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Article by DailyStocks_admin    (02-15-08 05:12 AM)

The Daily Magic Formula Stock for 02/15/2008 is King Pharmaceuticals Inc. According to the Magic Formula Investing Web Site, the ebit yield is 37% and the EBIT ROIC is >100%.

Dailystocks.com only deals with facts, not biased journalism. What is a better way than to go to the SEC Filings? It's not exciting reading, but it makes you money. We cut and paste the important information from SEC filings for you to get started on your research on a specific company.


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BUSINESS OVERVIEW

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 of Nevada, 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 Written Affirmation on June 22, 2006, 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,

• manufacturing,

• packaging,

• quality control and assurance,

• distribution,

• sales and marketing,

• business development, and

• regulatory management.

Through our national sales force we market our branded prescription pharmaceutical products to general/family practitioners, internal medicine physicians, cardiologists, endocrinologists, psychiatrists, neurologists, pain specialists, sleep specialists, 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 three key therapeutic areas: cardiovascular/metabolic, neuroscience, and hospital/acute care products. We believe each of our key therapeutic areas 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 all 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;

• 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 three key therapeutic areas. Using our internal resources and a disciplined business development process, we strive to be a leader and partner of choice in bringing innovative, clinically-differentiated therapies and technologies to market in our key therapeutic areas. We may also seek company acquisitions that add products or products in development, technologies or sales and marketing capabilities to our key therapeutic areas or that otherwise complement our operations. We also work to achieve organic growth by continuing to develop investigational drugs.

Business Segments

Branded pharmaceutical products constitute our largest business segment. In accordance with our corporate strategy, our branded pharmaceutical products can be divided into the following therapeutic areas:


• cardiovascular/metabolic ,

• neuroscience,

• hospital/acute care, and

• other.

Our Meridian Medical Technologies segment consists of our auto-injector business, which includes EpiPen ® . Royalties, another of our business segments, are derived from products we successfully developed and have licensed to third parties. Additionally, we manufacture third-party pharmaceutical products under contracts with a variety of pharmaceutical and biotechnology companies. Accordingly, contract manufacturing is a segment of our business.

Recent Developments

On February 26, 2007, we acquired all the rights to Avinza ® in the United States, its territories and Canada from Ligand Pharmaceuticals Incorporated. 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.

On January 9, 2007, we obtained an exclusive license to the hemostatic products designed for use outside of catheterization and electrophysiology laboratories by Vascular Solutions, Inc. (“Vascular Solutions”), which include products which we expect to market as Thrombi-Pad tm and Thrombi-Gel ® hemostats. The license also includes a product we expect to market as Thrombi-Paste tm , which is currently in development. Each of these products includes Thrombin-JMI ® as a component. Vascular Solutions will manufacture and supply the products for us.

On June 27, 2006, we entered into a co-exclusive agreement with Depomed, Inc. to commercialize Depomed’s Glumetza tm product. Glumetza tm is a once-daily, extended-release formulation of metformin for the treatment of patients with Type II diabetes that Depomed developed utilizing its proprietary Acuform tm drug delivery technology. Under the terms of the agreement, we assumed responsibility for promoting Glumetza tm in the United States and Puerto Rico, while Depomed has the right to co-promote the product using its own sales force in the future. Depomed will pay us a fee from gross profit, as defined in the agreement, generally net sales less cost of goods sold less a royalty Depomed must pay a third party. Depomed is responsible for the manufacture and distribution of Glumetza tm , while we bear all costs related to the use of our sales force to promote the product. We launched the promotion of Glumetza tm in the third quarter of 2006.

On June 22, 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 us an upfront fee of $75,000. In connection with the Co-Promotion Agreement, we agreed to pay Wyeth a promotional fee based on annual net sales of Altace ® . On July 5, 2006 we entered into an Amended and Restated Co-Promotion Agreement (“Amended Co-Promotion Agreement”) with Wyeth regarding Altace ® as a result of which, effective January 1, 2007, we assumed full responsibility for selling and marketing Altace ® . During 2006, the Wyeth sales force continued to co-promote the product with us and also shared in the marketing expenses. Under the Amended Co-Promotion Agreement, we have paid and will pay Wyeth a reduced annual fee.

On March 1, 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.

In February 2006, we entered into a collaboration with Arrow International Limited and certain of its affiliates, excluding Cobalt Pharmaceuticals, Inc. (collectively, “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 New Drug Applications (“NDAs”) regarding novel formulations of ramipril and intellectual property, including patent rights and technology licenses relating to these novel formulations. Under certain conditions, Arrow will be responsible for the manufacture and supply of new formulations of ramipril for us.

On December 6, 2005, we entered into a cross-license agreement with Mutual Pharmaceutical Company, Inc. Under the terms of the agreement, each party granted the other a license to certain intellectual property relating to metaxalone.

On November 9, 2005, we entered into a collaborative agreement with Pain Therapeutics, Inc. to develop and commercialize Pain Therapeutics’ drug candidate Remoxy tm and other abuse-deterrent opioid painkillers. Remoxy tm , an abuse-deterrent version of long-acting oxycodone, is an investigational drug in late-stage clinical development for the treatment of severe to chronic pain. We have worldwide exclusive rights to commercialize Remoxy tm and the other abuse-deterrent opioid drugs that are developed pursuant to the collaboration, other than in Australia and New Zealand.

On August 12, 2004, we entered into a collaborative agreement with Palatin Technologies, Inc. to jointly develop and, on obtaining necessary regulatory approvals, commercialize Palatin’s bremelanotide compound, which was formerly known as PT-141, for the treatment of male and female sexual dysfunction. Pursuant to the terms of the agreement, Palatin has granted us a co-exclusive license with Palatin to bremelanotide in North America and an exclusive right to collaborate in the licensing or sublicensing of bremelanotide with Palatin outside North America. Bremelanotide is the first compound in a new drug class called melanocortin receptor agonists under development to treat sexual dysfunction. This new chemical entity is being evaluated in Phase II clinical trials studying the efficacy and safety profile of varying doses of this novel compound in men experiencing erectile dysfunction (known as “ED”) and women experiencing female sexual dysfunction (known as “FSD”).

Industry

The pharmaceuticals 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 companies and challenges to patent protection and sales exclusivity;

• more frequent product liability litigation;

• 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 primarily can be divided into the following therapeutic areas:


• cardiovascular/metabolic (including Altace ® , Corzide ® , Corgard ® , Levoxyl ® and Cytomel ® ),

• neuroscience (including Skelaxin ® , Avinza ® and Sonata ® ),

• hospital/acute care (including Thrombin-JMI ® , Bicillin ® , Synercid ® and Intal ® ), and

• other.

Our branded pharmaceutical products are generally in high-volume therapeutic categories and we believe they are well known for their treatment indications (for example, Altace ® , Skelaxin ® , Avinza ® , Sonata ® and Levoxyl ® ). Branded pharmaceutical products represented approximately 87% of our total net revenues for each of the years ended December 31, 2006 and 2005.

Cardiovascular/Metabolic. Altace ® , an angiotensin converting enzyme (“ACE”) inhibitor, is our primary product within this category. In August 1999, the results of the Heart Outcomes Prevention Evaluation trial (the “HOPE trial”) were released. The HOPE trial determined that Altace ® significantly reduces the rates of stroke, myocardial infarction (heart attack) and death from cardiovascular causes in a broad range of high-risk cardiovascular patients. On October 4, 2000, the FDA approved our supplemental NDA (“sNDA”) related to Altace ® . This approval permits the promotion of Altace ® to reduce 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 (hypertension, elevated total cholesterol levels, low high-density lipoprotein (“HDL”) levels, cigarette smoking or documented microalbuminuria). Corzide ® is a beta-blocker diuretic combination product indicated for the management of hypertension. Corgard ® is a beta-blocker indicated for the management of hypertension as well as long-term management of patients with angina pectoris. Altace ® , Corzide ® and Corgard ® are marketed primarily to primary care physicians and cardiologists. Levoxyl ® and Cytomel ® , which are indicated for the treatment of thyroid disorders, are marketed primarily to primary care physicians and endocrinologists.

Neuroscience. Products in this category include Skelaxin ® , Avinza ® , and Sonata ® . Skelaxin ® is a muscle relaxant indicated for the relief of discomforts associated with acute, painful musculoskeletal conditions. 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. Skelaxin ® and Avinza ® are marketed primarily to primary care physicians, neurologists, orthopedic surgeons and pain specialists. Sonata ® is a nonbenzodiazepine treatment for insomnia which is promoted primarily to primary care physicians, neurologists, psychiatrists and sleep specialists.

Hospital/Acute Care. Products in this category are marketed primarily to hospitals. Our largest products in this category are Thrombin-JMI ® , Bicillin ® and Synercid ® . Thrombin-JMI ® aids in controlling minor bleeding during surgery. Synercid ® is an injectable antibiotic, primarily administered in hospitals, indicated for treatment of vancomycin-resistant enterococcus faecium and treatment of some complicated skin and skin structure infections. This category also includes several anti-infective products, including Bicillin ® , that are marketed primarily to general/family practitioners and internal medicine physicians and are prescribed to treat uncomplicated infections of the respiratory tract, urinary tract, eyes, ears and skin. These products are generally in technologically mature product segments. Intal ® , an oral multi-dose inhaler of non-steroidal anti-inflammatory agent indicated for the preventive management of asthma, is marketed primarily to primary care physicians, allergists and pediatricians.

Other. We also have other products that are marketed primarily to primary care physicians and certain specialists.

Meridian Medical Technologies Segment

Our Meridian Medical Technologies segment consists primarily 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.

The commercial pharmaceutical business of our Meridian segment primarily 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.

On March 1, 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 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.

Factors relating to our Meridian business make our future operating results uncertain and may cause them to fluctuate from period to period. With respect to EpiPen ® , some of the demand for the product is seasonal as a result of its use in the emergency treatment of allergic reactions to insect stings or bites. With respect to auto-injector products sold to government entities, demand for the product is affected by the cyclical nature of procurements as well as response to domestic and international events.

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. (formerly Fujisawa Healthcare, Inc.) manufactures and markets Adenoscan ® and Adenocard ® in the United States and Canada in exchange for royalties through the duration of the patents. We own one patent on Adenoscan ® with an expiration date of May 2009. We also have certain contractual rights tied to another patent covering Adenoscan ® which does not expire until 2015. 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.”

For a discussion regarding the potential risk of generic competition for Adenoscan ® , please see Note 18, “Commitments and Contingencies,” in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.”

Contract Manufacturing Segment

We utilize a portion of our excess manufacturing capacity to provide third-party contract manufacturing for other pharmaceutical and biotechnology companies. Contract manufacturing as a percentage of total revenues equaled approximately 1% for the year ended December 31, 2006. We believe contract manufacturing provides a means of absorbing overhead costs and, as such, is an efficient utilization of excess capacity.

Other Segment

Our alliance revenue from Depomed for the promotion of Glumetza tm is included in our Other segment.

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 1,100 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, cardiologists, endocrinologists, neurologists, psychiatrists, pain specialists, sleep specialists 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. Our telemarketing and direct mailing efforts are performed primarily by using a computer sampling system which we developed to distribute samples to physicians. 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, 2006, approximately 74% of our gross sales were attributable to three key wholesalers: McKesson Corporation (32%), Cardinal/Bindley (29%), 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, as well as products owned by other pharmaceutical companies under manufacturing and supply contracts.

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 manufacturing capabilities allow us to pursue drug development and product line extensions more efficiently. We manufacture a portion of the finished dosage form of Altace ® at our Bristol facility. However, currently many of our product lines, including Skelaxin ® , Sonata ® , Delestrogen ® , Intal ® , Tilade ® , Synercid ® and Cortisporin ® are manufactured for us by third parties. As of December 31, 2006, we estimate capacity utilization was approximately 30% at the Bristol facility, approximately 20% at the Rochester facility, approximately 100% at the Middleton facility, approximately 75% at the St. Petersburg facility and approximately 75% at the St. Louis facility. In 2006, we initiated an operational excellence program utilizing Six Sigma and lean manufacturing techniques to identify and execute cost saving and process improvement initiatives.

During the third quarter of 2006, we began to implement our plan to streamline manufacturing activities to improve operating efficiency and reduce costs, including the decision to transfer the production of Levoxyl ® from our St. Petersburg, Florida facility to our Bristol, Tennessee facility by the end of 2008. We expect to close our St. Petersburg, Florida facility following the transfer.

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 for us and for third parties with whom we have contracted. Generally, we have not had difficulty obtaining raw materials and components from suppliers. Currently, we rely on more than 500 suppliers to deliver the needed raw materials and components for our products.

We have experienced, and anticipate that we will continue to experience, periods of stock-outs in our inventory of Sonata ® . This product is manufactured for us by Wyeth. Wyeth has been unable to timely and consistently supply our forecasted need for Sonata ® since December 2006. It is anticipated that the problems with production of Sonata ® experienced by Wyeth will continue for an indeterminable period of time, leaving us, from time to time, if not continuously, without sufficient supply of product to meet demand. Our management is working with Wyeth to address these problems and transfer the manufacture of Sonata ® to another manufacturer, but we currently do not have a solution that will assure us of consistent supply. Given the competitive market for this product, we have and will likely continue to experience permanent erosion of our customer base, market share and sales.

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 70 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 conduct of our research and development, we utilize a virtual model led by our project management personnel, providing us with substantial flexibility and allowing high efficiency while minimizing internal fixed costs. Utilizing this model, 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 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.

Our development projects, including those for which we have collaboration agreements with third parties, include the following:


• Remoxy tm , an investigational drug for the treatment of severe to chronic pain, which is currently in Phase III clinical trials;

• Binodenoson, our next generation cardiac pharmacologic stress-imaging agent, which is currently in Phase III clinical trials;

• Vanquix tm , a diazepam-filled auto-injector for the treatment of acute, repetitive epileptic seizures, which is currently in Phase III clinical trials;

• Bremelanotide, an investigational drug for the treatment of ED and FSD, which is currently in late Phase II clinical trials;

• MRE0094, an investigational drug for the topical treatment of chronic diabetic neuropathic foot ulcers, which is currently in Phase II clinical trials; and

• T-62, an investigational drug for the treatment of neuropathic pain, for which we have completed Phase I clinical trials.

Development projects, including those in which we have collaboration agreements with third parties, that involve currently marketed compounds include the following:


• a novel formulation involving ramipril for which an NDA is pending;

• an Altace ® /diuretic combination product which is currently in Phase III clinical trials;

• a program to evaluate the safety and efficacy of Altace ® in children; and

• a new formulation of metaxalone.

Our research and development expenses increased to $143.6 million in 2006 from $74.0 million in 2005 and $67.9 million in 2004, excluding research and development in-process at the time of acquisition of a product, primarily as a result of our development projects discussed above. In-process research and development expenses were $110.0 million for the year ended December 31, 2006, $188.7 million for the year ended December 31, 2005 and $16.3 million for the year ended December 31, 2004. 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 U.S. Drug Enforcement Agency (“DEA”), the Consumer Product Safety Commission, the Federal Trade Commission, the U.S. Department of Agriculture, 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 development, testing, manufacture, safety, effectiveness, labeling, storage, record keeping, approval, advertising and promotion of our products and those manufactured by and for third parties. Product development and approval within this regulatory framework requires a number of years and involves the expenditure of substantial resources.

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, 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 and an FDA inspection, 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. 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, seizure of product or recall of product. We must report adverse experiences with the use of our products to the FDA, and the FDA could impose market restrictions on us such as labeling changes or product removal. 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, 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 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 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 2006 and 2005, 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.


CEO BACKGROUND

Philip A. Incarnati, age 53, has served as a director of King since November 2006. He has served as President and Chief Executive Officer of McLaren Health Care Corporation, an integrated health care system, since 1989. Before joining McLaren, Mr. Incarnati held top-level executive positions with the Wayne State University School of Medicine, Detroit Receiving Hospital and University Health Center, and Horizon Health System. Mr. Incarnati also serves on the board of Medical Staffing Network, Inc., a publicly-traded company, and on the board of PHNS, Inc. Mr. Incarnati earned both a Bachelor’s Degree and a Master’s Degree in management and finance from Eastern Michigan University (EMU). He was appointed to the EMU Board of Regents in 1992 by Michigan Governor John Engler, and he continues to serve on that Board. He served as Chairman of the EMU Board of Regents from 1995 until 2005.

Gregory D. Jordan, Ph.D. , age 55, has served as a director since June 2001. He has served as President of King College in Bristol, Tennessee since 1997, having joined the King College faculty in 1980. He received his Bachelor of Arts degree from Belhaven College in 1973; his Master of Arts and Divinity degrees from Trinity Evangelical Divinity School in 1976 and 1977, respectively; his Doctorate in Hebraic and Cognate Studies from Hebrew Union College Jewish Institute of Religion in 1987; and his Master of Business Administration degree from the Babcock Graduate School of Management at Wake Forest University in 2004.

Brian A. Markison , age 47, has served as President and Chief Executive Officer and as a director since July 2004. If reelected to the Board, Mr. Markison will also become Chairman of the Board as of the conclusion of the 2007 annual meeting of shareholders. He served as Chief Operating Officer from March 2004 until July 2004. Prior to joining King, Mr. Markison held various positions with Bristol-Myers Squibb since 1982. From 2001 until he joined King, he served 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. Mr. Markison also serves on the Board of Directors of Immunomedics, Inc., a publicly-held corporation. He previously served in various positions with Bristol-Myers Squibb relating to marketing and sales. He graduated from Iona College in 1982 with a Bachelor of Science degree.

Earnest W. Deavenport, Jr. , age 69, has served as a director since May 2000. In 2002, he retired from service as Chairman of the Board and Chief Executive Officer of Eastman Chemical Company, Kingsport, Tennessee, where he had served in various capacities since 1960. He was Chairman of the National Association of Manufacturers in 1998 and is currently a member of the National Academy of Engineering. Mr. Deavenport is also a member of the boards of directors of Acuity Brands, Inc. and Regions Financial Corporation, each a publicly-held corporation. Mr. Deavenport graduated from the Massachusetts Institute of Technology with a Master of Science degree in Management in 1985 and from Mississippi State University with a Bachelor of Science degree in Chemical Engineering in 1960.

Elizabeth M. Greetham , age 57, has served as a director since November 2003. She presently serves as Chief Executive Officer and President of ACCL Financial Consultants Ltd. From 1998 until 2004 she served as a director of DrugAbuse Sciences, Inc. and served as its Chief Executive Officer from August 2000 until 2004 and as Chief Financial Officer and Senior Vice President, Business Development from April 1999 to August 2000. Prior to joining DrugAbuse Sciences, Inc., Ms. Greetham was a portfolio manager with Weiss, Peck & Greer, an institutional investment management firm, where she managed the WPG Life Sciences Funds, L.P., which invests in select biotechnology stocks. She was previously a consultant to F. Eberstadt & Co. In total, Ms. Greetham has over 25 years of experience as a portfolio manager and health care analyst in the United States and Europe. She is a member of the boards of directors of Nventa Biopharmaceuticals Corporation and Ligand Pharmaceuticals, Inc., each a publicly-held corporation. Ms. Greetham earned a Master of Arts (Honours) degree in Economics from the University of Edinburgh, Scotland in 1971.

R. Charles Moyer, Ph.D., age 61, has served as a director since December 2000. Dr. Moyer presently serves as Dean of the College of Business at the University of Louisville. He is Dean Emeritus of the Babcock Graduate School of Management at Wake Forest University, having served as Dean from 1996 until his retirement from this position in August 2003, and as a professor from 1988 until 2005. Dr. Moyer held the GMAC Insurance Chair in Finance at Wake Forest University. Prior to joining the faculty at Wake Forest in 1988, Dr. Moyer was Finance Department Chairman at Texas Tech University. Dr. Moyer earned his Doctorate in Finance and Managerial Economics from the University of Pittsburgh in 1971, his Master of Business Administration degree from the University of Pittsburgh in 1968 and his Bachelor of Arts degree in Economics from Howard University in 1967.

D. Greg Rooker , age 59, has served as a director since October 1997. Mr. Rooker is the former owner and President of Family Community Newspapers of Southwest Virginia, Inc., Wytheville, Virginia, which consists of six community newspapers and a national monthly motor sports magazine. He retired from this position in 2000. He is a co-founder of The Jason Foundation and Brain Injury Services of SWVA, Inc., each a non-profit organization providing services to brain injury survivors. Mr. Rooker serves as Secretary/Treasurer of The Jason Foundation and as Vice-President of Brain Injury Services of SWVA, Inc. Mr. Rooker graduated from Northwestern University with a degree in Journalism in 1969.

Ted G. Wood , age 69, has served as a director since August 2003, and as Non-Executive Chairman of the Board since May 2004. Mr. Wood intends to step down from his position as Non-Executive Chairman as of the conclusion of the 2007 annual meeting of shareholders. He will become lead independent director at that time. Mr. Wood is retired from The United Company in Bristol, Virginia, where he served as Vice Chairman from January 2003 until August 2003. He previously served as President of the United Operating Companies from 1998 to 2002. Mr. Wood previously served as a director of King from April 1997 to May 2000. From 1992 to 1993, he was President of Boehringer Mannheim Pharmaceutical Corporation in Rockville, Maryland. From 1993 to 1994, he was President of KV Pharmaceutical Company in St. Louis, Missouri. From 1975 to 1991, he was employed by SmithKline Beecham Corporation where he served as President of Beecham Laboratories from 1988 to 1989 and Executive Vice President of SmithKline from 1990 to 1991. Mr. Wood is also a member of the board of directors of Alpha Natural Resources, Inc., a publicly-held corporation. He graduated from the University of Kentucky with a Bachelor of Science degree in Commerce in 1960. In 1986 he completed the Advanced Management Program at Harvard University.

COMPENSATION

Overview of Our Compensation Program

The fundamental goal of our compensation program is to build long-term shareholder value. In order to accomplish that goal, we must attract and retain exceptionally talented and capable executives, and we must provide those executives with incentives that motivate and reward them for achieving King’s immediate and longer-term operational, financial and scientific goals. To this end, our executive compensation is guided by the following key principles:


that executive compensation should depend upon company and individual performance;


that the interests of executives should be closely aligned with those of shareholders through equity-based compensation; and


that compensation should be appropriate and fair in comparison to the compensation provided to similarly situated executives within the pharmaceutical industry and within other publicly-traded companies of King’s size and complexity.

Vital to our compensation program are the decisions of, and guidance from, the Compensation and Human Resources Committee of our Board of Directors. This Committee (which we refer to, for purposes of this analysis, as “the Committee”) is composed entirely of directors who are independent of King under the independence standards established by the NYSE, the securities exchange where our common stock is traded. The Committee operates pursuant to a written charter adopted by the Board. If you would like to review the Committee’s charter, it is freely available on our website, www.kingpharm.com, by first choosing “Investor Relations” and then “Governance.” It is also available to any shareholder who requests a copy from our Secretary, James W. Elrod, at 501 Fifth Street, Bristol, Tennessee 37620.

The Committee has the authority and responsibility to establish and periodically review our executive compensation principles, described above. Importantly, the Committee also has sole responsibility for determining the corporate goals and objectives upon which the compensation of the chief executive officer (the “CEO”) is based, for evaluating the CEO’s performance in light of these goals and objectives and for determining the CEO’s compensation, including his equity-based compensation.

The Committee also reviews and approves the recommendations of the CEO with regard to the compensation and benefits of other executive officers. In accomplishing this responsibility, the Committee meets regularly with the CEO, approves cash and equity incentive objectives of the executive officers, reviews with the CEO the accomplishment of these objectives and approves the base salary and other elements of compensation for the executive officers. The Committee has full discretion to modify the recommendations of the CEO in the course of its approval of executive officer compensation, and it made a number of such modifications in 2006.

The Committee also annually reviews, and makes recommendations to the Board about, the compensation of non-employee directors (a function it performs in conjunction with the Board’s Nominating and Corporate Governance Committee).

During 2005, the Committee recommended the adoption of a new Incentive Plan to replace our existing stock option plans, and it was approved by our shareholders in May 2005. The Incentive Plan provides for the grant of various equity awards, such as stock options, restricted stock and performance share units, as well as cash incentive awards, to King’s employees and directors. The Committee is responsible for administering this Plan and it has sole authority to make grants to the CEO or any other executive officer.

In conjunction with its responsibilities related to executive compensation, the Committee also oversees the management development process, reviews plans for executive officer succession and performs various other functions.

The Committee consults regularly with an outside compensation consulting firm retained by the Committee. As it makes decisions about executive compensation, the Committee frequently obtains data from its consultant regarding current compensation practices and trends among United States companies in general and pharmaceutical and biosciences companies in particular, and reviews this information with its consultant. The Committee also discusses various other compensation matters with its consultant, both during the course of the Committee’s regular meetings and in private meetings. In addition, the Chairman of the Committee is in regular contact with the consultant and with management outside of Committee meetings regarding matters being considered or expected

to be considered by the Committee. During 2006, the Committee was advised by Hewitt Associates LLC, a global human resources consulting firm. For 2007, the Committee has retained James F. Reda and Associates as consultant.

Please note that throughout the discussion that follows the individuals who served as Chief Executive Officer and Chief Financial Officer during 2006, as well as the other individuals included in the Summary Compensation Table on page 28, are referred to as the “named executive officers.” At some points in the discussion we also refer more generally to our “executive officers,” the larger group of executives whose compensation requires the approval of the Committee under the terms of its charter.

MANAGEMENT DISCUSSION FROM LATEST 10K

Our Business

We are a vertically integrated pharmaceutical company that 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 three key therapeutic areas: cardiovascular/metabolic, neuroscience, and hospital/acute care products. We believe each of our key therapeutic areas 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 three key therapeutic areas. We may also seek company acquisitions which add products or products in development, technologies or sales and marketing capabilities to our key therapeutic areas or that otherwise complement our operations.

Utilizing our internal resources and a disciplined business development process, we strive to be a leader and partner of choice in bringing innovative, clinically-differentiated therapies and technologies to market in our key therapeutic areas.

Our business consists of five segments which include branded pharmaceuticals, Meridian Medical Technologies, royalties, contract manufacturing, and other. In accordance with our strategy, our branded pharmaceutical products can be divided into the following therapeutic areas:


• Cardiovascular/metabolic s (including Altace ® and Levoxyl ® ),

• Neuroscience (including Skelaxin ® , Avinza ® and Sonata ® ),

• Hospital/acute care (including Thrombin-JMI ® ), and

• Other.

Our Meridian Medical Technologies segment consists of our auto-injector business, which includes EpiPen ® 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. Our contract manufacturing segment manufactures pharmaceutical products for third parties under contracts with a number of pharmaceutical and biotechnology companies.

2006 Highlights

Introduction

During 2006, we achieved many important accomplishments that we believe better position us for long-term growth. Among our many accomplishments, we:


• expanded our portfolio of products;

• took steps to create opportunities to extend the life cycle of our Altace ® franchise; and

• advanced projects in our research and development pipeline.

We believe these accomplishments better position us to continue executing our strategy for long-term growth in 2007.

Expanded Product Portfolio

On January 9, 2007, we obtained an exclusive license to the hemostatic products designed for use outside catheterization and electrophysiology laboratories by Vascular Solutions, Inc. (“Vascular Solutions”), which include products which we expect to market as Thrombi-Pad tm and Thrombi-Gel ® hemostats. The license also includes a product we expect to market as Thrombi-Paste tm , which is currently in development. Each of these products includes Thrombin-JMI ® as a component. Vascular Solutions will manufacture and supply these products for us.

On September 6, 2006, we entered into an agreement to acquire 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. We completed our acquisition of Avinza ® on February 26, 2007. Under the terms of the asset purchase agreement, we paid Ligand $246.3 million and, in addition, paid certain liabilities, including a product-related liability totaling $49.1 million. As part of the transaction, we agreed to pay Ligand an ongoing royalty on net sales of Avinza ® and to assume payment of Ligand’s Avinza ® royalty obligations to third parties.

On June 27, 2006, we entered into a co-exclusive agreement with Depomed, Inc. (“Depomed”) to commercialize Depomed’s Glumetza tm product. Glumetza tm is a once-daily, extended-release formulation of metformin for the treatment of patients with Type II diabetes that Depomed developed utilizing its proprietary Acuform tm drug delivery technology. Under the terms of the agreement, we assumed responsibility for promoting Glumetza tm in the United States and Puerto Rico, while Depomed has the right to co-promote the product using its own sales force at some point in the future. Depomed will pay us a fee from gross profit, as defined in the agreement, generally net sales less cost of goods sold less a royalty Depomed must pay a third party. Depomed is responsible for the manufacture and distribution of Glumetza tm , while we bear all costs related to the use of our sales force for the product. We launched the promotion of Glumetza tm in the third quarter of 2006.

Altace Franchise

On June 22, 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 ® . On July 5, 2006, we entered into an amended and restated co-promotion agreement (“Amended Co-Promotion Agreement”) with Wyeth regarding Altace ® . Effective January 1, 2007, we assumed full responsibility for selling and marketing Altace ® . During 2006, the Wyeth sales force continued to co-promote the product with us and continued to share marketing expenses. We 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, with the fee not to exceed $215.3 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.

Wyeth will pay us a $20.0 million milestone fee if a specified Altace ® net sales threshold is achieved in 2008.

In February 2006, we entered into a collaboration with Arrow International Limited and certain of its affiliates, excluding Cobalt Pharmaceuticals, Inc. (collectively, “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 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. Under certain conditions, Arrow will be responsible for the manufacture and supply of new formulations of ramipril for us. Additionally, we have granted Cobalt Pharmaceuticals, Inc. a non-exclusive right to enter into the U.S. ramipril market with a generic form of the currently marketed Altace ® product, which would be supplied by us. Cobalt is an affiliate of Arrow, but is not a party to the collaboration.

Pursuant to the agreements, we made an upfront payment to Arrow of $35.0 million. During the fourth quarter of 2006, we made an additional payment of $25.0 million to Arrow. Arrow will also receive payments from us of $50.0 million during 2007. We classified these payments as in-process research and development expense in 2006. Additionally, Arrow will earn fees for the manufacture and supply of new formulations of ramipril.

In addition, we have in development an Altace ® /diuretic combination product which is currently in Phase III clinical trials.

Research and Development Pipeline

Our current research and development pipeline includes four products in Phase III clinical trials and two products in late Phase II clinical trials. Our Phase III products are led by Remoxy tm , an abuse-deterrent formulation of long-acting oxycodone for the treatment of moderate to severe chronic pain. In February 2006, Remoxy tm successfully completed a Special Protocol Assessment with the FDA. As a result, we, along with Pain Therapeutics, commenced a pivotal Phase III clinical trial with Remoxy tm in patients with severe chronic pain.

The Remoxy tm formulation consists of a sticky, high-viscosity mass that is not prone to injection or inhalation. It is intended to meet the needs of physicians who appropriately prescribe opioid painkillers and who seek to minimize risks of drug diversion, abuse or accidental patient misuse. Published data show that freezing, crushing, or submerging Remoxy tm in high-proof alcohol for hours at a time releases just a fraction of oxycodone compared to currently available formulations of oxycodone at time points when abusers presumably expect to be able to abuse its active ingredient.

Our Phase III products also include: binodenoson, a pharmacologic cardiac stress imaging agent intended to provide a reduced side effects profile compared to the currently approved product Adenoscan ® ; Vanquix tm , 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; and an Altace ® /diuretic combination product for the treatment of hypertension. We expect to file an NDA with the FDA for our Altace/diuretic combination product in the second half of 2007.

Our Phase II compounds are led by bremelanotide, under our collaborative agreement with Palatin Technologies. Bremelanotide is the first compound in a new drug class called melanocortin receptor agonists under development to treat sexual dysfunction in both men and women. In November 2006, we announced results from Phase II clinical trials evaluating bremelanotide in men experiencing erectile dysfunction (“ED”). We are continuing to evaluate data from these completed Phase II trials in men experiencing ED as we prepare for an end of Phase II meeting with the FDA in 2007. Also in 2006, we announced results from a Phase IIa clinical trial and initiated a Phase IIb clinical trial evaluating the effects of bremelanotide in women experiencing female sexual dysfunction (“FSD”).

In January 2006, we initiated the Phase II clinical program for MRE-0094, an adenosine A2a receptor agonist for the topical treatment of chronic, neuropathic, diabetic foot ulcers. During 2006 we also completed the Phase I clinical program for T-62, an adenosine A1 allosteric enhancer that we are developing for the treatment of neuropathic pain. We expect to begin the Phase II clinical program for T-62 in the first half of 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 Meridian Medical Technologies. These increases in gross sales were partially offset by a decline in prescriptions of certain of our branded pharmaceutical products during 2006.

Gross sales were higher in 2005 compared to 2004 primarily due to the effect of higher unit sales as a result of the effect of a higher level of wholesale inventory reductions of some of our branded pharmaceutical products during 2004, and price increases, particularly with respect to Thrombin-JMI ® .

In April 2004 we entered into inventory management agreements (“IMAs”) with each of our three key wholesale customers covering all of our branded products for the purpose of obtaining data regarding and reducing the level of wholesale inventories of our products. As we anticipated, entering into the IMAs adversely affected net sales of some of our branded pharmaceutical products, particularly during 2004, as wholesale inventory levels of these products were aggressively reduced.

During the fourth quarter of 2004, we amended our IMAs with our key wholesale customers with the objective of further reducing their inventories of our products. As a result, the average wholesale inventory level of our key products was further reduced during the fourth quarter of 2004 and the first quarter of 2005.

Based on inventory data provided by our key customers under the IMAs, we believe that wholesale inventory levels of our key products, Altace ® , Skelaxin ® , Thrombin-JMI ® , Sonata ® and Levoxyl ® , as of December 31, 2006, are at or below normalized levels. We estimate that the wholesale and retail inventories of our products as of December 31, 2006 represent gross sales of approximately $180.0 million to $190.0 million.

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. This law 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.

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 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.

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 18, “Commitments 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 reduced 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 18, “Commitments and Contingencies”, in Part IV, Item 15(a)(1), “Exhibits and Financial Statement Schedules.” In 2006, the utilization of overpayments reduced our rebate payments by approximately $25.0 million and has therefore reduced “Rebates Paid” in the table above.

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.

As a result of the actual returns during the first quarter of 2006, the estimated rate of returns used in the calculation of our returns reserve for some of our products continued to decrease. 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 “Accrual for Returns” table above reflects this adjustment as a reduction in the current provision. As a result of this increase in net sales, the co-promotion expense related to net sales of Altace ® in the first quarter of 2006 increased by approximately $1.0 million and royalty expense related to net sales of Skelaxin ® increased by approximately $1.0 million. The effect of the change in estimate on first quarter 2006 operating income was, therefore, approximately $6.0 million.

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 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.

Net sales from branded pharmaceutical products were higher in 2005 than in 2004 primarily due to the effect of higher unit sales and a lower rate of reserve for returns of some of these products in 2005 as a result of the effect of a higher level of wholesale inventory reductions of some of our branded pharmaceutical products during 2004, the effect of a reduction in reserves for returns and rebates during 2005 and price increases, particularly with respect to Thrombin-JMI ® .

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