable. In any event, we evaluate the remaining useful lives of our intangible assets each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization. This evaluation is performed through our quarterly evaluation of intangibles for impairment. Further, on an annual basis, we review the life of each intangible asset and make adjustments as deemed appropriate. In evaluating goodwill for impairment, we estimate the fair value of our individual business reporting units on a discounted cash flow basis. Assumptions and estimates used in the evaluation of impairment may affect the carrying value of long-lived assets, which could result in impairment charges in future periods. Such assumptions include projections of future cash flows and, in some cases, the current fair value of the asset. In addition, our depreciation and amortization policies reflect judgments on the estimated useful lives of assets.
 
We may incur impairment charges in the future if prescriptions for, or sales of, our products are less than current expectations and result in a reduction of our estimated undiscounted future cash flows. This may be caused by many factors, including competition from generic substitutes, significant delays in the manufacture or supply of materials, the publication of negative results of studies or clinical trials, new legislation or regulatory proposals.


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The gross carrying amount and accumulated amortization as of December 31, 2007 are as follows:
 
                         
    Gross
             
    Carrying
    Accumulated
    Net Book
 
    Amount     Amortization     Value  
    (In thousands)  
 
Branded
                       
Avinza®
  $ 285,700     $ 22,380     $ 263,320  
Skelaxin®
    275,663       138,254       137,409  
Sonata®
    61,961       61,646       315  
                         
Neuroscience
    623,324       222,280       401,044  
Hospital
    119,031       40,343       78,688  
Intal®
    34,033       28,196       5,837  
Other acute care
    98,342       33,231       65,111  
                         
Acute care
    132,375       61,427       70,948  
Altace®
    156,744       127,057       29,687  
Other legacy products
    128,517       72,277       56,240  
                         
Legacy products
    285,261       199,334       85,927  
                         
Total Branded
    1,159,991       523,384       636,607  
Meridian Auto-Injector
    178,821       35,732       143,089  
Royalties
    3,718       2,440       1,278  
Contract manufacturing
                 
All other
                 
                         
Total intangible assets
  $ 1,342,530     $ 561,556     $ 780,974  
                         
 
The net book value by type of intangible asset as of December 31, 2007 was as follows:
 
                         
          Trademarks, product
    Net Book
 
    Patents     rights and other     Value  
          (In thousands)        
 
Branded
                       
Avinza®
  $ 263,320     $     $ 263,320  
Skelaxin®
          137,409       137,409  
Sonata®
    315             315  
                         
Neuroscience
    263,635       137,409       401,044  
Hospital
    33,253       45,435       78,688  
Intal®
          5,837       5,837  
Other acute care
          65,111       65,111  
                         
Acute care
          70,948       70,948  
Altace®
          29,687       29,687  
Other legacy products
          56,240       56,240  
                         
Legacy products
          85,927       85,927  
                         
Total Branded
    296,888       339,719       636,607  
Meridian Auto-Injector
          143,089       143,089  
Royalties
    974       304       1,278  
Contract manufacturing
                 
All other
                 
                         
Total intangible assets
  $ 297,862     $ 483,112     $ 780,974  
                         


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The amounts for impairments and amortization expense for the twelve months ended December 31, 2007 and 2006 are as follows:
 
                                 
    Year Ended
    Year Ended
 
    December 31,
    December 31,
 
    2007     2006  
          Amortization
          Amortization
 
    Impairments     Expense     Impairments     Expense  
    (In thousands)     (In thousands)  
 
Branded
                               
Avinza®
  $     $ 22,380     $     $  
Skelaxin®
          17,427             15,548  
Sonata®
          270             12,883  
                                 
Neuroscience
          40,077             28,431  
Hospital
    968       10,730             11,072  
Intal®
    27,693       5,722       44,466       7,611  
Other acute care
    1,566       4,667       3,376       7,928  
                                 
Acute care
    29,259       10,389       47,842       15,539  
Altace®
    146,444       52,278             27,542  
Other legacy products
          10,384             15,662  
                                 
Legacy products
    146,444       62,662             43,204  
                                 
Total Branded
    176,671       123,858       47,842       98,246  
Meridian Auto-Injector
          8,001             7,474  
Royalties
          279             44  
Contract manufacturing
                       
All other
                       
                                 
Total
  $ 176,671     $ 132,138     $ 47,842     $ 105,764  
                                 
 
The remaining patent amortization period compared to the remaining amortization period for trademarks and product rights associated with significant products is as follows:
 
                 
    Remaining Life at December 31, 2007  
          Trademark &
 
    Patent     Product Rights  
 
Altace®
          3 months  
Skelaxin®
          6 years  
Avinza®
    9 years 11 months        
Intal®
          1 year  
 
  •  Inventories.  Our inventories are valued at the lower of cost or market value. We evaluate our entire inventory for short-dated or slow-moving product and inventory commitments under supply agreements based on projections of future demand and market conditions. For those units in inventory that are so identified, we estimate their market value or net sales value based on current realization trends. If the projected net realizable value is less than cost, on a product basis, we make a provision to reflect the lower value of that inventory. This methodology recognizes projected inventory losses at the time such losses are evident rather than at the time goods are actually sold. We maintain supply agreements with some of our vendors which contain minimum purchase requirements. We estimate future inventory requirements based on current facts and trends. Should our minimum purchase requirements under supply agreements or if our estimated future inventory requirements exceed actual inventory quantities that we will be able to sell to our customers, we record a charge in costs of revenues.
 
  •  Accruals for rebates, returns and chargebacks.  We establish accruals for returns, chargebacks, Medicaid, Medicare and commercial rebates in the same period we recognize the related sales. The accruals reduce revenues and are included in accrued expenses. At the time a rebate or chargeback


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  payment is made or a product return is received, which occurs with a delay after the related sale, we record a reduction to accrued expenses and, at the end of each quarter, adjust accrued expenses for differences between estimated and actual payments. Due to estimates and assumptions inherent in determining the amount of returns, chargebacks and rebates, the actual amount of product returns and claims for chargebacks and rebates may be different from our estimates.
 
Our product returns accrual is primarily based on estimates of future product returns over the period during which customers have a right of return which is in turn based in part on estimates of the remaining shelf life of our products when sold to customers. Future product returns are estimated primarily on historical sales and return rates. We also consider the level of inventory of our products in the distribution channel. We base our estimate of our Medicaid rebate, Medicare rebate and commercial rebate accruals on estimates of usage by rebate-eligible customers, estimates of the level of inventory of our products in the distribution channel that remain potentially subject to those rebates, and the terms of our commercial and regulatory rebate obligations. We base our estimate of our chargeback accrual on our estimates of the level of inventory of our products in the distribution channel that remain subject to chargebacks, and specific contractual and historical chargeback rates. The estimate of the level of our products in the distribution channel is based primarily on data provided by our three key wholesalers under inventory management agreements.
 
Our accruals for returns, chargebacks and rebates are adjusted as appropriate for specific known developments that may result in a change in our product returns or our rebate and chargeback obligations. In the case of product returns, we monitor demand levels for our products and the effects of the introduction of competing products and other factors on this demand. When we identify decreases in demand for products or experience higher than historical rates of returns caused by unexpected discrete events, we further analyze these products for potential additional supplemental reserves.
 
  •  Revenue recognition.  Revenue is recognized when title and risk of loss are transferred to customers, collection of sales is reasonably assured, and we have no further performance obligations. This is generally at the time products are received by the customer. Accruals for estimated returns, rebates and chargebacks, determined based on historical experience, reduce revenues at the time of sale and are included in accrued expenses. Medicaid and certain other governmental pricing programs involve particularly difficult interpretations of relevant statutes and regulatory guidance, which are complex and, in certain respects, ambiguous. Moreover, prevailing interpretations of these statutes and guidance can change over time. Royalty revenue is recognized based on a percentage of sales (namely, contractually agreed-upon royalty rates) reported by third parties. For additional information, please see Note 2, “Summary of Significant Accounting Policies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules”.
 
Recently Issued Accounting Standards
 
Effective January 1, 2007, we adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 is an interpretation of FASB Statement No. 109, Accounting for Income Taxes, and it seeks to reduce the variability in practice associated with measurement and recognition of tax benefits. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position that an entity takes or expects to take in a tax return. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Under FIN 48, an entity may only recognize or continue to recognize tax positions that meet a “more likely than not” threshold. We recorded the cumulative effect of applying FIN 48 of $1.5 million as a reduction to the opening balance of retained earnings as of January 1, 2007. The total gross liability under FIN 48 as of January 1, 2007 was $44.3 million. For additional information, please see Note 17, “Income Taxes” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”


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In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”). This statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are in the process of evaluating the effect of SFAS No. 157 on our financial statements and are planning to adopt this standard in the first quarter of 2008.
 
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are in the process of evaluating the effect of SFAS No. 159 on our financial statements and are planning to adopt this standard in the first quarter of 2008.
 
In June 2007, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities (“Issue 07-3”). Issue 07-3 addresses nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities and requires these payments be deferred and capitalized. Under Issue 07-03, expense will be recognized as the related goods are delivered or the related services are performed. Issue 07-03 is effective for financial statements issued for fiscal years beginning after December 15, 2007 and is applied prospectively for new contracts entered into on or after the effective date. We are in the process of evaluating the effect of Issue 07-3 on our financial statements and are planning to adopt this standard in the first quarter of 2008.
 
In December 2007, the Emerging Issues Task Force issued EITF Issue 07-01, Accounting for Collaborative Arrangements (“Issue 07-01”). Issue 07-01 requires collaborators to present the results of activities for which they act as the principal on a gross basis and report any payments received from (made to) other collaborators based on other applicable Generally Accepted Accounting Principles (“GAAP”) or, in the absence of other applicable GAAP, based on analogy to authoritative accounting literature or a reasonable, rational, and consistently applied accounting policy election. Issue 07-01 is effective for fiscal years beginning after December 15, 2008. We are in the process of evaluating the effect of Issue 07-01 on our financial statements, and we plan to adopt this standard in the first quarter of 2009.
 
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R), Business Combinations (“SFAS No. 141(R)”). This statement establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree and recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase. SFAS No. 141(R) also sets forth the disclosures required to be made in the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We are planning to adopt this standard in the first quarter of 2009.
 
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (“SFAS No. 160”). This statement establishes accounting and reporting standards that require that the ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated statement of financial position within equity, but separate from the parent’s equity; the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; and changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary be accounted for consistently. SFAS No. 160 also requires that any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value when a subsidiary is deconsolidated. SFAS No. 160 also sets forth the


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disclosure requirements to identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. SFAS No. 160 must be applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements. The presentation and disclosure requirements are applied retrospectively for all periods presented. We do not anticipate the adoption of SFAS No. 160 will have an effect on our financial statements.
 
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk
 
We are exposed to market risk for changes in the market values of some of our investments (“Investment Risk”) and the effect of interest rate changes (“Interest Rate Risk”). Our financial instruments are not currently subject to foreign currency risk or commodity price risk. We have no financial instruments held for trading purposes. At December 31, 2007, 2006 and 2005, we did not hold any derivative financial instruments, other than utility contracts which qualify as normal purchase and sales and derivatives associated with the convertible senior notes. The quantitative and qualitative disclosures about market risk are set forth below.
 
Interest Rate Risk
 
The fair market value (“fair value”) of long-term fixed interest rate debt is subject to interest rate risk. Generally, the fair market value of fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise. In addition, the fair value of our convertible debentures is affected by our stock price. The estimated fair value of our total long-term debt at December 31, 2007 was $340.0 million. Fair values were determined from available market prices, using current interest rates and terms to maturity. If interest rates were to increase or decrease 1%, the fair value of our long-term debt would increase or decrease by approximately $20 million.
 
Investment Risk
 
We have marketable securities which are carried at fair value based on current market quotes. Gains and losses on securities are based on the specific identification method.
 
For additional information related to our investment in debt securities, please see “Liquidity and Capital Resources” above.
 
Item 8.   Financial Statements and Supplementary Data
 
Our audited consolidated financial statements and related notes as of December 31, 2007 and 2006 and for each of the three years ended December 31, 2007, 2006 and 2005 are included under Item 15 and begin on page F-1.
 
Item 9.   Changes in Accountants and Disagreements with Accountants on Accounting and Financial Disclosure
 
None.
 
Item 9A.   Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
 
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management,


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including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required financial disclosure.
 
Management, with the participation of the Chief Executive Officer and Chief Financial Officer, carried out an evaluation, as required by Rule 13a-15(b) under the Exchange Act, of the effectiveness of the design and operation of the disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of December 31, 2007.
 
Based on this evaluation by management, the Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2007, our disclosure controls and procedures were effective.
 
Management’s Report on Internal Control over Financial Reporting
 
Management is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
Management has conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2007, based on the framework and criteria established in Internal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that internal control over financial reporting was effective as of December 31, 2007.
 
The effectiveness of our internal control over financial reporting as of December 31, 2007 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in its report which appears herein.
 
Changes in Internal Control over Financial Reporting
 
There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
Item 9B.   Other Information
 
None.
 
PART III
 
The information called for by Part III of Form 10-K (Item 10 — Directors, Executive Officers and Corporate Governance, Item 11 — Executive Compensation, Item 12 — Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, Item 13 — Certain Relationships and Related Transactions, and Director Independence and Item 14 — Principal Accounting Fees and Services), is incorporated by reference from our proxy statement related to our 2008 annual meeting of shareholders, which will be filed with the SEC not later than April 29, 2008 (120 days after the end of the fiscal year covered by this report).


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PART IV
 
Item 15.   Exhibits and Financial Statement Schedules
 
(a) Documents filed as a part of this report:
 
(1) Financial Statements
 
         
    Page Number
 
    F-1  
    F-3  
    F-4  
    F-5  
    F-6  
    F-7  
       
    S-1  
 
All other schedules have been omitted because of the absence of conditions under which they are required or because the required information is given in the above-listed financial statements or notes thereto.
 
(b)   Exhibits
 
The following Exhibits are filed herewith or incorporated herein by reference:
 
         
Exhibit
   
Number
 
Description
 
  3 .1(1)   Third Amended and Restated Charter of King Pharmaceuticals, Inc.
  3 .2(2)   Amended and Restated Bylaws of King Pharmaceuticals, Inc.
  4 .1(2)   Specimen Common Stock Certificate
  4 .2(2)   Form of Rights Agreement by and between King Pharmaceuticals, Inc. and The Bank of New York (successor in interest to Union Planters National Bank)
  10 .1(3)   Amended and Restated Co-Promotion Agreement, dated as of July 5, 2006, by and between King Pharmaceuticals, Inc. and Wyeth
  10 .2(4)   Indenture, dated as of March 29, 2006, among King Pharmaceuticals, Inc., certain Subsidiary Guarantors and The Bank of New York, as trustee, relating to King’s 11/4% Convertible Notes due 2026
  10 .3(4)   Registration Rights Agreement dated as of March 29, 2006 between King Pharmaceuticals, Inc., certain Subsidiary Guarantors and the initial purchasers of King’s 11/4% Convertible Notes due 2026
  10 .4(5)   1998 King Pharmaceuticals, Inc. Non-Employee Director Stock Option Plan
  10 .5(2)*   1997 Incentive and Nonqualified Stock Option Plan for Employees of King Pharmaceuticals, Inc.
  10 .6(5)*   1989 Incentive Stock Option Plan of Jones Medical Industries, Inc.
  10 .7(5)*   Jones Medical Industries, Inc. 1994 Incentive Stock Plan
  10 .8(5)*   Jones Medical Industries, Inc. 1997 Incentive Stock Plan
  10 .9(6)*   King Pharmaceuticals, Inc. 401(k) Retirement Savings Plan
  10 .10(7)*   The Medco Research, Inc. 1989 Stock Option and Stock Appreciation Rights Plan, as amended through July 29, 1998
  10 .11(8)   Credit Agreement dated as of April 23, 2002, among King Pharmaceuticals, Inc., and the Lenders therein, Credit Suisse First Boston, Cayman Islands Branch, as Administrative Agent, as Collateral Agent and as Swingline Lender, and Bank of America, NA, J.P. Morgan Securities Inc., and UBS Warburg LLC as Co-Syndication Agents, Wachovia Bank National Association, as Documentation Agent, Credit Suisse First Boston as Sole Lead Arranger and Bookrunner
  10 .12(9)*   Offer Letter to Brian A. Markison, dated July 15, 2004
  10 .13(10)*   King Pharmaceuticals, Inc. Severance Pay Plan: Tier I (Effective March 15, 2005)


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Exhibit
   
Number
 
Description
 
  10 .14(11)*   Offer letter to Joseph Squicciarino dated May 25, 2005
  10 .15(11)*   Offer letter to Eric J. Bruce dated May 19, 2005
  10 .16(12)*   Form of Restricted Stock Certificate and Restricted Stock Grant Agreement
  10 .17(12)*   Form of Option Certificate and Nonstatutory Stock Option Agreement
  10 .18(13)   Settlement Agreement, dated as of October 31, 2005, among the United States of America acting through the entities named therein, King Pharmaceuticals, Inc. and Monarch Pharmaceuticals, Inc.
  10 .19(13)   Settlement Agreement, dated as of October 31, 2005, among the state of Massachusetts, King Pharmaceuticals, Inc. and Monarch Pharmaceuticals, Inc. and general description of the other state settlement agreements
  10 .20(13)   Corporate Integrity Agreement, dated as of October 31, 2005, between the Office of Inspector General of the Department of Health and Human Services and King Pharmaceuticals, Inc.
  10 .21(14)*   King Pharmaceuticals, Inc. Incentive Plan
  10 .22(15)   Compensation Policy for Non-Employee Directors
  10 .23(16)†   Collaboration Agreement by and between King Pharmaceuticals, Inc. and Pain Therapeutics, Inc., dated as of November 9, 2005
  10 .24(16)†   License Agreement by and between King Pharmaceuticals, Inc. and Pain Therapeutics, Inc., dated as of December 29, 2005
  10 .25(16)†   License Agreement, by and between King Pharmaceuticals, Inc. and Mutual Pharmaceutical Company, Inc., dated as of December 6, 2005
  10 .26(17)   First Amendment, dated as of March 22, 2006, to the Credit Agreement, dated as of April 23, 2002, among King Pharmaceuticals, Inc., the Lenders and Credit Suisse First Boston, Cayman Islands Branch, as Administrative Agent
  10 .27(18)†   Generic Distribution Agreement by and between King Pharmaceuticals, Inc. and Cobalt Pharmaceuticals, Inc., dated as of February 12, 2006
  10 .28(18)†   Product Supply Agreement by and among King Pharmaceuticals, Inc., Selamine Limited, Robin Hood Holdings Limited and Arrow Pharm Malta Limited, dated as of February 12, 2006
  10 .29(18)†   Ramipril Application License Agreement by and among King Pharmaceuticals, Inc., Arrow International Limited and Robin Hood Holdings Limited, dated as of February 12, 2006
  10 .30(18)†   Ramipril Patent License Agreement by and among King Pharmaceuticals, Inc., Selamine Limited and Robin Hood Holdings Limited, dated as of February 12, 2006
  10 .31(18)†   Amended and Restated U.S. Product Manufacturing Agreement by and between King Pharmaceuticals, Inc. and Sanofi-Aventis Deutschland GmbH, dated as of February 27, 2006
  10 .32(18)   First Amendment to the U.S. Product Agreement by and between King Pharmaceuticals, Inc. and Sanofi-Aventis U.S. LLC, dated as of February 27, 2006
  10 .33(18)*   Form of Long-Term Performance Unit Award Agreement — One Year Performance Cycle
  10 .34(18)*   Form of Long-Term Performance Unit Award Agreement — Three Year Performance Cycle
  10 .35(19)†   Promotion Agreement, dated June 27, 2006, by and between King Pharmaceuticals, Inc. and Depomed, Inc.
  10 .36(19)   Form of Restricted Unit Certificate and Restricted Unit Grant Agreement
  10 .37(20)   Purchase Agreement, by and between Ligand Pharmaceuticals Incorporated, King Pharmaceuticals, Inc. and King Pharmaceuticals Research and Development, Inc., dated as of September 6, 2006
  10 .38(21)   Entry into Loan Agreement between King Pharmaceuticals, Inc. and Ligand Pharmaceuticals Incorporated, dated October 12, 2006
  10 .39(22)   Settlement Agreement, dated July 31, 2006, between King Pharmaceuticals, Inc., the Affected Current and Former Officers and Directors and the Plaintiffs in the Consolidated Class Action
  10 .40(22)   Form of Restricted Unit Certificate and Restricted Unit Grant Agreement
  10 .41(23)   Amendment No. 1 to Purchase Agreement, Contract Sales Force Agreement and Confidentiality Agreement by and between Ligand Pharmaceuticals Incorporated, King Pharmaceuticals, Inc. and King Pharmaceuticals Research and Development, Inc., dated as of January 3, 2007, effective as of November 30, 2006

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Exhibit
   
Number
 
Description
 
  10 .42(23)   Side Letter between King Pharmaceuticals, Inc., King Pharmaceuticals Research and Development, Inc. and Ligand Pharmaceuticals Incorporated dated December 29, 2006
  10 .43(24)*   2006 Executive Management Incentive Award
  10 .44(25)   Amendment No. 2 to Purchase Agreement, by and between King Pharmaceuticals, Inc., King Pharmaceuticals Research and Development, Inc. and Ligand Pharmaceuticals Incorporated, effective as of February 26, 2007
  10 .45(26)*   Form of Option and Nonstatutory Stock Option Agreement
  10 .46(26)*   Form of Restricted Stock Certificate and Restricted Stock Grant Agreement
  10 .47(26)*   Form Of Long-Term Performance Unit Award Agreement — One Year Performance Cycle
  10 .48(26)*   Form Of Long-Term Performance Unit Award Agreement — Three Year Performance Cycle
  10 .49(27)*   2007 Executive Management Incentive Award
  10 .50(28)*   Form of Retention Grant Agreement
  10 .51(28)   Form of Restricted Stock Unit Certificate and Restricted Stock Unit Grant Agreement
  10 .52(28)*   Form Of Long-Term Performance Unit Award Agreement — One Year Performance Cycle
  10 .53(28)*   Form Of Long-Term Performance Unit Award Agreement — Three Year Performance Cycle
  10 .54(28)   Compensation Policy for Non-Employee Directors
  10 .55(1)   Credit Agreement dated as of April 19, 2007 among King Pharmaceuticals, Inc.; the Lenders (as defined therein); Credit Suisse, Cayman Islands Branch, as Administrative Agent, Collateral Agent and Swingline Lender; Bank of America, N.A. and UBS Securities LLC, as Cosyndication Agents; Citigroup Global Markets Inc., Wachovia Bank, National Association and The Royal Bank of Scotland plc, as Codocumentation Agents; U.S. Bank National Association as Managing Agent; and the Issuing Banks (as defined therein).
  10 .56(29)†   Asset Purchase Agreement by and among King Pharmaceuticals, Inc., Monarch Pharmaceuticals, Inc., Parkedale Pharmaceuticals, Inc., King Pharmaceuticals Research and Development, Inc., and JHP Pharmaceuticals, LLC dated as of July 14, 2007.
  10 .57(30)*   King Pharmaceuticals, Inc. Amended and Restated Severance Pay Plan: Tier I.
  10 .58(31)†   License, Development and Commercialization Agreement, dated October 30, 2007, between King Pharmaceuticals Research and Development, Inc. and Acura Pharmaceuticals, Inc.
  10 .59(31)*   King Pharmaceuticals, Inc. Deferred Compensation Plan
  10 .60(32)   Amended and Restated King Pharmaceuticals, Inc. Non-Employee Directors’ Deferred Compensation Plan
  10 .61(32)*   Form of Restricted Stock Certificate and Restricted Stock Grant Agreement
  14 .1(33)   Corporate Code of Conduct and Ethics
  21 .1   Subsidiaries of the Registrant
  23 .1   Consent of PricewaterhouseCoopers LLP
  31 .1   Certificate of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  31 .2   Certificate of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  32 .1   Certificate of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
  32 .2   Certificate of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
Denotes management contract or compensatory plan or arrangement.
 
†  Portions of this Exhibit have been omitted and filed separately with the Securities and Exchange Commission as part of an application for confidential treatment pursuant to the Securities Exchange Act of 1934.

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(1) Incorporated by reference to King’s Quarterly Report on Form 10-Q filed August 7, 2007.
 
(2) Incorporated by reference to King’s Registration Statement on Form S-1 (Registration No. 333-38753) filed October 24, 1997.
 
(3) Incorporated by reference to King’s Quarterly Report on Form 10-Q filed November 9, 2006.
 
(4) Incorporated by reference to King’s Current Report on Form 8-K filed March 30, 2006.
 
(5) Incorporated by reference to King’s Registration Statement on Form S-8 filed September 6, 2000.
 
(6) Incorporated by reference to King’s Registration Statement on Form S-8 filed February 26, 1999.
 
(7) Incorporated by reference to King’s Registration Statement on Form S-8 filed March 9, 2000.
 
(8) Incorporated by reference to King’s Quarterly Report on Form 10-Q filed May 15, 2002.
 
(9) Incorporated by reference to King’s Quarterly Report on Form 10-Q filed March 21, 2005.
 
(10) Incorporated by reference to King’s Current Report on Form 8-K filed March 21, 2005.
 
(11) Incorporated by reference to King’s Quarterly Report on Form 10-Q filed August 9, 2005.
 
(12) Incorporated by reference to King’s Quarterly Report on Form 10-Q filed November 9, 2005.
 
(13) Incorporated by reference to King’s Current Report on Form 8-K filed November 4, 2005.
 
(14) Incorporated by reference to King’s Definitive Proxy Statement, filed April 28, 2005, related to the 2005 annual meeting of shareholders.
 
(15) Incorporated by reference to King’s Current Report on Form 8-K filed August 8, 2006.
 
(16) Incorporated by reference to King’s Annual Report on Form 10-K filed March 3, 2006.
 
(17) Incorporated by reference to King’s Current Report on Form 8-K filed March 28, 2006.
 
(18) Incorporated by reference to King’s Quarterly Report on Form 10-Q filed May 10, 2006.
 
(19) Incorporated by reference to King’s Quarterly Report on Form 10-Q filed August 9, 2006.
 
(20) Incorporated by reference to King’s Current Report on Form 8-K filed September 12, 2006.
 
(21) Incorporated by reference to King’s Current Report on Form 8-K filed October 18, 2006.
 
(22) Incorporated by reference to King’s Quarterly Report on Form 10-Q filed November 9, 2006.
 
(23) Incorporated by reference to King’s Current Report on Form 8-K filed January 5, 2007.
 
(24) Incorporated by reference to King’s Current Report on Form 8-K filed February 27, 2006.
 
(25) Incorporated by reference to King’s Current Report on Form 8-K filed March 2, 2007.
 
(26) Incorporated by reference to King’s Current Report on Form 8-K filed March 27, 2007.
 
(27) Incorporated by reference to King’s Quarterly Report on Form 10-Q filed May 10, 2006.
 
(28) Incorporated by reference to King’s Current Report on Form 8-K filed May 21, 2007.
 
(29) Incorporated by reference to King’s Current Report on Form 8-K filed July 19, 2007.
 
(30) Incorporated by reference to King’s Current Report on Form 8-K filed October 22, 2007.
 
(31) Incorporated by reference to King’s Current Report on Form 8-K filed November 5, 2007.
 
(32) Incorporated by reference to King’s Current Report on Form 8-K filed December 5, 2007.
 
(33) Incorporated by reference to King’s Current Report on Form 8-K filed December 8, 2005.


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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Shareholders of
King Pharmaceuticals, Inc.:
 
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of King Pharmaceuticals, Inc. and its subsidiaries (the “Company”) at December 31, 2007 and December 31, 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and the financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
 
As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for share-based compensation in 2006. As discussed in Note 17 to the consolidated financial statements, the Company changed the manner in which it accounts for uncertain tax positions in 2007.
 
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.


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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
/s/  PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
 
Raleigh, North Carolina
February 28, 2008


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KING PHARMACEUTICALS, INC.
 
CONSOLIDATED BALANCE SHEETS
as of December 31, 2007 and 2006
(In thousands, except share data)
 
                 
    2007     2006  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 20,009     $ 113,777  
Investments in debt securities
    1,344,980       890,185  
Marketable securities
    1,135        
Accounts receivable, net of allowance of $5,297 and $5,437
    183,664       265,467  
Inventories
    110,308       215,458  
Deferred income tax assets
    100,138       81,991  
Income tax receivable
    20,175        
Prepaid expenses and other current assets
    39,245       106,595  
                 
Total current assets
    1,819,654       1,673,473  
                 
Property, plant and equipment, net
    257,093       307,036  
Intangible assets, net
    780,974       851,391  
Goodwill
    129,150       121,152  
Marketable securities
          11,578  
Deferred income tax assets
    343,700       271,554  
Other assets (includes restricted cash of $16,480 and $15,968)
    96,251       93,347  
                 
Total assets
  $ 3,426,822     $ 3,329,531  
                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 76,481     $ 77,158  
Accrued expenses
    376,604       510,137  
Income taxes payable
          30,501  
                 
Total current liabilities
    453,085       617,796  
                 
Long-term debt
    400,000       400,000  
Other liabilities
    62,980       23,129  
                 
Total liabilities
    916,065       1,040,925  
                 
Commitments and contingencies (Note 19) 
               
Shareholders’ equity:
               
Preferred stock, 15,000,000 shares authorized, no shares issued or outstanding
           
Common stock, no par value, 600,000,000 shares authorized, 245,937,709 and 243,151,223 shares issued and outstanding
    1,283,440       1,244,986  
Retained earnings
    1,225,360       1,043,902  
Accumulated other comprehensive income (loss)
    1,957       (282 )
                 
Total shareholders’ equity
    2,510,757       2,288,606  
                 
Total liabilities and shareholders’ equity
  $ 3,426,822     $ 3,329,531  
                 
 
The accompanying notes are an integral part of the consolidated financial statements.


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KING PHARMACEUTICALS, INC.
 
CONSOLIDATED STATEMENTS OF INCOME
for the years ended December 31, 2007, 2006 and 2005
(In thousands, except share data)
 
                         
    2007     2006     2005  
 
Revenues:
                       
Net sales
  $ 2,054,293     $ 1,908,143     $ 1,694,753  
Royalty revenue
    82,589       80,357       78,128  
                         
Total revenues
    2,136,882       1,988,500       1,772,881  
                         
Operating costs and expenses:
                       
Costs of revenues, exclusive of depreciation, amortization and impairments shown below
    566,534       419,808       322,985  
                         
Selling, general and administrative, exclusive of co-promotion fees
    511,303       496,215       409,451  
Mylan transaction costs
                3,898  
Co-promotion fees
    179,731       217,750       223,134  
                         
Total selling, general and administrative
    691,034       713,965       636,483  
                         
Research and development
    149,425       143,596       74,015  
Research and development — in process upon acquisition
    35,310       110,000       188,711  
                         
Total research and development
    184,735       253,596       262,726  
                         
Depreciation and amortization
    173,863       147,549       147,049  
Asset impairments
    223,025       47,842       221,054  
Restructuring charges
    70,178       3,194       4,180  
Gain on sale of products
                (1,675 )
                         
Total operating costs and expenses
    1,909,369       1,585,954       1,592,802  
                         
Operating income
    227,513       402,546       180,079  
                         
Other income (expense):
                       
Interest income
    42,491       32,152       18,175  
Interest expense
    (7,818 )     (9,857 )     (11,931 )
Loss on investment
    (11,591 )           (6,182 )
Gain on early extinguishment of debt
          628        
Other, net
    223       (1,157 )     (2,026 )
                         
Total other income (expense)
    23,305       21,766       (1,964 )
                         
Income from continuing operations before income taxes
    250,818       424,312       178,115  
Income tax expense
    67,600       135,730       61,485  
                         
Income from continuing operations
    183,218       288,582       116,630  
Discontinued operations (Note 27):
                       
(Loss) income from discontinued operations
    (369 )     572       1,876  
Income tax (benefit) expense
    (132 )     205       673  
                         
Total (loss) income from discontinued operations
    (237 )     367       1,203  
                         
Net income
  $ 182,981     $ 288,949     $ 117,833  
                         
Income per common share:
                       
Basic: Income from continuing operations
  $ 0.75     $ 1.19     $ 0.48  
Income from discontinued operations
    0.00       0.00       0.01  
                         
Net income
  $ 0.75     $ 1.19     $ 0.49  
                         
Diluted: Income from continuing operations
  $ 0.75     $ 1.19     $ 0.48  
Income from discontinued operations
    0.00       0.00       0.01  
                         
Net income
  $ 0.75     $ 1.19     $ 0.49  
                         
 
The accompanying notes are an integral part of the consolidated financial statements.


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KING PHARMACEUTICALS, INC.
 
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
AND OTHER COMPREHENSIVE INCOME (LOSS)
for the years ended December 31, 2005, 2006 and 2007
(In thousands, except share data)
 
                                                 
                            Accumulated
       
                            Other
       
    Common Stock     Unearned
    Retained
    Comprehensive
       
    Shares     Amount     Compensation     Earnings     Income (Loss)     Total  
 
Balance, December 31, 2004
    241,706,583     $ 1,210,647     $     $ 637,120     $ 1,023     $ 1,848,790  
                                                 
Comprehensive income:
                                               
Net income
                      117,833             117,833  
Net unrealized gain on marketable securities, net of tax of $2,148
                            4,042       4,042  
Foreign currency translation
                            (78 )     (78 )
                                                 
Total comprehensive income
                                            121,797  
                                                 
Issuance of stock-based compensation
          10,742       (10,742 )                  
                                                 
Stock based compensation expense
                1,978                   1,978  
                                                 
Issuance of share-based compensation
    690,692                                
Exercise of stock options
    96,141       857                         857  
                                                 
Balance, December 31, 2005
    242,493,416     $ 1,222,246     $ (8,764 )   $ 754,953     $ 4,987     $ 1,973,422  
                                                 
Adoption of Statement of Financial Accounting Standard 123(R)
            (8,764 )     8,764                    
Comprehensive income:
                                               
Net income
                      288,949             288,949  
Net unrealized loss on marketable securities, net of tax of $2,761
                            (5,067 )     (5,067 )
Foreign currency translation
                            (202 )     (202 )
                                                 
Total comprehensive income
                                            283,680  
                                                 
Stock-based compensation expense
          24,718                         24,718  
                                                 
Exercise of stock options
    477,228       6,786                         6,786  
                                                 
Issuance of share-based compensation
    180,579                                
                                                 
Balance, December 31, 2006
    243,151,223     $ 1,244,986     $     $ 1,043,902     $ (282 )   $ 2,288,606  
                                                 
Comprehensive income:
                                               
Net income
                      182,981             182,981  
Reclassification of unrealized losses on marketable securities to earnings, net of tax of $377
                            615       615  
Foreign currency translation
                            1,624       1,624  
                                                 
Total comprehensive income
                                            185,220  
                                                 
Adoption of Financial Accounting Standards Board Interpretation No. 48
                      (1,523 )           (1,523 )
Stock-based compensation expense
          27,652                         27,652  
Exercise of stock options
    723,197       10,802                         10,802  
Issuance of share-based awards
    2,063,289                                
                                                 
Balance, December 31, 2007
    245,937,709     $ 1,283,440     $     $ 1,225,360     $ 1,957     $ 2,510,757  
                                                 
 
The accompanying notes are an integral part of the consolidated financial statements.


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KING PHARMACEUTICALS, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 2007, 2006 and 2005
(In thousands)
                         
    2007     2006     2005  
 
Cash flows from operating activities of continuing operations: