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Hi guys,

Just listened on the CC and would like to summarize some of my thoughts so far on KG.

Good points.
SEC investigation. Looks like there's going to be a settlement soon as KG has taken an additional $65 million charge for fines, I expect this to happen within the next quarter as executives responsible for this debacle have left the company. This will lift a major cloud of uncertainty for KG. In the CC management confirmed no criminal charges have been laid against them.

Inventory management. Due to the new agreements in place with the 3 largest wholesalers who account for 75% of KG's revenue, the channel inventories are coming down to an average value of 2.4 months of forward prescriptions. Revenue continues to take a hit (down 25% over previous year) as the wholesalers continue to pull down their inventory levels. I'd personally like to see inventory down to maximum of 1 to 1.5 months as a sign of good management, but this is wishful thinking on my part as management's target 2 months.

Major news is the merger with Mylan. Executives of KG agreed to be acquired by Mylan in an all stock transaction expected to close end of 2004. KG shareholders will get 0.9 shares of Mylan, so if you own 100 shares of KG, upon the merger you'll be getting 90 shares of Mylan. As Bill Man pointed out in his excellent article, Mylan is getting a good deal, At the same time shareholders of KG (the true owners of the company) are being paid $0.50 for their $1.00 bills. Let me explain with the following numbers based on the audited Mylan's and KG's financial statements curtsey of the 10K and non-audited 10Qs. We'll compare Mylan to KG and Mylan as the surviving company after the merger. Let's look at cash flow first off, with the numbers in millions, except per share value.

Year 2001 2002 2003 2004
Revenue $846.7 $1104 $1,269.2 $1,374.6
Cash from Ops $65.9 $346.5 $313.1 $225.6
Capital Expenditure $24.7 $20.6 $32.6 $118.5
Free Cash Flow $41.2 $325.9 $280.5 $107.1
Cash King Margin 4.7% 29.5% 22.1% 7.8%
Diluted Shares 293 286.6 282.3 276.3
FCF/Diluted Share $0.14 $1.14 $0.99 $0.39

Now compare that of KG's results in the same time frame. You'll have to dig through the 10Q and 10K as Mylan's and KG's year-end differs.

Year 2001 2002 2003 2004
Revenue $663.4 $949 $1,208.7 $1,473.6
Cash from Ops $243.1 $268 $449.5 $419.9
Capital Expenditure $27 $53.8 $79.9 $50.9
Free Cash Flow $216 $214.2 $369.6 $369
Cash King Margin 32.6% 22.6% 30.6% 25%
Diluted Shares 230.6 249.7 241.5 241.3
FCF/Diluted Share $0.94 $0.86 $1.53 $1.53

If one combines the above results into a merged entity, things are looking pretty good for Mylan to say the least, even with the increased share count.

Merged companies of Mylan+KG
Year 2001 2002 2003 2004
Revenue $1,510 $2,053 $2,478 $2,848
Cash from Ops $309 $614.5 $762.6 $645.5
Capital Expenditure $51.7 $74.4 $112.5 $169.4
Free Cash Flow $257.3 $540.1 $650.1 $476.1
Cash King Margin 17% 26.3% 26.2% 16.7%
Diluted Shares 523.6 536.3 523.8 517.6
FCF/Diluted Share $0.49 $1.07 $1.24 $0.92

How about the income statement? Again the tables below give a good comparison.

Year 2001 2002 2003 2004
Revenue $846.7 $1104 $1,269.2 $1,374.6
COG $464.5 $480.1 $597.8 $612.2
Gross Profit $382.2 $623.9 $671.4 $762.5
Gross Profit Margin 45.1% 56.5% 52.9% 55.5%
Net Profit $37.1 $260.3 $272.4 $334.6
Net Profit Margin 4.4% 23.8% 21% 24.34%
Diluted Shares 293 286.6 282.3 276.3
Profit/Share $0.13 $0.91 $0.96 $1.21

Year 2001 2002 2003 2004
Revenue $663.4 $949 $1,209 $1,474
COG $148.7 $197.3 $326.3 $392.4
Gross Profit $514.7 $751.7 $882.4 $1,081
Gross Profit Margin 77.6% 79.2% 73% 73.4%
Net Profit $103.1 $245.1 $104 $7.4
Net Profit Margin 15.6% 25.8% 8.6% 0.5%
Diluted Shares 230.6 249.7 241.5 241.3
Profit/Share $0.45 $0.98 $0.43 $0.03

Merged companies of Mylan+KG
Year 2001 2002 2003 2004
Revenue $1,510 $2,053 $2,478 $2,848
COG $613.2 $677.4 $924.1 $1005
Gross Profit $896.9 $1,375 $1,554 $1843
Gross Profit Margin 59.4% 67% 62.7% 64.7%
Net Profit $140.2 $505.4 $376.4 $342
Net Profit Margin 9.3% 24.6% 15.2% 12%
Diluted Shares 523.6 536.3 523.8 517.6
Profit/Share $0.27 $0.94 $0.72 $0.12

Of course one can point out that there is the concern of KG's future as patents are expiring on their leading products. This is where management has to step up to the plate and lead the company by acquiring new products that others don't want, then driving up sales with the 1,300 sales force that's costing shareholders $90 million a quarter to maintain. Speaking of generic competition, KG's management didn't satisfactorily answer the threat to Altace (their biggest money maker) Levoxyl and Selaxin. In the CC, management decided to drop the development of Altace - why on earth they would do this has me puzzled. I suppose the $70 million on R&D for the year is being spent on other things rather than protecting a product that generated $527 million in 2003.

If you believe management's spin, they say the merger is to have KG's specialized sales force of 1,300 for Mylan's new up coming cardiovascular drug - nebivolol (FDA approval expected in 2005), but you may be not seeing the other parts of the picture. In the combined company Mylan will be getting increased cash flows, increase cash margins, higher gross profit as well as gross profit margins and that will translate to better net profit margins on a normalized basis – assuming integration goes well. That's just the hard numbers. Mylan will also be getting a small pipeline (1 in Phase III, 1 on Phase II and 2 in Phase I) as well as the expertise in acquiring branded drugs.

From a numbers perspective, its almost a certain that things will be good for Mylan as KG's management has been aggressively writing off their balance sheet and forcing their results to look bad for the this year. This means a clean sheet for Mylan to absorb and virtually guaranteeing record profits as well as cash generation for the newly merged entity in 2005. I can picture executives on both sides having a celebration and patting themselves on the back as they toast their champagne glass to Wall Street Wise Men and say what a great job they've done.

I believe Mylan is getting more than the specialized sales force and as shareholder of KG stock, I'll be voting against the merger as management has clearly undersold the company to the detriment of the shareholders.

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